Recent sccie items

On the paradox of prudential regulations in the globalized economy; International reserves and the crisis: a reassessment*

Fri, 20 Feb 2009 00:00:00 +0000

This paper discusses two pertinent policy issues dealing with the global liquidity crisis - global prudential regulation reform, and reassessment of using international reserves in the crisis. We point out the paradox of prudential regulations – while the identity of economic actors that benefited directly from crises avoidance is unknown, the cost and the cumbrance of regulations are transparent. Hence, crises that had been avoided are imperceptible and are underrepresented in the political discourse, and the demand for prudential regulations declines during prolonged good times, thereby increasing the ultimate cost of eventual crises. While the seeds of the present crisis

were mostly home grown, international flows of capital magnified its costs. Global financial integration produces the by-product of “regulatory arbitrage” – capital tends to flow to underregulated countries, frequently resulting in excessive risk taking, in anticipation of future bailout. Dealing with...

The Puzzling Evolution of the Home Bias, Information Processing and Financial Openness

Tue, 19 Dec 2006 00:00:00 +0000

This paper presents a rational expectations model of asset prices with rationally inattentive investors that, unlike previous papers, can explain both the substantial amount of equity wealth invested domestically and the puzzling time series behavior of the home bias - an initial plateau before 1985, then a decrease until 1994 followed by stabilization on another plateau. When there is a financial liberalization, investors exploit past information to predict current asset payoffs. The resulting endogenous local information advantage generates a gradual decrease of the home bias until its steady state. In the long run, the home bias remains large due to the interaction of the optimal attention allocation with the optimal portfolio choice. Using measures for information capacity, informational advantages and ?financial openness as explanatory variables, we are able to explain at least 46.8% of the variation of the home bias for 19 developed countries from 1988 until 2004. Our...

Order Flow in the South: Anatomy of the Brazilian FX Market

Thu, 7 Dec 2006 00:00:00 +0000

Using a unique dataset that covers 100% of the Brazilian FX retail market, this paper contributes to the microstructure approach to exchange rates in at least four ways. First, we find a strict link between currency flows in the FX market and the Balance of Payments. Second, we develop an identication strategy in order to properly estimate the effect of customer order fl?ows on the exchange rate and ?find that dealers from the Brazilian FX market charge a premium of 0.03% in order to provide US$ 10 million of overnight liquidity. Third, we identify the nature of the feedback trading as "stabilizing"?: a 1% depreciation rate decreases the financial customer fl?ow by US$ 111 million and the commercial fl?ow by US$ 46 million. Finally, we find that the central bank sells in average US$ 28 million for each 1% depreciation in the exchange rate (lean-against-the-wind), and US$ 23 million for US$ 100 million of financial customer flow (liquidity provision).

Evaluating Foreign Exchange Market Intervention: Self-Selection, Counterfactuals and Average Treatment Effects

Thu, 15 Jun 2006 00:00:00 +0000

Studies of central bank intervention are complicated by the fact that we typically observe intervention only during periods of turbulent exchange markets. Furthermore, entering the market during these particular periods is a conscious “self-selection” choice made by the intervening central bank. We estimate the “counterfactual” exchange rate movements that allow us to determine what would have occurred in the absence of intervention and we introduce the method of propensity score matching to the intervention literature in order to estimate the “average treatment effect” (ATE) of intervention. Specifically, we estimate the ATE for daily Bank of Japan intervention over the January 1999 to March 2004 period. This sample encompasses a remarkable variation in intervention frequencies as well as unprecedented frequent intervention towards the latter part of the period. We find that the effects of intervention vary dramatically and inversely with the frequency of intervention: Intervention...

Prizes for Basic Research –Human Capital, Economic Might and the Shadow of History

Thu, 30 Mar 2006 00:00:00 +0000

This paper studies the impact of global factors on patterns of basic research across countries and time. We rely on the records of major scientific awards, and on data dealing with global economic and historical trends. Specifically, we investigate the degree to which scale or threshold effects, and path dependency account for countries share of major prizes [Nobel, Fields, Kyoto and Wolf]. We construct a stylized model, predicting that lagged relative GDP of a country relative to the GDP of all countries engaging in basic research is an important explanatory variable of country’s share of prizes. Scale effects imply that the association between the GDP share of a country and its prize share tends to be logistic -- above a threshold, there is a “take off” range, where the prize share increases at an accelerating rate with the relative GDP share of the country, until it reaches “maturity” stage. Our empirical analyses confirm the model’s predictions, showing the non linear effects...

