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Globalization and
Monetary Policy Institute

2009 Annual Report
Federal Reserve Bank of Dallas

Contents
Letter from the President

2

The Financial Crisis, Trade Finance and the
Collapse of World Trade

4

Summary of Activities

16

Conference on Globalization,
Political Economy and Trade Policy

18

Conference on Capital Flows, International Financial Markets
and Financial Crises

24

Abstracts of Globalization and Monetary Policy Institute
Working Papers Issued from October 2008 through October 2009

30

Facing Troubles in an Era of Globalization
A Conversation with Nathan Sheets

38

Who’s Who at the Institute

41

Published by the Federal Reserve Bank of Dallas, March 2010.
Articles may be reprinted on the condition that the source is credited
and a copy is provided to the Globalization and Monetary Policy
Institute, Federal Reserve Bank of Dallas, P.O. Box 655906, Dallas,
TX 75265-5906. This publication is available on the Internet at www.
dallasfed.org.

2 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Letter from the
President
As this publication goes to print, we are slowly
closing the books on one of the most tumultuous
economic periods since the Great Depression.
An infection in the American housing sector spread like an epidemic through financial
markets to countries around the world. In a matter
of months, economic growth in developing and
developed countries alike shifted abruptly into
reverse. International trade collapsed. Manufacturing activity plummeted. Employment growth hit a
wall before beginning a painful decline. No nation
was spared the contagion’s effects as the global
economy was dragged forcefully to the edge of a
precipice.
A global crisis of historic magnitude necessitated a commensurate global response. Monetary
policy makers around the world quickly began to
work together—announcing coordinated policy
movements and establishing swap lines for foreign
exchange.
The events of this crisis underscore an important fact: We live in a truly interconnected world.
What happens beyond our borders can have a
significant impact on our domestic economy and,
as a result, on U.S. monetary policy.
It was that fact that motivated my decision in
2005 to make the study of globalization and its implications for the conduct of monetary policy the
Dallas Fed’s signature research issue. That directive

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 3

culminated in the fall of 2007 with the formation of the Federal Open Market Committee—the Federal
Reserve’s principal policymaking group—to presour Globalization and Monetary Policy Institute.
Under its auspices, top minds from around

ent their work on inflation dynamics. These indi-

the globe have come together to explore the

viduals provided analytical support for the notion

linkages between an increasingly interconnected

that price pressures at home can be affected by

global economy and monetary policy. In the

economic slack abroad. While empirical evidence

two years since the institute’s establishment, its

remains fragile, one thing is clear: The Fed must

research team—under the advisement of profes-

remain abreast of international developments if it

sional and academic experts, including two central is to deliver on its mandate for price stability.
In the 2009 Annual Report of the Dallas Fed’s
bank governors and one Nobel laureate—has garnered considerable attention. Staff members have

Globalization and Monetary Policy Institute, read-

presented their findings at conferences across the

ers will learn more about these research efforts

country and published their research in some of

and activities over the past year. Members of this

the profession’s leading journals.

elite team are at the leading edge of economic

These individuals have also contributed

research and continue to build on the institute’s

significantly to the Federal Reserve’s understand-

reputation for excellence in the study of globaliza-

ing of our most recent crisis. For instance, in his

tion and its impact on monetary policy. While they

essay entitled “The Financial Crisis, Trade Finance

have not yet found all the answers, I am confident

and the Collapse of World Trade,” Director Mark

that they continue to ask the right questions. My

Wynne cuts through headlines lamenting the end

colleagues and I are most grateful for their efforts

of globalization to identify potential factors behind

and look forward to the insights we will derive

the recent collapse in world trade. Wynne argues

from their important work.

that the trade declines of the Great Recession were
likely a result of deteriorating global economic
activity and a drying up of trade finance. His
analysis provides evidence that protectionist policies—while always dangerous enough to warrant a
watchful eye—are not yet on a significant rise.
Members of institute staff were called upon by

Richard W. Fisher
President and CEO
Federal Reserve Bank of Dallas

The Fed must remain
abreast of international
developments if it is to
deliver on its mandate for
price stability.

4 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

The Financial Crisis,
Trade Finance and the
Collapse of World Trade
As economic activity in

The financial crisis that began in August 2007

holds that the financial crisis had an independent

many parts of the world

and intensified in the fall of 2008 pushed the global effect on trade flows, over and above the effect
it had on global economic activity, by limiting or
economy into its most severe recession since

started to recover in the

World War II. As 2009 drew to a close, there were

latter half of 2009, trade
volumes picked up.

severing access to trade finance. We will see that

signs that economic activity in many countries was the decline in trade was excessive, even given the
rebounding, but the fragile state of many countries’ severity of the recession. And there is evidence
financial systems and concerns about how govern- that reduced access to trade finance is an important part of the overall explanation.
ments and central banks will manage the exit
strategies from the extraordinary measures taken
to mitigate the worst effects of the crisis leave

What Has Happened to Global Trade?

many open questions about the ultimate course of

Despite the recent increase in the importance

the recovery. World trade collapsed in 2008–09 at

of international trade in services—long considered

a pace not seen since the Great Depression, raising the quintessential nontradable—the bulk of international trade still consists of trade in goods and
concerns that the financial crisis would lead to
deglobalization—a reversal of the globalization

commodities. Each month the CPB Netherlands

that has characterized the past three decades. As

Bureau for Economic Policy Analysis produces

global economic activity has rebounded, trade

a report on global trade in goods, along with a

flows have picked up as well, allaying some of

breakdown for the major groupings. Chart 1 shows

these fears. But the scale and the speed of the

the time series of global exports of goods since

collapse of global trade warrants investigation and

January 1991, when the series began. Following

poses a challenge for some standard models of

steady growth over most of the past decade, global

international economics.

exports peaked in the first half of 2008 (specifical-

In this essay I will discuss the impact that the

ly, in April 2008) and then posted a precipitous 20

crisis had on world trade. I will then review two ex-

percent decline through the early months of 2009.

planations for the severity of the collapse. One line

(The trough month was January 2009, but exports

of argument holds that given the normal behavior

hovered at close to their January level through

of trade flows over the course of the business

May 2009.)1 As economic activity in many parts

cycle and given the severity of this most recent

of the world started to recover in the latter half of

cyclical downturn, a major contraction of world

2009, trade volumes picked up, and at the time of

trade should have been expected. A second line of

writing, the volume of trade had increased 15.5

argument, which is not incompatible with the first,

percent from May through December 2009.

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 5

What was extraordinary about this trade

Japan’s exports peaked earlier and saw by far the

collapse was its scale and breadth. The 20 per-

largest decline, while U.S. exports peaked a bit later.

cent decline from peak to trough in the series in

Exports of the emerging economies also peaked

Chart 1 is the biggest in the history of that specific

in April 2008, with central and eastern Europe and

measure. Global trade declined during the 2001 re- Latin America peaking in January 2008, whereas
cession, but only by 7 percent. Other measures of

Asian exports did not peak until July. By early 2009,

global trade with a longer time series show that the exports had turned around in most regions of the
decline was the largest since World War II, indeed

world, with Latin America being the last to experi-

the largest since the Great Depression.

ence recovery. Just as Japan experienced the most

2

Furthermore, the trade collapse was wide-

severe downturn, so too has it experienced the

spread. As Table 1 shows, the collapse was not

sharpest rebound. But the advanced economies as

confined to the advanced economies that were

a whole seem to be lagging, held back in particular

at the epicenter of the financial crisis, but encom-

by the weak recovery of euro-area exports.

passed the emerging economies as well. Exports
Why Did Trade Collapse?

of the advanced economies—defined here as
the Organization for Economic Cooperation and

Many explanations have been proposed for

Development (OECD) excluding Turkey, South

the scale of the collapse in trade. One immediate

Korea and Mexico—peaked in April 2008 and

concern was that countries were raising tariff and

then declined 23.3 percent through January 2009.

nontariff barriers to trade flows to protect domes-

Chart 1
Global Trade Posts Historic Drop
Index, 2000 = 100
180
160

Global merchandise trade volume

140
120
100
80
60
40
20
0
’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
SOURCE: CPB Netherlands Bureau for Economic Policy Analysis World Trade Database.

6 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Table 1
Financial Crisis Takes Widespread Toll on World Exports
Peak month
Trough month
			
Advanced economies
U.S.
Euro area
Japan
Emerging economies
Asia
Latin America
Central and eastern Europe
Africa and Middle East

April 2008
July 2008
April 2008
January 2008
April 2008
July 2008
January 2008
January 2008
April 2008

January 2009
April 2009
February 2009
March 2009
January 2009
January 2009
August 2009
May 2009
April 2009

Peak to trough
(percent change)
–23.3
–24.7
–23.1
–41.4
–21.5
–24.7
–21.1
–30.8
–12.8

Trough to December 2009
(percent change)
12.6
20.2
8.4
40.3
22.0
29.5
20.9
12.9
8.5

SOURCE: CPB Netherlands Bureau for Economic Policy Analysis World Trade Monitor, December 2009.

There is very little
evidence to date that this
protectionist rhetoric
translated into more
restrictive trade policy.

tic industries from the worst of the downturn.

Development and the World Trade Organiza-

While there was a very real increase in protection-

tion on trade and investment policy responses to

ist rhetoric over the course of 2008 and 2009, there

the downturn in the G-20, it was noted that the

is very little evidence to date that this rhetoric

responses so far have been “relatively muted”

translated into more restrictive trade policy. Even-

(OECD, UNCTAD, WTO 2010). In the period Octo-

ett (2009) is less sanguine on this topic, noting

ber 2008 to October 2009, new import-restricting

a steady increase in the number of protectionist

measures introduced by the members of the G-20

measures implemented during 2009. He finds that

covered about 1.3 percent of G-20 imports (0.8
for several advanced economies the share of goods percent of global imports). In the more recent
affected by beggar-thy-neighbor policies exceeds
period from September 2009 through February
precrisis levels. However, given the short history

2010, new import-restricting measures covered

and nature of the data upon which this assess-

0.7 percent of G-20 imports. The report also noted

ment rests, it is difficult to know how important

that no major measures had been identified as

the effects are at the aggregate level. Importantly,

reducing market access among the G-20 members

Evenett also notes that “… few governments have

in the service sector, although it did draw attention

introduced anything like across-the-board dis-

to the potentially distortionary effects of govern-

crimination against foreign commercial interests;

ment support for the transportation and financial
in this respect, the world economy is still far from a sectors in a number of countries.
1930s-style protectionist outcome.”
To get a sense of what constitutes the normal
Policymakers seem to have absorbed the

behavior of trade over the course of the business
lesson of the Great Depression, when protectionist cycle, it is useful to look at the time series behavior
trade policy exacerbated the downturn.3 Meeting
of trade and economic activity in tandem. Chart 2
in London in April 2009, the leaders of the Group

plots the growth rate of global real gross domestic

of Twenty publicly declared that they would “…

product (GDP) and the growth rate of global ex-

not repeat the historic mistakes of protectionism

ports of goods and services over the past 25 years.

of previous eras.” In the most recent report from

Two points are worthy of note. First, global exports

the OECD, the U.N. Conference on Trade and

tend to move in tandem with global GDP: The cor-

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 7

relation between the growth rates of the two series

the OECD countries, while exports are 2.7 times

over the sample period is 0.84. That is, exports

more volatile than GDP.4
Why is that? Part of the reason appears to

are procyclical: They tend to boom when real
economic activity is booming and to slump when

be that despite recent innovations the composi-

real economic activity is slumping. Second, global

tion of international trade is still heavily skewed

exports are a lot more volatile than global GDP.

toward goods rather than services. Approximately

The standard deviation of the growth rate of global

80 percent of all global trade consists of trade in

GDP from 1986 to 2009 was 1.3 percent, while

goods, and this share has remained remarkably

the standard deviation of the growth rate of global

stable over time. By contrast, the share of goods

exports over the same period was 4.6 percent.

in global GDP has declined by about 10 percent-

We see the same pattern at the level of individual

age points over the past four decades, from about

countries. Engel and Wang (2007) report a series

a half in 1970 to slightly more than one-third in

of statistics on trade patterns in the OECD coun-

recent years. Close to 70 percent of U.S. exports

tries and show that the median (across countries)

by value are exports of goods, while goods make

correlation between the cyclical components of

up about 84 percent of U.S. imports (by value). By

imports and GDP is 0.61, while the median corre-

comparison, goods production accounts for only

The world economy is

lation between the cyclical components of exports

about one-fifth of overall production in the United

and GDP is 0.45. Likewise, they show that imports

States (measured as a share of value added).5 Fur-

still far from a 1930s-style

are about three times more volatile than GDP in

thermore, the goods traded across international

Chart 2
International Trade Moves with the Business Cycle
Annual growth rate (percent)
15
Global exports of
goods and services
10

5

Global GDP

0

–5

–10

–15
’80

’85

’90

’95

SOURCE: International Monetary Fund World Economic Outlook, January 2010 Update.

’00

’05

’10

protectionist outcome.

8 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

borders tend to be durable rather than nondu-

in their study of the Great Depression and Chari,

rable. Table 4 of Engel and Wang (2007) reports

Kehoe and McGrattan (2007) in their study of

the share of durable goods in the imports and

postwar U.S. business cycles.7 Levchenko, Lewis

exports of the OECD countries and shows that the

and Tesar start with demand relationships that

median share in recent decades has been around

express domestic consumption of foreign output

60 percent.

