Browsing by Author "Calvo, Guillermo A."
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Item Balance of Payment Crises In Emerging Markets: Large Capital Inflows and Sovereign Governments(1998-03-15) Calvo, Guillermo A.The paper shows that the combination of large capital inflows and sovereign governments could give rise to self-fulfilling balance of payments crises. It argues that a current account deficit could impair the resolution of such crises, but the crises themselves could occur even though the current account was in balance. The key is a weak financial sector, possibly made so by an accommodating central bank. In contrast with most of the literature on this subject, the paper endogenizes output and discusses the channels (New Classical and Keynesian) through which a BOP crisis can result in output collapse. Building on a Time to Build model, the paper shows that a growth slowdown can take place even though a BOP crisis brings about no current account reversal.Item Betting Against The State: Socially Costly Financial Engineering(Elsevier, 1999-05-29) Calvo, Guillermo A.The central question raised in the paper is the desirability of state-contingent contracts under imperfect policy credibility. The paper shows a benchmark case in which imperfect credibility of a trade liberalization program is distorting, and the distortion is magnified by statecontingent markets. In addition, it examines the welfare implications of gaining credibility concluding that, in general, more credibility is better than less, and examines the moral hazard faced by policymakers in carrying out reform in case the private sector is able to obtain insurance against its discontinuation.Item Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops(Journal of Applied Economics, 1998-11) Calvo, Guillermo A.The paper studies mechanisms through which a sudden stop in international credit flows may bring about financial and balance of payments crises. It is shown that these crises can occur even though the current account deficit is fully financed by foreign direct investment. However, equity and long-term bond financing may shield the economy from sudden stop crises. The paper also examines possible factors that could trigger sudden stops, and argues that the greater independence that countries have, as compared to regions of a given country, could help to explain why sudden stop crises are more prevalent and destructive at international than at national levels.Item Contagion in Emerging Markets: When Wall Street is a carrier(1999-05-02) Calvo, Guillermo A.The paper examines the case in which the capital market is populated by informed and uninformed investors. The uninformed try to extract information from informed investors’ trades. This opens up the possibility that if informed investors are forced to sell emerging market securities to meet margin calls, for example, this action may be misread by the uninformed investors as signaling low returns in emerging markets. The paper presents a simple model in which this type of Wall Street confusion may result in a collapse in emerging markets’ output.Item Empirical Puzzles of Chilean Stabilization Policy(The World Bank Publications, 1998-03-05) Calvo, Guillermo A.; Mendoza, Enrique G.This paper reviews Chilean stabilization policy during the 1990s and argues that, while the merits of Chilean policy should be praised, there are four puzzles in conventional interpretations of the Chilean experience worth studying. First, the policy of targeting indexed interest rates does not coincide with a policy of targeting real interest rates. Second, there is no systematic link between the decline in inflation and the upward adjustments in indexed interest rates. Third, changes in the exchange rate and in the performance of the external sector help explain the decline in inflation. Fourth, the strong cyclical growth of the real economy was influenced in part by the large and persistent increase in the world price of Copper. We provide statistical evidence favoring these arguments using recursively-identified vector-autoregression models, and sketch a model of staggered pricing under indexation that sheds some light on the Chilean case.Item Fear of Floating(2000-09-25) Calvo, Guillermo A.; Reinhart, Carmen M.In recent years, many countries have suffered severe financial crises, producing a staggering toll on their economies, particularly in emerging markets. One view blames fixed exchange rates-- “soft pegs”--for these meltdowns. Adherents to that view advise countries to allow their currency to float. We analyze the behavior of exchange rates, reserves, the monetary aggregates, interest rates, and commodity prices across 154 exchange rate arrangements to assess whether “official labels” provide an adequate representation of actual country practice. We find that, countries that say they allow their exchange rate to float mostly do not--there seems to be an