Prospect Group Policy Research Working Papers -- Recent Issues
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Rate Cycles (August 2024)
This paper analyzes cycles in policy interest rates in 24 advanced economies over 1970–2024, combining a new application of business cycle methodology with rich time-series decompositions of the shocks driving rate movements. “Rate cycles” have gradually evolved over time, with less frequent cyclical turning points, more moderate tightening phases, and a larger role for global shocks. Against this backdrop, the 2020–24 rate cycle has been unprecedented in many dimensions: it features the fastest pivot from active easing to a tightening phase, followed by the most globally synchronized tightening, and an unusually long period of holding rates constant. It also exhibits the largest role for global shocks—with global demand shocks still dominant, but an increased role for global supply shocks in explaining interest rate movements. Inflation and the growth in output and employment have, on average, largely returned to historical norms for this stage in a tightening phase. Any recalibration of interest rates going forward should be gradual, however, and account for the interactions between increasingly important global factors and domestic circumstances, combined with uncertainty as to whether rate cycles have reverted to pre-2008 patterns.
What Explains Global Inflation (December 2023)
This paper examines the drivers of fluctuations in global inflation, defined as a common factor across monthly headline consumer price index (CPI) inflation in G7 countries, over the past half-century. It estimates a Factor-Augmented Vector Autoregression model where a wide range of shocks, including global demand, supply, oil price, and interest rate shocks, are identified through narrative sign restrictions motivated by the predictions of a simple dynamic general equilibrium model. The authors report three main results. First, oil price shocks followed by global demand shocks explained the lion’s share of variation in global inflation. Second, the contribution of global demand and oil price shocks increased over time, from 56 percent during 1970–1985 to 65 percent during 2001–2022, whereas the importance of global supply shocks declined. Since the pandemic, global demand and oil price shocks have accounted for most of the variation in global inflation. Finally, oil price shocks played a much smaller role in global core CPI inflation variation, for which global supply shocks were the main source of variation. These results are robust to various sensitivity exercises, including alternative definitions of global variables, different samples of countries, and additional narrative restrictions.
Energy Price Shocks and Current Account Balances: Evidence from Emerging Market and Developing Economies (December 2023)
This paper investigates the effects of real energy price shocks on the current account balances of 45 emerging market and developing economies using country-specific structural vector autoregression models. The empirical results suggest that a 1 percent increase in real oil prices results in up to 0.11 percentage point cumulative improvement in the current account balances of oil exporters after five years, while a similar shock to real natural gas prices results in up to 0.06 percentage point improvement in the current account balances of natural gas exporters after five years. Real coal price shocks result in higher current account balances of oil exporters and natural gas exporters, suggesting substitution of coal with oil and natural gas in such cases. When the contributions of alternative real energy prices to the variance of current account balances are compared, oil price shocks dominate those of natural gas and coal prices. On the source of oil price shocks, the results support the view that the effects of oil demand shocks on current account balances are different from those of oil supply shocks. The results are robust to alternative specifications and identification schemes.
Forecasting Industrial Commodity Prices: Literature Review and a Model Suite (November 2023)
Almost two-thirds of emerging market and developing economies rely heavily on resource sectors for economic activity, fiscal and export revenues. In these economies, economic planning requires sound baseline projections for the global prices of the commodities they rely on and a sense of the risks around such baseline projections. This paper presents a model suite to prepare well-founded forecasts for the global prices for oil and six industrial metals (aluminum, copper, lead, nickel, tin, and zinc). The model suite adapts six approaches used in the literature and tests their forecast performance. Broadly speaking, futures prices or bivariate correlations performed well at short horizons, and consensus forecasts and a large-scale macroeconometric model performed well at long horizons. The strength of Bayesian vector autoregression models lies in generating forecast scenarios. The sizable forecast error bands generated by the model suite highlight the need for policy makers to engage in careful contingency planning for higher or lower prices.
