nep-mac New Economics Papers
on Macroeconomics
Issue of 2005‒11‒19
129 papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Monetary Concequences of Alternative Fiscal Policy Rules By Jukka Railavo
  2. Monetary Policy Shifts, Indeterminacy and Inflation Dynamics By Paolo Surico
  3. Monetary Policy and Fiscal Rules By Giancarlo Marini; Alessandro Piergallini
  4. Monetary and Fiscal Interactions without Commitment and the Value of Monetary Conservatism By Roberto Billi; Klaus Adam
  5. Income Inequality, Monetary Policy, and the Business Cycle By Stuart J. Fowler
  6. Changing Effects of Monetary Policy in the U.S. –Evidence from a Time-Varying Coefficient VAR By Christian Melzer; Thorsten Neumann
  7. A Rational Expectations Model of Optimal Inflation Inertia By Michael Kumhof; Douglas Laxton
  8. Keynesian Dynamics and the Wage-Price Spiral:Estimating and Analyzing a Baseline Disequilibrium Approach By W. Semmler; P. Chen; C. Chiarella
  9. The Optimal Inflation Buffer with a Zero Bound on Nominal Interest Rates By Roberto M. Billi
  10. Simple Pricing Rules, the Phillips Curve and the Microfoundations of Inflation Persistence By Richard Mash
  11. Non-Ricardian Households and Fiscal Policy in an Estimated DSGE Model of the Euro Area By Roland Straub; Günter Coenen
  12. Distributional Effects of Monetary Policies in a New Neoclassical Model with Progressive Income Taxation By Burkhard Heer; Alfred Maussner
  13. Money, Inventories and Underemployment in Deflationary Recessions By Gerd Weinrich; Luca Colombo
  14. The Exchange Rate and Canadian Inflation Targeting By Christopher Ragan
  15. Optimal Inflation Persistence: Ramsey Taxation with Capital and Habits By Sanjay K. Chugh
  16. The Mundell-Fleming-Dornbusch Model in a New Bottle By Anthony Landry
  17. The natural real interest rate and the output gap in the euro area - a joint estimation By Julien Garnier; Bjørn-Roger Wilhelmsen
  18. Monetary Policy under Adaptive Learning By Vitor Gaspar; Frank Smets
  19. An Interpretation of Fluctuating Macro Policies By Eric Leeper; Troy Davig
  20. A BVAR Forecasting Model For Peruvian Inflation By Gonzalo Llosa; Vicente Tuesta; Marco Vega
  21. Persistence and Nominal Inertia in a Generalized Taylor Economy: How Longer Contracts Dominate Shorter Contracts By Engin Kara; Huw Dixon
  22. Optimal Interest Rate Rules, Asset Prices and Credit Frictions By Tommaso Monacelli; Ester Faia
  23. Monetary Policy in an Estimated DSGE Model with a Financial Accelerator By Ali Dib; Ian Christensen
  24. On the Sources of the Inflation Bias and Output Variability By Gustavo Piga
  25. The Phillips Curve Under State-Dependent Pricing By Rudolf, B.; Bakhshi, H.
  26. Dynamic Limited Dependent Variable Modeling and US Monetary Policy By George Monokroussos
  27. Performance of Interest Rate Rules under Credit Market Imperfections By Beatriz de-Blas-Pérez;
  28. Declining Output Volatility: What Role for Structural Change? By Christopher Kent; Kylie Smith; James Holloway
  29. Estimating the Revealed Inflation Target: An Application to U.S. Monetary Policy By Daniel Leigh
  30. Uncertainty about the Persistence of Periods with Large Price Shocks and the Optimal Reaction of the Monetary Authority By Gonzalez F.; Rodriguez A.; Gonzalez-Garcia J.R.
  31. Real-time data for Norway: Output gap revisions and challenges for monetary policy By TOM BERNHARDSEN; ØYVIND EITRHEIM
  33. Bad for Euroland, Worse for Germany-The ECB's Record By Jorg Bibow
  34. The long-run output-inflation trade-off in the presence of menu costs By James Yetman; Wai Yip Alex Ho
  35. Does Financial Structure Matter for the Information Content of Financial Indicators? By Ramdane Djoudad; Jack Selody; Carolyn Wilkins
  36. What do robust policies look like for open economy inflation targeters? By Kirdan Lees
  37. Trends and cycles in the Euro Area: how much heterogeneity and should we worry about it? By Domenico Giannone; Lucrezia Reichlin
  38. Measuring the Effects of Real and Monetary Shocks in a Structural New-Keynesian Model By Andreas Beyer; Roger E.A. Farmer
  39. A dynamic model of a monetary production economy under the disequilibrium economics approach By Marco Raberto; Andrea Teglio
  40. Measuring Inflation Persistence: A Structural Time Series Approach By Maarten Dossche; Gerdie Everaert
  41. Eigenvalue filtering in VAR models with application to the Czech business cycle By Jaromír Beneš; David Vávra
  42. Bayesian Estimation of a DSGE Model with Financial Frictions for the U.S. and the Euro Area By Virginia Queijo
  43. Speculation, Liquidity Preference and Monetary Circulation By Korkut Erturk
  44. Forecasting with the New-Keynesian Model: An Experiment with Canadian Data By Ali Dib; Kevin Moran
  45. TIPS: Taking Inflation Premium Seriously By Min Wei; Stefania D'Amico; Don H. Kim
  46. Structural and Cyclical Unemployment: What Can We Derive from the Matching Function? By Kamil Galuscak; Daniel Muenich
  47. The Effects of EU Shocks on the Macrovariables of the Newly Acceded Countries -A Sign Restriction Approach By Alina Barnett
  48. How (Not) to Sell Money By Arup Daripa
  49. An estimated open-economy model for the EURO area By Marco Ratto; Werner Roeger
  50. Does information help recovering fundamental structural shocks from past observations? By Domenico Giannone; Lucrezia Reichlin
  51. Optimal Nonlinear Policy: Signal Extraction with a Non-Normal Prior By Eric Swanson
  52. Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious? By Carlos Capistrán-Carmona
