‘Global Spillovers and Economic Cycles’

That was the title of an illuminating EABCN/CEPR/Banque de France/European University Instituteconference I attended last week (organized by Philippe BacchettaLaurent FerraraJean Imbs, andMassimiliano Marcellino). The program is here, and papers here.

The conference call described the focus:

In an increasingly integrated global economy, assessing the propagation of shocks is becoming of major interest to the international economic cycles analysis. It is indeed challenging to evaluate the impact of certain types of shocks on global business cycles and to disentangle the various transmission channels, such as trade flows, financial linkages or confidence effects. This conference will focus on empirical and theoretical contributions providing an assessment of various spillover effects at a global level and new perspectives on structural analysis, forecasting and economic policy design and assessment.

The conference papers provided a refreshing combination of advanced theory and econometrics andrelevance to current policy concerns. All the papers were extremely interesting (I certainly learned a lot — there’s no way to keep up with all the developments, even when restricting oneself to international finance). I have to say it was also exhilerating to talk to people who believe in measurement, believe in the use of statistics, and who consider the possibility that policy could be welfare-enhancing (those following policy debates in the US know that not all people adhere to such views [1] [2]).

Lucrezia Reichlin (LBS) discussed the challenges of modeling of how central bank balance sheet measures affect output and other macrovariables. She highlighted the fact that using consolidated data were unlikely to be very useful in assessing what happens in the financial sector. Unfortunately, there’s no paper — although some of the material is available in published papers.

“International Spillovers: Real and Financial Channels,” by Ayhan Kose (International Monetary Fund), *Christopher Otrok (University of Missouri) and Eswar Prasad (Cornell University), is a must-read. In his presentation, Otrok elaborates on the decomposition of business cycles into global, regional and country specific factors, by further decomposing the global factor into spillover effects.

Institutional Investors Flows and the Geography of Contagion, by Damien Puy (European University Institute), used an incredibly detailed dataset of thousands of funds, to investigate the behavior of investors, by decomposing into global, regional and country-specific funds. One of his more notable findings is that the country-specific or idiosyncratic components of bond and equity flows is relatively small, suggesting that “push” “pull” factors are fairly unimportant [and “push” factors quite important] — mdc 6/5 . This was such a remarkable finding that I recommended that this finding be subjected to lots of robustness testing, in my discussion.

Perhaps the most provocative papers was The Puzzling Change in the International Transmission of U.S. Macroeconomic Policy Shocks, by Ethan Ilzetzki (London School of Economics) and Keyu Jin (London School of Economics). From the paper:

[T]his paper raises two challenges to existing knowledge on spillovers. First, we document a dramatic shift in how U.S. monetary and fiscal policy shocks are transmitted to other economies. In an earlier period prior to 1984, a contractionary monetary shock in the U.S. lowers output of the 8 largest high-income economies in the world (ex-US), and appreciates the US dollar in both nominal and real terms against these currencies. This accords with conventional views. In the sample post-1984, in which among the largest developing countries are also included, a contractionary monetary shock now raises output overseas and depreciates the U.S. dollar in real and nominal terms. Fiscal policy shocks have witnessed a similar metamorphosis: while unexpected fiscal expansions appreciated the dollar in both nominal and real terms in the earlier period, it depreciated the dollar in the later period. A natural question to ask is whether this qualitative shift in the nature of spillovers owes to changes in the foreign monetary policy reaction, and the answer is decidedly no: policy responses overseas are broadly similar across these two sample periods.

The second challenge is that the responses to U.S. monetary policy shocks in the latter period have become somewhat of an empirical conundrum. Exchange rate and output effects in foreign economies are opposite of predictions from standard theories. While aptly capturing many aspects of reality in earlier periods, these theories have a hard time describing recent patterns. There is reason to believe that an altogether di¤erent channel of transmission from the ones manating from existing models is required to understand even the basic effects on output and exchange rates. With a radical shift in the nature of transmission comes along a need for rethinking of the theoretical reference point on which policy prescriptions and welfare analysis are invariable based.

Ilzetzki and Jin attempt to rationalize these results by appealing to modifications to the theoretical framework (assumptions regarding pricing behavior, elasticities of substitution, etc.). Some of the commentators (myself included) conjectured that the use of bilateral models (e.g., US versus other countries) might be problematic, especially as other global factors might have become important in the latter period — including large purchases of government bonds by East Asian and oil-exporter central banks.

Other papers presented during poster sessions ranged in topic from elasticity optimism (Corbo and Osbat) [poster] and whether a Taylor rule is appropriate in a currency union characterized by nominal rigidities and financial frictions (Bhattarai, Lee, Park) (it isn’t).

Unfortunately, not all the papers are online, but over time more may be uploaded.

This piece is cross-posted from Econbrowser with permission.