nep-mac New Economics Papers
on Macroeconomics
Issue of 2005‒10‒29
sixty-five papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Expectations, Learning and Macroeconomic Persistence By Fabio Milani
  2. Money Demand and Macroeconomic Stability Revisited By Andreas Schabert; Christian Stoltenberg
  3. Is there a trade-off between inflation variability and output-gap variability in the EMU countries? By Philip Arestis; Kostas Mouratidis
  4. What are the Effects of Fiscal Policy Shocks? By Andrew Mountford; Harald Uhlig
  5. On Asymmetric Business Cycles and the Effectiveness of Counter-Cyclical Fiscal Policies By Nicolas Magud
  6. Transparency of Monetary Policy: Theory and Practice By Petra M. Geraats
  7. The Role of Inflation Differentials in Regional Adjustment: Evidence from the United States By Ivo J.M. Arnold; Clemens J.M. Kool
  8. Is A Unified Macroeconomic Policy Necessarily Better for a Common Currency Area? By Ansgar Belke; Daniel Gros
  9. Near-Rational Exuberance By James Bullard; George W. Evans; Seppo Honkapohja
  10. Towards a Monthly Business Cycle Chronology for the Euro Area By Emanuel Mönch; Harald Uhlig
  11. New evidence on the firm size effects in US monetary policy transmission By Ivo J.M. Arnold; Clemens J.M. Kool; Katharina Raabe
  12. A Heliocentric Journey into Germany's Great Depression By Mark Weder
  13. Equilibrium Implications of Fiscal Policy with Tax Evasion By Francesco Busato; Bruno Chiarini; Vincenzo di Maro
  14. UK Inflation Persistence: Policy or Nature? By Patrick Minford; Prakriti Sofat; Eric Nowell; Naveen Srinivasan
  15. Model Uncertainty and Endogenous Volatility By Wiliam Branch; George W. Evans
  16. Robustness of Inferences to Singularity Bifurcations By Yijun He; William Barnett
  17. Some Benets of Cyclical Monetary Policy By Ricardo de Oliveira Cavalcanti; Ed Nosal
  18. The Australian Business Cycle: A Coincident Indicator Approach By Christian Gillitzer; Jonathan Kearns; Anthony Richards
  19. What Drives ECB Monetary Policy? By Clemens J.M. Kool
  20. New Evidence on the Puzzles. Results from Agnostic Identification on Monetary Policy and Exchange Rates. By Almuth Scholl; Harald Uhlig
  21. Costs of Financial Instability, Household-Sector Balance Sheets and Consumption By Ray Barrell; Olga Pomerantz; E.Philip Davis
  22. Bank finance versus bond finance: what explains the differences between US and Europe? By Fiorella De Fiore; Harald Uhlig
  23. Policy Targeting with Model-Consistent Expectations By Martin Weale
  24. The Volatility of the Output Gap in the G7 By Ray Barrell; Sylvia Gottschalk
  25. Learning in a Misspecified Multivariate Self-referential Linear Stochastic Model By Eran A. Guse
  26. Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraint By François Ortalo-Magné; Sven Rady
  27. Optimal Sticky Prices under Rational Inattention By Bartosz Mackowiak; Mirko Wiederholt
  28. Consumption, Financial and Real Wealth in the G-5 (revised December 2004) By Ray Barrell; E.Philip Davis
  29. Un modèle MAcroDYNamique des économies des pays membres de l’UEMOA : MADYN By Nicolas Ponty
  30. Generalized Stochastic Gradient Learning By George W. Evans; Seppo Honkapohja; Noah Williams
  31. The Macro-dynamics of the Dutch Economy 1800-1913 By Jan Reijnders
  32. Labour Market Dynamics in Germany: Hirings, Separations, and Job-to-Job Transitions over the Business Cycle By Ronald Bachmann
  33. Competitive Risk Sharing Contracts with One-Sided Commitment By Dirk Krueger; Harald Uhlig
  34. Inflação e Défice Orçamental: Que Relação em Portugal? By Agostinho S. Rosa
  35. Uncovered Interest Rate Parity and the Expectations Hypothesis of the Term Structure: Empirical Results for the U.S. and Europe By Ralf Brüggemann; Helmut Lütkepohl
  36. Real Exchange Rate Overshooting RBC Style By Patrick Minford; Prakriti Sofat; Eric Nowell; David Meenagh
  37. Dutch Corporate Liquidity Management: New Evidence on Aggregation By Allard Bruinshoofd; Clemens J.M. Kool
  38. Are Eastern European Countries Catching Up? Time Series Evidence for Czech Republic, Hungary, and Poland By Ralf Brüggemann; Carsten Trenkler
  39. Redistributive Taxation and Personal Bankruptcy in US States By Charles Grant; Winfried Koeniger
  40. Estimating a Life Cycle Model with Unemployment and Human Capital Depreciation By Andreas Pollak
  41. The Impact of Business-Cycle Fluctuations on Private-Label Share By Lamey, L.; Deleersnyder, B.; Dekimpe, M.G.; Steenkamp, J.B.E.M.
  42. An economic policy for the fifth long wave By Angelo Reati; Jan Toporowski
  43. Learning with Heterogeneous Expectations in an Evolutionary World By Eran A. Guse
  44. Demographic and Education Effects on Unemployment in Europe: Economic Factors and Labour Market Institutions By Federico Biagi; Claudio Lucifora
  45. A Control Variate Method for Monte Carlo Simulations of Heath-Jarrow-Morton with Jumps By Carl Chiarella; Christina Nikitopoulos-Sklibosios; Erik Schlogl
  46. The Effects Of Employment Protection and Product Market Regulations on The Italian Labor Market By Kugler, Adriana; Pica, Giovanni
  47. National Saving and the Stability and Growth Pact. By Martin Weale
  48. Asymmetric Price Adjustment in the Small: An Implication of Rational Inattention By Daniel Levy; Haipeng (Allen) Chang; Sourav Ray; Mark Bergen
  49. A Test of the Strategic Effect of Basel II Operational Risk Requirements on Banks By Carolyn Currie
  50. Capital Controls: An Evaluation By Nicolas Magud; Carmen M. Reinhart
  51. Who Cares about Mortgage Interest Deductibility? By Martin Gervais; Manish Pandey
  56. Testing the Pooling Assumption in an Industry Panel of R&D Investment: What Do We Learn? By Bettina Becker; Stephen Hall
  57. How Should Europe's ICT Ambitions look like? An Interpretative Review of the Facts By Richard Nahuis; Henry van der Wiel
  58. Do Factor Shares Reflect Technology? By Benjamin Bental; Dominique Demougin
  59. Introducing Time-to-Educate in a Job Search Model By Sascha O. Becker
  60. Is the American Model Miss World? Choosing between the Anglo-Saxon model and a European-style alternative By Henri L.F. de Groot; Paul J.G. Tang; Richard Nahuis
  61. Trade Liberalisation and Employment Effects in Ukraine By Atanas Christev; Olga Kupets; Hartmut Lehmann
  62. Exchange Rate Pass-Through to Domestic Prices in Pakistan By Zulfiqar Hyder; Sardar Shah
  63. Competing for Criminal Money By Greg Rawlings; Brigitte Unger
  64. Modeling the FIBOR/EURIBOR Swap Term Structure: An Empirical Approach By Oliver Blaskowitz; Helmut Herwartz; Gonzalo de Cadenas Santiago
  65. Currency Manipulation versus Current Account Manipulation By Junning Cai

  1. By: Fabio Milani (Princeton University & University of California, Irvine)
    Abstract: This paper presents an estimated model with learning and provides evidence that learning can improve the fit of popular monetary DSGE models and endogenously generate realistic levels of persistence. The paper starts with an agnostic view, developing a model that nests learning and some of the structural sources of persistence, such as habit formation in consumption and inflation indexation, that are typically needed in monetary models with rational expectations to match the persistence of macroeconomic variables. I estimate the model by likelihood-based Bayesian methods, which allow the estimation of the learning gain coefficient jointly with the `deep' parameters of the economy. The empirical results show that when learning replaces rational expectations, the estimated degrees of habits and indexation drop near zero. This finding suggests that persistence arises in the model economy mainly from expectations and learning. The posterior model probabilities show that the specification with learning fits significantly better than does the specification with rational expectations. Finally, if learning rather than mechanical sources of persistence provides a more appropriate representation of the economy, the implied optimal policy will be different. The policymaker will also incur substantial costs from misspecifying private expectations formation.
