Working Papers
2025
May 2, 2025
Using Simulations for Cyber Stress Testing Exercises
Description: We demonstrate how computer-based simulations could support cyber stress testing exercises through a three-step framework. First, cyber-attack scenarios are designed to target the systemic nodes of a payment network at different times, disrupting a major bank, critical service provider, large-value payment system, and a foreign exchange settlement system. Second, the stress resulting from the scenarios is simulated using transaction-level data, and its impact is measured through a range of risk metrics. And third, cyber preparedness is discussed to identify effective practices that could strengthen the cyber resilience of the financial sector. The exercise provides insights into the main vulnerabilities of the financial sector and key transmission channels under plausible scenarios that necessitate preemptive action and recovery and response measures. For example, simulation results for Finnish data suggest that end-of-day liquidity risk is most severe when a cyber-attack hits a major bank or several banks simultaneously through dependence on a common critical service provider, compared to an attack on a centralized payment system where effective queuing and liquidity-saving mechanisms can better support recovery. Outcomes could be aggravated under more severe and prolonged scenarios.
May 2, 2025
Impact Dynamics of Natural Disasters and the Case of Pacific Island Countries
Description: This paper investigates the short- and medium-term economic impacts of natural disasters, focusing on Pacific Island Countries (PICs) and using global high-frequency nightlight data in addition to macroeconomic data. In this paper, we identify significant short-term effects on growth following natural disasters, which are exacerbated by high public debt and heightened climate vulnerability. Although the negative impacts generally diminish within a year for most countries, PICs face disproportionately larger and rising short-term disruptions (-1.4 percent of annual potential growth) and persistent medium-term consequences. Further analysis of PICs' fiscal, external, and real sectors following severe disasters using annual economic data reveals that weaker fiscal positions, partly driven by reduced output, may lead to an upward trend in public debt, and increased imports may deteriorate current account balances over the medium term. These findings underscore the need for robust counter-cyclical policies and proactive investments in climate resilience to mitigate the adverse effects of climate shocks and promote long-term economic stability
May 2, 2025
Fiscal Financing and Investment Irreversibility: The Role of Dividend Taxation
Description: We examine the macroeconomic, asset pricing, and public debt consequences of deficit financing dividend taxation in a dynamic general equilibrium model featuring partial investment irreversibility. Dividend taxes interact directly with the occasionally-binding irreversibility constraint, generating tax-augmented user-cost and hangover channels that both shape investment and debt-to-output fluctuations and account for a sizeable share of their long-run volatilities. Our analysis further reveals that debt-offsetting dividend tax hikes initially trigger investment inactivity through higher user-costs, followed by a surge driven by intertemporal tax arbitrage and hangover effects. Finally, debt-driven dividend tax rules amplify asset price fluctuations while delivering only modest fiscal revenue changes.
May 2, 2025
Labor Market Matching Efficiency and Koreas Low Post-Pandemic Unemployment
Description: Following the COVID-19 pandemic, Korea’s unemployment rate has remained significantly lower than pre-pandemic levels. This paper examines the dynamics of unemployment through a framework of labor market flows incorporating a matching function and identifies a sustained increase in labor market matching efficiency as the primary driver of persistently low post-pandemic unemployment. The framework further suggests that, barring an unlikely reversal of these efficiency gains, the unemployment rate is likely to remain below 3 percent in the medium term. Notably, despite heightened labor market tightness, post-pandemic wage growth in Korea has been modest. The paper develops a variant of the Diamond-Mortensen-Pissarides model, demonstrating that increased labor market matching efficiency helps account for this apparent paradox.
April 22, 2025
Power Hungry: How AI Will Drive Energy Demand
Description: The development and deployment of large language models like ChatGPT across the world requires expanding data centers that consume vast amounts of electricity. Using descriptive statistics and a multi-country computable general equilibrium model (IMF-ENV), we examine how AI-driven data center growth affects electricity consumption, electricity prices, and carbon emissions. Our analysis of national accounts reveals AI-producing sectors in the U.S. have grown nearly triple the rate of the private non-farm business sector, with firm-level evidence showing electricity costs for vertically integrated AI companies nearly doubled between 2019-2023. Simulating AI scenarios in the IMF-ENV model based on projected data center power consumption up to 2030, we find the AI boom will cause manageable but varying increases in energy prices and emissions depending on policies and infrastructure constraints. Under scenarios with constrained growth in renewable energy capacity and limited expansion of transmission infrastructure, U.S. electricity prices could increase by 8.6%, while U.S. and global carbon emissions would rise by 5.5% and 1.2% respectively under current policies. Our findings highlight the importance of aligning energy policies with AI development to support this technological revolution, while mitigating environmental impacts.
