Abstract: Inflation targeting (IT) has been adopted by a growing number of  countries and Latin America has been part of this world trend. This  paper reviews the recent IT experiences of Brazil, Chile, and Mexico,  applying a common empirical framework to the three country cases.  Inflation performance under IT and its associated output costs are  reported and compared favorably to a control group of other countries. The paper analyzes ways by which IT has contributed to  strengthen credibility: the effect of targets on inflation  expectations and on actual inflation, the low influence of inflation  shocks on core inflation, and the decline in inflation forecast  errors. Do the three inflation targeters exhibit fear of floating?  No, considering their relatively large exchange rate volatility and  moderate international reserve holdings. No, considering strongly  declining inflation-to-devaluation passthrough coefficients and  little evidence for monetary policy reaction to exchange rate shocks.  Yes, considering the frequency and intensity of sterilized exchange  interventions in comparison to other inflation targeters that float  more cleanly.

"Dollarization and Economic Performance: What Do we Really Know? " by  Sebastian Edwards  ; I. Igal Magendzo

    Abstract: In this paper we analyze the macroeconomic record of dollarized  economies. In particular, we investigate whether, as its supporters'  claim, dollarization is associated with lower inflation and faster  growth. We analyze this issue by using a matching estimator technique developed in the training evaluation literature. Our findings suggest  that inflation has been significantly lower in dollarized nations  than in non-dollarized ones. We also find that dollarized nations  have had a lower rate of economic growth than non-dollarized ones.  Finally, we find that macroeconomic volatility is not significantly  different across dollarized and non-dollarized economies. We  conjecture that the lower rate of economic growth in dollarized  countries is due, at least in part, to these countries' difficulties  in accommodating external disturbances, such as major term of trade  and capital flows shocks.

    Abstract: This paper reviews the literature on the effects of capital  account liberalization and stock market liberalization on economic  growth. The various empirical measures used to gauge the presence of  controls on capital account transactions as well as indicators of  stock market liberalization are discussed. We compare detailed  measures of capital account controls that attempt to capture the  intensity of enforcement with others that simply capture whether or  not controls are present. Our review of the literature shows the  contrasting results that have been obtained. These differences may  reflect differences in country coverage, sample periods and  indicators of liberalization. In order to reconcile these  differences, we present new estimates of the effects on growth of capital account liberalization and stock market liberalization. We  find some support for a positive effect of capital account  liberalization on growth, especially for developing countries.

    Abstract: We explore the interaction between exchange rates, institutional  investor currency flows and exchange-rate fundamentals. We find that  these flows are highly correlated with contemporaneous and lagged  exchange rate changes, and that they carry information for future  excess currency returns. This information, however, is not strongly  linked to future fundamentals. Flows are important in understanding  transitory elements of excess returns, which include short-run  underreaction and long-run overreaction. However, flows have a zero  or negative correlation with permanent components of excess returns.  We find that measured fundamentals - not flows - seem important in  understanding permanent elements of excess returns. We conclude that  investor flows are important for understanding deviations of exchange  rates from fundamentals, but not for understanding the long-run  currency values.

    Abstract: This paper examines how 12 'major depreciations' between 1997  and 2000 affected different measures of firm performance in a sample  of over 13,500 companies from around the world. Results suggest that  in the year after depreciations, firms have significantly higher  growth in market capitalization, but significantly lower growth in  net income (when measured in local currency). Firms with a higher  share of foreign sales exposure have significantly better performance  after depreciations, according to a range of indicators. Firms with  higher debt ratios tend to have lower net income growth, but there is  no robust relationship between debt exposure and the other  performance variables. Larger firms frequently have worse performance  than smaller firms, although the significance and robustness of this  result fluctuates across specifications.

    Abstract: The New Open Economy Macroeconomics has allowed economists to  tackle classical problems with new tools, while also generating new  ideas and questions. In their attempts to make the new models capture  empirical regularities, researchers have entertained a variety of  assumptions about the international pricing of goods, notably, models  of pricing to market and destination-currency pricing of exports.  Some of the resulting models imply that exchange-rate changes lack  international expenditure-switching effects, and they thus appear to  call for a radical rethinking of the role of exchange rates in  international adjustment. This paper argues that the recent  resurgence of exchange-rate pessimism stems from oversimplified  modeling strategies rather than from evidence. Like earlier episodes  starting with the extreme 'elasticity pessimism' of the early postwar  era, it is based on a misinterpretation of the empirical record.