    Keywords: persistence, constant-gain learning, expectations, habit formation in consumption, inflation inertia, Phillips curve, Bayesian econometrics, New-Keynesian model.
    JEL: C11 D84 E30 E50 E52
    Date: 2005–10–22
  2. By: Andreas Schabert; Christian Stoltenberg
    Abstract: This paper examines how money demand induced real balance effects contribute to the determination of the price level, as suggested by Patinkin (1949,1965), and if they affect conditions for local equilibrium uniqueness and stability. There exists a unique price level sequence that is consistent with an equilibrium under interest rate policy, only if beginning-of-period money enters the utility function. Real money can then serve as a state variable, implying that interest rate setting must be passive for unique, stable, and non-oscillatory equilibrium sequences. When end-ofperiod money provides utility, an equilibrium is consistent with infinitely many price level sequences, and equilibrium uniqueness requires an active interest rate setting. The stability results are, in general, independent of the magnitude of real balance effects, and apply also when prices are sticky. In contrast, under a constant money growth policy, equilibrium sequences are (likely to be) locally stable and unique for all model variants.
    Keywords: Real balance effects, predetermined money, price level determination, real determinacy, monetary policy rules
    JEL: E32 E41 E52
    Date: 2005–05
  3. By: Philip Arestis; Kostas Mouratidis
    Abstract: This paper examines the performance of monetary policy in eleven EMU countries for the whole period of the EMS. This is based on the trade-off between inflation variability and output-gap variability. To this end, we examine whether the introduction of an implicit inflation targeting by the EMU member countries after the Maastricht Treaty, changed the trade-off between inflation variability and output-gap variability. We employ a stochastic volatility model for two sub-periods of the EMS (i.e. before and after the Maastricht Treaty). We find that the trade-off varies amongst EMU countries. The implication of these findings is that there are asymmetries in the euro area, due to different economic structures among the member countries of the EMU.
    Date: 2004–05
  4. By: Andrew Mountford; Harald Uhlig
    Abstract: We propose and apply a new approach for analyzing the effects of fiscal policy using vector autoregressions. Unlike most of the previous literature this approach does not require that the contemporaneous reaction of some variables to fiscal policy shocks be set to zero or need additional information, such as the timing of wars, in order to identify fiscal policy shocks. The paper's method is a purely vector autoregressive approach which can be universally applied. The approach also has the advantages that it is able to model the effects of announcements of future changes in fiscal policy and that it is able to distinguish between the changes in fiscal variables caused by fiscal policy shocks and those caused by business cycle and monetary policy shocks. We apply the method to US quarterly data from 1955-2000 and obtain interesting results. Our key finding is that the best fiscal policy to stimulate the economy is a deficit-financed tax cut and that the long term costs of fiscal expansion through government spending are probably greater than the short term gains.
    Keywords: Fiscal Policy, Vector Autoregression, Bayesian Econometrics, Agnostic identification
    JEL: C32 E60 E62 H20 H50 H60
    Date: 2005–07
  5. By: Nicolas Magud (University of Oregon Economics Department)
    Abstract: In the presence of informational frictions and uncertainty, an investment model is developed to capture the asymmetric dynamics of business cycles. When affected by a negative shock, the economy responds differently than when hit by a positive shock, both in terms of size and recovery length. In this set up, the role for fiscal policy in smoothing the effects of business cycles fluctuations depends on the initial conditions of the economy at the time of the shock: based on the degree of fiscal fragility of the government, expansionary fiscal policy might be expansionary or contractionary in terms of output.
    Keywords: Asymmetric Information, Business Cycles, Fiscal Fragility, Fiscal Policy
    JEL: H32 E00 E22
    Date: 2002–12–01
  6. By: Petra M. Geraats
    Abstract: Transparency has become one of the main features of monetary policymaking during the last decade. This paper establishes some stylized facts. In addition, it provides a systematic overview of the practice of monetary policy transparency around the world. It shows much diversity in information disclosure, even for central banks with the same monetary policy framework, including inflation targeting. Nevertheless, the paper finds significant differences in transparency across monetary policy frameworks. The empirical findings are explained using key insights distilled from the theoretical literature. Thus, this paper aims to bridge the gap between the theory and practice of monetary policy transparency.
    Keywords: : Transparency, monetary policy, central bank communication
    JEL: E58 D82
    Date: 2005–10
  7. By: Ivo J.M. Arnold; Clemens J.M. Kool
    Abstract: Within a monetary union, regional inflation differentials lead to a competition between the real interest rate and wealth channels on the one hand and the real exchange rate channel on the other hand in the transmission of regional shocks. This may have implications for the length and vehemence of regional business cycles. This paper tries to quantify how these forces work against each other using regional data for the United States. Our estimates indicate that, following an increase in the regional inflation rate, in the short run the pro-cyclical effect through the real interest rate and wealth channels is strongest. After a period of about 3-4 years the cumulative worsening of the competitive position asserts its influence. Regional cycles in the housing market have a clear pro-cyclical effect and are, on their part, affected by regional real interest rates and real growth.
    Keywords: monetary union, regional effects, inflation differentials, monetary transmission
    JEL: E58
    Date: 2003–11
  8. By: Ansgar Belke; Daniel Gros
    Date: 2005
  9. By: James Bullard; George W. Evans; Seppo Honkapohja
    Abstract: We study how the use of judgement or “add-factors” in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in standard macroeconomic environments. Examples include a simple asset pricing model and the New Keynesian monetary policy framework. Inclusion of judgement in forecasts can lead to self-fulfilling fluctuations, but without the requirement that the underlying rational expectations equilibrium is locally indeterminate. We suggest ways in which policymakers might avoid unintended outcomes by adjusting policy to minimize the risk of exuberance equilibria. Key words: Learning, expectations, excess volatility, bounded rationality, monetary policy
    JEL: E52 E61
    Date: 2005–10
  10. By: Emanuel Mönch; Harald Uhlig
    Abstract: This paper is an exercise in dating the Euro area business cycle on a monthly basis. Using a quite flexible interpolation routine, we construct several monthly series of Euro area real GDP, and then apply the Bry-Boschan (1971) procedure. To account for the asymmetry in growth regimes and duration across business cycle phases, we propose to extend this method with a combined amplitude/phase-length criterion ruling out expansionary phases that are short and flat. Applying the extended procedure to US and European data, we are able to replicate approximately the dating decisions of the NBER and the CEPR.
    Keywords: business cycle, European business cycle, Euro area, Bry-Boschan, NBER methodology
    JEL: B41 C22 C82 E32 E58
    Date: 2003–01
  11. By: Ivo J.M. Arnold; Clemens J.M. Kool; Katharina Raabe
    Abstract: This paper employs US state level data on manufacturing and non-manufacturing industries to present new evidence on the transmission of US interest rate shocks. Part one of our study analyzes the interest rate sensitivity of industry earnings over the period 1958-2000/01. The vector autoregressive evidence points to differences in the interest rate sensitivity of industries and, hence, to the existence of an industry channel of monetary transmission. Building on these results, the second part investigates whether the industry characteristics business size and capital intensity can explain the cross-industry heterogeneity of monetary policy effects. We find that the conclusions strongly depend on the treatment of the mining industry. Including a dummy variable for the mining industry significantly reduces the explanatory power of business size but brings to the fore the effect of capital intensity.
    Keywords: Monetary transmission, industry effects, regional effects, business size
    JEL: E50 E52
    Date: 2005–04
  12. By: Mark Weder (University of Adelaide & CEPR)
    Abstract: The paper finds empirical evidence on the ripple effect of sunspots on the interwar German economy. It identifies a sequence of negative shocks to expectations for the 1927 to 1932 period. The artificial economy predicts the 1928-1932 depression and a long boom from 1933 onwards. Overall, a tangible fraction of interwar output volatility is attributed to sunspots.