Capital Controls in Emerging and Developing Economies and the Transmission of U.S. Monetary Policy (October 2023)
Emerging markets and developing economies (EMDEs) exhibit significantly greater volatility in asset returns than advanced economies. The commonalities in these returns (and flows) across countries are particularly strong for EMDEs. If these occur independently of the exchange rate regime and if these global financial cycle effects are furthermore independent of countries’ financial openness, the result is Obstfeld (2022)’s “Lemma”: countries can do nothing to decouple from the global financial cycle. Under the prevalent view that U.S. monetary policy is the key driver of the global financial cycle, countries then inherit U.S. monetary policy no matter what they do on exchange rates or capital control policies. Using structural vector autoregression models for 78 countries over 1995–2019, as well as different methods of identifying U.S. monetary policy shocks from the literature, this paper tests the proposition that countries with less open capital accounts exhibit systematically smaller responses to U.S. monetary policy shocks than low capital control countries. This paper also considers the role of other institutional features such as exchange rate regimes and foreign exchange interventions in explaining cross-country differences in the responses to the shocks. The empirical results suggest that more stringent capital controls exhibit smaller responses of interest rates and exchange rates to U.S. monetary policy shocks and that this result holds more firmly for EMDEs than advanced economies. In contrast, the analysis finds only weak evidence that the degree of exchange rate flexibility affects U.S. spillovers to foreign interest rates and exchange rates.
Is US Trade Policy Reshaping Global Supply Chains? (October 2023)
This paper examines the reshaping of supply chains using detailed US 10-digit import data (tariff-line level) between 2017 and 2022. The results show that while US-China decoupling in bilateral trade is real, supply chains remain intertwined with China. Over the period, China’s share of US imports fell from 22 to 16 percent. The paper shows that the decline is due to US tariffs. US imports from China are being replaced with imports from large developing countries with revealed comparative advantage in a product. Countries replacing China tend to be deeply integrated into China’s supply chains and are experiencing faster import growth from China, especially in strategic industries. Put differently, to displace China on the export side, countries must embrace China’s supply chains. Within products, the reorientation of trade is consistent with a “China + 1” strategy, as opposed to diversified sourcing across multiple countries. There is some evidence of nearshoring, but it is exclusive to border nations, and there is no consistent evidence of reshoring. Despite the significant reshaping, China remained the top supplier of imported goods to the US in 2022.
Measuring Total Carbon Pricing (June 2023)
While countries increasingly commit to pricing greenhouse gases directly through carbon taxes or emissions trading systems, indirect forms of carbon pricing—such as fuel excise taxes and fuel subsidy reforms—remain important factors affecting the mitigation incentives in an economy. Taken together, how can policy makers think about the overall pricesignal for carbon emissions and the incentive it creates? This paper develops a methodology for calculating a total carbon price applied to carbon emissions in a sector, fuel, or the whole economy. It recognizes that rarely is a single carbon price applied across an economy; many direct carbon pricing instruments target specific sectors or even fuels, much like indirect taxes on fossil fuels; and carbon and fuel taxes can be substituted one for another. Tracking progress on carbon pricing thus requires following both kinds of price interventions, their coverage, and specific exemptions. This inclusive total carbon pricing measure can facilitate progress in discussions on minimum carbon price commitments and inform assessments of the pricing of carbon embodied in traded goods. Calculations across 142 countries from 1991 to 2021 indicate that although direct carbon pricing now covers roughly a quarter of global emissions, the global total carbon price is not that much higher than it was in 1994 when the United Nations Framework Convention on Climate Change entered into force. Indirect carbon pricing still comprises the lion’s share of the global total carbon price, and it has stagnated. Taking these policy measures into account reveals that many developing countries—particularly net fuel importers—contribute substantially to global carbon pricing. Tackling fuel subsidy reform and pricing coal and natural gas emissions more fully would have a profound effect on aligning carbon prices across countries and sectors and with their climate costs.