(or imports) as a function of the price of foreign

So, international trade flows tend to move

goods relative to domestic goods (with a constant

with the business cycle; indeed, they tend to

elasticity) and the scale of domestic economic

increase by more in good times and decline by

activity (with a constant elasticity of unity). They

more in bad times than the rest of the economy. It

then calculate for each quarter since 1968 how far

should not then come as a great surprise that inter- actual trade flows are from the levels predicted

Some of the decline in

national trade flows have dried up in the midst of

by these demand relationships. They report that

the most severe global recession since World War

in second quarter 2009, U.S. imports were a lot

trade was a natural

II. Far from telling us about incipient deglobaliza-

lower than would have been predicted based on

cyclical phenomenon.

tion, as some feared at the time, some of the de-

this simple relationship. In Chart 3 I show my own

cline in trade was a natural cyclical phenomenon.

estimates of the trade wedge over the same period.
The collapse in 2009 stands out. The trade wedge,

The Excess Trade Collapse

the deviation of trade from levels predicted by

It appears that the decline in trade was greater relative prices and the level of economic activity,
than one might have expected, given what hap-

was –33 percent in the first quarter of 2009 and

pened over the same period to the usual determi-

–40 percent in the second. This suggests that the

nants of trade flows, specifically the relative price

financial crisis had a more direct impact on trade

of the traded goods and the level of economic

flows, over and above the effect it had through the

activity. For example, following Chinn (2009),

decline in economic activity. Why? One possibil-

Wynne and Kersting (2009) estimate a simple

ity is that stress in the financial system caused

model of U.S. import demand that relates real im-

financial institutions to cut back on trade finance

ports of goods and services into the United States

to exporting firms.

to U.S. real GDP and the real value of the dollar. A
priori one would expect imports to be positively

Access to Trade Finance as an

related to real GDP and negatively related to the

Explanation

real value of the dollar, and a simple model along

Before proceeding, we might pause to ask

these lines does a reasonably good job at captur-

exactly what trade finance is.8 The broadest defini-

ing the quarter-to-quarter changes in the growth of tion of trade finance includes every kind of loan,
U.S. imports over the past three decades. However,

insurance policy or guarantee that is directly tied

the model predicted a decline in U.S. imports of 3.7 to an international sale of a good or service. This
percent in first quarter 2009, but the actual decline

definition captures anything from direct trade

(in the vintage of data used in the Wynne and

credit extended by an exporter to an overseas cus-

Kersting study) was 11.3 percent.

tomer to government-backed guarantees issued by

6

A similar exercise is reported in Levchenko,

a country’s official export credit agency. The other

Lewis and Tesar (2009). However, rather than es-

key institutions involved in trade finance are com-

timate an import demand equation for the United

mercial banks, multilateral development banks

States, they perform a “wedge accounting” exercise and private insurers. In addition, various trade fiof the sort pioneered by Cole and Ohanian (2002)

nance instruments are used to insure against risks

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 9

Chart 3
The Trade Wedge Illustrates 2009 Collapse
Percent
40
30
20
10
0

The form that trade finance

–10

takes will typically depend
–20

on the degree of trust

–30

between the two parties

–40
–50

engaged in trade and the
’80

’85

’90

’95

’00

’05

degree to which one or both
parties is dependent on

SOURCES: Bureau of Economic Analysis; author's calculations.

bank financing.
arising from international transactions, such as

country with high political risk. Cash in advance is

commercial risk, transportation risk and political

least risky from the perspective of the exporter and

risk. According to some estimates, about 80 to 90

most risky from the perspective of the importer.

percent of global trade relies on trade finance, and

The allocation of risks is reversed when the trans-

most of this finance is short-term in nature.

action takes place on open account.

9

The form that trade finance takes will typically

Between these two extremes, banks offer a va-

depend on the degree of trust between the two

riety of products to offset the risk of nonpayment

parties engaged in trade and the degree to which

or nondelivery. A letter of credit is a commitment

one or both parties is dependent on bank financ-

by a bank on behalf of the importer that payment

ing. Transactions that involve only the exporter

will be made as soon as the terms and conditions

and importer can be done on a cash-in-advance

in the letter are satisfied. With a letter of credit, the

basis (where the importer pays the exporter before exporter need no longer be concerned about the
the goods are shipped) or on an open-account

creditworthiness of the importer, but only with the

basis (where the exporter is paid after the goods

creditworthiness of the issuing bank. However,

are shipped to the importer). The latter arrange-

letters of credit are typically the most expensive

ment constitutes an extension of trade credit in

form of trade finance. A less expensive option is

the usual sense by the exporter to the importer.

documentary collection, where the exporter uses

Cash in advance is used mainly when the importer a bank as its agent to collect payment from the
has particularly high credit risk or is located in a

importer once it presents the shipping documents

10 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

to the bank. While the bank facilitates payment

demand shocks) and find that the exports of

of the exporter, it does not offer any guarantee, so

manufacturing sectors that are more dependent

documentary collection is typically cheaper than a on external finance tend to grow significantly more
letter of credit. Banks also offer export credit insur-

slowly than other sectors during a banking crisis.

ance when goods are sold on open account and

However, what appears to be key is dependence

also finance exports through working capital loans. on bank finance as opposed to other forms of
What can we say quantitatively about the

external finance (for example, trade credit), which

impact of the financial crisis on the availability of

would be consistent with the idea that the avail-

trade finance? Surprisingly little, it turns out. There

ability of trade finance declines during banking

are no comprehensive measures of the volume of

crises. Iacovone and Zavacka also find that sectors

trade finance outstanding or indicators of its cost

with more tangible assets that can be used as col-

While exporters everywhere

or availability. Such measures as do exist provide

lateral also tend to do better in terms of maintain-

at best a partial picture of what is happening. As

ing exports during a banking crisis.11

were confronted with higher

Auboin (2009) notes, at present the only source of

trade finance costs, the

reliable data on trade finance is the Berne Union

trade finance has important implications for firms’

database, which covers trade credit insurance.

exports is provided by Amiti and Weinstein (2009).

decline in trade finance

When concerns about the availability of trade

They use a unique Japanese data set that allows

availability occurred

credit were at their peak in the fall of 2008, the

them to match banks to individual firms to exam-

International Monetary Fund conducted a survey

ine the consequences of the Japanese financial

primarily in the emerging

of major banks in emerging markets and advanced crises of the 1990s for Japanese manufacturing ex-

markets.

economies in conjunction with the Bankers’ Asso-

ports over that decade. Japanese exports declined

ciation for Finance and Trade to get a more com-

6.7 percent in 1993 and 7.1 percent in 1999.12 The

plete picture of the state of trade finance.10 More

first decline came on the heels of the first round

than 70 percent of the banks surveyed noted that

of bank problems following the bursting of the

the prices of letters of credit had risen relative to

stock price and real estate bubbles in 1989 and

2007, while more than 90 percent reported higher

1991, respectively. The second decline in exports

rates for short- and medium-term lending facilities

was preceded by an intensification of the financial

where the goods exported served as collateral.

crisis in late 1997 that culminated in the national-

Unsurprisingly, most of the survey respondents at-

ization of the Long-Term Credit Bank (at the time

tributed the higher prices to their increased cost of

the eighth-largest bank in the world) at the end of

funds. While exporters everywhere were confront-

1998. For each firm in their sample, which covers

ed with higher trade finance costs, the decline in

the period 1986 to 1999, they are able to identify

trade finance availability occurred primarily in the

its main “reference bank,” which is the bank that

emerging markets. Trade among advanced econo-

would typically handle the firms’ payment settle-

mies seemed largely unaffected by the availability

ment and foreign exchange dealings, that is, trade

(or otherwise) of trade finance, while the availabil-

finance needs. Amiti and Weinstein find a statisti-

ity of financing for imports from South Asia, South

cally significant relationship between the health

Korea and China had decreased sharply.

of these banks (as measured by changes in their

Research by Iacovone and Zavacka (2009)

Additional historical evidence that access to

market-to-book ratios) and firms’ export growth.

shows that banking crises generally do have an

Specifically, a deterioration in the health of a firm’s

impact on exports. They disentangle the effects

main reference bank is usually followed within a

of banking crises from the effects of other types

year by a decline in its exports. They also find that

of shocks that might affect exports (specifically,

while a deterioration in bank health also has a det-

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 11

Trade and Shipping
With the collapse of global trade, there was a simultaneous
collapse in the demand for shipping services to transport goods internationally. According to media reports, by the summer of 2009
almost 10 percent of the global merchant shipping fleet (container
ships, bulk carriers, tankers, car carriers and so on) had been laid
up due to the collapse in trade. Naturally this manifested itself
in shipping costs. While we do not have a good comprehensive
measure of what it costs to ship goods around the world, the
chart shows the recent behavior of two closely watched indexes.
The Baltic Dry Index tells us what is going on in one segment of
the shipping market, namely that for dry bulk commodities such as
coal, iron ore and grain. After peaking at 11,793 on May 20, 2008,
the index collapsed to 663 on Dec. 5, 2008 (a decline of just over
94 percent), before posting gradual improvements over the course
of 2009 and into 2010. The HARPEX index, produced on a weekly
basis by the shipbroking firm Harper Petersen, is a measure of
the cost of shipping containers. Unlike the Baltic Dry Index, it has
yet to show signs of a recovery. As of Jan. 1, 2010, the HARPEX
index stood at 317.44, down from a precrisis peak of 1,444.62.
The differential behavior of the two cost indexes over the past
year as trade volume picked up is interesting and probably reflects

capacity problems in the container liner services. This segment
of the shipping market, which accounts for close to two-thirds of
the market for seaborne trade, expanded dramatically as supply
chains became more globalized.
Movements in shipping costs reflect a number of factors.
The capacity of the global merchant shipping fleet adjusts only
slowly in response to increased demand due to greater trade volumes. Rapid growth in the demand for shipping capacity to move
raw materials to China and other emerging markets is believed
to have been instrumental in the run-up in the Baltic Dry Index
in 2007 and 2008. However, higher energy prices probably also
played a role. Oil prices, as measured by the price of West Texas
Intermediate, peaked at $145.66 a barrel on July 11, 2008. (Prices
of fuel oil—No. 2 New York—peaked the same day at $4.0425
a gallon.) The peak in oil prices came just two months after the
peak in the Baltic Dry Index, and then the two series declined
dramatically over the remainder of 2008. Both series have since
shown a steady improvement. The tight correlation between the
two series suggests that oil prices are an important component
of overall shipping costs. But it is also consistent with both series
being driven by a common third factor—global economic activity.

Shipping Costs Reflect Global Economic Activity
Index

Index

14,000

1,600
1,400

HARPEX

12,000

HARPEX
78 percent decline

10,000

1,200
1,000

8,000
800
6,000

Baltic Dry Index
600
Baltic Dry
94 percent decline

4,000

400

2,000

200

0
2006
SOURCES: Harper Petersen and Co.; Bloomberg.

2007

2008

2009

0
2010

12 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

rimental effect on domestic sales, the effect is a lot

understood as the entire array of financial prod-

smaller than the effect on exports, consistent with

ucts that serve to facilitate international trade. This

the view that exporting is a particularly finance-

includes—in addition to that portion of trade credit

dependent activity due to its greater riskiness.

extended to or received from foreign customers or

But is there any evidence that the drying up of vendors—bank loans to finance working capital
trade finance contributed to the excessive decline

to produce for export; letters of credit; insurance;

in global trade during the recent crisis? Levchenko, and the host of other financial products that exist
Lewis and Tesar (2009) investigate the possibility

to mitigate the risks associated with international

that a collapse of trade credit was a key determi-

trade.

nant of the collapse of U.S. imports and exports

Some indirect evidence that access to trade

over the period June 2008 through June 2009 by

finance was indeed a critical factor contributing to

The availability of trade

examining import and export performance over a

the 2008–09 decline in global trade is presented

large number of sectors and asking whether those

by Chor and Manova (2009). Their idea is to use

finance declines during

sectors that are most dependent on trade credit or

interbank lending rates in different countries as

banking crises.

most willing to extend it saw larger declines. They

a measure of the cost of external capital (includ-

are unable to find any statistically significant rela-

ing trade finance) to firms. They interpret higher

tionship, and they conclude that a collapse of trade interbank rates as being indicative of tighter credit
credit is not a plausible candidate for explaining

markets, and they document that countries with

the excess decline.

higher rates tend to export less to the United

However, this finding needs to be interpreted

States. Of course, the need to access external

with caution. The terms trade credit and trade

finance varies across sectors, as does the ability

finance are often used interchangeably, but as we

to post collateral for loans or the ability to obtain

have noted above, there are important differ-

trade credit. Chor and Manova show that coun-

ences. The term trade credit is best defined as

tries with tighter credit conditions suffered a larger

credit created or extended by a nonfinancial firm

decline in exports to the United States during the

to one of its customers when there is a mismatch

crisis, and these effects were most apparent in the

in time between when goods are ordered and

sectors that were most dependent on external fi-

delivered and when they are paid for. Trade credit

nance, had the fewest collateralizable assets or had

in this sense is reflected in the accounts receiv-

the least access to trade credit from trade partners.

able on a firm’s balance sheet (with a matching

Based on reduced-form estimates, they conclude

amount showing up in the accounts payable on

that “… U.S. imports would have fallen by 25.6%

the customer’s balance sheet.) Levchenko, Lewis

more if interbank rates had remained at their

13

and Tesar (2009) employ exactly such measures of peak September 2008 level through April 2009, estrade credit (either accounts payable relative to the sentially doubling the actual percentage decline in
cost of goods sold or accounts receivable relative

trade volumes observed after September 2009.”

to total sales) to assess whether a contraction in

The findings of Chor and Manova are consis-

trade credit played an important role in the con-

tent with the findings of Bricongne et al. (2009) for

traction of global trade. Of course, such measures

French exporters. They look at the performance

do not distinguish between trade credit extended

of about 100,000 individual French exporters

to domestic customers (or received from domestic

through April 2009 and find that firms in sectors

vendors) and trade credit extended to foreign cus-

more structurally dependent on external finance

tomers (or received from foreign vendors). Trade

experienced the biggest declines in exports.

finance, as it pertains to international trade, is best

However, their data do not allow them to distin-

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 13

guish between finance for international trade and

finance, had the fewest collateralizable assets and

finance for generic working capital.

had the least access to trade credit.

