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Box 6-4.—Sovereign Spreads in Emerging MarketsThe Asian crisis has introduced into popular parlance a numberof terms formerly encountered only in arcane financial discussionsamong bankers and economists. One of these is “sovereign spread.”A simple definition of sovereign spread is the difference betweenyields on bonds issued by the government of one country (forexample, an emerging market country) and those (safe) bondsissued by the government of a major industrial country. The yieldin question is the yield to maturity, or the rate of return earned byholding the bond until it matures (including all interest and principalpayments), and the bonds being compared must be of thesame maturity and currency denomination for the comparison tobe valid.Using the prices of bonds issued by governments in emergingmarket economies, one can measure the implicit risk premiumthat the market demands to compensate for the extra default riskentailed in holding a bond from a particular emerging market.(Default risk is the risk that the debtor will fail to pay all principaland interest on its obligation on time. The bonds of the majorindustrial country governments are considered to carry little or nodefault risk.) The sovereign spread on foreign currency-denominatedbonds measures only the default risk of a country’s obligations—notcurrency risk, because payments are to be made inforeign currency.During the periods of extreme market turbulence following theMexican peso crisis in 1994 and the Russian default in 1998, sovereignspreads rose sharply. In the latter episode these spreadsreached about 1,500 basis points by mid-September (Chart 6-2).Estimates of the default probabilities incorporated in emergingmarket bond prices can be derived fairly easily from their sovereignspreads, given the assumption that U.S. government bondsare default risk-free. At their height, these spreads implied veryhigh default probabilities for many countries, leading to the conclusioneither that markets were exceptionally pessimistic or thatinvestors were becoming exceedingly risk averse.A second interesting comparison relates to the difference inyields on dollar- and local currency-denominated bonds. As long asthe default risk on these bonds is the same, this differential measuresthe market’s assessment of currency risk, that is, the riskderiving from changes in the international value of the currency.Interestingly, even under most “fixed” exchange rate regimes, apositive currency risk premium can be observed, suggesting thatinvestors expect a devaluation at some point or that they requirean implicit “insurance” premium to compensate for that possibility.234
Chart 6-2 Perceived Risk and the Spread on Emerging Market BondsThe risk premium on emerging market bonds shot up between March and September1998. Spreads subsequently declined, then rose again following Brazil's devaluation.Stripped spread over Treasuries (basis points)2000Brazil devalues real(January 1999)15001000Mexican peso crisis(December 1994)East Asia crisis spreadsto Korea(November 1997)500Russia defaults(August 1998)01993 1994 1995 1996 1997 1998Source: J.P. Morgan Emerging Markets Bond Index.04/Jan/93 13/May/93 21/Sep/93 01/Feb/94 13/Jun/94 20/Oct/94 03/Mar/95 12/Jul/95 17/Nov/95 29/Mar/96 07/Aug/96 17/Dec/96 29/Apr/97 05/Sep/97 16/Jan/98 28/May/98 05/Oct/98Even the spreads between Treasuries and high-grade corporate bondsrose to some extent, reflecting the generalized increase in risk aversion.The huge losses and near-collapse of a prominent hedge fund contributedto the panic. By early October there were hints of a generalizedglobal credit crunch: rising spreads on the entire range of bond instrumentsfrom high-quality corporate bonds to junk bonds and emergingmarket sovereign instruments; an interruption of access to internationalcapital markets for most emerging economies; a drying up of bondfinancing in all emerging markets and a shrinkage in new bond issuesin industrial countries; evidence of a tightening of lending standards bycommercial banks in the United States; a slowdown in reportedearnings growth; and a contraction in stock markets worldwide.However, by the middle of November, conditions in international anddomestic capital markets had improved noticeably, thanks to a numberof positive developments:• The Administration, as discussed in Chapter 1, took the lead inproposing a comprehensive set of steps to contain and resolve the crisis.These proposals included measures to support growth in theindustrial countries, as well as policy reforms in emerging markets topromote their recovery; creation of a precautionary facility within theIMF to support countries subject to speculative pressures despitegood economic fundamentals; measures to support the acceleratedsystemic restructuring of Asian banks and corporations; significantincreases in the support by multilateral financial institutions of235
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EconomicReportof thePresidentTransm
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C O N T E N T SPageECONOMIC REPORT
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ECONOMIC REPORT OF THE PRESIDENTTo
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Once we have saved Social Security,
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THE ANNUAL REPORTOF THECOUNCIL OF E
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C O N T E N T SPageCHAPTER 1. MEETI
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PageCHAPTER 5. REGULATION AND INNOV
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Page2-3. Accounting for Growth in R
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Page6-5. Terms of Trade ...........