Will the Euro Eventually Surpass the Dollar As Leading International Reserve Currency?

Mon, 27 Mar 2006 00:00:00 +0000

Might the dollar eventually follow the precedent of the pound and cede its status as leading international reserve currency? Unlike the last time this question was prominently discussed, ten years ago, there now exists a credible competitor: the euro. This paper econometrically estimates determinants of the shares of major currencies in the reserve holdings of the world’s central banks. Significant factors include: size of the home country, inflation rate (or lagged depreciation trend), exchange rate variability, and size of the relevant home financial center (as measured by the turnover in its foreign exchange market). We have not found that net international debt position is an important determinant. Network externality theories would predict a tipping phenomenon. Indeed we find that the relationship between currency shares and their determinants is nonlinear (which we try to capture with a logistic function, or else with a dummy “leader” variable for the largest country)....

International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence

Mon, 23 May 2005 00:00:00 +0000

This paper tests the importance of precautionary and mercantilist motives in accounting for the hoarding of international reserves by developing countries, and provides a model that quantifies the welfare gains from optimal management of international reserves. While the variables associated with the mercantilist motive are statistically significant, their economic importance in accounting for reserve hoarding is close to zero and is dwarfed by other variables. Overall, the empirical results are in line with the precautionary demand. The effects of financial crises have been localized, increasing reserve hoarding in the aftermath of crises mostly in countries located in the affected region, but not in other regions. We also investigate the micro foundation of precautionary demand, extending Diamond and Dybvig (1983)’s model to an open, emerging market economy where banks finance long-term projects with short-term deposits. We identify circumstances that lead to large precautionary...

FDI and Trade – Two Way Linkages?

Tue, 10 May 2005 00:00:00 +0000

The purpose of this paper is to investigate the intertemporal linkages between FDI and disaggregated measures of international trade. We outline a model exemplifying some of these linkages, describe several methods for investigating two-way feedbacks between various categories of trade, and apply them to the recent experience of developing countries. After controlling for other macroeconomic and institutional effects, we find that the strongest feedback between the sub-accounts is between FDI and manufacturing trade. More precisely, applying Geweke (1982)’s decomposition method, we find that most of the linear feedback between trade and FDI (81%) can be accounted for by Granger-causality from FDI gross flows to trade openness (50%) and from trade to FDI (31%). The rest of the total linear feedback is attributable to simultaneous correlation between the two annual series.

Trade and Investment among China, the United States, and the Asia-Pacific Economies: An Invited Testimony to the U.S. Congressional Commission

Tue, 10 May 2005 00:00:00 +0000

In this paper I discuss six special features of China's trade and direct investment. These characteristics include an extensive role played by foreign-invested firms, a large percentage of re-exports and processed exports, a geographical concentration of trade and investment, a growing importance of high-technology trade and wholly foreign-owned enterprises being the dominant mode of investment.

As a developing economy, China is unusual in playing two important roles for the United States and for Asia-Pacific economies in general. It is a competitive, low-cost export platform. At the same time, it is a large and growing market. Japanese and U.S. affiliates located in China typically sell about half or more of their products produced in China in the domestic Chinese market.

U.S. government data show that U.S. affiliates in China are becoming more and more profitable. China has also become an important link in the global supply chain. There is a thick and growing...

The Idea of South Asia and the Role of the Middle Class

Thu, 5 May 2005 00:00:00 +0000

In the post-colonial world, the countries of South Asia have evolved politically in different ways, amidst internal and regional conflicts, but retained some commonality of institutions and cultures. Since the 1990s, the promise of market-led development and the growth of a middle class, especially in India, have reshaped expectations in a way not seen since the immediate post-colonial period, and provided the prospect of a region that combines its particular approach to governance with common aspirations and achievement of economic well-being – what might be a new “idea of South Asia.” This paper examines some aspects of the development of the South Asian middle class, their role in economic development, and the potential of the idea that shared middle class aspirations of material consumption can be a regional driving force. The paper argues that, for this potential to be realized, the middle class in South Asia may need to aspire to something more than private affluence...

Hard or Soft? Institutional Reforms and Infrastructure Spending as Determinants of Foreign Direct Investment in China

Tue, 26 Apr 2005 00:00:00 +0000

In this paper, we examine whether hard infrastructure in the form of more highways and railroads or soft infrastructure in the form of more transparent institutions and deeper reforms lead to more foreign direct investment (FDI). We use data of FDI from the United States, Japan, Hong Kong, Taiwan and Korea to various regions of China from 1990 to 2002. We control for the standard determinants of FDI--regional market sizes, wage rates, human capital and tax policies. Then we add indices of hard and soft infrastructures. We found that empirically soft infrastructure consistently outperforms hard infrastructure as a determinant of FDI.

