11

Original SinThe Pain, the Mystery

And the Road to Redemption Barry Eichengreen, Ricardo Hausmann & Ugo Panizza

UC Berkeley, Harvard, and IDB

22

MotivationMotivation Most countries cannot borrow abroad in their own Most countries cannot borrow abroad in their own

currencies, a problem we referred to three years ago currencies, a problem we referred to three years ago (Eichengreen and Hausmann, “Exchange Rates and (Eichengreen and Hausmann, “Exchange Rates and Financial Fragility,” Kansas City Fed, ed., Financial Fragility,” Kansas City Fed, ed., New New Challenges for Monetary Policy,Challenges for Monetary Policy, 1999) as “original sin” 1999) as “original sin”

If a country has a net foreign debt, this creates an If a country has a net foreign debt, this creates an aggregate currency mismatchaggregate currency mismatch

This mismatch is associated with output and capital This mismatch is associated with output and capital flow volatilityflow volatility

Monetary policies in such countries are rigid, while Monetary policies in such countries are rigid, while their central banks are unable to act as LLRs.their central banks are unable to act as LLRs.

They are vulnerable to crises, of the self-fulfilling They are vulnerable to crises, of the self-fulfilling variety and otherwise.variety and otherwise.

33

Implications for Reform of the Implications for Reform of the International Financial International Financial

ArchitectureArchitecture The conventional prescription of floating is The conventional prescription of floating is

problematic for countries with original sinproblematic for countries with original sin Inflation targeting is more difficult for such Inflation targeting is more difficult for such

countriescountries Stabilizing capital flows is more difficultStabilizing capital flows is more difficult Strengthening financial systems is more difficultStrengthening financial systems is more difficult Avoiding financial crises is more difficultAvoiding financial crises is more difficult All this raises the question of whether the All this raises the question of whether the

“architecture agenda” can succeed without “architecture agenda” can succeed without addressing original sinaddressing original sin

44

Key Question from this Point of Key Question from this Point of ViewView

Does the inability to borrow internationally in Does the inability to borrow internationally in domestic currency reflect problems with country domestic currency reflect problems with country policies and institutions or systematic problems?policies and institutions or systematic problems?

We argue that the problem is too pervasive (and We argue that the problem is too pervasive (and too weakly correlated with country characteristics) too weakly correlated with country characteristics) to be entirely explicable on the first set of grounds.to be entirely explicable on the first set of grounds.

This leads us to a systemic explanation for the This leads us to a systemic explanation for the problem, which in turn leads us to an international problem, which in turn leads us to an international proposal for its solutionproposal for its solution

(We will only touch on causes here; Ugo Panizza will (We will only touch on causes here; Ugo Panizza will have more to say about them in a later session.)have more to say about them in a later session.)

55

Outline of the PaperOutline of the Paper

Original sin: measurementOriginal sin: measurement IncidenceIncidence ConsequencesConsequences CausesCauses Learning from the outliersLearning from the outliers The Road to redemptionThe Road to redemption

66

MeasurementMeasurement Measuring original sin is not straightforward.Measuring original sin is not straightforward. In principle, we want to measure external In principle, we want to measure external

liabilities in own currency as a share of total liabilities in own currency as a share of total external liabilitiesexternal liabilities

We use data gathered by the BIS on the We use data gathered by the BIS on the currency denomination of bonds and money currency denomination of bonds and money market instrumentsmarket instruments

We also consider BIS data on cross-border bank We also consider BIS data on cross-border bank lending, although the data are less complete lending, although the data are less complete (both in country coverage and currency (both in country coverage and currency breakdown)breakdown)