  53. The Term Structure of Interest Rates and the Public Debt Issuance Policy: A Note By Gustavo Piga; Giorgio Valente
  54. Production, Capital Stock and Price Dynamics in Simple Model of Closed Economy By Kodera J.; Vosvrda M.
  55. The Recent Shift in Term Structure Behavior from a No-Arbitrage Macro-Finance Perspective By Tao Wu; Glenn Rudebusch
  56. Interbank market under the currency board: Case of Lithuania By Marius Jurgilas
  57. Expectation Formation and Endogenous Fluctuations in Aggregate Demand By Maciej K. Dudek
  58. An Estimated DSGE Model for The German Economy By Ernest Pytlarczyk
  59. Learning about which measure of inflation to target By Luis-Felipe Zanna; Marco Airaudo
  60. Robustifying Learnability By Peter von zur Muehlen; Robert J. Tetlow
  61. Quantifying the Inefficiency of the US Social Security System By J. C. Parra; M. Huggett
  62. The role of contracting schemes for the welfare costs of nominal rigidities By Matthias Paustian
  63. Insurance Policies for Monetary Policy in the Euro Area By Volker Wieland; Keith Kuester
  64. Testing Near-Rationality Using Detail Survey Data By Stefan Palmqvist; Michael F. Bryan
  65. Computational Efficiency and Macroeconomic Stability under Centralized Exchange: Evidence from Swiss and US Exchange Data By James Stodder
  66. Bank finance versus bond finance - what explains the differences between US and Europe? By Fiorella De Fiore; Harald Uhlig
  67. Expansionary Fiscal Shocks and the Trade Deficit By Christopher Erceg; Luca Guerrieri
  68. The Fed and the Stock Market By Paolo Surico; Antonello D'Agostino; Luca Sala
  69. Learning and Endogenous Business Cycles in a Standard Growth Model By Laurent Cellarier
  70. Should we be surprised by the unreliability of real-time output gap estimates? Density estimates for the Euro area By James Mitchell
  71. Trend and Cycles: A New Approach and Explanations of Some Old Puzzles By Tatsuma Wada; Pierre Perron
  72. Time Consistent Policy in Markov Switching Models By Fabrizio Zampolli; Andrew P. Blake
  73. Common Trends and Common Cycles in Canadian Sectoral Output By Christoph Schleicher; Francisco Barillas
  74. Resurrecting the Expectations Hypothesis: How to Extract Additional Information From the Term Structure of Interest Rates By Andrea Carriero
  75. Inflation Bias after the Euro: Evidence from the UK and Italy By Giancarlo Marini; Alessandro Piergallini
  76. Effects of Macroeconomic Shocks to the Quality of the Aggregate Loan Portfolio By Ivan Baboucek; Martin Jancar
  77. Debt stabilizing fiscal rules By Philippe Michel; Leopold von Thadden; Jean-Piere Vidal
  78. Shifting Expectations about Technology Growth as a Propagation Mechanism By Masashi Saito
  79. Gains from International Monetary Policy Coordination: Does It Pay to Be Different? By Evi Pappa; Zheng Liu
  80. DSGE Models in a Data-Rich Environment By Marc P. Giannoni; Jean Boivin
  81. The link between interest rates and exchange rates - do contractionary depreciations make a difference? By Marcelo Sánchez
  82. Accounting for Changes in the Homeownership Rate By Matthew Chambers; Carlos Garriga
  83. Do so-called multivariate filters have better revision properties? An empirical analysis By L Christopher Plantier; Ozer Karagedikli
  84. Macroeconomic Sources of Risk in the Term Structure By Michael R. Wickens
  85. A Time-Frequency Analysis of the Coherences of the US Business By Christian Richter; Andrew Hughes Hallett
  86. Capital controls, two-tiered exchange rate systems and exchange rate policy : the South African experience By Schaling,Eric
  87. Time Consistent Control in Non-Linear Models By Steven Ambler; Florian Pelgrin
  88. Measuring the NAIRU with Reduced Uncertainty: A Multiple Indicator-Common Component Approach By Arabinda Basistha; Richard Startz
  89. Interest Rate Pegs, Wealth Effects and Price Level Determinacy By Barbara Annicchiarico; Giancarlo Marini
  90. Forecasting Canadian GDP: Region-Specific versus Countrywide Information By Frédérick Demers; David Dupuis
  91. Parallel Monies, Parallel Debt: Lessons from the EMU and Options for the New EU By Giorgio Basevi; Lorenzo Pecchi
  92. Measuring the Effects of Employment Protection on Job Flows: Evidence from Seasonal Cycles By Justin Wolfers
  93. The Kalman Foundations of Adaptive Least Squares: Applications to Unemployment and Inflation By J. Huston McCulloch
  94. Housing Wealth and Mortgage Contracts By Joseph B. Nichols
  95. Estimating the potential output of the euro area with a semi-structural multivariate Hodrick-Prescott filter By Matthieu LEMOINE; Odile CHAGNY
  96. Forecasting Aggregates by Disaggregates By Kirstin Hubrich; David F. Hendry
  97. The Relationship Between Growth and Investment By B Bhaskara Rao
  98. On the Distributional Effects of Trade Policy: A Macroeconomic Perspective By Luis San Vicente Portes
  99. Proyecciones desagregadas de la variación del índice de precios al consumidor (IPC), del índice de precios al por Mayor (IPM) y del Crecimiento del Producto Real (PBI) By Carlos Barrera-Chaupis
  100. Finding an Example of an Optimising Agent with Cyclical Behaviour By Peter J. Stemp
  101. Credit Card Debt Puzzles By Michael Haliassos; Michael Reiter
  102. The Scarring Effect of Recessions By Min Ouyang
  103. Endogenous Tax Evasion and Reserve Requirements: A Comparative Study in the Context of European Economies By Rangan Gupta
  104. Growth Effects of Age-related Productivity Differentials in an Ageing Society. A Simulation Study for Austria By Hofer, Helmut; Url, Thomas
  105. To Leave or Not To Leave: The Distribution of Bequest Motives By Wojciech Kopczuk; Joseph Lupton
  106. Welfare and Growth Effects of Alternative Fiscal Rules for Infrastructure Investment in Brazil By Pedro Cavalcanti Gomes Ferreira; Leandro Gonçalves do Nascimento
  107. Making a match: combining theory and evidence in policy-oriented macroeconomic modelling By Alasdair Scott; George Kapetanios; Adrian Pagan
  108. Growth volatility and technical progress: a simple rent-seeking model By Charles Ka-Yui Leung; Sam Hak Kan Tang; Nicolaas Groenewold
  109. Proprietary Income, Entrepreneurial Risk and the Predictability of U.S. Stock Returns By Mathias Hoffmann
  110. Global bond portfolios and EMU By Philip R. Lane
  111. Strong contagion with weak spillovers By Martin Ellison; Liam Graham; Jouko Vilmunen
  112. Population Aging and the Macroeconomy: Explorations in the Use of Immigration as an Instrument of Control By Frank T. Denton; Byron G. Spencer
  113. Economic Growth and Finance. A cointegration analysis in US and Japan By Giuseppina Testa
  114. Welfare Effects of Tax Policy in Open Economies: Stabilization and Cooperation By Sunghyun Henry Kim; Jinill Kim
  115. An Economics-based Energy Account for Classical Mechanics By Professor John M. Hartwick
  116. Unexploited Connections Between Intra- and Inter-temporal Allocation By Thomas F. Crossley; Hamish W. Low
  117. Aging, pension reform, and capital flows: A multi-country simulation model By Axel Boersch-Supan; Alexander Ludwig
  118. Limited Participation, Income Distribution and Capital Account Liberalization By Eva de Francisco
  119. On the Benefits of Exchange Rate Flexibility under Endogenous Tradedness of Goods By Kanda Naknoi; Michael Kumhof; Douglas Laxton
  120. European Stock Market Dynamics Before and After the Introduction of the Euro By Joseph Friedman; Yochanan Shachmurove
  121. Human Capital, R&D and Competition in Macroeconomic Analysis By Erik Canton; Bert Minne; Ate Nieuwenhuis; Bert Smid; Marc van der Steeg
  122. Inequality and Growth: A Semiparametric Investigation By Dustin Chambers
  123. Investment-Specific Technical Change and the Production of Ideas By Roberto M Samaniego
  124. Curve Forecasting by Functional Autoregression By A. Onatski; V. Karguine
  125. Evolución de las finanzas Municipales del Valle del Cauca y la efectividad de la Ley 617 del 2000 - (1987-2003) By Jaime Andrés Collazos; José Vicente Romero
  126. Equilibrium Correlation of Asset Price and Return By Charles Ka Yui Leung
  127. Tax Changes and Asset Pricing: Time-Series Evidence By Clemens Sialm
  128. ESTIMATING EXPORT EQUATIONS By B Bhaskara Rao; Rup Singh
  129. Tax Policies, Vintage Capital, and Entry and Exit of Plants By Dennis W. Jansen; Shao-Jung Chang

  1. By: Jukka Railavo (Monetary Policy and Research Department Bank of Finland)
    Abstract: In this paper we analyse the monetary impact of alternative fiscal policy rules using the debt and deficit, both mentioned as measures of fiscal policy performance in the Stability and Growth Pact (SGP). We use a New Keynesian model, with distortionary taxation and an appropriately defined output gap. The economy is hit by two fundamental shocks: demand and supply shocks, which are orthogonal to each other. Monetary policy is conducted by an independent central bank that will optimise. Under discretionary monetary policy the size of the inflation bias depends on the fiscal policy regime. Using the timeless perspective approach to precommitment, output persistence increases compared to the discretionary case. The result holds with the alternative fiscal policy rules, and inflation and output persistence reflects the economic data. With the deficit rules, the autocorrelation of the tax rate is near unity irrespective of the monetary policy regime, and irrespective of the fiscal policy parameters and targets. Thus we revive Barro's (1979) random walk result with the deficit rules
    Keywords: Inflation, monetary policy, fiscal policy, policy coordination
    JEL: E52 E31 E61 E62
    Date: 2005–11–11
  2. By: Paolo Surico (Monetary Assessment & Strategy Division Bank of England)
    Abstract: The New-Keynesian Phillips curve plays a central role in modern macroeconomic theory. A vast empirical literature has estimated this structural relationship over various postwar full-samples. While it is well know that in a New-Keynesian model a `weak' central bank response to inflation generates sunspot fluctuations, the consequences of pooling observations from different monetary policy regimes for the estimates of the structural Phillips curve had not been investigated. Using Montecarlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable persistence in the estimated process of inflation. This persistence however is not an intrinsic feature of the economy; rather it is endogenous to the policy regime and results from the self full-filling nature of inflation expectations. By neglecting indeterminacy the estimates of the forward-looking term of the structural Phillips curve are shown to be biased downward. The implications are in line with the empirical evidence for the U.K and U.S
    Keywords: indeterminacy, New-Keynesian Phillips curve, Montecarlo, bias, persistence
    JEL: E58 E31 E32
    Date: 2005–11–11
  3. By: Giancarlo Marini (University of Rome II - Faculty of Economics); Alessandro Piergallini (University of Rome II; University of Bristol - Department of Economics)
    Abstract: This paper studies the performance of monetary policy under alternative fiscal regimes in a dynamic New Keynesian optimizing general equilibrium model with wealth effects. The interactions between fiscal policy and interest rate rules are shown to have relevant implications for the existence of a unique rational expectations equilibrium. When calibrated to Euro Area quarterly data, the model simulation results show that the preferred monetary-fiscal regime for inflation stabilization consists of a generalized Taylor rule with a low degree of inertia coupled with a public debt-GDP ratio targeting rule.
