Cross-Country Determinants of  Resilience to Global Inflationary Shocks

The post-pandemic surge in inflation has been a concern for policymakers across the globe. Using a panel of 72 countries with quarterly data, we estimate the effect of global shocks on consumer prices. Comparing pre- and post-pandemic cumulative responses to consumer prices, we find that global demand shock has always led to persistent increases in prices. The global supply chain pressure temporarily affected prices before the pandemic but became very persistent in the post-pandemic world. Further geopolitical risk and global economic policy uncertainty emerged as inflationary shocks only recently. Finally, we show that countries with lower dependence on imported commodities and higher current account balances are more resilient to these inflationary shocks.

Fiscal Spillover in Emerging Economies:  Real vs. Financial Channels

Fiscal policy is an important tool for business cycle stabilization and has significant spillover due to real and financial channels. In this paper, we estimate the spillover of US fiscal policy shock in emerging economies which is distinct from the US monetary policy spillover. We find that- similar to its effect in advanced economies- the shock lowers the real policy rate in emerging economies. Results suggest a disconnect between long-term rate and policy rate that leads to the steepening of the yield curve in emerging economies due to the shock. Contrary to its effect in the US, we find that this shock leads to a prolonged appreciation of real effective exchange rates in emerging economies and hurts their external competitiveness. These effects of US government expenditure shock in emerging economies are direct and not indirectly driven by the effect of this shock on GDP growth and inflation in emerging economies although the shock leads to contraction of output in emerging economies.

Government Size and Risk Premium

Given the rise in the government debt level in recent times, this paper aims to understand the effect of an increase in government size on risk premium and its transmission in the economy. We jointly identify the term spread shock (originating at the short-end and the long-end) and the government size shock, using max share identification. Term spread shock originating at the long-end is driven by higher risk premium unlike the shock originating at the short-end, and increases inflation and reduces growth. Results suggest that the increase in the share of government expenditure in GDP (size) increases long-term rates by increasing the risk (term premium) and hence obstructs the transmission of monetary policy. As expected, the effect of government size on risk premium is more pronounced during recessions compared to expansions. By including a news shock about future economic activity, we rule out that the effect of government size shock on term premium is not driven by a news shock. We estimate the parameters of a new Keynesian model with term premium by matching the responses in data with responses from the model. The model can generate a similar rise in risk premium due to the increase in government size, and the estimated parameters suggest that the coefficient of risk aversion in recession times is more than twice that of during expansions.

Revenue & Cost Uncertainties and Market Power 

Using administrative plant-level data from India, we estimate the effect of revenue and cost uncertainties on markup (product market power), markdown (labor market power), and combined market power. We show that historical two and three-digit industry averages of exports, imported inputs, and oil share are valid instruments for exports, imported inputs, and oil share at the plant level. Results suggest that revenue and cost uncertainties affect markup differently, revenue uncertainty decreases whereas cost uncertainty increases markup. Despite the opposite effect of these uncertainty measures on product market power, revenue and cost uncertainties tend to increase combined market power. This is because the revenue uncertainty significantly increases labor market power. Although, heightened cost uncertainties reduce labor market power but by less compared to increases in product market power. Given the results obtained in this paper, it is important to make a distinction between revenue and cost uncertainty to understand their cyclical nature. 

Digitalisation and material well-being at household level

Recent developments in FinTech have made financial inclusion a policy priority across the globe. Using aggregate data, we observe that quality-of-life indices that include financial inclusion strongly correlate with per-capita income across Indian states. In this context, using two rounds of household-level survey data from India spread over two decades, we explore the extent to which financial inclusion enables consumption smoothing, as consumption levels tend to correlate with both types of inclusion. Our results suggest that traditional financial inclusion is more effective compared to digital financial inclusion for consumption smoothing. This is because traditional inclusion leads to a larger reduction in borrowing costs compared to digital inclusion. Further, consumption smoothing due to financial inclusion depends upon wealth; at higher levels of wealth, consumption smoothing due to both types of inclusion is more pronounced. This is driven by an imperfection in financial markets where higher wealth acts as collateral and leads to a further reduction in the borrowing costs for these households. 

Optimism and Pessimism in Indian Business Cycle

In this paper, we estimate a heterogenous agent new Keynesian model using Indian data to understand the sources of the recent decline in GDP growth. We implement a shock to bond in utility and show that this shock captures the optimism and pessimism (borrowing constraint being binding) for optimizing (savers) households. Pessimism shock is inversely related to preference shock, giving a structural interpretation of preference shock. Numerical simulations suggest that the amplification of monetary policy effects in the heterogenous agents model depends upon the habit persistence in consumption for non-optimizing households. Results from Bayesian estimation suggest that pessimism shock is the significant driver of the Indian business cycle and the recent decline in growth has been driven by household pessimism. The sluggish and significantly lower credit growth in the late 2010s makes these findings intuitively appealing.

Commodity Prices and Twin Balance Sheet Crisis

In the workhorse new Keynesian models, sectoral deflation is of little consequence unless it affects overall inflation. But in practice, sectoral deflation combined with nominal debt contracts and rigidity in the labour market can have large and significant adverse effects. Using data from India (the second largest steel producer in the world), we estimate the effect of large movements in metals prices during 2011-16 on financial and non-financial firms. As expected, a decrease in commodity prices led to a decline in profit in general and defaulting firms experienced an even larger decline in profitability. Using a difference-in-differences design, we find that banks having higher exposure to the metals sector declared significantly higher non-performing assets post commodity price crash compared to banks having little or no exposure. Hence, a large decline in commodity price can cause a prolonged twin balance sheet crisis which has not received enough attention in the existing literature. This type of balance sheet crisis hurts credit and economic growth in the medium run. Results also suggest that the large decline in domestic metals prices post 2011 was mostly driven by lower import prices from China and less than proportionate depreciation of the exchange rate.

