nep-mac New Economics Papers
on Macroeconomics
Issue of 2005‒03‒13
27 papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Wage formation under low inflation By Steinar Holden
  2. Large T and small N : A three-step approach to the identification of cointegrating relationships in time series models with a small cross-sectional dimension. By Roger Hammersland
  3. Savers, Spenders and Fiscal Policy in a Small Open Economy By Egil Matsen; Tommy Sveen; Ragnar Torvik
  4. Who was in the driving seat in Europe during the nineties, International financial markets or the BUBA? By Roger Hammersland
  5. A structural cointegrating VAR approach to macroeconometric modelling By A Garratt; K Lee; M H Pesaran; Yongcheol Shin
  6. Competitive Equilibrium Hyperinflation under Rational Expectations By Fernando de Holanda Barbosa; Alexandre Barros da Cunha; Elvia Mureb Sallum
  7. Public Debt Indexation and Denomination, The Case of Brazil: A Comment By Rubens Penha Cysne
  8. Central bank power is a matter of faith By Bengtsson, Ingemar
  9. Econometric Inference, Cyclical Fluctuations, and Superior Information By Michel Normandin
  10. Updating the UK's code for fiscal stability By Carl Emmerson; Chris Frayne; Sarah Love
  11. Fiscal Policy Rules and Regime (In)Stability: Evidence from the U.S. By Carlo Favero; Tommaso Monacelli
  12. Monetary Policy in Real Time By Domenico Giannone; Lucrezia Reichlin; Luca Sala
  13. Inflation Adjustment and Labour Market Structures: Evidence from a Multi-Country Study By Nunziata, Luca; Bowdler, Christopher
  14. Regionalism in West Africa: Do Polar Countries Reap the Benefits? A Role for Migration By Konseiga, Adama
  15. A less effective monetary transmission in the wake of EMU? Evidence from lending rates pass-through By Gianluca Di Lorenzo; Giuseppe Marotta
  16. Estimating Life-Cycle Parameters from Consumption Behavior at Retirement By John Laitner; Dan Silverman
  17. Stocks, Bonds, Money Markets and Exchange Rates: Measuring International Financial Transmission By Michael Ehrmann; Marcel Fratzscher; Roberto Rigobon
  18. Monetary Policy with Judgment: Forecast Targeting By Lars E.O. Svensson
  19. Explaining Returns with Cash-Flow Proxies By Peter Hecht; Tuomo Vuolteenaho
  20. A model of Equilibrium Exchange Rates for the New Zealand and Australian dollar By Simon Wren-Lewis
  22. Measuring the Institutional Change of the Monetary Regime in a Political Economy Perspective (Groups of interest and monetary variables during the Currency Board introduction in Bulgaria) By Nikolay Nenovsky; Yorgos Rizopoulos
  23. Inflation Targeting, Between Rhetoric and Reality. The Case of Transition Economies By Daniel Daianu; Laurian Lungu
  24. Targeting Relative Inflation Forecast as Monetary Policy Framework for Adopting the Euro By Lucjan T. Orlowski
  25. Existence of solutions in continuous-time optimal growth models By Hippolyte d'Albis; Pascal Gourdel; Cuong Le Van
  26. Elasticity of Substitution between Capital and Labor and its applications to growth and development By Samuel de Abreu Pessoa; Silvia Matos Pessoa; Rafael Rob
  27. Second-Best Optimal Taxation of Capital and Labor in a Developing Economy By Cecilia Garcia Penalosa; Stephen J. Turnovsky

  1. By: Steinar Holden (University of Oslo and Norges Bank)
    Abstract: This paper reviews the literature on the effects of low steady-state inflation on wage formation, focusing on four different effects. First, under low inflation, downward nominal wage rigidity (DNWR) may prevent real wage cuts that would have happened had inflation been higher. Second, wages (and prices) are given in nominal contracts, and inflation affects both how often wages are adjusted, and to what extent wages are set in a forward-looking manner. Third, incomplete labour contracts may provide workers with scope for inflicting costs on the firm without violating the contract, thus forcing the firm to accept a rise in nominal wages. Fourth, if effort depends on wages relative to a reference level, and workers and firms underweight inflation when updating the reference level, positive but moderate inflation may reduce wage pressure. The paper ends by a brief survey of empirical evidence, and a discussion of whether labour markets may adapt to a low inflation environment.