    Keywords: Fiscal Policy Rules, Monetary Policy, Wealth Effects
    JEL: E52 E58 E63
  4. By: Roberto Billi; Klaus Adam (Research Department CEPR and European Central Bank)
    Abstract: We study monetary and fiscal policy games in a dynamic sticky priceeconomy where monetary policy sets nominal interest rates and fiscal policy provides public goods financed with distortionary labor taxes. We compare the Ramsey outcome to non-cooperative policy regimes where one or both policymakers lack commitment power. Absence of fiscal commitment gives rise to a public spending bias, while lack of monetary commitment generates the well-known inflation bias. An appropriately conservative monetary authority can eliminate the steady state distortions generated by lack of monetary commitment and may even eliminate the distortions generated by lack of fiscal commitment. The costs associated with the central bank being overly conservative seem small, but insufficient conservatism may result in sizable welfare losses
    Keywords: optimal monetary and fiscal policy, lack of commitment, sequential policy, discretionary policy
    JEL: E52 E62 E63
    Date: 2005–11–11
  5. By: Stuart J. Fowler
    Abstract: The effects of changes in monetary policy are studied in a general equilibrium model where money facilitates transactions. Because there are two types of agents, workers and capitalists, different elasticities of money demand exist, implying that monetary policy influences the distribution of income. Only when earnings inequality is incorporated into monetary policy rule is the model able to replicate cyclical fluctuations of both real and nominal aggregates as well as the inequality measure. Additionally, monetary policy becomes more countercyclical when the fraction of transfers received by the workers increases. These results can support a theory that the distribution of seigniorage revenues between the workers and capitalists changed in 1979
    Keywords: Inflation, Income Distribution, Heterogenous Agents, Perturbation
    JEL: E32 E42 E50
    Date: 2005–11–11
  6. By: Christian Melzer; Thorsten Neumann
    Abstract: We estimate a time-varying coefficient VAR model for the U.S. economy to analyse (i) if the effect of monetary policy on output has been changing systematically over time, and (ii) if monetary policy has asymmetric effects over the business cycle. We find that the impact of monetary policy shocks has been gradually declining over the sample period (1962-2002), as some theories of the monetary transmission mechanism imply. In addition, our results indicate that the effects of monetary policy are greater in a recession than in a boom.
    JEL: E52 E32 C52
    Date: 2005–11–11
  7. By: Michael Kumhof (Modeling Division, Research Department International Monetary Fund); Douglas Laxton
    Abstract: This paper presents a monetary model with nominal rigidities and maximizing, rational, forward-looking households, intermediaries and firms. It differs from conventional models in this class in two key respects. First, price (and wage) setters set pricing policies, including an updating rate for future prices, instead of price levels. Second, output fluctuations during the period of a pricing policy are costly to firms. The paper is motivated by some important shortcomings of conventional models, namely their inability to generate inflation inertia, inflation persistence and recessionary disinflations without introducing either an ad-hoc updating rule or learning. While learning is clearly important, we are interested in the contribution that structural rigidities can make in a forward-looking and optimizing model. The model does generate all of the above effects in response to monetary policy shocks. The channel for these effects in the model is the long-run or inflation updating component of firms' pricing policies. This is distinct from another frequently stressed reason for inflation inertia and persistence, a slow response of marginal cost to shocks, which is also present in our model because all components of marginal cost, not just wages, are sticky. In work in progress, we are estimating the model using Bayesian techniques.
    Keywords: Inflation inertia, price setting behavior, output volatility
    JEL: E31 E32
    Date: 2005–11–11
  8. By: W. Semmler; P. Chen; C. Chiarella
    Abstract: In this paper, we reformulate the theoretical baseline DAS-AD model of Asada, Chen, Chiarella and Flaschel (2004) to allow for its somewhat simplified empirical estimation. The model now exhibits a Taylor interest rate rule in the place of an LM curve and a dynamic IS curve and dynamic employment adjustment. It is based on sticky wages and prices, perfect foresight of current inflation rates and adaptive expectations concerning the inflation climate in which the economy is operating. The implied nonlinear 6D model of real markets disequilibrium dynamics avoids striking anomalies of the old Neoclassical synthesis and can be usefully compared with the model of the new Neoclassical Synthesis when the latter is based on both staggered prices and wages. It exhibits typical Keynesian feedback structures with asymptotic stability of its steady state for low adjustment speeds and with cyclical loss of stability -- by way of Hopf bifurcations -- when certain adjustment speeds are made sufficiently large. In the second part we provide system estimates of the equations of the model in order to study its stability features based on empirical parameter estimates with respect to its various feedback channels. Based on these estimates we find that the dynamics is strongly convergent around the steady state, but will loose this feature if the inflationary climate variable adjusts sufficiently fast. We also study to which extent more active interest rate feedback rules or downward wage rigidity can stabilize the dynamics in the large when the steady state is made locally repelling by a faster adjustment of inflationary expectations. We find support for the orthodox view that (somewhat restricted) money wage flexibility is the most important stabilizer in this framework, while monetary policy should allow for sufficient steady state inflation in order to avoid stability problems in areas of the phase space where wages are still not very flexible in a downward direction
    Keywords: DAS-DAD growth, wage and price Phillips curves, nonlinear estimation, stability, economic breakdown, persistent cycles, monetary policy.
    JEL: E24 E31 E32
    Date: 2005–11–11
  9. By: Roberto M. Billi (- Center for Financial Studies)
    Abstract: This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfare-theoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economy
    Keywords: inflation inertia, downward nominal rigidity, nonlinear policy, liquidity trap
    JEL: C63 E31 E52
    Date: 2005–11–11
  10. By: Richard Mash
    Abstract: We analyze the microfoundations of the Phillips curve, a key relationship in general macroeconomics and models of monetary policy in particular. The form in current widespread use includes both forward looking expected inflation and lagged inflation. The presence of lagged inflation is necessary to generate predicted inflation persistence to match actual persistence in real world data but it has proved very difficult to microfound. Recent contributions from Christiano, Eichenbaum and Evans (JPE, 2005) and Gali and Gertler (JME, 1999) have attempted to provide such microfoundations through the assumption of indexing or rule of thumb behaviour. We question the nature of the indexing rules or rules of thumb assumed and re-derive these models for the case where firms choose constrained optimal simple pricing rules. We find that the models no longer convincingly predict inflation persistence
    Keywords: Monetary policy, Phillips curve, Inflation persistence, Microfoundations
    JEL: E52 E58 E22
    Date: 2005–11–11
  11. By: Roland Straub; Günter Coenen (IMF public)
    Abstract: In this paper, we revisit the effects of government spending shocks on private aggregate consumption within an estimated New-Keynesian DSGE model of the euro area featuring non-Ricardian households and a relatively detailed fiscal policy set up. Employing Bayesian inference methods, we show that the presence of non-Ricardian households is in general conducive to raising the level of aggregate consumption in response to government spending shocks when compared with the benchmark specification without non-Ricardian households. As a practical matter, however, we find that there is only a fairly small chance that government spending shocks crowd in aggregate consumption, mainly because the estimated share of non-Ricardian households is relatively low, but also due to the large negative wealth effect induced by the highly persistent nature of government spending shocks
    Keywords: fiscal policy, DSGE models, non-Ricardian households.