    Abstract: This paper provides a framework for examining developing-country  financial crisis. It is based upon Hyman Minsky's financial fragility  thesis and applied to the case of Thailand 1984-1999. There is  empirical evidence for the evolution of the Thai economy through the  Minskian regimes (hedged through speculative to Ponzi) in the period  prior to the onset of the 1997 Asian crisis. Evidence also suggests  that the Ponzi regime has two stages and that the rate of return on  nonproductive speculative investment turns negative as the country  entered the Ponzi regime. The diversion of foreign capital inflows to  speculative investment played an important part in the deterioration  of the Thai financial position. These results, if general, have  strong implications for the field of country risk analysis, in  particular, for the design of early warning models of financial  crisis for developing countries.

        Abstract: This paper analyzes the stabilizing properties of alternative  monetary policy regimes. In practice there is a choice between two  broad types of monetary policy regimes: a fixed exchange rate regime or a floating exchange rate regime. In this paper I compare exchange  rate targeting with different floating exchange rate regimes: strict  price level targeting, flexible price level targeting and output gap targeting. The paper also evaluates the actual choice of monetary  policy regime for seven countries with a pure floating exchange rate  regime. In most cases the actual regime can be described as flexible   price level targeting. The results suggest that flexible and strict  price level targeting gives lower real and nominal variability than  both exchange rate targeting and output gap targeting.

    Abstract: In this paper we study the changes in corporate valuation,  investments, and financing choices induced by the formation of  Economic and Monetary Union (EMU) in Europe. We use corporate-level  data from ten countries that adopted the euro, the three EU countries  that did not join EMU, as well as Norway and Switzerland. We show  that the introduction of the euro has increased valuations for large  firms in EMU countries, especially in countries that had experienced  currency crises. Firm values have also increased for firms that were  previously exposed to currency risks irrespective of size.  Investments have increased for all firms, but the effects are bigger  for large firms and for firms coming from countries with experiences  of currency depreciations. The increase in investments has been  financed mainly via debt issues. The evidence provided here supports  the view that the introduction of the euro has lowered firms' cost of  capital by eliminating currency risks among the countries that have adopted the common currency, and by further increasing capital market  integration in Europe.

    Abstract: This paper argues that the frequent failure of the debt swaps is  not an accident. Instead, it follows from fundamental forces driven  by the market's assessment of the scarcity of fiscal revenue relative
 to the demand for fiscal outlays. It follows from the observation  that arbitrage forces systematically impact prices in asset markets.  Ignoring these price adjustments would lead to too optimistic an assessment of the gains from swaps or buybacks. A by-product of our  paper is to highlight the perils of financial engineering that  ignores the intertemporal constraints imposed by fiscal fundamentals.   As a country approaches the range of partial default (either on  domestic or external debt), swaps may not provide the expected  breathing room and could even bring the crisis forward. Our  methodology combines three independent themes: exchange rate crises  as the manifestation of excessive monetary injections [Krugman-Flood- Garber], the fiscal theory of inflation [Sargent-Wallace (1981)], and  sovereign debt. The integrated framework derives devaluation and  external debt repudiation as part of a public-finance optimizing  problem. We shows that under conditions similar to those which  prevailed in Russia and Argentina prior to their meltdown, swaps are  not just neutral, but could actually make the situation worse and  even trigger a speculative attack. An unsettlingly clear implication  of the model is that there may be very few options left once public  debt reaches levels regarded as unsustainable in relation to fiscal  fundamentals. Dollarization only makes matters worse, and pushes the  debt write-down option to the fore.

