![]() There are also other ways of improving risk sharing and avoiding the need for costly restructuring negotiations. To this end, they discuss the idea of adding to future government bond issues so-called sovereign cocos, contractual provisions that automatically lengthen maturities or reduce interest and amortization payments when a pre-specified debt/GDP ratio is reached. It can also avoid the need for what otherwise might be a lengthy process of renegotiation between debtors and creditors during which time economic activity falls and everyone suffers. Automating the process has key advantages: it preserves the integrity of the contract (which avoids the uncertainties involved in triggering CDS) it is predictable and it can be priced. Thus it is well worth listening to what they have to say about further ideas for structuring capital flows ex ante in such a way as to avoid messy and costly restructuring ex post.īarkbu, Mody, and Eichengreen explore how to automate the restructuring decision. One of the co-authors of International Financial Crises and the IMF: What the Historical Record Shows, Barry Eichengreen, is not just the pre-eminent economic historian of this field but also supplied a lot of the intellectual force behind the adoption of Collective Action Clauses after the preceding round of emerging market crises (e.g., Eichengreen, 2003 and Eichengreen and Mody, 2004). An important lesson for countries facing large inflows today. Countries in the upper quarter of restrictiveness of FX-related prudential measures do better in a crisis than those in the bottom quarter, by a whopping margin of 2 ½ – 3 ½ % percentage points of growth. (Frankel and Rose, 1996, among many others.) Probably the most important finding by Chamon et al is a reasonably strong statistical association between pre-crisis prudential and capital control policy and resilience to the sudden stop. Previous researchers have found that shifts of this sort in the composition of inflow, as opposed to reductions in the level of inflows per se, reduce the probability of a crisis. Chamon and co-authors find that capital controls and FX-related prudential measures can both help shift the composition of lending, away from FX-denominated bank loans and toward equity and FDI components of capital inflows. ![]() For example, even if one is ideologically opposed to capital controls, or has been persuaded by research such as Kristin Forbes (2007) that the famous Chile controls caused undesirable distortions, it is hard to be opposed to prudential banking regulations, especially in light of the origins of the 2008 crisis. This helps avoid exacerbating what is often a sterile oversimplified debate. Chamon and co-authors develop three new country indices: one for financial-sector capital controls, one for prudential regulation of foreign exchange transactions in the domestic banking sector, and one for domestic prudential policies. Too many discussions lump financial regulations together (speaking indiscriminately of Tobin taxes, Chile-style or Brazil-style controls on short-term capital inflows, Venezuela’s controls on outflows, etc., even though these are completely different things). In Managing Capital Inflows: The Role of Controls and Prudential Policies,Chamon, Ghosh, Ostry, and Qureshi do something very important. In particular, we define the crisis period as late 2008 and early 2009, whereas the earlier papers I mentioned ended in 2008. Why did the Dominguez paper and my paper find that reserves had a significant effect, and others did not? My guess is that it has to do with different definitions. Their single most important finding is that real GDP growth recovery after the global financial crisis was stronger for countries that had accumulated large reserve holdings before the crisis. One of the technical contributions of the paper by Dominguez and co-authors is to subtract estimates of interest income and valuation changes from officially report levels of reserves in order to get at the actively managed component. A series of papers by Andy Rose and Mark Spiegel ( 2009a, b) also found no significant effect. Blanchard, Faruqee and Klyuev (2009) was one. Some of the early studies found that reserve holdings did not seem to help countries withstand the crisis better. ![]() When the global financial crisis hit, it was possible to test the proposition. Larry Summers (2006) was one prominent example I must admit that his argument sounded sensible to me at the time. Some economists thought that China, especially, but other emerging market countries as well, were holding far more foreign exchange reserves than they needed to withstand shocks. The question that Dominguez, Hashimoto, and Ito address in International Reserves and the Global Financial Crisis, had been actively debated in the years before 2008.
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