Capital Controls, Currency Wars, and International Cooperation

Bianca De Paoli and Anna Lipinska

The debate over whether there’s a case for limiting capital flows has intensified recently—both in media and academic forums. The traditional view has generally been that the voluntary exchange of funds across borders makes everyone better off: Borrowers have access to cheaper credit while lenders enjoy higher returns on their investments. But, as a recent article in The Economist highlights, this view has been revisited. In this post, we review arguments on this issue and discuss how our recent research contributes to the debate.

Japanese Inflation Expectations, Revisited

Benjamin R. Mandel and Geoffrey Barnes

An important measure of success for monetary policy is a central bank’s ability to anchor inflation expectations; inflation expectations influence actual inflation and, hence, the achievement of a given inflation goal. This notion has special significance for Japan, where CPI inflation has been intermittently negative since 1994 and where it is widely believed that expectations of future inflation have been persistently negative (that is, ongoing deflation is expected). In this post, we describe and evaluate an alternative, market-based measure of Japanese inflation expectations based on international price parity conditions. We find that recent inflation expectations have attained a level substantially higher than their previous peaks over the past three years.

Does Import Competition Improve the Quality of Domestic Goods?

Mary Amiti and Amit Khandelwal

Firms must produce high-quality goods to be competitive in international markets, but how do they transition from producing low- to high-quality goods? In a new study (“Import Competition and Quality Upgrading,” forthcoming in the Review of Economics and Statistics), we focus on how tougher import competition affects firms’ decisions to upgrade the quality of their goods. Our results, which we summarize in this post, show that stiffer import competition affects quality-upgrading decisions. For firms already producing very high-quality goods, lower tariffs induce them to produce goods of even higher quality. However, for firms producing very low-quality goods, lower tariffs actually discourage quality upgrading. Ours is the first study to show a significant relationship between import competition and quality.

A New Approach for Identifying Demand and Supply Shocks in the Oil Market

Jan Groen, Kevin McNeil, and Menno Middeldorp

An oil-price spike is often used as the textbook example of a supply shock. However, rapidly rising oil prices can also reflect a demand shock. Recognizing the difference is important for central bankers. A supply-driven increase in the price of oil can result in higher unemployment and inflation, leaving central bankers with the difficult decision to loosen policy, tighten policy, or not respond at all. A demand-driven increase reflecting global growth may support the case for tighter policy. In this post, we describe an approach for decomposing oil price changes into supply and demand shocks using financial market data.

The Exchange Rate Disconnect

Mary Amiti, Oleg Itskhoki, and Jozef Konings

Why do large movements in exchange rates have small effects on international goods prices? This empirical regularity is a central puzzle in international macroeconomics. In a new study, we show that the key to understanding this exchange rate disconnect is to take into account that the largest exporters are also the largest importers. This is important because when exporters import their intermediate inputs, they face offsetting exchange rate effects on their marginal costs. For example, a depreciation of the euro relative to the U.S. dollar makes exports in U.S. dollars cheaper—but it also makes imports in euros more expensive. Using Belgian firm-level data, we show that exporters that import a large share of their inputs pass on a much smaller share of the exchange rate shock to export prices. Interestingly, import-intensive firms typically have high export market shares and hence set high markups and actively move them in response to changes in marginal cost, thus providing a second channel that limits the effect of exchange rate shocks on export prices. Our results show that a small exporter with no imported inputs has a nearly complete pass-through of more than 90 percent, while a firm at the 95th percentile of both import intensity and market share distributions has a pass-through of 56 percent, with the two mechanisms playing roughly equal roles. These findings have important implications for aggregate macroeconomic variables.

China’s Impact on U.S. Inflation

Mary Amiti and Mark Choi

U.S. import prices of consumer goods shipped from China have been moderating in recent quarters, following an upward surge of 11 percent between mid-2010 and the end of 2011. These price changes have far-reaching consequences for U.S. businesses and consumers, because China is the largest single supplier of imports to the United States, accounting for more than 20 percent of nonoil imports and more than 30 percent of consumer goods. In this post, we track U.S. import price movements in different product categories from China by constructing import price indexes that use highly disaggregated data. We also explore various underlying factors that might explain these important trends.

Ring-Fencing and "Financial Protectionism" in International Banking

Linda Goldberg and Arun Gupta

Some market watchers and academic researchers are concerned about a “Balkanization” of banking, owing to a sharp decline in cross-border international banking activity (see chart below), and an increased home bias of financial transactions. Meanwhile, policy and regulatory efforts are under consideration that may further induce banks to shift away from international activity, including ring-fencing of domestic banking operations, other forms of "financial protectionism," and enhanced oversight and prudential measures.

The Different Paths of Greece and Spain to High Unemployment

Thomas Klitgaard and Ayşegül Şahin

Euro area GDP remains below its 2007 level due to the global financial meltdown and the subsequent sovereign debt crisis in the periphery countries. Unemployment rates make it clear that some countries have fared much worse than others—the rates in Spain and Greece today are over 25 percent and are much higher than rates in the next highest, Portugal (15.7 percent), and in the euro area (11.6 percent). Quite a change from 2007, when Spain and Greece had lower unemployment rates than the euro area as a whole. In this post, we show that while the unemployment rates in the two countries are similar today, the paths have been very different. The employment decline in Greece, like in the euro area, has been proportional to the country’s steep decline in GDP; Spain’s employment has fallen much more than output, due in part to its notable labor market flexibility.

Income Flows from U.S. Foreign Assets and Liabilities

Matthew Higgins and Thomas Klitgaard

Foreign investors placed roughly $1.0 trillion in U.S. assets in 2011, pushing the total value of their claims on the United States to $20.6 trillion. Over the same period, U.S. investors placed $0.5 trillion abroad, bringing total U.S. holdings of foreign assets to $16.4 trillion. One might expect that the large gap of -$4.2 trillion between U.S. assets and liabilities would come with a substantial servicing burden. Yet U.S. income receipts easily exceed payments abroad. As we explain in this post, a key reason is that foreign investments in the United States are weighted toward interest-bearing assets currently paying a low rate of return while U.S. investments abroad are weighted toward multinationals' foreign operations and other corporate claims earning a much higher rate of return.

Follow That Money! How Global Banks Manage Liquidity Globally

Nicola Cetorelli and Linda Goldberg

Banks increasingly move money around the world. Over the last thirty years, gross international claims of banks from all countries have grown ten-fold, reaching a peak of about $25 trillion in 2007 (see chart below). Such global banking flows have been much in the news recently, sometimes depicted as a key culprit of the transmission around the globe of the shocks following the bankruptcy of Lehman Brothers, and more recently the European sovereign debt crisis. The discourse in the regulatory arena seems to share this sentiment, with a bias towards curbing some of the global banking activity (for example, Bank for International Settlements, CGFS 2010, and the United Kingdom Independent Commission on Banking 2011). We acknowledge that global banking has contributed to the international propagation of shocks during the 2007 to 2009 crisis, as shown in a range of recent studies (for example, Acharya and Schnabl 2010, Cetorelli and Goldberg 2011, and 2012). However, we argue that there still are many unknowns regarding the intensity and the direction of global banking flows, as well as the consequences of these flows. There is a pressing need to refine our understanding of these dynamics, not just from a positive angle, but also to inform policy analysis. We take steps in this direction in some of our research, discussed in this blog post. We show that global banks manage liquidity on a global scale and that internal funding reallocations are bank and business-model specific. This centralized liquidity management is a feature of normal times, as well as a feature of market stress periods.