epidemic case of “fear of floating.” Since countries that are classified as having a free or a managed float mostly resemble noncredible pegs--the so-called “demise of fixed exchange rates” is a myth--the fear of floating is pervasive, even among some of the developed countries. We present an analytical framework that helps to understand why there is fear of floating.Item Fixed Versus Flexible Exchange Rates: Preliminaries of a Turn-of-Millenium Rematch(1999-05-16) Calvo, Guillermo A.This note examines the pros and cons of flexible and fixed exchange rates in terms of a bear-bones model which, however, takes into account features that have played a prominent role in recent currency crises, namely, volatility of capital flows and the real exchange rate, currency substitution and financial fragility, and the Credit Channel.Item Inflation Stabilization and BOP Crises in Developing Countries(Elsevier, 1999) Calvo, Guillermo A.; Végh, Carlos A.High and persistent inflation has been one of the distinguishing macroeconomic characteristics of many developing countries - particularly in Latin America - since the end of World War II. Pazos (1972) coined the term "chronic inflation" to refer the this phenomenon. In his view, chronic inflation is quite a different creature from the much more spectacular hyperinflations studied by Cagan (1956). First, unlike hyperinflations whose duration is measured in terms of months, chronic inflation may last for decades. Second, countries learn how to live with high and persistent inflation by creating various indexation mechanisms which, in turn, tend to perpetuate the inflationary process. As a result, inflation does not have an inherent propensity to accelerate and, if it does, soon reaches a new plateau.Item Monetary and Exchange Rate Policy for Mexico: Key Issues and a Proposal(1997-06-08) Calvo, Guillermo A.In these notes I lay out basic considerations which I believe are relevant for the design of monetary/exchange-rate policy, MEP, in Mexico. In my view, there are no ‘magic’ formulas. For some countries, an iron-clad currency board may be a desirable arrangement, while for others flexible exchange rates would be appropriate. This is so because ‘money’, unlike regular goods like bread, derives its value from convention, institutions and, more than any other good, from expectations. Thus, a key consideration in the design of MEP is the credibility of policymakers - - the latter being heavily determined by history and institutions which are, by necessity, countryspecific. Section II discusses some traditional goals of MEP, while Section III examines the role of credibility and flexibility to ensure its effectiveness. Section IV studies the recent experience in Mexico and shows that the proximate case for the 1994 financial debacle was a failed attempt at interest-rate smoothing, coupled with having ignored the role of external factors. Moreover, this section briefly examines MEP after the crisis. It concludes that MEP is highly accommodative and may have contributed to the existence of a “peso problem.” The latter, in turn, may give rise to further real appreciation of the currency. Section V presents a brief summary of the pros and cons of different MEPs. This is complemented in Section VI with a discussion of other policies and considerations that are essential for the sustainability of any MEP. More specifically, I will discuss the role of fiscal policy, management of domestic public debt and the role of the financial sector. Section VII offers some ideas for a MEP for Mexico based on previous considerations. In a nutshell, I propose adopting a system of flexible exchange rates, much like the present one, but with a longer horizon and complemented with a sliding floor on the nominal exchange rate to prevent large and sudden currency appreciation. Furthermore, I argue in favor of free-floating interest rates and no controls on capital mobility, except for reserves requirements aimed at preventing sudden and sizable growth in bank credit. Comparison with present MEP and some criticisms are discussed in Section VIII. Questions about long-term goals and transition are presented in Section IX. Appendix I examines a simple formal model to rationalize the effect of the MEP after the December 1994 crisis, while Appendix II analyzes some technical implications of the proposed exchange rate rule.Item Notes on Price Stickiness: With Special Reference to Liability Dollarization and Credibility(2000-12-23) Calvo, Guillermo A.This paper is motivated by trying to understand the implication of price stickiness in Emerging Market economies, EMs. The issue is important because EMs are subject to significantly higher volatility of fundamentals than advanced countries (see Hausmann and Rojas-Suarez (1996)). Thus, full-equilibrium relative prices are also likely to exhibit large volatility in EMs, making price stickiness an even more critical issue in