Working Papers
2025
February 14, 2025
Sandcastles and Financial Systems: A Sandpile Metaphor
Description: Social welfare costs from bank resolution, including contagion and moral hazard, are often thought to be minimized when supervisors can direct the merger of a failing bank with a sound, healthy one. However, social losses may become even larger if the absorbing institutions fail themselves. We ask whether social welfare losses are indeed lower when supervisors intervene rather than not. We use the sand pile/Abelian model as a metaphor to model financial losses which, as sand grains that fall onto a pile, eventually lead to a slide/failure. When capital in the system is insufficient to absorb the failing institution there will be welfare losses. Results suggest that, over the longer-term, social costs are lower when supervisors manage mergers. Additionally, financial networks that have a structure that minimizes social losses also minimize crises frequency. However, the bank employed resolution strategy will determine which financial network structures are associated with the minimum average loss per bankruptcy event.
February 14, 2025
Europe’s Productivity Weakness: Firm-Level Roots and Remedies
Description: Europe faces a well-known productivity malaise, with a large and widening aggregate productivity gap relative to the U.S. In this paper, we provide a novel diagnosis of the firm-level roots of Europe’s productivity growth slowdown through an analysis of data covering the universe of firms in Europe and the U.S over their life cycles. Compared to their U.S. counterparts, we identify critical performance gaps among both Europe’s frontier firms and young high-growth firms. Our firm-level analyses reveal that smaller markets and limited market-based financing are key bottlenecks for frontier European firms, while skill shortages and insufficient risk capital, such as venture capital, hinder the formation and subsequent growth of young firms in Europe. These findings suggest that removing remaining intra-Europe barriers to accelerate factor and product markets integration, alongside national reforms to facilitate swifter resource reallocation and enhance human capital, could help revive Europe’s productivity growth.
February 14, 2025
Transport Frictions and the Pass-Through of Global Price Shocks in a Spatial Model of Low-Income Countries
Description: We develop a spatial dynamic general equilibrium model of a small open agricultural economy to study the impact of global food, fuel and fertilizer price shocks on consumption patterns of heterogeneous households located in different regions, under alternative fiscal responses, including direct price subsidies and household transfers. We show strong spatial heterogeneity in response to shocks, with associated implications for welfare. In particular, while urban households’ consumption baskets are more exposed to the direct effects of global food price shocks, remote rural households’ production and consumption are more exposed to supply-side dislocations associated with shocks to fuel and fertilizer prices.
February 7, 2025
Strengthening Fiscal Frameworks in the Presence of Rising Risk of Natural Disasters
Description: This study investigates the impact of rising risk of natural disasters on rule-based fiscal frameworks. It explores the extent to which countries adhere to their fiscal rules in the presence of rising risk of natural disasters. To ensure a consistent analysis, we construct an index measuring the strenghth of fiscal rules, utilizing principal component analysis for a panel of 104 countries. The study employs a panel two-stage least squares estimation method to assess the impact of natural disaster risks on fiscal rules. The results, which are robust across various country groupings, suggest that natural disaster risks play a significant role in the determination of rule-based fiscal framework. After controlling for other determinants, the results show that countries with established fiscal rules are strengthening these rules in response to rising natural disaster risks. Nonetheless, the results are mixed across different country groups, with varying magnitude of impact. This suggests that countries currently operating fiscal rules will need to enhance their efforts to more comprehensively integrate natural disaster risks into their fiscal frameworks.
February 7, 2025
Climate News and Asset Valuations: Insights from Latin America
Description: We study the impact of climate-related news on asset prices in eight Latin American countries. We use both newspapers and official announcements to construct daily, country-specific indices via textual analysis, reflecting media coverage of transition risks, climate opportunities, regulatory actions, and physical risks. Leveraging an unbalanced daily panel data set of 628 firms from 2000 to 2023, we find a significant and robust climate risk premium in Latin America, which is higher for "browner" firms and has increased in more recent years. Focusing on major climate policies announced in official gazettes after the legislative process has been completed, we show that the publication of the laws is associated with a protracted decline in the relative stock prices of high-emission firms.
February 7, 2025
Government Debt and Growth: The Role of R&D
Description: Economic growth in the advanced economies (AEs) has been slowing down since the early 2000s, while government debt ratios have been rising. The recent surge in debt at the onset of the Covid-19 pandemic has further intensified concerns about these phenomena. This paper aims to offer insight into the high-debt low-growth environment in AEs by exploring a causal link from government debt to future growth, specifically through the impact of debt on R&D activities. Using data from manufacturing industries since the 1980s, it shows that (i) government debt leads to a decline in growth, particularly in R&D-intensive industries; (ii) the differential effect of government debt on these industries is persistent; and (iii) more developed or open financial systems tend to mitigate this negative impact. These findings contribute to our understanding of the relationship between government debt and growth in AEs, given the role of technological progress and innovation in economic growth.
January 31, 2025
TLTRO Spillovers Outside the Euro Area
Description: We examine spillovers from ECB’s TLTROs on European countries outside the euro area. Using individual banks’ balance sheet data, we find that TLTROs lowered funding and lending rates for foreign-owned subsidiaries, especially in emerging market economies. We also find an increase in profitability among foreign subsidiaries and no effects on solvency risk. The effects are sizable--every €1 billion in exposure to TLTROs via parent banks is associated with 0.2 bps reduction in deposit rates and 0.4 bps reduction in lending rates of foreign subsidiaries. This underscores the need to factor euro area monetary policies into policy settings outside the euro area.
January 31, 2025
The HIPC Initiative and China’s Emergence as a Lender: post hoc or propter hoc?
Description: Twenty years after the Heavily Indebted Poor Countries (HIPC) debt relief initiative, debt levels in low-income countries are rising again, renewing sustainability concerns. The prevailing view suggests that China and other emerging lenders exploited the HIPC initiative to expand lending. Using a synthetic control method to generate a counterfactual, we find that, contrary to this narrative, China and other emerging lenders reduced net lending after debt relief; only multilateral creditors increased it. Furthermore, we find no support for the claim that debt relief encouraged lending to political allies. Overall, debt relief seems to have had limited influence on subsequent lending patterns.
January 31, 2025
An Evaluation of World Economic Outlook Forecasts: Any Evidence of Asymmetry?
Description: Using a large cross-country dataset covering over 150 countries and more than 10 macroeconomic variables, this study examines the consistency of IMF World Economic Outlook (WEO) forecasts with the full information rational expectations (FIRE) hypothesis. Similar to Consensus Economics forecasts, WEO forecasts exhibit an overreaction to news. Our analysis reveals that this overreaction is asymmetric, with more measured response to bad news, bringing forecasts closer to the FIRE benchmark. Moreover, forecasts align more closely with FIRE hypothesis during economic downturns or when a country is part of an IMF program. Overreaction becomes more pronounced for macroeconomic variables with low persistence and for forecasts over longer horizons, consistent with recent theoretical models. We also develop a model to explain how state-dependent nature of attentiveness may drive this asymmetric overreaction.
January 31, 2025
Firm Performance, Business Supports and Zombification over the Pandemic
Description: Did the COVID-19 pandemic zombify the economy? Commentators have pointed to the pandemic and related business support measures potentially fueling zombification. Using administrative data covering the universe of Canadian firms, we find a broad-based decline in the share of zombie firms across industries relative to pre-pandemic levels. Whereas business support measures kept firms alive and operating as non-zombie firms, the decline in the zombie firm share was caused by would-be zombie firms exiting, indicative of the pandemic’s cleansing effects. As a consequence, while aggregate labour productivity worsened in Canada over the pandemic, it was not driven by zombie firms.