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Unconventional Policies and Exchange Rate Dynamics
(with Ruy Lama and Juan Pablo Medina Guzman)
Working Paper No. 17/237

We study exchange rate dynamics under cooperative and self-oriented policies in a two-country DSGE model with unconventional monetary and exchange rate policies. The cooperative solution features a large exchange rate adjustment that cushions the impact of negative shocks and a moderate use of unconventional policy instruments. Self-oriented policies (Nash equilibrium), however, entail limited exchange rate movements and an aggressive use of unconventional policies in both countries. Our results highlight the role of international policy cooperation in allowing the exchange rate to play the traditional role of shock absorber.

"Foreign Exchange Intervention under Policy Uncertainty"
(with Ruy Lama and Juan Pablo Medina Guzman)
IMF Working Paper 16/67, 2016

We study the use of foreign exchange (FX) intervention as an additional policy instrument in an environment with learning, where agents infer the central bank policy rules from its policy actions. Under full information, a central bank focused on stabilizing output and inflation can achieve better outcomes by using FX intervention as an additional policy tool. Under policy uncertainty, where agents perceive that monetary policy may also have exchange rate stabilization goals, the use of FX intervention entails a trade-off, reducing output volatility while increasing inflation volatility. While having an additional policy tool is always beneficial, we find that the optimal magnitude of intervention is higher in monetary policy regimes with lower uncertainty. These results indicate that the benefits of using FX intervention as an additional stabilization tool are greater in regimes where monetary policy is credibly focused on output and inflation stabilization.

"The Cost of Foreign Exchange Intervention: Concepts and Measurement"
(with Rui Mano)
IMF Working Paper 16/89, 2016

The accumulation of large foreign asset positions by many central banks through sustained foreign exchange (FX) intervention has raised questions about its associated fiscal costs. This paper clarifies conceptual issues regarding how to measure these costs both from an ex-post and an ex-ante (relevant for decision making) perspective, and estimates both marginal and total costs for 73 countries over the period 2002-13. We find ex-ante marginal costs for the median emerging market economy (EME) in the inter-quartile range of 2-5.5 percent per year; while ex-ante total costs (of sustaining FX positions) in the range of 0.2-0.7 percent of GDP per year for light interveners and 0.3-1.2 percent of GDP per year for heavy interveners. These estimates indicate that fiscal costs of sustained FX intervention (via expanding central bank balance sheets) are not negligible.

"Can Foreign Exchange Intervention Stem Exchange Rate Pressures from Global Capital Flow Shocks?"
(with Olivier Blanchard and Irineu de Carvalho Filho). 
NBER Working Paper 21427; PIIE Working Paper WP15-18; IMF WP 15/159

Many emerging market economies have relied on foreign exchange intervention (FXI) in response to gross capital inflows. In this paper, we study whether FXI has been an effective tool to dampen the effects of these inflows on the exchange rate. To deal with endogeneity issues, we look at the response of different countries to plausibly exogenous gross inflows, and explore the cross country variation of FXI and exchange rate responses. Consistent with the portfolio balance channel, we find that larger FXI leads to less exchange rate appreciation in response to gross inflows.

"Unveiling the Effects of Foreign Exchange Intervention; A Panel Approach"
(with Noemie Lisack and Rui Mano)
IMF Working Paper 15/130, 2015

We study the effect of foreign exchange intervention on the exchange rate relying on an instrumental-variables panel approach. We find robust evidence that intervention affects the level of the exchange rate in an economically meaningful way. A purchase of foreign currency of 1 percentage point of GDP causes a depreciation of the nominal and real exchange rates in the ranges of [1.7-2.0] percent and [1.4-1.7] percent respectively. The effects are found to be quite persistent. The paper also explores possible asymmetric effects, and whether effectiveness depends on the depth of domestic financial markets.

"Global Financial Shocks and Foreign Asset Repatriation; Do Local Investors Play a Stabilizing Role?"
(with Marie-Louise Djigbenou and Sebastian Sosa)
Journal of International Money and Finance, Elsevier, vol. 60(C), pages 8-28, 2016.
IMF Working Paper 14/60, 2014

We study the dynamic response of gross capital flows in emerging market economies to different global financial shocks, using a panel vector-autoregressive (PVAR) approach. Our focus lies primarily on the potentially stabilizing role played by domestic investors in offsetting the response of foreign investors to adverse global shocks. We find that, while foreign investors tend to retrench from emerging markets in response to global risk aversion and monetary policy shocks, foreign asset repatriation by resident investors does not always follow suit. Local investors play a meaningful stabilizing role in the face of global risk aversion shocks, with sizeable asset repatriation largely offsetting the retrenchment of non-residents. In contrast, foreign investor retrenchment in response to global monetary policy shocks is not mirrored by asset repatriation. Finally, we find robust evidence that positive global real shocks tend to have a positive impact on net capital inflows to emerging markets. Our results shed light on the likely impact of the Fed's QE tapering on capital flows to emerging market economies.