77

Table 1: International bonded Table 1: International bonded debt by country groups and debt by country groups and

currenciescurrencies 1993-1998 Total Debt

Instruments Issued by residents

Total Debt Instruments Issued by residents in

own currency

Total debt instrument issued in

groups’ currency

Share of own

currency

Share of groups’ currency

Major financial centers

939.1 34% 493.6 64% 1868.4 68.1% 52.6% 199.0%

Euroland 855.9 31% 198.4 26% 647.5 23.6% 23.2% 75.7% Other Developed Countries

390.1 14% 68.6 9% 128.2 4.7% 17.6% 32.9%

Developing Countries

269.0 10% 6.3 1% 16.8 0.6% 2.3% 6.3%

International Organizations

289.7 11% 0.0 0% 0.0 0.0% 0.0% 0.0%

ECU 0.0 0% 0.0 0% 82.8 3.0% 0.0% 0.0% Total 2743.7 100% 766.8 100% 2743.7 100.0% 27.9% 100.0%

1999-2001 Major financial centers

2597.7 45% 1773.6 61% 3913.8 67.8% 68.3% 150.7%

Euroland 1885.6 33% 1071.5 37% 1722.2 29.8% 56.8% 91.3% Other Developed Countries

477.6 8% 45.9 2% 89.9 1.6% 9.6% 18.8%

Developing Countries

434.0 8% 11.6 0% 47.4 0.8% 2.7% 10.9%

International Organizations

378.4 7% 0.0 0% 0.0 0.0% 0.0% 0.0%

ECU 0.0 0% 0.0 0% 0.0 0.0% 0.0% 0.0% Total 5773.3 100% 2902.5 100% 5773.3 100.0% 50.3% 100.0%

88

Major FinancialCenters (64 %)

Euroland(26%)

Other Developed (9%)

Developing (>1%)

Total Debt issued in own currency (93-98)

Major FinancialCenters (34 %)

Total Debt issued by residents (93-98)

Euroland(31%)

Other Developed (14%)

Developing (10%)

99

Major FinancialCenters (61 %)

Major FinancialCenters (45 %)

Euroland(37%)

Euroland(33%)

Other Developed (<2%)

Other Developed (8%) Developing

(8%)

InternationalOrganizations (7%)

Total Debt issued in own currency (99-01)

Total Debt issued by residents (99-01)

1010

Things to NoteThings to Note

In 1993-8, Big 4 countries (financial centers: US, UK, Japan, In 1993-8, Big 4 countries (financial centers: US, UK, Japan, Switzerland) issued only 34% of global debt, but fully 68% Switzerland) issued only 34% of global debt, but fully 68% of global debt was denominated in their currencies. of global debt was denominated in their currencies.

(By comparison, countries soon to become members of (By comparison, countries soon to become members of Euroland issued 31% of global debt but 24% was Euroland issued 31% of global debt but 24% was denominated in their currencies. For them, original sin was denominated in their currencies. For them, original sin was a problem, but only a small one.) a problem, but only a small one.)

Other developed countries issued 14% but had only 5% Other developed countries issued 14% but had only 5% denominated in their own currencies. Evidently, original sin denominated in their own currencies. Evidently, original sin is a problem even for developed countries aside from is a problem even for developed countries aside from financial centers.financial centers.

Developing countries issued 10% of global debt but had Developing countries issued 10% of global debt but had only 1% in their own currencies.only 1% in their own currencies.

Main difference after 1998 is growing importance of euro as Main difference after 1998 is growing importance of euro as a currency of denomination (relative to the legacy a currency of denomination (relative to the legacy currencies). currencies).

1111

Table 2: Cross-border bank Table 2: Cross-border bank claimsclaims

1995-1998 Total Bank Debt

of residents (BIL USD)

Total debt in major five currencies

Share in Major Five Currencies

Major Financial Centers 3,141 44.9% 2,448 44.02% 77.9% Euroland 1,637 23.4% 1,479 26.60% 90.3% Other Developed Countries 263 3.8% 167 3.00% 63.5% Offshore 502 7.2% 434 7.80% 86.4% Developing Countries 1,305 18.7% 995 17.89% 76.2% International Organizations 23 0.3% 17 0.31% 71.4% Unallocated 127 1.8% 22 0.40% 17.7% Total 6,998 100.0% 5,561 100.00% 79.5% 1999-2001

Total Bank Debt by residents (BIL USD)

