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IMF surveillance and financial markets A political economy analysis

IMF surveillance and financial markets A political economy analysis. Paper by Marcel Fratzscher and Julien Reynaud European Journal of Political Economy, 27, 405–422, 2011 Presented by Paola Belloni and Sofia Mazzadi. MOTIVATION.

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IMF surveillance and financial markets A political economy analysis

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  1. IMF surveillance and financial markets A political economy analysis Paper by Marcel Fratzscher and Julien Reynaud European Journal of Political Economy, 27, 405–422, 2011 Presented by Paola Belloni and Sofia Mazzadi

  2. MOTIVATION Because of the recent financial crisis, a fundamental change in the international financial architecture has become necessary. The objective pursued is to establish global economic and financial stability both in the short-run and over the longer term. Clearly this situation increased the importance of the IMF’s SURVEILLANCE role (both bilateral and multilateral). Two other issues are strictly linked to surveillance: • Information: the paper we are presenting aims to evaluate the financial market reaction to IMF surveillance communication. • Political power: the main objective of this paper is to test whether political economy factors influence IMF surveillance.

  3. BRIEF LITERARY REVIEW The literature that analyses IMF surveillance is scarce. The only one theme that was investigated is the transparency, one of main focus of studies on IMF communication related to surveillance issues. On the contrary, there exists a wide literature studying how political interests influence the lending activities of the IMF. • Some studies focus on the effects of news of IMF financial support on financial markets and the most important results achieved are: • IMF financial support has a significant influence on financial markets. • Sovereign bond spreads of emerging markets are used to determine whether the bond markets react to IMF lending • Others studies deal with the determinants of IMF loans and they let us to conclude that: • Political economy factors have been found to play a significant role in IMF lending decision.

  4. RESEARCH QUESTIONS Questions that are investigated throughout the paper:

  5. DATA, VARIABLES AND ECONOMETRICAL STRATEGY • What are PINs? • The acronyms stands for Public Information Notice • They are the outcomes of the discussion of the IMF with member countries • Annual frequency • It contains an assessment of economic development, short-term macroeconomic projections and policy suggestions • They were established in 1996 The paper presents a panel data analysis for all published PINs, Staff Reports and Board Meetings of 36 emerging market economies for the period 1996 – 2007. The authors chose to classify each PIN, Ai,t– in terms of their favourableness – on a scale from -2 (very negative) to +2 (very favourable).

  6. The classification of most PINs was relatively clear and uncontroversial. In order to deal with possibly ambiguous assessments, both authors read and classified each PIN separately, and very few PINs were found to be ambiguous in their assessments. The classification was made much easier by the fact that PINs follow a particular structure and are relatively consistent in the language used over time and across countries.

  7. FIRST MODEL • The main hypothesis of the paper is that the IMF surveillance is more favourable towards politically powerful members, • but what is the role played by the macroeconomics fundamental? WhereAi;trepresents the PIN assessment andMi;tcaptures the macroeconomic performance of each of the 36 countries. Econometrical specification:

  8. NEW VARIABLES ADDED The paper aims to investigate how the sovereign spreads react to PIN releases. In order to perceive this result, the authors had to introduce some new variables. • Dummy variables to measure the power at IMF: • Quota used > 140% (=1 when the loan surpass 140% of country’s quota) • IMF executive director (=1 when the country holds a seat at the executive board). • Other proxies for political factors: the share of national staff in the IMF, the presence of G7 embassies, the importance of strategic resources such as oil reserves and pipelines, civil nuclear capacities and the presence US–UK–France military troops. • Variables expressing bilateral trade and financial linkages between the country under surveillance and the US and the EU.

  9. SECOND MODEL Hypothesis to be tested: IMF surveillance is systematically more favourable for politically influential countries. WhereAi;trepresents the PIN assessment,Mi;tcaptures the macroeconomic performance andXi;tthe political power of each of the 36 countries. ✓ HP VERIFIED The overall PIN assessment appears to be systematically more favourable for countries that have an Executive Director, use a large share of their quota, hold a permanent ornon-permanent seat at the UN Security Council or are a nuclear power. PIN assessments are also determined by the macroeconomic conditions of a country: higher growth, lower unemployment or inflation, and larger reserve and government balance all indicate a better assessment in the PIN. Econometrical specification:

  10. THIRD MODEL Hypothesis to be tested: there is an effect of political influence on sovereign spreads directly through the assessment in the PINs. Wheresi;tindicates the sovereign spreads, represents the PIN assessment due to political economy factors and the PIN assessment due to macroeconomic fundamental. ✓ HP VERIFIED As expectedγ<0 and significant: a positive influence in the PIN lowers spreads systematically. λis not statistically significant: the effect of the macroeconomic component of the PIN assessmentexerts an effect on sovereign spreads only to the extent that it deviates from market views. Econometrical specification:

  11. The evidence of this table confirms that it is primarily the political economy influence in the PIN assessment that affects financial markets, and not the component accounted for by fundamentals. Part of this political economy influence appears to stem from the assessment of countries’ fiscal policy stance as wellas international policies.

  12. FOURTH MODEL • Where si;t indicates the sovereign spreads, Mi;tcaptures the macroeconomic performance andXi;tthe political power of each of the 36 countries,Ztindicates the fundamental common to all coutries. PINi;tis a dummy variable =1 if a PIN has been released for a specific country ion a particular day t. The aim of the authors is to provide an alternative test of the presence of a political influence in IMF surveillance by analyzing the unconditional response of sovereign spreads to PIN releases. So, they identify the political economy influence that may be contained in IMF surveillance by analyzing the contemporaneous effect of PIN releases on sovereign spreads of countries. Econometrical specification: Hypothesis of interest:

  13. POTENTIAL PROBLEMS of this MODEL Potential problems of this model • Omitted variable bias • Potential time variation in spreads • Heteroskedasticity and skewness in the daily data Potential solutions • Including a set of explanatory variables and country fixed effect • Controlling the time variation with the inclusion of common fundamentals Zt • Using a robust estimator

  14. RESULTS OF THE FOURTH MODEL There is evidence for the presence of a significant political economy influence in IMF surveillance. We estimate three model: the first and the second are for all available days in the sample period 2001-2007 and include country fixed effect the third stems from a pooled estimation including only those countries on those day when they had a PIN release.

  15. HOW TO SOLVE MULTICOLLINEARITY • Some of the proxies become statistically insignificant. • The macroeconomic fundamentals included are mostly not statistically significant One trouble due to the inclusion of so many different proxies for the countries’ power at the IMF, geopolitical influence and economic relevance is one of multicollinearity. In order to provide a more encompassing model specification, the authors estimated a model for the statistically significant political economy.

  16. CONCLUSIONS This paper leads the reader to conclude that: • IMF surveillance matters: it has a sizeable political economy influence • As tested in the previous models, it’s crucial that financial markets reaction is more favorable to PIN releases of politically powerful member countries. • The linkage between the financial market and the surveillance is driven by the sovereign spread reaction to PIN release.

  17. OTHER ISSUES AND COMMENTS • It could be important and innovative to find a new proxy of the IMF surveillance role: there is to much of subjectivity in the use of the PIN release. • This study can be extended to other emerging country: such a small sample doesn’t allow the authors to provide a generalized inference. • This article is very interesting because of the new way of investigating the IMF role: the previous literature was focused only on the political interaction of its loans, without analysing the impact the surveillance on financial markets.

  18. THANK YOU FOR YOUR ATTENTION!!!!!

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