نوسانات قیمت نسبی تحت توقف های ناگهانی : ارتباط اثرات ترازنامه

Sudden Stops are associated with increased volatility in relative prices. We introduce a model based on information acquisition to rationalize this increased volatility. An empirical analysis of the conditional variance of the wholesale price to consumer price ratio using panel ARCH techniques confirms the relevance of Sudden Stops and potential balance sheet effects as key determinants of relative price volatility, where balance sheet effects are captured by the interaction of a proxy for potential changes in the real exchange rate (linked to the degree of external leverage of the absorption of tradable goods) and a measure of domestic liability dollarization.

The succession of financial crises in Emerging Market economies (EMs) that materialized throughout the second half of the 1990s,3 affecting a wide range of countries in terms of standard fundamentals in a relatively short time span, suggests that systemic financial market forces, coupled with specific country vulnerabilities to capital account shocks, lie at the heart of these developments. The vast literature on contagion in capital markets that emerged following these events acknowledges the existence of systemic effects (or “excess” volatility in spreads and asset prices), and it attempts to identify underlying characteristics that work as coordination factors. For example, contagion between two countries could be due to the fact that they belong to a particular asset class (Rigobón, 2001), borrow from the same banks (van Rijckeghem and Weder, 2000), or share a set of overexposed mutual funds (Broner and Gelos, 2003). Inspired by the Russian crisis of 1998, Calvo (1999) provides a model for contagion based on liquidity shocks to international investors, triggered by developments in a particular country that spread to other countries as international investors sell other assets in their portfolio to restore liquidity. As a result of contagion, EMs have been subject to large and unexpected falls in capital inflows or Sudden Stops. Although the origins of Sudden Stops (or “incipient” Sudden Stops) typically reflect systemic shocks to capital markets, the probability that a particular country will experience a full-fledged Sudden Stop with large capital flow reversals could still depend on domestic factors representing vulnerabilities to this external shock. That is, the probability of experiencing a full-fledged Sudden Stop, conditional on the materialization of an “incipient” Sudden Stop could be a function of domestic factors. As established in Calvo et al. (2004), potential balance sheet effects are key domestic drivers of the probability of experiencing a Sudden Stop. This is mainly due to the fact that Sudden Stops may entail a dramatic change in the level of the real exchange rate (RER). Abstracting from supply-side effects, this is simply the corollary of a cut in current account financing that forces a fall in aggregate demand, which, in turn, induces a drop in the price of non-tradable goods relative to that of tradable goods,4 so that the RER (defined as the inverse of this relative price) will rise. This change-in-level effect in the RER becomes larger the less open a country is (i.e., the smaller the supply of tradable goods,5 and given supply elasticities), as less tradable resources will be available to cushion the impact of the cut in foreign financing (see Calvo et al., 2003 for details). EMs may find RER fluctuations quite challenging to deal with when their financial systems are dollarized, especially if domestic banks lend to non-tradable sectors in foreign currency.6 Thus, this phenomenon that we will refer to as Domestic Liability Dollarization (DLD) is particularly treacherous because Sudden Stops and subsequent RER swings could trigger major uncertainty about the solvency of the banking system as loans become non-performing, sometimes leading to bank runs, which almost inevitably affect the payments system and cause disruption in transactions and output. Thus, the combination of large potential RER fluctuations and DLD could prove deadly, as balance sheet effects kick in and bring about a major shakeup of the domestic banking system. Building on Calvo et al. (2004), we focus on another (but related) angle of Sudden Stops, namely, the issue of short-term relative price volatility (such as that of the wholesale price index (WPI) to consumer price index (CPI) ratio) and its determinants, with particular emphasis on the impact of balance sheet effects under Sudden Stop episodes. We care about volatility because when firms are debt-ridden (as is likely to be the case after a capital flow episode) and financial markets do not have access to contingent contracts, relative price volatility may bring about financial havoc. The reason we believe that balance sheet effects may have an impact on relative price volatility is that the former, by affecting the probability of a Sudden Stop, may lead to higher volatility in aggregate demand. Related empirical work, such as that of Kaminsky and Reinhart (2001), deals with the behavior of the conditional volatility of high frequency7 nominal exchange rate and asset price returns at the country level, and notes that there are periods of global turmoil, where the materialization of spikes in volatility tend to coincide across countries. Hausmann et al. (2004) focus instead on the long-run volatility of the real effective exchange rate in an effort to explain differences in the conditional variance of changes in the RER between developing and developed countries. They establish that there is indeed a difference in the persistence of the conditional variance process between developed and developing countries, but no major factor affects the conditional variance of changes in the RER other than perhaps the size of terms of trade shocks. Our approach is different in that it focuses on the behavior of the WPI to CPI ratio instead of measures of the bilateral or multilateral RER, and it explores the effects of Sudden Stops and balance sheet effects on the conditional variance of this ratio.8 This relative price has not been as extensively studied as the RER, and, yet, there may be grounds to believe that it may better capture the domestic behavior of the price of tradables vis-à-vis that of non-tradables following Sudden Stop events and devaluation. For example, Burstein et al. (2003) find that during crises, the retail price of tradable goods moves much less than the “at dock” price of imports and exports, which tend to follow nominal exchange rate movements more closely. This is due to the fact that many tradable goods require the use of non-tradable inputs before they reach the retail market, and, thus, their retail price reflects a non-tradable component. Therefore, the WPI, which typically has a sizeable tradable component, may capture more appropriately the behavior of the retail price of tradable goods than the nominal exchange rate. This may be important when analyzing balance sheet factors because if the domestic price of tradable goods does not track the nominal exchange rate one to one in times of crisis, even tradable sectors may experience problems in a context of high liability dollarization. A key question that we ask is how Sudden Stops and balance sheet factors affect the volatility of relative prices. Even though it is clear that Sudden Stops involve major changes in the level of the RER, it is not as clear how the disruption created by Sudden Stops may introduce increased volatility in relative prices. We propose a model where information plays a key role in determining relative price volatility. Sudden Stops typically coincide with an increase in systemic risk, which is mirrored by a bigger correlation of investment projects and a consequent increase in the variance of investment portfolios. This increased variance provides an incentive for investors to acquire additional information about investment projects, an action that leads to a larger response from investors to shocks, which, in turn, introduces more volatility in aggregate demand and in relative prices. This framework provides a rationale for the observed relationship between Sudden Stops and increased relative price volatility that is supported by our empirical findings. In a similar fashion, an increase in potential balance sheet effects due to higher potential changes in the real exchange rate (were a Sudden Stop to materialize) may also provide incentives for investors to acquire additional information, thus introducing further volatility in relative prices. Casual empirical observation reveals that more than half of Sudden Stops in EMs are associated with spikes in volatility of the WPI to CPI ratio (measured as a substantial increase in the conditional variance of an autoregressive conditional heteroskedasticity (ARCH) specification). This suggests that major relative price turbulence is a key characteristic of Sudden Stop phenomena. Additionally, while close to half of the volatility spikes in the WPI/CPI ratio in EMs coincide with Sudden Stops, only 9% of these spikes occur during Sudden Stop phases in developed countries, suggesting that Sudden Stops are not a relevant source of relative price volatility for the latter group, but are a factor to consider for EMs. We test these results formally by estimating a panel ARCH model of the cyclical component of the WPI to CPI ratio and find that Sudden Stops do increase the conditional variance of this ratio. Balance sheet factors, captured by a measure of potential changes in the RER, coupled with a measure of domestic liability dollarization are also robust across specifications in explaining increases in the conditional variance.

