Macroeconomics in Emerging Markets

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					The Macroeconomics of Asset
Shortages

     Ricardo J. Caballero
     MIT and NBER

     http://web.mit.edu/caball/www

     Fall 2007
Overview
   A conjecture…
       Excess demand for (financial assets) store of value
        and collateral by households, corporations,
        governments, insurance companies, financial
        intermediaries
           No direct evidence…(both supply and demand are very
            hard to measure)
           But the implications of this single ingredient are
            consistent with many of the main macroeconomic events
            of the last decade and more (Occam’s razor )…
               Dark matter…
Overview
   Equilibrium response of asset prices and
    valuations have macroeconomic implications
       “Global imbalances”
       Recurrent speculative “bubbles’’ (emerging markets,
        dot-coms, real estate, gold, commodities, emerging
        markets…)
           Flight to quality episodes
       Low long real interest rates
       Low inflation and deflations
   Rebalancing is a response to changes in the
    location of asset production
Emerging Markets
   Capital’s ability to produce output is only
    imperfectly linked to its ability to generate assets
       Weaknesses: Institutional, macroeconomic, political,
        liquidity
       Result: Asset shortage is a chronic feature. Cycles of
        capital outflows (store value abroad) and domestic
        bubbles (store value in fragile coordination dependent
        assets)
   Collapse in Capital Flows to SE Asia in the Late 90s
                                     Capital Flows to SEA-5*                                                                                                          Synchronization of Boom and
                                    (in millions of US dollars, last four quarters)                                                                                      Bust in Capital Flows
                                                                                                                                                                                (in % of GDP, last four quarters)
80000
                                                                                               Asian Crisis

60000
                                                                                                                                                                                    Boom                     Bust
40000                                                                                                                                                                           Average 1984-88 peak 1996           peak 1996
                                                                                                                                                                                      vs           vs                  vs
                                                                                                                                                                                   peak 1996   trough 1998            2002
20000

                                                                                                                                                                  Thailand            9,7            -22,6           -11,2
    0
                                                                                                                                                                  Indonesia           2,6            -21,9            -7,0

-20000
                                                                                                                                                                  Korea               6,4            -14,5            -3,2
                                                                                                                                                                  Philippines         8,0            -10,3           -14,8
-40000
                                                                                                                                                                  Malaysia            6,1             -5,7           -10,9
-60000
                                                                                                                                                                  SEA-5               6,1            -15,0            -9,4
-80000
                                                                                                                                                         Jul-02
                                             Jul-92




                                                                                                   Jul-97




                                                                                                                                       Nov-00
                           Nov-90




                                                                                 Nov-95
                                    Sep-91




                                                                                          Sep-96




                                                                                                                                                Sep-01
                                                                                                                              Jan-00
                  Jan-90




                                                                        Jan-95
         Mar-89




                                                               Mar-94
                                                      May-93




                                                                                                            May-98
                                                                                                                     Mar-99




  *SEA-5 includes Indonesia,Korea, Malaysia, Philippines and Thailand
  Source: Calvo et al (2006)
The World Economy
   Globalization transfers local asset shortages to
    the world at large
       Asset crashes around the world (Japan, EMs) reduced
        the supply of assets (today…)
       Large asset shortages in China and commodity-
        economies
   Anglo-Saxon economies, and the US in
    particular, are the main asset producers
       Large capital gains and flows to producers of scarce
        assets
   The so-called “global imbalances” is a symptom
    of asset-scarcity
       Capital gains and losses are very heterogeneous
        across the world
   Low interest rates
       It is one of the market mechanisms to create assets
        (increase value) out of the few ones it has
   Low inflation is another
       It is the market mechanism to increase the value of scarce
        nominal assets

                                                38


                                                33
         Percentage change in consumer prices




                                                28


                                                23


                                                18


                                                13


                                                8


                                                3


                                                -2
                                                     1990   1992   1994     1996   1998   2000        2002    2004   2006

                                                                          World     USA          EU          Japan
The World Economy: Bubbles
   … and yet another market mechanism (recall
    EMEs) is high valuations or speculative bubbles
The World Economy: Bubbles

   Bubbles in “the small”:
       We tend to focus on (be distracted by?) risk-shifting,
        regulatory problems, etc.
       Most recent example: sub-prime
   My view: these are mainly stories of “location”
       Instead, the real story is what creates the
        environments that are conducive to speculative
        behavior…
           Shortage of assets…
           (btw, central bank supplied liquidity is endogenous…)
The World Economy: Bubbles
   The environment is much harder to deal with
    than a specific problem in a specific market…
       Trying to chase and prick bubbles may lead to lots of
        instability and very limited success… (conservation
        law)
       Bubbles are providing a useful service
       Problems:
           They introduce volatility / location (huge problem for
            EMEs)
           May distort allocation of factors of production (e.g. real
            estate)
The World Economy: Bubbles
   Solution: ???

       Short run: (science fiction…)
           Try to spread them
           Concentrate them on non-resource consuming / input
            assets
           In any event, interest rate policy has little to do with this,
            aside from the “divine coincidence” (excessive
            aggregate bubbles lead to inflation)


       Long run: financial development in the South…
Flight to Quality
   Shortage of assets leads to high valuations and
    the emergence of speculative bubbles with
    uncertain location

   In turn, these factors lead to financial innovation
    and effectively uncollateralized leverage, which
    leave the economy exposed to flight to quality
    episodes (Knightian uncertainty)
$250 Billion

   1% change in the stock market > $250 billion

   Why has this created a credit crisis?
       The Dow fell from near 14,000 pre-crisis to a low of
        13,000 on 8/16
       7% fall = $2.1 trillion of loss in wealth

       8X the subprime loss !
Uncertainty

   Newness
       Short historical record
       Past prices for statistical analysis?
       How do securities react in a stress event?
       Who is exposed?


“ When confronted with uncertainty, human beings invariably
    attempt to disengage from medium to long-term commitments
    in favor of safety and liquidity”
                         -Alan Greenspan after the 1998 Crisis
Flight to Quality
   Regulator’s incentive is to impose larger
    collateral holdings
       Costly in an environment with asset scarcity
   If F-to-Q doesn’t go away, or too much
    regulation, the cost will be large since frozen
    assets exacerbate the asset shortage. Non-
    recessionary interest rate is much lower…
   Hope: where will these savings go in the
    medium run? Not many options at the aggregate
    level… this is one of the main reasons we are in
    this environment…
World Rebalancing

   The dollar has depreciated about 20% relative to
    the Euro over the last year, and even more
    relative to some EMEs… why?
       Loss of growth advantage vs Euro area and Japan
       Sub-prime crisis
       Emerging market bubbles are being reignited
   Prices (exchange rate) change faster than
    quantities
Summary

   A simple ingredient, a shortage of store-of-value
    assets, can explain the main global
    macroeconomic phenomena of recent years
       Global “imbalances”, low real interest rates and
        inflation, emergence of speculative bubbles, flight to
        quality episodes…
   Volatility, associated to financial markets
    phenomena, is an intrinsic and unavoidable
    feature of an environment with such shortage
The Macroeconomics of Asset
Shortages

     Ricardo J. Caballero
     MIT and NBER

     http://web.mit.edu/caball/www

     Fall 2007

				
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