The Giant Sucking Sound: Is China Diverting Foreign Direct Investments from Other Asian Economies?

Tue, 26 Apr 2005 00:00:00 +0000

Is China taking direct investments away from other Asian economies? Theoretically, a growing China can add to other countries’ direct investments by creating more opportunities for production-networking and raising the need for raw materials and resources. At the same time, the extremely low Chinese labor costs may lure multinationals away from other Asian sites when the foreign corporations consider alternative locations for low-cost export platforms. In this paper, we explore this important issue empirically. We use data for eight Asian economies (Hong Kong, Taiwan, Republic of Korea, Singapore, Malaysia, Philippines, Indonesia and Thailand) from 1985 to 2001 and control for the determinants of their inward direct investment. We then add China’s inward foreign direct investment as an indicator of the “China Effect”. Due to issues of simultaneity, we use a random effects simultaneous equation model to estimate our coefficients. We have three results: (1) The level of...

FDI Flows to Latin America, East and Southeast Asia and China: Substitutes or Complements?

Tue, 26 Apr 2005 00:00:00 +0000

China in recent years has emerged as the largest recipient of foreign direct investment (FDI) in the world. Many analysts and government officials in the developing world have increasingly expressed concerns that they are losing competitiveness to China. Is China diverting FDI from other developing countries?

Theoretically, a growing China can add to other countries’ direct investment by creating more opportunities for production networking and raising the need for raw materials and resources. At the same time, the extremely low Chinese labor costs may lure multinationals away from sites in other developing countries when the foreign corporations consider alternative locations for low-cost export platforms.

In this paper, we explore this important research and policy issue empirically. We focus our studies on East and Southeast Asia as well as Latin America. For Asia, we use data for eight Asian economies (Hong Kong, Taiwan, Republic of Korea, Singapore, Malaysia,...

Globalization and taste convergence: The cases of wine and beer

Thu, 17 Mar 2005 00:00:00 +0000

This paper investigates changes in cultural consumption patterns for a low-concentration industry: wine and beer. Using data on 38 countries from 1963-2000, there is clear convergence in the consumption of wine relative to beer between 1963 and 2000. Convergence occurs even more quickly within groups of countries that have a higher degree of integration. A key prediction of international trade is confirmed in the data: greater trade integration weakens the association between production and consumption patterns -- although the relative consumption of wine can be explained well in 1963 by grape production and latitude, these variables are much less significant in 2000. Despite these “scientific” explanations for the consumption of wine, there is also a cultural angle to wine consumption. While the relative wine consumption of France and Germany is converging, several Latin American countries fail to converge. The patterns of convergence are consistent with dynamics of adjustment...

What Matters for Financial Development? Capital Controls, Institutions, and Interactions

Wed, 2 Mar 2005 00:00:00 +0000

We extend our work (Chinn and Ito, 2002) focusing on the links between capital account liberalization, legal and institutional development, and financial development, especially that in equity markets. In a panel data analysis encompassing 108 countries and twenty years ranging from 1980 to 2000, we explore several dimensions of the financial sector. First, we test whether financial openness can lead to equity market development when we control for the level of legal and institutional development. Then, we examine whether the opening of the goods sector is a precondition for financial opening. Finally, we investigate whether a well-developed banking sector is a precondition for financial liberalization to lead to equity market development and also whether bank and equity market development complements or substitutes. Our empirical results suggest that a higher level of financial openness contributes to the development of equity markets only if a threshold level of general legal...

Financial Liberalizations in Latin-America in the 1990s: A Reassessment

Tue, 1 Mar 2005 00:00:00 +0000

This paper studies the experience of Latin-America [LATAM] with financial liberalization in the 1990s. The rush towards financial liberalizations in the early 1990s was associated with expectations that external financing would alleviate the scarcity of saving in LATAM, thereby increasing investment and growth. Yet, the data and several case studies suggest that the gains from external financing are overrated. The bottleneck inhibiting economic growth is less the scarcity of saving, and more the scarcity of good governance. A possible interpretation for these findings is that in countries where private savings and investments were taxed in an arbitrary and unpredictable way, the credibility of a new regime could not be assumed or imposed. Instead, credibility must be acquired as an outcome of a learning process. Consequently, increasing the saving and investment rates tends to be a time consuming process. This also suggests that greater political instability and polarization...

