« Econ 398 for Tuesday | Main | Econ 398 Papers »



Taylor Theodossiou

I like many of my other classmates reading this article found it difficult to understand. However, I did see a similarity between this article and the idea that has resurfaced consistently in class that there is always a multitude of other factors that influence whatever is happening. Eichengreen and Mody were looking at the role interest rates of industrial countries played in the developing world, especially in relation to their creditworthiness. It makes sense that “an increase in the industrial country interest rates increases the debt service burden borne by the borrower countries, thereby reducing their ability to repay their debts and hence lowering their creditworthiness,” however; they argue that there has been little evidence to support this claim. The paper addresses the limitations of the previous studies that caused this failure of evidence and I thought it was interesting the way in which they tried to address the problem with their study. They tried to address both the supply- and demand-side effect, something that they argued their predecessors had not done, and that it was through this that they were able to determine a significant interest rate response. They still kept their model relatively simple, from what I could understand, but they were able to this model to prove something that had only been proven qualitatively before. Although I might not have understand all of the details that were in this paper I was able to see how looking at something in a new way could have profound effects on the interpretation.


In what seems to be a fairly common theme, I was also confused by some of the jargon used in Eichengreen and Mody's article. However, through my experience with the loanable funds market in Professor Goldsmith's Macroeconomics class, I believe that I was able to understand the article's core arguments.

Like some of my other classmates, I was surprised to find that a substantial amount of research has determined that interest rates in highly-developed countries do not necessarily affect the capital flows in under-developed nations. After all, reverting back to what I learned in macroeconomics, it almost seems obvious that lower interest rates in highly-developed countries like the United States encourage a flow of capital to emerging markets with higher yields. Using a simple model of the loanable funds market, the supply of loanable funds will decrease in influential markets where interest rates have fallen, effectively encouraging lending in other markets.

By looking at both the supply and demand sides of the model, Eichengreen and Mody attempt to prove a significant correlation between interest rates in developed markets and inflows of capital to emerging markets. In my opinion, they are successful in proving this relationship. By accounting for the behavior of the borrowers', particularly in countries with fixed-rate securities (such as those in East Asia), the authors are able to uncover at least one reason that past studies have not found a conclusive relationship between interest rates and lending in established and emerging markets, respectively. In these countries with fixed-rate securities, during times of increased interest rates in the United States or other major markets, the supply of bonds is decreased in response to a decreasing demand. In other words, in response to rising interest rates in global money centers, several countries with emerging markets have effectively decreased the supply of bonds, thus increasing the price and limiting the rise in spreads.

In short, I am relieved to discover that the principles I learned in macroeconomics are not necessarily based on faulty logic and evidence.

Mac McKee

Someone more familiar with finance and economic history than I would have had an easier time with this paper. In addition to some math jargon, I was unfamiliar with some of the phenomena that Eichengreen and Mody alluded to as references. I was able to figure out some of them, and was fascinated by the impact that US interest rates have on the availability of capital in developing nations. While I'd never considered this, it's rather intuitive and leads one to ask why this isn't a more widely-known economic idea. As the authors point out, more traditional elements of economic development and globalization are typically linked to an improved fiscal climate in developing countries.These elements of development are useful and necessary, but also incomplete; they fail to account for demand for credit in developing countries. As a result, often too much credit enters a market without the institutions to use it and vice versa. This oversight leads to a misunderstanding of what factors actually influence the availability of credit. Moreover, because investment is often imprecise (as Wilson pointed out) there are further failures to provide credit in the right amounts to the right countries.