EMs than in advanced countries.Item On Dollarization(1999-04-20) Calvo, Guillermo A.Recent worldwide turmoil in financial markets is triggering a major revision of the conventional wisdom about Emerging Market countries’ (EMs) macroeconomic management. As a result, the debate is wide open as to the set of policies and institutional arrangements that would ensure EMs’ macroeconomic stability. Opinions range from those favoring further pursuing market-friendly reforms to controls on capital mobility and even trade, and from dollarization to floating exchange rates. The debate on the appropriate exchange rate system, in particular, has taken center-stage.Item Política Económica en Aguas Borrascosas: Vulnerabilidad Financiera en Economías Emergentes(2000-10-26) Calvo, Guillermo A.Es para mí un gran honor y me hace muy feliz recibir el Premio de Economía Rey Juan Carlos, instituido por la Fundación José Celma Prieto. No hay un hecho más evocativo y emocionante para un latinoamericano que recibir un premio de la Madre Patria y que lleva el nombre de Su Majestad. Me siento muy agradecido, además, porque se cita mi labor científica, en contraposición a mis aventuras como pronosticador de crisis financieras. La ciencia económica es muy imprecisa pero es un pilar importante de la paz y la democracia. Sin ella, le sería muy difícil al gobierno tener un diálogo constructivo con los ciudadanos. La política económica no estaría sujeta a ningún tipo de disciplina intelectual. Al final del día sólo quedaría la violencia o la dictadura para dirimir estas cuestiones. Esa ha sido siempre la razón práctica de mi interés por esta disciplina. Un premio tan prominente como el que se me ha concedido, me da la plataforma para dar ese mensaje a las generaciones futuras. Muchas gracias.Item Rational Contagion and the Globalization of Securities Markets(Elsevier, 2000-06) Calvo, Guillermo A.; Mendoza, Enrique G.This paper argues that globalization may promote contagion by weakening incentives for gathering costly information and by strengthening incentives for imitating arbitrary market portfolios. In the presence of short-selling constraints, the gain of gathering information at a fixed cost may diminish as markets grow. Moreover, if a portfolio manager’s marginal cost for yielding below-market returns exceeds the marginal gain for above-market returns, there is a range of optimal portfolios in which all investors imitate arbitrary market portfolios and this range widens as the market grows. Numerical simulations suggest that these frictions can have significant implications for capital flows in emerging markets.Item Testimony on Dollarization(2000-06-22) Calvo, Guillermo A.I was invited here to explain about Dollarization, the benefits and costs for the US and the countries that adopt it. Before I start my formal presentation, I would like to state, in no uncertain terms, that I am a firm supporter of such system for many Emerging Market economies, EM, especially if it is done within the context of a Treaty with the US (as in Senator Connie Mack’s proposal). Moreover, I believe global dollarization will have direct economic benefits for the US, and enhance its role as a worldwide leader. Dollarization is the decision to abandon the national currency and replace it by the US Dollar (or some other hard currency like the Euro). This is a major economic and political decision. By default, a dollarized country adopts US monetary policy, even though the two countries could be going through different phases of the business cycle. Moreover, a dollarized country gives up the option of assisting banks by printing money in the case of a systemic bank run. In the first, and more substantive, part of my presentation I will argue that EM have already given up those functions. Therefore, dollarization is a win-win proposition except possibly for some fiscal costs (called seigniorage in the technical jargon). In the second part of the presentation I will evaluate the advantages of regional dollarization, and argue that dollarization is a winning proposition for the US. I will start the discussion by focusing on two key themes: Fear of Floating, and Lender of Last Resort.Item Testimony On Full Dollarization(1999-04-22) Calvo, Guillermo A.I will discuss the motivation and potential benefits of full dollarization, namely, abandoning domestic currency (identified with the peso) and adopting a foreign currency (identified with the U.S. dollar), with special reference to emerging-market economies. I will argue, first, that full dollarization is especially advantageous for countries with large dollar debts, and, second, that in these economies standard criticisms against full dollarization are largely unwarranted.Item Uncertain Duration of Reform: Dynamic Implications(Cambridge University Press, 1998) Calvo, Guillermo A.; Drazen, AllanWe develop a framework to study the effects of policies of uncertain duration on