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CHAPTER 1Meeting Challenges and Bui
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Box 1-1.—The Dating of Business C
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Chart 1-1 Core Inflation and Unempl
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expansion prematurely. In fact, the
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the duration of the typical unemplo
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throughout that decade of peace and
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all individuals aged 65 and older r
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extent that it would reduce Social
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the vulnerability of the internatio
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access. Even so, international agre
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eliminated entirely, because the go
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Nevertheless, adjustment assistance
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CHAPTER 2Macroeconomic Policyand Pe
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Then the chapter explores two other
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target Federal funds rate brought t
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high of 66.8 percent in the third q
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the third-quarter deceleration and
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(that is, excluding food and energy
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probably would have increased by ab
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Equities clearly involve risk as we
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highest level in at least 40 years
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attributed to the lesser liquidity
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971231 980106 980112 980116 980122
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about the potential impact of large
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With respect to leverage, the degre
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noted earlier, investment-grade bor
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Chart 2-8 Corporate Profits and Net
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is attributable to the strong econo
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productivity; the latter is in turn
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the year 2000, mistaking it instead
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Box 2-2.—continuedare not expecte
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construct an accurate forecasting m
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is estimated as the location where
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the recent surge in productivity re
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Box 2-3.—continuedhowever. Import
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Chart 2-12 Three Measures of Core I
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a level of capacity utilization tha
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Box 2-4.—continuedChanges to be i
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Nonfarm manufacturing and trade inv
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has been for the past 3 years. But
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who have traditionally not fared as
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Box 3-1.—continuedas well as full
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and been replaced by younger, more
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Particularly interesting, however,
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Chart 3-5 Median Hourly Wages of Me
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In fact, in 1990 immigrants and nat
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Box 3-2.—continuedsome firms may
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Box 3-3.—continuedmaximum of $3,7
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willing to hire welfare recipients
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participation. The renewed increase
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TANF grants in reserve at the Treas
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JOB DISPLACEMENTWorkers are conside
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evidence finds that the percentage
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their non-labor market activities.
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The Administration is especially co
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CHAPTER 4Work, Retirement, and theE
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Chart 4-1 Life Expectancy at Age 65
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Population aging is not just an Ame
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Box 4-1.—continuedfor couples and
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earlier retirement, by increasing l
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uyouts may also have contributed to
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Box 4-2.—Social Security RulesThe
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available with the same hourly pay,
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Box 4-4.—Types of Pension PlansUn
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worker—declined. More of these ol
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survey) was about 13 percent higher
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well-being is that families have di
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Chart 4-9 Living Arrangements of El
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mentioned earlier in this chapter a
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Box 4-7.—The Federal Role in Empl
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inequality among retirees who have
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whether minorities and women are li
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TABLE 4-4.—Poverty Rates Among th
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TABLE 4-6.—Family Holdings of Fin
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variety of reasons, including the f
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the number of patents granted in th
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The United States has a decades-lon
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matter, depending on various condit
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company Roche Holdings, Ltd. Some o
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The antitrust authorities’ linkin
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espective Writings and Discoveries.