Ex ante carrots instead of ex post sticks: two examples

Tue, 1 Mar 2005 00:00:00 +0000

This paper argues that the limited ability to help developing countries in a crisis should shift the focus to policies helping in reducing the ex ante probability of crises. Indirectly, such policies would also alleviate the depths of realized crises. Two specific ideas are explored:

I. International reserves escrow accounts: Managing international reserves provides an effective mechanism for self insurance. The hazard of this mechanism is that international reserves are easy prey for opportunistic policy makers in polarized countries characterized by political instability. This hazard may be alleviated by escrow accounts run by the International Financial Institutions (IFIs), where part of the international reserves of a country are saved and would be used if pre-set conditions, like large TOT deteriorations, are met. The IFIs may offer a subsidized return on these escrow accounts in order to encourage countries to reduce external borrowing and to increase fiscal savings....

Is Financial Openness a Bad Thing? An Analysis on the Correlation Between Financial Liberalization and the Output Performance of Crisis-Hit Economies

Wed, 17 Nov 2004 00:00:00 +0000

This paper investigates the link between capital account openness and the output cost associated with a currency crisis. Although the Malaysian experience during the Asian crisis of 1997-98 made many researchers and policy makers interested in the effectiveness of a policy restricting cross-border financial transactions to minimize the output cost, this association has not been exposed to a thorough empirical investigation. The probit analysis in this paper shows that the higher the level of financial openness is, the less likely countries are to experience a currency crisis among industrialized and less developed countries. It is found that a higher level of financial openness prior to a crisis helps to reduce output losses for industrialized countries, but not for less developed or emerging market countries. It is also shown that the duration of post-crisis output contraction can be shorter when an industrialized country has a high level of financial openness, but for the...

Transaction Costs, Information Technology and Development

Tue, 16 Nov 2004 00:00:00 +0000

This paper explores potential channels through which information technology (IT) affects economic development. The channel emphasized here is the reduction of transaction costs through the use of information technology. We discuss the nature of transaction costs, their possible impacts on economic outcomes, and the impacts of IT on transaction costs. We provide a theoretical discussion of how a reduction in transaction costs may affect the number of intermediate goods that are produced, and in turn how that number may affect the development path of the economy. We then draw on our fieldwork in rural India that examined the economics of rural Internet kiosks, and relate this multifaceted case study to the theoretical discussion of transaction costs. We conclude with a broader discussion of the potential impact of IT on developing economies.

Sovereign Debt, Volatility and Insurance

Thu, 4 Nov 2004 00:00:00 +0000

External debt increases the vulnerability of indebted emerging market economies to macroeconomic volatility and financial crises. Capital account reversals often lead sovereign debt repayment crises that are only resolved after prolonged and difficult debt restructuring. Foreign indebtedness exacerbates domestic financial distress in crisis, increasing both the incidence and severity of emerging market crises. These outcomes contrast with the presumption that access to international capital markets should help countries to smooth domestic consumption and investment against macroeconomic shocks. This paper uses models of sovereign to reconsider the role of sovereign debt renegotiation for international risk sharing and presents an approach for analyzing contractual innovations for implementing contingent debt repayments. The financial innovations that might allow risk-sharing rather than risk-inducing capital flows go beyond contractual changes that ease debt renegotiation by...

Trade, Interdependence and Exchange Rates

Mon, 1 Nov 2004 00:00:00 +0000

The empirical “gravity” equation is extremely successful in explaining bilateral trade. This paper shows how a multi-country model of specialization and costly trade (i.e. a microfounded gravity model) can be applied to explain empirical exchange rate puzzles. One such puzzle is the fact that nominal exchange rates are enormously volatile, but that this volatility does not appear to affect inflation. The gravity model is very successful in explaining this puzzle. In a sample of 25 OECD countries in the post- Bretton Woods period, the gravity prediction of inflation substantially outperforms the purchasing power parity prediction. The gravity prediction matches the volatility of actual inflation, and tracks its path closely. The superior performance of the gravity prediction is explained primarily by the fact that it takes account of the interaction of specialization with home bias. The stability of inflation in very open economies is explained in addition by the fact that the...

Some Patterns in Center-State Fiscal Transfers in India: An Illustrative Analysis

Tue, 28 Sep 2004 00:00:00 +0000

India’s federal system is distinguished by tax and expenditure assignments that result in large vertical fiscal imbalances, and consequent transfers from the central government to the state governments. Several channels are used for these transfers: the Finance Commission, the Planning Commission, and central government ministries. We use panel data on center-state transfers to examine how the economic and political importance of the states influences the level and the composition of per capita transfers to the states, as well as differences in temporal patterns of Planning Commission and Finance Commission transfers. We find evidence that states with indications of greater bargaining power seem to receive larger per capita transfers, and that there is greater temporal variation in Planning Commission transfers.