    Keywords: wage formation, nominal contracts, downward nominal wage rigidity, inflation
    JEL: J5 J3 E31
    Date: 2004–11–10
  2. By: Roger Hammersland (Norges Bank)
    Abstract: This paper addresses cointegration in small cross-sectional panel data models. In addition to dealing with cointegrating relationships within the cross-sectional dimension, the paper explicitly addresses the issue of cointegration between cross-sections. The approach is based upon a well-known distributional result for the trace test when some of the cointegrating vectors are a priori known, and advocates a three-step procedure for the identification of the cointegrating space when dealing with two-dimensional data. The first step of this procedure utilizes traditional techniques to identify the long-run relationships within each cross-sectional unit separately. In the second step these first step relationships are then treated as known when searching for potential long run relationships between units in a joint analysis comprising the whole cross-sectional dimension. The third step of the procedure then finally reestimate all free parameters of the identified long-run structure to get rid of a potential simultaneity bias as a result of a non-diagonal covariance matrix. Identification of the long-run structures of Norwegian exports and international interest rate relationships are used as examples. Norwegian mainland exports have here been divided into two cross-sectional units; the traditional goods sector and the service sector. While in the study of international interest rate relationships the two sectors investigated are Germany and the US. The examples are used to address the more general issues of the degree of independence in capital markets and in goods markets of small open economies.
    Keywords: Cointegration, Panel data, transmission mechanism, monopolistic competition, exports
    JEL: C32 C33 E43 F12 F41
    Date: 2004–11–12
  3. By: Egil Matsen (Norwegian University of Science and Technology and Norges Bank); Tommy Sveen (Norges Bank); Ragnar Torvik (Norwegian University of Science and Technology and Norges Bank)
    Abstract: This paper analyzes the effects of fiscal policy in an open economy. We extend the savers-spenders theory of Mankiw (2000) to a small open economy with endoge- nous labor supply. We first show how the Dornbusch (1983) consumption-based real interest rate for open economies is modified when labor supply is endogenous. We then turn to the effects of fiscal policy when there are both savers and spenders. With this heterogeneity taken into account, tax cuts have a short-run contractionary effect on domestic production, and increased public spending has a short-run expan- sionary effect. Although consistent with recent empirical work, this result contrasts with those of most other theoretical models. Transitory changes in demand have per- manent real effects in our model, and we discuss the implications for real exchange- rate dynamics. We also show how "rational" savers may magnify or dampen the responses of "irrational" spenders, and show how this is related to features of the utility functions.
    Keywords: rule-of-thumb consumers, fiscal policy, open economy
    JEL: E21 E62 F41
    Date: 2004–12–29
  4. By: Roger Hammersland (Norges Bank)
    Abstract: The purpose of this paper is to reexamine empirically the relationship between long-term interest rates in well integrated ?nancial markets. The analysis focuses on long-term interest rates in the US and Germany and has been carried out within the framework of a ?ve dimensional VAR for the simultaneous determination of short- and long-term interest rates in the US and Germany and the rate of exchange rate depreciation. The results strongly support the existence of a long-run relationship between the long-term German and the longterm US interest rate and imply a full pass-through of changes in the long-term US rate into the corresponding German rate. The analysis also substantiates that the direction of causality goes from the longterm US to the long-term German interest rate. With regard to the possibility of controlling the long end of the market on the part of the Bundesbank, the paper apparently takes on a rather pessimistic view, as there is nothing to indicate a long-run relationship between shortand long-term German interest rates. However, the strong in?uence that short-term German interest rates exhibit on German long-term interest rates in the very short run according to the structural model of this paper, might be taken to indicate that the opposite is the case, as e ects originating from expectations of future short-term interest rates might totally neutralize an unequivocally positive short-run portfolio e ect in the long run. If this is the case, there is nothing strange to the fact that one is unable to identify a long-run relationship between short- and long-term German interest rates. On the contrary, it is exactly what to be expected if the monetary transmission mechanism works appropriately.
    Keywords: Cointegration, Simultaneous Equation Models, International Interest Rate Linkages, Transmission Mechanism
    JEL: C32 E43 E52 E58
    Date: 2004–12–31
  5. By: A Garratt; K Lee; M H Pesaran; Yongcheol Shin
    Abstract: In this paper we discuss the 'structural cointegrating VAR' approach to macroeconometric modelling and compare it to other approaches currently followed in the literature, namely the large-scale simultaneous equation macroeconometric models, the structural VARs, and the dynamic stochastic general equilibrium models. The structural cointegrating VAR approach has the attractive features that the estimated long-run relationships embedded in the model are theory consistent, and have a clear economic interpretation, and yet the short-run dynamics are flexibly estimated within a VAR framework. The approach is illustrated using a small quarterly macroeconometric model of the UK. The uses of the model in impulse response analysis and probability forecasting is also discussed.