Total debt in major five currencies

Share in Major Five Currencies

Major Financial Centers 3,691 47.3% 3,146 49.59% 85.2% Euroland 2,263 29.0% 2,080 32.79% 91.9% Other Developed Countries 356 4.6% 223 3.52% 62.8% Offshore 458 5.9% 381 6.01% 83.1% Developing Countries 887 11.4% 673 10.61% 75.8% International Organizations 18 0.2% 17 0.27% 93.7% Unallocated 134 1.7% 19 0.30% 14.5% Total 7,808 100.0% 6,344 100.00% 81.3%

1212

Things to NoteThings to Note

In 1993-8, Big 4 countries (financial centers: US, UK, Japan, In 1993-8, Big 4 countries (financial centers: US, UK, Japan, Switzerland) issued only 34% of global debt, but fully 68% Switzerland) issued only 34% of global debt, but fully 68% of global debt was denominated in their currencies. of global debt was denominated in their currencies.

(By comparison, countries soon to become members of (By comparison, countries soon to become members of Euroland issued 31% of global debt but 24% was Euroland issued 31% of global debt but 24% was denominated in their currencies. For them, original sin was denominated in their currencies. For them, original sin was a problem, but only a small one.) a problem, but only a small one.)

Other developed countries issued 14% but had only 5% Other developed countries issued 14% but had only 5% denominated in their own currencies. Evidently, original sin denominated in their own currencies. Evidently, original sin is a problem even for developed countries aside from is a problem even for developed countries aside from financial centers.financial centers.

Developing countries issued 10% of global debt but had Developing countries issued 10% of global debt but had only 1% in their own currencies.only 1% in their own currencies.

Main difference after 1998 is growing importance of euro as Main difference after 1998 is growing importance of euro as a currency of denomination (relative to the legacy a currency of denomination (relative to the legacy currencies). currencies).

1313

Measurement IssuesMeasurement Issues

In constructing a measure of original sin, we In constructing a measure of original sin, we would like to take into account both bank and would like to take into account both bank and bond market data.bond market data.

We would like to acknowledge the fact that in We would like to acknowledge the fact that in some cases countries may be able to hedge some cases countries may be able to hedge their currency exposurestheir currency exposures

To this end, we measure original sin in several To this end, we measure original sin in several alternative ways.alternative ways.

It turns out that are key results emerge almost It turns out that are key results emerge almost regardless of which of the following indices we regardless of which of the following indices we use.use.

1414

A First Measure Considering A First Measure Considering Only Bond Data (the higher the Only Bond Data (the higher the

value, the greater the sin)value, the greater the sin)

i

iiOSIN i

country by issued Securities

currency in country by issued Securities11

1515

A Second Measure (including A Second Measure (including loans as well as securities)loans as well as securities)

i

iINDEXAi

country by issued Loans Securities

currenciesmajor in country by issued Loans Securities

1616

A Third Measure (which A Third Measure (which accounts for the fact that debt accounts for the fact that debt in currency in currency ii issued by other issued by other

countries creates an countries creates an opportunity for country opportunity for country ii to to

hedge)hedge)

i

iINDEXBi

country by issued Securities

currency in Securities1

1717

A Fourth Measure (which A Fourth Measure (which eliminates negative values, eliminates negative values, where there is more debt in where there is more debt in

currency currency i i than country than country i i has in has in total, since countries cannot total, since countries cannot hedge more debt than they hedge more debt than they

issue)issue)

0,

country by issued Securities

currency in Securities1max3

i

iOSIN i

1818

Note that we consider yet additional Note that we consider yet additional measures in the paper.measures in the paper.

But in Table 1, please focus on the But in Table 1, please focus on the columns for columns for OSINOSIN3, this last measure.3, this last measure.

Note that we distinguish the periods Note that we distinguish the periods before and after the advent of the before and after the advent of the euro.euro.