So, evidence in support of the trade finance

Finance is often viewed as a veil on the engine

story is, at best, suggestive. A more conclusive

of the real economy, but as has been observed,

evaluation of the idea will depend on better

“when the veil flutters, the engine sputters.” The

measures of trade finance becoming available.

collapse of global trade in 2008–09 has drawn

But the evidence does highlight the need for a

attention to the little-studied area of trade finance

better understanding of finance’s role in facilitating and the important role it plays in facilitating global
international trade and points to the existence of a

commerce.

financial accelerator for exports similar to that gen—Mark Wynne

erally believed to exist for real economic activity.
Conclusions
In 2008–09, global trade collapsed at a pace
not seen since the Great Depression, raising concerns in some quarters that the globalization of the
past three decades was going to be reversed. Global
trade has since recovered (although it has yet to
attain its precrisis level), and to date there seems
to have been limited use of protectionist measures.
However, given the prospect of elevated unemployment levels in many countries for some time to
come, the pressures to engage in some form of protectionism will remain and will continue to pose
a threat to free trade. Much of the decline in trade
can be explained by the severity of the downturn
in economic activity. But some of the decline was
excessive, over and above what would have been
warranted by the collapse in activity.
In this essay, I have focused on limited access
to trade finance as a possible explanation for the
excessive decline. Existing models of international
trade do not assign a prominent role to access
to trade finance as an important determinant of
trade. And data limitations make it very difficult to
determine just how important a role trade finance
plays empirically. But the limited evidence available suggests that access to trade finance is an
important determinant of a firm’s ability to export
and that the declines in exports to the United
States were greatest among firms in countries
where access to finance was already limited and
for firms that were most dependent on external

Notes
An alternative measure of global trade from the OECD’s
Main Economic Indicators tells a similar story. After
peaking at $2.606 trillion (measured in year 2000 dollars)
in first quarter 2008, global imports of goods and services
declined to a low of $2.164 trillion in second quarter 2009
(a decline of just under 17 percent), before rebounding in
the third quarter. The OECD’s measure of global exports of
goods and services peaked at $2.572 trillion (2000 dollars)
in second quarter 2008. This was not all that different
from the first quarter figure of $2.271 trillion. The exports
measure bottomed out at $2.160 trillion in second quarter
2009 (a decline of 16 percent) and subsequently rebounded. The OECD measure has the advantage of including
trade in services as well as having a longer time series
than the CPB measure. However, it tends to lag the CPB
series in terms of availability and also relies more heavily
on projections for a number of countries rather than actual
published data.
2
For example, the measure of global exports reported as
part of the International Monetary Fund’s International
Financial Statistics database, which starts with April
1949, showed exports declining by 25 to 30 percent (on a
12-month basis) each month from January through August
2009. The only declines of comparable magnitude in this
measure occurred in 1956, when exports fell about 20 percent each month from June through December. However,
these statistics measure nominal rather than real trade
volumes. The measure of global exports of goods and services that the OECD reports as part of its Main Economic
Indicators is a real series (measured in constant 2005
dollars). This series starts in first quarter 1970. In the first
and second quarters of 2009, global exports as measured
by this series posted declines in excess of 14 percent (on a
four-quarter basis) in both quarters, the largest declines in
the series’ history.
3
The extent to which the resort to protectionism during the
Great Depression contributed to the severity of the Depression is the subject of some controversy. Mario Crucini and
James Kahn (1996) were the first to conduct a quantitative
analysis of tariffs’ contribution to the decline in economic
1

Much of the decline in trade
can be explained by the
severity of the downturn
in economic activity. But
some of the decline was
excessive, over and above
what would have been
warranted by the collapse in
activity.

14 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

activity during the Great Depression. They showed that
even when international trade constitutes a small share
of aggregate output, tariffs and other trade barriers can
have a significant negative effect on GDP if the goods that
are traded are used as intermediate inputs in production.
They conclude that the tariff war during the 1930s could
have reduced U.S. gross national product by as much as 2
percent.
4
The statistics that Engel and Wang (2007) report are
based on Hodrick–Prescott filtered data with smoothing
parameter of 1600.
5
Goods production (defined as the sum of agriculture, mining, construction and manufacturing) accounts for a slightly
higher share of gross output, closer to 30 percent.
6
The most recent vintage of the National Income and
Product Accounts puts the decline of first quarter 2009 at
10.7 percent.
7
See also Ahearne, Kydland and Wynne (2005) and
Cociuba and Ueberfeldt (2008) for examples of wedge accounting exercises, albeit in closed-economy frameworks.
8
See chapter 18 of Bekaert and Hodrick (2009) for a
lengthy exposition of various options for financing international trade, or see U.S. Department of Commerce (2008).
9
See, for example, Auboin (2009).
10
See Dorsey (2009) and International Monetary Fund
(2009).
11
According to Table 2 of Iacovone and Zavacka, tangible
assets are 62 percent of the total assets of firms in the
petroleum refining sector but a mere 14 percent of assets
in the office and computing sector.
12
Exports also declined 1.8 percent in 1998 but posted
increases in every other year of the decade.
13
See also the discussion in footnote 2 of Amiti and Weinstein (2009) on the differences between the accounting and
finance uses of these terms.

References
Ahearne, Alan, Finn Kydland and Mark A. Wynne (2005),
“Ireland’s Great Depression,” Economic and Social Review
37 (2): 215–43.
Amiti, Mary, and David E. Weinstein (2009), “Exports and
Financial Shocks,” NBER Working Paper Series, no. 15556
(Cambridge, Mass., National Bureau of Economic Research,
December).
Auboin, Marc (2009), “Boosting the Availability of Trade
Finance in the Current Crisis: Background Analysis for
a Substantial G20 Package,” CEPR Policy Insight no. 35
(London, Centre for Economic Policy Research, June).
Bekaert, Geert, and Robert J. Hodrick (2009), International
Financial Management (Upper Saddle River, N.J.: Pearson
Prentice Hall).

Bricongne, Jean-Charles, Lionel Fontagné, Guillaume
Gaulier, Daria Taglioni and Vincent Vicard (2009), “Firms
and the Global Crisis: French Exports in the Turmoil,”
Banque de France Document de Travail no. 265 (Paris,
Banque de France, December).
Chari, V.V., Patrick J. Kehoe and Ellen R. McGrattan
(2007), “Business Cycle Accounting,” Econometrica 75 (3):
781–836.
Chinn, Menzie (2009), “Update on U.S. Exports and Imports:
The Collapse Continues,” Econbrowser blog, June 23,
2009, www.econbrowser.com/archives/2009/06/update_
on_us_ex.html#more.
Chor, Davin, and Kalina Manova (2009), “Off the Cliff and
Back? Credit Conditions and International Trade During the Global Financial Crisis” (Rochester, N.Y., Social
Science Research Network, Dec. 15), http://ssrn.com/
abstract=1502911.
Cociuba, Simona E., and Alexander Ueberfeldt (2008),
“Driving Forces of the Canadian Economy: An Accounting
Exercise,” Federal Reserve Bank of Dallas, Globalization
and Monetary Policy Institute Working Paper no. 6 (March).
Cole, Harold L., and Lee Ohanian (2002), “The U.S. and the
U.K. Great Depressions Through the Lens of Neoclassical
Growth Theory,” American Economic Review Papers and
Proceedings 92 (2): 28–32.
Crucini, Mario J., and James Kahn (1996), “Tariffs and Aggregate Economic Activity: Lessons from the Great Depression,” Journal of Monetary Economics 38 (3): 427–67.
Dorsey, Thomas (2009), “Trade Finance Stumbles,” Finance
and Development 46 (1): 18–19.
Engel, Charles, and Jian Wang (2007), “International Trade
in Durable Goods: Understanding Volatility, Cyclicality and
Elasticities,” Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Paper no. 3
(November).
Evenett, Simon J. (2009), The Unrelenting Pressure of
Protectionism: The 3rd GTA Report—A Focus on the
Asia-Pacific Region (London: Centre for Economic Policy
Research).
Iacovone, Leonardo, and Veronika Zavacka (2009), “Banking
Crises and Exports: Lessons from the Past,” Policy Research Working Paper Series, no. 5016 (Washington, D.C.,
World Bank, August).

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 15

International Monetary Fund (2009), “Survey of Private
Sector Trade Credit Developments” (Washington, D.C.,
International Monetary Fund, February), www.imf.org/
external/np/pp/eng/2009/022709.pdf.
Levchenko, Andrei A., Logan Lewis and Linda L. Tesar
(2009), “The Collapse of International Trade During the
2008–2009 Crisis: In Search of the Smoking Gun,” Gerald
R. Ford School of Public Policy Research Seminar in International Economics Discussion Paper no. 592 (Ann Arbor,
Mich., University of Michigan, August).
OECD, UNCTAD and WTO (2010), “Report on G20 Trade
and Investment Measures” (Organization for Economic
Cooperation and Development, U.N. Conference on Trade
and Development, and the World Trade Organization,
March), www.wto.org/english/news_e/news10_e/trim_
report_08mar10_e.doc.
U.S. Department of Commerce: International Trade Administration (2008), Trade Finance Guide: A Quick Reference
for U.S. Exporters (Washington, D.C.: U.S. Department of
Commerce).
Wynne, Mark A., and Erasmus K. Kersting (2009), “Trade,
Globalization and the Financial Crisis,” Federal Reserve
Bank of Dallas Economic Letter, no. 8.

16 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Summary of Activities
For 2009, the Dallas Fed had two high-

was accepted for publication at the Journal of

priority objectives that pertained to research:

International Money and Finance in December

“Produce high-quality current analysis and

2008 (too late for inclusion in last year’s annual

long-term research that enable the Dallas Fed to report). Anthony Landry’s paper “Expectations
be an active player and intellectual leader in the

and Exchange Rate Dynamics: A State-Depen-

Federal Open Market Committee’s monetary

dent Pricing Approach,” which was circulated as

policy deliberations” and “Promote research

Research Department Working Paper No. 0604,

that deepens our understanding of the implica-

was accepted for publication at the Journal of

tions of globalization for U.S. monetary policy

International Economics in December 2008.

through the Globalization and Monetary Policy

Ananth Ramanarayanan’s paper “Vertical

Institute.” Contributing to these two high-pri-

Specialization and International Business Cycle

ority objectives, Enrique Martínez-García and

Synchronization” (joint with Costas Arkolakis

Mark Wynne gave a presentation on the global

of Yale University), which appeared as Institute

slack hypothesis to the full FOMC at its Decem-

Working Paper No. 21, was accepted for publica-

ber 2009 meeting. This presentation was part

tion in the Scandinavian Journal of Economics

of a broader set of presentations on inflation

in a December 2009 special issue of that journal

dynamics. The paper underlying the presenta-

on “Heterogeneous Firms and International

tion is forthcoming as a Staff Paper in 2010.

Trade.” Enrique Martínez-García’s paper “Investment and Trade Patterns in a Sticky-Price,

Academic Research
The core business product of the institute

Open-Economy Model” (coauthored with
Globalization and Monetary Policy Institute

is its Working Paper series. By year end, we had

research associate Jens Søndergaard of the Bank

circulated 40 papers in the series. One of the

of England) was accepted for publication in a

working papers contributed by our advisory

book of conference proceedings. (For recent

board member William White on “Should Mon-

working paper abstracts, see page 30.)

etary Policy ‘Lean or Clean’?” received some
high-profile press coverage and was one of the
most downloaded publications on our website
in 2009.
However, working papers are just an

Bank Publications
The institute published eight international
updates on the web and five Economic Letters
on “Seeking Stability: What’s Next for Banking

intermediate step—the ultimate objective is

Regulation?” (by Simona Cociuba), “Trade,

to have the research meet the standards of the

Globalization and the Financial Crisis” (by

peer-reviewed literature and be published in

Mark Wynne and research associate Erasmus

academic journals. Jian Wang’s paper “Home

Kersting), “Ties that Bind: Bilateral Trade’s Role

Bias, Exchange Rate Disconnect, and Optimal

in Synchronizing Business Cycles” (by Ananth

Exchange Rate Policy,” which was circulated as

Ramanarayanan), “Has Greater Globalization

Research Department Working Paper No. 0701,

Made Forecasting Inflation More Difficult?”

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 17

(by Mark Wynne and Patrick Roy) and “Labor

of England and the Bank for International

Market Globalization in the Recession and

Settlements), as well as several high-profile

Beyond” (by W. Michael Cox, Richard Alm and

conferences (most notably the Econometric

Justyna Dymerska). The institute also published

Society North American summer meeting and

one Staff Paper on “Exchange Rate Policies”

the Canadian Economics Association annual

by senior fellow Charles Engel. The staff also

meeting). Mark Wynne gave a series of lectures

received some external recognition for their

on “Globalization and Financial Services” at the

contributions to Bank publications. The Winter

American Bankers Association Stonier National

2009 issue of the Journal of Economic Perspec-

Graduate School of Banking at the University of

tives, a publication of the American Economic

Pennsylvania in June.

Association, highlighted Anthony Landry’s 2008

The institute hosted a number of external

Economic Letter on “The Big Mac: A Global-to-

seminar speakers over the course of the year, and

Local Look at Pricing” in its Recommendations

we added 11 research associates to our network.

for Further Reading listing. Simona Cociuba’s

(A list of all the research associates is on page 44.)

Economic Letter on bank regulation is featured
on the St. Louis Fed’s website dedicated to the
financial crisis.

Other Activity
Governor Masaaki Shirakawa of the Bank of
Japan formally joined the advisory board of the

Conferences and Seminars
Institute economists have been active over

institute effective July 3, and Heng Swee Keat,
managing director of the Monetary Authority of

the past year presenting their work at conferenc-

Singapore, joined the advisory board in August.

es and seminars. Staff gave several presentations

A key component of the institute’s strategy

at the January 2009 meeting of the American

to promote research and raise the visibility of

Economic Association and organized sessions

the Dallas Fed in the broader research commu-

at the meeting. In April, the institute organized a

nity is to run a very active visitor and seminar

conference on “Globalization, Political Economy program. We hosted a number of visitors over
and Trade Policy” jointly with the Department

the summer, including Ina Simonovska of the

of Economics at Southern Methodist University.

University of California at Davis, Karen Lewis of

(More details are provided in the conference

the University of Pennsylvania, Pengfei Wang of

summary on page 18.) On Oct. 1–2, we hosted

Hong Kong University of Science and Tech-

the annual meeting of the Federal Reserve

nology and Chikako Baba of the University of

System Committee on International Economic

Wisconsin and IMF. Erasmus Kersting, a recent

Analysis at the San Antonio Branch. On Nov.

Texas A&M Ph.D. and currently a visiting as-

13–14, we hosted a joint conference with the

sistant professor at SMU, spent the summer

Bank of Canada on international capital flows

working with Mark Wynne on a project on

at the Dallas office. (More details are provided

international trade finance and its role in the

in the conference summary on page 24.) The

contraction of global trade over the last year.

institute also cosponsored a conference with the

Tatsuma Wada from Wayne State University be-

O’Neil Center for Global Markets and Freedom

gan an extended visit to the institute in Septem-

at SMU on Oct. 16 on “What Do Businesses Need ber. Several of these visitors have subsequently
to Succeed in Today’s Global Economy?”

joined our network of research associates.