    JEL: E32 E62
    Date: 2005–11–11
  12. By: Burkhard Heer; Alfred Maussner (School of Economics and Management Free University of Bolzano-Bozen)
    Abstract: In our dynamic optimizing sticky price model, agents are heterogenous with regard to their assets and their income. Unanticipated inflation redistributes income and wealth. In order to model the wealth distribution, we study a 60-period OLG model with aggregate uncertainty. A positive technology shock increases the concentration of wealth as measured by the Gini coefficient considerably. In particular, a one percent increase of the technology level results in a one percent increase of the Gini coefficient. An unexpected expansionary monetary policy is found to reduce the inequality of the wealth distribution. In addition, we find that the business cycle dynamics in the OLG model in response to both a technology shock and a monetary shock are different from those in the corresponding representative-agent model
    Keywords: Distribution Effects, Unanticipated Inflation, Heterogeneous Agents
    JEL: E31 E32 E52
    Date: 2005–11–11
  13. By: Gerd Weinrich; Luca Colombo
    Abstract: This paper investigates monetary shocks and the rôle of inventories with respect to the occurrence of deflationary recessions. We propose a non-tâtonnement approach involving temporary equilibria with rationing in each period and price adjustment between successive periods. By amplifying spillover effects inventories imply that, following a restrictive monetary shock, the economy may converge to a quasi-stationary Keynesian underemployment state, in which case money is persistently non-neutral. Contrary to conventional wisdom, this is favored by sufficient downward flexibility of the nominal wage. The model is applied to the current deflationary Japanese recession, and we propose an economic policy to overcome it
    Keywords: Inventories, non-tatonnement, price adjustment, non-neutrality of money, deflationary recession
    JEL: D45 D50 E32
    Date: 2005–11–11
  14. By: Christopher Ragan
    Abstract: The author provides a non-technical explanation of the role played by the exchange rate in Canada's inflation-targeting monetary policy. He reviews the motivation for inflation targeting and describes the monetary transmission mechanism. Though the exchange rate is an integral component of the transmission mechanism, the author explains why it is not a target for monetary policy. He provides a simple taxonomy for exchange rate movements, distinguishing between movements associated with direct shocks to aggregate demand and those unrelated to such direct shocks. He explains the importance to monetary policy of determining the cause of any given movement in the exchange rate, and of determining the net effect on aggregate demand. The author also describes Canadian monetary policy during the 2003–04 period, a time when the Canadian dollar appreciated sharply against the U.S. dollar.
    Keywords: Exchange rates; Inflation targets; Monetary policy implementation
    JEL: E50 E52 F41
    Date: 2005
  15. By: Sanjay K. Chugh
    Abstract: Ramsey models of fiscal and monetary policy with perfectly-competitive product markets and a fixed supply of capital predict highly volatile inflation with no serial correlation. In this paper, we show that an otherwise-standard Ramsey model that incorporates capital accumulation and habit persistence predicts highly persistent inflation. The result depends on increases in either the ability to smooth consumption or the preference for doing so. The effect operates through the Fisher relationship: a smoother profile of consumption implies a more persistent real interest rate, which in turn implies persistent optimal inflation. Our work complements a recent strand of the Ramsey literature based on models with nominal rigidities. In these models, inflation volatility is lower but continues to exhibit very little persistence. We quantify the effects of habit and capital on inflation persistence and also relate our findings to recent work on optimal fiscal policy with incomplete markets
    Keywords: Optimal fiscal and monetary policy, inflation persistence, Ramsey model, habit formation
    JEL: E50 E61 E63
    Date: 2005–11–11
  16. By: Anthony Landry (Economics Boston University)
    Abstract: We introduce elements of state-dependent pricing and strategic complementarity within an otherwise standard "New Open Economy Macroeconomics" model, and develop its implications for the dynamics of real and nominal economic activity. Under a traditional Producer-Currency-Pricing environment, our framework replicates key international features following a domestic monetary shock. In contrast with its time-dependent counterpart, our approach delivers (i) a high international output correlation relative to consumption correlation, (ii) a delayed surge in inflation across countries, (iii) a delayed overshooting of exchange rates, and (iv) a J-curve dynamic in the domestic trade balance. Moreover, our model emphasizes the expenditure-switching effect as an important channel of monetary policy transmission, and consequently keeps the spirit of the Mundell-Fleming-Dornbusch model within the confines of the microfounded dynamic general equilibrium approach
    Keywords: international monetary policy transmission, international comovements, state-dependent pricing, strategic complementarity.
    JEL: F41 F42
    Date: 2005–11–11
  17. By: Julien Garnier (European University Institute and University of Parix X-Nanterre); Bjørn-Roger Wilhelmsen (Central Bank of Norway, Economics Department, Oslo, Norway)
    Abstract: The notion of a natural real rate of interest, due to Wicksell (1936), is widely used in current central bank research. The idea is that there exists a level at which the real interest rate would be compatible with output being at its potential and stationary inflation. This paper applies the method recently suggested by Laubach and Williams to jointly estimate the natural real interest rate and the output gap in the euro area over the past 40 years. Our results suggest that the natural rate of interest has declined gradually over the past 40 years. They also indicate that monetary policy in the euro area was on average stimulative during the 1960s and the 1970s, while it contributed to dampen the output gap and inflation in the 1980s and the 1990s.
    Keywords: Real interest rate gap; output gap; Kalman filter; euro area.
    JEL: C32 E43 E52 O40
    Date: 2005–11
  18. By: Vitor Gaspar; Frank Smets
    Abstract: The paper studies the conduct of monetary policy, in a simple new Keynesian model, with adaptive learning on the part of the private sector. A key feature is that even though we start out with a linear “structural†model, the system and hence policy responses inherit the non-linear feature of the updating equations for the estimated parameters. In the paper, we contrast two different monetary policy regimes. In the first the central bank follows a simple rule, which comes from the first order conditions, for optimal policy under discretion in the case of rational expectations. In the second, the central bank has full information about the structure of the economy, including the adaptive learning mechanism. It takes the expectations formation mechanism explicitly into account when deriving optimal policy. This framework allows an explicit discussion of the importance of keeping inflation expectations under control. We illustrate with an application to a regime change, where we assume that the incumbent policymaker did not take the learning into account and allowed the expectation formation process to become unhinged. However, before inflation expectations (and actual inflation) spirals out of control, we assume that a sophisticated central banker, who does take the effect of learning into account, takes charge and study how the economy adjusts after the regime change. Under our assumptions the transition is slow. We claim that some features of the transition match important stylised facts associated with the Volcker disinflation in the US. In the end the fully optimal policy delivers less inflation and output gap volatility. It does so by anchoring inflation expectations thereby contributing to the overall stability of the economy. To achieve this result optimal policy is conditional on the degree of perceived persistence. As perceived persistence increases so does inertia in the policy response in the face of inflation shocks. We compare the contrast between the two policy regimes in the paper with the difference between the rational expectations under discretion and commitment.
    Keywords: monetary policy, adaptive learning, regime change
    JEL: E5 E52 E65
    Date: 2005–11–11
  19. By: Eric Leeper; Troy Davig (Department of Economics College of William and Mary)
    Abstract: This paper estimates simple regime-switching rules for monetary policy and tax policy over the post-war period in the United States and imposes the estimated policy process on a standard dynamic stochastic general equilibrium model with nominal rigidities. The estimated joint policy process produces a unique stationary rational expectations equilibrium in a simple New Keynesian model. We characterize policy impacts across regimes
    Keywords: Policy rules, Markov-switching, DSGE models
    JEL: E42 E51 E52
    Date: 2005–11–11
  20. By: Gonzalo Llosa (Interamerican Development Bank and Central bank of Peru); Vicente Tuesta (Central Bank of Peru); Marco Vega (Central Bank of Peru)
    Abstract: We build a simple non-structural BVAR forecasting framework to predict key Peruvian macroeconomic data, in particular, inflation and output. Unlike standard applications we build our Litterman prior specification based on the fact that the structure driving the dynamics of the economy might have shifted towards a state where a clear nominal anchor has become well grounded (Inflation Targeting). We compare different BVAR specifications with respect to a ”naive” random walk and we find that they outperform the random walk in terms of inflation forecasts at all horizons. However, our PBI forecasts are not accurate enough to beat a ”naive” random walk.
