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Original Sin The Pain, the Mystery And the Road to Redemption

Original Sin The Pain, the Mystery And the Road to Redemption. Barry Eichengreen, Ricardo Hausmann & Ugo Panizza UC Berkeley, Harvard, and IDB. PART II THE MYSTERY. Indexes of Original Sin (the higher the value, the greater the sin). Securities. issued. by. country. i. in. currency.

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Original Sin The Pain, the Mystery And the Road to Redemption

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  1. Original Sin The Pain, the Mystery And the Road to Redemption Barry Eichengreen, Ricardo Hausmann & Ugo Panizza UC Berkeley, Harvard, and IDB

  2. PART IITHE MYSTERY

  3. Indexes of Original Sin (the higher the value, the greater the sin) Securities issued by country i in currency i = - OSIN 1 1 i Securities issued by country i Securities + Loans by country i in major currencies = INDEXA i Securities + Loans by country i (1 0) Securities in currency i = OSIN 3 Max , - i Securities issued by country i OSIN 2 Max ( INDEXA , OSIN 3 ) = i i i

  4. Reacting to yesterday • Several people argued that developing the local market for long-term fixed-rate debt is the key to solving international original sin • Let us look at measures of this domestic ability to borrow at home in own currency (JP Morgan’s “Guide to Local Currency markets”) + FC DST = DSIN + + FC DDST DLT

  5. Domestic original sin Argentina Malaysia Venezuela Indonesia Turkey Brazil Greece Mexico Hong Kong Czech Republic Chile Philippines Poland Hungary Israel Singapore Thailand Slovak Republic South Africa India Taiwan 0 0.2 0.4 0.6 0.8 1 1.2

  6. India Israel Brazil Venezuel Turkey Mexico Malaysia 1 Philippnesi Indonesi Hungary Chile Argentin Egypt, A Slovak R Singapore Greece Taiwan OSIN Hong Kong South Africa Poland Czech Re 0 .010961 1 DSIN

  7. Recent Theories • Underdevelopment of institutions and policies in general • Inadequate monetary credibility • Fiscal profligacy • Weak contract enforcement • Presence or absence of trade sanctions • Political economy stories

  8. Original Sin and the level of development (1) (2) (3) (4) Dropping Financial Centers OSIN3 OSIN3 LGDP_PC -0.012 -0.036 -0.007 -0.021 (0.74) (1.23) (0.42) (1.10) SIZE -0.072 -0.190 -0.083 -0.139 (2.37)** (3.83)*** (2.50)** (3.25)*** FIN_CENTER -0.767 (7.37)*** EUROLAND -0.239 -0.236 (1.94)* (1.93)* OTH_DEVELOPED -0.066 -0.069 (0.67) (0.71) Constant 1.061 1.25 1.022 1.130 (9.17)*** (5.41)*** (8.73)*** (7.40)*** Observations 75 75 69 69

  9. SGP .359822 BEL MEX IND GRC PAK SWE GBR AUT IDN LKA TUR KOR NOR THA HUN JOR FIN BHR COL ISR MAR DNK TUN MLT USA ZWE ISL UKR NET SLV DOM SVN CHL DEU MDA CRI PER ARG KAZ CAN MUS CYP ESP SVK EST LVA POL LUX BOL CHE e( SIN33_A | X) AUS FRA ZAF ITA CZE -.898761 -1.72332 1.2301 e( LGDP_PC | X )

  10. coef = .02726463, (robust) se = .08081867, t = .34 IDN TUR VEN MYS ARG .426209 BRA GRC MEX EGY HKG CZE e( dsin2 | X) CHL PHL POL HUN ISR SGP THA SVK ZAF IND -.53772 -2.32983 1.77617 e( GDP_PC | X )

  11. Original Sin and Monetary Credibility • Foreign investors do not want to lend in a unit that the borrower can manipulate • This should not apply as much to private borrowers • Why no inflation indexed debt? • There is a peso problem and borrowers do not want to use their own currency

