nep-cba New Economics Papers
on Central Banking
Issue of 2007‒08‒14
25 papers chosen by
Alexander Mihailov
University of Reading

  1. Is the U.S. Bankrupt? By Laurence J. Kotlikoff
  2. Inflation without a quantity of money: a simple Wicksellian model outlined By William Coleman
  3. Asset-Price Misalignments and Monetary Policy: How Flexible Should Inflation-Targeting Regimes Be? By Jack Selody; Carolyn Wilkins
  4. Inflation risk premia in the term structure of interest rates By Peter Hoerdahl; Oreste Tristani
  5. Japan's monetary policy transition, 1955-2004 By Rhodes, James; Yoshino, Naoyuki
  6. Is Old Money Better than New? Duration and Monetary Regimes By Mihov, Ilian; Rose, Andrew K.
  7. The Rise and Fall of U.S. Inflation Persistence By Beechey, Meredith; Österholm, Pär
  8. Uncover Latent PPP by Dynamic Factor Error Correction Model (DF-ECM) Approach: Evidence from five OECD countries By Qin, Duo
  9. Optimal Monetary Policy in an Interdependent World By Michael Evers
  10. Optimum Policy Domains in an Interdependent World By Michael P. Evers
  11. CHINA'S REAL EXCHANGE RATE PUZZLE By Rod Tyers; Jane Golley; Iain Bain
  12. China’s Real Exchange Rate By Rod Tyers; Jane Golley
  13. The Exchange Rate Targeting of Central Banks Revised: The Role of Long-term Interest Rates By Lahtinen, Markus; Mäki-Fränt, Petri
  14. Are All Measures of International Reserves Created Equal? An Empirical Comparison of International Reserve Ratios By Cheung, Yin-Wong; Yuk-Pang Wong, Clement
  15. Efectos de valoración en la posición de inversión internacional de España By Arturo Macías; Álvaro Nash
  16. Real Interest Parity in the EU and the Consequences for Euro Area Membership: Panel Data Evidence, 1979-2005 By Martin O'Brien
  17. Liquidity, Redistribution, and the Welfare Cost of Inflation By Jonathan Chiu; Miguel Molico
  18. Measuring Long-Run Exchange Rate Pass-Through By de Bandt, Olivier; Banerjee, Anindya; Kozluk, Tomasz
  19. Multilateral Adjustment and Exchange Rate Dynamics: The Case of Three Commodity Currencies By Jeannine Bailliu; Ali Dib; Takashi Kano; Lawrence Schembri
  20. Synchronisation and Staggering of Deposit Account Interest Rate Changes By John K. Ashton
  21. Two plus two equals six: an alternative explanation of why so many goods prices end in nine By Nigel W. Duck
  22. Pairwise-core Monetary Trade in the Lagos-Wright Model By Tai-wei Hu; John Kennan; Neil Wallace
  23. On Policy Relevance of Ramsey Tax Rules By Selim, Sheikh
  24. Search Frictions on Product and Labor markets : Money in the Matching Function By Etienne, LEHMANN; Bruno, VAN DER LINDEN
  25. The Great Depression in Belgium from a Neo-Classical Perspective By Luca, PENSIEROSO

  1. By: Laurence J. Kotlikoff (Department of Economics, Boston University and the National Bureau of Economic Research)
    Abstract: Is the U.S. bankrupt? Or to paraphrase the Oxford Dictionary, is the U.S. at the end of its resources, exhausted, stripped bear, destitute, bereft, wanting in property, or wrecked in consequence of failure to pay its creditors? Many would scoff at this notion. They’d point out that the country has never defaulted on its debt, that its debt-to-GDP ratio is substantially lower than that of Japan and other developed countries, that its long-term nominal interest rates are historically low, that the dollar is the world’s reserve currency, and that China, Japan, and other countries have an insatiable demand for U.S. Treasuries. Others would argue that the official debt reflects nomenclature, not fiscal fundamentals, that the sum total of official and unofficial liabilities is massive, that federal discretionary spending and medical expenditures are exploding, that the U.S. has a history of defaulting on its official debt via inflation, that the government has cut taxes well below the bone, that countries now holding U.S. government bonds can sell them in a nanosecond, that the financial markets have a long and impressive record of mispricing securities, and that financial implosion is just around the corner. This paper explores these views from both partial and general equilibrium perspectives. It concludes that countries can go broke, that the U.S. is going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of U.S. fiscal institutions is essential to secure the nation’s economic future. The paper offers three policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy. The policies would replace the current tax system with a retail sales tax, personalize Social Security, and move to a globally budgeted universal healthcare system implemented via individual-specific health insurance vouchers. The radical nature of these proposals reflects the critical nature of our time. Unless the U.S. moves quickly to fundamentally change and restrain its fiscal behavior, its bankruptcy will become a foregone conclusion.