    Abstract: We propose a model of exchange-rate regime choice which accounts  for the existence of a continuous range of regimes, the need for real  exchange-rate adjustment in response to shocks, the existence of  capital account shocks and of balance-sheet effects, the sensitivity  of prices to the nominal exchange rate, and the need for a commitment  to make any given regime sustainable. Non-ordered Logit estimations  on a cross-section sample of 126 emerging and developed countries  before and after 1997-1998 currency crises broadly support our  approach.. Specifically, we find that there is still a case for  intermediate regimes in countries where the interest rate channel is  weaker and which do not depend too much on commodities. The empirical  model correctly predicts up to 83% of observed exchange rate regimes,  and the recent "hollowing out" of intermediate regimes. It also  provides a benchmark to assess the recent changes in individual  exchange rate regimes.

    Abstract: There is a startling gap between, allegedly, globalization- induced changes in international competition for foreign direct  investment (FDI) and recent empirical evidence on the relative  importance of determinants of FDI in developing countries. We show  that surprisingly little has changed since the late 1980s.  Traditional market-related determinants are still dominant factors.  Among non-traditional FDI determinants, only the availability of  local skills has clearly gained importance. As concerns the interface  between trade policy and FDI, we find that the tariff jumping motive  for FDI had lost much of its relevance well before globalization  became a hotly debated issue.

    Abstract: The currency crises of the 1990s all exhibit a divergence of the  nominal and the real exchange rate together with an increase in the  negative current account. The nominal rate does not reflect inflation  differences fully and the ensuing real appreciation leads to a  negative current account. This pattern holds for the Czech, the  Mexican, Brazilian, Argentinian as well as the South Korean currency  crises. It seems to be an iron law of currency crises.

    Abstract: Although there is now widespread agreement in the economics  profession that discretionary counter-cyclical'fiscal policy has not  contributed to economic stability and may have actually been  destabilizing at particular times in the past, there is one important  condition when discretionary fiscal policy can play a constructive  role: in a sustained downturn when aggregate demand and interest  rates are low and when prices are falling or may soon be falling.  This short note begins by summarizing the general case against using  fiscal policy for stabilization. It next considers the argument for  using a hyperexpansive' monetary policy to reduce the risk that a low  rate of inflation will lead to a deflationary situation in which  monetary policy becomes ineffective. Such a policy would increase the   risk of asset price bubbles and of a misaligned exchange rate.  Discretionary fiscal policy provides an alternative way to stimulate  the economy when aggregate demand and interest rates are low and when   prices are falling or may soon be falling. A stimulus can be achieved without increasing budget deficits if the fiscal policy acts by  providing an incentive for increased private spending. Specific  examples for the U.S. and Japan are considered.

    Abstract: The paper surveys a theory of FDI, which captures a unique  feature: hands-on management standards, that enable investors to  react in real time to a changing economic environment. Equipped with  superior managerial skills, foreign direct investors are able to  outbid portfolio investors for the top productivity firms in a  particular industry in which they have specialized in the source  country. Consequently, FDI investors would make investment, both  larger, and of higher quality (namely, with large rates of returns),  than the domestic investors. The theory can explain both two-way FDI  flows among developed countries, and one-way FDI flows from developed  to developing countries. Gains to the host country from FDI stem from  the informational value of FDI. The predictions of the theory are  consistent with evidence from panel data: larger FDI coefficients in  the domestic investment and output growth regressions relative to the  portfolio equity flow and international loan coefficients, reflect a  more significant role for FDI in the domestic investment process than  other types of capital inflows.

    Abstract: In this paper we characterize empirically the comovements of  macro variables typically observed in middle income countries, as   well as the boom-bust cycle' that has been observed during the last   two decades. We find that many countries that have liberalized their   financial markets, have witnessed the development of lending booms.   Most of the time the boom gradually decelerates. But sometimes the   boom ends in twin currency and banking crises, and is followed by a  protracted credit crunch that outlives a short-lived recession. We  also find that during lending booms there is a real appreciation and  the nontradables (N) sector grows faster than the tradables (T)  sector. Meanwhile, the opposite is true in the aftermath of crisis.  We argue that these comovements are generated by the interaction of   two characteristics of financing typical of middle income countries:   risky currency mismatch and asymmetric financing opportunities across   the N- and T-sectors.