    Keywords: Structural Cointegrating VAR, Macroeconomic Modelling, Generalised Impulse Responses, Persistence Profiles, Probability Forecasts.
    JEL: C32 C5 E17
  6. By: Fernando de Holanda Barbosa (EPGE/FGV); Alexandre Barros da Cunha; Elvia Mureb Sallum
    Date: 2005–01
  7. By: Rubens Penha Cysne (EPGE/FGV)
    Date: 2005–03
  8. By: Bengtsson, Ingemar (Department of Economics, Lund University)
    Abstract: This paper reconsiders how central banks get involved in the process of determining nominal variables such as market interest rates and inflation rates. It is argued that the traditional story deriving central bank power from its monopoly of issuing base money is flawed. That story - in its various guises - is based on the quantity equation. This equation, however, is only applicable in the hypothetical only-cash-world, i.e. in a world where all transactions has to be paid for with central bank issued notes and coins. Nevertheless, the vast majority of economists would agree that, in practice, central banks seem to influence interest and inflation rates. Here, we suggest that the explanation is that central banks have acquired a role as focal point for those variables. It is possible because interest setting is a coordination game, in which agents have to predict each others expectations.
    Keywords: entral Banking; Focal Points; Inflation; Monetary Policy; Money; Quantity Theory
    JEL: C70 E31 E42 E43 E44 E51 E52 E58
    Date: 2005–03–04
  9. By: Michel Normandin (IEA, HEC Montréal)
    Abstract: This paper presents and assesses a procedure to estimate conventional parameters characterizing fluctuations at the business cycle frequency, when the economic agents’ information set is superior to the econometrician’s one. Specifically, we first generalize the conditions under which the econometrician can estimate these ‘cyclical fluctuation’ parameters from augmented laws of motion for forcing variables that fully recover the agents’ superior information. Second, we document the econometric properties of the estimates when the augmented laws of motion are possibly misspecified. Third, we assess the ability of certain information criteria to detect the presence of superior information.
    Keywords: Block bootstrap; Hidden variables; Laws of motion for forcing variables; Monte Carlo simulations.
    JEL: C14 C15 C32 E32
    Date: 2004–12
  10. By: Carl Emmerson (Institute for Fiscal Studies); Chris Frayne (Institute for Fiscal Studies); Sarah Love (Institute for Fiscal Studies)
    Abstract: The 1998 Code for Fiscal Stability sets out the framework within which UK fiscal policy is now set. While having such a code does not make it easier for a Government to meet its fiscal objectives, it may improve the economic credibility of the policy process. To date the Code has generally worked well, and in any case many of the Treasury’s practices exceed the minimum requirements of the Code. However, improvements could be made in the light of recent experiences. In particular it would be preferable for less emphasis to be placed on the precise forecasts for fiscal aggregates and greater emphasis to be placed on the magnitude of the risks to those forecasts. Using the projections contained in the March 2004 Budget, and information on the size of errors made in the past, we estimate that there is now a 60% chance that the Chancellor’s “golden rule” will be met without further tax increases or spending cuts. This compares to 74% for the forecast made by the Treasury 12 months earlier. As well as clarifying how cautious forecasts are, the uncertainty surrounding projections for fiscal aggregates also has implications for the way in which progress towards any fiscal rules should be interpreted.
    JEL: E62 H62
    Date: 2004–11
  11. By: Carlo Favero; Tommaso Monacelli
    Abstract: We employ Markov-switching regression methods to estimate fiscal policy feedback rules in the U.S. for the period 1960-2002. Our approach allows to capture policy regime changes endogenously. We reach three main conclusions. First, fiscal policy may be characterized, according to Leeper (1991) terminology, as active from the 1960s throughout the 1980s, switching gradually to passive in the early 1990s and switching back to active in early 2001. Second, regime-switching fiscal rules are capable of tracking the time-series behaviour of the U.S. primary deficit better than rules based on a constant parameter specification. Third, regime-switches in monetary and fiscal policy rules do not exhibit any degree of synchronization. Our results are at odds with the view that the post-war U.S. fiscal policy regime may be classified as passive at all times, and seem to pose a challenge for the specification of the correct monetary-fiscal mix within recent optimizing macroeconomic models considered suitable for policy analysis.