    Date: 2007–03
  2. By: William Coleman
    Abstract: The paper advances a simple and tractable Wicksellian model of inflation, in which the price level is determined by the interaction of the nominal rate of return on capital with a rule that governs the interest rate at which the Central Bank supplies money, and in which the equality of the supply of money with its demand has no explanatory role to play.
    Keywords: Wicksell, inflation, monetary policy, central banks
    JEL: E31 E52 E58
    Date: 2007–07
  3. By: Jack Selody; Carolyn Wilkins
    Abstract: The authors analyze the extent to which inflation-targeting frameworks should incorporate flexibility in order to respond to asset-price misalignments and other atypical events. They examine the costs and benefits of adding flexibility to the Bank's current inflation-targeting framework, and conclude that maintaining low and stable consumer price inflation is the best contribution that monetary policy can make to promoting economic and financial stability, although some flexibility in the target horizon may allow monetary policy to deal appropriately with asset-price bubbles and other atypical events. The authors suggest that monetary policy may, in principle, be better able to maintain low and stable consumer price inflation by leaning against an asset-price bubble (even though it may mean that inflation deviates longer than usual from its target), when such an event is well identified and likely to have significant real economic effects. This circumstance is likely to be rare in practice, however, because economists are far from being able to determine consistently and reliably when leaning against a particular bubble is likely to be successful. The authors also describe ongoing Bank research to better understand the transmission of asset prices to the real economy and the interaction between asset prices and optimal monetary policy.
    Keywords: Monetary policy framework; Inflation targets
    JEL: E5 E6
    Date: 2007
  4. By: Peter Hoerdahl; Oreste Tristani
    Abstract: This paper estimates the size and dynamics of inflation risk premia in the euro area, based on a joint model of macroeconomic and term structure dynamics. Information from both nominal and index-linked yields is used in the empirical analysis. Our results indicate that term premia in the euro area yield curve reflect predominantly real risks, i.e. risks which affect the returns on both nominal and index-linked bonds. On average, inflation risk premia were negligible during the EMU period but occasionally subject to statistically signifcant fluctuations in 2004-2006. Movements in the raw break-even rate appear to have mostly reflected such variations in inflation risk premia, while long-term inflation expectations have remained remarkably anchored from 1999 to date.
    Keywords: Term structure of interest rates, inflation risk premia, central bank credibility
    Date: 2007–05
  5. By: Rhodes, James; Yoshino, Naoyuki
    Abstract: This paper surveys the postwar evolution of Bank of Japan (BOJ) monetary policy. Using both qualitative and quantitative data, we describe the changes in the money supply process in response to changing institutional constraints. We focus on the transition from quantitative to qualitative control mechanisms, illuminating, in particular, the important role of the BOJ’s lending guidance (window guidance) in the early periods and financial liberalization in subsequent periods. Monetary policy reaction functions are estimated and used to verify major changes in policy instruments, targets, and indicators.
    Keywords: Japanese Monetary Policy
    JEL: E52 E51
    Date: 2005
  6. By: Mihov, Ilian; Rose, Andrew K.
    Abstract: We compare the duration and performance of different monetary regimes, especially the contrast between countries those that fix exchange rates and those that target inflation. Inflation targeting is a more durable policy; no country has yet been forced to abandon an inflation target, while many have abandoned fixed exchange rates. Indeed, even though inflation targeting began only in 1990, the duration of inflation targeting regimes is at least as long as, or longer than all alternative monetary regimes for comparable countries. Regime duration also matters in monetary policy; older regimes are typically more successful than younger ones in achieving low inflation.
    Keywords: empirical, panel, exchange, rate, inflation, policy, data, success, target, filter, time
    JEL: E52 E58
    Date: 2007
  7. By: Beechey, Meredith (Monetary Affairs Division); Österholm, Pär (Department of Economics)
    Abstract: This paper estimates the path of inflation persistence in the United States over the last 50 years and draws implications about the evolution of the Federal Reserve's monetary-policy preferences. Standard models of central bank optimization predict that the central bank's preference for output stability is a determinant of inflation persistence. Hence, time variation of that preference should be reflected in changes in inflation persistence. We estimate an ARMA(1,q) model with a time-varying autore- gressive parameter for monthly U.S. inflation data from 1955 to 2006.The coefficients provide an estimate of the inflation target and the path of inflation persistence. The estimated inflation target over the sample is approximately 2.8 percent and we find that inflation persistence declined substantially during Volcker and Greenspan's tenures to a level significantly less than one and significantly below that of the 1970s and early 1980s.