Staff presented their research at a number of prestigious venues (such as the Bank

—Mark Wynne

18 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Conference on Globalization,
Political Economy and
Trade Policy
On April 24 and 25, 2009, the Globalization

final goods are produced by combining the

and Monetary Policy Institute joined with South-

outputs of the tasks, which might be regarded as

ern Methodist University to cosponsor a confer-

similar to intermediate goods. This final step has to

ence on Globalization, Political Economy and

be done in the headquarters country. In a previ-

Trade Policy at SMU’s Collins Executive Education ous paper, the authors proposed a theory of task
Center. Nine scholarly papers were presented and trade between countries with dissimilar relative
discussed in three sessions.
The first session consisted of two papers
describing offshoring’s impact on the distribution
of work and the relative unemployment and wages

factor endowments, generating interesting results
that differ from the traditional factor endowmentbased Heckscher–Ohlin model.
In the present paper, Grossman and Rossi-

of unskilled labor. A third offering focused on how

Hansberg propose a theory of task trade between

foreign direct investment (FDI) flows from more-

countries that have similar relative factor endow-

to less-developed countries influence innovation.

ments but differ in size. Firms produce differenti-

The second session started with a paper

ated goods by performing a continuum of tasks,

focusing on the rationale for multilateral trade

each of which generates local spillovers. Tasks can

agreements, followed by two presentations on in-

be performed at home or abroad, but offshoring

ternational protection of intellectual property. The

costs vary. A crucial assumption is that the tasks

first two papers in the last session concern export

are characterized by external economies of scale

dynamics, and the third discusses the relationship

at the national level.

between bilateral trade agreements and multilateral trade liberalization.

In equilibrium, tasks with the highest offshoring costs may not be traded at all. Among the
remainder, those with higher offshoring costs are

Offshoring and FDI
Princeton University professor Gene Gross-

performed in the country that has higher wages
and aggregate output. When offshoring costs

man presented the conference’s first paper, titled

aren’t too high, firms concentrate certain tasks in

“Task Trade Between Similar Countries” and

particular locations to realize external economies

coauthored with his Princeton colleague Esteban

of scale. Grossman and Rossi-Hansberg discuss

Rossi-Hansberg.

the relationship between equilibrium wages, equi-

Most models treat the objects of international
trade as final goods, not abstract tasks. However,

librium outputs and relative country size, examining how the pattern of specialization reflects the

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 19

model’s key parameters.

workers’ wages. The unskilled wage can increase or

The theory predicts the pattern of task special- decrease as a result of offshoring.
ization for countries that differ only in size. The

The opening session’s final paper, titled

authors find an equilibrium always exists in which

“Southern Innovation and Backward Knowledge

the larger country has higher wages and greater

Spillovers: A Dynamic FDI Model,” was presented

aggregate output of final goods.

by professor Keith E. Maskus of University of

If offshoring costs are low enough and the
countries aren’t too different in size, another equilibrium may exist in which the smaller country

Colorado at Boulder and coauthored with his colleague Yin He.
The focus is a theory concerning the trade and

has higher wages and greater aggregate output. In

FDI relationships between the more-advanced

either case, the country with the higher wages and

countries of the North and the less-developed

output performs tasks that are more difficult and

countries of the South.

costly to offshore.
Syracuse University professor Devashish

The authors develop a model in which the
portion of Northern firms choosing to become

Mitra presented the second paper, titled “Search

multinationals is endogenous. In the benchmark

and Offshoring in the Presence of ‘Animal Spirits,’”

model, Northern firms engage in innovation

coauthored with Priya Ranjan of the University of

based on the local knowledge stock and learning-

California at Irvine.

by-doing (LBD), and a share of these products is

The authors introduce two sources of unem-

transferred to Southern production via FDI. An

ployment in a two-factor, closed-economy general

increase in Southern imitation limits the rate at

equilibrium model—search frictions and fairness

which countries become multinational.

considerations. Models with search friction are the

Up to this point, the model is pretty standard.

most widely used for analyzing unemployment

The Maskus and He innovation involves extending

in a general equilibrium setting. Recently, mod-

the model to permit Southern innovation based on

els with fairness considerations have generated

the amount of local knowledge and LBD. Because

increasing interest.

Southern firms have higher innovation costs, this

Basically, this kind of model assumes un-

generates inefficient specialization in both regions

skilled workers demand wages that aren’t too far

and reduces global growth. The authors also allow

below those of skilled workers. This normally leads

for “backward spillovers” to Northern innovation,

to unemployment of unskilled workers but not

which partially restores global efficiency and

necessarily skilled workers.

growth.

In the present paper, the authors find that

Backward spillovers from the South to the

a binding fair-wage constraint increases the

North do occur. In his presentation, Mascus point-

unskilled unemployment rate and can at the same

ed out that the video compact disk was invented

time lead to a higher jobless rate for skilled work-

in China, but the technology wasn’t patented. A

ers. The wages of unskilled workers increase and

Japanese firm learned and patented the technol-

the wages of skilled workers decrease.

ogy, which eventually evolved into the DVD.

Next they introduce offshoring of unskilled

The model’s results highlight a possibility not

jobs into the model, which makes it more likely

widely recognized. Specifically, technology trans-

that the fair-wage constraint becomes bind-

fer through multinational investment tends to rise

ing. Offshoring of unskilled jobs always leads to

with a decline in imitation risk, perhaps achieved

increases in unskilled unemployment, decreases

through strengthening intellectual property pro-

in skilled unemployment and increases in skilled

tection. Thus, multinationals may kick off a process

20 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

in the South in which local imitation and LBD

competitive markets. In all the models, address-

establish the possibility of domestic innovation as

ing inefficient terms-of-trade restrictions in trade

R&D costs fall.

volume is the only rationale for trade agree-

In equilibrium, however, all Southern firms
that innovate and invest in multinational subsidiaries must obtain the same economic return

ments—whether or not governments have political
or economic objectives.
Having identified the problem trade agree-

and cover both the innovation costs and the FDI

ments might solve, Bagwell and Staiger proceed to

setup cost. This implies that costs of innovation

the next step and evaluate the form that efficiency-

will remain higher in the South than the North. As

enhancing pacts might take. Once again, their

a result, inefficient specialization can reduce FDI

results parallel the established results for models

and global knowledge accumulation.

with perfectly competitive markets.

To counter this, a Southern policy of strength-

In particular, Bagwell and Staiger show that

ening intellectual property protection and reduc-

the principles of reciprocity and non-discrimi-

ing the costs of inward investment can expand

nation (i.e., most-favored-nation provisions) are

multinational contacts and growth, an effect

efficiency-enhancing because they undo the

enhanced by backward spillovers to the advanced

terms-of-trade restrictions in trade volume that

countries.

occur when governments pursue unilateral trade
policies.

Trade and Intellectual Property
Stanford University professor Kyle Bagwell
kicked off the second session with “Profit Shifting

The analysis suggests that the important implications of the terms-of-trade approach are quite
general, applying not just to perfectly competitive

and Trade Agreements in Imperfectly Competitive but also to a wide range of imperfectly competitive
Markets,” coauthored with his Stanford colleague

markets. However, they emphasize that this paper

Robert W. Staiger.

considers only markets for which the number of

The authors have been leaders in the analysis
of multilateral trade agreements. They argue that

firms is fixed.
In a companion paper in 2008, they consid-

countries constrained by such agreements are less

ered imperfectly competitive models in which the

likely to alter the terms of trade in their favor and

number of firms is endogenous. They concluded

impose negative externalities on other countries.

that the inefficiencies associated with terms-of-

Their previous work has mainly concentrated on

trade motivations provide the only rationale for

perfectly competitive markets.

trade agreements in this setting as well.

Under imperfect competition, trade policies

Edwin Lai of the Federal Reserve Bank of

can alter the terms of trade, shift profits from one

Dallas presented the next paper, “Innovation,

country to another and moderate or exacerbate

Intellectual Property Protection and Globaliza-

existing distortions associated with monopoly

tion,” coauthored with Davin Chor of Singapore

power. In light of the various ways trade policies

Management University.

may influence welfare, we might expect that new

Patent protection often takes the form of

rationales for trade agreements would arise under

restrictions on how easily innovators are allowed

imperfectly competitive markets.

to invent around existing patents, which the au-

In their paper, the authors consider a se-

thors term “patent breadth.” Lai and Chor explore

quence of trade models that feature imperfectly

the implications of a patenting regime based on

competitive markets, finding the same basic

patent breadth by incorporating such intellectual

rationale for trade agreements as under perfectly

property protection considerations in a quality-im-

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 21

provement model of technology, trade and growth. SMU’s Kamal Saggi.
The authors first study how changes in pat-

The paper analyzes the effects of strengthen-

ent breadth affect innovation rates and welfare

ing intellectual property rights in developing coun-

in a closed-economy benchmark. In considering

tries on the level and composition of industrial

whether to increase patent breadth, policymakers

development. The authors first develop the theory

face a tradeoff between the benefits of higher in-

of a North–South product cycle in which Northern

novation rates and the costs of higher prices from

innovation, Southern imitation and FDI are all

granting patent-holders monopoly pricing power

endogenous.

for a longer duration. They find an optimal breadth

The theory predicts that intellectual property

under certain reasonable conditions, suggesting

rights reform in the South leads to increased FDI

government intervention to protect intellectual

from the North as developed country firms shift

property will improve welfare.

production to less-developed country affiliates.

The paper goes on to formulate an open-

This FDI accelerates Southern industrial develop-

economy model in which countries interact

ment, bringing increases in both the South’s share

through trade and firms patent internationally.

of global manufacturing and the pace at which

They find a stable equilibrium for patent breadth

production of recently invented goods shifts to

in which national governments underprotect intel- the South. In addition, the model predicts that
lectual property from a global perspective.
This result is similar to findings in a 2004
paper by Lai and Grossman, which analyzed
international patent protection based on duration

Northern resources will be reallocated to R&D as
production shifts to the South, driving an increase
in the global rate of innovation.
The authors go on to test the model’s predic-

rather than breadth. Interestingly, home and for-

tions by analyzing the responses of U.S.-based

eign patent-breadth policies are strategic comple-

multinationals and domestic industrial production

ments—at least in the symmetric equilibrium.

to intellectual property rights reforms in the 1980s

This contrasts with Grossman and Lai’s finding

and 1990s.

that home and foreign patent-length policies are
strategic substitutes.
In the present paper, Lai and Chor also find

First, they find that multinational companies
expand the scale of their activities in countries that
reform intellectual property rights. Multinationals

that countries with larger domestic markets or

that make extensive use of intellectual property

lower innovative capabilities would tend to set

disproportionately increase their use of these

larger patent breadths. In addition, globalization’s

inputs.

reduced trade frictions lead countries to lower

Second, there is an overall expansion of

patent breadths. As a result, globalization actually

industrial activity after intellectual property rights

leads to lower equilibrium research intensities in

reform, and highly disaggregated trade data indi-

all countries. Other studies have found that global-

cate an increase in the number of initial exports

ization has no general impact on research intensi-

in response to reform. These results suggest that

ties, making this result even more surprising.

the expansion of multinational activity more than

Next on the program was professor Lee
Branstetter of Carnegie Mellon University, who

offsets any decline in indigenous firms’ acquiring
intellectual property through imitation.

presented a paper titled “Intellectual Property
Rights, Imitation and Foreign Direct Investment:
Theory and Evidence,” coauthored with Columbia’s
Raymond Fisman, Harvard’s C. Fritz Foley and

Export Dynamics and Trade Pacts
The third session’s first paper, titled “A Search
and Learning Model of Export Dynamics,” was

22 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

presented by New York University professor Jonathan Eaton and coauthored with Marcela Eslava,
C. J. Krizan, Maurice Kugler and James Tybout.
A goal of policy in many developing countries

several products and export to many markets.
To understand this type of export entrepreneurship, Freund and Pierola examine data on
Peru’s nontraditional agriculture exports from

is establishing new markets for nontraditional

1994 to 2007. This sector grew sixfold over the

exports. Well-known success stories from Latin

period, driven in large part by firm entry and new

America include Brazilian regional jets, Chilean

product and market discoveries.

wines and Colombian cut flowers. By finding new

The authors identify a pattern of trial and er-

buyers abroad, governments hope to create jobs,

ror: Firms frequently enter and exit both products

bolster demand for their currencies and further

and markets. Exits are more likely after one year

industrial development.

and among firms that start small. Large exporters

The paper presents a preliminary theoretical

tend to be the first to discover products and mar-

framework for analyzing export dynamics at the

kets new to their country, and they export more

firm level. Specifically, the authors assume that

products to more markets.

export success reflects a process of search and
learning in foreign markets. Producers interested

Freund and Pierola develop a model that
explains how entrepreneurs decide to develop

in a particular overseas market devote resources to new export products and markets in a business
identifying potential buyers. When they find one,

environment characterized by sunk costs of

they learn something about their products’ appeal

discovery and uncertainty about costs and foreign

in this market. They also learn about the potential

demand. The model explains many features of the

for profits by observing the experiences of rivals

Peruvian data.

selling similar products in the foreign market.

The authors’ theoretical framework assumes

Taking stock of the available information,

uncertainty about exporting and sunk costs—this

firms initially not selling in the foreign market

leads to a process of trial and error, with a high

update their beliefs about potential export profits,

share of exits after one year. Good entrepreneurs

and they adjust the intensity of their search efforts

develop large firms that tend to export more to a

accordingly, attempting to maximize their net

given product and market, enter more markets

expected profit streams. Export gains take place

and more products, and enter new markets and

when firms receive positive early signals about

products earlier. Firms also start small and grow

potential profits, both from their own experiences

exports over time to avoid large losses from un-

and from rivals’ experiences, and they intensify

competitive products. The data seem to confirm

their search and marketing efforts, adding quickly

these predictions.

to their foreign client base.
World Bank economist Caroline Freund

The conference’s last paper was “Bilateralism, Multilateralism and the Quest for Global Free

presented the next paper, “Export Entrepreneurs:

Trade,” presented by Ryerson University professor

Evidence from Peru,” coauthored with her World

Halis Murat Yildiz and coauthored with Kamal

Bank colleague Marta Denisse Pierola.

