Research

The Dollar exchange rate synchronizes house prices globally. When the dollar appreciates (depreciates), house prices rise (fall) globally. As the source of this comovement we identify the joint dependence of borrowing countries on US dollar lending from global banks headquartered outside the US. Unlike US banks, these banks’ refinancing conditions depend on the dollar exchange rate, with banks in countries for whose currencies it is more expensive to hedge being particularly exposed.

Local government debt in Germany crowds out private investment to the tune of one percent of GDP per year. The reason: forced to lend to local governments by their statutory mandate, local public banks try to “make up” for the low yields on municipal debt by charging SMEs higher rates in locally segmented credit markets. This effect is exacerbated by the dire straits of municipal finances in Germany which, we argue, is a direct consequence of the debt brake at the federal and state levels that shifted many expensive government tasks to municipalities.

An interpretative survey of the literature on how international capital flows affect house prices, published in the Oxford Research Encyclopedia of Economics and Finance.

Based on historical bank branch-level lending and deposit data from 1920s’ Japan, we show how branch banking integrated peripheral markets with the rest of the country, with large urban banks – those headquartered in Tokyo and Osaka – using deposit supply shocks in peripheral areas to fund lending in their core markets. Faced with high-yielding lending opportunities in central prefectures, urban banks bid up deposit rates in peripheral areas, raising local banks’ funding costs and forcing them to become more effective in their screening. This competitive reallocation of capital through funding markets allowed banks to maintain a functional specialization in different customer segments and we argue that this mechanism helps explain the continued coexistence of small relationship lenders and large integrated arm’s-length lenders in local banking markets in many countries.

U.S. state-level banking deregulation during the 1980s considerably dampened the fallout on local economies of the China trade shock a decade later. The reason: households in financially integrated areas could more easily borrow against their housing wealth to smooth consumption. This kept house prices and wages in the non-tradable sector up, facilitating labor reallocation away from manufacturing.

After the inception of the euro, the real economy in most member countries remained dependent on credit by domestic banks, which increasingly funded themselves through cross-border interbank funding. We find that this pattern of ‘double-decker’ banking integration exposed domestic banks to sharp declines in cross-border interbank lending during the eurozone crisis. As a result, domestic banks reduced lending which led to large declines in output in sectors with many small (bank-dependent) firms. We propose a quantitative small open economy model to account for these patterns and conclude that a global banking shock leading to a sudden stop in cross-border interbank lending in the eurozone is required to account for them.

During Japan’s Lost Decade, regional credit reallocation by nationwide (‘integrated’) banks mitigated the real effects from the bank liquidity shock in prefectures with many bank-dependent SMEs. We propose a novel instrument for regional banking integration that exploits the historical segmentation of banking markets in Japan which goes back to the institutions set up for silk export finance in the late 19th century. Our results show how integrated banking markets limit macroeconomic asymmetries in a monetary union during a financial crisis - even if the crisis mainly affects integrated banks (as was the case during the Lost Decade).

The global savings glut (i.e. capital flows from China and other emerging economies into the U.S.) contributed significantly to the rise and fall of U.S. house prices prior to and during the great financial crisis. For identification, we exploit that interstate banking deregulation during the 1980s - a decade prior to the savings glut - cast a long shadow: in states that opened their banking markets to out-of-state banks earlier, house prices were more sensitive to aggregate U.S. capital inflows during 1997-2012. We use bank-level data to identify the mechanism behind this stylized fact: capital inflows relaxed the value-at-risk constraints of geographically diversified (‘integrated’) U.S. banks more than those of local banks. Hence, mortgage credit expanded more in states where integrated banks had a relatively bigger market share (due to early deregulation).

