11

Currency WarsCurrency Wars

Jeffrey FrankelJeffrey FrankelHarpel Professor of Capital Formation & Growth,Harpel Professor of Capital Formation & Growth,

Harvard University Harvard University

MAS Sponsored Public Lecture, Singapore, 8 March, 2011MAS Sponsored Public Lecture, Singapore, 8 March, 2011

22

What What areare currency wars? currency wars? • Review of the last 6 months.Review of the last 6 months.• Is the currency war metaphor appropriate?Is the currency war metaphor appropriate?

Which emerging markets are intervening the most Which emerging markets are intervening the most to dampen the appreciation of their currencies?to dampen the appreciation of their currencies?• What is the right way to measure it?What is the right way to measure it?• What What shouldshould they be doing? Lessons from recent crises. they be doing? Lessons from recent crises.

33

Currency Wars chronologyCurrency Wars chronology

September 15, 2010September 15, 2010

Japan buys $20 b for ¥, Japan buys $20 b for ¥, • after 6-year absence from FX markets;after 6-year absence from FX markets;

• thereby joining Switzerland, the other floater thereby joining Switzerland, the other floater to have appreciated in 2008-09 GFC and to have appreciated in 2008-09 GFC and to have fought it by FX intervention.to have fought it by FX intervention.

44

September 27 September 27 warning from Brazil’s Finance warning from Brazil’s Finance Minister Guido Mantega:Minister Guido Mantega:

““We’re in the midst of We’re in the midst of an international currency war, an international currency war, a general weakening of currency. a general weakening of currency. This threatens us because it takes away our This threatens us because it takes away our competitiveness.”competitiveness.”

I.e., countries everywhere are trying I.e., countries everywhere are trying to push down the value of their currencies, to push down the value of their currencies, to gain exports and employment,to gain exports and employment,• a goal that is not globally consistent.a goal that is not globally consistent.

Currency Wars chronology, Currency Wars chronology, continuedcontinued

55

Currency Wars chronology,Currency Wars chronology, Nov.2010Nov.2010

As European sovereign debt crisis resurfaces As European sovereign debt crisis resurfaces in Ireland, euro hits low in Ireland, euro hits low (1.3 $/€(1.3 $/€ Nov.17Nov.17).).

Chinese government, Chinese government, responding to 4.4% inflation responding to 4.4% inflation in Octoberin October • raises interest rate, raises interest rate, • reserve requirements, reserve requirements, • & price controls.& price controls.

US core inflation falls to 0.6% for year, US core inflation falls to 0.6% for year, • the lowest since 1957.the lowest since 1957.

66

Currency Wars chronology, Currency Wars chronology, Nov.2010Nov.2010

G20 Summit in Korea G20 Summit in Korea was the first chaired by a non-G8 countrywas the first chaired by a non-G8 country

77

Currency Wars chronology, Currency Wars chronology, Nov.2010Nov.2010

Nov. 12: G-20 Summit in Seoul Nov. 12: G-20 Summit in Seoul was judged a failure, at least for Obama:was judged a failure, at least for Obama:• Rebuff of US proposal for cap on Current Account Rebuff of US proposal for cap on Current Account

surpluses at 4% of GDP.surpluses at 4% of GDP.• No pledge to refrain from “competitive undervaluation” No pledge to refrain from “competitive undervaluation” • A suggestion to countries with widely used currencies A suggestion to countries with widely used currencies

like the $ to “be vigilant against excess volatility,” like the $ to “be vigilant against excess volatility,” a warning against loose monetary policya warning against loose monetary policy. .

88

Currency Wars chronology,Currency Wars chronology, Nov. 2010Nov. 2010

Nov.21: Fed announces QE2 decision --Nov.21: Fed announces QE2 decision --• Will purchase $600b in bonds.Will purchase $600b in bonds.

• Short-term market reaction -- $ depreciates.Short-term market reaction -- $ depreciates.

• Critiques -- Critiques -- Sarah Palin & John Taylor: Sarah Palin & John Taylor:

“US is debauching its currency.”“US is debauching its currency.” Germany, China & Brazil: Germany, China & Brazil:

“$“$ depreciationdepreciation == deliberatedeliberate salvo salvo in in currencycurrency wars.”wars.”