    Keywords: Sunspots, Great Depression, Germany, Temin (1971)
    JEL: E32 N14
    Date: 2005–10–21
  13. By: Francesco Busato; Bruno Chiarini; Vincenzo di Maro (Department of Economics, University of Aarhus, Denmark)
    Abstract: This paper generates high frequency data for the underground labor and the underground production using a theoretical general equilibrium model, over the sample 1970:01-1992:04 (32 years; 128 observations). We compare selected time series properties of the generated series with those of the corresponding series estimated with classical methodologies. The generated series for underground labor and underground production present a wider range and are more volatile than all other series estimated with classical methodologies. The analysis, next, suggests that the underground labor is pro-cyclical with respect to the GDP, that is lagging it by approximately one quarter, and that underground labor series generated from the theoretical model are highly persistent. Finally, the estimated correlation between the cyclical component of our generated-from-theory underground labor productivity and the actual series of aggregate GDP is negative (-0.34), while official yearly estimates present a positive (but very low) correlation with the cyclical component of GDP (0.12). This suggests that the underground sector has a positive impact over the productivity at the business cycle frequency, while it dampens productivity fluctuations at a lower frequency.
    Keywords: Real Business Cycle Models, Underground Economy
    JEL: E32
    Date: 2005–10–27
  14. By: Patrick Minford (Cardiff Business School); Prakriti Sofat; Eric Nowell; Naveen Srinivasan (Cardiff Business School)
    Abstract: A large econometric literature has found that post-war US inflation exhibits very high persistence, approaching that of a random walk process. Given similar evidence for other OECD countries, many macroeconomists have concluded that high inflation persistence is a 'stylized fact'. The objective of this paper is to show that degree of inflation persistence is not</i> an inherent structural characteristic of an economy, but in fact a function of the stability and transparency of monetary policy regime in place. We begin by estimating univariate processes for inflation across different periods, allowing for structural breaks based on a priori</em> knowledge of the UK economy. Then we examine whether, a rather straightforward model, easily micro-founded in a standard classical set-up can generate the facts such as we find them. We calibrate our structural model for each of the regimes and solve it analytically for the implied persistence in the inflation process. We compare this theoretical prediction with the estimated persistence for each regime. Finally we bootstrap our model to generate pseudo inflation series and check whether the actual persistence coefficients lie within the 95 percent confidence limits implied by the bootstraps. As a robustness exercise we do the same for the Liverpool model.
    Date: 2005
  15. By: Wiliam Branch (University of Californis - Irvine); George W. Evans (University of Oregon Economics Department)
    Abstract: This paper identifies two channels through which the economy can generate endogenous inflation and output volatility, an empirical regularity, by introducing model uncertainty into a Lucas-type monetary model. The equilibrium path of inflation depends on agents' expectations and a vector of exogenous random variables. Following Branch and Evans (2004) agents are assumed to underparameterize their forecasting models. A Misspecification Equilibrium arises when beliefs are optimal given the misspecification and predictor proportions based on relative forecast performance. We show that there may exist multiple Misspecification Equilibria, a subset of which are stable under least squares learning and dynamic predictor selection. The dual channels of least squares parameter updating and dynamic predictor selection combine to generate regime switching and endogenous volatility.
    Keywords: Lucas model, model uncertainty, adaptive learning, rational expectations, volatility
    JEL: C53 C62 D83 D84 E40
    Date: 2005–10–18
  16. By: Yijun He (Washington State University); William Barnett (University of Kansas)
    Abstract: Euler equation models represent an important class of macroeconomic systems. Our research on the Leeper and Sims Euler equations macroeconomic model reveals the existence of singularity-induced bifurcations, when the model's parameters are within a confidence region about the parameter estimates. Although known to engineers, singularity bifurcation has not previously been seen in the economics literature. We earlier encountered more common forms of bifurcation within the parameter space of the Bergstrom and Wymer continuous time macroeconometric model of the UK economomy. We have found that in each of those models, the point estimates of the parameters are near a bifurcation boundary that intersects the confidence region. Because dynamics are different on each side of a bifurcation boundary, this problem creates a substantial loss in robustness of inferences regarding dynamics. Since singularity bifurcation is more troubling than the types more widely known to economists, we find that the transition in econometrics from earlier structural models to Euler equation models with 'deep' parameters may cause these robustness problems to become more difficult to analyze.
    Keywords: bifurcation macroeconometrics dynamics nonlinearity singularity
    JEL: C14 C22 E37 E32
    Date: 2005–10–20
  17. By: Ricardo de Oliveira Cavalcanti (EPGE/FGV); Ed Nosal
    Date: 2005–10
  18. By: Christian Gillitzer (Reserve Bank of Australia); Jonathan Kearns (Reserve Bank of Australia); Anthony Richards (Reserve Bank of Australia)
    Abstract: This paper constructs coincident indices of Australian economic activity using techniques for estimating approximate factor models with many series, using data that begin in the early 1960s. The resulting monthly and quarterly indices both provide plausible measures of the Australian business cycle. The indices are quite robust to the selection of variables used in their construction, the sample period used in estimation, and the number of factors included. Notably, only a small number of factors is needed to adequately capture the business cycle. The coincident indices provide a much smoother representation of the cycle in economic activity than do standard national accounts measures, especially in the period prior to the early 1980s. Accordingly, they suggest that the marked decline in volatility evident in quarterly Australian GDP growth that occurred up to the 1980s may overstate the reduction in the volatility of economic activity and may at least partially reflect improvements in the measurement of GDP. Because the coincident indices present a smoother perspective of the business cycle in the 1960s and 1970s, they identify fewer recessions in this period than does GDP. Over the past 45 years, the coincident indices locate three recessions – periods when there was a widespread downturn in economic activity; in 1974–1975, 1982–1983 and 1990–1991.
    Keywords: business cycle; factor models; coincident indicator; Australia
    JEL: E32 E30 C40
    Date: 2005–10
  19. By: Clemens J.M. Kool
    Abstract: In this paper I have analyzed ECB interest rate setting in the first 5 years of its existence. Contrary to popular belief and continuous ECB statements, the ECB has not acted has as an obsessed inflation fighter. By any measure, output considerations do play a significant role in the ECB's policy rule. If anything, the ECB has been on the loose side, especially since 2001, when taking economic development in the euro area as a whole as the starting point. Actual interest rates have been consistent with German (and to a lesser extent French) preferences, however. It suggests the ECB puts a dominant weight on German economic developments. Small peripheral countries receive too low weight rather than too high. In case the ECB actually focuses on euro area wide developments, its looseness is comparable to that of the Fed. In case ECB policy actually is geared towards Germany's preferences ­ or perhaps the average German-French preferences -- the ECB has been much closer to a standard Taylor-rule interest rate setting than the Fed. In that scenario, the Fed indeed has been much more aggressive in the lowering of its interest rates in the face of adverse economic shocks.
    Date: 2005–03
  20. By: Almuth Scholl; Harald Uhlig
    Abstract: Past empirical research on monetary policy in open economies has found evidence of the ’delayed overshooting’, the ’forward discount’ and the ’exchange rate’ puzzles. We revisit the effects of monetary policy on exchange rates by applying Uhlig’s (2005) identification procedure that involves sign restrictions on the impulse responses of selected variables. We impose no restrictions on the exchange rate to leave the key question as open as possible. The sign restriction methodology avoids the “price puzzles” of the identification strategies used by Eichenbaum-Evans (1995) and by Grilli-Roubini (1995, 1996), which are particularly pronounced, when using an updated data set. We find that the puzzles regarding the exchange rates are still there, but that the quantitative features are different. In response to US monetary policy shocks, the peak appreciation happens during the first year after the shock for the US-German and the US-UK pair, and during the first two years for the US-Japan pair. This is consirably quicker than the three-year horizon found by Eichenbaum-Evans. There is a robust forward discount puzzle implying a large risk premium. We study this issue, introducing and calculating conditional Sharpe ratios for a Bayesian investor investing in a hedged position following a US monetary policy shock. For foreign monetary policy shocks, we find more robust results than with the Grilli-Roubini recursive identification strategy: the posterior distribution regarding the exchange reaction looks rather similar across countries and VAR specifications. In particular, we find that there seems to be considerable uncertainty regarding the initial reaction of the exchange rate. Quantitatively, monetary policy shocks seem to have a minor impact on exchange rate fluctuations.