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Page 184 and 185: machine owned by another. The disti
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Page 190 and 191: In another part of the Internet mar
Page 192 and 193: technology at hand. But incentive-b
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Page 196 and 197: In contrast to both performance and
Page 198 and 199: The SO 2 experience reveals several
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Page 202 and 203: Consumers’ investment in energy e
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Page 206 and 207: Chart 5-2 Energy Efficiency and Pri
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Page 210 and 211: Box 5-9.—Is There an Environmenta
Page 212 and 213: larger coal plants. In 1994 these t
Page 214 and 215: around the country, and seven other
Page 216 and 217: other social goals. The fund would
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Page 220 and 221: Chart 6-1 Net Capital Flows to Deve
Page 222 and 223: Box 6-1.—The Explosive Growth of
Page 224 and 225: Recent Financial LiberalizationIn m
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Page 228 and 229: Box 6-2.—Market-Based (Arm’s-Le
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Page 234 and 235: social safety nets in the crisis co
Page 236 and 237: Box 6-5.—Moral Hazard in Financia
Page 238 and 239: Empirical studies confirm that, by
Page 240 and 241: withdrew $26 billion in 1997. Altho
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Page 244 and 245: 8.5 percent of GDP in 1998. Indones
Page 246 and 247: sary revenues to meet these extra i
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Page 252 and 253: Chart 6-3 Real Value of the Dollar
Page 254 and 255: The increase in the trade deficit a
Page 256 and 257: Chart 6-6 Current Account BalanceTh
Page 258 and 259: Chart 6-7 Economic Growth and Trade
Page 260 and 261: investment. The U.S. gross investme
Page 262 and 263: Chart 6-10 Current Account Deficit
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Page 266 and 267: REFORM OF THE INTERNATIONAL FINANCI
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Page 278 and 279: Issues Posed by Hedge Funds and Oth
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egulation of inflows to banks alone
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complement the role of official fin
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emerging markets will take time to
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Box 7-1.—continuedpartner; a stro
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Chart 7-1 European Short-Term Inter
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members agreed in a separate Growth
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Box 7-2.—continuedthrough an auto
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advantages of EMU to U.S. residents
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Box 7-3.—How Does the Dollar Rank
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connection between the currency in
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as an economic superpower early in
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Appendix AREPORT TO THE PRESIDENT O
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Council Members and Their Dates of
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The Chair and Members work as a tea
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countries. The Council heads the U.
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Chief of Staff and General CounselM
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affiliations. They are Christopher
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C O N T E N T SNATIONAL INCOME OR E
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B-71. Aggregate reserves of deposit
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General NotesDetail in these tables
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TABLE B-1.—Gross domestic product
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TABLE B-2.—Real gross domestic pr
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TABLE B-4.—Percent changes in rea
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TABLE B-5.—Contributions to perce
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TABLE B-6.—Chain-type quantity in
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TABLE B-7.—Chain-type price index
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TABLE B-9.—Real gross domestic pr
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Year orquarterGrossdomesticproductT
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YearBased on1972 SIC:TABLE B-13.—
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TABLE B-15.—Output, costs, and pr
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TABLE B-17.—Real personal consump
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TABLE B-19.—Real private gross fi
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TABLE B-21.—Real government consu
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TABLE B-23.—Real inventories and
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TABLE B-25.—Real exports and impo
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TABLE B-27.—Relation of national
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TABLE B-28.—National income by ty
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TABLE B-29.—Sources of personal i
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TABLE B-31.—Total and per capita
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TABLE B-32.—Gross saving and inve
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POPULATION, EMPLOYMENT, WAGES, AND
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TABLE B-35.—Civilian population a
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TABLE B-37.—Civilian employment b
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TABLE B-39.—Civilian labor force
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TABLE B-41.—Civilian employment/p
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TABLE B-43.—Civilian unemployment
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TABLE B-45.—Unemployment insuranc
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TABLE B-46.—Employees on nonagric
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TABLE B-48.—Employment cost index
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Year orquarterTABLE B-50.—Changes
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Year or monthTABLE B-52.—Industri
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TABLE B-54.—Capacity utilization
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Year or monthTABLE B-56.—New hous
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TABLE B-58.—Manufacturers’ ship
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PRICESTABLE B-60.—Consumer price
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TABLE B-61.—Consumer price indexe
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TABLE B-63.—Changes in special co
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TABLE B-65.—Producer price indexe
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YearandmonthMONEY STOCK, CREDIT, AN
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TABLE B-70.—Components of money s
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TABLE B-72.—Bank credit at all co
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TABLE B-73.—Bond yields and inter
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TABLE B-74.—Credit market borrowi
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TABLE B-76.—Mortgage debt outstan
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GOVERNMENT FINANCETABLE B-78.—Fed
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TABLE B-80.—Federal receipts and
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TABLE B-82.—Federal Government re
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TABLE B-84.—Federal and State and
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TABLE B-86.—State and local gover
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TABLE B-88.—Maturity distribution
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CORPORATE PROFITS AND FINANCETABLE
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TABLE B-92.—Corporate profits of
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TABLE B-94.—Relation of profits a
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Year or monthTABLE B-96.—Business
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End of yearTotalassetsTABLE B-98.
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YearFarm population,April 1Number(t
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YearTABLE B-102.—U.S. exports and
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TABLE B-103.—U.S. international t
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TABLE B-105.—U.S. international t
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TABLE B-107.—International invest
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TABLE B-109.—Civilian unemploymen
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TABLE B-111.—International reserv
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