  12. By: Domenico Giannone; Lucrezia Reichlin; Luca Sala
    Abstract: We analyse the panel of the Greenbook forecasts (sample 1970-1996) and a large panel of monthly variables for the US (sample 1970-2003) and show that the bulk of dynamics of both the variables and their forecasts is explained by two shocks. Moreover, a two factor model which exploits, in real time, information on many time series to extract a two dimensional signal, produces a degree of forecasting accuracy of the federal funds rate similar to that of the markets, and, for output and inflation, similar to that of the Greenbook forecasts. This leads us to conclude that the stochastic dimension of the US economy is two. We also show that dimension two is generated by a real and nominal shock, with output mainly driven by the real shock and inflation by the nominal shock. The implication is that, by tracking any forecastable measure of real activity and price dynamics, the Central Bank can track all fundamental dynamics in the economy.
  13. By: Nunziata, Luca (Nuffield College, Oxford, University of Milan and IZA Bonn); Bowdler, Christopher (Nuffield College, Oxford)
    Abstract: An empirical analysis of the impact of labour market structures on the response of inflation to macroeconomic shocks is presented. Results based on a 20 country panel show that if labour market coordination is high, the effect on inflation of movements in unemployment, import prices, tax rates and productivity is dampened, both on impact and dynamically. In contrast, monopoly power in labour supply, measured by the percentage unionisation of the workforce, appears to amplify the response of inflation to its reduced form determinants. These findings are attributed to the behaviour of wages following movements in demand- and supply-side conditions.
    Keywords: inflation, input price shocks, labour market coordination, trade union density
    JEL: E31 J51
    Date: 2005–03
  14. By: Konseiga, Adama (Center for Development Research (ZEF) and IZA Bonn)
    Abstract: In the present globalization era an increasing attention is paid to the ambiguous relationship between international migration, brain drain, and economic growth, but few papers analyzed the growth impact of skilled migration. The paper filled the research gap by building the first dataset on brain drain from seven countries of the western African Union (WAEMU) and highlighted the size of the brain loss toward Côte d’Ivoire and France. Burkina Faso shows a more severe brain drain to Cote d’Ivoire compare to other similar sahelian countries whereas the reverse holds when considering the destination France. The subsequent empirical strategy consists in comparing the growth performance of an economy without migration to the counterpart economy. The regional growth convergence analysis shows higher convergence rate once the brain circulation is accounted for. However, the effect of brain gain holds only for countries with migration outside WAEMU toward an industrialized country (France) and failed when migration, as is the case for Burkina Faso, flows into Cote d’Ivoire the polar economy of the Union. Therefore, migration can be used as a powerful force working toward income convergence between capital-rich and capital-poor countries.
    Keywords: economic growth, brain drain, human capital formation, measurement error, panel estimation
    JEL: E13 F22 J24 C23 O15 C82
    Date: 2005–03
  15. By: Gianluca Di Lorenzo; Giuseppe Marotta
    Abstract: A new approach to search for structural breaks in the retail lending rates pass-through in the wake of EMU is proposed and implemented for Italy and Portugal. The econometric exercise shows that breakpoints cluster in the second semester 1999 and that the pass-through on short term lending is, in contrast with earlier research, sizeably lower in the post-break period. The recently proposed distinction between monetary policy and cost-of-funds approaches in the passthrough analysis does not yield different breakpoints. These results challenge the widely held view that EMU has in its wake enhanced the effectiveness of monetary transmission via the banking sector and made it more uniform across countries, because of rising and converging PTs. A strengthened relationship lending could at least partly explain the reduced passthrough in the Italian case.
    Keywords: Interest rates; Monetary policy; European Monetary Union; Relationship lending; Cointegration analysis; Structural breaks
    JEL: E43 E52 E58 F36
    Date: 2005–03
  16. By: John Laitner; Dan Silverman
    Abstract: Using pseudo-panel data, we estimate the structural parameters of a life--cycle consumption model with discrete labor supply choice. A focus of our analysis is the abrupt drop in consumption upon retirement for a typical household. The literature sometimes refers to the drop, which in the U.S. Consumer Expenditure Survey we estimate to be approximately 16%, as the "retirement--consumption puzzle." Although a downward step in consumption at retirement contradicts predictions from life--cycle models with additively separable consumption and leisure, or with continuous work-hour options, a consumption jump is consistent with a setup having nonseparable preferences over consumption and leisure and requiring discrete work choices. This paper specifies a life--cycle model with these latter two elements, and it uses the empirical magnitude of the drop in consumption at retirement to provide an advantageous method of identifying structural parameters --- most importantly, the intertemporal elasticity of substitution.