Risk sharing in the EMU collapsed during the eurozone crisis. We show that one important reason for this was that there was too little direct (i.e. bank-to-real-sector) cross-border banking integration and too much interbank integration. Interbank integration leaves firms and households fully exposed to idiosyncratic banking sector shocks and therefore does not provide risk sharing benefits during financial crises. Conversely, direct banking integration helps risk sharing by allowing the real sector to diversify its funding sources. We find that equity market integration (‘capital market union’) and (direct) banking integration (‘banking union’) are complements: firms’ access to cross-border credit helps stabilize labor income and investment in the face of country-specific shocks while making firms’ profits more volatile. Better equity market integration then contributes to internationally diversifying these increased fluctuations in profits.

Sorting currencies on past consumption growth is equivalent to sorting them on interest rates: during normal times, high past-consumption-growth currencies appreciate more (depreciate less) than uncovered interest parity would imply. This is a risk premium because these currencies also depreciate strongly during global shocks. We explain our findings in a quantitative model of habit formation in consumption: countries with high past consumption growth have low risk aversion (i.e. a high risk absorption capacity) and high interest rates. Efficient risk sharing implies that countries with lower risk aversion bear larger drops in consumption in globally bad times. This is achieved through a depreciation of these currencies, which effectively transfers purchasing power to countries with low risk bearing capacity.

This piece zooms in on the drivers of province-level capital flows in China. They are much the same as those driving aggregate flows: expected rising prices of non-tradables such as housing, education and social services, and to a lesser extent future investment growth. In addition to the earlier aggregate analysis, here we exploit the heterogeneity of capital flow patterns across provinces and correlate them with province-level characteristics. The results buttress the view that the usual-suspect financial frictions (‘savings wedges’) - such as lack of access of private firms to credit and a lack of domestic investment opportunities for households - drive surpluses.

The paper shows that variation in the aggregate U.S. consumption-income ratio is dominated by variation in entrepreneurial income and predicts excess returns on the U.S. stock market. This pattern is consistent with an entrepreneurial risk mechanism of asset pricing in which fluctuations in the non-hedged business risk of wealthy entrepreneurs (who are also an important group of owners of public equity) lead to variation in risk appetite and thus in stock prices. Consistent with this mechanism, I find that the link between stock prices and the entrepreneurial consumption-income ratio has weakened as access to finance for entrepreneurs has improved following U.S. state-level banking deregulation in the 1980s and as stock ownership has become more dispersed with the advent of mutual funds and investment vehicles such as 401(k) pension plans.

What drives China’s current account? Primarily, expected real appreciation - i.e. expected rising prices of non-tradables such as housing, education and social services - and, to a lesser extent, future investment growth. This pattern suggests that factors related to China’s domestic development (and that induce firms and households to save for precautionary reasons and primarily in housing markets rather than in other assets) account for China’s persistent surpluses until the global financial crisis.

Securitization of mortgage debt is a good idea in principle because it makes risks internationally tradable that were hitherto local and non-diversifiable: housing. We show that U.S. sales of securitized mortgage debt actually helped global risk sharing when credit was abundant prior to the global financial crisis, but that this mechanism broke down when credit dried up during the global financial crisis.

Is financial globalization associated with improved international consumption risk sharing? We argue that, theoretically, the impact of financial globalization should show up first and most robustly in the lower frequencies of the data, and we show that this is the case empirically: by the end of our sample period (1960-2007), up to 40% of long-term idiosyncratic consumption risk is shared between industrialized countries - as compared to less than 10% before 1990. This dramatic increase is associated with a huge increase in international capital income flows: while capital income flows remain relatively limited as a channel of risk sharing at business-cycle horizons, their contribution to international risk sharing at longer horizons has increased substantially. Much of this increase can be attributed to the growth in international asset positions over the recent globalization period.

An interpretative survey with four answers: (i) consumption risk sharing seems to have increased among industrialized countries but much less in the emerging world; (ii) the increase in risk sharing is generally found to be stronger in studies that focus on trends rather than on purely cyclical variation in the data; (iii) globalization has not only affected consumption responses to output shocks but also the structure of these shocks themselves, which in turn has affected the measurement of risk sharing; (iv) taking stock of (ii) and (iii), I show that risk sharing in East Asia started to increase once the region had recovered from the Asian crisis of the late 1990s.