1919

Table 3: Measures of Table 3: Measures of original sin by country original sin by country

groupingsgroupingsGroup

OSIN1 1993-1998

OSIN1 1999-2001

OSIN2 1993-1998

OSIN2 1999-2001

OSIN3 1993-1998

OSIN3 1999-2001

Financial centers 0.58 0.53 0.34 0.37 0.07 0.08

Euroland 0.86 0.52 0.55 0.72 0.53 0.09*

Other Developed 0.90 0.94 0.80 0.82 0.78 0.72

Offshore 0.98 0.97 0.95 0.98 0.96 0.87

Developing 1.00 0.99 0.98 0.99 0.96 0.93

LAC 1.00 1.00 1.00 1.00 0.98 1.00

Middle East & Africa

1.00 0.99

0.97 0.99 0.95 0.90

Asia & Pacific 1.00 0.99 0.95 0.99 0.99 0.94

Eastern Europe 0.99 1.00 0.97 0.98 0.91 0.84

2020

GraphGraph 11: Measures of : Measures of original sin by country original sin by country

groupingsgroupings

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Financial Centers Euroland Other Developed Developing

OSIN1 OSIN2 OSIN3

2121

GraphGraph 22: Measures of original : Measures of original sin by sin by regions (developing regions (developing

countries)countries)

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

LAC Middle East & AfricaAsia & PacificEastern Europe

OSIN1 OSIN2 OSIN3

2222

Things to NoteThings to Note

Lowest levels of original sin for the financial Lowest levels of original sin for the financial centers, followed by the Euroland countriescenters, followed by the Euroland countries

Note that the Euroland countries experience a Note that the Euroland countries experience a major decline in original sin following the major decline in original sin following the introduction of the eurointroduction of the euro

Other industrial countries have higher values.Other industrial countries have higher values. Developing countries have still higher values.Developing countries have still higher values. Among developers, OS is lowest for accession Among developers, OS is lowest for accession

economies, highest in Latin America.economies, highest in Latin America.

2323

Table 4: Countries with OSIN3 Table 4: Countries with OSIN3 <0.8, excluding financial <0.8, excluding financial

centerscenters Non Euroland Euroland Country 1993 -98 1999 -01 Country 1993 -98 1999-01 Czech Republic 0.0 0.00 Italy 0.00 0.00 Poland 0.82 0.00 France 0.23 0.12 New Zealand 0.63 0.05 Portugal 0.42 0.24 South Africa 0.44 0.10 Belgium 0.76 0.39 Hong Kong 0.72 0.29 Spain 0.59 0.42 Taiwan 1.00 0.54 Netherlands 0.64 0.47 Singapore 0.96 0.70 Ireland 0.94 0.59 Australia 0.55 0.70 Greece 0.93 0.60 Denmark 0.80 0.71 Finland 0.96 0.62 Canada 0.55 0.76 Austria 0.90 0.68

2424

Graph 3: Graph 3: OSIN3OSIN3 in Euroland in Euroland

0

0.23

0.42

0.76

0.590.64

0.94 0.930.96

0.9

0

0.12

0.24

0.390.42

0.47

0.59 0.6 0.62

0.68

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Italy France Portugal Belgium Spain Netherlands Ireland Greece Finland Austria

93-98 99-01

2525

The Non-Euroland outliers The Non-Euroland outliers are not all floatersare not all floaters

1

2

3

Australia Canada Poland Czech Rep.

South Africa

SingaporeDenmark HongKong

New Zealand

Floaters

Intermediate

FixersLYS 3

Average 1993 - 2001

2626

Things to NoteThings to Note

The Euroland countries of course feature The Euroland countries of course feature prominentlyprominently

Accession economies and overseas regions of Accession economies and overseas regions of 1919thth century European settlement are also century European settlement are also numerous.numerous.

Both fixed-rate Hong Kong and floating-rate Both fixed-rate Hong Kong and floating-rate Singapore and Taiwan appear on this list Singapore and Taiwan appear on this list (raising questions about whether a particular (raising questions about whether a particular exchange rate regime helps for eliminating exchange rate regime helps for eliminating original sin)original sin)

2727

Original Sin is also Original Sin is also PersistentPersistent

Table 5 in the paper classifies countries Table 5 in the paper classifies countries as issuing (gold) indexed debt or as issuing (gold) indexed debt or domestic currency debt in the mid-19domestic currency debt in the mid-19thth century. (Some cases are mixed.)century. (Some cases are mixed.)