    JEL: E21 D11 D12
    Date: 2005–03
  17. By: Michael Ehrmann; Marcel Fratzscher; Roberto Rigobon
    Abstract: The paper presents a framework for analyzing the degree of financial transmission between money, bond and equity markets and exchange rates within and between the United States and the euro area. We find that asset prices react strongest to other domestic asset price shocks, and that there are also substantial international spillovers, both within and across asset classes. The results underline the dominance of US markets as the main driver of global financial markets: US financial markets explain, on average, more than 25% of movements in euro area financial markets, whereas euro area markets account only for about 8% of US asset price changes. The international propagation of shocks is strengthened in times of recession, and has most likely changed in recent years: prior to EMU, the paper finds smaller international spillovers.
    JEL: E44 F3 C5
    Date: 2005–03
  18. By: Lars E.O. Svensson
    Abstract: "Forecast targeting," forward-looking monetary policy that uses central-bank judgment to construct optimal policy projections of the target variables and the instrument rate, may perform substantially better than monetary policy that disregards judgment and follows a given instrument rule. This is demonstrated in a few examples for two empirical models of the U.S. economy, one forward looking and one backward looking. A complicated infinite-horizon central-bank projection model of the economy can be closely approximated by a simple finite system of linear equations, which is easily solved for the optimal policy projections. Optimal policy projections corresponding to the optimal policy under commitment in a timeless perspective can easily be constructed. The whole projection path of the instrument rate is more important than the current instrument setting. The resulting reduced-form reaction function for the current instrument rate is a very complicated function of all inputs in the monetary-policy decision process, including the central bank's judgment. It cannot be summarized as a simple reaction function such as a Taylor rule. Fortunately, it need not be made explicit.
    JEL: E42 E52 E58
    Date: 2005–03
  19. By: Peter Hecht; Tuomo Vuolteenaho
    Abstract: Stock returns are correlated with contemporaneous earnings growth, dividend growth, future real activity, and other cash-flow proxies. The correlation between cash-flow proxies and stock returns may arise from association of cash-flow proxies with one-period expected returns, cash-flow news, and/or expected-return news. We use Campbell's (1991) return decomposition to measure the relative importance of these three effects in regressions of returns on cash-flow proxies. In some of the popular specifications, variables that are motivated as proxies for cash-flow news also track a nontrivial proportion of one-period expected returns and expected-return news. As a result, the R2 from a regression of returns on cash-flow proxies may overstate or understate the importance of cash-flow news as a source of return variance.
    JEL: E44 G10 G12
    Date: 2005–03
  20. By: Simon Wren-Lewis (Reserve Bank of New Zealand)
    Abstract: This paper extends the `Five Area Bilateral Equilibrium Exchange Rate' (FABEER) model used in Wren-Lewis (2003) to include New Zealand and Australia. This model calculates medium term exchange rates conditional on assumptions for `sustainable' current accounts. The model suggests that the equilibrium value of both currencies has been declining over the last ten years and that both currencies were near fair value (on average) during 2002. Equilibrium values against the US dollar are estimated to be around 0.50 (New Zealand) and 0.59 (Australia), although these estimates are sensitive to the assumed equilibrium values for variables like commodity prices and the current account.
    JEL: E17 E61 F31
    Date: 2004–08
  21. By: Aghassi Mkrtchyan
    Abstract: The impact of macroeconomic management (monetary policy) and administrative price adjustments on price variability in a low inflation economy characterized by relatively frequent administrative price adjustments is examined. Fluctuations of market determined prices, prices of agricultural goods in particular, are linked to the lack of synchronization between administrative price changes and monetary policy. If monetary policy does not account for expected changes in administrative prices, demand in “free” goods markets will shift causing fluctuation of prices for agricultural goods, because the supply of these goods is highly inelastic in Armenia. The findings contribute to a better understanding of agricultural price variability during 1998-2002. The impact of macroeconomic policy and structural adjustments on income distribution and rural poverty incidence are also examined. This research has immediate policy implications since Armenia will undergo major upward price adjustments for goods and services with regulated prices, which may have a negative impact on income distribution if aggregate demand management is unchanged.