India’s System of Intergovernmental Fiscal Relations

Mon, 23 Aug 2004 00:00:00 +0000

This paper examines several aspects of India’s system of Intergovernmental Fiscal Relations (IGFR). It first reviews the origins and context within which the IGFR system was established and examines how it has evolved. It describes the nature of the system, including assignment of powers and functions, intergovernmental fiscal transfers and the principles that guide their design. It examines several other dimensions of the IGFR system, such as its interface with policy imperatives, evolution of norms, and recent institutional developments. It concludes with an assessment of lessons learned so far, and key challenges that lie ahead.

Liberalizing Capital Flows in India: Financial Repression, Macroeconomic Policy and Gradual Reforms

Thu, 29 Jul 2004 00:00:00 +0000

Capital account liberalization in financially repressed economies often leads to a period of rapid capital inflows followed by financial crisis. This paper considers the vulnerability of the Indian economy to financial crises with international financial integration and the policy agenda for further liberalization of capital flows. The legacy of financial repression on fiscal and financial policies poses the primary challenge to stable integration of the domestic financial markets of India with international capital markets. Brief overviews of the theory and experience of liberalization elsewhere and of the recent liberalization by India frame the discussion of the risks of liberalization and sequencing of policy reforms.

Foreign Capital, Inflation, Sterilization, Crowding-Out and Growth: Some Illustrative Models

Mon, 26 Jul 2004 00:00:00 +0000

This paper discusses some puzzles in the contemporary macroeconomic scene in India, from the perspective of public finance and economic development. These include a fiscal deficit higher than it was during the 1991 crisis, but without a large current account deficit or rise in inflation or interest rates, a rising inflow of external capital, accompanied by the RBI’s sterilizing these inflows and accumulating large reserves, even in the face of low inflation. We offer a critique of some previous analyses, and some models that are suggestive of how real and monetary factors might be integrated in providing a firmer grounding for the policy debates current in India.

Sources for Financing Domestic Capital - is Foreign Saving a Viable Option for Developing Countries?

Fri, 2 Jul 2004 00:00:00 +0000

This paper proposes a new method for measuring the degree to which the domestic capital stock is self-financed. The main idea is to use the national accounts to construct a self-financing ratio, indicating what would have been the autarky stock of tangible capital supported by actual past domestic saving, relative to the actual stock of capital. We use the constructed measure of self-financing to evaluate the impact of the growing global financial integration on the sources of financing domestic capital stocks in developing countries. On average, 90% of the stock of capital in developing countries is self financed, and this fraction was surprisingly stable throughout the 1990s. The greater integration of financial markets has not changed the dispersion of self-financing rates, and the correlation between changes in de-facto financial integration and changes in self-financing ratios is statistically insignificant. There is no evidence of any “growth bonus” associated with increasing...

Sudden Stops and the Mexican Wave: Currency Crises, Capital Flow Reversals and Output Loss in Emerging Markets

Fri, 2 Jul 2004 00:00:00 +0000

Sudden Stops are the simultaneous occurrence of a currency/balance of payments crisis with a reversal in capital flows (Calvo, 1998). We investigate the output effects of financial crises in emerging markets, focusing on whether sudden-stop crises are a unique phenomenon and whether they entail an especially large and abrupt pattern of output collapse (a “Mexican wave”). Despite an emerging theoretical literature on Sudden Stops, empirical work to date has not precisely identified their occurrences nor measured their subsequent output effects in broad samples. Analysis of Sudden Stops may provide the key to understanding why some currency/balance of payments crises entail very large output losses, while others are frequently followed by expansions. Using a panel data set over the 1975-97 period and covering 24 emerging-market economies, we distinguish between the output effects of currency crises, capital inflow reversals, and sudden-stop crises. We find that sudden-stop crises...

Effectiveness of Official Daily Foreign Exchange Market Intervention Operations in Japan

Fri, 2 Jul 2004 00:00:00 +0000

Japanese official intervention in the foreign exchange market is of by far the largest magnitude in the world, despite little or no evidence that it is effective in moving exchange rates. Up until recently, however, official data on intervention has not been available for Japan. This paper investigates the effectiveness of intervention using recently published official daily data and an event study methodology. The event study better fits the stochastic properties of intervention and exchange rate data, i.e. intense and sporadic bursts of intervention activity juxtaposed against a yen/dollar rate continuously changing, than standard time-series approaches. Focusing on daily Japanese and US official intervention operations, we identify separate intervention “episodes” and analyze the subsequent effect on the exchange rate. Using the non-parametric sign test and matched-sample test, we find strong evidence that sterilized intervention systemically affects the exchange...