  12. Original sin and monetary credibility (1) (2) (3) (4) Dropping OLS same Instrumental Fin centers sample as 4 Variables OSIN3 OSIN3 OSIN3 OSIN3 AV_INF 0.098 0.100 0.119 -0.132 (2.09)** (2.10)** (1.41) (1.57) SIZE -0.104 -0.113 -0.183 -0.183 (2.83)*** (2.88)*** (3.36)*** (3.34)*** FIN_CENTER -0.716 -0.598 -0.595 (7.42)*** (5.12)*** (5.34)*** EUROLAND -0.146 -0.136 -0.225 -0.222 (1.41) (1.31) (1.57) (1.59) OTH_DEVELOPED -0.070 -0.062 -0.105 -0.102 (0.91) (1.31) (0.76) (0.81) Constant 1.055 1.060 0.953 0.954 (19.12)*** (22.26)*** (33.00)*** (32.47)*** Observations 33 33 74 68 R-squared 0.76 0.76 0.66 0.37

  13. SGP .386774 BEL MEX GRC SWE GBR AUT IND PAK TUR ISR LKA UKR IDN NOR KOR JOR HUN FIN THA MLT BHR MAR DNK PER COL ARG ISL TUN USA NET KAZ ZWE DEU SVN DOM CHL SLV CRI MDA CYP MUS CAN BOL ESP EST LVA SVK POL LUX CHE AUS e( SIN33_A | X) FRA ZAF ITA CZE -.920488 -1.58672 3.08266 e( INF | X )

  14. .470317 MYS IDN VEN TUR ARG BRA GRC MEX EGY HKG CZE CHL e( dsin2 | X) PHL POL HUN ISR SGP THA SVK ZAF IND -.53772 -.242879 1.08381 e( AV_INF | X )

  15. MYS IDN VEN TUR .466594 GRC MEX EGY HKG CZE CHL e( dsin2 | X) PHL POL HUN ISR SGP THA SVK ZAF IND -.497336 -.150053 .313087 e( AV_INF | X )

  16. Original sin in Euroland 120% 100% 80% 60% 40% 20% 0% ? ? ?

  17. Original sin in Euroland 120% 100% 80% 60% 40% 20% 0% ? Luxembourg Germany

  18. Original sin in Euroland 120% 100% 80% 60% 40% 20% 0% Luxembourg Netherlands Portugal Germany Belgium Austria Finland Ireland Greece France Spain Italy

  19. Original sin and contract enforcement • Investors are reluctant to lend to government if institutions designed to enforce their claims are weak • Weak institutions prevent the creation of sophisticated contracts that could limit moral hazard at the borrower level (Chamon, 2002, Aghion et al., 2002)

  20. Original sin and contract enforcement (1) (2 OSIN3 OSIN3 Dropping Financial Centers RULEOFLAW 0.038 0.038 (0.98) (0.97) SIZE -0.098 -0.107 (2.77)*** (2.83)*** FIN_CENTER -0.803 (8.81)*** EUROLAND -0.219 -0.210 (2.07)** (2.00)* OTH_DEVELOPED -0.152 -0.145 (1.73)* (1.67) Constant 0.975 0.976 (47.90)*** (46.69)*** Observations 75 69 R-squared 0.66 0.37

  21. SGP .391291 BEL IND MEX GBR AUT SWE GRC PAK TUR KOR LKA BHR FIN JOR NOR HUN ISR MAR IDN THA DNK TUN USA COL NET CHL ISL ARG MLT ZWE UKR DOM SVN CRI PER MDA MUS DEU CAN SLV CYP KAZ POL ESP EST LVA SVK LUX BOL CHE AUS e( SIN33_A | X) FRA ZAF ITA CZE -.924132 -.924632 .846272 e( RULEOFLAW | X )

  22. IDN VEN TUR ARG MYS .443264 GRC MEX EGY HKG CZE CHL e( dsin2 | X) PHL POL HUN ISR SGP THA SVK ZAF IND -.520665 -1.27337 1.58399 e( KAUFF | X )