"Foreign Exchange Interventions and their Impact on Exchange Rate Levels" (Intervenciones en el mercado cambiario y su efecto en el tipo de cambio")
(with Camilo E. Tovar Mora)
Monetaria, vol. 0(1), pages 1-48, January-J., 2014; Monetaria, vol. 0(1), pages 1-54, enero-jun, 2014

This paper examines foreign exchange intervention practices and their effectiveness in containing currency appreciation, using a new qualitative and quantitative database for a panel of 15 economies covering 2004-2010, with special focus on Latin America. Qualitatively, it examines institutional aspects such as declared motives, instruments employed, the use of rules versus discretion, and the degree of transparency. Quantitatively, it assesses the effectiveness of sterilized interventions in influencing the exchange rate using a two-stage IV-panel data approach, which helps overcome endogeneity bias. Results suggest that interventions slow the pace of appreciation, but the effects decrease rapidly with the degree of capital account openness. At the same time, interventions are more effective in the context of already overvalued exchange rates.

"Foreign Exchange Intervention; A Shield Against Appreciation Winds?"
(with Camilo E. Tovar Mora)
IMF Working Paper 11/165, 2011  

This paper examines foreign exchange intervention practices and their effectiveness using a new qualitative and quantitative database for a panel of 15 economies covering 2004 - 10, with special focus on Latin America. Qualitatively, it examines institutional aspects such as declared motives, instruments employed, the use of rules versus discretion, and the degree of transparency. Quantitatively, it assesses the effectiveness of sterilized interventions in influencing the exchange rate using a two-stage IV-panel data approach to overcome endogeneity bias. Results suggest that interventions slow the pace of appreciation, but the effects decrease rapidly with the degree of capital account openness. At the same time, interventions are more effective in the context of already ‘overvalued' exchange rates.


"Terms-of-Trade Cycles and External Adjustment"
(with N. E. Magud and A. M. Werner)
International Review of Economics and Finance, vol. 54, March 2018, Pages 103-122
IMF Working Paper 17/29, 2017

We study the process of external adjustment to large terms-of-trade level shifts—identified with a Markov-switching approach—for a large set of countries during the period 1960–2015. We find that adjustment to these shocks is relatively fast. Current accounts experience, on average, a contemporaneous variation of only about ½ of the magnitude of the price shock—indicating a significant volume offset—and a full adjustment within 3–4 years. Dynamics are largely symmetric for terms-of-trade booms and busts, as well as for advanced and emerging market economies. External adjustment is driven primarily by offsetting shifts in domestic demand, as opposed to variations in output (also reflected in the response of import rather than export volumes), indicating a strong income channel at play. Exchange rate flexibility appears to have played an important buffering role during booms, but less so during busts; while international reserve holdings have been a key tool for smoothing the adjustment process.

"Four decades of terms-of-trade booms: A metric of income windfall"
(with Nicolas E. Magud)
Journal of International Money and Finance, Elsevier, vol. 55(C), pages 162-192, 2015.

We study Latin America's history of terms-of-trade booms during the period 1970–2012 through the prisms of a metric that quantifies the associated exogenous income shock (‘income windfall’). We also document saving patterns during these episodes and propose a measure of how much of the income windfall was saved (i.e., the marginal saving rate). We find that Latin America's terms-of-trade shock of the last decade has not differed much in magnitude from that observed during the 1970s, but the associated income windfall has been substantially larger. While aggregate saving increased more than in past episodes, the share of the windfall saved has been lower, suggesting that greater aggregate savings reflect mainly the sheer size of the exogenous income shock rather than a greater effort to save it.

"Four Decades of Terms-of-Trade Booms; Saving-Investment Patterns and a New Metric of Income Windfall"
(with Nicolas E. Magud)
IMF Working Paper 13/103, 2013

We study the history of terms-of-trade booms (during 1970–2012), with a focus on Latin America, through the prisms of a simple metric that quantifies the associated income windfall. We also document saving patterns during these episodes and propose a measure of how much of the income windfall was saved. We find that Latin America‘s terms-of-trade shocks of the last decade have not differed much in magnitude from those observed during the 1970s, but that the associated windfall have been substantially larger. While aggregate saving increased more than in past episodes, the share of the windfall saved (the marginal saving rate) seems to be lower, suggesting that greater aggregate saving reflects mainly the sheer size of the windfall rather than a greater 'effort' to save it. Finally, we find evidence that, while savings during the boom help to increase post-boom income, the composition of such savings matters. Specifically, in past episodes, savings allocated to foreign asset accumulation appear to have contributed more to post-boom income than those devoted to domestic investment.