    Abstract: We develop a simple information-based model of FDI flows in   which the abundance of intangible' capital in the source countries,   which generates expertise in cream-skimming investment projects in   the host countries and enhances FDI flows. Corporate transparency in  the host countries, on the other hand, diminishes the value of this  expertise and thereby reduces the flow of FDI. Empirical evidence  (from a sample of 12 source countries and 45 host countries over the   1980s and 1990s) which is analyzed in a gravity equation model   provides some support to our theoretical hypotheses. The gains from   FDI in the host country in our model are reflected in a more e.cient   size of stock of domestic capital and its allocation across firms.   These gains depend crucially (and inversely) on the degree of   competition among FDI investors.

    Abstract: In this paper I discuss in what way, if any, the collapse of   Argentina's experience with a currency board has affected the policy   debate on the appropriate exchange rate regime in emerging and   transition countries. More specifically, I deal with three issues:   (1) I discuss some important aspects of the Argentine experience. (2)  I provide a comparative evaluation of economic performance under   strict dollarization. And (3), I analyze emerging countries'   experiences with flexible exchange rates, including the issue of fear   of floating.'

    Abstract: A currency area can be a self-validating optimal policy regime, even when monetary unißcation does not foster real economic integration and intra-industry trade. In our model, ßrms choose the optimal degree of exchange rate pass-through to export prices while accounting for expectedmonetary policies, and monetary authorities choose optimal policy ruleswhile taking ßrms' pass-through as given. We show that there exist two equilibria, each of which deßnes a self-validating currency regime. In theßrst, ßrms preset prices in domestic currency and let prices in foreigncurrency be determined by the law of one price. Optimal policy rulesthen target the domestic output gap, and àoating exchange rates supportthe àex-price allocation. In the second equilibrium, ßrms preset prices in consumer currency, and a monetary union is the optimal policy choice for all countries. Although a common currency helps synchronize business cycles across countries, àexible exchange rates deliver a superior welfareoutcome.

      Abstract: Considerable attention has been paid to the possibility that  large-scale IMF-led financing packages may have distorted incentives  in international financial markets, leading private investors to provide more credit to emerging market countries, and at lower  interest rates, than might otherwise have been the case. Yet, prior  attempts to identify such distortions have yielded mixed evidence, at  best. This paper makes three contributions to our ability to assess  the empirical importance of moral hazard in international financial  markets. First, it is argued that because large international  "bailouts" did not commence until the 1995 Mexican crisis, financial  indicators prior to that time could not have reflected a significant  degree of this type of moral hazard. Therefore, one test for the  existence of moral hazard is that the access of emerging markets to  international credit is significantly easier than it was prior to  1995. Second, the paper argues that because private investors expect  large-scale IMF-led packages to be extended primarily to economically  or geo-politically important countries, moral hazard, if it exists,  should lead these countries to have easier terms of access to credit  than smaller, non-systemically important countries. Finally, in  addition to looking at bond spreads, the focus of earlier empirical  analyses of moral hazard, the paper also examines trends in capital  flows to gauge the access of emerging market countries to external  finance. Looking at the evidence in light of these considerations,  the paper concludes that there is little support for the view that  moral hazard is significantly distorting international capital  markets at the present time.

    Abstract: According to conventional models, flexible exchange rates play  an equilibrating role in open economies, depreciating in response to  adverse shocks, boosting net exports, and stimulating aggregate
demand. However, critics argue that, at least in developing  countries, devaluations are more contractionary and more inflationary  than conventional theories would predict. Yet, it is not clear  whether devaluations per se have led to adverse outcomes, or rather  the disruptive abandonments of pegged exchange-rate regimes  associated with devaluations. To explore this hypothesis, we estimate  VAR models to compare the responses to devaluation of developing  economies and two types of industrial economies: those that have  consistently floated, and those that have sustained fixed exchange-  rate regimes as well. We find that both of these types of industrial  economies exhibit conventional (i.e., expansionary) responses to  devaluation shocks, compared with the contractionary responses  exhibited by developing countries. This finding suggests that  exchange rate movements may be more destabilizing in developing  countries than in industrial countries, regardless of exchange rate  regime.

