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Are Balance of Payments Crises Rational?
... Erzielen die staatlichen Parteien nicht rechtzeitig eine Einigung über die Budgetzusammensetzung, kommt es zur spekulativen Attacke. Velasco (1994) behandelt die mangelhafte Internalisierung eines Budgetziels, wenn die Ausgabenkompetenz auf mehrere Ministerien verteilt ist. Stein und Streb (1994) beschäftigen sich mit asymmetrischer Information in einem Fall, in dem es fiskalpolitisch sinnvoll ist, zu Lasten der Devisenreserven Inflation in die Zukunft zu verschieben und dabei eine Zahlungsbilanzkrise in Kauf zu nehmen. ...
... However, in a democratic or fragmented society like India, building a coalition for reform is not easy even in a crisis period. In this regards, Velasco's (1994) model helps explain the linkage of crisis to reform. ...
After the second oil shock in the mid-1980s increased the need for structural adjustment, many developing countries initiated economic policy reform. In the 1990s, Krueger’s (2000) second stage of reform, the momentum grew as economists’ views on reform tended to converge on the so-called Washington Consensus, as articulated by Williamson (1990) and summarized in Williamson (1994b)
... However, group decision making will often suffer from the Condorcet paradox, where groups which do not have a dictator will behave as if they have non-transitive preferences even though the preferences of every individual in the group are transitive. Work by Velasco (1994) finds that speculative attacks may be generated through noncooperative competition between different branches of government. It is also possible, at least potentially, that they may arise through non-strategic, but non-dictatorial decision making process of a single branch of government. ...
This paper demonstrates that the implications of first-generation speculative attack models do not hold if there is a rational, forward-looking policy maker. The policy maker will be able to avoid predictable speculative attacks by introducing uncertainty into the decisions of speculators. This changes the sudden attack into a prolonged period of increasing speculation and uncertainty. In addition, the model provides useful insights into the viability of temporary nominal anchor policies, and a theoretical foundation for a useful empirical methodology.
... Some interesting recent models have offered explicit political underpinnings for models such as Krugman's. Guidotti and Végh (1992) develop a model in which a "war of attrition" over balancing the national budget leads to continuing finance through reserve drains; if agreement is not reached in time, a crisis can occur. Velasco (1993) considers a scenario with divided government in which reserve drains occur because individual ministries fail to internalize the overall public—sector constraint. Stein and Streb (1993) propose an asymmetric-information model in which governments may rationally run down foreign reserves so as to push inflation into the future, thus Riks ...
Once one recognizes that governments borrow international reserves and exercise other policy options to defend fixed exchange rates during currency crises, the question arises: What factors determine a government's decision to abandon a currency peg or hang on? In a setting of purposeful action by the authorities, the possibility of self-fulfilling crises becomes important. Speculative anticipations depend on conjectured government responses, which depend, in turn, on how price changes that are themselves fueled by expectations affect the government's economic and political positions. The circular dynamic implies a potential for crises that need not have occurred, but that do because market participants expect them to. In contrast to this picture, most previous literature on balance-of- payments crises ignores the response of government behavior to markets. That literature, I argue, throws little light on events such as the European Exchange Rate Mechanism collapse of 1992-93. This paper then presents two different models in which crisis and realignment result from the interaction of rational private economic actors and a government that pursues well-defined policy goals. In both, arbitrary expectational shifts can turn a fairly credible exchange-rate peg into a fragile one.
... A variant along the same lines is developed by Velasco (1994), who considers a model in which two organized groups treat the state's resources as a common pool, and decide every period how much to extract from the pool. For simplicity and tractability, the choice is limited to one of two options: One option is to extract a "large" share, which leads to a build-up of government debt and a reduction over time in the state's net wealth. ...
One of the eventual consequences of the global debt crisis was a wave of market-oriented economic reforms. This paper discusses the state of our knowledge on the political economy of this process. Why were inefficient, and often unsustainable policies maintained for so long? Why are so many governments reforming now, after decades of adherence to policies of an opposite kind? Have the reformers internalized the correct lessons from the East Asian experience? Finally, are there any helpful rules for reformers to follow in guiding their policies through complicated political terrain?