99

Jan.14, 2011: Jan.14, 2011: Secy.Secy. Geithner notes that Geithner notes that ---- including China’s higher including China’s higher inflation inflation -- -- RMB is appreciating in real terms.RMB is appreciating in real terms.

That suggests (appropriately) lower USG priority That suggests (appropriately) lower USG priority on the currency issueon the currency issue• than on IPR, North Korea than on IPR, North Korea

& other issues& other issues

in Jan.19 in Jan.19 Obama-Hu summit.Obama-Hu summit.

Currency Wars chronology, Currency Wars chronology, Jan.Jan. 20112011

1010

Data sources: The Economist, BLS, CEIC, Thomson Reuters

5% nominal appreciation per annum 5% nominal appreciation per annum + 5% inflation differential + 5% inflation differential

≈ 10% real appreciation per annum≈ 10% real appreciation per annum over last half-yearover last half-year

Global Macro Monitor

1111

Currency Wars chronology, Currency Wars chronology, 20112011

Feb. 4, 2011Feb. 4, 2011• In biannual report to Congress, U.S. Treasury In biannual report to Congress, U.S. Treasury

calls RMB "substantially undervalued." calls RMB "substantially undervalued." • But it once again refrains from But it once again refrains from

naming China a currency manipulator,naming China a currency manipulator,• and points out and points out realreal appreciation appreciation

is running at 10% per annum.is running at 10% per annum.

1212

Feb. 15, 2011:Feb. 15, 2011:US Treasury Secretary US Treasury Secretary Geithner fails to Geithner fails to convince Brazil to convince Brazil to

jointly pressure China.jointly pressure China.

Financial Times Feb. 16, 2011

Currency Wars chronologyCurrency Wars chronology

Mantega responds:Mantega responds:“the $ is as much a “the $ is as much a problem as the RMB.”problem as the RMB.”

1313

Feb. 18-19, 2011:Feb. 18-19, 2011:

First meeting of G20 ministers First meeting of G20 ministers in France’s year as host.in France’s year as host.

Sarkozy no longer talking Sarkozy no longer talking of “a new Bretton Woods.”of “a new Bretton Woods.”

But G20 goes ahead with But G20 goes ahead with a system of indicators, a system of indicators, • including real exchange rates, current account including real exchange rates, current account

balances, budget deficits and sovereign debt levels.balances, budget deficits and sovereign debt levels.

1414

Fear of non-cooperative “competitive devaluation” Fear of non-cooperative “competitive devaluation” is an argument for fixed exchange ratesis an argument for fixed exchange rates• rooted in the 1930s.rooted in the 1930s.• It is why the architects of It is why the architects of

the post-war monetary order the post-war monetary order chose fixed exchange rates chose fixed exchange rates at Bretton Woods, NH, in 1944.at Bretton Woods, NH, in 1944.

But it is now used to argue that China But it is now used to argue that China should move should move from fixingfrom fixing to to floatingfloating..• US Congressmen don’t US Congressmen don’t

care about regimes;care about regimes;• they just want a stronger RMB vs. $.they just want a stronger RMB vs. $.

Is the currency war metaphor applicable?Is the currency war metaphor applicable?

1515

Meanwhile, fear of “competitive devaluation” Meanwhile, fear of “competitive devaluation” is also used as an argument against is also used as an argument against US monetary expansion.US monetary expansion.

But But monetary expansion is notmonetary expansion is nota “beggar-thy-neighbor” policya “beggar-thy-neighbor” policy::

• Although in theory it should depreciate $,Although in theory it should depreciate $,

• at the same time it boosts US growth & so imports.at the same time it boosts US growth & so imports.

• The net of the two effects on trade balance The net of the two effects on trade balance is ambiguous in theory and ≈ 0 in practice.is ambiguous in theory and ≈ 0 in practice.

• Do other countries want a U.S. “double dip” ?Do other countries want a U.S. “double dip” ?

Is the currency war metaphor applicable?Is the currency war metaphor applicable?

1616

Economic historians have decided Economic historians have decided competitive devaluation under 1930s competitive devaluation under 1930s conditions was not a problem after all.conditions was not a problem after all.