It shows a very strong and significant It shows a very strong and significant correlation with countries suffering from correlation with countries suffering from original sin (issuing foreign currency original sin (issuing foreign currency denominated or indexed debt) today.denominated or indexed debt) today.

2828

Original sin is highly Original sin is highly persistentpersistent

00.10.20.30.40.50.60.70.80.9

GoldClauses

MixedClauses

DomesticCurrency

OSIN3 and Flandreau-Sussman classification circa 1850

The Pain of Original SinThe Pain of Original Sin

(The consequences)(The consequences)

3030

Recall the ProblemRecall the Problem

If an original sin country has a net foreign debt and If an original sin country has a net foreign debt and it is in foreign currency, then there is an aggregate it is in foreign currency, then there is an aggregate currency mismatchcurrency mismatch

If no one else issues debt in its currency, then If no one else issues debt in its currency, then foreign exposures can then be passed around by foreign exposures can then be passed around by residents like a hot potato, but foreign exposure residents like a hot potato, but foreign exposure cannot be hedged in the aggregate.cannot be hedged in the aggregate.

This can have important implications for exchange This can have important implications for exchange rate policy, capital flows, and output volatility, rate policy, capital flows, and output volatility, among other things. We explore these implications among other things. We explore these implications in turn, starting with the exchange rate.in turn, starting with the exchange rate.

3131

Original sin and exchange Original sin and exchange rate flexibilityrate flexibility

We use the Levy-Yeyati and Sturzenegger We use the Levy-Yeyati and Sturzenegger classification, M2/Reserves, and exchange classification, M2/Reserves, and exchange rate variability/reserve variability as 3 rate variability/reserve variability as 3 measures of the dependent variable.measures of the dependent variable.

Note that there are good reasons to think that Note that there are good reasons to think that these things will be affected by original sin. these things will be affected by original sin.

There are of course the theoretical reasons There are of course the theoretical reasons mentioned earlier. But there are also mentioned earlier. But there are also empirical reasons. Consider:empirical reasons. Consider:

32320 0.2 0.4 0.6 0.8 1

United StatesUnited Kingdom

JapanNew Zealand

CanadaAustralia

South AfricaDominican Rep.

SwitzerlandGermany

IndiaSwedenThailand

PhilippinesKorea

JamaicaBrazil

ParaguayIsrael

NorwayMexico

GuatemalaCzech. Republic

IndonesiaGreece

ColombiaPoland

ChilePeru

Singapore

0.013

0.021

0.048

0.057

0.058

0.062

0.064

0.087

0.094

0.105

0.133

0.137

0.230

0.242

0.243

0.245

0.253

0.259

0.262

0.287

0.302

0.303

0.314

0.335

0.362

0.409

0.446

0.485

0.637

0.879

Reserves/M2

Levels of ReservesLevels of Reserves

3333

e( R

ES

M2

| X)