Trade Elasticities in Aggregate Models : Estimates for 191 Countries (June 2023)
Armington’s insight that imports and domestically produced goods were imperfect substitutes has unleashed extensive estimates of the associated trade elasticity, primarily for developed countries. This notion of product differentiation, which extends symmetrically to exports and domestic goods, has underpinned trade-focused, computable general equilibrium models of developing countries, including the aggregate, compact version, the 1–2–3 model. Noting that estimates of trade elasticities for developing countries are few, this paper remedies the situation. Using the vector error correction model as the primary method and controlling for global trends and other factors, the analysis derives the long-run elasticity estimates for 191 countries, ranging from China (population of 1.4 billion) to Tuvalu (11,200), including 45 of 48 Sub-Saharan African countries and understudied countries such as Benin, the Republic of Congo, Niger, Fiji, Haiti, Kiribati, and Tajikistan. Import and export elasticities of high-income countries average about 1.4, reflecting the greater diversity of their economies; developing countries’ elasticities average around 0.7 for imports and 0.6 for exports. Elasticities generally rise with per capita income. That the elasticity is greater than one for developed and less for developing countries implies asymmetric responses to shocks, which conforms to intuition and corroborates the analytical results from the 1–2–3 model.
Are Carbon Taxes Good for South Asia? (May 2023)
This paper estimates the effects of gradually introducing a US$25/ton CO2 -equivalent carbon tax in South Asian economies using the Climate Policy Assessment Tool (CPAT). The results for South Asia suggest that monetized welfare co-benefits net of efficiency costs from such a tax—regardless of what other economies or regions do— are resoundingly positive, at 1.4 percent of GDP in 2030. Revenues from the carbon tax are estimated at 1.3 percent of GDP in 2030, which is substantial for a region with a low tax-to-GDP ratio. Once these revenues are recycled, the Keynesian multiplier effect through increased public investment and transfers to households is associated with slightly positive net economic growth rate effects. Household incidence analysis shows that the carbon tax can be designed as an equity-enhancing policy, given net reductions in the Gini coefficient for consumption from revenue recycling. The carbon tax is also associated with a 2 percent weighted average input cost increase across economic sectors in 2030. Finally, the paper discusses selected results on and the political economy of a comprehensive energy price reform package (fossil fuel subsidy phaseout and carbon tax), with broad guidance on its implementation. Overall, the paper provides supportive evidence for the green transition, showing that there need not be a trade-off between inclusive growth and going green in South Asia.
International Tax Spillovers and Tangible Investment, with Implications for the Global Minimum Tax (May 2023)
This paper articulates and, using newly-assembled data, explores how international taxation affects aggregate tangible cross-border investment. Spillovers from statutory tax rates abroad seem: As sizable as effects from the host’s rate; larger than previous consensus values (attributed to a systematic bias from FDI data); and consistent with ‘implicit’ profit shifting through real investment (rather than ‘paper’ profit shifting). Contrary to much policy discussion, the results also imply that: Host countries’ marginal effective tax rates have at best a weak effect on real investment; those elsewhere have none; and, applied to the prospective global minimum tax, inward tangible investment in most sample countries will increase.
Fiscal Procyclicality in Commodity Exporting Countries: How Much Does It Pour and Why? (May 2023)
A large literature has documented that fiscal policy is procyclical in emerging markets and developing economies and acyclical/countercyclical in advanced economies. This paper analyzes fiscal procyclicality in commodity-exporting countries. It first shows that the degree of fiscal procyclicality is twice as high in commodity exporters than in non-commodity exporters. Further, while fiscal procyclicality has been falling in commodity exporters over the past 15 years, it is still pervasive and has fallen slower than in non-commodity exporting countries. In addition to testing the main theories behind fiscal procyclicality in commodity exporters and the role of institutional variables, the paper makes two novel contributions. First, based on the idea of fiscal procyclicality as a “when it rains, it pours” phenomenon (that is, contractionary fiscal policy amplifies the effects of a fall in commodity prices), the paper shows that, on average, government spending amplifies the business cycle by 21 percent of the initial drop in output following a fall in commodity prices. Put differently, the “pours” component accounts for 17 percent of the total fall in output. Second, the paper estimates the welfare costs of fiscal procyclicality at 2.6 percent of the costs associated with the regular business cycle in commodity exporters.