True, countries couldn’t all devalue True, countries couldn’t all devalue against each other,against each other,

But they could and did all devalue against goldBut they could and did all devalue against gold• which worked to ease global monetary policy, which worked to ease global monetary policy,

just what was needed.just what was needed.

The same was needed in 2008-09The same was needed in 2008-09 and Fed easing supplied it.and Fed easing supplied it.

Is the currency war metaphor applicable?Is the currency war metaphor applicable? continuedcontinued

1717

The currency war talk The currency war talk -- especially the criticism of US monetary policy -- especially the criticism of US monetary policy -- -- seems to forget the point of floating rates:seems to forget the point of floating rates:

• Different countries will generally have Different countries will generally have different needs at any point in time different needs at any point in time

e.g., high unemployment in US & European periphery, e.g., high unemployment in US & European periphery,

while China & Brazil & India are overheating.while China & Brazil & India are overheating.

Is the currency war metaphor applicable?Is the currency war metaphor applicable? continuedcontinued

1818

Inflation has recently crept up in many Inflation has recently crept up in many of the major emerging marketsof the major emerging markets

Goldman Sachs BRICs Monthly, Feb.18, 2011

1919

In the advanced economies, by In the advanced economies, by contrast, inflation is still lowcontrast, inflation is still low

Goldman Sachs BRICs Monthly,Feb.18, 2011

2020

and climbed back up to 4.9% as of Feb.2011

Source: WSJ

Chinese inflation reached 8% in 2008

2121

Meanwhile, US core inflation is the lowest in 50 yearsMeanwhile, US core inflation is the lowest in 50 years

Jan 2011

2222

The point of a floating rate system: The point of a floating rate system: the US can choose its easy monetary policy the US can choose its easy monetary policy and Brazil its tight monetary system,and Brazil its tight monetary system,

with appreciation of US $ vs. Braz. real with appreciation of US $ vs. Braz. real accommodating the divergence. accommodating the divergence.

Multilateral cooperation is not necessary for this.Multilateral cooperation is not necessary for this.

Is the currency war metaphor applicable?Is the currency war metaphor applicable? continuedcontinued

2323

But other kinds of international cooperation But other kinds of international cooperation areare needed; needed;• the “war” & 1930s metaphors are not totally misplaced:the “war” & 1930s metaphors are not totally misplaced:

Currency war could turn into trade warCurrency war could turn into trade war

• if Congress follows through on legislation to impose if Congress follows through on legislation to impose (WTO-illegal)(WTO-illegal) tariffs tariffs on China as punishment for non-appreciation.on China as punishment for non-appreciation.

• Protectionism is a beggar-thy-neighbor policyProtectionism is a beggar-thy-neighbor policy unlike monetary expansion.unlike monetary expansion.

• Until now, the US & G20 have held the line on protectionism Until now, the US & G20 have held the line on protectionism compared to the milder recessions of 1991 & 2001,compared to the milder recessions of 1991 & 2001, let alone the Smoot Hawley tariff of 1930.let alone the Smoot Hawley tariff of 1930.

Is the currency war metaphor applicable?Is the currency war metaphor applicable? continuedcontinued

2424

China would take some responsibilityChina would take some responsibility• to reallocate its economy away from to reallocate its economy away from

exclusive reliance on exports & manufacturingexclusive reliance on exports & manufacturing toward domestic consumption & services,toward domestic consumption & services,

• health, education, housing, environment, insurance & other health, education, housing, environment, insurance & other services.services.

• How? By allowing the RMB to appreciate,How? By allowing the RMB to appreciate,• but also by increasing domestic demand.but also by increasing domestic demand.

Meanwhile, the US would also take responsibility.Meanwhile, the US would also take responsibility.• The US should take steps today to lock The US should take steps today to lock

in a future return to fiscal responsibility,in a future return to fiscal responsibility, e.g., by putting Social Security on a firm footing.e.g., by putting Social Security on a firm footing.

Ideally the US & China would reach agreement Ideally the US & China would reach agreement on how to address current account imbalances:on how to address current account imbalances:

2525

Bottom line on currency war metaphorBottom line on currency war metaphor

The metaphor is not fully appropriate.The metaphor is not fully appropriate.

Yes, China finds uncomfortable Yes, China finds uncomfortable the pressure of capital inflows, the pressure of capital inflows, • which is indeed increased by US monetary ease.which is indeed increased by US monetary ease.

