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"Inflation Stabilization" (with C. Vegh), chapter in Handbook of Macroeconomics, edited by J. Taylor and M. Woodford.
Notes on Price Stickiness: With Special Reference to Liability Dollarization and Credibility , December 23, 2000
Fear of Floating (with C. Reinhart), September 25, 2000
ABSTRACT:In recent years, many countries have suffered severe financial crises, producing a staggering toll
on their economies, particularly in emerging markets. One view blames fixed exchange rates--
"soft pegs"--for these meltdowns. Adherents to that view advise countries to allow their
currency to float. We analyze the behavior of exchange rates, reserves, the monetary aggregates,
interest rates, and commodity prices across 154 exchange rate arrangements to assess whether
"official labels" provide an adequate representation of actual country practice. We find that,
countries that say they allow their exchange rate to float mostly do not--there seems to be an
epidemic case of "fear of floating". Since countries that are classified as having a free or a
managed float mostly resemble noncredible pegs--the so-called "demise of fixed exchange rates"
is a myth--the fear of floating is pervasive, even among some of the developed countries. We
present an analytical framework that helps to understand why there is fear of floating.
Capital Market And The Exchange Rate With Special Reference to the Dollarization Debate in Latin America. April 14, 2000
Betting Against The State: Socially Costly Financial Engineering May 29, 1999
ABSTRACT: The central question raised in the paper is the desirability of state-contingent contractsunder imperfect policy credibility. The paper shows a benchmark case in which imperfectcredibility of a trade liberalization program is distorting, and the distortion is magnified by state-contingentmarkets. In addition, it examines the welfare implications of gaining credibilityconcluding that, in general, more credibility is better than less, and examines the moral hazardfaced by policymakers in carrying out reform in case the private sector is able to obtain insuranceagainst its discontinuation.
Rational Contagion and the Globalization of Securities Markets(with E.Mendoza), forthcoming in Journal of International Economics, May 17, 1999
ABSTRACT: This paper argues that globalization may promote contagion by weakening incentives forgathering costly information and by strengthening incentives for imitating arbitrarymarket portfolios. In the presence of short-selling constraints, the gain of gatheringinformation at a fixed cost may diminish as markets grow. Moreover, if a portfoliomanager's marginal cost for yielding below-market returns exceeds the marginal gainfor above-market returns, there is a range of optimal portfolios in which all investorsimitate arbitrary market portfolios and this range widens as the market grows.Numerical simulations suggest that these frictions can have significant implications forcapital flows in emerging markets.
Fixed vs. Flexible Exchange Rates. Preliminaries of a Turn-of-Millennium Rematch May 16, 1999
ABSTRACT:This note examines the pros and cons of flexible and fixed exchange rates in terms of a
bear-bones model which, however, takes into account features that have played a prominent role
in recent currency crises, namely, volatility of capital flows and the real exchange rate, currency
substitution and financial fragility, and the Credit Channel.
Contagion In Emerging Markets: when Wall
Street is a carrier (Technical Supplement to "Understanding the Russian
Virus"), May 2, 1999
Abstract: The paper examines the case in which the capital market is populated by informed and
uninformed investors. The uninformed try to extract information from informed investors'
trades. This opens up the possibility that if informed investors are forced to sell emerging market
securities to meet margin calls, for example, this action may be misread by the uninformed
investors as signaling low returns in emerging markets. The paper presents a simple model in
which this type of Wall Street confusion may result in a collapse in emerging markets' output.
Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops, July 20, 1998
Balance of Payment Crises In Emerging Markets March 15, 1998
ABSTRACT: The paper shows that the combination of large capital inflows and sovereign governments
could give rise to self-fulfilling balance of payments crises. It argues that a current account
deficit could impair the resolution of such crises, but the crises themselves could occur even
though the current account was in balance. The key is a weak financial sector, possibly made so
by an accommodating central bank. In contrast with most of the literature on this subject, the
paper endogenizes output and discusses the channels (New Classical and Keynesian) through
which a BOP crisis can result in output collapse. Building on a Time to Build model, the paper
shows that a growth slowdown can take place even though a BOP crisis brings about no current
account reversal.
"Uncertain Duration of Reform: Dynamic Implications" with A. Drazen. January 1998
ABSTRACT: We develop a framework to study the effects of policies of uncertain duration on
consumption dynamics under both complete and incomplete markets. We focus on the dynamic
implications of market incompleteness, specifically on the lack of state-contingent bonds. Two
policies are considered: pure output-increasing and tariff-reducing (trade liberalization). With
complete markets, the output-increasing policy leads to flat consumption, while with no
contingent assets, consumption jumps upward on the announcement of the policy, continues
rising as long as the policy is in effect, and collapses when it is abandoned. A similar
consumption path obtains in a trade liberalization in the realistic case of low elasticity of
substitution and no rebate of tariffs. Market incompleteness rationalizes the existence of
gradual changes in consumption.
Why Is 'The Market' So Unforgiving September 21, 1996
"Varieties of Capital-Market Crises," May 21, 1996
ABSTRACT:The paper is motivated by the recent balance-of-payment crisis in Mexico
and other emerging markets. The first part of the paper deals with
extensions of Krugman (1979) to account for (1) bonds, (2) banks and
banks' bailouts, and (3) cycle-linked government revenue. Extension (3)
shows that the Robichek-Lawson view that, in the absence of fiscal
disequilibrium, current account deficits should be of no concern to the
policymaker is wrong in general, even though markets and information are
perfect. An example is developed in which a crisis-prone stabilization
program leads individuals to increase consumption in the short run,
thereby increasing tax revenue (Talvi effect) and balancing the fiscal
budget. However, the consumption binge takes place only because the
stabilization program is expected to fail. After crisis erupts,
consumption collapses and the fiscal deficit sharply rises.
The second part of the paper examines models in which the crisis is
provoked by bond holders' behavior. It is shown that when there exists
a large number of investment projects with mutually independent returns,
the sensitivity of demand for these projects is high, and grows without
limit as the number of these projects increases without bound. In
addition, if there exists a fixed cost in getting information about each
project and the number of projects is large enough, then investors would
have no incentive to acquiring further information on any given
project. An implication of these results is that capital flows to
emerging markets could be highly sensitive to "rumors." The paper
discusses a multiple-equilibrium model in which these rumors could
result in major damage, even though the initial shock is small.