Saggi of SMU.

Like the previous paper, this one considers

Whether bilateralism is a stepping stone or

the dynamics of exporting firms’ entry and exit.

stumbling block to multilateral trade liberalization

In developing countries, many exporters produce

has long been a topic of intense debate. This paper

only for foreign markets. These firms tend to be

develops an equilibrium theory of trade agree-

larger and more productive than firms focused

ments and evaluates the relative merits of bilateral-

on the domestic market, and they often produce

ism and multilateralism.

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 23

The authors envision a three-country game in
which each nation faces a range of policy options
in negotiating trade agreements—join with both
trading partners (i.e., practice free trade), select
just one of them for a bilateral pact, or don’t deal
with either of them (i.e., opt for the status quo under which all countries impose their optimal tariffs
on each other).
To determine whether bilateralism matters,
they also analyze this game under the assumption that countries follow a purely multilateral
approach to trade liberalization. Thus, both the
degree and nature of trade liberalization are endogenously determined.
First, Yildiz and Saggi find that global free
trade is the only stable equilibrium, regardless
of whether countries can pursue bilateral agreements. This lends support to the view that bilateral
trade agreements aren’t stumbling blocks to multilateral trade liberalization.
The second finding focuses on countries with
asymmetric endowment levels. For them, there exist circumstances under which free trade is a stable
equilibrium only if countries are free to pursue
bilateral trade agreements. This supports the view
that bilateral trade agreements are stepping stones
to multilateralism. These results hold even when
governments are politically motivated—that is,
they value producer interests and tariff revenue
more than consumer benefits that come from freer
trade.
—Edwin Lai

24 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Conference on Capital Flows,
International Financial Markets
and Financial Crises
Financial markets throughout the world have
become increasingly more developed in recent

markets—and their regulation—impact the rest
of the economy? Specifically, do they result in

decades. At the same time, global financial integra- stabilization or amplification of macroeconomic
tion has risen: Cross-border financial flows and as- fluctuations in response to shocks? The remainder
set holdings have increased significantly over time, of this summary explains why this research is fruitshowing deepening financial-market linkages

ful in the context of the current financial turmoil

between countries. Economists in various fields

and summarizes the researchers’ contributions.

have been addressing the effects of more sophisticated financial markets and international financial

Why We Need Better Models

integration, but many open issues remain. These

Two of the conference papers nicely illustrate

include evaluating the degree and the macroeco-

how the global dimension of the current financial

nomic effects of financial integration, assessing

crisis underscores the need to develop and apply

the role of regulating financial intermediaries and

new theoretical models to address these questions.

understanding the emergence and transmission of Steve Kamin from the Federal Reserve Board
financial crises.
The current global financial crisis has brought

presented evidence (in a paper coauthored with
Laurie Pounder from the Federal Reserve Board)

to light the need to develop a better understand-

on the degree to which direct financial links

ing of these issues and their implications for

with the U.S. help explain the different effects on

policymaking. To this end, on Nov. 13–14, 2009,

foreign countries’ financial markets. Specifically,

the Federal Reserve Bank of Dallas and the Bank

Kamin and Pounder ask whether the exposure of a

of Canada cosponsored a conference on capital

country’s financial sector to U.S. mortgage-backed

flows, international financial markets and financial securities (MBS) or its dependence on U.S. dollar
crises.1 The purpose of the conference was to bring

funding can explain how the financial sector in

together researchers working on various aspects of that country fared early in the crisis. This question
financial markets and financial crises. Many of the

is motivated by the fact that, up until late 2008, the

papers presented at the conference addressed one

crisis had very different effects on many foreign

of two broad questions. The first is, how integrated
are international financial markets and how effective are they at sharing resources and risk? Second,
what are the channels through which financial

The papers presented can be found online at dallasfed.org/
institute/events/09capital.cfm. The names mentioned in bold
throughout this summary are those of the presenters at the
conference.
1

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 25

countries. If these differences depend closely on

crises in one market affect others, it is important to

how much those countries were linked to the

understand financial integration in the first place—

markets for U.S. MBS or short-term U.S. dollar

the degree to which it has progressed and the

funding—arguably the markets where the financial reasons it has done so. Moreover, the various chancrisis originated—then the way the financial crisis

nels of international financial transmission are not

was transmitted abroad would be fairly clear. For-

obvious, so it is also important to understand what

eign financial institutions that directly held a lot of

they are and how they work.

U.S. MBS would have sustained tremendous losses
when the market for these assets turned sour, and

How Integrated Are Financial Markets?

foreign institutions dependent on dollar funding

It is common to point to the rise of cross-

would have run into trouble when funding in these border asset holdings as evidence of international
markets dried up. However, interestingly, Kamin

financial integration. While such observations

and Pounder find that these direct financial links

tell us a lot about how integrated economies are,

explain very little of the decline in financial sector

they leave open the questions of why this trade in

indicators in foreign countries; some with very

financial assets matters, and what exactly are the

little exposure to U.S. MBS had quite negative ef-

frictions or conditions that make financial markets

fects on their financial institutions, and vice versa.

more or less imperfect. For these reasons, a long

In a paper coauthored with Shang-Jin Wei

line of research has used theoretical models to

from Columbia University, Hui Tong from the

understand the role of financial market integration

IMF also addressed the issue of how the effects

and the degree to which certain market frictions

of the current crisis were transmitted abroad.

can rationalize the observed data. In the context

Tong and Wei’s paper, in contrast to Kamin and

of short-run economic fluctuations, standard

Pounder’s, looks at how nonfinancial firms fared in theory provides a role for international financial
countries with different levels of dependence on

markets to move resources to their most produc-

foreign capital flows. The paper asks whether firms tive location, as well as to share risk. International
operating in sectors that tend to depend heavily

trade in financial assets allows a country with a

on outside financing experienced more severe

boom to receive investment from abroad, tempo-

liquidity problems in countries more dependent

rarily importing more than it exports. In addition,

on foreign capital inflows. Tong and Wei find that

domestic and foreign households trade financial

while higher overall inflows of foreign capital

assets to smooth out fluctuations in their income

were associated with more severe effects on firms,

stream and consumption. The level of financial

the composition of capital flows matters as well.

market integration can in part be understood from

Foreign capital in the form of foreign direct invest-

measuring how effective these mechanisms are,

ment (FDI) was less a culprit than non-FDI capital. and four of the conference papers approach this
The reasoning behind this may be that FDI, in the
form of foreign multinationals buying out exist-

task from different angles.
The basic idea of shifting resources to where

ing firms or creating subsidiaries, is a more stable

they can be most productively used implies that

source of foreign financing than non-FDI capital,

country pairs with highly integrated financial

including debt or portfolio equity investment.

markets should have less synchronized output

These two papers show how thinking about

fluctuations than country pairs with less financial

the current financial crisis brings one back to the

integration. However, the rise of global financial

two main questions raised above. If financial mar-

integration has coincided with more interna-

kets in different countries are so integrated that

tional business cycle synchronization, not less.

26 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Sebnem Kalemli-Ozcan from the University of

frame and set of countries that do not include ma-

Houston, in a paper with Elias Papaioannou from

jor financial disruptions, so it aims to understand

Dartmouth College and José Luis Peydró from

the functioning of financial markets in “normal”

the European Central Bank, sheds some light on

times. Whether this is different from the transmis-

this apparent contradiction. Their paper consid-

sion effects of financial markets during periods of

ers data on cross-border banking—the amounts

financial stress is a topic that comes up in several

of foreign assets and liabilities banks in a country

other conference papers.

have—to reevaluate the relationship between

Looking at implications for consumption rath-

financial integration and output synchronization.

er than output, Robert Kollmann from Université

Kalemli-Ozcan, Papaioannou and Peydró find that

Libre de Bruxelles presented a paper addressing

when financial integration is measured at the level

the risk-sharing role of international financial mar-

of individual banks, country pairs that are more

kets. Models with perfect financial markets predict

integrated do have less synchronized business

that relative consumption between two countries

cycles; that is, there is evidence of the standard

should be tightly linked with the real exchange

resource shifting mechanism. The main difference

rate—the relative price of national consumption

with previous work is the authors’ ability to use the

baskets, expressed in a common currency. This

Steve Kamin from the Federal

microlevel bank data to control for common global means that the functioning of financial markets

Reserve Board and Alessandro

factors that have increased both financial integra-

Rebucci from Inter-American

tion and business cycle synchronization over time. consumption basket is relatively inexpensive

Development Bank

Importantly, however, the paper considers a time

ensures that households in a country whose
compared with that of a trading partner temporarily consume relatively more. Again, this is another
prediction that is not borne out in the data, where
there is a very weak relationship between relative
consumption and real exchange rates. Kollmann
presented a model in which some households
do not have access to financial markets, a feature
motivated by a widely noted observation that
a large fraction of households in the U.S. actually hold no financial assets and therefore just
consume their income. In Kollmann’s model, the
presence of these “hand-to-mouth” consumers can
break the link between aggregate consumption
and real exchange rates. The lesson of the paper is
that, from the perspective of sharing consumption
risk, international financial integration is far from
complete, but this has more to do with households’
access to financial assets than with the development of financial markets.
In another paper highlighting the difference
between international and domestic financial markets, Diego Valderrama from the Federal Reserve
Bank of San Francisco (in joint work with Katherine Smith from the U.S. Naval Academy) considers

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 27

why the composition of capital flows in developing ciation and expenditure on imports would decline,
economies is so different from that in industrial-

closing the deficit. Since the early ’90s, however,

ized economies. Specifically, developing countries

the U.S. has run a sustained trade deficit, despite

have large inflows of FDI and outflows—or smaller a persistent depreciation of the U.S. dollar. Dong’s
inflows—of debt, while developed economies tend

paper attributes this largely to the fact that imports

to have the opposite pattern. Smith and Valder-

and exports have become less sensitive to changes

rama build on the observation that it is costlier in

in their relative prices. She points to higher costs

developing countries for firms to issue debt than it

for domestic distribution and increased rigidity in

is in developed economies. This provides multina-

prices as possible explanations for why changes in

tional firms the incentive to purchase firms in de-

import and export prices do not pass through as

veloping countries and use their more developed

strongly to the quantities of goods imported and

financial markets to finance debt; FDI provides

exported. The paper addresses the need to think

the channel for this. At the same time, households

about international financial markets in the con-

would like to save some of their income to smooth

text of a broader environment, including interna-

out fluctuations; they do this by lending abroad

tional trade in goods.

because of the higher costs domestic firms face
to borrow. The message in this paper is again that

Channels of Financial Transmission

seemingly incompatible observations can be ratio-

The second broad set of questions addressed

nalized as the product of individuals’ participation

in the conference papers covers the mechanisms

in financial markets, as imperfections in these

by which shocks are transmitted through the

markets affect their decisions and therefore also

financial system to the rest of the economy. These

affect macroeconomic aggregates.

questions are of direct relevance when thinking

While international trade in financial assets

about the current financial crisis, and the papers

certainly has effects on consumption, output

covered various ways in which frictions in finan-

and the composition of capital flows, its most

cial markets can propagate or amplify shocks to

direct mechanical manifestation is simply in the

generate severe recessions.

balance of trade in goods. A country that imports

Three papers addressed in detail the effects

more than it exports is borrowing from its trading

of collateral and leverage in the financial system:

partners, and a country whose exports outstrip

those by Anton Korinek from the University of

imports is lending to its trading partners. Indeed,

Maryland (coauthored with Olivier Jeanne from

without cross-country trade in financial assets,

Johns Hopkins University), Michael Devereux

there can be no gap between a country’s exports

from the University of British Columbia (coau-

and imports. In reality, trade imbalances are signif- thored with James Yetman from the Bank for Inicant—most clearly illustrated by the large and per- ternational Settlements, Hong Kong) and Enrique
sistent trade deficit of the U.S. with the rest of the

Mendoza from the University of Maryland. These

world. In her paper at the conference, Wei Dong

papers all study a basic mechanism by which

from the Bank of Canada asks what can account

small shocks can trigger large real macroeconomic

for the behavior of the U.S. trade balance in recent

effects through asset prices. In the presence of

decades. The question is motivated by the obser-

a collateral constraint (alternatively a leverage con-

vation that, prior to the early 1990s, a standard

straint), individuals—such as banks, households or

mechanism naturally stabilizing the trade balance

firms—cannot borrow more than a certain fraction

seemed to be working: A country with a large trade of the value of their assets. When this constraint is
deficit would experience an exchange rate depre-

binding, a small negative shock to asset prices can

28 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

generate large effects: The value of collateral falls,

argue that moderate taxes on foreign borrowing in-

causing borrowing and consumption to decline,

hibit excessively large credit booms and therefore

which can reduce the value of assets further, caus-

reduce or eliminate the chances of an economy

ing a cycle of asset price declines and reduced bor- experiencing severe credit busts.
rowing and consumption. The three papers apply
this basic mechanism in various ways.
Jeanne and Korinek explain how an economy

Devereux and Yetman consider the effects
of collateral constraints on the international
transmission of shocks. The motivation for this

borrowing from abroad can experience credit

question is the widely noted observation that

booms and busts that are inefficiently large from a

the current financial crisis spread very quickly to

social perspective. Rising asset prices increase the

many countries, even between those that did not

value of collateral and so allow further borrowing,

have close links through international trade. The

making it more likely that the collateral constraint

more important links between these countries

is eventually hit, triggering the decline described

may be through financial markets, but the channel

above. This is socially inefficient because of an

of transmission through international financial

externality: An individual who takes on more debt

linkages is not clearly understood. (In fact, the

does not take into account the effect this action

general intuition described in the previous sec-

Igor Livshits from the University

has on asset prices and therefore on others’ bor-

tion, and one of the paper’s results, indicate that in

of Western Ontario and Robert

rowing constraints. As such, Jeanne and Korinek

normal times financial links should in fact dampen

Kollmann from the Université

propose the classic solution to dealing with an

transmission of shocks.) Devereux and Yetman

Libre de Bruxelles

externality: a tax on individuals’ borrowing. They

argue that the basic mechanism working through
collateral constraints can explain international
transmission of shocks through financial linkages.
Since investors in a country diversify their asset
holdings between domestic and foreign assets,
shocks to the foreign country that decrease foreign
asset prices can lower the value of the domestic
investor’s collateral and therefore lower domestic
borrowing and consumption because of a tighter
collateral constraint.
Mendoza’s paper is a contribution toward
understanding if the effects of collateral constraints matter quantitatively for macroeconomic
aggregates. Specifically, under standard assumptions on economic behavior, would we ever expect
these constraints to have large macroeconomic
effects? If so, what are the conditions for that to
happen? Mendoza shows that, in fact, introducing
collateral constraints into a standard quantitative
theoretical framework can result in financial crises
as infrequent, but recurrent, events. Importantly,
a shock does not need to be exceptionally large
or of unusual nature for a financial crisis to occur.
The buildup of debt can bring the economy close

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 29

to its collateral constraint, when a small shock can

are silent on the effects of financial frictions and

trigger the declining asset price–collateral–bor-

the transmission of shocks through financial inter-

rowing cycle described above. This type of event

mediaries, but Dib’s work presents a framework in

would be infrequent because households typically

which these effects can be studied. He finds that

accumulate precautionary savings, which keeps

the presence of an active banking sector with a

them out of the region of debt where constraints

frictional interbank market can amplify the effects

threaten to bind.

of supply-side shocks but dampen the effects

Two other papers in the conference, by Igor

of financial shocks. In addition, his framework

Livshits from the University of Western Ontario

provides a role for the sorts of unconventional

(coauthored with Koen Schoors from the Uni-

monetary policies pursued by the Fed and many

versity of Ghent) and Ali Dib from the Bank of

central banks over the past year, including liquidity

Canada, illustrate the role of the banking sector in

injections and asset swaps.

the transmission of shocks. Regulation on banks’

The overall lessons from the papers at this

capital adequacy and leverage has been at the

conference reflect the progress that comes with

center of the discussion on reforming the financial

sharing insights among researchers working in

system, so it is important to understand the bank-

various fields. Indeed, some of the clearest implica-

ing system and how bank regulation affects the

tions for understanding the current crisis in the

economy.