Currency Crises, Capital Account Liberalization, and Selection Bias

Fri, 2 Jul 2004 00:00:00 +0000

Are countries with unregulated capital flows more vulnerable to currency crises? Efforts to answer this question properly must control for “self selection” bias since countries with liberalized capital accounts may also have more sound economic policies and institutions that make them less likely to experience crises. We employ a matching and propensity score methodology to address this issue in a panel analysis of developing countries. Our results suggest that, after controlling for sample selection bias, countries with liberalized capital accounts experience a lower likelihood of currency crises. That is, when two countries have the same likelihood of allowing free movement of capital (based on historical evidence and a very similar set of economic and political characteristics)—and one country imposes controls and the other does not-- the country without controls has a lower likelihood of experiencing a currency crisis. This result is at odds with the conventional wisdom...

Time Series Analysis of U.S.-East Asia Commodity Trade, 1962-1992

Wed, 26 May 2004 00:00:00 +0000

We examine the composition of bilateral trade between the United States and each of eight Asian Pacific economies from 1962 to 1992. Two complementary time series analyses of individual commodities at the SITC four-digit level indicate that significant change occurred in trade composition during this period. For the eight bilateral trade relationships, commodities representing from fifty to seventy percent of 1992 dollar trade volume have shown statistically significant change in the magnitude and, in some cases, in the direction of net trade balance, over the thirty-year period. Results support the conclusion that changes in trade patterns in both low-tech industries, such as textiles and clothing, and more high-tech industries, such as electronic parts and electronic goods were important in these so-called Asian tigers as their economies advanced.

International reserves management and capital mobility in a volatile world: Policy considerations and a case study of Korea

Fri, 21 May 2004 00:00:00 +0000

This paper characterizes the precautionary demand for international reserves driven by the attempt to reduce the incidence of costly output decline induced by sudden reversal of short-term capital flows. It validates the main predictions of the precautionary approach by investigating changes in the patterns of international reserves in Korea in the aftermath of the 1997-8 crisis. This crisis provides an interesting case study, especially because of the rapid rise in Korea’s financial integration in the aftermath of the East- Asian crisis, where foreigners’ shareholding has increased to 40% of total Korean market capitalization. We show that the crisis led to structural change in the hoarding of international reserves, and that the Korean monetary authority gives much greater attention to a broader notion of ‘hot money,’ inclusive of short-term debt and foreigners’ shareholding.

Asymmetric Federalism in India

Fri, 30 Apr 2004 00:00:00 +0000

The focus of this paper is unequal arrangements and special treatment for some units within Indian federalism, namely. We first explore the conceptual issues – the causes and consequences of asymmetric federalism. Next, we trace the evolution of Indian federalism and analyze the factors contributing to the asymmetric arrangements in political, administrative and fiscal relations. We bring out asymmetric arrangements arising from constitutional arrangements or conventions evolved over the years. Recent political developments and asymmetric treatment due to administrative and political exigencies are also analyzed.

The Political Economy of India’s Federal System and its Reform

Tue, 20 Apr 2004 00:00:00 +0000

This article examines the nature of India’s federal system, and recent and potential reforms in its structure and working. We summarize key federal institutions in India, focusing particularly on the mechanisms for Center-state transfers. These transfers are large, and are the major explicit method for dealing with inequalities across constituent units of the federation. We examine the evidence on how India’s political economy has affected the practical workings of the transfer mechanisms. This is followed by a consideration of actual and possible reforms in India’s federal institutions, including tax assignments and local government, and a discussion of how they might be implemented in a politically feasible manner.

Was Japan’s Real Interest Rate Really Too High During the 1990s? The Role of the Zero Interest Rate Bound and Other Factors

Mon, 12 Apr 2004 00:00:00 +0000

Japan’s more than a decade long “Great Recession” has presented a disconcerting case of what could happen if interest rates are bounded by zero and deflation sets in. Since Krugman (1998), the commonplace observation is that the deflationary situation combined with the zero nominal interest rate has caused elevated real interest rates, thereby nullifying monetary policy. This paper investigates this oft -cited claim and examines whether it is associated with anomalies in the way real interest rates are determined by employing an error correction model (ECM) based on the time-varying parameter model with Markov-switching variances. Using this model it is revealed that during the 1980s both ex ante and ex post rates were often lower than the equilibrium rates, indicating strong and persistent optimism among agents. However in the 1990s the ex ante real interest rate was persistently higher than the equilibrium, indicating the pessimistic expectations among agents. The time-varying...