  23. Original sin and fiscal solvency • Governments with weak fiscal account will have incentives to debase their currencies • Lucas and Stokey (1983) • Calvo and Guidotti (1990) • Corsetti and Mackowiak (2002)

  24. Original sin and fiscal solvency (1) (2) (3) (4) OSIN3 OSIN3 OSIN3 OSIN3 DE_GDP -0.145 (1.85)* DE_RE -0.035 (1.18) DEFICIT -0.313 (0.49) FISC -0.073 (1.62) SIZE -0.117 -0.099 -0.126 -0.123 (3.32)*** (2.75)*** (3.20)*** (3.22)*** Fin_Cent -0.745 -0.759 -0.737 -0.742 (7.19)*** (8.70)*** (6.73)*** (6.75)*** Euroland -0.152 -0.180 -0.160 -0.154 (1.71)* (1.81)* (1.62) (1.63) Oth_Dev -0.120 -0.109 -0.121 -0.123 (1.80)* (1.39) (1.61) (1.74)* Constant 1.066 0.996 1.056 0.996 (23.28)*** (26.20)*** (18.41)*** (41.56)*** N.Obs 64 74 57 57 R-squared 0.67 0.66 0.65 0.66

  25. SGP BEL .264978 MEX IDN SWE GBR GRC THA NOR PAK AUT KOR IND COL FIN TUR LKA HUN MLT SLV TUN UKR JOR DOM ISR SVN MAR DNK USA ZWE ISL SVK CHL KAZ NET DEU CRI EST LVA PER ESP ARG CYP MDA MUS CAN POL CHE BOL LUX AUS e( SIN33_A | X) ZAF FRA ITA CZE -.847888 -1.29744 1.39966 e( FISC | X )

  26. TUR IDN .551769 GRC MEX CZE CHL e( dsin2 | X) PHL POL HUN ISR SGP THA SVK ZAF IND -.41216 -.486835 .755834 e( DE_GDP | X )

  27. Original Sin and Trade • Countries that trade heavily have more incentives to meet their contractual obligations (Eaton and Gersovitz, 1981) • Should not affect denomination • Trade creates deeper currency markets

  28. Original Sin and Trade (1) (2) OSIN3 OSIN3 Dropping Financial Centers OPEN -0.033 -0.028 (0.98) (0.85) SIZE -0.087 -0.095 (2.25)** (2.34)** FIN_CENTER -0.780 (8.77)*** EUROLAND -0.254 -0.244 (2.24)** (2.16)** OTH_DEVELOPED -0.090 -0.083 (1.13) (1.05) Constant 0.996 0.992 (35.46)*** (35.40)*** Observations 75 69 R-squared 0.69 0.34

  29. GRC .241124 MEX BEL PAK IND GBR SWE TUR AUT KOR COL IDN LKA FIN SGP ISR NOR HUN MAR USA THA BHR DNK ISL JOR TUN ARG SLV CHL PER ZWE SVN CRI MDA DEU CYP DOM NET KAZ ESP UKR MUS EST LVA CAN POL SVK BOL CHE AUS LUX e( SIN33_A | X) ZAF FRA ITA CZE -.943281 -.431822 1.81548 e( OPEN | X )

  30. Original sin and political economy • The presence of a domestic constituency of local currency debt-holders may limit the government’s incentives to debase its currency • So original sin arises from the fact that, without a domestic constituency, the government cannot commit to protect foreign bond-holders (Tirole, 2002)

  31. Original sin and political economy (1) (2) (3) (4) OSIN3 OSIN3 OSIN3 OSIN3 Dropping Financial Centers DC_GDP -0.084 (0.96) FOR_DOM -0.883 (1.17) SIZE_FIN -0.069 -0.298 (0.33) (1.05) SIZE -0.093 -0.105 -0.095 -0.098 (2.70)*** (2.75)*** (2.69)*** (2.71)*** FIN_CENTER -0.700 -0.725 -0.747 (6.23)*** (8.09)*** (7.68)*** EUROLAND -0.135 -0.170 -0.167 -0.123 (1.12) (1.68)* (1.53) (1.06) OTH_DEVELOPED -0.082 -0.091 -0.096 -0.078 (1.09) (1.20) (1.28) (1.07) Constant 1.019 0.990 0.979 0.971 (43.91)*** (25.01)*** (45.71)*** (38.11)*** R-squared 0.66 0.66 0.66 0.37