U.S. may come from the work on emerging-market

Livshits’ paper addresses questions on how

debt crises, as in the papers presented by Mendoza

banking regulation should respond to changes in

and Korinek. Another theme of the conference

the riskiness of assets. Prudential banking regula-

papers, aside from the topics each one addressed,

tion aims to curtail excessive risk taking, and it is

was the integration of the analysis of “normal” eco-

standard practice to do this by providing incen-

nomic conditions with the study of crisis periods.

tives for banks to hold safe assets. However, when

From the perspective of understanding why crises

the risk of safe assets rises, the failure of banking

happen and what the policy implications are, this

regulation to recognize this change can make the

is an extremely important step. The policy implica-

banking system vulnerable. Livshits illustrates this

tions of some of the work presented at the confer-

with a stark example: In 1998, bank regulation in

ence reflect the importance of this integration.

Russia considered the government’s debt to be

For example, both Korinek and Jeanne’s results

safe, even as the risk of default on this debt was

and Mendoza’s paper show that it is important to

rising. This policy encouraged banks to gamble on

consider how policies affect the incentives to accu-

risky currency securities to the point that when the mulate debt before a crisis. More generally, many
government did finally default, the banking system of the other papers presented illustrate the need to
crashed. This paper, therefore, carries important

understand the degree of integration of financial

lessons on the effects of bank regulation and raises markets and the channels of financial transmisquestions about the best way to induce efficient

sion in order to form policy that works through

investment by banks.

their operation. The overall picture is encouraging

Dib’s paper makes progress on understanding

for future research developing these ideas further.

the macroeconomic effects of banking by introducing a banking sector that intermediates credit
into a variant of the models used by many central
banks for policy analysis. Typically, these models

—Ananth Ramanarayanan

30 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Globalization and Monetary
Policy Institute Publications
Abstracts of Working Papers Issued from October 2008 through October 2009

No. 21

No. 22

Vertical Specialization and Interna-

The Taylor Rule and Forecast Intervals

tional Business Cycle Synchronization

for Exchange Rates

Costas Arkolakis and Ananth Ramanarayanan

Jian Wang and Jason J. Wu

Abstract: We explore the impact of vertical spe-

Abstract: This paper attacks the Meese–Rogoff

cialization—trade in goods across multiple stages

(exchange rate disconnect) puzzle from a dif-

of production—on the relationship between trade

ferent perspective: out-of-sample interval fore-

and international business cycle synchroniza-

casting. Most studies in the literature focus on

tion. We develop a model in which the degree of

point forecasts. In this paper, we apply Robust

vertical specialization is endogenously determined Semi-parametric (RS) interval forecasting to a
group of Taylor rule models. Forecast intervals for
by comparative advantage across heterogeneous
goods and varies with trade barriers between

twelve OECD exchange rates are generated, and

countries. We show analytically that fluctuations

modified tests of Giacomini and White (2006) are

in measured productivity in our model are not

conducted to compare the performance of Taylor

linked across countries through trade, despite the

rule models and the random walk. Our contribu-

greater transmission of technology shocks implied

tion is twofold. First, we find that in general, Taylor

by higher degrees of vertical specialization. In

rule models generate tighter forecast intervals than

numerical simulations, we find this transmission

the random walk, given that their intervals cover

is insufficient in generating substantial depen-

out-of-sample exchange rate realizations equally

dence of business cycle synchronization on trade

well. This result is more pronounced at longer hori-

intensity.

zons. Our results suggest a connection between
exchange rates and economic fundamentals:

Published as “Vertical Specialization and Inter-

economic variables contain information useful

national Business Cycle Synchronization” in

in forecasting the distributions of exchange rates.

Scandinavian Journal of Economics, vol. 111, no. 4,

The benchmark Taylor rule model is also found to

2009, pp. 655–80.

perform better than the monetary and PPP models. Second, the inference framework proposed
in this paper for forecast-interval evaluation can
be applied in a broader context, such as inflation
forecasting, not just to the models and interval
forecasting methods used in this paper.

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 31

No. 23

after G7 meetings, but not at longer horizons.

Exchange Rate Pass-Through in a

While the success of the G7 is partly dependent on

Competitive Model of Pricing-to-Market the market environment, it is also to a significant
Raphael Auer and Thomas Chaney
degree endogenous to the policy process itself. The
Abstract: This paper extends the Mussa and Rosen

findings indicate that the reputation and cred-

(1978) model of quality-pricing under perfect

ibility of the G7, as well as its ability to form and

competition. Exporters sell goods of different

communicate a consensus among individual G7

qualities to consumers who have heterogeneous

members, are important determinants for the G7’s

preferences for quality. Production is subject to de- ability to manage major currencies. The paper concreasing returns to scale and, therefore, supply and cludes by analyzing the factors that help the G7
the toughness of competition react to cost changes build reputation and consensus and by discussing
brought about by exchange rate fluctuations. First, the implications for global economic governance.
we predict that exchange rate shocks are imperfectly passed through into prices. Second, prices of

Published as “How Successful Is the G7 in Manag-

low quality goods are more sensitive to exchange

ing Exchange Rates?” in the Journal of Internation-

rate shocks than prices of high quality goods.

al Economics, vol. 79, no. 1, 2009, pp. 78–88.

Third, in response to an exchange rate appreciation, the composition of exports shifts towards

No. 25

higher quality and more expensive goods. We test

Do China and Oil Exporters Influence

these predictions using highly disaggregated price

Major Currency Configurations?

and quantity U.S. import data. We find evidence

Marcel Fratzscher and Arnaud Mehl

that in response to an exchange rate appreciation,

Abstract: This paper analyses the impact of the

the composition of exports shifts towards high unit shift away from a U.S. dollar focus of systemically
price goods. Therefore, exchange rate pass-through important emerging market economies (EMEs)
rates that are measured using aggregate data will

on configurations between the U.S. dollar, the

tend to overstate the actual extent of pass-through.

euro and the yen. Given the difficulty that fixed or
managed U.S. dollar exchange rate regimes remain

Published as “Exchange Rate Pass-Through in a

pervasive and reserve compositions mostly kept

Competitive Model of Pricing-to-Market” in Jour-

secret, the identification strategy of the paper is

nal of Money, Credit and Banking, Supplement to

to analyse the market impact on major currency

vol. 41, no. 1, 2009, pp. 151–75.

pairs of official statements made by EME poli-

No. 24

cymakers about their exchange rate regime and
reserve composition. Developing a novel database

How Successful Is the G7 in Managing for 18 EMEs, we find that such statements not only
Exchange Rates?
have a statistically but also an economically sigMarcel Fratzscher

nificant impact on the euro, and to a lesser extent

Abstract: The paper assesses the extent to which

the yen against the U.S. dollar. The findings suggest

the Group of Seven (G7) has been successful in its

that communication hinting at a weakening of

management of major currencies since the 1970s.

EMEs’ U.S. dollar focus contributed substantially to

Using an event-study approach, the paper finds

the appreciation of the euro against the U.S. dollar

evidence that the G7 has been overall effective

in recent years. Interestingly, EME policymakers

in moving the U.S. dollar, yen and euro in the in-

appear to have become more cautious in their

tended direction at horizons of up to three months communication more recently. Overall, the results

32 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

underscore the growing systemic importance of

to hold diversified portfolios. We show that the

EMEs for global exchange rate configurations.

interaction of the following ingredients generates
a realistic equity home bias: capital accumulation,

Published as “Do China and Oil Exporters Influ-

shocks to the efficiency of physical investment, as

ence Major Currency Configurations?” in Journal

well as international trade in stocks and bonds.

of Comparative Economics, vol. 37, no. 3, 2009, pp.

In our model, domestic stocks are used to hedge

335–58.

fluctuations in local wage income. Terms of trade
risk is hedged using bonds denominated in local

No. 26

goods and in foreign goods. In contrast to related

Monthly Pass-Through Ratios

models, the low level of international diversifica-

Marlene Amstad and Andreas M. Fischer

tion does not depend on strongly countercyclical

Abstract: This paper estimates monthly pass-

terms of trade. The model also reproduces the

through ratios from import prices to consumer

cyclical dynamics of foreign asset positions and of

prices in real time. Conventional time series meth-

international capital flows.

ods impose restrictions to generate exogenous
shocks on exchange rates or import prices when

Published as “International Portfolios, Capital

estimating pass-through coefficients. Instead,

Accumulation and Foreign Assets Dynamics” in

a natural experiment based on data releases

Journal of International Economics, vol. 80, no. 1,

defines our shock to foreign prices. Our estimation

2010, pp. 100–12.

strategy follows an event-study approach based
on monthly releases in import prices. Projections

No. 28

from a dynamic common factor model with daily

Investment and Trade Patterns in a

panels before and after monthly releases of import

Sticky-Price, Open-Economy Model

prices define the shock. This information shock

Enrique Martínez-García and Jens Søndergaard

allows us to recover a monthly pass-through ratio.

Abstract: This paper develops a tractable two-

We apply our identification procedure to Swiss

country DSGE model with sticky prices à la Calvo

prices and find strong evidence that the monthly

(1983) and local-currency pricing. We analyze

pass-through ratio is around 0.3. Our real-time

the capital investment decision in the presence of

estimates yield higher pass-through ratios than

adjustment costs of two types, the capital adjust-

time series estimates.

ment cost (CAC) specification and the investment adjustment cost (IAC) specification. We

No. 27

compare the investment and trade patterns with

International Portfolios, Capital Accu-

adjustment costs against those of a model without

mulation and Foreign Assets Dynamics adjustment costs and with (quasi-) flexible prices.
Nicolas Coeurdacier, Robert Kollmann and

We show that having adjustment costs results

Philippe Martin

into more volatile consumption and net exports,

Abstract: Despite the liberalization of capital

and less volatile investment. We document three

flows among OECD countries, equity home bias

important facts on U.S. trade: a) the S-shaped

remains sizable. We depart from the two familiar

cross-correlation function between real GDP and

explanations of equity home bias: transaction

the real net exports share, b) the J-curve between

costs that impede international diversification,

terms of trade and net exports, and c) the weak

and terms of trade responses to supply shocks that and S-shaped cross-correlation between real GDP
provide risk sharing, so that there is little incentive

and terms of trade. We find that adding adjustment

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 33

costs tends to reduce the model’s ability to match

tral monetary authority. When capital markets are

these stylized facts. Nominal rigidities cannot ac-

integrated, the fiscal policy of one country will in-

count for these features either.

fluence equilibrium wages and interest rates. Thus,
there are fiscal spillovers within a federation. The

Published as “Investment and Trade Patterns in a

magnitude and direction of these spillovers, in par-

Sticky-Price, Open-Economy Model” in The Eco-

ticular the presence of a crowding out effect, can

nomics of Imperfect Markets: The Effect of Market

be influenced by the choice of monetary policy

Imperfections on Economic Decision-Making,

rules. We find that there does not exist a monetary

Giorgio Calcagnini and Enrico Saltari, ed., New

policy rule that completely insulates agents in one

York: Springer, 2009

region from fiscal policy in another. Some familiar
policy rules, such as pegging an interest rate, can

No. 29

provide partial insulation.

Monetary Policy Strategy in a
Global Environment

No. 31

Philippe Moutot and Giovanni Vitale

Fiscal Stabilization with Partial

Abstract: Since the mid-1980s the world economy

Exchange Rate Pass-Through

has gone through profound transformations of

Erasmus K. Kersting

which the sources and effects are probably not yet

Abstract: This paper examines the role of fiscal sta-

completely understood. The process of continu-

bilization policy in a two-country framework that

ous integration in trade, production and financial

allows for a general degree of exchange rate pass-

markets across countries and economic regions—

through. I derive analytical solutions for optimal

which is what is generally defined as “globaliza-

monetary and fiscal policy which are shown to

tion”—affects directly the conduct of monetary

depend on the degree of pass-through. In the case

policy in a variety of respects. The aim of this paper of partial pass-through, an optimizing policymaker
is to present an overview of the structural implica-

uses countercyclical fiscal stabilization in addition

tions of globalization for the domestic economies

to monetary stabilization. However, in the extreme

of developed countries and to deduct from these

cases of complete or zero pass-through, the fiscal

implications lessons for the conduct of monetary

stabilization instrument is not employed. There

policy, and in particular the assessment of risks to

is also no additional gain from the fiscal instru-

price stability.

ment in the case of coordination between the two
countries. These results are due to the specific

Published as “Monetary Policy Strategy in a Global way the optimal fiscal policy rule affects marginal
Environment, “ European Central Bank, Occasion-

costs: Rather than being a substitute for monetary

al Paper, no. 106, August 2009.

policy, fiscal policy complements it by increasing
the correlation of the marginal cost terms within

No. 30

and across countries. This in turn makes monetary

Insulation Impossible: Fiscal

policy more effective at stabilizing them.