The Elusive Link Between FDI and Economic Growth (April 2023)
This paper revisits the link between FDI and economic growth in emerging and developing economies. Analysis of the early decades of the sample shows that there is no statistically significant correlation between FDI and growth for countries with average levels of education or financial depth. In line with previous contributions, this correlation is positive and statistically significant for countries with sufficiently well-developed financial sectors or high levels of human capital. However, the findings also show that the link between FDI and growth varies over time. For more recent periods, there is a positive and statistically significant relationship between FDI and growth for the average country, with local conditions having a negative effect on this link. The paper also develops a novel instrument aimed at addressing the endogeneity of FDI inflows. Instrumental variable estimates suggest that the results are unlikely to be driven by endogeneity, and the results on the role of absorptive capacities may be due to the GVC revolution in the 1990s.
Commodity Price Cycles: Commonalities, Heterogeneities, and Drivers (April 2023)
This paper studies commodity price cycles and their underlying drivers using a dynamic factor model. The study employs a sample of 39 monthly commodity prices over 1970:01 to 2019:12. The analysis identifies global and group–specific cycles in commodity markets and includes them in a structural vector autoregressive model together with measures of global economic activity and global inflation, to disentangle their response to global demand, global supply, and commodity market-specific shocks. The findings reveal the following main results. (i) There exists a global cycle in commodity markets that accounts for an increasing fraction of co-movement in commodity prices over the past two decades, particularly for energy, metals, and precious metals. (ii) The results are heterogeneous across groups of commodities, with group-specific commodity cycles existing for grains and precious metals over the full sample period, 1970–2019. Metal and energy prices exhibit within-group synchronization over 1970–99; however, in recent years, their movements have become increasingly aligned with the global business cycle. (iii) Since 2000, the global commodity cycle is largely driven by global supply shocks, such as rapid productivity growth in emerging markets and developing economies, which increase demand for commodities. (iv) The large price spikes observed during the two most prominent commodity market boom-bust episodes of the past half-century (1972–74 and 2006–08) are driven additionally by shocks that are orthogonal to global economic activity such as shifts in speculative demand for commodities.
Global Footprints of U.S. Energy Innovations: Energy Efficiency and the Shale Revolution (April 2023)
This paper studies the effects of U.S. energy shocks on international economic activity and the world oil market. The analysis uses a set of factor-augmented vector autoregressions to identify and compare the impact of unanticipated changes in U.S. energy efficiency and U.S. oil supply over 1980Q1–2019Q4. The identification strategy relies on the fact that positive shocks in both cases decrease the real price of oil and increase global gross domestic product (GDP), while generating opposite implications for world oil production and consumption. On average, U.S. energy efficiency shocks have a larger impact on the real price of oil and global GDP than U.S. oil supply shocks. Historical decompositions suggest that in 2010–19, U.S. oil supply shocks increased GDP by 2 percent, while (negative) energy efficiency shocks decreased global GDP by 1.3 percent. The latter effect dominated during the second shale boom in 2017–19. Considerable heterogeneity exists in cross-country responses, with favorable implications for GDP in advanced and emerging market oil importers and adverse implications for oil exporters. The empirical findings are interpreted through the lens of a dynamic general equilibrium multi-country model that features a global oil market and where key parameters are estimated using indirect inference.