But this is a far more legitimate way But this is a far more legitimate way to let China feel the pressure to appreciateto let China feel the pressure to appreciate

than are US threats of WTO-illegal tariffs.than are US threats of WTO-illegal tariffs.

2626

Intervention in emerging markets Intervention in emerging markets

to fight currency appreciationto fight currency appreciation Who is doing how much?Who is doing how much?

• It is not enough to look at increases in FX reserves.It is not enough to look at increases in FX reserves.• The question: The question:

for a given increase in Exchange Market Pressure for a given increase in Exchange Market Pressure (EMP), how much does the central bank absorb as an (EMP), how much does the central bank absorb as an rise in the value of currency (exchange rate) versus rise in the value of currency (exchange rate) versus how much as an increase in the how much as an increase in the quantityquantity (reserves). (reserves).

How much How much shouldshould it intervene, vs. appreciate? it intervene, vs. appreciate?• What can we learn from recent crises?What can we learn from recent crises?

2727

Capital flows to emerging markets, especially Asia, Capital flows to emerging markets, especially Asia, recovered quickly from the 2009 recession.recovered quickly from the 2009 recession.

These countries again show big balance of payments surplusesThese countries again show big balance of payments surpluses

Goldman Sachs

2828

The 4The 4thth wave of inflows was reflected as an increase wave of inflows was reflected as an increase in Exchange Market Pressurein Exchange Market Pressure

on all Asian countries in 2010,on all Asian countries in 2010,Singapore & Korea the most.Singapore & Korea the most.

Goldman Sachs

Global Economics Weekly 11/07 Feb.16, 2011

EMP is definedas the sum of currency appreciation plus increase in Reserves (Net Foreign Assets)as a fraction of Monetary Base.

2929

Singapore has taken the inflows Singapore has taken the inflows heavily in the form of reserves,heavily in the form of reserves,

GS Global ECS Research

less-managed floating

(“more appreciation-friendly”) →

High EMP

Low EMP

↑ more-managedfloating

while India & Malaysia in 2010 took the inflows while India & Malaysia in 2010 took the inflows in the form of currency appreciation.in the form of currency appreciation.

3030

China gets the most attention, China gets the most attention, partly because it is so large in trade andpartly because it is so large in trade and

partly because it absorbs most of its Exchange Market partly because it absorbs most of its Exchange Market Pressure as FX intervention, rather than appreciationPressure as FX intervention, rather than appreciation

%

3131

Korea (& Singapore & Taiwan Korea (& Singapore & Taiwan PoCPoC) are also ) are also adding heavily to reserves.adding heavily to reserves.

GS Global ECS Research

3232

In Asia since 2008, India, followed by Indonesia, In Asia since 2008, India, followed by Indonesia, have had the greatest tendency to float, given EMP; have had the greatest tendency to float, given EMP;

HongHong Kong & Singapore the least, followed by MalaysiaKong & Singapore the least, followed by Malaysia && ChinaChina..

Goldman Sachs Global Economics Weekly 11/07 Feb. 16, 2011

3333

India, Indonesia, & ChinaIndia, Indonesia, & Chinaare in danger of overheatingare in danger of overheating

GS Global Economics Weekly No. 11/08, Feb. 23, 2011

=> Indonesia & India havedone right to allow appreciation.

3434

In Latin America, renewed inflowsIn Latin America, renewed inflows

less-managed floating (“more appreciation-friendly”)

more-managed floating

GS Global ECS Research

but as appreciation in Chile & Colombiabut as appreciation in Chile & Colombia. . are reflected mostly as reserve accumulation in Peru,are reflected mostly as reserve accumulation in Peru,

3535

If a country faces an increase in If a country faces an increase in exchange market pressure, should it exchange market pressure, should it

appreciate? Or intervene?appreciate? Or intervene?

It is the old debate over floating It is the old debate over floating versus fixed exchange rate.versus fixed exchange rate.

What can we learn about the answer What can we learn about the answer from recent crises?from recent crises?

3636

Two lessons from the 1990s emerging Two lessons from the 1990s emerging market currency crisesmarket currency crises

Advantages of floating:Advantages of floating:• Speculators don’t have a target to shoot at;Speculators don’t have a target to shoot at;• Accommodate shocks;Accommodate shocks;• Discourage unhedged $ liabilities.Discourage unhedged $ liabilities.