Spillovers in a Monetary Union
Russell Cooper, Hubert Kempf and Dan Peled
Abstract: This paper studies the effects of monetary policy rules in a monetary union. The focus of
the analysis is on the interaction between the fiscal
policy of member countries (regions) and the cen-

34 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

No. 32

domestic inflation rates by estimating a structural

Has Globalization Transformed U.S.

model for a sample of G-7 economies. The model

Macroeconomic Dynamics?

can capture the potential effects of global output

Fabio Milani

fluctuations on both the aggregate supply and the

Abstract: This paper estimates a structural New

aggregate demand relations in the economy, and it

Keynesian model to test whether globalization

is estimated using full-information Bayesian meth-

has changed the behavior of U.S. macroeconomic

ods. The empirical results reveal a significant effect

variables. Several key coefficients in the model—

of global output on aggregate demand in most

such as the slopes of the Phillips and IS curves,

countries. Through this channel, global economic

the sensitivities of domestic inflation and output

conditions can indirectly affect inflation. The

to “global” output, and so forth—are allowed in the

results, instead, do not seem to provide evidence

estimation to depend on the extent of globalization in favor of altering domestic Phillips curves to in(modeled as the changing degree of openness to

clude global slack as an additional driving variable

trade of the economy), and, therefore, they be-

for inflation.

come time-varying. The empirical results indicate
that globalization can explain only a small part of

No. 34

the reduction in the slope of the Phillips curve. The

Should Monetary Policy

sensitivity of U.S. inflation to global measures of

“Lean or Clean”?

output may have increased over the sample, but

William R. White

it remains very small. The changes in the IS curve

Abstract: It has been contended by many in the

caused by globalization are similarly modest. Glo-

central banking community that monetary policy

balization does not seem to have led to an attenu-

would not be effective in “leaning” against the

ation in the effects of monetary policy shocks. The

upswing of a credit cycle (the boom) but that

nested closed economy specification still appears

lower interest rates would be effective in “cleaning”

to provide a substantially better fit of U.S. data than up (the bust) afterwards. In this paper, these two
various open economy specifications with time-

propositions (can’t lean, but can clean) are exam-

varying degrees of openness. Some time variation

ined and found seriously deficient. In particular, it

in the model coefficients over the postwar sample

is contended in this paper that monetary policies

exists, particularly in the volatilities of the shocks,

designed solely to deal with short-term problems

but it is unlikely to be related to globalization.

of insufficient demand could make medium-term
problems worse by encouraging a buildup of debt

No. 33

that cannot be sustained over time. The conclusion

Global Slack and Domestic Inflation

reached is that monetary policy should be more

Rates: A Structural Investigation for

focused on “preemptive tightening” to moderate

G-7 Countries

credit bubbles than on “preemptive easing” to

Fabio Milani

deal with the aftereffects. There is a need for a new

Abstract: Recent papers have argued that one im-

macrofinancial stability framework that would

plication of globalization is that domestic inflation

use both regulatory and monetary instruments to

rates may have now become more a function of

resist credit bubbles and thus promote sustainable

“global,” rather than domestic, economic condi-

economic growth over time.

tions, as postulated by closed-economy Phillips
curves. This paper aims to assess the empirical importance of global output in determining

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 35

No. 35

if the power of the corresponding short-horizon

European Hoarding: Currency Use

regression is low. We simulate population R-

Among Immigrants in Switzerland

squared for long-horizon regressions in the latter

Andreas M. Fischer

setting, using Monetary and Taylor rule models of

Abstract: Do immigrants have a higher demand

exchange rates calibrated to the data. Simulations

for large-denominated banknotes than natives?

show that long-horizon regression can have sub-

This study examines whether cash orders for CHF

stantial forecasting power for exchange rates.

1000 notes, a banknote not used for daily transactions, is concentrated in Swiss cities with a high

No. 37

foreign-to-native ratio. Controlling for a range of

Global, Local, and Contagious Inves-

socio-economic indicators across 250 Swiss cities,

tor Sentiment

European immigrants in Switzerland are found to

Malcolm Baker, Jeffrey Wurgler and Yu Yuan

hoard fewer CHF 1000 banknotes than natives. A

Abstract: We construct indexes of investor senti-

1 percent increase in the immigrant-to-native ratio

ment for six major stock markets and decompose

leads to a reduction in currency orders by CHF

them into one global and six local indexes. Relative

4000. This negative correlation between immi-

market sentiment is correlated with the relative

grant-to-native ratio and currency orders for CHF

prices of dual-listed companies, validating the in-

1000 notes holds irrespective of the European

dexes. Both global and local sentiment are contrar-

immigrants’ country of origin. Hoarding of large-

ian predictors of the time series of major markets’

denominated banknotes by natives is attributed to

returns. They are also contrarian predictors of the

tax avoidance.

time series of cross-sectional returns within major
markets: When sentiment from either global or

No. 36

local sources is high, future returns are low on

Can Long-Horizon Forecasts Beat the

various categories of difficult-to-arbitrage and

Random Walk Under the Engel–West

difficult-to-value stocks. Sentiment appears to be

Explanation?

contagious across markets based on tests involv-

Charles Engel, Jian Wang and Jason Wu

ing capital flows, and this presumably contributes

Abstract: Engel and West (EW, 2005) argue that

to the global component of sentiment.

as the discount factor gets closer to one, presentvalue asset pricing models place greater weight

No. 38

on future fundamentals. Consequently, current

A Model of International Cities: Impli-

fundamentals have very weak forecasting power

cations for Real Exchange Rates

and exchange rates appear to follow approxi-

Mario J. Crucini and Hakan Yilmazkuday

mately a random walk. We connect the Engel–

Abstract: We develop a model of cities each inhab-

West explanation to the studies of exchange rates

ited by two agents, one specializing in manufactur-

with long-horizon regressions. We find that under

ing, the other in retail distribution. The distribution

EW’s assumption that fundamentals are I(1) and

sector represents the physical transformation of all

observable to the econometrician, long-horizon

internationally traded goods from the factory gate

regressions generally do not have significant

to the final consumer. Using a panel of micro-pric-

forecasting power. However, when EW’s assump-

es at the city level, we decompose the cross-sec-

tions are violated in a particular way, our analytical tional variance of long-run LOP deviations into the
results show that there can be substantial power

fraction due to distribution costs, trade costs and a

improvements for long-horizon regressions, even

residual. For the median good, trade costs account

36 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

for 50 percent of the variance, distribution costs

components to estimate co-movements between

account for 10 percent with 40 percent of the vari-

remittances and output series. Empirical results

ance unexplained. Since the sample of items in the

indicate that remittances are countercyclical with

data are heavily skewed toward traded goods, we

all the home countries: Mexico, El Salvador and

also decompose the variance based on the median Turkey. With respect to source countries, remitgood on an expenditure-weighted basis. Now the

tances to Mexico are countercyclical with the

tables turn, with distribution costs accounting for

United States business cycle, while remittances

43 percent, trade costs 36 percent and 21 percent

from the United States to El Salvador and remit-

of the variance unexplained.

tances from Germany to Turkey are strongly
procyclical with output fluctuations in the source

No. 39

country. The contribution of this paper to the

State-Dependent Pricing, Local-

literature is twofold: (1) I use high-frequency data

Currency Pricing, and Exchange Rate

(quarterly) for a relatively long period of time;

Pass-Through

and (2) I employ more recent and sophisticated

Anthony Landry

econometric techniques in the decomposition of

Abstract: This paper presents a two-country DSGE

the series into stochastic permanent and cyclical

model with state-dependent pricing as in Dotsey,

components. The existing literature lacks both of

King, and Wolman (1999) in which firms price-

these important aspects of my analysis. I show that

discriminate across countries by setting prices in

once both of these factors are incorporated into

local currency. In this model, a domestic monetary the analysis, empirical results are more aligned to
expansion has greater spillover effects to foreign
prices and foreign economic activity than an
otherwise identical model with time-dependent
pricing. In addition, the predictions of the statedependent pricing model match the business-

those predicted by economic theory.

Working Papers Issued from October 2007
through September 2008

time-dependent pricing model when driven by

No. 1
Is Openness Inflationary? Imperfect Competition and Monetary Market Power

monetary policy shocks.

Richard W. Evans

No. 40

No. 2
A Monetary Model of the Exchange Rate
with Informational Frictions

cycle moments better than the predictions of the

Business Cycles and Remittances: Can
the Beveridge–Nelson Decomposition
Provide New Evidence?
Roberto Coronado

Enrique Martínez-García
Published as “A Model of the Exchange Rate with Informational Frictions,” in B.E. Journal of Macroeconomics, vol. 10,
no. 1, 2010, Contributions, Article 2.

Abstract: In this paper, I analyze the business cycle No. 3
International Trade in Durable Goods: Underproperties of remittances and output series for
three pairs of countries: United States–Mexico,
United States–El Salvador, and Germany–Turkey.
Using an unobserved components state-space
model (via the Beveridge–Nelson decomposition),
I decompose the remittances and output series
into stochastic permanent and cyclical components. I then use the resulting stationary cyclical

standing Volatility, Cyclicality, and Elasticities

Charles Engel and Jian Wang

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 37

No. 4
Cross-Border Returns Differentials

Stephanie E. Curcuru, Tomas Dvorak and
Francis E. Warnock
Published as “Cross Border Returns Differentials” in
Quarterly Journal of Economics, vol. 123, no. 4, 2008, pp.
1495–1530.
No. 5
Production Sharing and Real Business
Cycles in a Small Open Economy

José Joaquín López
No. 6
Driving Forces of the Canadian
Economy: An Accounting Exercise

Simona E. Cociuba and Alexander Ueberfeldt
No. 7
Accounting for Persistence and Volatility of
Good-Level Real Exchange Rates: The Role of
Sticky Information

Mario J. Crucini, Mototsugu Shintani and
Takayuki Tsuruga

No. 13
Globalization, Domestic Inflation and Global
Output Gaps: Evidence from the Euro Area

Alessandro Calza
No. 14
The Effect of Trade with Low-Income Countries on U.S. Industry

Raphael Auer and Andreas M. Fischer
No. 15
Variety, Globalization, and Social
Efficiency

W. Michael Cox and Roy J. Ruffin
No. 16
Technical Note on ‘The Real Exchange Rate
in Sticky Price Models:
Does Investment Matter?’

Enrique Martínez-García and Jens Søndergaard
No. 17
The Real Exchange Rate in Sticky Price Models: Does Investment Matter?

Published as “Accounting for Persistence and Volatility of
Good-Level Real Exchange Rates: The Role of Sticky Information” in Journal of International Economics, In press accepted manuscript, 2010, doi:10.1016/j.jinteco.2010.01.003.

Enrique Martínez-García and Jens Søndergaard

No. 8
How Should Central Banks Define Price
Stability?

Sophie Guilloux and Enisse Kharroubi

Mark A. Wynne
No. 9
Country Portfolios in Open Economy Macro
Models

Michael B. Devereux and Alan Sutherland
No. 10
Vehicle Currency

Michael B. Devereux and Shouyong Shi
No. 11
Globalization and Monetary Policy:
An Introduction

Enrique Martínez-García
No. 12
Financial Globalization, Governance, and the
Evolution of the Home Bias

Bong-Chan Kho, René M. Stulz and
Francis E. Warnock
Published as “Financial Globalization, Governance, and
the Evolution of the Home Bias” in Journal of Accounting
Research, vol. 47, no. 2, 2009, pp. 597–635.

No. 18
Some Preliminary Evidence on the Globalization–Inflation Nexus

No. 19
Default and the Maturity Structure
in Sovereign Bonds

Cristina Arellano and Ananth Ramanarayanan
No. 20
An International Perspective on
Oil Price Shocks and U.S.
Economic Activity

Nathan S. Balke, Stephen P. A. Brown and
Mine K. Yücel

38 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Facing Troubles in an
Era of Globalization
A Conversation with Nathan Sheets

Reprinted from Southwest

Q. For more than a year, we’ve been

Economy, First Quarter 2009,

trying to contain a global financial

Federal Reserve Bank of Dallas

crisis. What went wrong?
A. The global economy has sustained the most

Economist Nathan Sheets,

intense and far-reaching financial shock in at least

director of the Federal

number of factors have contributed to it. Most

Reserve Board’s Division of

important, our major financial institutions weren’t

International Finance, puts

There’s plenty of blame to go around. We should

a global perspective on the

also include credit rating agencies, the regulators,

current economic crisis and

down in the capacity to analyze and understand

the Fed’s response to it.

the risk in the system.

50 years, a truly phenomenal financial shock. A

managing risk in a careful and prudent way.

corporate boards and investors. There was a break-

A lot of folks see this crisis as first and foremost about housing. I see housing being more of
a trigger that brought this failure of risk management to light.

We’re now seeing those financial shocks
having a real impact on spending, production and

Q. What does all this mean for your

GDP across the globe. I see this occurring through

bailiwick—international finance?

three important channels.

A. The implications for the financial system are

First, banks’ willingness to lend has signifi-

profound. We’ve seen a huge increase in risk aver-

cantly deteriorated, so firms and individuals aren’t

sion among investors. We’ve seen marked stresses

getting the credit they need.

in various kinds of financial markets, ranging from
very short-term interbank markets all the way to

Second, we’ve seen a huge adverse wealth
shock. With stock markets down as much as 50

longer-term debt markets. Equity prices have fallen percent and housing prices falling in a number of
significantly. There aren’t many markets that have countries, people don’t have the balance sheets to
escaped the blow.

sustain spending.
Third, the financial developments have hit
consumer and business confidence. It’s true in the

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 39

U.S., U.K. and euro area, where the financial shock

Q. How does the international dimen-

has been intense, but it’s also true in emerging-

sion affect the Fed’s analysis and

market economies, where they didn’t have the

actions?

financial exposure.