    Keywords: Bayesian VAR, Forecasting, Inflation Targeting
    JEL: E31 E37 E47 C11 C53
    Date: 2005–11
  21. By: Engin Kara; Huw Dixon (Economics Univeristy of York)
    Abstract: n this paper we develop the Generalize Taylor Economy (GTE) in which there are many sectors with overlapping contracts of different lengths. We are able to show that even in economies with the same average contract length, monetary shocks will be more persistent when there are longer contracts. In particular we are able to solve the puzzle of why Calvo contracts appear to be more persistent than simple Taylor contracts: it is because the standard calibration of Calvo contracts is not correct
    Keywords: Persistence, Taylor contract, Calvo
    JEL: E50 E24 E32 E52
    Date: 2005–11–11
  22. By: Tommaso Monacelli; Ester Faia
    Abstract: We study optimal monetary policy in two prototype economies with sticky prices and credit market frictions. In the first economy, credit frictions apply to the financing of the capital stock, generate acceleration in response to shocks and the "financial markup" (i.e., the premium on external funds) is countercyclical and negatively correlated with the asset price. In the second economy, credit frictions apply to the flow of investment, generate persistence, and the financial markup is procyclical and positively correlated with the asset price. We model monetary policy in terms of welfare-maximizing interest rate rules. The main finding of our analysis is that strict inflation stabilization is a robust optimal monetary policy prescription. The intuition is that, in both models, credit frictions work in the direction of dampening the cyclical behavior of inflation relative to its credit-frictionless level. Thus neither economy, despite yielding different inflation and investment dynamics, generates a trade-off between price and financial markup stabilization. A corollary of this result is that reacting to asset prices does not bear any independent welfare role in the conduct of monetary policy
    JEL: E52 F41
    Date: 2005–11–11
  23. By: Ali Dib; Ian Christensen
    Abstract: This paper estimates a sticky-price DSGE model with a financial accelerator to assess the importance of financial frictions in the amplification and propagation of the effects of transitory shocks. Structural parameters of two models, one with and one without a financial accelerator, are estimated using a maximum-likelihood procedure and post-war US data. The estimation and simulation results provide some quantitative evidence in favour of the financial accelerator model. The financial accelerator appears to play an important role in investment fluctuations, but its importance for output depends on the nature of the initial shock
    Keywords: Monetary policy, Financial accelerator, DSGE estimation
    JEL: E31 E44 E51
    Date: 2005–11–11
  24. By: Gustavo Piga (University of Rome II)
    Abstract: Why do dynamic inconsistencies in monetary policy exist? In this paper a traditional model without put inefficiencies is introduced, but monetary policy is allowed to be influenced by the various constituencies in the economy, that pressure Congress in turn to pressure the central bank to adopt a particular policy stance. The paper shows that in this economy an inflation bias arises due to the lobbying pressures of outsiders. Furthermore, it shows that if lobbying pressures are high enough, an inflation bias cannot be avoided for any finite level of central bank independence. It also shows that introducing the realistic feature of lobbying pressures has an impact on the stabilization properties of monetary policy. When a supply shock occurs, the shock is totally absorbed by a non myopic trade union which has no lobbying costs. This is independent of any finite degree of conservativeness of the central banker, who has to accept an extreme increase in price instability. It is shown that monetary policy delegation is therefore sub-optimal in achieving price-stability compared to labor-market reforms meant to remove monopsonistic elements. However, the same structural policies will induce greater output instability by strengthening the power of conservative central bankers
    JEL: E52 E58 E31
    Date: 2005–02–04
  25. By: Rudolf, B. (Economic Studies Swiss National Bank); Bakhshi, H.
    Abstract: This paper is related to a large recent literature studying the Phillips curve in sticky-price equilibrium models. It differs in allowing for the degree of price stickiness to be determined endogenously. A closed-form solution for short-term inflation is derived from the dynamic stochastic general equilibrium (DSGE) model with state-dependent pricing originally developed by Dotsey, King and Wolman. This generalised Phillips curve encompasses the New Keynesian Phillips curve (NKPC) based on Calvo-type price-setting as a special case. It describes current inflation as a function of lagged inflation, expected future inflation, and current and expected future real marginal costs. The paper demonstrates that inflation dynamics generated by the model for a broad class of time and state-dependent price-setting behaviours are well approximated by the popular hybrid NKPC (with one lag of inflation) in a low-inflation environment. This provides an explanation of why the hybrid NKPC performs well in describing inflation dynamics across industrial countries. It implies, however, that the reduced-form coefficients of the hybrid NKPC may not have a structural interpretation
    Keywords: State-dependent pricing, inflation dynamics, Phillips curve.
    JEL: E31 E32
    Date: 2005–11–11
  26. By: George Monokroussos (Economics UCSD)
    Abstract: I estimate, using real-time data, a forward-looking monetary policy reaction function that is dynamic and that also accounts for the fact that there are substantial restrictions in the period-to-period changes of the Fed's policy instrument. I find a substantial contrast between the periods before and after Paul Volcker's appointment as Fed Chairman in 1979, both in terms of the Fed's response to expected inflation and in terms of its response to the (perceived) output gap: In the pre-Volcker era the Fed's response to inflation was substantially weaker than in the Volcker-Greenspan era; conversely, the Fed seems to have been more responsive to real activity in the pre-Volcker era than later
    JEL: C25 E52 E58
    Date: 2005–11–11
  27. By: Beatriz de-Blas-Pérez (Facultad de Ciencias Económicas y Empresariales Universidad de Navarra);
    Abstract: The stabilization effects of Taylor rules are analyzed in a limited participation framework with and without credit market imperfections in capital goods production. Financial frictions substantially amplify the impact of shocks, and also reinforce the stabilizing or destabilizing effects of interest rate rules. However, these effects are reversed relative to New Keynesian models: under limited participation, interest rate rules are stabilizing for productivity shocks, but imply an output-inflation tradeoff for demand shocks. Moreover, because financial frictions imply excessive fluctuation, stabilization via an interest rate rule can be a welfare-improving response to productivity shocks.
    Keywords: financial frictions, Taylor rules, limited participation, stabilization policy.
    JEL: E13 E44 E5
    Date: 2005–11
  28. By: Christopher Kent (Reserve Bank of Australia); Kylie Smith (Reserve Bank of Australia); James Holloway (Reserve Bank of Australia)
    Abstract: The decline in output volatility in a number of countries over the past few decades has been well-documented, though less agreement has been reached about the causes of this decline. In this paper, we use a panel of data from 20 OECD countries to see if there is a role for various indicators of structural reform in explaining the general decline in output volatility. We suggest that reforms in product and labour markets can reduce volatility of aggregate output by encouraging productive resources to shift more readily in response to differential shocks across firms and sectors. In contrast to other studies, we include direct measures of product market regulations and monetary policy regimes as indicators of structural reform. We find that less product market regulation and stricter monetary policy regimes have played a role in reducing output volatility. Our estimates are reasonably robust to a number of alternative specifications, including those that attempt to control for a possible trend in common (unexplained) innovations to output volatility such as a possible decline in the magnitude of global shocks.
