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We propose a “dominant currency paradigm” with three key features: dominant currency pricing, pricing complementarities, and imported inputs in production. We test this paradigm using a new dataset of bilateral price and volume indices for more than 2,500 country pairs that covers 91 percent of world trade, as well as detailed firm-product-country data for Colombian exports and imports. In strong support of the paradigm we find that (i) noncommodities terms-of-trade are uncorrelated with exchange rates; (ii) the dollar exchange rate quantitatively dominates the bilateral exchange rate in price pass-through and trade elasticity regressions, and this effect is increasing in the share of imports invoiced in dollars; (iii) US import volumes are significantly less sensitive to bilateral exchange rates, compared to other countries’ imports; (iv) a 1 percent US dollar appreciation against all other currencies predicts a 0.6 percent decline within a year in the volume of total trade between countries in the rest of the world, controlling for the global business cycle. We characterize the transmission of, and spillovers from, monetary policy shocks in this environment.

International currencies fulfill different roles in the world economy, with important synergies across those roles. We explore the implications of currency hegemony for the external balance sheet of the United States, the process of international adjustment, and the predictability of the US dollar exchange rate. We emphasize the importance of international monetary spillovers and of the exorbitant privilege, and we analyze the emergence of a new Triffin dilemma.

A safe asset is a simple debt instrument that is expected to preserve its value during adverse systemic events. The supply of safe assets, private and public, has historically been concentrated in a small number of advanced economies, most prominently the United States. Over the last few decades, with minor cyclical interruptions, the supply of safe assets has not kept up with global demand. The reason is straightforward: the collective growth rate of the advanced economies that produce safe assets has been lower than the world's growth rate, which has been driven disproportionately by the high growth rate of high-saving emerging economies such as China. The signature of this growing shortage is a steady increase in the price of safe assets; equivalently, global safe interest rates must decline, as has been the case since the 1980s. The early literature, brought to light by Ben Bernanke's famous “savings glut” speech of 2005, focused on a general shortage of assets without isolating its safe asset component. The distinction, however, has become increasingly important over time, particularly in the aftermath of the subprime mortgage crisis and its sequels. We begin by describing the main facts and macroeconomic implications of safe asset shortages. Faced with such a structural conundrum, what are the likely short- to medium-term escape valves? We analyze four of them, each with its own macroeconomic and financial trade-offs.

The secular decline in safe interest rates since the early 1980s has been the subject of considerable attention. In this short paper, we argue that it is important to consider the evolution of safe real rates in conjunction with three other first-order macroeconomic stylized facts: the relative constancy of the real return to productive capital, the decline in the labor share, and the decline and subsequent stabilization of the earnings yield. Through the lens of a simple accounting framework, these four facts offer suggestive insights into the economic forces that might be at work.

We provide an empirical and theoretical analysis of the Greek crisis of 2010. We first benchmark the crisis against all episodes of sudden stops, sovereign debt crises, and lending booms/busts in emerging and advanced economies since 1980. The decline in Greece’s output, especially investment, is deeper and more persistent than in almost any crisis on record over that period. We then propose a stylized macrofinance model to understand what happened. We find that a severe macroeconomiCadjustment was inevitable given the size of the fiscal imbalance; yet, a sizable share of the crisis was also the consequence of the sudden stop that started in late 2009. Our model suggests that the size of the initial macro/financial imbalances can account for muchof the depthof the crisis. When we simulate an emerging-market sudden stop withinitial debt levels (government, private, and external) of an advanced economy, we obtain a Greek crisis. Finally, in recent years, the lack of recovery appears driven by elevated levels of nonperforming loans and strong price rigidities in product markets.

This paper presents a model of international portfolios with real exchange rate and non-financial risks that account for observed levels of equity home bias. Bonds matter: in equilibrium, investors structure their bond portfolio to hedge real exchange rate risks. Equity home bias arises when non-financial income risk is negatively correlated with equity returns, after controlling for bond returns. Our framework allows us to derive equilibrium bond and equity portfolios in terms of directly measurable hedge ratios. An empirical application to G-7 countries finds strong empirical support for the theory. We are able to account for a significant share of the equity home bias and obtain an aggregate currency exposure of bond portfolios comparable to the data.

We explore the consequences of safe asset scarcity on aggregate demand in a stylized IS-LM/Mundell Fleming style environment. Acute safe asset scarcity forces the economy into a “safety trap” recession. In the open economy, safe asset scarcity spreads from one country to the other via capital flows, equalizing interest rates. Acute global safe asset scarcity forces the economy into a global safety trap. The exchange rate becomes indeterminate but plays a crucial role in both the distribution and the magnitude of output adjustment across countries. Policies that increase the net supply of safe assets somewhere are output enhancing everywhere.