"Commodity Price Cycles; The Perils of Mismanaging the Boom"
(with Sebastian Sosa)
IMF Working Paper 11/283, 2011

Commodity-exporting countries have significantly benefited from the commodity price boom of recent years. At the current juncture, however, uncertain global economic prospects have raised questions about their vulnerability to a sharp fall in commodity prices and the policies that can shield it from such a shock. To address these questions, this paper takes a long term (4 decade) view at emerging markets' commodity dependence, the history of commodity price busts and the role of policies in mitigating or amplifying their economic impact. The paper highlights the stark difference in trends between Latin America - one of the most vulnerable regions given its high, and rising, commodity dependence - and emerging Asia - which has evolved from being a net exporter to a net importer of commodities in the last 40 years. We find evidence, however, that while commodity dependence is an important ingredient, a country's ultimate degree of vulnerability to commodity price shocks is to a great extent determined by the flexibility and quality of its policy framework. Policies in the run-up of sharp terms-of-trade drops - especially when those are preceded by booms - play a particularly important role. Limited exchange rate flexibility, a weak external position, and loose fiscal policy tend to amplify the negative effects of these shocks on domestic output. Financial dollarization also appears to act as a shock "amplifier."

MONETARY POLICY ––––––––––––––––––

US Policy Mix and the Trade Balance
(with Carolina Osorio Buitron)
IMF Working Paper 17/204, 2017

The strong US policy response to the 2008-09 financial crisis raised concerns about its impact (spillovers) on other countries, with great focus on the monetary stimulus but little attention to fiscal policy, despite their combined deployment. Using a sign-restricted structural VAR approach, we study the trade spillovers of the post-crisis policy mix, by assessing the joint impact of monetary and fiscal policy. We find that aggregate trade effects, as reflected in the trade balance, varied across time, reflecting the different timing of fiscal and monetary stimuli, with overall positive spillovers in the immediate aftermath of the crisis. At the same time, reflecting the different transmission mechanisms of monetary policy, we find that the effects differed greatly between trading partners with fixed and flexible exchange rates. In general, our results highlight (i) the importance of studying fiscal and monetary policy spillovers jointly in order to avoid attenuation bias from omitted variables; and (ii) that trading partners’ exchange rate regimes are of first order importance in determining the impact of policy spillovers.

Tipping the Scale: The Working of Monetary Policy through Trade
(with Carolina Osorio Buitron)
IMF Working Paper 17/142, 2017

Monetary policy entails demand augmenting and demand diverting effects, with its impact on the trade balance—and spillovers to other countries—depending on the relative magnitude of these opposing effects. Using US data, and a sign-restricted structural VAR identification strategy, we investigate how monetary policy shocks affects the trade balance, shedding light on the importance of the two effects. Overall, the results indicate that monetary policy has a meaningful impact on the trade balance. A monetary loosening (tightening) leads to a strengthening (weakening) of the overall trade balance, indicating that, on average, demand diversion dominates. This effect of monetary policy on trade is revealed in full when distinguishing between trading partners with fixed exchange rates—for which only demand augmenting operates—and flexible exchange rates—for which both effects operate. We also explore spillover differences between conventional and unconventional monetary policy, as well as changes in spillovers in the postcrisis period (due to an impaired monetary transmission mechanism). While our results suggest that monetary policy comes with spillovers through trade, they should not be interpreted as evidence against the use of this policy instrument as such. From a global perspective, optimal monetary policy should be assessed in conjunction with deployment of other policy measures, including the ability of recipient countries to deploy their own policy measures to offset undesirable spillovers.

"Does Central Bank Capital Matter for Monetary Policy?"
(with Camilo E. Tovar Mora and Pedro Castro)
Open Economies Review, Springer, vol. 27(1), pages 183-205, February 2016.
IMF Working Paper 12/60, 2012

This paper examines empirically whether central bank capital influences the conduct of monetary policy. To this end, we estimate interest rate rules for a sample of 41 countries and employ linear and non-linear regression methods to test if a measure of central bank financial strength can explain deviations of actual interest rates from those predicted by the estimated interest rate (Taylor-like) rules. Our results suggest that central bank capital is indeed a relevant factor behind interest rate policy decisions.