Advantages of holding forex reservesAdvantages of holding forex reserves• Reduces danger of crisis.Reduces danger of crisis.

How did these lessons fare in the 2008-10 crises?How did these lessons fare in the 2008-10 crises?

3737

The variables that show up as the strongest predictors of The variables that show up as the strongest predictors of countrycountry crises in 83 pre-2009 studies: crises in 83 pre-2009 studies:

(i) low reserves and (ii) currency overvaluation(i) low reserves and (ii) currency overvaluation

0% 10% 20% 30% 40% 50% 60% 70%

Reserves

Real Exchange Rate

GDP

Credit

Current Account

Money Supply

Budget Balance

Exports or Imports

Inflation

Equity Returns

Real Interest Rate

Debt Profile

Terms of Trade

Political/Legal

Contagion

Capital Account

External Debt

% of studies where leading indicator was found to be statistically signficant(total studies = 83, covering 1950s-2009)

Source: Frankel & Saravelos (2010)

Early Warning Indicators

3838

Best and Worst Performing Countries Best and Worst Performing Countries -- F&S (2010), -- F&S (2010), Appendix 4Appendix 4

-25% -20% -15% -10% -5% 0% 5% 10%

China

India

Morocco

Egypt, Arab Rep.

Indonesia

Jordan

Sri Lanka

Argentina

Poland

Australia

Turkey

Finland

Mexico

Georgia

Russian Federation

Macao, China

Estonia

Ukraine

Latvia

Lithuania

GDP Change, Q2 2008 to Q2 2009

Top 10

Bottom 10

64 countries in sample

3939

Exchange Market

Pressure

Currency % Changes

(H208-H109

Recourse to IMF

(SBA only)

Equity %Chng (Sep08-Mar09)

Equity % Chng

(H208-H109)

Significant and

Consistent Sign?^

Independent Variable

Reserves (% GDP)0.164 (3.63)

0.087 (2.98)

-1.069 (-1.66)

0.011 (0.12)

0.010 (0.14)

Yes

Reserves (% external debt)0.000 (1.06)

0.000 (1.1)

-0.006 (-2.29)

0.000 (1.81)

0.000 (2.65)

Yes

Reserves (in months of imports)0.004 (2.25)

0.003 (1.95)

-0.119 (-3.01)

0.006 (1.32)

0.009 (2.32)

Yes

M2 to Reserves0.000 (0.27)

0.000 (0.76)

-0.044 (-0.91)

0.000 (0.02)

-0.000 (-0.09)

Short-term Debt (% of reserves)-0.000 (-1.97)

-0.000 (-4.22)

0.000 (2.13)

-0.001 (-2.89)

-0.001 (-3.11)

Yes

REER (5-yr % rise)-0.440 (-5.55)

-0.210 (-3.19)

1.728 (2.15)

-0.182 (-1.24)

-0.185 (-1.61)

Yes

REER (Dev. from 10-yr av)-0.475 (-3.96)

-0.230 (-2.47)

2.654 (2.56)

-0.316 (-1.71)

-0.316 (-2.1)

Yes

GDP growth (2007, %)-0.000 (-0.2)

0.001 (0.94)

0.070 (2.58)

-0.001 (-0.1)

-0.007 (-0.71)

GDP Growth (last 5 yrs)-0.003 (-0.81)

0.000 (0.26)

0.084 (2.4)

-0.003 (-0.26)

-0.014 (-1.15)

GDP Growth (last 10 yrs)0.000 (0.14)

0.001 (0.43)

0.064 (1.66)

-0.012 (-0.67)

-0.020 (-1.12)

Change in Credit (5-yr rise, % GDP)-0.021 (-0.36)

-0.035 (-0.98)

0.552 (1.02)

-0.274 (-2.97)

-0.248 (-4.13)

Yes

Change in Credit (10-yr rise, % GDP)-0.017 (-0.93)

-0.011 (-1.05)

0.210 (1.03)

-0.089 (-1.65)

-0.089 (-2.35)

Credit Depth of Information Index (higher=more)-0.008 (-1.06)

0.000 (0.05)

