The recent reversal of capital flows to emerging markets has pointed up the continuing relevance of the sudden stop problem. This paper analyzes the sudden stops in capital flows to emerging markets since 1991. It shows that the frequency and duration of sudden stops have remained unchanged, but that the relative importance of different factors in their incidence is now different. Global factors appear to have become more important relative to country-specific characteristics and policies. In addition, sudden stops now tend to affect different parts of the world simultaneously, rather than bunching regionally. Stronger macroeconomic and financial frameworks have allowed policy makers to respond more flexibly, but these more flexible responses have not mitigated the impact of the phenomenon. These findings suggest that the challenge of understanding and coping with capital-flow volatility is far from fully met.
The context for Studer’s interesting and largely successful book, as indicated by its title, is Pomeranz’s influential monograph comparing Europe and Asia and the research of other members of the so-called California School.1 According to these scholars, the two continents showed little difference in economic development prior to the nineteenth century. The subsequent divergence of their economic fortunes cannot be attributed to culture, religion, family structure, political institutions, and other long-lived, deep-seated features, since these factors had done nothing previously to hold Asia back or give Europe a leg up. Rather, the Great Divergence reflected special factors, such as coal deposits that proved fortuitous for Europe given nineteenth-century technological developments and the acquisition of a military capacity that enabled the European powers to gain colonial control of overseas territories and their resources.This thesis rests uneasily with the large literature pointing to the expansion of trade, advances in technology, and improvements in living standards in Europe in preceding centuries—for example, with the literature emphasizing that Europe experienced a commercial revolution involving the articulation of local, regional, and transnational markets before the Industrial Revolution. It is possible that similar developments also occurred in Asia but that they have not been adequately documented by historians. Recently, however, Shiue and Keller have shown a way forward.2 Using differences in grain prices across regions as a measure of market development, they found that markets were as well developed in China as in Europe during the eighteenth century. Indirectly, their findings provided additional ammunition for the California School.But China is not Asia, as Studer reminds us in undertaking an analogous exercise for India and reaching different conclusions. Grain prices varied more across regions in India than in Europe during the eighteenth and nineteenth centuries. Geography was a major reason for this difference, he argues, given that the cost of waterborne transport was one-tenth that of transporting freight by road. Europe had an advantage not only in navigable rivers but also in natural harbors and strategically located islands. The railway helped when it came to India in the 1850s, but the question is why it failed to help more. One answer, not really considered in this book, is that India’s system, overseen by the British colonial authorities, was built to enhance military command and control, not to service markets. Another answer is cumulative causation: Once European markets began to integrate, the results set in motion a process of further economic development and market growth with which India has been unable to keep pace until now.Studer handles his data carefully and uses appropriate econometric methods, rendering his results entirely convincing. Along with broad-based comparisons of Europe and India, he provides a focused analysis of Switzerland and Pune—two hilly, inland regions with no access to sea harbors. In this case, too, the comparison favors Europe or, more precisely, Switzerland, suggesting that physical geography, though important, is not the only factor at play.Ultimately, the challenge for Studor is to link his statistical findings for grain prices back to the larger historical debate that motivated the exercise. Are price differentials an adequate measure of market development? Do we understand the roles of geography, technology, and institutions in the evolution of those markets? Do we know more now than we did before this study about whether market development was at the root of the Great Divergence? Statistical studies like Studer’s can only hint at the answers to these larger questions. But this is not to dismiss their value; ultimately they are how we make progress on scholarly debates.
