Speculation in the Oil Market

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Luciana Juvenal
Ivan Petrella
January 2012

“While global demand shocks account for the largest share of oil price fluctuations, speculative shocks are the second most important driver. (ii) The comovement between oil prices and the prices of other commodities is explained by global demand and speculative shocks. (iii) The increase in oil prices over the last decade is mainly driven by the strength of global demand. However, speculation played a significant role in the oil price increase between 2004 and 2008 and its subsequent collapse. Our results support the view that the financialization process of commodity markets explains part of the recent increase in oil prices.”.

http://research.stlouisfed.org/wp/2011/2011-027.pdf

Sticky Prices: A New Monetarist Approach

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Allen Head
Lucy Qian Liu
Guido Menzio
Randall Wright
October 2011

“Why do some sellers set nominal prices that apparently do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption; here it is a result. We use search theory, with two consequences: prices are set in dollars, since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When the money supply increases, some sellers may keep prices constant, earning less per unit but making it up on volume, so profit stays constant. The calibrated model matches price-change data well. But, in contrast with other sticky-price models, money is neutral.”

http://www.nber.org/papers/w17520.pdf

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Global Asset Pricing

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Karen K. Lewis
July 2011

“Financial markets have become increasingly global in recent decades, yet the pricing of internationally traded assets continues to depend strongly upon local risk factors, leading to several observations that are difficult to explain with standard frameworks. Equity returns depend upon both domestic and global risk factors. Further, local investors tend to overweight their asset portfolios in local equity. The stock prices of firms that begin to trade across borders increase in response to this information. Foreign exchange markets also display anomalous relationships. The forward rate predicts the wrong sign of future movements in the exchange rate, implying that traders can make profits by borrowing in lower interest rate currencies and investing in higher interest rate currencies. Furthermore, the sign of the foreign exchange premium changes over time, a fact difficult to reconcile with consumption variability. In this review, I describe the implications of the current body of research for addressing these and other global asset pricing challenges.”

http://papers.nber.org/papers/w17261

What's Next for the Dollar?

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Martin S. Feldstein
July 2011

“The real trade weighted value of the dollar fell 11 percent against the Federal Reserve Bank’s index of major currencies during the 12 months through May 2011 and 31 percent during the past ten years. Four strong market forces are likely to cause further declines over the next several years: a portfolio rebalancing by major international investors who regard their portfolios as overweight dollars, the large US current account deficit, a Chinese policy to raise consumption, and interest rate differences that make dollar investments less attractive.

A declining dollar could have a powerful positive effect on the short-run performance of the American economy by raising exports (now more than $1.3 trillion) and inducing American consumers to shift from imports to American made products and services. Without a boost to demand from an increase in net exports, the U.S. recovery is likely to remain weak and could run out of steam.

There are of course also negative effects of a falling dollar: reducing the real value of any given level of personal incomes by raising the cost to households of the imported products that they consume and creating inflationary pressures as import prices rise.”

http://papers.nber.org/papers/w17260

Capital flows: Catalyst or Hindrance to economic takeoffs?

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Joshua Aizenman
Vladyslav Sushko
July 2011

“This paper applies a probit estimation to assess the relationship between economic takeoffs during 1950-2000 and inflows of portfolio debt, portfolio equity, and FDI, controlling for country’s stock of short-term external debt and commodity terms of trade. Average level of FDI inflows is associated with a 23 percent higher takeoff probability relative to a zero FDI inflow benchmark, and this effect is highest for the Latin America subsample, with a 65 rise in takeoff probability. Higher stock of short term external debt has been associated with a substantial negative effect on the probability of a takeoff, and the effect of the short terms debt overhang is largest for Latin American countries. Yet, virtually all the takeoffs were associated with a rise in portfolio debt inflows. At the sample mean, inflow of portfolio debt is associated with approximately 25 percent higher probability of a takeoff. In contrast, a one standard deviation increase in equity outflows (inflows) is associated with a 47 percent (17 percent) decline in the probability of a takeoff. A one standard deviation improvement in commodity terms of trade is associated with 28 percent higher takeoff probability.”