e( SIN33_A | X )-.878934 .307706

-.410813

.341941

CZE

USA

CHE

JPN

ZAF

TTO

HKG

CANSURAUS

NIC

NZD

IND

IDN

PAK

POL

ZWE

LKA

MDA

PHL

SVK

BOLPNGUKR

BGR

ROM

MAR

JORJAM

KAZ

DOM

BHR

GTMTHA

SLV

BRB

TUN

LVA

BHS

LBN

PER

RUS

COL

MUS

MYS

TUR

CRI

MEX

EST

VEN

HUN

CHL

MLT

DNK

BRA

OMN

CYP

URY

ARG

SVN

KORISRISL

NOR

Original sin and reserves over M2

34340 5 10 15 20 25 30 35

JamaicaNorwayGreecePoland

GuatemalaChilePeru

ParaguaySingapore

IsraelMexico

ColombiaSweden

IndiaCzechKorea

Dominican Rep.Indonesia

SwitzerlandPhilippines

South AfricaGermany

BrazilCanada

ThailandAustralia

New ZealandUnited Kingdom

United StatesJapan

0.272

0.362

0.390

0.416

0.417

0.424

0.506

0.615

0.690

0.760

0.838

0.926

0.976

1.215

1.260

1.345

1.583

2.154

2.272

2.324

2.466

2.842

2.920

3.369

6.617

6.913

12.682

17.946

.380

30.454

Relative Volatilities: Exchange Rate and Reserves

Intervention using reservesIntervention using reserves

std(dev)/std(res/m2)

3535

e( R

VE

R |

X)

e( SIN33_A | X )-.878092 .309288

-1.08857

1.61765

CZE

USA

CHE

JPN

ZAF

TTO

HKG

CAN

AUS

NICNZD

IND

IDNPAK

POLZWELKAMDAPHL

SVKPNG

BOLUKR

BGR

JOR

ROMMAR

JAM

BHR

KAZ

DOMSGP

ECUGTMTHA

SLV

BRB

TUN

BHS

LVA

LBN

PERRUS

COL

MYS

MUS

TUR

CRI

MEX

EST

HUN

VENCHL

MLT

DNK

OMN

CYP

URYARG

SVN

KOR

ISR

ISL

NOR

Original Sin and relative volatility of exchange and

reserves

3636

Multivariate AnalysisMultivariate Analysis

We control for GDP per capita, openness, and foreign We control for GDP per capita, openness, and foreign debt/GNP, and focus on the coefficient of OSIN3.debt/GNP, and focus on the coefficient of OSIN3.

We run weighted LS (weighted by share of securities in We run weighted LS (weighted by share of securities in total debt) and also ordered probit for the LYS total debt) and also ordered probit for the LYS measure.measure.

OS is negatively correlated with exchange rate OS is negatively correlated with exchange rate flexibility using all 3 measures. (Time series and cross flexibility using all 3 measures. (Time series and cross section evidence, and instrument variables regressions, section evidence, and instrument variables regressions, support that this is not reserve causality.)support that this is not reserve causality.)

The effect is important: eliminating OS is enough to The effect is important: eliminating OS is enough to move countries by a full category in the LYS move countries by a full category in the LYS classification.classification.

3737

Table 6: Original sin and Table 6: Original sin and exchange rate flexibilityexchange rate flexibility

(1) (2) (3) LYS RESM2 RVER

OSIN3 0.984 0.248 -0.801 (2.98)*** (3.74)*** (2.02)** LGDP_PC 0.268 -0.053 0.026 (3.61)*** (1.85)* (0.61) OPEN 0.178 -0.014 1.017 (1.85)* (0.41) (2.88)*** SHARE2 58.719 -35.858 -569.562 (0.46) (0.66) (2.36)** Constant -1.389 0.531 0.104 (1.79)* (1.73)* (0.17) Observations 75 65 65 R-squared 0.22 0.37 0.62

3838

Output and Capital Flow Output and Capital Flow VolatilityVolatility

Output volatility is measured as the SD of GDP Output volatility is measured as the SD of GDP growth.growth.

Capital flow volatility is the SD of capital Capital flow volatility is the SD of capital flow/domestic credit ratioflow/domestic credit ratio

We control for level of development, openness, We control for level of development, openness, foreign debt, and terms of trade volatility.foreign debt, and terms of trade volatility.

Again, we run weighted least squaresAgain, we run weighted least squares Original sin account for more than ¼ of the Original sin account for more than ¼ of the

difference in volatility between developed and difference in volatility between developed and developing countries.developing countries.