    Keywords: vector autoregressions, agnostic identification, forward discount bias puzzle, exchange rate puzzle, exchange rates, monetary policy
    JEL: C32 E58 F31 F42
    Date: 2005–07
  21. By: Ray Barrell; Olga Pomerantz; E.Philip Davis
    Abstract: The literature on costs of financial instability tends to focus on fiscal costs and the impact on GDP of banking crises. In this paper we analyse the effect of a banking or currency crisis on consumption. We show that consumption plays an important role in the macroeconomic adjustment following a financial crisis. Furthermore, the effect of a crisis is aggravated by high leverage, notably as shown by the effect of a high debt-income ratio, despite the benefits of financial liberalisation in easing liquidity constraints. It is also greater in a small open economy than in the G-7. Meanwhile, falling house prices are shown to be part of the transmission process of financial instability, and high nominal interest rates are an indicator of sharp declines in consumption. A simulation for a banking crisis underlines the important role of monetary and fiscal policy in easing the impact of a financial crisis on consumption and other expenditure components. Viewed in the light of growing gearing, or leverage, in recent years, the results imply that a banking crisis taking place now could have a greater incidence than in the past, especially if macroeconomic policy is unable to respond, as for a small country in EMU.
    Date: 2004–07
  22. By: Fiorella De Fiore; Harald Uhlig
    Abstract: We present a dynamic general equilibrium model with agency costs, where heterogeneous firms choose among two alternative instruments of external finance-corporate bonds and bank loans. We characterize the financing choice of firms and the endogenous financial structure of the economy. The calibrated model is used to address questions such as: What explains differences in the financial structure of the US and the euro area? What are the implications of these differences for allocations? We find that a higher share of bank finance in the euro area relative to the US is due to lower availability of public information about firms' credit worthiness and to higher effciency of banks in acquiring this information. We also quantify the effect of differences in the financial structure on per-capita GDP.
    Keywords: Financial structure, agency costs, heterogeneity
    JEL: E20 E44 C68
    Date: 2005–08
  23. By: Martin Weale
    Abstract: Studies of inflation targeting make the distinction between strict and flexible inflation targeting. The problem of strict inflation targeting has so far been analysed by treating it as a special case of a standard optimal control problem and the algorithms used have not provided an exact solution. This paper presents a formal solution to the problem of strict inflation targeting in a economy with a forward-looking variable. It explains how the results can be applied with more than one forward-looking variable. It also draws on relevant control theory results. The results are illustrated on a small macro-economic model. It is shown that the use of a solution method which exploits the existence of a forward-looking variable delivers a solution which would not be easy to find by standard control methods.
    Date: 2004–05
  24. By: Ray Barrell; Sylvia Gottschalk
    Abstract: The decline in output volatility in the US has been variously ascribed to changes in the policy regime reflected in inflation volatility, improved stockholding and increased international integration. We investigate output volatility in the G7 in a panel context treating these as competing explanations. We show that an encompassing panel has a significant role for both net financial wealth and trade openness. There is also a role for inflation volatility, even though previous studies have ignored the fact that it may be endogenous and its role therefore spurious. However, its importance clearly varies over time and across countries, and it appears less important as an explanation of declining volatility in the US than it does in the UK. Changes in openness appear to be at least as important in explaining the decline in US output volatility.
    Date: 2004–05
  25. By: Eran A. Guse
    Abstract: This paper introduces a general method to study stability (under learning) of equilibria resulting from agents with misspecified perceptions of the law of motion of the economy. This is done by transforming the actual and perceived laws of motion into the form of seemingly unrelated regressions and then linearly projecting the actual law of motion into the same class as the perceived law of motion. I study the New Keynesian IS-LM model with inertia under all possible classes of restricted perceptions. It turns out that the results found in Bullard and Mitra (2002, 2003) are robust under misspeci.ed expectations.
    Keywords: Adaptive Learning; Expectational Stability; Monetary Policy Rules; Restricted Perceptions Equilibria; Seemingly Unrelated Regression
    JEL: E4 E5
    Date: 2005–10
  26. By: François Ortalo-Magné (Department of Real Estate and Urban Land Economics, University of Wisconsin-Madison, 975 University Avenue, Madison, WI 53706, USA); Sven Rady (Department of Economics, University of Munich, Kaulbachstr. 45, D-80539 Munich, Germany)
    Abstract: We propose a life-cycle model of the housing market with a property ladder and a credit constraint. We focus on equilibria which replicate the facts that credit constraints delay some households' first home purchase and force other households to buy a home smaller than they would like. The model helps us identify a powerful driver of the housing market: the ability of young households to afford the down payment on a starter home, and in particular their income. The model also highlights a channel whereby changes in income may yield housing price overshooting, with prices of trade-up homes displaying the most volatility, and a positive correlation between housing prices and transactions. This channel relies on the capital gains or losses on starter homes incurred by credit-constrained owners. We provide empirical support for our arguments with evidence from both the U.K. and the U.S.
    Keywords: Housing Demand, Income Fluctuations, Overlapping Generations, Collateral Constraint
    JEL: E32 G12 G21 R21
    Date: 2005–05
  27. By: Bartosz Mackowiak; Mirko Wiederholt
    Abstract: In the data, individual prices change frequently and by large amounts. In standard sticky price models, frequent and large price changes imply a fast response of the aggregate price level to nominal shocks. This paper presents a model in which price setting firms optimally decide what to observe, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in the data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms’ environment.
    Keywords: rational inattention, sticky prices, real effects of nominal shocks
    JEL: E3 E5 D8
    Date: 2004–06
  28. By: Ray Barrell; E.Philip Davis
    Abstract: Financial assets are generally chosen for encapsulating wealth effects in empirical work on aggregate consumption, but there is growing interest in tangible wealth, notably housing, as a potential determinant. We estimate consumption functions for the G-5, country-by-country and on a panel basis, which encapsulate roles for both tangible and financial wealth. Results suggest that tangible wealth plays a distinctive role in the determination of consumption in the short- and long-run. We also detect a marked negative effect of real interest rates. Results are of particular relevance to monetary policy, as well as being of importance for modelling and forecasting.
    Date: 2004–05
  29. By: Nicolas Ponty (INSEE, PNUD)
    Abstract: La programmation financière et monétaire tient une place centrale dans les négociations entre les autorités nationales des pays en développement et les institutions de Bretton Woods. Elle répond notamment à la nécessité d’établir une cohérence prospective entre l’évolution des principaux agrégats macroéconomiques : comptes nationaux, soldes budgétaires, situation monétaire, balance des paiements extérieurs et endettement extérieur. Sur la période récente, le suivi macroéconomique des pays en développement a connu différentes évolutions. D’abord, une surveillance multilatérale, notamment en matière budgétaire, s’est mise en place sous l’égide des organisations régionales. Ensuite, les appuis financiers extérieurs sont de plus en plus fréquemment décidés sous la forme d’une aide budgétaire et sur la base d’une conditionnalité de performance. Enfin, la programmation budgétaire sur un horizon de moyen terme s’est renforcée avec la mise en place récente de Cadre des Dépenses à Moyen Terme (CDMT). Pour répondre à ces évolutions, les outils macroéconomiques d’analyse et de prévision actuellement disponibles doivent être renforcés. Cette étude, menée dans le cadre spécifique des pays membres de l’UEMOA, propose un modèle pays MAcro structurel DYNamique, MADYN. La modélisation retenue repose bien entendu sur le cadre comptable minimal de la programmation financière et monétaire (cf. partie I). Il le complète en amont par une prise en compte systématique des variables d’environnement et de politique économique. Les différents blocs du modèle sont présentés (cf. partie II). Un panorama des principaux déterminants théoriques des comportements modélisés est alors présenté. La dernière et troisième partie précise la cohérence d’ensemble du modèle et ses conditions, en analyse variantielle et aussi en prévision. Financial and monetary programming holds a central place in negotiations between national authorities of developing countries and Breton Woods institutions. It answers in particular the need for establishing a prospective coherence between the evolution of the main macroeconomic aggregates : national accounts, fiscal balances, monetary situation, external payments and external debt. Over the recent period, the macroeconomic follow-up of developing countries has gone through various evolutions. Initially, a multilateral monitoring, notably in fiscal area, was launched under the guidance of regional organisations. Then, Official Development Assistance is more and more frequently delivered in the form of budgetary aid and on conditionality based performance. Finally, budgetary programming on a medium term horizon was reinforced with the recent launching of a Medium Term Expenditure Framework (MTEF). To answer these evolutions, currently available macroeconomic tools for analysis and forecast must be strengthened. This study, undertaken within the specific framework of WAEMU member States, sets up a MAcro DYNamic structural model, MADYN. The modelling approach is based of course on the minimal accounting framework of the financial and monetary programming (See part I). It is characterised upstream by taking into account of environmental and economic policy variables. The various blocks of the model are presented (See part II). A survey of the overriding theoretical determinants of the behaviours is then presented. The last and third part specifies the overall consistency of the model and its conditions of use, both in counterfactual analysis and also in forecasting. (Full text in french)
    JEL: C1 E17 E60
    Date: 2005–10
  30. By: George W. Evans; Seppo Honkapohja; Noah Williams
    Abstract: We study the properties of generalized stochastic gradient (GSG) learning in forwardlooking models. We examine how the conditions for stability of standard stochastic gradient (SG) learning both di1er from and are related to E-stability, which governs stability under least squares learning. SG algorithms are sensitive to units of measurement and we show that there is a transformation of variables for which E-stability governs SG stability. GSG algorithms with constant gain have a deeper justification in terms of parameter drift, robustness and risk sensitivity.