Using a theoretical model based on information acquisition under increased uncertainty, we rationalize why Sudden Stops and balance sheet effects may affect the variance of key relative prices such as the WPI to CPI ratio. Increased variance (due, for example, to increased correlation among investment projects during Sudden Stop episodes) spurs investors to acquire additional information, which translates into greater volatility in investment decisions and in relative prices. In a similar fashion, it can be argued that an increase in the probability of experiencing a Sudden Stop due to an increase in potential balance sheet effects implies a larger probability that asset returns will become more volatile, providing incentives to acquire better information and leading to further volatility in relative prices. Casual observation of the properties of a key relative price such as the WPI to CPI ratio, a measure of the bdomesticQ real exchange rate, suggests that Sudden Stops are associated with increases in this ratio’s volatility. In particular, major changes in volatility are associated more than 40% of the time with Sudden Stops in EMs, but rarely so in developed countries Formal empirical analysis of the determinants of the conditional variance of the WPI to CPI ratio under a family of ARCH specifications confirms that Sudden Stops, as well as potential balance sheet effects, are highly relevant in understanding sharp increases in volatility. The effects that these balance sheet factors impinge on the conditional variance of the WPI to CPI ratio are consistent with our previous finding that balance sheet effects affect the probability of experiencing a Sudden Stop, once informational aspects highlighted by our theoretical model are factored in. In the world of EMs, where contingent contracts are more fiction than fact, sharp increases in relative price volatility during a Sudden Stop could have substantial welfare effects. These results contribute to the expansion of a research program on factors affecting the volatility of relative prices, a key element that needs to be more widely understood given its relevance in the design of policies for EMs, where reduction of volatility and policymaking under high volatility rank at the top of the research agenda.