A key precursor of twentieth-century financial crises in emerging and advanced economies alike was the rapid buildup of leverage. Those emerging economies that avoided leverage booms during the 2000s also were most likely to avoid the worst effects of the twenty-first century's first global crisis. A discrete-choice panel analysis using 1973-2010 data suggests that domestic credit expansion and real currency appreciation have been the most robust and signicant predictors of financial crises, regardless of whether a country is emerging or advanced. For emerging economies, however, higher foreign exchange reserves predict a sharply reduced probability of a subsequent crisis.

Three of the most important recent facts in global macroeconomics — the sustained rise in the US current account deficit, the stubborn decline in long run real rates, and the rise in the share of US assets in global portfolio — appear as anomalies from the perspective of conventional wisdom and models. Instead, in this paper we provide a model that rationalizes these facts as an equilibrium outcome of two observed forces: a) potential growth differentials among different regions of the world and, b) heterogeneity in these regions’ capacity to generate financial assets from real investments. In extensions of the basic model, we also generate exchange rate and FDI excess returns which are broadly consistent with the recent trends in these variables. More generally, the framework is flexible enough to shed light on a range of scenarios in a global equilibrium environment.

The paper proposes a unified framework to study the dynamics of net foreign assets and exchange rate movements. We show that deteriorations in a country's net exports or net foreign asset position have to be matched either by future net export growth (trade adjustment channel) or by future increases in the returns of the net foreign asset portfolio (hitherto unexplored financial adjustment channel). Using a newly constructed data set on US gross foreign positions, we find that stabilizing valuation effects contribute as much as 31% of the external adjustment. Our theory also has asset pricing implications. Deviations from trend of the ratio of net exports to net foreign assets predict net foreign asset portfolio returns one quarter to two years ahead and net exports at longer horizons. The exchange rate affects the trade balance and the valuation of net foreign assets. It is forecastable in and out of sample at one quarter and beyond. A one standard deviation decrease of the ratio of net exports to net foreign assets predicts an annualized 4% depreciation of the exchange rate over the next quarter.

This paper assesses the prospects of a 2021 time bomb in small and medium-sized enterprises (SME) failures triggered by the generous support policies enacted during the 2020 COVID-19 crisis. Policies implemented in 2020, on their own, do not create a 2021 time bomb for SMEs. Rather, business failures and policy costs remain modest. By contrast, credit contraction poses significant risk. Such a contraction would disproportionately affect firms that could have survived COVID-19 in 2020 without any fiscal support. Even in that scenario, most business failures would not arise from excessively generous 2020 policies but rather from the contraction of credit to the corporate sector. JEL classification: L26, E32, M21 Key words: business formation, entrepreneurship, business dynamism, recessions, Working Paper 2021-6 January 2021 The global COVID-19 shock was unexpected, severe, and complex. The initial policy response, hastily cobbled together in the first quarter of 2020, was designed to [...]

We estimate the impact of the COVID-19 crisis on business failures among small and medium-size enterprises (SMEs) in seventeen countries using a large representative firm-level database. We use a simple model of firm cost minimization and measure each firm's liquidity shortfall during and after COVID-19. Our framework allows for a rich combination of sectoral and aggregate supply, productivity, and demand shocks. We estimate a large increase in the failure rate of SMEs under COVID-19 of nearly 9 percentage points, absent government support. Accommodation and food services; arts, entertainment, and recreation; education; and other services are among the sectors most affected. The SME jobs at risk due to business failures related to COVID-19 represent 3.1 percent of private sector employment. Despite the large impact on business failures and employment, we estimate only moderate effects on the financial sector: the share of nonperforming loans on bank balance sheets would increase by up to 11 percentage points, representing 0.3 percent of banks' assets, and would result in a 0.75 percentage point decline in the common equity tier 1 capital ratio. We also evaluate the cost and effectiveness of various policy interventions. The fiscal cost of an intervention that narrowly targets at-risk firms can be modest (0.54 percent of gross domestic product). However, at a similar level of effectiveness, nontargeted subsidies can be substantially more expensive (1.82 percent of gross domestic product). Our results have important implications for the severity of the COVID-19 recession, the design of policies, and the speed of the recovery. JEL classification: D2, E65, G33 Key words: COVID-19, business failures, liquidity, small business, Working Paper 2020-21 December 2020 1 Introduction The COVID-19 economic shock is unprecedented both in its complexity and severity. Nationwide lockdowns, in conjunction with behavioral changes due to the fear [...]

Anyone looking at recent financial headlines could be forgiven for thinking that the international monetary system is under heavy strains. The People's Bank of China faces severe private capital outflows, [...]