This paper reconsiders the arguments for binding fiscal and budget rules such as those implied by the Maastricht Treaty fiscal criteria for a monetary union in Europe. Given the concern in Europe about “excessive” budget deficits caused by political biases in fiscal policy, we consider in a theoretical framework the trade-off between rules and discretion in fiscal policy in the presence of politically motivated fiscal deficits. We discuss the role of a political bias when deficits are motivated by economic shocks such as recessions and in economies which are open to international trade in assets and goods. We find that endowing politically biased governments with the ability to respond to economic shocks with deficit finance will not exacerbate the existing political biases. In an open economy, the ability to borrow abroad will significantly increase the deficit. However, restrictions to public foreign borrowing will not reduce the political bias as long as the private sector has access to international capital markets at the same terms as the government. The analysis suggests that a certain degree of fiscal discretion might be beneficial and that Maastricht type of rules might impose excessive constraints on the behavior of fiscal authorities.
This chapter surveys the recent literature on the theory of macroeconomic policy. We study the effect of various incentive constraints on the policy making process, such as lack of credibility, political opportunism, political ideology, and divided government. The survey is organized in three parts. Part I deals with monetary policy in a simple Phillips curve model: it covers credibility issues, political business cycles, and optimal design of monetary institutions. Part II deals with fiscal policy in a dynamic general equilibrium set up: the main topics here are credibility of tax policy, and political determinants of budget deficits. Part III studies economic growth in models with endogenous fiscal policy.
High-inflation economies often exhibit stop–go cycles of inflation, rather than smooth inflationary processes. This paper relates these stop–go episodes of inflation to a political cycle: the government can try to repress inflation until after the elections in order to increase the chances of being reelected. This is modeled as a two-period game of incomplete information where voters try to pick the most competent government, and inflation (which signals lack of competency) can be lowered by the government in the short run through foreign debt accumulation. Several stabilization episodes, such as the Primavera Plan in Argentina and the Cruzado Plan in Brazil, are used to motivate the model.
This article introduces endogenous institutional change into a neoclassical growth model. For some parameter values, all Markov perfect equilibria involve a shift from common property to private property followed by a shift back to common property. Even in the presence of a linear production technology, this sequence of switches generates growth rates that are increasing at low levels of capital and decreasing at high levels of capital. This result rationalizes the hump-shaped growth path followed by some countries through history, as well as the conditional convergence observed in postwar data. For other parameter values, there are also equilibria in which common property prevails forever. This result rationalizes the low-growth traps in which many poor countries find themselves. Copyright 1997 by Kluwer Academic Publishers
Economic reforms are often postponed even if they are clearly beneficial. I argue that this may reflect a government's need to improve its reputation before it can enact a reform successfully. I study a model in which the government has a commitment problem in setting taxes that pay for reform. Market expectations about future policy, which determine investment, become fundamental for the reform's success. Reform may be postponed as the government builds credibility with a period of low taxes. Depending on expectations, better equilibria may exist. The robustness of this explanation and its policy implications are discussed.
This paper contributes empirically to our understanding of informed traders. It analyzes traders' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which--simultaneously--use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.
This paper explores how the Stability and Growth Pact may cope with the future costs of population ageing in the European Union. Clearly, population ageing has forced countries to reform their pension systems, and will continue to do so, both by reducing the generosity of pension arrangements and by switching to funding rather than relying on pure pay-as-you go pension provision. We study how such reforms affect the room for adhering to the Pact, but also how the Pact may induce or hamper the incentives for reform. In our analysis we will draw on recent literature on the Pact and on the pensions and the ageing problem. We will also calibrate a simple model for addressing intergenerational equity. Keywords: Public pensions, population ageing, government budget deficit and debt, European Union Stability and Growth Pact.