April 11, 2025
Shifting Advantages: Do Subsidies Shape Cross-Border Investment?
Description: Industrial policies have been on the rise with subsidies provided to firms accounting for the lion’s share of interventions. The effects of these measures on productivity, trade, investment and other economic and non-economic variables are largely an open question. This paper examines empirically the link between subsidies and inward cross-border investment using data on greenfield investments across a large sample of advanced and emerging economies between 2010 and 2020. Employing a difference-in-difference approach, we find that—while the average effect of all subsidies is zero—financial subsidies, such as loans and loan guarantees, increase new cross-border investment projects by an average of 7%. These effects are primarily driven by capital-intensive sectors in capital-abundant countries, suggesting that subsidies can affect foreign direct investment—but they reinforce (rather than reshape) countries’ comparative advantage.
April 11, 2025
Inflation Targeting and the Legacy of High Inflation
Description: As inflation targeting (IT) turns 35, it has become a key institutional monetary framework by central banks. Yet, this paper shows that stark differences exist among inflation targeting countries in the conduct of monetary policy. Behind such heterogeneity, the legacy of a high inflation history appears as a preponderant factor. We propose a model that diverges from existing IT workhorse models by adding path-dependence (to a forward-looking model) and potentially imperfect central bank credibility. We show that achieving low inflation (hitting the target) requires more aggressive monetary policy, and is costlier from an output point of view, when individuals’ past inflationary experiences shape their inflation expectation formation. In turn, we provide empirical evidence of the need for these two theoretical additions. Countries that experienced a high level of inflation before adopting the IT regime tend to respond more aggressively to deviations of inflation expectations from the central bank’s target. We also point to the existence of a credibility puzzle, whereby the strength of a central bank’s monetary policy response to deviations from the inflation target remains broadly unchanged even as central banks gain credibility over time. Put differently, a country’s inflationary past casts a long and persistent shadow on central banks.
April 11, 2025
K Wasn’t Built in a Day
Description: Physical capital takes time to build. Yet, the measurement of time to build and of its response to firm behavior remain scant. We fill this gap using project-level data from India. We document new facts on cross-sectional heterogeneity in time to build; and exploit quasi-experimental variation in credit supply to establish that firms accelerate ongoing projects and start fewer new projects when credit dries up. We rationalize our findings with a novel model of endogenous time to build. A credit crunch increases firm appetite for immediate relative to delayed cash flows. Firms then accelerate projects closer to completion and postpone unbegun projects. Such a mechanism is borne out in the data: projects proxied to be more mature are sped up the most. We quantify our model to match our causal estimates, and the joint distribution of project costs and gestation lags. Endogenous time to build generates endogenous amplification and state-dependence of investment on the distribution of projects along completion stages. Endogenous time to build is policy relevant. Contractionary monetary policy faces headwinds when the distribution of projects skews towards mature projects. Tax policy, in turn, can flexibly reshuffle investment expenditures over time with tax credits.
April 11, 2025
Do ESG Considerations Matter for Emerging Market Sovereign Spreads?
Description: This paper aims to investigate the determinants of sovereign spreads for a panel of 79 emerging markets and development economies (EMDEs) over the period 2001-2021, with a particular focus on the role of Environmental, Social, and Governance (ESG) factors. Using panel fixed-effect regressions, our results show that improvements in ESG factors tend to reduce sovereign spreads, alongside domestic variables capturing growth, fiscal and external balances, and global factors such as U.S. interest rates and changes in global risk sentiment. In particular, we find that governance is a key factor in explaining movements in sovereign spreads, including perceptions of government effectiveness, regulatory quality, and the control of corruption. Social and environmental aspects, proxied by population purchasing power and greenhouse gas emissions, respectively, also play significant roles. Our contribution to the literature is threefold: first, we confirm the results of previous papers on the relevance of ESG in explaining emerging market spread movements; second, we delve deeper by unpacking the elements that matter most within ESG factors; and third, we construct an aggregate ESG indicator using principal components analysis to summarize its overall impact.
April 11, 2025
Firm Financing During Sudden Stops: Can Governments Substitute Markets?
Description: We analyze whether central bank credit lines and government-backed guarantees helped mitigate the impact of the pandemic's sudden stop, marked by the abrupt withdrawal of international capital, using administrative data on the universe of Chilean firms. Our regression discontinuity design reveals that eligible firms increased domestic borrowing at lower costs. These policies reduced the cost of domestic debt compared to foreign debt, easing access to capital. An open economy model explains the complementarity of both interventions--credit lines and guarantees--in relaxing collateral constraints, reducing financial intermediaries' risk aversion and boosting domestic credit supply amidst shrinking international flows.