    Abstract: Sudden Stops are the simultaneous occurence of a  currency/balance of payments crisis with a reversal in capital flows  (Calvo, 1998). We investigate the output effects of financial crises  in emerging markets, focusing on whether sudden-stop crises are a  unique phenomenon and whether they entail an especially large and  abrupt pattern of output collapse (a "Mexican wave"). Despite an emerging theoretical literature on Sudden Stops, empirical work to  date has not precisely identified their occurences nor measured their  subsequent output effects in broad samples. Analysis of Sudden Stops may provide the key to understanding why some currency/balance of  payments crises entail very large output losses, while others are  frequently followed by expansions. Using a panel data set over the  1975-97 period and covering 24 emerging-market economies, we  distinguish between the output effects of currency crises, capital  inflow reversals, and sudden-stop crises. We find that sudden-stop  crises have a large negative, but short-lived, impact on output  growth over and above that found with currency crises. A currency  crisis typically reduces output by about 2-3 percent, while a Sudden  Stop reduces output by and additional 6-8 percent in the year of the  crisis. The cumulative output los of a Sudden Stop is even larger,  around 13-15 percent over a three-year period. Out model estimates  correspond closely to the output dynamics of the "Mexican wave" (such  as seen in Mexico in 1995, Turkey in 1994 and elsewhere), and out-of-  sample predictions of the model explain the sudden (and seemingly  unexpected) collapse in output associated with the 1997-98 Asian  Crisis. The empirical results are robust to alternative model  specifications, lag structures and using estimation procedures (IV  and GMM) that correct for bias associated with simultaneity and  estimation of dynamic panel models with country-specific effect.

     Abstract: We analyze the impact of financial globalization on asset  prices, investment and the possibility of crashes driven by self- fulfilling expectations in emerging markets. In a two-country model  with one emerging market (intermediate income level) and one  industrialized country (high income level), we show that  liberalization of capital flows increases asset prices, investment  and income in the emerging market. However, for intermediate levels  of international financial transaction costs, we find that  pessimistic expectations can be self-fulfilling, leading to a  financial crash. The crash is accompanied by capital flight, a drop  in income and investment below the financial autarky level and more  market incompleteness. We show that emerging markets are more prone  to financial crashes simply because they have a lower income level  and not because of the existence of market failures (moral hazard or  credit constraints), bad monetary policies or exchange rate regimes.

     Abstract: Exchange rate regime optimality,as well as monetary policy  effectiveness,depends on the tightness of the link between exchange  rate movements and import prices.Recent debates hinge on whether
producer-currency pricing (PCP)or local-currency pricing (LCP) of  imports is more prevalent,and on whether exchange rate pass-through  rates are endogenous to a country 's macroeconomic conditions.We provide cross-country and time series evidence on both of these issues for the imports of twenty-five OECD countries. Across the OECD,and especially within manufacturing industries,there is
compelling evidence of partial pass-through in the short-run ­  rejecting both PCP and LCP. Over the long run,PCP is more prevalent  for many types of imported goods.Higher inflation and exchange rate  volatility are weakly associated with higher pass-through of exchange  rates into import prices. However, for OECD countries, the most  important determinants of changes in pass-through over time are
microeconomic and relate to the industry composition of a country 's  import bundle.

     Abstract: This paper models and tests the implications of costly  enforcement of property rights on the pattern of foreign direct  investment (FDI). We posit that domestic agents have a comparative  advantage over foreign agents in overcoming some of the obstacles  associated with corruption and weak institutions. We model these  circumstances in a principal-agent framework with costly ex-post  monitoring and enforcement of an ex-ante labor contract. Ex-post  monitoring and enforcement costs are assumed to be lower for domestic  entrepreneurs than for foreign ones, but foreign producers enjoy a  countervailing productivity advantage. Under these asymmetries,  multinationals pay higher wages than domestic producers, in line with  the insight of efficiency wages and with the evidence about the  multinationals wage premium.' FDI is also more sensitive to increases  in enforcement costs. We then test this prediction for a cross  section of developing countries. We use Mauro's (2001) index of  economic corruption as an indicator of the strength of property right  enforcement within a given country. We compare corruption levels for  a large cross section of countries in 1989 to subsequent FDI flows  from 1990 to 1999. We find that corruption is negatively associated  with the ratio of subsequent foreign direct investment flows to both  gross fixed capital formation and to private investment. This finding  is true for both simple cross-sections and for cross-sections  weighted by country size.