Information Technology and Rural Development in India

Mon, 29 Mar 2004 00:00:00 +0000

How can information technology (IT) contribute to rural development? What are the channels through which impacts can be realized, and what are the practical means for realizing potential benefits? This paper examines several ongoing projects that aim to provide IT-based services to rural populations in India. These projects are distinguished by the goal of commercial sustainability, which supports scalability and, therefore, more widespread benefits. The analysis highlights the common building blocks required for successful implementation, and the relative strengths and weaknesses of different approaches.

Some Economic Consequences of India's Institutions of Governance: A Conceptual Framework

Tue, 23 Mar 2004 00:00:00 +0000

This paper examines the functioning of some of India’s institutions of governance, namely, the legislative and executive branches of government, the judiciary, and the bureaucracy, from an instrumental, economic perspective. Governance is analyzed along three dimensions: (1) the degree of commitment or durability of laws and rules, (2) the degree of enforcement of these laws, and (3) the degree of decentralization of jurisdictions with respect to local public goods. It is suggested that India's experience of governance reflects insufficiencies in all three dimensions: of durability, enforcement, and decentralization, with adverse consequences for economic efficiency. The paper concludes with a brief normative discussion of collective action in general, and alternative structures of institutions of governance.

Implications of a Changing Economic Structure for the Strategy of Monetary Policy

Tue, 23 Mar 2004 00:00:00 +0000

This paper surveys the implications of uncertainty for the design of monetary policy. Among the topics discussed are the impact of imperfect or noisy information on the performance of simple rules, the performance of rules that are robust to the exogenous disturbance processes, the effects of parameter uncertainty, and the implications of robust control. The analysis is conducted using a new Keynesian framework. One finding is that difference rules seem to perform well in the presence of imperfect information about the output gap.

DO LABOR ISSUES MATTER IN THE DETERMINATION OF U.S. TRADE POLICY? AN EMPIRICAL REEVALUATION

Tue, 23 Mar 2004 00:00:00 +0000

Some recent empirical studies, motivated by Grossman and Helpman’s (1994) well-known “Protection for Sale” model, suggest that very few factors (none of them laborrelated) determine trade protection. This paper reexamines the roles that labor issues play in the determination of trade policy. We introduce collective bargaining, differences in labor mobility across industries, and trade union lobbying into the protection for sale model and show that the equilibrium protection rate in our model depends upon these labor market variables. In particular, our model predicts that trade protection is structurally higher than in the original Grossman-Helpman model if the trade union of a sector lobbies but capital owners do not, because union workers collect part of the protection rents. On the other hand, equilibrium protection is lower if capital owners lobby but the trade union does not, because part of the protection rents is dissipated to workers. Using data from U.S. manufacturing,...

Trade-related Job Loss and Wage Insurance: A Synthetic Review

Tue, 23 Mar 2004 00:00:00 +0000

This paper seeks to promote further integration of empirical and theoretical discussions of trade and worker adjustment. From my recent studies of the costs of job loss, I develop a set of stylized facts of trade-related job loss, with a focus on worker characteristics and labor market consequences. These stylized facts are relevant to any (credible) model of trade liberalization and adjustment costs. I then discuss the basic ideas of wage insurance and summarize the little that is known about how a program might work if implemented in the U.S. A final section provides a list of issues for a model of trade that will be consistent with the empirical stylized facts, sets out questions for future research and concludes.

Do High Oil Prices Presage Inflation? The Evidence from G-5 Countries

Mon, 15 Mar 2004 00:00:00 +0000

We estimate the effects of oil price changes on inflation for the United States, United Kingdom, France, Germany, and Japan using an augmented Phillips curve framework. We supplement the traditional Phillips curve approach taking into account the growing body of evidence suggesting that oil prices may have asymmetric and nonlinear effects on output and that structural instabilities may exist in those relationships. Our statistical estimates suggest current oil price increases are likely to have only a modest effect on inflation in the U.S, Japan, and Europe. Oil price increases of as much as 10 percentage points will lead to direct inflationary increases of about 0.1-0.8 percentage points in the U.S. and the E.U. Inflation in Europe, traditionally thought to be more sensitive to oil prices than in the U.S., is unlikely to show any significant difference in sensitivity from that in the United States and in fact may be less in some countries.