Fiscal Policy Volatility and Growth in Emerging Markets and Developing Economies (April 2023)
This paper studies the volatility of fiscal policy in a large sample of countries with a focus on emerging markets and developing economies and commodity exporters over 1990–2021. The findings show that fiscal policy has been more volatile in emerging markets and developing economies than in advanced economies, and in commodity exporters relative to non-commodity exporters over this period. The degree of commodity dependence, and institutional and policy variables can explain a large percentage of the cross-country variation in volatility. The existence of fiscal rules, a more liberalized capital account, and more flexible exchange rates are all associated with lower fiscal policy volatility. The paper also shows the negative macroeconomic consequences of this additional volatility on economic growth, finding that, over a 30-year period, it can explain 8 percent of the income gap between the emerging markets and developing economies and advanced economies in the sample.
The Global Investment Slowdown: Challenges and Policies (March 2023)
Investment growth in emerging market and developing economies (EMDEs) is expected to remain below its average rate of the past two decades through the medium term. This subdued outlook follows a decade-long, geographically widespread investment growth slowdown before the COVID-19 pandemic. An empirical analysis covering 2000-21 finds that periods of strong investment growth were associated with strong real output growth, robust real credit growth, terms of trade improvements, growth in capital inflows, and investment climate reform spurts. Each of these factors has been decreasingly supportive of investment growth since the 2007-09 global financial crisis. Weak investment growth is a concern because it dampens potential growth, is associated with weak trade, and makes achieving the development and climate-related goals more difficult. Policies to boost investment growth need to be tailored to country circumstances, but include comprehensive fiscal and structural reforms, including repurposing of expenditure on inefficient subsidies. Given EMDEs’ limited fiscal space, the international community will need to significantly increase international cooperation, official financing and grants, and leverage private sector financing for adequate investment to materialize.
Investment in Emerging Market and Developing Economy Regions: Trends, Prospects, and Policy Options (March 2023)
Investment growth slowed in the past decade in all emerging market and developing economy (EMDE) regions, but most sharply in East Asia and the Pacific (EAP) and the Middle East and North Africa (MNA). Yet, pressing investment needs remain. All regions need to boost infrastructure investment and investment in mitigating and adapting to climate change and reversing pandemic-related learning losses. In other areas, investment needs vary by region. They include accommodating high and rising urbanization (EAP, Latin America and the Caribbean [LAC], South Asia [SAR]); boosting productivity, especially in sectors that employ large proportions of the population (for example, agriculture in Sub-Saharan Africa [SSA]); rebuilding after conflict (Europe and Central Asia [ECA], MNA, SSA); improving trade linkages (LAC); and preparing for future public health crises. Across all EMDE regions, policy priorities include strengthening the efficiency of public investment, boosting private investment (especially in ECA, LAC, and MNA), and expanding the availability of finance for investment (especially in SSA, LAC).
The Past and Future of Regional Potential Growth: Hopes, Fears, and Realities (March 2023)
Potential growth slowed in most emerging market and developing economy (EMDE) regions in the past decade. The steepest slowdown occurred in the Middle East and North Africa (MNA), followed by East Asia and the Pacific (EAP), although potential growth in EAP remained one of the two highest among EMDE regions, the other being South Asia (SAR), where potential growth remained broadly unchanged. Projections of the fundamental drivers of growth suggest that, without reforms, potential growth in EMDEs will continue to weaken over the remainder of this decade. The slowdown will be most pronounced in EAP and Europe and Central Asia because of slowing labor force growth and weak investment, and least pronounced in Sub-Saharan Africa where the multiple adverse shocks over the past decade are assumed to dissipate going forward. Potential growth in Latin America and the Caribbean, MNA, and SAR is expected to be broadly steady as slowing population growth is offset by strengthening productivity. The projected declines in potential growth are not inevitable. Many EMDEs could lift potential growth by implementing reforms, with policy priorities varying across regions.