    Keywords: adaptive learning, E-stability, recursive least squares, robust estimation
    JEL: C62 C65 D83 E10 E17
    Date: 2005–10
  31. By: Jan Reijnders
    Abstract: This paper presents a quantitative analysis of recently published Dutch national income statistics 1800-1913. An effort is made to identify Kondratieff waves in volume series relating to gross domestic product and expenditure. It is found that Kondratieff waves can be identified in most series. An interesting result is that the long waves in volume series appear to run contrary to the long waves in price series. This finding is at variance with the received view on long waves. It is argued that this typical result may be explained with reference to the so-called `Keynes effect'. Key Words Trends, Long Waves, National Income Statistics, The Netherlands, Fourier Analysis. JEL code E32, E12
    Keywords: Trends, Long Waves, National Income Statistics, The Netherlands, Fourier Analysis
    JEL: E32 E12
    Date: 2004–07
  32. By: Ronald Bachmann
    Abstract: In this paper, we provide a comprehensive overview of labour market dynamics in Western Germany by looking at gross worker flows. To do so, we use a subsample of the registry data collected by the German social security system, the IAB employment sample, for the time period 1975-2001. The latter provides daily information on 2% of the German workforce covered by social security legislation. Using these data, we are able to exactly calculate the number of transitions between the different labour market states, and between different employers over time. We first provide an overview of the cross-section and time series properties of these flows. We then study the cyclical features of gross worker flows, accessions, and separations. We find that separations are relatively flat over the cycle, while accessions are markedly procyclical, and that the increased flow into unemployment in a recession is mainly due to reduced hirings, and hence lower job-to-job transitions, rather than increased match separations. Our findings have important implications both for the way we view recessions and for the role of the labour market as a propagation mechanism for productivity shocks.
    Keywords: worker flows, accessions, separations, business cycle, job-to-job, employer-to-employer
    JEL: J63 J64 J21 E24
    Date: 2005–09
  33. By: Dirk Krueger; Harald Uhlig
    Abstract: This paper analyzes dynamic equilibrium risk sharing contracts between profit-maximizing intermediaries and a large pool of ex-ante identical agents that face idiosyncratic income uncertainty that makes them heterogeneous ex-post. In any given period, after having observed her income, the agent can walk away from the contract, while the intermediary cannot, i.e. there is one-sided commitment. We consider the extreme scenario that the agents face no costs to walking away, and can sign up with any competing intermediary without any reputational losses. We demonstrate that not only autarky, but also partial and full insurance can obtain, depending on the relative patience of agents and financial intermediaries. Insurance can be provided because in an equilibrium contract an up-front payment effectively locks in the agent with an intermediary. We then show that our contract economy is equivalent to a consumption-savings economy with one-period Arrow securities and a short-sale constraint, similar to Bulow and Rogoff (1989). From this equivalence and our characterization of dynamic contracts it immediately follows that without cost of switching financial intermediaries debt contracts are not sustainable, even though a risk allocation superior to autarky can be achieved.
    Keywords: Long-term contracts, Risk Sharing, Limited Commitment, Competition
    JEL: G22 E21 D11 D91
    Date: 2005–02
  34. By: Agostinho S. Rosa (Department of Economics, University of Évora)
    Abstract: Os principais determinantes da variação da inflação no período 1954-95 parecem ser a inflação externa (ou a sua variação) e a variação da taxa de câmbio efectiva do escudo. Verifica-se uma relação de longo prazo entre a taxa de inflação e a taxa de variação dos custos unitários de trabalho quase unitária, mas a resposta da variação da inflação ao erro de equilíbrio entre a taxa de inflação e a variação dos custos unitários é lenta e quase insignificante ao passo que a resposta dos custos unitários de trabalho a esse desequilíbrio é rápida e significativa o que sugere que a direcção de causalidade é muito mais pronunciada da taxa de inflação para os custos de trabalho, do que ao contrário. Isto parece significar que os salários se ajustam imediatamente ao crescimento da inflação, enquanto a inflação se ajusta lentamente ao crescimento dos salários. O saldo do Sector Público Administrativo em percentagem do PIB (SPA) não é significativo na relação de curto prazo, na equação da inflação, no entanto, é significativo na equação dos custos unitários de trabalho, o que pode implicar relação positiva indirecta entre a variação da inflação e o défice orçamental desfasado.
    Keywords: Inflação, Saldo Orçamental, Raízes Unitárias, Cointegração
    JEL: C12 C13 C32 E24 E31
    Date: 2005
  35. By: Ralf Brüggemann; Helmut Lütkepohl
    Abstract: A system of U.S. and euro area short- and long-term interest rates is analyzed. According to the expectations hypothesis of the term structure the interest rate spreads should be stationary and according to the uncovered interest rate parity the difference between the U.S. and euro area longterm interest rates should also be stationary. If all four interest rates are integrated of order one, one would expect to find three linearly independent cointegration relations in the system of four interest rate series. Combining German and European Monetary Union data to obtain the euro area interest rate series we find indeed the theoretically expected three cointegration relations, in contrast to previous studies based on different data sets.
    Keywords: Expectations hypothesis of the term structure, uncovered interest rate parity, unit roots, cointegration analysis
    JEL: C32
    Date: 2005–04
  36. By: Patrick Minford (Cardiff Business School); Prakriti Sofat (Cardiff Business School); Eric Nowell; David Meenagh (Cardiff Business School)
    Abstract: The objective of this paper is to establish the ability of a Real Business Cycle model to account for the behaviour of the real exchange rate (RXR), using UK experience as our empirical focus. We specify a dynamic general equilibrium open economy model based on optimising decisions of rational agents; the first order conditions from the households. and firms' optimisation problems are used to derive the behavioural equations of the model. As we model the UK, a medium-sized open economy, we take the world economy as given. We keep the model in its non- linear form and hence solve it numerically. The interaction with the rest of the world comes in the form of uncovered real interest rate parity and current account both of which are explicitly micro-founded. The paper discusses simulation results of a 1 percent productivity shock, which shows clearly that on impact RXR appreciates and then goes back to a new depreciated equilibrium, producing a business cycle. This deterministic simulation is very encouraging to the idea that the behaviour of RXR may be explicable within an RBC context. Ultimately to test whether our model is consistent with the facts, we bootstrap our model to generate pseudo RXR series and check if the ARIMA parameters estimated for the data lie within 95% confidence limits implied by our model. We find that our model tells quite a good story, the gyrations of the RXR can be explained within an RBC framework.
    Date: 2005
  37. By: Allard Bruinshoofd; Clemens J.M. Kool
    Abstract: In this paper we investigate Dutch corporate liquidity management in general, and target adjustment behaviour in particular. To this purpose, we use a simple error correction model of corporate liquidity holdings applied to firm-level data for the period 1977-1997. We confirm the existence of long-run liquidity targets at the firm level. We also find that changes in liquidity holdings are driven by short-run shocks as well as the urge to converge towards targeted liquidity levels. The rate of target convergence is higher when we include more firm-specific information in the target. This result supports the idea that the degree of error in defining liquidity targets associates negatively with the observed rate of target convergence. It also suggests that the slow speeds of adjustment obtained in many macro studies on money demand are artefacts of aggregation bias.