0.224 (2.4)

-0.006 (-0.37)

-0.018 (-1.33)

Bank liquid reserves to bank assets ratio (%)0.000 (3.84)

0.000 (0.5)

-0.000 (-11.44)

-0.002 (-0.54)

-0.002 (-0.79)

Yes

Current Account (% GDP)0.001 (1.48)

0.002 (2.7)

-0.023 (-2.09)

0.009 (3.84)

0.007 (3.95)

Yes

Current Account, 5-yr Average (% GDP)0.000 (0.48)

0.001 (1.82)

-0.025 (-1.72)

0.007 (2.4)

0.006 (2.74)

Yes

Current Account, 10-yr Average (% GDP)0.000 (0.14)

0.002 (1.39)

-0.035 (-2.11)

0.008 (2.21)

0.007 (2.44)

Yes

Net National Savings (% GNI)0.002 (1.6)

0.001 (2.33)

-0.013 (-1.22)

0.006 (2.92)

0.004 (2.28)

Yes

Gross National Savings (% GDP)0.003 (2.01)

0.001 (2.53)

-0.015 (-1.36)

0.008 (3.42)

0.006 (3.03)

Yes

Change in M3 (5-yr rise, % GDP)0.000 (0.46)

-0.000 (-0.16)

-0.000 (-0.08)

-0.004 (-1.08)

-0.004 (-2.79)

Change in M2 (5-yr rise, % GDP)0.000 (0.33)

-0.000 (-0.29)

0.006 (0.51)

-0.005 (-1.25)

-0.006 (-2.86)

Trade Balance (% GDP)0.001 (1.73)

0.001 (1.78)

-0.014 (-1.51)

0.006 (2.72)

0.003 (1.97)

Yes

Exports (% GDP)0.000 (0.93)

0.000 (1.97)

-0.002 (-0.53)

0.000 (0.02)

-0.000 (-0.83)

Imports (% GDP)-0.000 (-0.15)

0.000 (0.57)

0.002 (0.79)

-0.000 (-0.73)

-0.000 (-1.36)

Inflation (average, last 5 yrs)-0.006 (-1.76)

-0.001 (-0.75)

0.094 (3.4)

0.000 (0.01)

0.002 (0.26)

Yes

Inflation (average, last 10 yrs)-0.002 (-2.03)

-0.001 (-1.54)

0.017 (2.04)

-0.000 (-0.16)

0.000 (0.18)

Yes

Stock Market (5 yr % change)-0.006 (-0.86)

-0.006 (-1.34)

0.035 (0.74)

-0.016 (-3.72)

-0.018 (-5.59)

Yes

Stock Market (5 yr return/st.dev.)0.010 (0.31)

-0.024 (-1.02)

-0.394 (-1.17)

-0.097 (-1.92)

-0.042 (-0.93)

Real Interest Rate-0.001 (-0.79)

-0.000 (-0.42)

-0.022 (-1.05)

0.005 (1.81)

0.004 (1.85)

Yes

Deposit Interest Rate-0.014 (-4.43)

-0.003 (-1.72)

0.058 (1.78)

0.019 (3.33)

0.009 (1.39)

Short-term Debt (% of exports)-0.000 (-0.04)

-0.000 (-1.43)

0.000 (0.36)

-0.004 (-3.28)

-0.003 (-2.82)

Yes

Short-term Debt (% of external debt)-0.001 (-1.41)

-0.001 (-2.1)

0.009 (1.17)

-0.001 (-0.34)

-0.000 (-0.03)

Public Debt Service (% of exports)0.002 (3.04)

0.000 (1.18)

-0.036 (-1.14)

0.008 (1.22)

0.005 (0.98)

Public Debt Service (% GNI)0.001 (2.37)

0.000 (0.97)

-0.050 (-0.71)

0.003 (0.33)

0.002 (0.3)

Multilateral Debt Service (% Public Debt Service)0.001 (1.77)

0.000 (0.52)

0.001 (0.17)

-0.001 (-1.05)

0.000 (0.01)

Aid (% of GNI)0.002 (2.81)

0.000 (1.22)

-0.141 (-3.23)

-0.007 (-0.77)

-0.001 (-0.15)

Yes

Financing via Int. Cap. Markets (gross, % GDP)-0.000

(0)-0.000 (-0.48)