Consumption risk sharing among U.S. federal states is procyclical - it increases in U.S.-wide booms and decreases in U.S.-wide recessions. These business-cycle fluctuations in inter-state risk sharing are driven mainly by states in which small businesses account for a large share of income or employment. State-level banking deregulation during the 1980s loosened the dependence of interstate risk sharing on the business cycle, mainly through its impact on states with many small firms. Our results establish a major benefit from bank deregulation: small firms’ access to credit and, with it, interstate risk sharing have improved mainly when it is most urgently needed - in nationwide economic downturns.

Simple asset pricing implies that differences in currency risk premia (aka persistent deviations from uncovered interest parity) across countries reflect differential exposures of these countries’ exchange rates to global shocks. We explore the implications of this logic for the Swiss franc and for Swiss monetary policy. The Swiss franc exchange rate is a ‘small’ safe-haven currency and therefore particularly prone to global shocks. While the franc’s role as a safe haven has fluctuated over time and across currency pairs, the importance of global shocks for the franc’s exchange rate imposes additional constraints on Swiss monetary policy.

Would wider equity ownership help improve inter-regional consumption risk sharing between households? We use data from the Italian Survey of Household Income and Wealth to show that it would. Mutual equity funds are usually diversified at the national level. Cross-regional patterns of equity fund ownership are qualitatively consistent with simple portfolio theory: regions with more asymmetric business cycles are more diversified because they have higher fund participation rates (the extensive margin of diversification) and higher average holdings of equity funds (diversification’s intensive margin). Also, fund holdings increase with the exposure of non-tradable income components (such as labor or entrepreneurial income) to regional shocks. We conclude: yes, increased equity market participation could substantially improve interregional risk sharing.

Although the real exchange rate–real interest rate (RERI) relationship is central to most open economy macroeconomic models, empirical support for the relationship is generally found to be rather weak. In this paper we re-investigate the RERI relationship using bilateral US real exchange rate data spanning the period 1978–2007. Instead of testing one particular model, we build on Campbell and Shiller [1987. Cointegration tests of present-value models. Journal of Political Economy 95, 1062–1088] to propose a metric of the economic significance of the relationship. Our empirical results provide robust evidence that the RERI link is economically significant and that the real interest rate differential is a reasonable approximation of the expected rate of depreciation over longer horizons.

The bulk of evidence on the lack of international risk sharing is based on regressions of idiosyncratic consumption growth on idiosyncratic output growth. This paper argues that the results from such regressions obtained from international data are, however, not directly comparable to those based on regional data: the standard practice of running such regressions on international data fails to account for persistent international differentials in consumer prices, whereas—implicitly—most of the literature based on regional data has accounted for these differences. When risk sharing regressions are set up in conceptually the same way in international and regional data sets, the estimated coefficients are also very similar. To explore this result further, we adapt the variance decomposition of Asdrubali et al. (Q J Econ 111:1081–1110, 1996) to allow for deviations from purchasing power parity across countries. While quantity (income and credit) flows are the dominant channel of risk sharing among regions, relative consumption and output price (internal terms of trade) fluctuations account for the bulk of the deviation from the complete markets outcome in international data. To the extent that persistent differences in consumer prices are an indication of goods market segmentation, our findings provide empirical evidence for the proposition by Obstfeld and Rogoff (NBER Macroeconomics Annual 2000, 2000) that segmented international goods markets rather than asset market incompleteness may account for the (apparent) lack of risk sharing between countries.

