Since introduction of cointegration and error-correction modeling, the definition of the J-curve has changed to reflect short-run deterioration combined with long-run improvement of the trade balance due to currency depreciation. Standard methods such as ARDL approach of Pesaran et al. (2001) assume that adjustment of variables follow a linear path. It is now recognized that the adjustment process could be nonlinear. Application of Non-linear ARDL approach of Shin et al. (2013) provides more evidence of the J-curve supporting non-linear adjustment of variables as well as asymmetric effects of exchange rate changes on the trade balance, using bilateral trade balance models of the U.S. with each of her six largest trading partners.
This paper compares the importance of precautionary and mercantilist motives in the hoarding of international reserves by developing countries. Overall, empirical results support precautionary motives; in particular, a more liberal capital account regime increases international reserves. Theoretically, large precautionary demand for international reserves arises as a self-insurance to avoid costly liquidation of long-term projects when the economy is susceptible to sudden stops. The welfare gain from the optimal management of international reserves is of a first-order magnitude, reducing the welfare cost of liquidity shocks from a first-order to a second-order magnitude.
Recent studies have analysed the ability of measures of uncertainty to predict movements in macroeconomic and financial variables. The objective of this paper is to employ the recently proposed nonparametric causality-in-quantiles test to analyse the predictability of returns and volatility of sixteen U.S. dollar-based exchange rates (for both developed and developing countries) over the monthly period of 1999:01–2012:03, based on information provided by a news-based measure of relative uncertainty, i.e., the differential between domestic and U.S. uncertainties. The causality-in-quantile approach allows us to test for not only causality-in-mean (1st moment), but also causality that may exist in the tails of the joint distribution of the variables. In addition, we are also able to investigate causality-in-variance (volatility spillovers) when causality in the conditional-mean may not exist, yet higher order interdependencies might emerge. We motivate our analysis by employing tests for nonlinearity. These tests detect nonlinearity, as well as the existence of structural breaks in the exchange rate returns, and in its relationship with the EPU differential, implying that the Granger causality tests based on a linear framework is likely to suffer from misspecification. The results of our nonparametric causality-in-quantiles test indicate that for seven exchange rates EPU differentials have a causal impact on the variance of exchange rate returns but not on the returns themselves at all parts of the conditional distribution. We also find that EPU differentials have predictive ability for both exchange rate returns as well as the return variance over the entire conditional distribution for four exchange rates.
Using a novel panel data set we study the macroeconomic determinants of non-performing loans (NPLs) across 75 countries during the past decade. According to our dynamic panel estimates, the following variables are found to significantly affect NPL ratios: real GDP growth, share prices, the exchange rate, and the lending interest rate. In the case of exchange rates, the direction of the effect depends on the extent of foreign exchange lending to unhedged borrowers which is particularly high in countries with pegged or managed exchange rates. In the case of share prices, the impact is found to be larger in countries which have a large stock market relative to GDP. These results are robust to alternative econometric specifications.
We investigate the relationship between economic growth and lagged international capital flows, disaggregated into FDI, portfolio investment, equity investment, and short-term debt. We follow about 100 countries during 1990-2010 when emerging markets became more integrated into the international financial system. We look at the relationship both before and after the global crisis. Our study reveals a complex and mixed picture. The relationship between growth and lagged capital flows depends on the type of flows, economic structure, and global growth patterns. We find a large and robust relationship between FDI - both inflows and outflows - and growth. The relationship between growth and equity flows is smaller and less stable. Finally, the relationship between growth and short-term debt is nil before the crisis, and negative during the crisis.
While the negative effect of uncertainty shocks on economic activity is well documented in many empirical studies, little is known about the extent to which the effect differs across various kinds of uncertainty, especially in the emerging market economy context. Using the newly available economic policy uncertainty index from six emerging market economies (Brazil, Chile, China, India, Korea, and Russia), we compare the impact of financial uncertainty shocks—measured by stock market volatility—and that of policy uncertainty shocks on the economy. We find that financial uncertainty shocks have much larger and more significant impact on output than policy uncertainty shocks, except for China where the government has direct controls over financial market activity. While our finding differs from the existing studies about advanced economies that find no smaller effects of policy uncertainty shocks on output than financial uncertainty shocks, it is consistent with the recent emphasis on financial frictions as a propagation mechanism of uncertainty shocks.
In this paper we study the taxes vs. debt choice for public funding when spending is in large part predictable due to entitlement programs, but the necessary fiscal corrections may not be instantly and indefinitely elastic as usually assumed. We study fiscal behavior in a large sample of countries to determine what fiscal regimes have been used in practice, and what they reveal about the trade-off between raising taxes vs. issuing debt. Unsurprisingly, we find that fiscal discipline and the aims of fiscal rules have varied over the past 50 years. Discipline has generally weakened and there has been a greater tendency to use debt. But governments are no less forward looking than they were. Perhaps more surprising, the high debt countries were more disciplined than low debt economies—but with worse outcomes because of their poor starting positions and more persistent public spending. The low debt countries have exploited their stronger initial position to allow less discipline; a “resting on one’s laurels” approach.