-0.011 (-0.57)

-0.012 (-2.14)

-0.005 (-1)

Legal Rights Index (higher=more rights)-0.009 (-1.49)

-0.006 (-1.46)

0.008 (0.15)

-0.017 (-1.52)

-0.015 (-1.78)

Business Extent of Disclosure Index (higher=more disclosure)

-0.002 (-0.39)

-0.001 (-0.32)

-0.024 (-0.52)

-0.001 (-0.13)

-0.000 (-0.1)

Portfolio Flows (% GDP)-0.616 (-2.88)

-0.435 (-3.33)

2.090 (0.74)

-0.979 (-0.77)

-0.889 (-0.77)

Yes

FDI net inflows (% GDP)-0.000 (-2.05)

-0.000 (-0.87)

-0.000 (-0.04)

-0.000 (-2.57)

-0.000 (-2.05)

Yes

FDI net outflows (% GDP)0.000 (1.8)

0.000 (0.81)

-0.000 (-0.45)

0.000 (3.38)

0.000 (2.84)

Yes

Net FDI (% GDP)0.001 (1.15)

0.000 (0.44)

-0.002 (-0.27)

-0.000 (-0.13)

-0.000 (-0.27)

External Debt Service (% GNI)0.000 (0.91)

0.000 (0.05)

-0.000 (-0.04)

-0.016 (-5.11)

-0.013 (-4.87)

Yes

Present Value of External Debt (% exports)0.000 (0.08)

-0.000 (-0.38)

-0.000 (-0.06)

-0.001 (-3.55)

-0.001 (-3.92)

Yes

Present Value of External Debt (% GNI)0.000 (0.16)

-0.000 (-0.82)

0.000 (0.38)

-0.003 (-4.39)

-0.002 (-3.8)

Yes

Peg (1 = peg)0.100 (3.89)

0.055 (3.34)

-0.577 (-1.89)

-0.075 (-1.67)

-0.041 (-1.04)

Yes

Financial Openness (0=open)0.083 (2.76)

0.023 (1.16)

-0.587 (-1.72)

0.059 (0.68)

0.003 (0.05)

Yes

M3 (% GDP)0.001 (4.12)

0.000 (4.47)

-0.020 (-3.45)

0.000 (0.31)

-0.000 (-0.22)

Yes

M2 (% GDP)0.001 (4.24)

0.000 (4.78)

-0.022 (-3.43)

0.000 (0.4)

-0.000 (-0.03)

Yes

Domestic Credit (% GDP)0.040 (1.53)

0.009 (0.61)

-0.593 (-2.66)

-0.010 (-0.22)

-0.027 (-0.62)

Domestic Credit Provided by Banks (% GDP)0.000 (1.81)

0.000 (1.52)

-0.006 (-3.17)

-0.000 (-0.21)

-0.000 (-0.55)

Yes

Domestic Credit to Priv. Sector (% GDP)0.000 (1.87)

0.000 (1.51)

-0.012 (-3.13)

-0.000 (-0.5)

-0.000 (-0.87)

Yes

Market Cap of Listed Companies (% GDP)0.000 (1.65)

0.000 (2.01)

-0.006 (-1.41)

0.000 (1.35)

0.000 (1.47)

South Asia0.045 (0.81)

0.045 (2.12)

0.476 (0.99)

0.158 (1.81)

0.033 (0.54)

Yes

Europe & Central Asia-0.150 (-4.43)

-0.095 (-5.61)

0.636 (2.09)

-0.202 (-4.43)

-0.167 (-4.64)

Yes

Middle East & North Africa0.080 (2.7)

0.061 (2.86)

-0.003 (0.05)

0.049 (0.84)

Yes

East Asia & Pacific0.071 (2.71)

0.034 (1.58)

-0.629 (-1.34)

0.135 (2.63)

0.054 (1.08)

Yes

Sub-Saharan Africa-0.006 (-0.14)

-0.024 (-0.83)

-0.424 (-0.98)

-0.068 (-0.89)

0.047 (0.72)

Latin America & Carribean-0.014 (-0.23)

-0.013 (-0.39)

0.205 (0.47)

-0.049 (-0.84)

-0.048 (-0.93)

North America0.061 (0.92)

0.041 (0.91)

-0.030 (1.1)

0.024 (0.95)

*OLS with heteroscedasticity robust standard errors performed for four continuous variables; probit for IMF recourse variable^At least two statistically signficant coefficients, of which all must have consistent sign (consistent = same sign, with exception of coefficient on IMF recourse variable, which should have opposite sign)

RESERVES

REER

GDP

CURRENT

ACCOUNT

CREDIT

MONEY

STOCK

MKT

TRADE

INFL.