In spite of two decades of financial globalization, consumption‐based indicators do not seem to signal more international risk sharing. We argue that the fraction of idiosyncratic consumption risk that gets shared among industrialized countries has actually increased considerably over the period 1980–2000 and, in particular, during the 1990s—from around 30 to more than 60 percent. However, standard consumption‐based measures of risk sharing—such as the volatility of consumption conditional on output or international consumption correlations—have been unable to detect this increase because consumption has also been affected by the concurrent decline in the volatility of output growth in most industrialized countries since the 1980s. First, the volatility of output at business‐cycle frequencies has declined by more than has the volatility of permanent fluctuations. Since consumption reacts mainly to permanent shocks, it appears more volatile in relation to current changes in output. This effect seems to have offset the tendency of financial globalization to lower the volatility of consumption conditional on output. Second, because the variability of permanent global shocks has also fallen, international consumption correlations have also generally not increased as financial markets have become more integrated.

This paper studies the long-run relationship between consumption, asset wealth and income—the consumption–wealth ratio—based on German data from 1980 to 2003. We find that departures from this long-run relationship mainly predict adjustments in income. The German consumption–wealth ratio also contains considerable forecasting power for a range of business cycle indicators, including the unemployment rate. This finding is in contrast to earlier studies for some of the Anglo-Saxon economies that have shown that the consumption–wealth ratio reverts to its long-run mean mainly through subsequent adjustments in asset prices. While the German consumption wealth ratio contains little information about future changes in German asset prices, we report that the U.S. consumption–wealth ratio has considerable forecasting power for the German stock market. One explanation of these findings is that in Germany—due to structural differences in the financial and pension systems—the share of publicly traded equity in aggregate household wealth is much smaller than in the Anglo-Saxon countries. We discuss the implications of our results for the measurement of a potential wealth effect on consumption.

We investigate empirically how industrialized countries and U.S. states share consumption risk at horizons between one and thirty years. U.S. federal states share about 50 percent of their permanent idiosyncratic risk through cross-state capital income flows. While insurance against transitory fluctuations in output is virtually complete, OECD countries do not share any of their permanent idiosyncratic risk. Our results suggest that purely transaction cost based theories cannot explain the home bias, since the potential welfare gains from insurance against permanent shocks would by far outweigh that of insuring against transitory variation. We conclude that permanent and transitory shocks constitute two qualitatively different kinds of risk and that various forms of endogenous market incompleteness may render permanent shocks a lot harder to insure, in particular at the international level.

The idea to learn about international capital mobility from saving and investment data remains appealing. Our approach is based on VAR methods and overcomes some of the problems associated with saving–investment regressions when the data are non-stationary. We propose a new measure of long-run capital mobility that can be easily calculated as a by-product of the estimation procedure of a cointegrated VAR. In an application to historical US and British data, we find long-run capital mobility to have been remarkably stable over the century whereas variations in the mobility of capital primarily seem to have affected short-run capital flows.

Intertemporal models of the current account generally assume that global shocks do not affect the current account. We use this assumption to identify global and country‐specific shocks in a bivariate VAR of output and the current account. Cross‐country evidence from the G7 economies suggests that this identification works surprisingly well. We then employ our method to collect stylized facts on international macroeconomic fluctuations. We find that long‐term output growth is driven mainly by global factors in most G7 countries and that country‐specific shocks are less persistent and generally less volatile than global shocks.

Long-run recursive identification schemes are very popular in the structural VAR literature. This note suggests a two-step procedure based on QR decompositions as a solution algorithm for this type of identification problem. Our procedure will always deliver the exact solution and it is much easier to implement than a Newton-type iteration algorithm. It may therefore be very useful whenever quick and precise solutions of a long-run recursive scheme are required, e.g. in bootstrapping confidence intervals for impulse responses.

This paper contributes to the empirics of the intertemporal approach to the current account. We use a cointegrated VAR framework to identify permanent and transitory components of country‐specific and global shocks. Our approach allows us to investigate empirically the sensitivity to persistence implied by many forward‐looking models and our results shed new light on the excess volatility of investment encountered by Glick and Rogoff (1995). In G7 data, we find the relative current‐account and investment response to be in line with the intertemporal approach.