    Keywords: Monetary policy; Central bank preferences; Inflation persistence; Time-varying parameters; Kalman filter
    JEL: E52 E58
    Date: 2007–07–12
  8. By: Qin, Duo
    Abstract: This study explores a new modelling approach to bridge the gap between the bilateral setting of one ‘domestic’ economy facing one ‘foreign’ entity in theory and multilateral country data in reality. Under the approach, purchasing power parity (PPP) is embedded in latent disequilibrium factors, being extracted from a large set of bilateral price disparities; the factors are then used as error-correction leading indicators to explain exchange rate and inflation. Modelling experiments on five OECD countries using monthly data show promising results, which reverse the common belief that PPP is at best a very long-run relationship at the macro level.
    Keywords: PPP, law of one price, dynamic factor, error correction
    JEL: C22 C33 F31
    Date: 2007
  9. By: Michael Evers
    Abstract: In the literature on international monetary policy, the paradigm is that gains from coordination are fairly small. Monetary policy is conducted to stabilize macroeconomic fluctuations and gains from policy coordination arise from preventing national monetary authorities from strategically manipulating the terms of trade by means of these stabilization policy instruments. However, as it has been emphasized by \cite{lucas:2003a}, welfare gains from stabilizing fluctuations are generically small since they are of second order. In this paper, I develop a dynamic stochastic two-country model with sticky wages and a cash-in-advance restriction which is in the spirit of the New Open Economy Macroeconomics framework. In this environment, monetary authorities can manipulate the terms of trade by conducting a general short-run monetary policy using both the nominal interest rate and the money supply. The money supply affects the terms of trade by altering the nominal exchange rate ex post and it is used in the traditional way so as to stabilize macroeconomic fluctuations. The nominal interest rate affects the terms of trade by changing expected inflation ex ante. Self-oriented national policymakers use the nominal interest rates to raise the terms of trade ex ante. This leads to an inefficient inflation tax whose welfare effects are of first order. Consequently, gains from monetary policy coordination are of first order.
    Keywords: International Policy Coordination, General Short-Run Monetary Policy, New Open Economy Macroeconomics
    JEL: F41 F42
  10. By: Michael P. Evers
    Abstract: In this paper, I argue that international policy coordination requires to include both monetary as well as fiscal policy because both sides include policy instruments that allow the strategic manipulation of the country's terms of trade. Hence, the coordination of one part of national macroeconomic policies through an international agreement still leaves room for national authorities to still unilaterally manipulate the terms of trade by means of different policy instruments. In a simple and tractable dynamic stochastic two-country sticky-wage model in line with the recent New Open Economy Macroeconomics it is demonstrated that potential gains from international policy coordination are squandered if policymakers only cooperate on monetary policy. Moreover, by letting the fiscal policy instruments be chosen non-cooperatively, monetary policy coordination might even create welfare losses as compared to no macroeconomic policy coordination at all.
    Keywords: International Policy Coordination; Monetary and Fiscal Policy Interaction; Beggar-Thy-Neighbor; New Open Economy Macroeconomics
    JEL: F41 F42 E62 E63
  11. By: Rod Tyers; Jane Golley; Iain Bain
    Abstract: International pressure to revalue China’s currency stems in part from the expectation that rapid economic growth should be associated with a real exchange rate appreciation. This hinges on the Balassa-Samuelson hypothesis under which economic growth, stemming from improvements in traded sector productivity, causes non-traded prices to rise. The puzzle is that, while evidence on China’s productivity and prices supports this hypothesis, its real exchange rate has shown no long run tendency to appreciate. Resolution requires extension of the hypothesis to allow for effects on the real exchange rate due to non-traded productivity improvements or, in association with failures of the law of one price for traded goods, labour supply growth and growth-related demand switches due to changes in financial capital flows and trade distortions. The sensitivity of China’s real exchange rate to these determinants is reviewed with the results confirming that financial and capital outflows are dominant depreciating forces in the short run. Along with WTO accession trade reforms, it is shown that the heretofore rising surplus of Chinese domestic saving over its investment has restrained the real exchange rate from appreciating since the late 1990s.