3939

Table 7: Original sin and Table 7: Original sin and volatility volatility

(1) (2) VOL_GROWTH VOL_FLOW

OSIN3 0.011 7.103 (1.96)* (3.58)*** LGDP_PC -0.012 -3.214 (2.14)** (2.56)** OPEN -0.001 -4.181 (0.12) (1.20) VOL_TOT -0.000 0.223 (0.86) (1.08) SHARE2 -14.287 147.265 (1.72)* (0.04) Constant 0.135 32.825 (2.25)** (2.39)** Observations 77 33 R-squared 0.40 0.64

4040

Original Sin & Credit RatingsOriginal Sin & Credit Ratings

Countries with original sin will have more Countries with original sin will have more volatile debt service ratios and deficits, volatile debt service ratios and deficits, because their service obligations will be more because their service obligations will be more exchange-rate and interest-rate sensitive.exchange-rate and interest-rate sensitive.

Greater fiscal volatility means lower credit Greater fiscal volatility means lower credit ratings, other things equal.ratings, other things equal.

This can explain, inter alia, why the This can explain, inter alia, why the correlation of credit ratings with debt and correlation of credit ratings with debt and deficit variables is so low (as shown on the deficit variables is so low (as shown on the next slide).next slide).

4141

The Weak Relationship The Weak Relationship Between Debt/GDP and Between Debt/GDP and

Credit RatingsCredit Ratings

rati

ng

fo

reig

n c

urr

ency

net_debt/gdp-.291965 1.13803

5

19

ARG

AUS

AUT

BEL

BRA

CAN

CHN

CRI

CYP

CZE

DNK

DOM

EST

FIN

DEU

GRC

HUN

ISL

IND

ISR

ITA

JPN

JOR

LVA

MEXMAR

NOR

PAK

PAN

PRY

POL

PRT

SVN

ESPSWE

TTO

TUN

TUR

GBR USA

4242

Multivariate AnalysisMultivariate Analysis

We control for standard determinants of We control for standard determinants of credit rates, public debt/GDP, public credit rates, public debt/GDP, public debt/tax revenues, and level of debt/tax revenues, and level of development.development.

Estimates are by weighted least squares Estimates are by weighted least squares and double censored Tobit.and double censored Tobit.

Results, on next slide, suggest that Results, on next slide, suggest that eliminating original sin increases country eliminating original sin increases country credit rating by three notches.credit rating by three notches.

4343

Table 8: Original sin and Table 8: Original sin and credit ratingscredit ratings

(1) (2) (3) (4) RATING1 RATING1 RATING1 RATING1 DE_GDP2 -1.553 -1.815 (1.91)* (2.19)** DE_RE2 -0.599 -0.665 (1.40) (1.52) LGDP_PC 3.189 3.051 2.884 2.764 (8.54)*** (7.59)*** (6.47)*** (5.68)*** OSIN3 -3.429 -3.324 -4.883 -4.435 (3.85)*** (3.49)*** (3.49)*** (3.11)*** Constant -12.369 -11.059 -8.751 -7.889 (3.16)*** (2.60)** (1.89)* (1.57) Observations 56 49 51 44 R-squared 0.82 0.81 0.81 0.80

Causes of original sinCauses of original sin

Immaculate conception and Immaculate conception and the road to redemption the road to redemption

Miner’s canary or cause?Miner’s canary or cause?

Is OS one more symptom of Is OS one more symptom of poor institutions, or is it a poor institutions, or is it a

different kind of different kind of phenomenon?phenomenon?

4646

Recent TheoriesRecent Theories

Underdevelopment of institutions and Underdevelopment of institutions and policies in generalpolicies in general

Inadequate monetary credibilityInadequate monetary credibility Fiscal profligacyFiscal profligacy Weak contract enforcementWeak contract enforcement Presence or absence of trade sanctionsPresence or absence of trade sanctions Political economy storiesPolitical economy stories We will leave our discussion of these We will leave our discussion of these

theories and evidence to Ugo tomorrow, but theories and evidence to Ugo tomorrow, but here we need to make one important point:here we need to make one important point:

4747

Inadequacy of Conventional Inadequacy of Conventional ExplanationsExplanations

None of a variety of measures of levels of None of a variety of measures of levels of development, monetary credibility, fiscal development, monetary credibility, fiscal profligacy, strength of contract enforcement, profligacy, strength of contract enforcement, trade dependence, or political economy have trade dependence, or political economy have much traction.much traction.