DEBT COMPOSITI

ON

INT

RATE

CAPITAL

FLOWS

EXT DEBT

REGI

ON

FINANCIAL MKT

DEVELOPMENT

F & Saravelos (2010): Multivariate

Table Appendix 7

Coefficients of Regressions of Crisis Indicators on Each Independent Variable and GDP per Capita* (t-stat in parentheses)bolded number indicates statistical signficance at 10% level or lower

ST Debt/Res

PPP

CA/GDP

NS/GDP

4040

ReservesReserves

Even though many developing & emerging market Even though many developing & emerging market countries described themselves as floating,countries described themselves as floating,

most took advantage of the boom of 2003-2008 most took advantage of the boom of 2003-2008 to build up reserves to unheard of heights, to build up reserves to unheard of heights, • in the aftermath of the crises of 1994-2001.in the aftermath of the crises of 1994-2001.

in contrast to past capital booms (1975-81, 1990-97).in contrast to past capital booms (1975-81, 1990-97).

4141

When the 2008-09 global financial crisis hit,When the 2008-09 global financial crisis hit,• those countries that had taken advantage of those countries that had taken advantage of

the 2003-08 boom to build up reserves did better.the 2003-08 boom to build up reserves did better. E.g., Obstfeld, Shambaugh & Taylor E.g., Obstfeld, Shambaugh & Taylor (2009)(2009) Frankel & Saravelos Frankel & Saravelos (2010),(2010),

This had also been the most common finding This had also been the most common finding in the many studies of Early Warning Indicators in the many studies of Early Warning Indicators in past emerging market crises.in past emerging market crises.

4242

Poland,Poland, the the only continental EU member with a floating only continental EU member with a floating exchange rate, was also the only one to escape exchange rate, was also the only one to escape negative growth in the global recession of 2009negative growth in the global recession of 2009

2006 2007 2008 2009 2010 Exchange Rate

Poland6.2  6.8  5.1  1.7  3.5f 

Floating

Lithuania7.8  9.8  2.9  -14.7  -0.6f 

Fixed

Latvia12.2  10.0  -4.2  -18.0  -3.5f 

Fixed

Estonia10.6  6.9  -5.1  -13.9  0.9f 

Fixed

Slovakia8.5  10.6  6.2  -4.7  2.7f 

Euro

Czech Republic6.8  6.1  2.5  -4.1  1.6f 

Flexible

Hungary3.6  0.8  0.8  -6.7  0.0f 

Flexible Source: Cezary Wójcik, 2010

(de facto)

% change in GDP

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DepreciationDepreciation boostedboosted netnet exports; contribution to GDPexports; contribution to GDP growth growth > > 100%100%

3,2

3,5

3,7

4,0

4,2

4,5

4,7

I III V VII IX XI I III V VII IX XI I III V VII IX

2008 2009 2010

8,0

13,0

18,0

23,0

28,0

Contribution of Net X to GDP:

2009: 2,5 3,4 3,2 3,4

GDP growth rate: 1,7

Source: Cezary Wójcik

kroon / $Estonia

Latvialats / $

zlotys / $

The Polish exchange rate increased by 35%. The Polish exchange rate increased by 35%.

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New lesson regarding exchange rate regimesNew lesson regarding exchange rate regimes

Old conventionalOld conventional wisdom: The choice was between wisdom: The choice was between • fixing fixing (changes in reserves; not in exchange rate) vs.(changes in reserves; not in exchange rate) vs.

• floatingfloating (changes in exchange rate; no reserves). (changes in exchange rate; no reserves).

Now it appears that:Now it appears that:• Intermediate regimes are indeed viable.Intermediate regimes are indeed viable.• Holding reserves Holding reserves andand floating are floating are bothboth useful. useful.

4545