    JEL: C68 C53 E27 F21 F43 F47 O11
    Date: 2007–06
  12. By: Rod Tyers; Jane Golley
    Abstract: International pressure to revalue China’s currency stems in part from the expectation that rapid economic growth should be associated with a real exchange rate appreciation. This hinges on the Balassa-Samuelson hypothesis under which economic growth, stemming from improvements in traded sector productivity, causes non-traded prices to rise. More generally, real depreciations can stem from non-traded productivity improvements or, in association with failures of the law of one price for traded goods, labour supply growth and growth-related demand switches due to changes in the saving rate, trade distortions or investment risk premia. This chapter examines the sensitivity of China’s real exchange rate to these determinants. The results confirm that financial capital inflows are a dominant appreciating force in the short run, helping to explain why it is the surplus of Chinese domestic saving over its investment that has restrained the real exchange rate from appreciating during the past decade. In the long term, the appreciating effect of the inevitable fall in the saving rate is likely to be at least partially offset by the depreciating effects of skill acquisition and services productivity growth. Indeed, if future Chinese growth is propelled by these factors, a long term real depreciating trend could be in store.
    JEL: C68 C53 E27 F21 F43 F47 J11 J13 J26 O11
    Date: 2007–05
  13. By: Lahtinen, Markus; Mäki-Fränt, Petri
    Abstract: Using a New Keynesian macro model, the paper reconsiders the question, whether the central banks should directly respond to exchange rate movements. It is assumed that the transmission of monetary policy to output is carried out by the long-term interest rate, which is determined as a sum of expectations of short-term interest rates and a non-negligible term premium. According to the results, the central banks could gain from stabilizing the exchange rate movements more than suggested in the previous literature. The welfare gains are more clearly seen in the reduced volatility of inflation than stabilization of output, however.
    Keywords: Open economy, Exchange rate determination, Monetary policy
    JEL: E32 E52 E58
    Date: 2007
  14. By: Cheung, Yin-Wong; Yuk-Pang Wong, Clement
    Abstract: Using available annual data of 174 economies since 1957, we examine the similarities and differences of seven international reserve ratios. While individual international reserve ratios display substantial variations across economies, they are associated with an economy’s characteristics including geographic location, income level, stage of development, degree of indebtedness, and exchange rate regime. The association pattern varies across time and type of international reserve ratios. Interestingly, there is only limited evidence that Asian and non-Asian economies have significantly different international reserve hoarding behavior. Our results suggest that the inference about whether an economy is hoarding too many or too few international reserves depends on the choice of international reserve ratio. Further, different international reserve ratios exhibit different persistence profiles, but the evidence of dependence on structural characteristics is rather weak.
    Keywords: International Reserve Ratios, Structural Characteristics, Cross-Economy Analysis
    JEL: F30 F40
    Date: 2007
  15. By: Arturo Macías (Banco de España); Álvaro Nash (Banco Central de Chile)
    Abstract: The International Investment Position records the value of foreign assets and liabilities of an economy in a given date. Its evolution is determined by the financial transactions of the Balance of Payments, which affects the volume of assets and liabilities, by differences in the valuation of the stock, derived from changes in prices or exchange rates, and by other adjustments, that are primarily reclassifications of foreign assets. The objective of this article is to compute the price and exchange rate effects implicit in the evolution of the International Investment Position of Spain, taking into account its possible limitations. The valuation effects are determined by the characteristics of the financial instrument and the information sources available for every heading of the IIP. In this article, disaggregated data by denomination currency of the instrument are used for every heading. On the other hand, for portfolio investment, asset-by-asset data available for 2003 and 2004 are used. In addition, for IED data, which are mainly not recorded at market price (and given that price changes for those instruments between 1993 and 2006 have been substantial), it is developed a methodology in order to reconstruct the value of IED assets and liabilities, including the valuation associated with price changes. The conclusions of this work for the Spanish case provide evidence that stock revaluation explains a very important share of the IIP changes for the latest years. The 55% of the increase of the IIP between 1993 and 2004 is related to value changes due to price or exchange rate changes. The accumulation of these value changes is equal to the 19% of the GDP of the year 2004. The decomposition of this effect between price effect and exchange rate effect can be estimated for 1997-2004 period, and the increase in the net IIP debt position (247.930 million euros) can be explained in a 52% by Balance of Payments transactions, and 47.3% is the result of revaluation of the instruments and other adjustments. This 47.3% can be decomposed in a 27.6% due to price effects, 10.1% due to exchange rate effects and the remaining 9.6% is the result of other non determined variations.