This paper analyzes the sustainability of fixed exchange rates by extending the time inconsistency framework to a fully dynamic context in which the level of a state variable (in this case debt) determines the payoffs available to the government at each point in time. The model yields the following results. If debt is sufficiently low, there is an equilibrium in which the government does not devalue. For an intermediate range of debt levels, the government devalues in response to an attack but not otherwise, so that self-fulfilling attacks can occur. Finally, for yet another debt range there can also be sunspot equilibria in which an attack (and the corresponding devaluation) occurs with positive probability.
In this paper we investigate empirically the determinants of inflation, seigniorage and fiscal deficits in developing countries. We first test the optimal taxation theory of inflation for a group of 21 LCDs. We find that the implications of this theory are rejected for all these countries. We then proceed to implement a number of tests based on the new political economy approach to macroeconomic policies: we deal with some of the implications of a credibility and reputation model, and of a strategic government behavior model. We find that the data support the most important predictions of the political economy view of fiscal policy. Our measures of political instability and political polarization play an important role in explaining cross country differences in seigniorage, inflation, government borrowing and fiscal deficits. We end by discussing directions for future research.
A public debt theory is constructed in which the Ricardian invariance theorem is valid as a first-order proposition but where the dependence excess burden on the timing of taxation implies an optimal time path of debt issue. A central proposition is that deficits are varied in order to maintain expected constancy in tax rates. This behavior implies a positive effect on debt issue of temporary increases in government spending (as in wartime), a countercyclical response of debt to temporary income movements, and a one-to-one effect of expected inflation on nominal debt growth. Debt issue would be invariant with the outstanding debt-income ratio and, except for a mirror effect, with the level of government spending. Hypotheses are tested on U.S. data since World War I. Results are basically in accord with the theory. It also turns out that a small set of explanatory variables can account for the principal movements in interest-bearing federal debt since the 1920s.
The analysis of the revenue from the creation of fiat money is usually carried out in terms of comparative statics. Given the value of relevant parameters, the rate of inflation which maximizes revenue is characterized as the one yielding the highest stream of revenue once all adjustments have been completed: either some rate of monetary expansion is set, and the results corresponding to the long-run values of the variables are analyzed (Friedman 1971), or the inflation rate is fixed at the outset and adjustments taken to be instantaneous, but assuming away any effect of the once-and-for-all changes in real cash balances on the variable to be maximized (revenues), that is, assuming that those changes are met by once-and-for-all changes in the price level (Bailey 1956). Of course, both procedures amount to the same thing. This is, indeed, the correct analysis in processes in which the transition period can be assumed away because the long-run value of the variable to be maximized is reached asymptotically from the very beginning, so that the highest stream at any point is also the stream with the highest present value at the initial point. This is not so in the case of the revenue
The collapse of a fixed exchange rate is typically marked by a sudden balance-of-payments crisis in which"speculators" fleeing from the domestic currency acquire a large portion of the central bank's foreign exchange holdings.Faced with such an attack, the central bank often withdraws temporarily from the foreign exchange market, allowing the exchange rate to float freely before devaluing and returning to a fixed-rate regime. This paper links the timing of the initial speculative attack to the magnitude of the expected devaluation and to the length of the transitional period off loating. An implication of the analysis is that there exist devaluations so sharp and transition periods so short that acrisis must occur the moment the market first learns that the current exchange parity will eventually be altered. For sufficiently long transition periods, the floating exchange rate"overshoots" its new peg before appreciating back toward it;for shorter periods, the rate depreciates monotonically to its new fixed level. Accordingly, the central bank's return tothe foreign exchange market can occasion a capital outflow or a capital inflow.
Competitive Extemalities and the timal Seigniorage Segmentation J urnal of Money, Credit and Banking
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On gie Time Consistency of Policy in a Monetary Economy Econometrica Fractured Liberalism: Argentina under Martinez de Hoz Economic Development and Cultural Change Balance of Payments Crises in a Cash-in
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Mirman The Great Fish War: An Example Using the
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