    Keywords: business cycles; volatility; panel regression; structural reform; monetary policy; OECD
    JEL: E32 E52 E58
    Date: 2005–10
  29. By: Daniel Leigh (European International Monetary Fund)
    Abstract: This paper proposes a new method of estimating the Taylor rule with a time-varying implicit inflation target and a time-varying natural rate of interest. The inflation target and the natural rate are modelled as random walks and are estimated using maximum likelihood and the Kalman filter. I apply this method to U.S. monetary policy over the last 25 years to understand how the Federal Reserve’s target has varied during this broadly successful period. Stability tests indicate significant time variation in the implicit target. In the early 1980s, during the Volcker disinflation, the inflation target is near 3%. In the late 1980s and early 1990s, the target is close to actual inflation of 3-4% and only declines once the 1990-91 recession reduces inflation to 1-2%, corroborating historical evidence of an “opportunistic approach to disinflation.†Finally, over 2001-2004, the target rises to 2-3%, behaviour that can be interpreted as a response the risks of hitting the zero bound on nominal interest rates
    Keywords: Taylor rule, time-varying parameters, Kalman filter
    JEL: C22 E31 E52
    Date: 2005–11–11
  30. By: Gonzalez F.; Rodriguez A. (Economic Studies Division Bank of Mexico); Gonzalez-Garcia J.R.
    Abstract: Uncertainty about the persistence of periods characterized by large price shocks is an important aspect of monetary policy. This type of uncertainty posed some difficulties for central banks in 2004. This paper formalizes the treatment of this type of uncertainty by solving an optimal control problem in which the economy randomly alternates between two regimes characterized by different magnitudes of price shocks. By using an open economy model, we find that the optimal policy rule is both regime-contingent and robust. In particular, we find that: a) the optimal reaction of the interest rate is dependent on both the current regime and on the difference in the magnitude of the shocks between regimes; b) the alternation between regimes leads to more aggressive policy reactions with respect to inflation and the second lag of the real exchange rate; and c) after a robust selection of transition probabilities, the min-max probability of switching to the regime with large price shocks increases when such regime is more harmful. In general, cautious behavior renders smaller losses than recklessness for the central bank. This result argues in favor of caution over recklessness in the formulation of monetary policy when there is uncertainty about the persistence of periods with large price shocks
    Keywords: monetary policy, Markov regime-switching, optimal control, robustness, model uncertainty, inflation targeting
    JEL: C6 E5
    Date: 2005–11–11
  31. By: TOM BERNHARDSEN (Research Department Norges Bank (The Central Bank of Norway)); ØYVIND EITRHEIM
    Abstract: Monetary policy conducted in real time has to take into account the preliminary nature of recent national accounts data. Not only recent data, but also figures dating many years back are potentially subject to revisions. This means that there is a danger that an important part of the central bank's information set is flawed for a substantial period of time. In this paper we present results based on quarterly vintages of real-time data for Norway from 1993Q1 to 2003Q4. We describe the nature and causes of the data revisions and investigate whether the revisions are true martingale differences or whether they can be forecasted. In the spirit of Orphanides and van Norden (2002), we analyze how data revisions and model uncertainty affect the reliability of output gap estimates. We find that total revisions of output gap estimates are heavily influenced by uncertainty about the trend at the end of the sample and that data revisions are of less importance, i.e., they are of smaller magnitude and show less persistence than other sources of output gap revisions. Finally, we analyse the implications of output gap uncertainty for monetary policy using a small New Keynesian macroeconomic model
    Keywords: Monetary policy, output gap, real-time data, interest rate rules
    JEL: C53 E37 E52
    Date: 2005–11–11
  32. By: B Bhaskara Rao (University of the South Pacific); Rup Singh (University of the South Pacific)
    Abstract: Demand for money is an important macroeconomic relationship. Its stability has implications for the choice of monetary policy targets. This paper estimates demand for narrow money in Fiji and evaluates its robustness and stability. It is found that there is a well determined stable demand for money in Fiji, for three decades, from 1971 to 2002 and its dynamics are adequately captured by the cointegration and error- correction models. Income and interest rate elasticities are found to be significant.
    Keywords: Demand for money, Monetary policy, Income and interest rate elasticities, Cointegration, Error correction, Unit roots, Stability.
    JEL: C1 C5
    Date: 2005–11–11
  33. By: Jorg Bibow (The Levy Economics Institute)
    Abstract: This paper assesses the contribution of the European Central Bank (ECB) to Germany’s ongoing economic crisis, a vicious circle of decline in which the country has become stuck since the early 1990s. It is argued that the ECB continues the Bundesbank tradition of asymmetric policymaking: the bank is quick to hike, but slow to ease. It thereby acts as a brake on growth. This approach has worked for the Bundesbank in the past because other banks behaved differently. Exporting the Bundesbank “success story” to Euroland has undermined its working, however; given its sheer size, Euroland simply cannot freeload on external stimuli forever. While Euroland cannot do without proper demand management, the Maastricht regime and especially the ECB are firmly geared against it. The ECB’s monetary policies have been biased against growth and have thus proved bad for Euroland as a whole. Meanwhile, the German disease of protracted domestic demand weakness has spread across much of Euroland. Yet, by pursuing its peculiar traditions of wage restraint and procyclical public thrift, the ECB’s policies have had even worse results for Germany. Fragility and divergence undermine the euro’s long-term survival.
    Keywords: German unification, Bundesbank, policy inconsistency, stability culture, ECB, EMU
    JEL: E31 E42 E58 E61 E63 E65 E66 H62
    Date: 2005–11–17
  34. By: James Yetman; Wai Yip Alex Ho (School of Economics and Finance University of Hong Kong)
    Abstract: We examine the long-run output-inflation trade-off under the assumption that firms face menu costs and set prices in a state dependent fashion. We argue that these characteristics capture the idea that the long-run output-inflation trade-off is driven by (predictable) trend inflation, and the degree of price rigidity should be chosen optimally by firms in the long run, at least on average. We find that state dependent pricing implies a non-trivial departure from long-run monetary neutrality in terms of output, and a larger one in terms of utility. This is because trend inflation substantially influences average mark-ups, relative price distortions, and resources required for changing prices. The optimal level of long-run inflation is zero.
    Keywords: State Dependent Pricing, Menu Costs, Phillips Curve
    JEL: E20 E31
    Date: 2005–11–11
  35. By: Ramdane Djoudad; Jack Selody; Carolyn Wilkins
    Abstract: Of particular concern to monetary policy-makers is the considerable unreliability of financial variables for predicting GDP growth and inflation. As Stock and Watson (2003) find, some financial variables work well in some countries or over some time periods and forecast horizons, but the results do not show any clear pattern. This may be caused by the changing nature of financial structures within countries across time, or the differing types of financial structures across countries. The authors assess the extent to which financial structure across countries influences the information content of financial variables for predicting real GDP growth and inflation. Their assumption is that financial asset prices will dominate financial quantities in economies with highly developed market-based financial systems. The authors use standard methods to determine the predictive content of common financial asset prices and quantities for 29 countries. They find no systematic pattern between financial structure and whether financial asset prices or quantities are the best financial indicators for monetary policy. Importantly, financial quantities are sometimes the best financial indicator, even in economies with highly developed market-based financial systems. The authors conclude that it would be difficult to tell, a priori, whether a financial asset price or quantity would be the best indicator for monetary policy for a particular country at a particular point in time.
    Keywords: Inflation and prices; Business fluctuations and cycles; Credit and credit aggregates; Monetary aggregates; Interest rates
    JEL: E31 E32
    Date: 2005
  36. By: Kirdan Lees (Economics Reserve Bank of New Zealand)
    Abstract: For policymakers, thinking about best practice monetary policy means thinking about uncertainty. Open economy monetary policymakers face an additional source of uncertainty – exchange rate dynamics. This paper identifies policy rules robust to the open economy inflation targeters face in practice. For Knight (1921), uncertainty differs from risk because the policymaker does not know the nature of the uncertainty and is unable to form a probability distribution or risk statement, over different possible models. Hansen and Sargent (2004) apply Knight’s (1921) philosophy to the linear-quadratic control framework, recognizing that policy-makers work with models which are approximations to some true, unknown model and seek a rule that is robust to models close to the policymaker’s best approximation. While there exist some open economy robust control policy experiments (Leitemo and Söderström (2004) obtain analytical robust control solutions for a purely forward-looking new Keynesian model) the majority of the literature focuses on the closed economy. This paper calibrates a single open economy model to capture the key open economy dynamics for Australia, Canada and New Zealand, three of the earliest inflation targeters that form a useful dataset for identifying robust monetary policy rules in practice. Robust policies are found to respond more aggressively to not only inflation and the output gap, but also the exchange rate and its associated shock. This result generalizes to the context of a flexible inflation targeting central bank that cares about the volatility of the real exchange rate. However, when the central bank places only a small weight on interest rate smoothing and fears misspecification in only exchange rate determination, a more aggressive response to the lag of the exchange rate is not warranted. It is shown that the benefits of an exchange rate channel far outweigh the concomitant costs of uncertain exchange rate determination.
    Keywords: uncertainty; open economy; robust control
    JEL: E52 E58 F41
    Date: 2005–11–11
  37. By: Domenico Giannone (Universite' Libre de Bruxelles, ECARES); Lucrezia Reichlin (European Central Bank, CEPR)
    Abstract: Not so much and we should not, at least not yet.
    Keywords: International Business Cycles, Euro Area, Risk Sharing, European Integration, Income Insurance.