SOVEREIGN DEBT ––––––––––––––––––

"Intertwined Sovereign and Bank Solvencies in a Model of Self-Fulfilling Crisis" 
(with Sandra Lizarazo)
International Review of Economics & Finance, Elsevier, vol. 39(C), pages 428-448, 2015
IMF Working Paper 12/178, 2012

The financial crisis in the periphery of Europe, similar to previous crises in emerging markets, has shown that large fiscal financing needs are often met by borrowing heavily from domestic banking systems. As public debt approaches sustainability limits, however, banks' high exposure to sovereign risk creates a fragile inter-dependence between fiscal and bank solvency. The paper presents a simple model that illustrates how this interdependence creates conditions conducive to a self-fulfilling twin crisis; and discusses possible financial arrangements that can prevent crisis equilibria.

"External Factors in Debt Sustainability Analysis: An Application to Latin America?"

(with S. Sosa)

Journal of Banking and Financial Economics, vol. 1(5), pages 81-120, June 2016.

This paper develops a framework for debt sustainability analysis that integrates econometric estimates of the effect of global factors on a set of key domestic variables that determines public and external debt dynamics. The methodology is applied to assess debt sustainability in Latin America—a region highly sensitive to external conditions. Results suggest that, while some countries in the region are well placed to withstand moderate or even large foreign shocks, many would benefit from strengthening their fiscal positions to be able to deploy countercyclical policies under adverse scenarios, especially tail events. External sustainability, on the other hand, does not appear to be a source of concern for most countries.

"External Conditions and Debt Sustainability in Latin America"
(with Sebastian Sosa)
IMF Working Paper 13/27, 2013

Highly favorable external conditions have helped Latin America strengthen its economic fundamentals over the last decade. But, has the region built enough buffers to guard itself from a weakening of the external environment? This paper addresses this question by developing a simple framework that integrates econometric estimates of the effect of global factors on key domestic variables that determine public and external debt dynamics, with the IMF‘s standard debt sustainability framework. Results suggest that, while some countries in the region are well placed to withstand moderate or even large shocks, many would benefit from having stronger buffers to be in a position to deploy countercyclical policies, especially under tail events. External sustainability, on the other hand, does not appear to be a source of concern for most countries.

"Original Sin and Procyclical Fiscal Policy; Two Sides of the Same Coin?"
IMF Working Paper 08/209, 2008

The paper develops a simple model of sovereign debt where default both through direct repudiation and through inflation are possible and give rise to (endogenous) constraints on the currency composition and the level of public debt. This set up allows to show that procyclicality of fiscal policy in EMEs can arise as a by-product of the "original sin" and both can be explained by the presence of weak monetary institutions which cannot commit to price stability. The paper suggests that, as monetary institutions in EMEs strengthen, the "original sin" would fade away and the cyclical properties of fiscal policy would improve.

OTHER TOPICS ––––––––––––––––––

“Gone with the Headwinds; Global Productivity"
(with R. A. Duval, D. Furceri, S. Kılıç Çelik, K. Koloskova and M. Poplawski-Ribeiro)
IMF Staff Discussion Note 17/04, 2017

Productivity growth—the key driver of living standards—fell sharply following the global financial crisis and has remained sluggish since, adding to a slowdown already in train before. Building on new research, this note finds that the productivity slowdown reflects both crisis legacies and structural headwinds. In advanced economies, the global financial crisis has led to “productivity hysteresis”—persistent productivity losses from a seemingly temporary shock. Behind this are balance sheet vulnerabilities, protracted weak demand and elevated uncertainty, which jointly triggered an adverse feedback loop of weak investment, weak productivity and bleak income prospects. Structural headwinds—already blowing before the crisis—include a waning ICT boom and slowing technology diffusion, partly reflecting an aging workforce, slowing global trade and weaker human capital accumulation. Reviving productivity growth requires addressing remaining crisis legacies in the short run while pressing ahead with structural reforms to tackle longer-term headwinds.