A. Let me give you a concrete example. Many
financial institutions outside the U.S. have had

Q. How has the accelerating global-

significant demand for short-term dollar fund-

ization of recent decades shaped this

ing. They made loans to corporations in dollars or

crisis?

bought U.S.-denominated assets, and they needed

A. The fact that we’re more globalized now has

dollars to fund those assets. I can’t think of a previ-

been one of the extraordinary features of this crisis. ous instance of financial stress associated with
You look at trends in many financial markets—the

such pronounced demand for dollars outside our

U.S. line, the U.K. line, the euro-area line, the Japan

borders.

line—and they’re all moving together more or less

The interbank markets these institutions

in lockstep. The degree of integration has been

depended on for funding essentially froze up last

phenomenal.

fall, and it created huge excess demand for short-

Part of that is a reflection of the fact that

term dollar liquidity abroad. Many of these foreign

our financial markets were highly integrated, so

institutions would come to New York or other U.S.

subprime loans issued here ended up on foreign

markets in search of dollars, so it would at times

balance sheets. We’re also very integrated through

spill over into our markets and create stresses.

trade channels, meaning that the slowdown that’s

In response, the Fed joined with other major

occurred as a result of this financial shock has hit

central banks to create a network of swap facili-

other economies and fed back into ours.

ties, where we provide foreign central banks dollar

One way of framing this is the debate about

liquidity and they give us an equivalent amount

decoupling. If the U.S. economy slows or U.S.

of their currencies. They then lend these dollars to

financial markets encounter problems, what does

financial institutions in their economies that need

that mean for the rest of the world? There really

them. There’s very little risk for the Fed. We have

was quite an argument about decoupling until

claims on the foreign central banks as well as hold-

about six months ago, centered on the question of

ings of their currencies to protect us.

whether other countries could avoid the troubles

We have had to extend the scope and influ-

brewing in the United States. Now, it’s clear that we ence of our liquidity facilities beyond our national
rise and fall together.

borders, and that’s been a new challenge.

Given the degree of integration and similar
failures of risk management across the world, I

Q. Has globalization put greater

think this episode is in some sense deeper than it

emphasis on cooperation with other

would have been otherwise.

central banks?

That doesn’t mean that there aren’t many

A. Absolutely. Central banks regularly commu-

positive factors from globalization. There are

nicated through mechanisms that were already

important efficiency gains, for example, but we’re

in place, but the global stresses we’ve been facing

seeing that we’re tied together and that we have

have made it all the more important that central

many common vulnerabilities and shortcomings.

banks interact to keep each other informed and,

We need to work together to manage these chal-

where possible, even coordinate policy.

lenges and the responses to them.

The swap agreements are an important
example of this. Another is the coordinated inter-

40 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

est rate cuts by the Fed and other central banks

the moment is the so-called financial accelerator

in early October. Easing monetary policy was in

effect, where sharp declines in asset prices hit the

the interest of each of these economies, but there’s

balance sheets of firms and individuals and make

a strong additional statement that’s made when

them less creditworthy. This can be a mechanism

central banks show they’re cooperating to address

through which these kinds of financial shocks eat

global problems.

into the economy and become quite intense.
Another current issue is the zero lower

Q. What else will help us deal with

bound. What are the implications for policy and

global financial threats?

the economy once short-term interest rates, the

A. These aren’t just Fed issues but matters of the

traditional tool for monetary policy, have been cut

broader financial architecture. We need better

to nearly zero. What’s the next step?

mechanisms to address problems faced by very
large institutions that can be seen as too big to fail.

Q. How will this financial crisis affect

We also need a well-articulated resolution process

the pace of globalization?

for a wider range of financial institutions. We have

A. If anything, it may accelerate globalization in

a good mechanism for addressing commercial

the sense that we’re now very aware that we need

banks under stress, but there’s nothing comparable to work closely together with other countries on
for some other types of institutions.

such things as financial-sector supervision and
rating assets. Major financial institutions are truly

Q. More broadly, has globalization

global in scope, and if we’re approaching things

affected the way the Federal Reserve

one way and the French another and the Germans

does its job?

another and the British another, it creates disso-

A. It’s certainly different. These dollar-funding

nance in the global economy.

pressures I mentioned earlier are a manifestation

The leaders of the G-20 economies met in No-

of just how much things have changed. We see this vember in Washington, and they’re going to meet
increased interdependence among economies

again in early April in London. They’re in the midst

and the need for collaboration among central

of addressing many of these issues in a global way,

banks and regulators in various countries.

and I think we’ll find that process has some staying

Some people have argued that the effective-

power. We’ll end up more integrated, more coher-

ness of monetary policy is being diminished,

ent and more consistent across countries than we

and I don’t see that. Globalization has shifted

were before this crisis erupted.

the range of variables and the things you need to

Along the way, there’s risk of protectionism

think about. You need to focus not only on what’s

emerging. History teaches that we’re more pros-

going on within your own borders and your own fi- perous if we’re open rather than closed—especially
nancial markets but also on what’s going on in the

at times like this. Think about what happened

rest of the world and in global financial markets.

in the Great Depression, when countries put up

There are feedback effects that are significant for

sizable tariffs and global trade collapsed. That can

assessing economic conditions and making policy

start a downward spiral for the global economy, so

decisions.

we have to guard very forcefully against protec-

We’re constantly trying to expand our analytical tool kit and improve our understanding of how
economies and policies work. It’s not explicitly
global, but one issue we’re thinking hard about at

tionism.

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 41

Who’s Who at the Institute
Director of the Institute

Senior Fellows

Mark A. Wynne joined the Federal Reserve Bank

Marianne Baxter is a professor of economics at

of Dallas in 1989 and is currently a senior econo-

Boston University. Her research interests include

mist and vice president. He is widely published

macroeconomics, international economics and

in many leading professional journals. During

finance. Baxter’s current work studies the effect

1997–98, Wynne worked on issues related to

of alternative monetary policy rules in highly

monetary policy strategy under economic and

integrated, globalized industrial economies. She

monetary union for the European Monetary

previously taught at the Universities of Virginia,

Institute and, later, the European Central Bank.

Rochester and California, Santa Barbara. She also

He holds first-class honors B.A. and M.A. degrees

served on the president’s advisory committee at

from the National University of Ireland (University

the Federal Reserve Bank of New York and has

College, Dublin) and an M.A. and a Ph.D. from the

been a visiting scholar at the Federal Reserve

University of Rochester.

Banks of Richmond, New York, Chicago and Minneapolis. Baxter received a B.A. in economics and

Advisory Board Chairman

statistics from the University of Rochester and her

John B. Taylor is Mary and Robert Raymond

Ph.D. in economics from the University of Chicago.

Professor of Economics at Stanford University. He
is a globally recognized expert on international

W. Michael Cox is director of the O'Neil Center for

monetary and financial issues and has produced

Global Markets and Freedom at Southern Method-

extensive research on monetary policy, fiscal

ist University's Cox School of Business and former

policy and international economic policy. Taylor

senior vice president and chief economist at the

is recognized throughout the economics profes-

Dallas Fed. He is author of a host of essays and

sion and within monetary policy circles as the

reports that have received extensive attention from

originator of the Taylor rule, a guiding principle for

leading publications including the Wall Street Jour-

macroeconomic stabilization followed by many

nal, New York Times and USA Today. He is also

central banks. He also serves as senior fellow at

widely published in the nation's leading economic

the Hoover Institution and Stanford Institute for

journals. Cox received an undergraduate degree

Economic Policy Research, was founding director

in business and economics from Hendrix College

of the Stanford Introductory Economics Center

and a Ph.D in economics from Tulane University.

and is a research associate at the National Bureau
of Economic Research. Taylor has many years of

Mario Crucini is an associate professor of eco-

distinguished service with the U.S. government,

nomics at Vanderbilt University. He is currently

most recently as undersecretary of Treasury for

an associate editor of the Journal of International

international affairs from 2001 to 2005. He was a

Economics and the Journal of Money, Credit and

member of the president’s Council of Economic

Banking. He is also a member of the board of

Advisers from 1989 to 1991. He received a B.A. in

editors of the Review of International Economics.

economics from Princeton University and a Ph.D.

Crucini has written widely on international busi-

in economics from Stanford University.

ness cycles, the contribution of trade policy to the

42 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Great Depression and, most recently, international Francis E. Warnock is associate professor of
pricing. He received a B.A. from the University of

business administration at the Darden Graduate

Western Ontario and an M.A. and Ph.D. from the

School of Business at the University of Virginia.

University of Rochester.

He is currently a faculty research fellow at the
National Bureau of Economic Research and a

Michael B. Devereux is professor of economics

research associate at the Institute for International

at the University of British Columbia and a visiting

Integration Studies at Trinity College Dublin. He

scholar at the International Monetary Fund in

was recently a consultant at the International

Washington, D.C. He is widely published in leading

Monetary Fund and a research fellow at the Hong

economic journals and is associate editor of the In-

Kong Monetary Authority. In addition, he served

ternational Journal of Central Banking. He received for several years as senior economist in the Intera B.A. in economics and politics and an M.A. in

national Finance Division at the Federal Reserve

economics from University College, Dublin, and a

Board. Warnock received a B.A. from Johns Hop-

Ph.D. from Queen’s University, Kingston, Ontario.

kins University and Ph.D. from the University of
North Carolina at Chapel Hill.

Charles Engel is professor of economics at the
University of Wisconsin–Madison and a research

Institute Staff Economists

associate of the National Bureau of Economic

Simona E. Cociuba joined the Dallas Fed in 2007.

Research. He has written extensively on exchange

Her major fields of concentration are macroeco-

rate determination. He is currently coeditor of the

nomics, growth and development. She received

Journal of International Economics and has been a

a Ph.D. in economics from the University of Min-

visitor or consultant to many central banks, includ- nesota.
ing the Board of Governors of the Federal Reserve,
De Nederlandsche Bank, Reserve Bank of Austra-

Anthony Landry joined the Federal Reserve Bank

lia, Bank of England and several Federal Reserve

of Dallas in 2006. Previously, he worked at the

Banks. He received a B.A. from the University of

Bank of Canada. Landry’s recent research focuses

North Carolina at Chapel Hill and a Ph.D. from the

on the effects of nominal rigidities in the context of

University of California–Berkeley.

open-economy macroeconomic models. He holds
an M.A. in economics from McGill University and

Karen Lewis is the Joseph and Ida Sondheim Pro-

a Ph.D. in economics from Boston University.

fessor in International Economics and Finance at
the University of Pennsylvania’s Wharton School.

Enrique Martínez-García’s main research

In that position, she also serves as codirector of the interests are in the fields of international macroWeiss Center for International Financial Research.

economics and finance, monetary economics and

She has served as associate editor for a host of

applied econometrics. Previously, Martínez-García

publications and is regularly cited for her work in

was a teaching and research assistant at the Univer-

international financial markets and monetary eco-

sity of Wisconsin–Madison and at the university’s

nomics. Lewis received a B.A. from the University

Center for World Affairs and the Global Economy.

of Oklahoma and an M.A. and a Ph.D. from the

He also worked at the Bank of England. He holds

University of Chicago.

a B.A. from the University of Alicante in Spain, an
M.A. from the University of Pennsylvania and a
Ph.D. from UW–Madison, all in economics.

Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 43

Ananth Ramanarayanan joined the Dallas Fed

Advisory Board Members

in 2007, after receiving a Ph.D. in economics from

Charles Bean

the University of Minnesota. His research interests

Deputy Governor

are in the fields of international trade and macro-

Bank of England

economics.
Martin Feldstein
Jian Wang is a senior economist with primary

George F. Baker Professor of Economics

research interests in open-economy macroeco-

Harvard University

nomics, international finance and monetary

and President Emeritus

economics. Prior to joining the Bank, he taught at

National Bureau of Economic Research

the University of Wisconsin–Madison. He holds an
M.A. from the University of Arkansas and a Ph.D.

Heng Swee Keat

in economics from UW–Madison.

Managing Director
Monetary Authority of Singapore

Support Staff
Janet Koech has been an economic analyst for the R. Glenn Hubbard
Globalization and Monetary Policy Institute since

Dean, Graduate School of Business

October 2007. Koech holds B.A. and M.A. degrees

Columbia University

in economics from the University of Kansas. She is
from Kenya.

Otmar Issing
President, Center for Financial Studies

Hector Mendoza has been a research analyst for

Frankfurt am Main, Germany

the Globalization and Monetary Policy Institute since November 2009. He graduated from

Finn Kydland

Northwestern University with a B.S. in industrial

Henley Professor of Economics

engineering and received an M.S. in financial

University of California, Santa Barbara

and industrial economics from the University of

Nobel Laureate (2004)

London Royal Holloway College. He is a native of
Mexico.

Guillermo Ortiz
Governor

Patrick Roy began working at the Dallas Fed as a

Banco de México

research assistant in November 2007. He graduated from Bentley College in 2005 with a B.S. in

Kenneth Rogoff

economics. Roy was deployed to Iraq as a platoon

Thomas D. Cabot Professor of Public Policy

leader in 2006–07 and still serves as an officer in

Harvard University

the Texas Army National Guard.
Masaaki Shirakawa
Governor
Bank of Japan
William White
Former Economic Adviser and Head
Monetary and Economic Department
Bank for International Settlements

44 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report

Research Associates

Erasmus Kersting

Raphael Auer

Southern Methodist University

Swiss National Bank
Enisse Kharroubi
Chikako Baba

Bank of France

International Monetary Fund
Robert Kollmann
Claudio Borio

European Centre for Advanced Research in

Bank for International Settlements

Economics and Statistics

Alessandro Calza

Fabio Milani

European Central Bank

University of California, Irvine

Andrew Filardo

Philippe Moutot

Bank for International Settlements

European Central Bank

Andreas Fischer

Shigenori Shiratsuka

Swiss National Bank

Bank of Japan

Marcel Fratzscher

Jens Søndergaard

European Central Bank

Bank of England

Bill Gruben

Giovanni Vitale

Texas A&M International University

European Central Bank

Sophie Guilloux

Yu Yuan

Bank of France

University of Iowa

Ping He
Tsinghua University