    Keywords: posición de inversión internacional, balanza de pagos, efecto valoración, inversión exterior directa, international investment position, balance of payments, valuation effects, foreign direct investment
    JEL: F10 F20 F40
    Date: 2007–08
  16. By: Martin O'Brien (Economic and Social Research Institute (ESRI))
    Abstract: This paper examines whether macroeconomic convergence is an automatic outcome of forming a currency union by combining an analysis of real interest parity (RIP) in the EU with the argument for the endogeneity of the Optimum Currency Area (OCA) criteria. Using the DF-GLS and the CIPS* panel unit root test, RIP is tested for a sample of Euro area and non-Euro area EU member states with respect to Germany for key sub-periods covering 1979 M3 – 2005 M12. RIP is not found to hold for most of the sample between 1979 M3 and 1998 M12. There is evidence in favour of RIP for most of the Euro area sample during the 1999 M1 – 2005 M12 sub-period, exceptions being Ireland, Italy and Spain. RIP does not hold for any of the non-Euro area countries during the same period. This indicates some support for the endogeneity hypothesis, with the caveat that certain country-specific issues can seriously hinder the “automatic” integration process.
    Date: 2007–03
  17. By: Jonathan Chiu; Miguel Molico
    Abstract: This paper studies the long run welfare costs of inflation in a micro-founded model with trading frictions and costly liquidity management. Agents face uninsurable idiosyncratic uncertainty regarding trading opportunities in a decentralized goods market and must pay a fixed cost to rebalance their liquidity holdings in a centralized liquidity market. By endogenizing the participation decision in the liquidity market, this model endogenizes the responses of velocity, output, the degree of market segmentation, as well as the distribution of money. We find that, compared to the traditional estimates based on a representative agent model, the welfare costs of inflation are significantly smaller due to distributional effects of inflation. The welfare cost of increasing inflation from 0% to 10% is 0.62% of income for the U.S. economy and 0.20% of income for the Canadian economy. Furthermore, the welfare cost is generally non-linear in the rate of inflation, depending on the endogenous responses of the liquidity market participation to inflation and liquidity management costs.
    Keywords: Inflation: costs and benefits
    JEL: E40 E50
    Date: 2007
  18. By: de Bandt, Olivier; Banerjee, Anindya; Kozluk, Tomasz
    Abstract: The paper discusses the issue of estimating short- and long-run exchange rate pass-through to import prices in euro area countries and reviews some problems with the measures recently proposed in the literature. Theoretical considerations suggest a long-run Engle and Granger cointegrating relationship (between import unit values, the exchange rate and foreign prices), which is typically ignored in existing empirical studies. We use time series and up-to-date panel data techniques to test for cointegration with the possibility of structural breaks and show how the long-run may be restored in the estimation. The main finding is that allowing for possible breaks around the formation of EMU and the appreciation of the euro starting in 2001 helps restore a long run cointegration relationship, where over the sample period the fixed component of the pass-through decreased while the variable component tended to increase.
    Keywords: exchange rates, pass-through, import prices, panel cointegration, structural break
    JEL: C23 F14 F31 F36 F42
    Date: 2007
  19. By: Jeannine Bailliu; Ali Dib; Takashi Kano; Lawrence Schembri
    Abstract: In this paper, we empirically investigate whether multilateral adjustment to large U.S. external imbalances can help explain movements in the bilateral exchange rates of three commodity currencies -- the Australian, Canadian and New Zealand (ACNZ) dollars. To examine the relationship between exchange rates and multilateral adjustment, we develop a new regimeswitching model that augments a standard Markov-switching framework with a threshold variable. This enables us to model the exchange rate dynamics of our commodity currencies in the context of two regimes: one in which multilateral adjustment to large U.S. external imbalances is an important factor driving the commodity currencies and the second in which there are no significant U.S. external imbalances and hence multilateral adjustment is not a factor. We compare the performance of this model, both in and out-of-sample, to several other alternative models. In addition to developing this new model, another distinguishing feature of our paper is that we estimate all of our models using a Bayesian approach. We opt for a Bayesian approach in this context because it provides a simpler and more intuitive means of evaluating and comparing our different non-nested models. Moreover, it is relatively straightforward using a Bayesian approach to evaluate the importance of nonlinearities in the relationship between exchange rates and multilateral adjustment. Our findings suggest that during periods of large U.S. imbalances, fiscal and external, an exchange rate model for the ACNZ dollars should allow for multilateral adjustment effects. Moreover, we also find evidence to suggest that the adjustment of exchange rates to multilateral adjustment factors is best modelled as a non-linear process.