    Keywords: Inflation, price variability, regulated prices
    JEL: E31 E61
    Date: 2004–11–01
  22. By: Nikolay Nenovsky; Yorgos Rizopoulos
    Abstract: The paper explores the possibilities to measure the institutional change in the monetary field. A political economy theoretical framework is built up, where the change of the monetary regime is analyzed as the outcome of the debtors - creditors interactions. In this perspective, the value of some traditional monetary variables during the period before and after the introduction of the Currency Board in Bulgaria, in 1997, reveals the main actors' evolving relative positions.
    Keywords: institutional change, monetary regime, Currency Board, transition, Bulgar
    JEL: E42 E52 O10 P30
    Date: 2004–12–01
  23. By: Daniel Daianu; Laurian Lungu
    Abstract: The paper examines the inflation targeting regime in the context of transition economies. Recent years have witnessed an increasing number of central banks in these countries moving towards the implementation of inflation targeting regimes. However, the success of such a regime depends largely on the degree to which certain general requirements are met. As experience in a number of transition economies has shown so far, targeting inflation is not an easy task. The ongoing restructuring process in these economies makes the inflation forecasting process more difficult and introduces an additional source of uncertainty in the system. By unequivocally choosing inflation as a nominal anchor the central banks could face potential dilemmas if, for example, exchange rate appreciated too much under the pressure of massive capital inflows. The paper presents the broad framework in which inflation targeting could operate efficiently and attempts to assess the extent to which such a regime, when applied to transition economies, could fit into this framework.
    Keywords: Inflation Targeting, Eastern Europe
    JEL: E52 E60
    Date: 2005–01–01
  24. By: Lucjan T. Orlowski
    Abstract: This study proposes relative inflation forecast targeting as an operational framework of monetary policy for adopting the euro by the EU new Member States. This strategy assumes containing differentials between the domestic and the eurozone inflation forecasts as an operational target. A model prescribing the RIFT framework is presented along with a set of appropriate policy indicator variables and instrument rules. The proposed framework advances the strategy based on relatively strict inflation targeting that is currently pursued by some NMS. Several ARCHclass tests in various functional forms are employed for providing preliminary empirical evidence on convergence of inflation differentials relative to the euro area for Poland, Czech Republic and Hungary.
    Keywords: Inflation targeting; Monetary convergence; Euro adoption; EU new Member States.
    JEL: E42 E52 E61 F36 P24
    Date: 2005–02–01
  25. By: Hippolyte d'Albis (EUREQua); Pascal Gourdel (CERMSEM); Cuong Le Van (CERMSEM)
    Abstract: This paper studies the existence of solutions in continuous time optimization problems. It provides a theorem whose conditions can be easily checked in most models of the optimal growth theory including those with increasing return and multi-sector economies.
    Keywords: Existence of solutions; optimization; continuous time; optimal growth
    JEL: C61 D91 E13
    Date: 2004–06
  26. By: Samuel de Abreu Pessoa (Graduate School of Economics, Fundacao Getulio Vargas); Silvia Matos Pessoa (Department of Economics, University of Pennsylvania); Rafael Rob (Department of Economics, University of Pennslyvania)
    Abstract: This paper estimates the elasticity of substitution of an aggregate production function. The estimating equation is derived from the steady state of a neoclassical growth model. The data comes from the PWT in which different countries face different relative prices of the investment good and exhibit different investment-output ratios. Then, taking advantage of this variation we estimate the long-run elasticity of substitution. Using various estimation techniques, we find that the elasticity of substitution is 0.7, which is lower than the elasticity, 1, that is traditionally used in macro-development exercises. We show that this lower elasticity reinforces the power of the neoclassical model to explain income differences across countries as coming from differential distortions.
    Keywords: Demand for Investment, Dynamic Panel Data, Elasticity of Substitution
    JEL: D24 D33 E25
    Date: 2005–03–04
  27. By: Cecilia Garcia Penalosa (CNRS, GREQAM and IDEP); Stephen J. Turnovsky (University of Washington)
    Abstract: This paper examines how the tax burden in a developing economy should be distributed between capital income and labor income. We study a two-sector model, where the traditional sector is "informal" and consequently cannot be taxed by the government. In this set up, we find that the optimal (second-best) tax structure in order to raise a certain amount of revenue requires to tax capital income at least as much as labor income, and possibly more.
    Keywords: endogenous growth, optimal taxation, informal sector, developing economies.
    JEL: E62 O17 O23
    Date: 2003–05

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