Commodity Price Shocks and Non-Performing Assets in the Indian Banking Sector

Non-performing assets in the Indian banking sector increased significantly in the 2010s, accompanied by a slowdown in credit and GDP growth rates. In this paper, we show that non-performing assets in the banking sector and profit ratios in commodity-sensitive non-financial sectors are highly correlated with global commodity prices. To estimate the effect of movement in commodity price on non-performing assets, we create nominal price and inflation exposure indices for banks using novel data on banks’ sectoral exposure and commodity prices. These measures capture banks’ exposure to commodity prices through their borrowers’ profitability and cash flow and act as income shocks for banks. Results from a range of models suggest that a 1% decline in nominal exposure increases non-performing assets by 0.20-1.35% and these models explain ~30% of the variation in non-performing assets. The increase in non-performing assets is followed by a decrease in credit growth. These results help us in understanding the origins of India's twin balance sheet crisis.

Does productivity growth boost domestic savings? Causal evidence using event studies and model-based instruments

Domestic resource mobilisation, as a key policy challenge for developing economies, raises questions on what determines cross-country differences in savings behaviour and whether saving precedes growth or vice versa. We show that the reduced-form correlation is of little use; thus we create savings and growth transitions, and use event studies and a generalised synthetic control framework to show that productivity growth transitions cause a sustained increase in savings ratio, whereas savings transitions do not bring any change in productivity growth. Using an IV strategy with technological shocks estimated from a Neo-classical growth model, we show these shocks as valid instruments for TFP growth, with a similar response in savings, suggesting that one percentage-point increase in TFP growth raises savings by 0.75 percentage-point over 5 years. We conclude that countries should focus on promoting policies to boost productivity growth and thereby achieve higher savings instead of focusing on savings-induced policies alone

Exchange Rate Pass-through and Monopsony Power in a Large Emerging Economy 

The exchange rate pass-through (ERPT) literature has not considered the labour market effects of exchange rate changes. Using a product-level data set from India, we find significant but incomplete exchange rate pass-through to export and import prices. These incomplete pass-through estimates imply significant exogenous changes in prices, generating gains for producers. Further, with a plant-level Indian data set, we show that these gains, arising from currency depreciation, are shared with labour as reflected in lower markdown, and this price gain brings their wages closer to the competitive wage. As expected, the gains for labour from depreciation are higher in the case of exporting plants and lower for plants using imported inputs.  These results suggest significant welfare effects of exchange rate movements which have not been documented in this literature. 

Oil Price Dynamics in Times of Uncertainty: Revisiting the Role of Demand and Supply shocks

Drivers of real oil prices have been explored extensively in the literature with little consensus. Using a new identification scheme based on forecast error variance, we identify oil-specific demand, demand and oil supply shocks that maximize the sum of forecast error variance of three variables explained by their respective shocks. Estimation with the sample period until 2007, suggests that the three identified shocks have similar effects as in the early literature, with oil-specific demand shocks playing a prominent role. However, in the post-crisis period supply shocks have emerged as a source of short-run increase in oil prices and demand shocks do not have a long-run effect on prices, unlike in the pre-crisis period. Even with the inclusion of uncertainty shock, this transition to a supply shock driving oil prices in the short-run survives. These estimates overwhelmingly suggest zero short-run supply elasticity, a matter of debate in recent literature. Although oil-specific demand shocks are predominant drivers of real oil prices, six episodes (including COVID-19) considered in this paper suggest that other shocks have also played a significant role in driving oil prices in different episodes and cannot be ignored while evaluating the oil price dynamics.

Bank Credit Risk and Macro-Prudential Policies:  Role of counter-cyclical capital buffer 

This paper investigates the impact of Counter-Cyclical Capital Buffer (CCyB) as a macro-prudential policy, on bank credit risk. Using a unique daily data set consisting of 4939 credit default swaps (CDS) of 70 banks from 25 countries over the period 2010-2019, we find that CCyB tightening decreases bank-level CDS spread while CCyB loosening increases CDS spread. This heterogeneous effect of CCyB arises due to its asymmetric effect on the capital ratio (equity-to-total assets) of banks. Tightening CCyB significantly increases capital, whereas loosening CCyB does not impact capital. Thus, by imposing on banks to hold capital buffer, the CCyB regulation enables them to mitigate any rise in credit risk during uncertain times when bank assets lose value. Therefore, macro-prudential policies for banks to hold higher levels of capital during good times are justified to contain financial market risks during downturns. 

Market volatility, monetary policy and the term premium

In this paper, we use time-varying VAR models to study the effects of option-implied measures of equity and bond market volatilities on the government bond term premium and key macroeconomic variables. We show that the high correlation between the two volatilities requires that shocks to these variables be jointly identified. We find that a positive shock to the VIX reduces the term premium. We interpret this effect as the result of investors shifting their portfolios away from riskier assets. The positive shock to the VIX also has contractionary and disinflationary effects. By contrast, a positive shock to the MOVE, which reflects heightened uncertainty about future changes in interest rates, raises the term premium. Similar to a VIX shock, an increase in bond market volatility also has a contractionary effect, although the negative effects on output and inflation are smaller. Both VIX and MOVE shocks resemble negative demand shocks, albeit of different intensity, to which the central bank responds by easing monetary policy. Depending on the type of volatility impacting the economy, a contraction in output can be associated either with a flattening or steepening of the yield curve.