    Keywords: Corporate liquidity demand, Precautionary liquidity
    JEL: C33 C43 E41 G3
    Date: 2004–02
  38. By: Ralf Brüggemann; Carsten Trenkler
    Abstract: The catching up process in Czech Republic, Hungary, and Poland is analyzed by investigating the integration properties of log-differences in per-capita GDP versus the EU15 and a Mediterranean country group. We account for structural changes by using unit root tests that allow for two endogenous breaks in the level and the trend. We find that Czech Republic and Hungary are stochastically converging towards the Mediterranean group, while only Czech Republic is stochastically converging towards EU15. Remaining per capita GDP differences are only reduced by deterministic trends. Extrapolating these trends we find that catching up will take about 20 years.
    Keywords: Stochastic convergence, Catching up, Unit root tests, EU accession
    JEL: C32 E24
    Date: 2005–03
  39. By: Charles Grant (University of Reading and EUI); Winfried Koeniger (IZA Bonn, University of Bonn and EUI)
    Abstract: Both personal bankruptcy and redistributive taxes can insure households’ consumption risk and both vary considerably across US states. We derive sufficient conditions under which more redistributive taxation makes bankruptcy exemptions less attractive both for the intratemporal insurance and for inter-temporal consumption smoothing. Exploiting data variation over time for 18 US states 1980-2003, we find considerable support for our model’s predictions: (i) redistributive taxation and bankruptcy exemptions are negatively correlated; (ii) both policies are associated with more equal consumption growth whereas the effect on unsecured household debt is less clear-cut.
    Keywords: personal bankruptcy, consumer credit, redistributive taxes and transfers
    JEL: E21 E61 G18
    Date: 2005–10
  40. By: Andreas Pollak (University of Freiburg)
    Abstract: I estimate a life cycle model of consumption choice with unemployment risk. Employed individuals face the risk of losing their job. Unemployed agents receive job random offers of different quality, which they can accept or reject. Following the loss of a job and during unemployment, an agent’s productivity declines. Using micro data, I estimate the structural model for Germany, the UK, and the US following the method of simulated moments approach of Duffie and Singleton. The estimated model is used to perform policy simulations that highlight the relationship between the unemployment insurance scheme and the unemployment rates of different age groups.
    Keywords: Method of Simulated Moments, Unemployment Insurance, Life- Cycle Models, Human Capital
    JEL: C51 D1 E2 J24 J31 J38 J64
    Date: 2005–10–23
  41. By: Lamey, L.; Deleersnyder, B.; Dekimpe, M.G.; Steenkamp, J.B.E.M. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: This study investigates the cyclical dependence of private-label success in four countries. The results show that private-label share behaves countercyclically. Moreover, asymmetries are present in both the extent and speed of up- and down-ward movements in private-label share over the business cycle. Finally, part of private-labels? share gain during contractions is found to be permanent.
    Keywords: Business cycle;Private-label Success;Time-series Econometrics;
    Date: 2005–10–18
  42. By: Angelo Reati (Technical University of Lisbon); Jan Toporowski (University of Amsterdam)
    Abstract: The paper starts by reviewing a recent contribution on long-waves, in order to recall the essential points of a theory that, better than any other, is able to explain the long term development of capitalist economies. Considering that the present technological revolution in ICT is part of the broad phenomenon of a new long wave, it follows that the main focus of economic policy should be to support the diffusion of the new technological style and to favour the institutional changes required by such an objective. On the basis of a selective view of what is deemed crucial to foster the full implementation of the new long wave, four broad guidelines are suggested: (i) a Keynesian policy for demand; (ii) a policy to re-establish the primacy of productive capital through systematic concerted open market operations to regulate liquidity in the financial markets; (iii) a reconstruction of the employment relationship that, while taking into consideration the requirements of the new technological paradigm, preserves the essential features of the “European social model”; a targeted flexibility of labour, that contrasts with the all-out market flexibility that results from the neoclassical theory, is also suggested; (iv) a regime for intellectual property rights that avoids the drawbacks – both ethical and economic – of current US practices.
    Keywords: long-waves
    JEL: C6 D5 D9
    Date: 2005–10–21
  43. By: Eran A. Guse
    Abstract: This paper studies a game theoretic model where agents choose between two updating rules to predict a future endogenous variable. Agents rationally choose between these predictors based on relative performance. Conditions for evolutionary stability and stability under learning are found for the Nash solutions and corresponding parameter equilibria. Stability conditions are contingent upon parameter values and the initial distribution of heterogeneity. However, when the cost of using the more advanced updating rule is sufficiently large, all agents will asymptotically use the more parsimonious, or Minimum State Variable (MSV), updating rule.
    Keywords: Adaptive Learning; Evolutionary Dynamics; Heterogeneous Expectations; Multiple Equilibria; Rational Expectations.
    JEL: C62 D84 E37
    Date: 2005–10
  44. By: Federico Biagi (Università di Padova and SDA Bocconi); Claudio Lucifora (Università Cattolica, FEEM, CEPR and IZA Bonn)
    Abstract: We analyse the effects of demographic and education changes on unemployment rates in Europe. Using a panel of European countries for the 1980-2000 period - disaggregated by cohort, gender and education -, we empirically test the economic effects of two stylised facts that have occurred in recent decades: the "baby bust" and the "education boom". We find that structural shifts in the population age structure play an important role and that a lot of variation is also attributable to educational changes, the latter usually neglected in aggregate studies. Results show that demographic and education shocks are qualitatively different for young (adult) workers as well as for more (less) educated people. While adult workers and more educated individuals, in general, experience lower unemployment rates, changes in the population age structure appear to be positively related to young workers’ unemployment rates while they have no effect on adults. Conversely changes in the skill structure ("education boom"), even when controlling for skill-biased technological change, reduce the unemployment of the more educated. Labour market institutions also influence unemployment rates in different ways. Unemployment benefits are found to have a positive impact on unemployment, while bargaining coordination and employment protection reduce it.
    Keywords: unemployment, demographic, education, labour market institutions
    JEL: E24 J31 J51 J65
    Date: 2005–10
  45. By: Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Christina Nikitopoulos-Sklibosios (School of Finance and Economics, University of Technology, Sydney); Erik Schlogl (School of Finance and Economics, University of Technology, Sydney)
    Abstract: This paper examines the pricing of interest rate derivatives when the interest rate dynamics experience infrequent jump shocks modelled as a Poisson process and within the Markovian HJM framework developed in Chiarella & Nikitopoulos (2003). Closed form solutions for the price of a bond option under deterministic volatility specifications are derived and a control variate numerical method is developed under a more general state dependent volatility structure, a case in which closed form solutions are generally not possible. In doing so, we provide a novel perspective on the control variate methods by going outside a given complex model to a simpler more tractable setting to provide the control variates.
    Keywords: HJM model; jump process; bond option prices; control variate; Monte Carlo simulation
    JEL: E43 G33 G13
    Date: 2005–09–01
  46. By: Kugler, Adriana; Pica, Giovanni
    Abstract: Labor market regulations have often been blamed for high and persistent unemployment in Europe, but evidence on their impact remains mixed. This paper analyzes how labor and product market regulations interact to affect turnover and unemployment. We present a matching model which illustrates how barriers to entry in the product market mitigate the impact of labor market deregulation. We, then, use the Italian Social Security employer-employee panel to study the interaction between barriers to entry and dismissal costs. We exploit the fact that costs for unjust dismissals in Italy increased for firms below 15 employees relative to bigger firms after 1990. We find that the increase in dismissal costs after 1990 decreased accessions and separations in small relative to big firms, especially for women. Moreover, consistent with our model, we find evidence that the reduction in dismissal costs had smaller effects on turnover for women in sectors faced with strict product market regulations.
    Date: 2003–11–01
  47. By: Martin Weale
    Abstract: Many of the arguments used to justify the Stability and Growth Pact’s concern with budget deficits in fact relate to levels of national saving. Countries with large budget deficits tend to have low levels of national saving but some countries such as the UK have low levels of national saving for structural reasons associated with the private sector. A good case can be made that budgetary targets should be tighter for countries with structurally low saving than for countries with savings levels adequate to allow wealth to grow in line with income.