The Determinants of the Global Digital Divide: A Cross-Country Analysis of Computer and Internet Penetration

Mon, 15 Mar 2004 00:00:00 +0000

To identify the determinants of cross-country disparities in personal computer and Internet penetration, we examine a panel of 161 countries over the 1999-2001 period. Our candidate variables include economic variables (income per capita, years of schooling, illiteracy, trade openness), demographic variables (youth and aged dependency ratios, urbanization rate), infrastructure indicators (telephone density, electricity consumption), telecommunications pricing measures, and regulatory quality. With the exception of trade openness and the telecom pricing measures, these variables enter in as statistically significant in most specifications for computer use. A similar pattern holds true for Internet use, except that telephone density and aged dependency matter less. The global digital divide is mainly – but by no means entirely – accounted for by income differentials. For computers, telephone density and regulatory quality are of second and third importance, while for...

Labor Market Rigidities and the Political Economy of Trade Protection

Fri, 12 Mar 2004 00:00:00 +0000

Labor market rigidities are commonly believed to be a major reason for imposing trade impediments. In this paper, I introduce labor market rigidities (such as influential trade unions and high unemployment benefits), that are prevalent in continental European countries, into the well-known Grossman and Helpman (1994) protection for sale model, which has emerged as the leading model in the political economy of trade protection literature. I show that contrary to commonly held views, these labor market rigidities do not necessarily increase equilibrium trade protection. A testable equilibrium trade protection equation is also derived. The findings in this paper are hence particularly relevant for empirical tests of trade policy determinants in economies with more regulated labor markets.

Fiscal Policy in India: Lessons and Priorities

Fri, 12 Mar 2004 00:00:00 +0000

This paper assesses India’s current fiscal situation, its likely future evolution, and impacts on the economy. We examine possible reforms of macroeconomic policy (including fiscal, monetary and exchange rate policy) and broader institutional reforms that will bear on the macroeconomic situation. We also consider the political feasibility of possible reforms. We examine both medium and longer run scenarios, and fiscal sustainability and adjustment going beyond conventional government budget deficits, to include off-budget liabilities, both actual and contingent. We conclude with our assessment of reforms focused on improving the fisc.

Deposit Insurance, Regulatory Forbearance and Economic Growth: Implications for the Japanese Banking Crisis

Thu, 22 Jan 2004 00:00:00 +0000

An endogenous growth model with financial intermediation is used to show how public deposit insurance and weak prudential regulation can lead to banking crises and permanent declines in economic growth. The impact of regulatory forbearance on investment, saving and asset price dynamics under perfect foresight are derived in the model. The assumptions of the theoretical model are based on essential features of the Japanese financial system and its regulation. The model demonstrates how banking and growth crises can evolve under perfect foresight. The dynamics for economic aggregates and asset prices predicted by the model are shown to be generally consistent with the experience of the Japanese economy and financial system through the 1990s. We also test our maintained hypothesis of rational expectations using asset price data for Japan over the 1980s and 1990s. An implication of our analysis is that delaying the resolution of banking crises adversely affects future economic...

The Euro Area and World Interest Rates

Mon, 24 Nov 2003 00:00:00 +0000

We analyze the behavior of world interest rates, focusing on the ramifications of European Monetary Union. Our analysis indicates that nominal US interest rates tend to drive European rates at both the short and long horizons. There is some evidence that US rates are becoming increasingly influenced by European rates, but the relationship is still far from symmetric, despite EMU. We also investigate the empirical determinants of real interest rates over the past decade and a half. Real US interest rates also have an influence upon European rates, although German rates do not appear to have a similar effect upon US rates. Conditioning on foreign interest rates, we find that real interest rates on government debt depend significantly upon current and expected levels of debt, in Europe as in the US.

Military Expenditure, Threats, and Growth

Wed, 19 Nov 2003 00:00:00 +0000

This paper clarifies one of the puzzling results of the economic growth literature: the impact of military expenditure is frequently found to be non-significant or negative, yet most countries spend a large fraction of their GDP on defense and the military. We start by empirical evaluation of the non-linear interactions between military expenditure, external threats, corruption, and other relevant controls. While growth falls with higher levels of military spending, given the values of the other independent variables, we show that military expenditure in the presence of threats increases growth. We explain the presence of these non-linearities in an extended version of Barro and Sala-i-Martin (1995), allowing the dependence of growth on the severity of external threats, and on the effective military expenditure associated with these threats.

International Reserve Holdings with Sovereign Risk and Costly Tax Collection