    Keywords: Exchange rates; Econometric and statistical methods
    JEL: F31 F32 C11 C22
    Date: 2007
  20. By: John K. Ashton (Centre for Competition Policy, University of East Anglia)
    Abstract: This study examines the frequency and form of deposit account interest rate change. Specifically, the question of whether depost rate change is synchronised with other banks or staggered at periodic intervals is addressed. Overall, evidence consistent with individual banks changing deposit interest rates in a staggered manner is recorded. Further, larger banks are seen to change interest rates in a more synchronised manner than smaller banks. Lastly, when banks offer multiple deposit accounts, these products' interest rates are generally changes simultaneously by individual banks. These findings extend the current understanding of deposit interest rate change, and indicate that UK deposit interest rate setting is relatively rigid.
    Keywords: Retail banking, interest rates, staggering, synchronisation
    JEL: G21
    Date: 2007–01
  21. By: Nigel W. Duck
    Abstract: The prevalence of prices ending in 99 cents is explained as the result of rational consumers rounding prices up. Monopolists are shown to be harmed by this practice whereas consumers may gain. The model is compared with two other models: Basu's (1997) model and one which assumes consumers round prices down.
    Keywords: Consumer rationality, price perception, pricing
  22. By: Tai-wei Hu; John Kennan; Neil Wallace
    Abstract: The Lagos-Wright model has been analyzed using particular trading protocols. Here, weakly and strongly implementable allocations are studied, where weak and strong are used in the sense of (weak) Nash (immune to individual defection) and strong Nash (immune to individual and cooperative pairwise defection). It is shown that the first-best allocation is strongly implementable without intervention for all sufficiently high discount factors. And, if people are free to skip the centralized meeting, then Friedman-rule intervention that uses lump-sum taxation in the centralized meeting to raise the return on money does not enlarge even the set of weakly implementable allocations.
    JEL: E40
    Date: 2007–08
  23. By: Selim, Sheikh
    Abstract: The Ramsey approach to optimal taxation and Ramsey tax rules have amassed substance in economic theory. However, they are often criticized on grounds of practicality, fairness, feasibility and some other aspects of designing actual tax policy. This paper presents a collection of these views; it discusses how closely or remotely Ramsey rules are followed in designing tax policy. It presents some recent tax reforms in the US and in the UK that have closely, if not completely, followed the principle of distortion minimization. Despite the widely speculated difficulty associated with mapping normative tax rules into positive policy design, it is possible to implement taxes that have strong correspondence to Ramsey tax formulas. This paper also discusses why some implemented tax rules lack consistency with Ramsey principles, or why it is often difficult to establish correspondence between some implemented taxes and Ramsey tax rules.
    Keywords: Optimal Taxation, Policy Relevance, Ramsey Tax Rules
    JEL: E61 E62 H21 H30
    Date: 2007
  24. By: Etienne, LEHMANN; Bruno, VAN DER LINDEN (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics)
    Abstract: This paper builds a macroeconomic model of equilibrium unemployment in which firms persistently face difficulties in selling their production and this affects their decisions to create jobs. Due to search-frictins on the product market, equilibrium unemployment is a U-shaped function of the ratio of total demand to total supply on this market. When prices are at their Competitive Search Equilibrium values, the unemployment rate is minimized. Yet, the Competitive Search Equilibrium is not efficient. Inflation is detrimental to unemployment.
    Keywords: Equilibrium unemployment, Matching, Inflation, Demand Constraints
    JEL: E12 E24 E31 J63
    Date: 2007–03–28
  25. By: Luca, PENSIEROSO (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics)
    Abstract: This paper casts the Belgian Great Depression of the 1930s within a dynamic stochastic general equilibrium (DSGE) framework. Results show that a total factor productivity shock within a standard real business cycle model is unsatisfactory. Introducing war expectations in the baseline model produces little improvement. Given the evidence on sticky wages put forward by historians, it shows that a simple DGSE model with sticky wages ˆ la Taylor improves on the result.
    Keywords: Great Depression; Belgium; sticky wages; dynamic stochastic general equilibrium
    JEL: E13 N14
    Date: 2007–08–02

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