    JEL: E32 C33 C53 F2 F43
    Date: 2005–11–15
  38. By: Andreas Beyer; Roger E.A. Farmer
    Abstract: We develop a technique for analyzing the dynamics of shocks in structural linear rational expectations models. Our work differs from standard SVARs since we allow expectations of future variables to enter structural equations. We show how to estimate the variance-covariance matrix of fundamental and non-fundamental shocks and we construct point estimates and confidence bounds for impulse response functions. Our technique can handle both determinate and indeterminate equilibria. We provide an application to U.S. monetary policy under pre and post Volcker monetary policy rules
    Keywords: Identification, indeterminacy, rational expectations models.
    JEL: C39 C62 D51
    Date: 2005–11–11
  39. By: Marco Raberto; Andrea Teglio
    Abstract: This paper presents a model of a monetary production economy with non-Walrasian good, labor and money markets. In the non-Walrasian approach, transactions occur at non clearing prices and agents's demand and supply are affected by quantity constraints in the opposite side of the market. The model is characterized by a representative firm, which maximize profits subject to a production technology, a representative consumer, which maximize utility subject to a budget constraint, and by a central bank which provide liquidity. The consumer provides the labor force and owns all the equities of the firm. The main result of the model is the existence of non-Warlasian equilibria which are suboptimal with respect to Warlasian ones. Furthermore, non-Warlasian equilibria are characterized by money non-neutrality and proper monetary policies are found to be able to bring the system near to the Walrasian point
    Keywords: disequilibrium economics; economic dynamics, monetary policy
    JEL: D92 E12 E37 E5
    Date: 2005–11–11
  40. By: Maarten Dossche (Research National Bank Belgium - Ghent University); Gerdie Everaert
    Abstract: Time series estimates of inflation persistence incur an upward bias if shifts in the inflation target of the central bank remain unaccounted for. Using a structural time series approach we measure different sorts of inflation persistence allowing for an unobserved time-varying inflation target. Unobserved components are identified using Kalman filtering and smoothing techniques. Posterior densities of the model parameters and the unobserved components are obtained in a Bayesian framework based on importance sampling. We find that inflation persistence, expressed by the half-life of a shock, can range from 1 quarter in case of a cost-push shock to several years for a shock to long-run inflation expectations or the output gap
    Keywords: Inflation persistence, Inflation target, Kalman filter
    JEL: C11 C13 C22
    Date: 2005–11–11
  41. By: Jaromír Beneš (Czech National Bank, Monetary and Statistics Department, Prague, Czech Republic); David Vávra (Czech National Bank, Monetary and Statistics Department, Prague, Czech Republic)
    Abstract: We propose the method of eigenvalue filtering as a new tool to extract time series subcomponents (such as business-cycle or irregular) defined by properties of the underlying eigenvalues. We logically extend the Beveridge-Nelson decomposition of the VAR time-series models focusing on the transient component. We introduce the canonical state-space representation of the VAR models to facilitate this type of analysis. We illustrate the eigenvalue filtering by examining a stylized model of inflation determination estimated on the Czech data. We characterize the estimated components of CPI, WPI and import inflations, together with the real production wage and real output, survey their basic properties, and impose an identification scheme to calculate the structural innovations. We test the results in a simple bootstrap simulation experiment. We find two major areas for further research - first, verifying and improving the robustness of the method, and second, exploring the method’s potential for empirical validation of structural economic models.
    Keywords: Business cycle; inflation; eigenvalues; filtering; Beveridge-Nelson decomposition; time series analysis.
    JEL: C32 E32
    Date: 2005–11
  42. By: Virginia Queijo
    Abstract: This paper aims to evaluate the importance of frictions in credit markets for business cycles in the U.S. and the Euro area. For this purpose, I modify the DSGE financial accelerator model developed by Bernanke, Gertler and Gilchrist (1999) and estimate it using Bayesian methods. The model is augmented with frictions such as price indexation to past inflation, sticky wages, consumption habits and variable capital utilization. My results indicate that financial frictions are relevant in both areas. Using the Bayes factor as criterion, the data favors the model with financial frictions both in the U.S. and the Euro area in five different specifications of the model. Moreover, the size of the financial frictions is larger in the Euro area
    Keywords: DSGE models; Bayesian estimation; financial accelerator
    JEL: E3 E4 E5
    Date: 2005–11–11
  43. By: Korkut Erturk
    Keywords: speculation, liquidity, monetary circulation
    Date: 2005–12
  44. By: Ali Dib; Kevin Moran
    Abstract: This paper documents the out-of-sample forecasting accuracy of the New Keynesian Model for Canadian data. We repeatedly estimate the model over samples of increasing lengths, forecasting out-of-sample one to four quarters ahead at each step. We then compare these forecasts with those arising from an unrestricted VAR using recent econometric tests. We show that the accuracy of the New Keynesian model's forecasts compares favourably to that of the benchmark. The principle of parsimony is invoked to explain these results
    Keywords: out-of-sample forecasting ability, estimated DGSE models
    JEL: E32 E37 E58
    Date: 2005–11–11
  45. By: Min Wei; Stefania D'Amico; Don H. Kim
    Abstract: This paper asks the question of whether the newly available TIPS yields data can help us achieve a better understanding of the real term structure and the inflation expectations. The yield differential between TIPS and comparable nominal coupon securities is not a direct measure of inflation expectations, because it contains inflation risk premium, and because the TIPS yield may depart from the true "real yield," due to low investor demand especially in the early years. Without using data from the (indexed) real bond market, we cannot fully identify the real interest rate from the inflation risk premium, unless we assume that all information affecting the real term structure is reflected in the nominal bond prices. Even with this assumption, empirical identification of the real term structure is hard to achieve because of the poor measurement and the frequent revisions of the price series. We develop a flexible multifactor term-structure model to allow for suitable specifications of liquidity premium on TIPS, as well as complications caused by lagged indexation. We estimate the model by the Kalman filter using TIPS yields, nominal bond yields, realized inflation and survey data on interest rates and inflation
    Keywords: TIPS, Inflation risk premium, term structure of interest rates
    JEL: E43 E44 G12
    Date: 2005–11–11
  46. By: Kamil Galuscak; Daniel Muenich
    Abstract: We explain movements in the UV space, i.e. the relationship between stocks of unemployment and vacancies known as the Beveridge curve, in the Czech Republic during 1995-2004. While the Beveridge curve is described by labour market stocks, we explain shifts in the Beveridge curve using gross labour market flows by estimating the matching function. We interpret parameter changes in the matching function during the business cycle, distinguishing cyclical and structural changes in the unemployment rate. We find that labour market flows are very good coincidence predictors of turning points in the business cycle. We show that the Czech economy already suffers from the labour market hysteresis common in many other developed market economies in the EU.
    Keywords: Beveridge curve, Czech Republic, matching function, panel data, structural unemployment.
    JEL: E24 E32 J41 J64 C23
  47. By: Alina Barnett
    Abstract: This paper analyses the response of seven of the newly acceded countries (NACs)to EU supply and monetary shocks. A typical NAC perceives an EU technology disturbance as a positive supply shock and an EU monetary expansion as a negative demand shock. When we split the seven countries into two groups, results for group one which includes the Czech Republic, Hungary, Poland and Slovakia suggest that an EU supply shock feeds through as a demand shock, increasing both prices and output. This hints that trade acts as a strong channel of EU shock propagation. For both groups, monetary disturbances explain a large proportion of NAC’s output fluctuation while technology disturbances account for a significant part of export variations. EU shocks are identified as in Canova and De Nicol´o (2002) using sign restrictions of the cross-correlation function of the variables’ responses to orthogonal disturbances. These restrictions are derived from an SDGE model
    Keywords: structural VAR, sign restrictions, European Integration, business cycles
    JEL: C2 F42 E32
    Date: 2005–11–11
  48. By: Arup Daripa (Birkbeck College)
    Abstract: A repo auction is a multi-unit common value auction in which bidders submit demand functions. Such auctions are used by the Bundesbank as well as the European Central Bank as the principal instrument for implementing monetary policy. In this paper, we analyze a repo auction with a uniform pricing rule. We show that under a uniform pricing rule, the usual intuition about the value of exclusive information can be violated, and implies free riding by uninformed bidders on the information of the informed bidders, lowering payoff of the latter. Further, free riding can distort the information content of auction prices, in turn distorting the policy signals, hindering the conduct of monetary policy. The results agree with evidence from repo auctions, and clarifies the reason behind the Bundesbank's decision to switch away from the uniform price format. Our results also shed some light on the rationale behind the contrasting switch to the uniform price format in US Treasury auctions.