Read moreThe "tapering talk" starting \n on May 22, 2013, when Federal Reserve Chairman Ben Bernanke \n first spoke of the possibility of the U.S. central bank \n reducing its security purchases, had a sharp negative impact \n on emerging markets. India was among those hardest hit. The \n rupee depreciated by 18 percent at one point, causing \n concerns that the country was heading toward a financial \n crisis. This paper contends that India was adversely \n impacted because it had received large capital flows in \n prior years and had large and liquid financial markets that \n were a convenient target for investors seeking to rebalance \n away from emerging markets. In addition, India's \n macroeconomic conditions had weakened in prior years, which \n rendered the economy vulnerable to capital outflows and \n limited the policy room for maneuver. The paper finds that \n the measures adopted to handle the impact of the tapering \n talk were not effective in stabilizing the financial markets \n and restoring confidence, implying that there may not be any \n easy choices when a country is caught in the midst of \n rebalancing of global portfolios. The authors suggest \n putting in place a medium-term policy framework that limits \n vulnerabilities in advance, while maximizing the policy \n space for responding to shocks. Elements of such a framework \n include a sound fiscal balance, sustainable current account \n deficit, and environment conducive to investment. In \n addition, India should continue to encourage relatively \n stable longer-term flows and discourage volatile short-term \n flows, hold a larger stock of reserves, avoid excessive \n appreciation of the exchange rate through interventions with \n the use of reserves and macroprudential policy, and prepare \n the banks and firms to handle greater exchange rate volatility.
Read moreThe topic of the Intereconomics/CEPS conference for which this paper was written was framed as a question: convergence or divergence in the EU? I am prepared to give an unambiguous answer. That answer is yes.
Read moreWe assess the role of economic and security considerations in the currency composition of international reserves. We contrast the “Mercury hypothesis” that currency choice is governed by pecuniary factors familiar to the literature, such as economic size and credibility of major reserve currency issuers, against the “Mars hypothesis” that this depends on geopolitical factors. Using data on foreign reserves of 19 countries before World War I, for which the currency composition of reserves is known and security alliances proliferated, our results lend support to both hypotheses. We find that military alliances boost the share of a currency in the partner’s foreign reserve holdings by 30 percentage points. These findings speak to current discussions about the implications of possible U.S. disengagement from global geopolitical affairs. In a hypothetical scenario where the U.S. withdraws from the world, our estimates suggest that long-term U.S. interest rates could rise by as much as 80 basis points, assuming that the composition of global reserves changes but their level does not.
Read moreAccording to conventional wisdom, capital flows are fickle. Focusing on emerging markets, we ask whether this conventional wisdom still holds in our contemporary world. Our results show that, despite recent structural and regulatory changes, much of it survives. Foreign direct investment (FDI) inflows are more stable than non-FDI inflows. Within non-FDI inflows, portfolio debt and bank-intermediated flows remain the most volatile. Whereas FDI inflows are driven mainly by pull factors, portfolio debt and equity are driven mainly by push factors; bank-intermediated flows are driven a combination of push and pull factors. Capital outflows from emerging markets behave differently, however. FDI outflows from emerging markets have grown and become significantly more volatile. There is similarly an increase in the volatility of bank-intermediated capital outflows from emerging markets. Our findings underscore that outflows from emerging markets, both FDI and bank-related flows, have come to play a growing role and warrant greater attention from analysts and policymakers.
Read moreWe study the impact of technology on the reaction of financial markets to information, focusing on the foreign exchange market.We contrast the "thin-skinned" view that technological improvements cause markets to react more to new information with the "thick-skinned" view that they react less.We pinpoint exogenous technological changes using the timing of the connection of countries via the submarine fiber-optic cables used for electronic trading.Cable connections dampen the response of exchange rates to macroeconomic news, consistent with the "thick-skinned" hypothesis.This is in line with the view that technology eases access to information and reduces trend-following behavior.According to our estimates, cable connections reduce the reaction of exchange rates to U.S. monetary policy news by 50 to 80 percent.
Read moreWe review the growth experience of middle-income countries. Economic factors associated with growth appear to differ between middle-income and other countries. The efficiency of the financial system is importantly related to the growth rate in low- and middle-income countries, but appears to matter less as one moves up the income scale. Demographic variables also matter importantly in low-income countries. In middle-income countries, in contrast, measures of the financial system no longer appear to matter as importantly, as if inefficiencies in banking and financial systems are no longer as binding a constraint as at earlier stages of financial development; nor are demographic variables as important as before. At this point, other variables gain a growing role: these include whether the country experiences a banking or currency crisis, the extent of non-foreign direct investment capital inflows, and government debt as a share of gross domestic product.
Read moreI ask whether President Donald Trump's tariffs are fit for purpose: that is, whether they are appropriately designed to advance his goals. My answer is negative.
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