consumption dynamics under both complete and incomplete markets. We focus on the dynamic implications of market incompleteness, specifically on the lack of state-contingent bonds. Two policies are considered: pure output-increasing and tariff-reducing (trade liberalization). With complete markets, the output-increasing policy leads to flat consumption, while with no contingent assets, consumption jumps upward on the announcement of the policy, continues rising as long as the policy is in effect, and collapses when it is abandoned. A similar consumption path obtains in a trade liberalization in the realistic case of low elasticity of substitution and no rebate of tariffs. Market incompleteness rationalizes the existence of gradual changes in consumption.Item Understanding The Russian Virus, with special reference to Latin America(1998-10-13) Calvo, Guillermo A.Although Tequila and Asian crises took the world by surprise and had global repercussions, after a short while financial turmoil remained somewhat regionally confined. Tequila crisis started in Mexico and claimed Argentina as a victim, but the rest of the world was virtually unscathed. Similarly, the Asian crisis began in Thailand and spread all over Asia but did not cause major capital outflows in Latin America. Advanced economies’ financial sectors were little touched by either. Early results, however, strongly suggest that the recent Russian crisis may have more serious implications. Negative effects seem deeper, credit to emerging markets economies, EMs, has frozen, and a major recession in those economies is becoming more likely. Why? This is the central issue addressed in the present note. I will argue that the world capital market is populated by essentially two types of investors: informed, and non-informed (or less-informed). As a general rule, the former lead and the latter follow, and there is no major difference of opinion between the two groups. This system works reasonably well as long as there is no need for one group to carry out a significant portfolio recomposition. For, in that case, one group will have to sell and the other buy. This is precisely what, in my view, happened after Russia’s debt repudiation: the capital loss suffered by Russia’s bond holders, triggered ‘margin calls’ on highly leveraged informed investors, forcing them to sell some of their EM holdings to the other group, i.e., the non-informed (for whom leveraging was less attractive due to their poorer information). This is a complicated operation because the informed investors’ sellout makes the non-informed think that there must be some fundamental problem with EMs. As a result, EM security prices drop by more than can be accounted for by conventional fundamentals. This is key for the explanation offered in this note.Item When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options(1999-06-29) Calvo, Guillermo A.; Reinhart, Carmen M.In this paper we present evidence that capital account reversals have become more severe for emerging markets. Because policy options are limited in the midst of a capital market crisis and because so many countries have already had crises recently, we focus on some of the policies that could reduce the incidence of crises in the first place, or at least make the sudden stop problem less severe. In this regard, we consider the relative merits of capital controls and dollarization. We conclude that, while the evidence suggests that capital controls appear to influence the composition of flows skewing flows away from short maturities, such policies are not likely to be a long-run solution to the recurring problem of sudden capital flow reversals. Yet, because fear of floating, many emerging markets are likely to turn to increased reliance on controls. Dollarization would appear to have the edge as a more marketoriented option to ameliorate, if not eliminate, the sudden stop problem.Item Why is 'The Market' so Unforgiving? Reflections on the Tequilazo(1996-09-21) Calvo, Guillermo A.Mexico’s financial debacle and its impact on other emerging markets (the Tequila effect) has raised many fundamental questions. Mexico achieved fiscal balance in 1993, undertook several fundamental market-oriented reforms, signed a free trade agreement with a very large market (the NAFTA), became a member of the OECD, and was hailed by international institutions as a paramount example of successful reform. Yet, the December 20, 1994, devaluation brought the economy down like a house of cards. Output fell by more than 7 percent in 1995, the current account deficit sharply swung from about 8 percent of GDP in 1994 to zero, and investors turned their noses away from high-yield Mexican public debt even though the international community had plunked about $50 billion in a rescue package. In addition, Mexican problems quickly spread around the world’s emerging markets, including those exhibiting long and enviable track records.