    Date: 2004–05
  48. By: Daniel Levy; Haipeng (Allen) Chang; Sourav Ray; Mark Bergen
    Abstract: We study the implications of rational inattention for individual price dynamics. Analyzing scanner data that cover 29 product categories over a eight-year period from a large Mid-western supermarket chain, we uncover a surprising regularity in the data--small price increases occur more frequently than small price decreases. We find that this asymmetry holds for price changes of up to about 15­30 cents (in absolute terms) and 3­10 percent (in relative terms). The asymmetry disappears for larger price changes. We document this finding for the entire data set, as well as for individual product categories considered. Moreover, we find that the asymmetry holds even when we exclude from the data the observations pertaining to inflationary periods. Given the inability of the existing theories to explain the particular form of asymmetry we document, we offer a new theory of asymmetric price adjustment, which can explain our findings. The theory, which is an extension of the literature on "rational inattention," argues that observing, processing, and reacting to price change information is not a costless activity. An important implication of rational inattention is that consumers may rationally choose to ignore--and thus not to respond to--small price changes, creating a "range of inattention" along the demand curve. This range of consumer inattention, we argue, gives the retailers incentive for asymmetric price adjustment "in the small." These incentives, however, disappear for large price changes, because large price changes are noticed by consumers and therefore trigger their response. Thus, no asymmetry is observed "in the large."
    Keywords: Asymmetric Price Adjustment, Rational Inattention, Cost and Benefit of Information Acquiring and Processing, Price Rigidity
    JEL: E31 D11 D21 D80 L11 M31
    Date: 2004–07
  49. By: Carolyn Currie (School of Finance and Economics, University of Technology, Sydney)
    Abstract: Most problematic of the Basel II capital adequacy requirements is the subset of Pillar I, requiring provision for operational risk (OR) as distinct from credit and market risk. Previous tests of the strategic effect of this new regulation from three prior Quality Impact Studies (QIS) conducted in G10 countries under the guidance of the Bank for International Settlements, have concluded that OR requirements poses difficulties of definition, implementation, and strategic planning. Anticipated strategic effects include dramatic changes to product development, investment and asset mix, as well as the necessity to rapidly develop new risk rating models and techniques, together with vastly expanded internal and external audit compliance routines. Unlike QIS1, 2 and 3, QIS4 focuses on operational risk, but still has drawbacks. This paper discusses its approach, in view of the ongoing difficulties that banks are experiencing with operational risk, particularly in the construction of a database. It concludes by listing the unanswered questions that have not even been addressed in four studies of the strategic impact of Basel II?s OR requirements. It also suggests that many smaller banks and emerging nations may not be able to use the sophisticated approaches and hence will suffer a competitive disadvantage. Hence in view of drawbacks in the simpler approaches such as lack of correlation of operational risk and revenue, other indicators such as the standard deviation of efficiency measures are suggested.
    Keywords: operational risk; Basel II
    JEL: E42 E44 E58
    Date: 2005–09–01
  50. By: Nicolas Magud (University of Oregon Economics Department); Carmen M. Reinhart (University of Maryland and NBER)
    Abstract: The literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is no unified theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a “success” and (iv) the empirical studies lack a common methodology—furthermore these are significantly “overweighted” by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to “standardize” the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Control Effectiveness Index (WCCE Index). The difference between them lies only in that the WCCE controls for the differentiated degree of methodological rigor applied to draw conclusions in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well known episodes than those of Chile and Malaysia.
    Date: 2005–06–01
  51. By: Martin Gervais (University of Western Ontario); Manish Pandey (The University of Winnipeg)
    Abstract: We use the Survey of Consumer Finances to measure the change in federal tax liability that would result should mortgage interest no longer be deductible from taxable income. We argue that the elimination of this housing tax provision would lead households to reshuffle their balance sheet, thereby lowering the amount of interest income taxes collected. We find that the cost of this tax provision is between 35 and 65 percent of the estimates produced by the Office of Management and Budget, depending on the types of assets one assumes would be used to lower mortgage debt following the removal of the provision. Furthermore, since mostly rich households would be in a position to reshuffle their balance sheet following such a change in tax policy, the distributional effect of this program are much smaller than conventionally believed.
    Keywords: mortgage interest deductibility; housing; taxation; redistribution
    JEL: E62 G11 H24 H31
    Date: 2005
  52. By: Jairo Núñez
    Abstract: El estudio presenta la situación actual de los ingresos tributarios del orden local para identificar su tendencia y estructura, y para establecer comparaciones entre los municipios según el tamaño de la población, la región geográfica y el nivel de desarrollo. Así mismo presenta la relación entre el incremento de los ingresos y el aumento en las coberturas de servicios sociales, el esfuerzo fiscal después de la reforma a las transferencias y los determinantes de los principales indicadores fiscales municipales.
    Keywords: Ingresos tributarios locales
    JEL: E62
    Date: 2005–08–01
  53. By: Jairo Núñez
    Abstract: El estudio presenta la situación actual de los ingresos tributarios del orden local para identificar su tendencia y estructura, y para establecer comparaciones entre los municipios según el tamaño de la población, la región geográfica y el nivel de desarrollo. Así mismo presenta la relación entre el incremento de los ingresos y el aumento en las coberturas de servicios sociales, el esfuerzo fiscal después de la reforma a las transferencias y los determinantes de los principales indicadores fiscales municipales.
    Keywords: Ingresos tributarios locales
    JEL: E62
    Date: 2005–08–01
  54. By: Jairo Núñez
    Abstract: El estudio tiene como objetivo medir el impacto de la Ley 789 de 2002 sobre la estabilidad laboral, el desempleo y la formalización de las relaciones laborales. Utilizando un análisis de supervivencia se encontró que la duración del desempleo cae fuertemente entre 2004 y 2002. Parte de este efecto se debe a la reforma laboral que entró en vigencia en abril de 2003. Así mismo, la probabilidad de encontrar empleo en el sector formal se incrementó cerca de 6% como consecuencia de la reforma. Por consiguiente, se puede afirmar que los cambios en la legislación laboral ayudaron a formalizar la economía y a mejorar la calidad del empleo. Por otro lado, se encontró que la duración del empleo aumenta en aquellos sectores donde se esperaban fuertes impactos de la reforma, y lo más posible es que estos efectos aumenten en el largo plazo.
    Keywords: Flexibilidad laboral
    JEL: E24
    Date: 2005–07–20
  55. By: Jairo Núñez
    Abstract: El estudio tiene como objetivo medir el impacto de la Ley 789 de 2002 sobre la estabilidad laboral, el desempleo y la formalización de las relaciones laborales. Utilizando un análisis de supervivencia se encontró que la duración del desempleo cae fuertemente entre 2004 y 2002. Parte de este efecto se debe a la reforma laboral que entró en vigencia en abril de 2003. Así mismo, la probabilidad de encontrar empleo en el sector formal se incrementó cerca de 6% como consecuencia de la reforma. Por consiguiente, se puede afirmar que los cambios en la legislación laboral ayudaron a formalizar la economía y a mejorar la calidad del empleo. Por otro lado, se encontró que la duración del empleo aumenta en aquellos sectores donde se esperaban fuertes impactos de la reforma, y lo más posible es que estos efectos aumenten en el largo plazo.
    Keywords: Flexibilidad laboral
    JEL: E24
    Date: 2005–07–20
  56. By: Bettina Becker; Stephen Hall
    Abstract: In this paper we test the pooling assumption for the determinants of industry R&D investment. Most studies consider pooled estimates, but if the parameters differ across industries, pooled coefficients will not provide reliable estimates of individual industry effects. Moreover, pooled coefficients may not even be consistent estimates of the average. For a panel of UK manufacturing industries we find that pooling is only valid for output fluctuations, lagged R&D and real interest rates. Implementing the test results into our model, we find government funding is only significant for low-tech R&D. Skilled labour and foreign R&D matter only in high-tech industries.