  32. BEL SGP .287533 MEX GRC PAK IND SWE AUT IDN TUR GBR KOR LKA NOR COL HUN ISR THA FIN JOR MAR DNK TUN MLT ISL SLV USA ZWE NET CHL ARG UKR SVN PER DOM CRI MDA CYP DEU KAZ ESP CAN MUS SVK EST LVA POL BOL CHE AUS e( SIN33_A | X) FRA ZAF ITA CZE -.903856 -.364298 .212954 e( SIZE_FIN | X )

  33. Putting everything together OSIN3 OSIN3_NOI OSIN3 OSIN3 Dropping Financial centers LGDP_PC -0.022 0.011 -0.056 -0.009 -0.045 (0.47) (0.23) (1.04) (0.17) (0.93) FISC -0.071 -0.097 -0.095 -0.062 -0.069 (1.33) (1.89)* (1.52) (1.04) (1.21) SIZE -0.146 -0.157 -0.241 -0.147 -0.148 (3.10)*** (3.21)*** (3.86)*** (2.93)*** (2.90)*** SIZE_FIN 0.062 0.020 0.270 -0.106 -0.158 (0.25) (0.09) (0.53) (0.23) (0.41) RULEOFLAW 0.086 0.004 0.035 0.075 0.052 (0.98) (0.06) (0.38) (0.85) (0.60) INF 0.040 0.013 0.054 0.037 0.043 (1.59) (0.70) (1.58) (1.45) (1.52) OPEN -0.136 -0.111 -0.155 -0.095 -0.031 (1.39) (1.22) (1.10) (0.78) (0.26) FIN_CENTER -0.746 -0.687 (7.11)*** (7.11)*** EUROLAND -0.168 -0.152 -0.148 (1.69)* (1.60) (1.35) OTH_DEVELOPED -0.163 -0.173 -0.159 (1.68)* (1.81)* (1.65) Constant 1.240 1.018 1.550 1.104 1.337 (3.33)*** (2.73)*** (3.40)*** (3.50)*** (2.85)*** R-squared 0.68 0.73 0.48 0.45 0.43

  34. GRC .327155 BEL ISL AUT PAK GBR SWE LKA MEX MLT ISR COL SLV CYP FIN JOR TUR NOR HUN IDN MDA DNK SGP KOR PER MAR ZWE TUN SVN THA USA IND CRI DEU ARG KAZ BHR BOL CHE EST LVA CHL MUS DOM UKR NET SVK ESP LUX CAN POL AUS e( SIN33_A | X) ZAF FRA ITA CZE -.950572 -1.24736 2.16883 e( SIZE | X )

  35. coef = -.13523022, (robust) se = .04692612, t = -2.88 GRC .337008 BEL ISL AUT PAK GBR SWE LKA ISR MEX COL FIN TUR SLV JOR NOR HUN CYP MLT DNK MDA PER IDN MAR IND USA ZWE KOR TUN ARG SGP CRI BHR SVN DEU BOL KAZ THA CHL LVA MUS CHE EST UKR NET DOM e( SIN33_A | X) ESP SVK LUX CAN POL AUS ZAF FRA ITA -.547786 -1.24938 2.18988 e( SIZE | X )

  36. Bottom Line • Original sin is not merely a problem of country policies (one need not deny the relevance of these, of course). • It is also a problem with the operation of the international system (given transactions costs, a world of heterogeneous countries, and network effects that lock in the status quo). • Redemption therefore requires international action to overcome the inertia in the system.

  37. Original Sin The Pain, the Mystery And the Road to Redemption Barry Eichengreen, Ricardo Hausmann & Ugo Panizza UC Berkeley, Harvard, and IDB

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