Same is true for a variety of samples, Same is true for a variety of samples, specifications and econometric treatments.specifications and econometric treatments.

Only robust correlates are country size and Only robust correlates are country size and financial-center status (which is, in a sense, financial-center status (which is, in a sense, what we are trying to explain).what we are trying to explain).

4848

Why Might a Few Important Why Might a Few Important Currencies So Dominate the Global Currencies So Dominate the Global

Portfolio?Portfolio? Additional currencies add decreasing Additional currencies add decreasing

diversification benefits but constant diversification benefits but constant transaction costs.transaction costs.

International transaction costs and International transaction costs and heterogeneityheterogeneity

Network externalities may give a small Network externalities may give a small number of vehicle currencies special number of vehicle currencies special attraction.attraction.

Countries seeking to add their currencies to Countries seeking to add their currencies to the global portfolio thus face an uphill battle.the global portfolio thus face an uphill battle.

And each that succeeds makes life tougher And each that succeeds makes life tougher for the others.for the others.

4949

Bottom LineBottom Line

Original sin is not merely a problem of Original sin is not merely a problem of country policies (one need not deny the country policies (one need not deny the relevance of these, of course).relevance of these, of course).

It is also a problem with the operation of the It is also a problem with the operation of the international system (given transactions international system (given transactions costs, a world of heterogeneous countries, costs, a world of heterogeneous countries, and network effects that lock in the status and network effects that lock in the status quo).quo).

Redemption therefore requires international Redemption therefore requires international action to overcome the inertia in the system.action to overcome the inertia in the system.

5050

Lessons from outliersLessons from outliers

Countries that have recently escaped Countries that have recently escaped original sin seem to have done so original sin seem to have done so through non-nationals issuing debt in through non-nationals issuing debt in domestic currencydomestic currency

IFIs have played a major role in this IFIs have played a major role in this processprocess

Borrowers swap their obligations with Borrowers swap their obligations with residentsresidents

5151

Our proposalOur proposal

We propose an index based on an We propose an index based on an inflation-adjusted basket of EM inflation-adjusted basket of EM currenciescurrencies Historically it shows trend appreciation, Historically it shows trend appreciation,

low volatility and negative correlation with low volatility and negative correlation with industrial country consumptionindustrial country consumption

We propose that the WB, other IFIs and We propose that the WB, other IFIs and C-5 governments issue debt in this C-5 governments issue debt in this index and swap obligations with EMsindex and swap obligations with EMs

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The seminarThe seminar

Theoretical papers on consequences of OSTheoretical papers on consequences of OS Cespedes, Chang and Velasco ask what are the Cespedes, Chang and Velasco ask what are the

consequences for domestic policies and for the consequences for domestic policies and for the ability to stabilize the economyability to stabilize the economy

Jeanne and Zettelmeyer ask about the Jeanne and Zettelmeyer ask about the implications for the international financial implications for the international financial architecturearchitecture

Historical papers on the origin of OSHistorical papers on the origin of OS Bordo Meissner and RedishBordo Meissner and Redish Flandreau and SussmanFlandreau and Sussman

5353

The seminarThe seminar

Theoretical papers on causes of OSTheoretical papers on causes of OS Jeanne on poor monetary credibilityJeanne on poor monetary credibility Corsetti on fiscal dynamics and crisesCorsetti on fiscal dynamics and crises Chamon and Hausmann on the Chamon and Hausmann on the

interaction between borrowers and CBsinteraction between borrowers and CBs EHP on the empirical mystery of OSEHP on the empirical mystery of OS

RedemptionRedemption Detailes outline of our proposalDetailes outline of our proposal

5454

Original SinThe Pain, the Mystery

And the Road to Redemption Barry Eichengreen, Ricardo Hausmann & Ugo Panizza

UC Berkeley, Harvard, and IDB