Potential Growth: A Global Database (March 2023)
Potential growth—the rate of expansion an economy can sustain at full capacity and employment—is a critical driver of development progress. It is also a major input in the formulation of fiscal and monetary policies over the business cycle. This paper introduces the most comprehensive database to date, covering the nine most commonly used measures of potential growth for up to 173 countries over 1981–2021. Based on this database, the paper presents three findings. First, all measures of global potential growth show a steady and widespread decline over the past decade, with all the fundamental drivers of growth losing momentum over time. In 2011–21, potential growth was below its 2000–10 average in nearly all advanced economies and roughly 60 percent of emerging market and developing economies. Second, adverse events, such as the global financial crisis and the COVID-19 pandemic, contributed to the decline. At the country-level also, national recessions lowered potential growth even five years after their onset. Third, the persistent impact of recessions on potential growth operated through weaker growth of investment, employment, and productivity.
Potential Growth Prospects: Risks, Rewards, and Policies (March 2023)
Potential output growth around the world slowed over the past two decades. This slowdown is expected to continue in the remainder of the 2020s: global potential growth is projected to average 2.2 percent per year in 2022–30, 0.4 percentage point below its 2011-21 average. Emerging market and developing economies (EMDEs) will face an even steeper slowdown, of about 1.0 percentage point to 4.0 percent per year on average during 2022–30. The slowdown will be widespread, affecting most EMDEs and countries accounting for 70 percent of global GDP. Global potential growth over the remainder of this decade could be even slower than projected in the baseline scenario — by another 0.2–0.9 percentage point a year — if investment growth, improvements in health and education outcomes, or developments in labor markets disappoint, or if adverse events materialize. A menu of policy options is available to help reverse the trend of weakening economic growth, including policies to enhance physical and human capital accumulation; to encourage labor force participation by women and older adults; to improve the efficiency of public spending; and to mitigate and adapt to climate change, including infrastructure investment to facilitate the green transition.
Trade as an Engine of Growth: Sputtering but Fixable (March 2023)
International trade has been an important engine of output and productivity growth historically. But since the global financial crisis, world trade growth has slowed, reflecting cyclical and structural forces. The COVID-19 pandemic and Russia’s invasion of Ukraine have further disrupted commodity markets, global supply chains and the trade that accompanies them. A removal of impediments that raise trade costs could reinvigorate world trade. Trade costs, on average, roughly double the cost of internationally traded goods relative to domestically sold goods. Tariffs amount to only one-twentieth of average trade costs; the bulk are incurred in shipping and logistics, and trade procedures and processes at and behind the border. Despite a decline since 1995, trade costs remain about one-half higher in EMDEs than in advanced economies; about two-fifths of this gap appears to be due to higher shipping and logistics costs and a further two-fifths due to trade policy. A comprehensive reform package to lower trade costs could yield large dividends. It is estimated that among the worst-performing EMDEs, a hypothetical reform package to improve logistics and maritime connectivity to the standards of the best-performing EMDEs would halve trade costs.
Understanding the Global Drivers of Inflation: How Important Are Oil Prices? (January 2023)
This paper examines the global drivers of inflation in 55 countries over 1970–2022. The paper estimates a Factor-Augmented Vector Autoregression model for each country and assess the importance of several global (demand, supply, and oil price) and domestic shocks. It reports three main results. First, global shocks have explained about 26 percent of inflation variation in a typical economy. Oil price shocks accounted for only about 4 percent of inflation variation, but they had a statistically significant impact on inflation in three-quarters of the countries. Second, global shocks have become more important in driving inflation variation over time. The share of inflation variance caused by oil price shocks increased from 4 percent prior to 2000 to roughly 9 percent during 2001–22. They also accounted for some of the steep runup in inflation between mid-2021 and mid-2022. Third, oil price shocks tended to contribute significantly more to inflation variation in advanced economies, countries with stronger global trade and financial linkages, commodity importers, net energy importers, countries without inflation-targeting regimes, and countries with pegged exchange rate regimes. The headline results are robust to a wide range of exercises—including alternative measures of global factors and oil prices—and aggregation of countries.
Last Updated: Sep 09, 2024