http://papers.nber.org/papers/w17258

Policy Instruments To Lean Against The Wind In Latin America

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Gilbert Terrier, Rodrigo Valdés, Camilo E. Tovar, Jorge Chan-Lau, Carlos Fernández-Valdovinos, Mercedes García-Escribano, Carlos Medeiros, Man-Keung Tang, Mercedes Vera Martin, and Chris Walker

July 2011

This paper reviews policy tools that have been used and/or are available for policy makers in the region to lean against the wind and review relevant country experiences using them. The instruments examined include: (i) capital requirements, dynamic provisioning, and leverage ratios; (ii) liquidity requirements; (iii) debt-to-income ratios; (iv) loan-to-value ratios; (v) reserve requirements on bank liabilities (deposits and nondeposits); (vi) instruments to manage and limit systemic foreign exchange risk; and, finally, (vii) reserve requirements or taxes on capital inflows. Although the instruments analyzed are mainly microprudential in nature, appropriately calibrated over the financial cycle they may serve for macroprudential purposes.

http://www.imf.org/external/pubs/ft/wp/2011/wp11159.pdf

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Unemployment in an Estimated New Keynesian Model

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Jordi Galí
Frank Smets
Rafael Wouters

“We reformulate the Smets-Wouters (2007) framework by embedding the theory of unemployment proposed in Galí (2011a,b). We estimate the resulting model using postwar U.S. data, while treating the unemployment rate as an additional observable variable. Our approach overcomes the lack of identification of wage markup and labor supply shocks highlighted by Chari, Kehoe and McGrattan (2008) in their criticism of New Keynesian models, and allows us to estimate a “correct” measure of the output gap. In addition, the estimated model can be used to analyze the sources of unemployment fluctuations.”

http://www.nber.org/papers/w17084

Banks, Market Organization, and Macroeconomic Performance: An Agent-Based Computational Analysis

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Quamrul Ashraf
Boris Gershman
Peter Howitt

“This paper is an exploratory analysis of the role that banks play in supporting the mechanism of exchange. It considers a model economy in which exchange activities are facilitated and coordinated by a self-organizing network of entrepreneurial trading firms. Collectively, these firms play the part of the Walrasian auctioneer, matching buyers with sellers and helping the economy to approximate equilibrium prices that no individual is able to calculate. Banks affect macroeconomic performance in this economy because their lending activities facilitate entry of trading firms and also influence their exit decisions. Both entry and exit have conflicting effects on performance, and we resort to computational analysis to understand how they are resolved. Our analysis sheds new light on the conflict between micro-prudential bank regulation and macroeconomic stability. Specifically, it draws an important distinction between “normal” performance of the economy and “worst-case” scenarios, and shows that micro prudence conflicts with macro stability only in bad times. The analysis also shows that banks provide a “financial stabilizer” that in some respects can more than counteract the more familiar financial accelerator.”

http://papers.nber.org/papers/w17102

Exchange Rates in Emerging Countries: Eleven Empirical Regularities from Latin America and East Asia

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Sebastian Edwards
May 2011

“In this paper I discuss some of the most important lessons on exchange rate policies in emerging markets during the last 35 years. The analysis is undertaken from the perspective of both the Latin American and East Asian nations. Some of the topics addressed include: the relationship between exchange rate regimes and growth, the costs of currency crises, the merits of “dollarization,” the relation between exchange rates and macroeconomic stability, monetary independence under alternative exchange rate arrangements, and the effects of the recent global “currency wars” on exchange rates in commodity exporters.”

http://www.nber.org/papers/w17074.pdf

Federal Reserve Policies and Financial Market Conditions during the Crisis

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Scott A. Brave
Hesna Genay
May 2011

“During the recent financial crisis, the Federal Reserve implemented a series of extraordinary and unconventional policies to alleviate the impact of the crisis on financial markets and the economy. In this paper, we examine the effects of these policies on broad financial market conditions, explicitly taking into account that policy was endogenously determined in response to prevailing financial market and economic conditions. We find that the Fed was more likely to initiate or expand new programs when financial market conditions were tighter than usual and economic conditions deteriorating. We also find that the Fed’s policies improved broad financial market conditions significantly at  announcement and that the improvements were associated primarily with program initiations and expansions.”

http://chicagofed.org/digital_assets/publications/working_papers/2011/wp2011_04.pdf