    Date: 2004–05
  57. By: Richard Nahuis; Henry van der Wiel
    Abstract: In this Discussion Paper we analyse how Europe's ICT ambition can be translated into a policy agenda. To achieve this, we provide a quantitative overview of the importance of ICT and the relative position of Europe versus the US. Next we provide a discussion of potential explanations for the differences in ICT use and production. We find that Europe's position with respect to ICT use and production is not only worse compared to that of the US. In some areas Europe is ahead of the US, whereas in others Europe lags on an aggregate level. Our main conclusion is that Europe should not aim at creating an ICT-production cluster but it should aim at removing barriers to ICT use. The reasons are as follows. It is not a sensible strategy to specialise in industries where one has a comparative disadvantage. Moreover, the largest benefit from ICT is in its use not in its production. JEL classification: H89, D2, E61
    JEL: H89 D2 E61
    Date: 2005–04
  58. By: Benjamin Bental; Dominique Demougin
    Abstract: This note demonstrates that it is easily possible to compute technological parameters out of national income accounting data in the presence of bargaining in the labor market. Applying the method to US data, we obtain that the output elasticity with respect to capital exceed 0.5.
    Keywords: Factor Shares, Nash Bargaining
    JEL: E23 E25
    Date: 2005–09
  59. By: Sascha O. Becker (CES, CESifo and IZA Bonn)
    Abstract: Transition patterns from school to work differ considerably across OECD countries. Some countries exhibit high youth unemployment rates, which can be considered an indicator of the difficulty facing young people trying to integrate into the labor market. At the same time, education is a time-consuming process, and enrolment and dropout decisions depend on expected duration of studies, as well as on job prospects with and without completed degrees. One way to model entry into the labor market is by means of job search models, where the job arrival hazard is a key parameter in capturing the ease or difficulty in finding a job. Standard models of job search and education assume that skills can be upgraded instantaneously (and mostly in the form of on-the-job training) at a fixed cost. This paper models education as a time-consuming process, a concept which we call time-to-educate, during which an individual faces the trade-off between continuing education and taking up a job.
    Keywords: job search, education, enrollment, dropouts
    JEL: E24 J31 J41 J64
    Date: 2005–10
  60. By: Henri L.F. de Groot; Paul J.G. Tang; Richard Nahuis
    Abstract: In Lisbon, the European Union has set itself the goal to become the most competitive economy in the world in 2010 without harming social cohesion and the environment. The motivation for introducing this target is the substantially higher GDP per capita of US citizens. The difference in income is mainly a difference in the number of hours worked per employee. In terms of productivity per hour and employment per inhabitant, several European countries score equally well or even better than the United States, while at the same time they outperform the United States with a more equal distribution of income. The European social models are at least as interesting as the US model that is often considered a role model. In an empirical analysis for OECD countries, we aim to unravel `the secret of success'. Our regression results show that income redistribution (through a social security system) does not necessarily lead to lower participation and higher unemployment, provided that countries supplement it with active labour market policies. Especially, spending on employment services like job-search assistance and vocational guidance, seems effective. Furthermore, the results suggest that generous unemployment benefits of short duration contribute to employment without widening the income distribution.
    Keywords: welfare states, income inequality, unemployment, productivity, participation, labour market policies
    JEL: E24 H5 J21
    Date: 2004–10
  61. By: Atanas Christev; Olga Kupets; Hartmut Lehmann
    Abstract: This paper addresses a controversial issue in the current literature, namely the effects of trade liberalisation on labour market job flows. It studies the case of Ukraine where we view the sudden openness of the economy to trade as a quasi-natural experiment. We use disaggregated data on manufacturing industries and customs data on trade flows according to the shifting trade patterns after the disintegration of CMEA trade regime. We provide some first evidence that 3-digit NACE sector job flows are driven by idiosyncratic factors within industries. Other things equal, there is increased labour shedding as larger non-state share in industry relates to less job creation and more job destruction. Trade openness does affect job flows in Ukrainian manufacturing disproportionately according to trade orientation. We find that while trade with CIS decreases job destruction, trade with the EU increases excess reallocation mainly through job creation.
    Keywords: Job creation, job destruction, Ukraine, trade flows
    JEL: E24 F14 J63 P23
    Date: 2005
  62. By: Zulfiqar Hyder (State Bank of Pakistan); Sardar Shah (State Bank of Pakistan)
    Abstract: This paper assesses the extent to which the movements in exchange rate affect domestic wholesale and consumer prices in Pakistan by analyzing data from January 1988 to September 2003. The empirical model is a recursive VAR, suggested by McCarthy (2000), incorporating a distribution chain of pricing. Impulse response function and variance decomposition are used to measure the exchange rate pass-through to domestic prices. The major findings of this paper are: (1) the exchange rate movements have only a moderate effect on domestic prices, i.e., exchange rate pass-through is low; (2) the exchange rate pass-through is more stronger in wholesale price index (WPI) relative to consumers price index (CPI); (3) the impact of pass-through on domestic prices spreads over 12 months, however, the effect is mostly felt in the first four months; (4) the exchange rate pass-through to consumer prices have further weakened after the free float of Rupee/Dollar parity in July 2000; (5) within the WPI commodity groups, the exchange rate pass- through is stronger in ‘Fuel & Lighting’ and ‘Manufactures’ groups while in the case of CPI, pass-through is more pronounced in ‘Transport & Communication’ and ‘Fuel & Lighting’ group. Furthermore, the exchange rate pass-through to domestic prices is much stronger in higher inflationary environment during Jan-88 to Dec-97 relative to lower inflationary environment down the road.
    Keywords: Exchange Rate Pass-through, Domestic Prices, Impulse Response Function, Variance Decomposition
    JEL: E
    Date: 2005–10–22
  63. By: Greg Rawlings; Brigitte Unger
    Abstract: To compete for criminal money by means of low bank secrecy seems a tempting strategy for countries in order to attract additional funds. We show in a model that this "Seychelles-strategy" can increase national output, in particular if a country takes a (Stackelberg ) leadership in the competition game. If all countries try to do the same, there will be a race to the bottom and a supranational authority like the FATF (Financial Action Task Force) must intervene. However, there are also some intrinsic barriers to the "Seychelles-strategy". Among others, criminal capital might crowd out legal capital and money laundering might increase crime. Our findings suggest that countries have created niches for laundering. Small countries can free ride for a while, but eventually will face external sanctions and internal crime problems.
    Date: 2005–06
  64. By: Oliver Blaskowitz; Helmut Herwartz; Gonzalo de Cadenas Santiago
    Abstract: In this study we forecast the term structure of FIBOR/EURIBOR swap rates by means of recursive vector autoregressive (VAR) models. In advance, a principal components analysis (PCA) is adopted to reduce the dimensionality of the term structure. To evaluate ex–ante forecasting performance for particular short, medium and long term rates and for the level, slope and curvature of the swap term structure, we rely on measures of both statistical and economic performance. Whereas the statistical performance is investigated by means of the Henrikkson–Merton statistic, the economic performance is assessed in terms of cash flows implied by alternative trading strategies. Arguing in favor of local homogeneity of term structure dynamics, we propose a data driven, adaptive model selection strategy to ’predict the best forecasting model’ out of a set of 100 alternative implementations of the PCA/VAR model. This approach is shown to outperform forecasting schemes relying on global homogeneity of the term structure.
    Keywords: Principal components, Factor Analysis, Ex–ante forecasting, EURIBOR swap rates, Term structure, Trading strategies
    JEL: C32 C53 E43 G29
    Date: 2005–04
  65. By: Junning Cai (University of Hawaii at Manoa)
    Abstract: It is said that a country’s currency peg can become currency manipulation representing protracted government intervention in the foreign exchange market that gives it unfair competitive advantage in international trade yet prevents effective balance of payments in its trade partners. Regarding this widespread fallacy, this paper explains why currency peg is not currency manipulation even when it keeps a country’s currency undervalued. We clarify that 1) government is inherently a major player in the financial market and hence “no protracted intervention” is a meaningless guideline for designating currency manipulation; 2) exchange rate flexibility is neither a sufficient nor a necessary condition for fixing current account imbalance and hence currency peg would not prevent effective current account adjustments; and 3) as far as causing “unfair” trade advantage is concerned, currency peg is less guilty than the attempt to prevent or fix current account imbalance; and obligating a country to adjust its currency to accommodate its trade partners’ current account management would unfairly impair this country’s trade advantage.
    Keywords: currency manipulation; current account; exchange rate; RMB controversies
    JEL: E52 F31 F32
    Date: 2005–10–24

This nep-mac issue is ©2005 by Soumitra K Mallick. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.