Institutional Quality, the Cyclicality of Monetary Policy and Macroeconomic Volatility
(forthcoming in Journal of Macroeconomics, March 2014, 39: 113-155) [pdf]
In contrast to industrialized countries, emerging market economies
are characterized by pro- or a-cyclical monetary policies and high output volatility. This paper
argues that those facts can be related to a long-run feature of the economy -namely, its
institutional quality (IQL). The paper presents evidence that supports the link between an
index of IQL (law and order, government stability, investment profile, etc.), and (i) the
cyclicality of monetary policy, and (ii) the volatilities of output and the nominal interest rate.
In a DSGE model, foreign investors that choose a portfolio of direct investment and lending to
domestic agents, face a probability of partial confiscation which works as a proxy that captures
IQL. The economy is hit by external shocks to demand for home goods and productivity shocks while
its central bank seeks to stabilize inflation and output. In the long run, a lower IQL tends to
discourage external liabilities. If there is a positive external demand shock, we observe an
increase in output and real appreciation. The latter operates through two opposite channels.
First, it directly increases the opportunity cost of leisure generating incentives to expand
labor supply. Second, it reduces the real value of the debt denominated in foreign currency which
stimulates consumption but contracts the labor supply. If the IQL is low, the economy attracts
fewer loans for domestic consumers and shows a lower debt-to-consumption ratio in the steady state.
This implies that the reduction of the real value of the debt caused by the real appreciation is
smaller. Given this low wealth effect, the real appreciation leads to an expansion of the labor
supply. Wages drop and inflation diminishes. The central bank reacts by cutting its policy rate
to stabilize inflation and generates a negative comovement between output and the nominal interest
rate (pro-cyclical policy). As a corollary, negative correlations between policy rates and output
are not necessarily an indicator of destabilizing polices even in the presence of demand shocks.
[Working paper version]
A Threshold Model of the US Current Account
(Current version: October 18, 2013) [pdf]
What drives the US current account imbalances? Is there solid evidence that the behavior of the current account is
different during deficits and surpluses or that the size of the imbalance matters? Is there a threshold relationship
between the US current account and its main drivers? We estimate a multivariate threshold model to answer these questions
using the instrumental variable estimation proposed by Caner and Hansen (2004). Rather than concluding that the size or the
sign of (previous) external imbalances matters, we find that a trend line is the most important threshold variable. There
exists a regime before and another after the third quarter of 1997, a period that coincides with the onset of the
Asian financial crisis and the Taxpayer Relief Act of 1997. Statistically significant determinants in the second regime
are the fiscal surplus, productivity, productivity volatility, oil prices, the real exchange rate, and the real interest rate.
Productivity has become a more important driver since 1997.
Do Good Institutions Promote Countercyclical Macroeconomic Policies?
(with C. Calderón and K. Schmidt-Hebbel)
[Working paper version]
The literature has argued that developing countries are unable to adopt counter-cyclical
monetary and fiscal policies due to financial imperfections and unfavorable political-economy
conditions. Using a world sample of 115 industrial and developing countries for 1984-2008,
we nd that the level of institutional quality plays a key role in countries' ability to implement
counter-cyclical macroeconomic policies. The results show that countries with strong
(weak) institutions adopt counter- (pro-) cyclical macroeconomic policies, re
ected in extended
monetary policy and scal policy rules. The threshold level of institutional quality
at which monetary and scal policies are a-cyclical is found to be similar.
Is the US Current Account Symmetric over the Business Cycle?
(Current version: October 2013 -- Available soon) [pdf]
Traditionally, the literature that attempts to explain the link between the current account and output finds and
matches a linear negative relationship (Mendoza, 1991; Backus et al., 1995). On the other hand, some researchers
have argued that there exist nonlinearities in the dynamics of current accounts (Bergsten, 2002; Holman, 2001;
Clarida et al., 2005). By using a nonparametric regression, I find a U-shaped relationship between the US current
account and the cyclical component of its real GDP. That is, when output is above (below) its long-run level, the
current account and detrended output are positively (negatively) correlated. This fact is robust to different
measures of external imbalances and econometric specifications.
Financial Globalization, Low World Interest Rates, and Global Imbalances: A Note with a Simple Two-Country Model
(Current version: October 9, 2013) [pdf]
We can understand the role of the liberalization of capital outflows on the global imbalances, the increasing
share of US equities in foreign investors' portfolio, and the decline in the world interest rate and the S&P
dividend-price ratio, facts observed during the last three decades, when taxes on international assets holdings
are reduced in a simple two-country model with costs of portfolio adjustment.