"Are Foreign Banks a 'Safe Haven'? Evidence from Past Banking Crises"
(with Eugenio Cerutti).
IMF Working Paper 15/43, 2015  

The presence of foreign banks in emerging markets has increased markedly over the last two decades, raising questions about their potentially stabilizing or destabilizing role during times of financial distress. Most studies on this subject have focused on banks’ asset side (i.e., their lending behavior). This paper focuses on their liability side, studying the behavior of depositors vis-à-vis foreign banks. We rely on data from the banking crises in Argentina and Uruguay over the period 1994-2002 to conduct the study. The paper focuses on three questions; (i) are foreign banks perceived as a safe haven during bank runs?; (ii) does their legal structure (branch versus subsidiary) matter?; (iii) do perceptions depend on the nature of the crisis? Contrary to the commonly held view that foreign banks play a stabilizing role during domestic banking crises, we do not find robust evidence in this regard. Only in one (large) bank run episode, out of five studied, there is evidence of safe haven perceptions towards foreign branches.

"Global Financial Shocks and Their Economic Impact on Emerging Market Economies,"
(with Camilo E. Tovar Mora)
Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 4(02), pages 1-27, 2013
IMF Working Paper 12/188, 2012

The world has experienced episodes of global financial stress every 2.5 years on average over the past two decades, with repercussions on a global scale. Over the same period, emerging economies have improved their macroeconomic fundamentals while becoming increasingly integrated with the world. Against this backdrop, are these economies more or less vulnerable to large global financial shocks? What roles have macroeconomic fundamentals and financial integration played in amplifying or buffering the impact of these shocks? This paper addresses these questions by examining the output cost associated with these events in 40 emerging and nine "small" advanced economies during the period 1990–2010.

"Intra-Regional Spillovers in South America; Is Brazil Systemic After All?"
(with Sebastian Sosa)
The World Economy, Wiley Blackwell, vol. 37(3), pages 456-480, 03, 2014.
IMF Working Paper 12/145, 2012

The high business cycle correlation between Brazil (the large neighbour in South America) and other countries in the region has been a frequent source of concern for policymakers, as it has been viewed as evidence of the large influence of the former country on its neighbours. This paper studies the importance of such influence, documenting trade linkages over the last two decades and quantifying spillover effects in a vector autoregression setting. We find that, after controlling for common external factors, spillovers from Brazil are only relevant for Southern Cone economies (especially Mercosur's members) and Peru, but not for the rest of South America, and these findings are consistent with the extent of trade linkages between these countries. We find also that spillovers can take two different forms: the transmission of Brazil-specific shocks and the amplification of global shocks – through their impact on Brazil's output. Finally, we also find suggestive evidence that depreciations of Brazil's currency may not have significant impact on output of its key trading partners.

OLDER PROJECTS ––––––––––––––––––

"Modernizing Bank Regulation in Support of Financial Deepening; The Case of Uruguay"
(with Torsten Wezel and Mario Mansilla)
IMF Working Paper 09/199, 2009  

This paper studies how Uruguay's regulatory framework was gradually strengthened to address shortcomings identified during the 2002-03 crisis, to align with international standards and, more recently, to deal with cyclical pressures resulting in an acceleration of bank lending. In particular, regulatory reforms pertaining to loan classification and provisioning as well as liquidity requirements are reviewed and evaluated against best practices. The paper concludes that prudential regulation in Uruguay now generally conforms to high standards while also embracing innovative elements such as dynamic provisioning.

"Determinantes del Riesgo Soberano en Uruguay"
(with Karina Azar, Cecilia Oreiro and Fiorella Tramontín)

Documentos de trabajo 2007001, Banco Central del Uruguay, 2007

En el presente trabajo se busca identificar los determinantes del spread soberano de Uruguay a los efectos de incluir esta variable en los modelos de predicción macroeconómicos del Banco Central del Uruguay. Para el análisis de largo plazo se utiliza la técnica de Vectores Autorregresivos con restricciones de cointegración, mientras que para la dinámica de ajuste de los desequilibrios de corto plazo se utiliza el Modelo Vectorial de Corrección de Errores. Los resultados encontrados van en línea con la literatura existente en cuanto a la importancia de los fundamentos externos en la determinación del riesgo soberano de países emergentes, aunque los fundamentos domésticos también son relevantes en la determinación del spread de Uruguay. Se encuentra una relación de largo plazo entre el spread de Uruguay y la tasa de inflación, el ratio deuda pública sobre producto, los desequilibrios del tipo de cambio real, el rendimiento de los bonos de Estados Unidos a diez años y el spread de los países emergentes. Se verifica, también, la existencia de un cambio estructural con un aumento en la correlación entre el spread de Uruguay y el de los países emergentes a partir de la pérdida del grado de inversión. En el corto plazo, el spread soberano esta afectado por los términos de intercambio y el ratio de activos de reserva sobre producto. Sin embargo, estos resultados deben interpretarse con cuidado debido a la corta duración de las series de datos disponibles y la cercanía de la crisis económica.