Richard Nelson

I have to agree that the interest rates paper was a bit difficult to understand. It kept switching back and forth between Latin America, Japan, industrial nations, America, etc, so often that it was hard to follow what was actually being studied. I did find it interesting, though, because I did a lot of work with Latin America this summer, as well as the broader trends in emerging markets. I would have to say that I agree more with the side that “emphasize the influence of interest rates in the creditor countries over international capital flows,” especially for US investors. Everybody wants to get the best return for every dollar they invest – period. Because we have been in such a low rate fixed income environment, everyone is looking for alternative places to put money and earn returns. Over this summer, emerging market companies literally threw debt at the market and investor after investor was willing to pick it up. Brazil and Mexico, in particular, had a huge amount of new debt issuances. Every time, they would list it as 200-300 million (USD denominated) with an estimated 7-8% coupon (for example), and almost every single one issued at the lowest end of the coupon estimate. Same thing went for pretty much everything that offered a good coupon, despite Argentina’s second sovereign “default” and a slowing growth in many other Latam countries, particularly Brazil. Why did this happen? They offered better returns than anyone else, and investors were willing to take on the extra risk rather than starve from yieldlessness. There was also an incentive for these Latam countries, because they could issue a huge amount of debt at very competitive coupon rates, given their inherent riskiness, and it ultimately led to the massive inflows of external credit that this paper talks about.

So, I would say that I am of the second side. However, the other notable events that were happening were serious reforms in Latam, especially Mexico and Chile. Both had reforms in energy, healthcare, pensions, government officials…so a lot…and both of these countries had the same story. But, there was so little attention given to these reforms by most people that I offered to put together a packet for them on the reforms – point being, I don’t think people care as much about the reforms that COULD come about. Sure, they are kept on the radar, but it seemed to me like the bigger story was what was current right now, and that was a need for yield in a low interest rate market.

Griffin Cook

While it’s been mentioned by a few other people, it might as well be said again. With this paper, we once again see the practicality of simplified economic models, and see that the application of simple economic principles can yield more agreeable results than conjecture and assumptions based on complicated environments with countless undetermined variables and uncontrollable effects, such as the “qualitative accounts” of other papers with which these results are at odds. Overall, the intuition seems to hold according to Eichengreen and Mody’s results: when U.S. interest rates rise, the demand for bonds by investors in Latin America (and East Asia to an extent) falls. The fact that previous studies seem to have not distinguished supply- and demand-side effects in understanding their results, as noted on page 21, is rather surprising.

One of the other interesting take-aways (if I’m interpreting correctly) is the effect of credit rating on the spreads of bonds. If credit ratings rise along with the U.S. interest rate and those with poor credit ratings drop out of the market and cause bond yields to decrease due to downward pressure, then it would seem important to me that developing nations and investors in them be provided with opportunities for better credit. The volatility of countries in Latin America or places with similar economic instability, as noted in the paper, is responsible for lower credit ratings, but perhaps an initiative to provide such places with the resources necessary for better stability and the opportunity to develop better credit ratings with more resistance to economic shocks would be a beneficial practice for a number of reasons. The primary, obvious reason is simply better economic and credit conditions for these countries. But in addition, higher credit ratings means investors in these countries would not drop out of the bond market when U.S. interest rates rise, which would also reduce the downward pressure on spread from bonds, and enable the investors to better help develop the economic climate in the Latin American or East Asian countries as well.

Mary Beth Benjamin

I first want to acknowledge that I had some difficulty understanding this article as I am not much of a finance person and many of the details of this this article were beyond my level of comprehension. I think my thoughts on this article after our class discussion would be more substantive. However, it seems that the purpose of this paper is to explain the role of interest rates in developed countries and how they impact the availability, and the flow of capital to developing countries. Interest rates affect how people borrow and loan their money. It is natural that people would prefer to put your money into markets that offer higher interest rates, are more developed and have lower-risk because they offer higher returns. In addition to this point, Eichengreen and Mody also talk about the importance of looking at the issue of interest rates from both the supply and the demand side to provide a more complete view of the factors that increase capital flows to emerging markets. The main take away for me was the idea that there are always a large number of variables, which all seem to be interconnected that could all be playing a part in what is happening to interest rates and the flow of capital on the macro-level. In examining each of these variables, we see that they have a profound effect on how our the simple models can be tweaked to yield complete different explanations.

The comments to this entry are closed.