    Keywords: Repo auction, Informational Free Riding, Monetary Policy Signals
    JEL: D44 E50
    Date: 2005–11–17
  49. By: Marco Ratto; Werner Roeger
    Abstract: We estimate a small open economy DSGE model for the euro area. The household sector optimises an intertemporal utility function with habit persistence. Households decide about asset accumulation, consumption and sets wages in a monopolistically competitive labour market. Households trade bonds internationally and there is a risk premium determined by the degree of foreign indebtedness. Firms are owned by domestic households. Consistent with the household objective function they determine labour demand, capacity, investment and they set prices in a monopolistically competitive goods market by maximising the market value of the corporate sector. Apart from technological constraints, decisions are subject to convex adjustment costs. Monetary policy is modelled via a Taylor rule. A Bayesian estimation approach is applied, using the Dynare code, by Michel Juillard, via the log-linearisation of the model around the steady state, solution of the forward looking log-linear model and computation of the likelihood via Kalman filter. After estimating the posterior mode via standard optimisation routines, the posterior distribution of model parameters is estimated with a Metropolis Markov Chain Monte Carlo approach. Unobserved components are also derived, such as technology, target inflation, capital utilisation. A full Bayesian impulse response analysis is then performed, comprising a detailed sensitivity analysis of the main dynamical features of the model simulations versus changes in model parameters.
    JEL: C13 C15 E12 E17
    Date: 2005–11–11
  50. By: Domenico Giannone (Universite' Libre de Bruxelles, ECARES); Lucrezia Reichlin (European Central Bank, CEPR)
    Abstract: This paper asks two questions. First, can we detect empirically whether the shocks recovered from the estimates of a structural VAR are fundamental? Second, can the problem of non-fundamentalness be solved by considering additional information? The answer to the firrst question is 'yes' and that to the second is 'under some conditions'.
    JEL: C32 C33 E00 E32 O3
    Date: 2005–11–15
  51. By: Eric Swanson
    Abstract: The literature on optimal monetary policy typically makes three major assumptions: 1) policymakers’ preferences are quadratic, 2) the economy is linear, and 3) stochastic shocks and policymakers’ prior beliefs about unobserved variables are normally distributed. This paper relaxes the third assumption and explores its implications for optimal policy. The separation principle continues to hold in this framework, allowing for tractability and application to forward-looking models, but policymakers’ beliefs are no longer updated in a linear fashion, allowing for plausible nonlinearities in optimal policy. We consider in particular a class of models in which policymakers’ priors about the natural rate of unemployment are diffuse in a region around the mean. When this is the case, it is optimal for policy to respond cautiously to small surprises in the observed unemployment rate, but become increasingly aggressive at the margin. These features of optimal policy match statements by Federal Reserve officials and the behavior of the Fed in the 1990s
    Keywords: nonlinear policy, optimal filtering, signal extraction, learning, non-normal priors
    JEL: E52
    Date: 2005–11–11
  52. By: Carlos Capistrán-Carmona
    Abstract: This paper documents that inflation forecasts of the Federal Reserve systematically under-predicted inflation before Volker's appointment as Chairman and systematically over-predicted it afterward. It also documents that, under quadratic loss, commercial forecasts have information not contained in the forecasts of the Federal Reserve. It demonstrates that this evidence leads to a rejection of the joint hypothesis that the Federal Reserve has rational expectations and quadratic loss. To investigate the causes of this failure, this paper uses moment conditions derived from a model of an inflation targeting central bank to back out the loss function implied by the forecasts of the Federal Reserve. It finds that the cost of having inflation above the target was larger than the cost of having inflation below it for the post-Volker Federal Reserve, and that the opposite was true for the pre-Volker era. Once these asymmetries are taken into account, the Federal Reserve is found to be rational and to efficiently incorporate the information contained in forecasts from the Survey of Professional Forecasters
    Keywords: Asymmetric loss function, Inflation forecasts, Forecast Evaluation
    JEL: C53 E52
    Date: 2005–11–11
  53. By: Gustavo Piga (University of Rome II); Giorgio Valente (The Chinese University of Hong Kong)
    Abstract: We estimate, using a previously unexploited set of data for the Italian public debt, quarterly yield curves over the period 1970-1996 to test the main implications of the expectations hypothesis theory (EH). Our empirical results show that short-term interest rates move according to the prediction of the EH, though the same cannot be found for long-term interest rates. In addition, using a probit model, we investigate the public debt issuance policy. We find and interpret a significant relationship between the slope of the yield curve and the probability of an increase in the aggregate duration of the outstanding debt.
    Keywords: Term Structure of Interest Rates, Expectations Hypothesis, Public Debt Management
    JEL: H63 E44 E58 E61
    Date: 2004–04–30
  54. By: Kodera J.; Vosvrda M.
    Abstract: The purpose of this paper is to study a price level dynamics in a simple four-equation model. A basis of this model is developed from dynamical Kaldorian model which could be noticed very frequently in works of non-linear economic dynamics. Our approach is traditional. The difference is observed in a choice of an investment function. The investment function depending on the difference of logarithm of production and logarithm of capital (logarithm of the productivity of capital) is in a form of the logistic function. These two equations create relatively closed sub-model generating both production and capital stock trajectories. Two other equations describe the price level dynamics as a consequence of money market disequilibrium and continuously adaptive expectation of inflation. Our investigation is firstly aimed to core model dynamics, i.e., a dynamics of the production and capital stock. Secondly is to analyze dynamics of the model as a whole, i.e., to the first part is superadded the price dynamics and expected inflation dynamics depending on both an adaptation parameter of the commodity market and a parameter of the expectation. Thirdly we compute Lyapunov exponents for a simple model of closed economy showing it’s a chaotic behavior. Simulation studies are performed
    Keywords: Production, Capital Stock, Price Dynamics, Expected Inflation
    JEL: E22 E31
    Date: 2005–11–11
  55. By: Tao Wu; Glenn Rudebusch
    Abstract: This paper examines a recent shift in the dynamics of the term structure and interest rate risk. We first use standard yield-spread regressions to document such a shift in the U.S. in the mid-1980s. Over the pre- and post-shift subsamples, we then estimate dynamic, affine, no-arbitrage models, which exhibit a significant difference in behavior that can be largely attributed to changes in the pricing of risk associated with a "level" factor. Finally, we suggest a link between the shift in term structure behavior and changes in the risk and dynamics of the inflation target as perceived by investors
    JEL: E43 E44 G12
    Date: 2005–11–11
  56. By: Marius Jurgilas (Economics University of Connecticut)
    Abstract: This paper studies the liquidity effect in the environment of a currency board. Under such an environment, the endogeneity issue common to other monetary regimes does not arise, thereby allowing for a straightforward analysis. Using daily data from the interbank market in Lithuania, we estimate the liquidity effect and show that, contrarily to the existent literature, overnight interest rates tend to fall at the end of reserve holding period while being higher at the beginning. Thus the martingale hypothesis of the interest rates is rejected. It is also shown that banks do not utilize aggregate liquidity information provided by the Central Bank of Lithuania due to the structural impediments of the market
    Keywords: interbank market, liquidity effect, currency board, Lithuania
    JEL: E52 E58
    Date: 2005–11–11
  57. By: Maciej K. Dudek
    Abstract: The paper recognizes that expectations and the process of their formation are subject to standard decision making and are determined as a part of equilibrium. Accordingly, the paper presents a basic framework in which the form of expectation formation is a choice variable. At any point in time rational economic agents decide on the basis of the level of utility what expectation formation technology to use and as a consequence what expectations to hold. As economic decisions are conditioned on expectations holding proper or rational expectations eliminates the possibility of ex ante inefficiencies. The choice of expectation formation technology is not trivial as the paper assumes that information gathering and processing are costly. Consequently, economic agents must make informed decisions with the regard to the quality of expectation formation technologies they wish to use. The paper shows that agents' optimization over expectations not only adds on to realism, but also can carry non trivial implications for the behavior of macroeconomic variables. Specifically, the paper illustrates that endogenous expectation revisions can be a source of permanent oscillations in aggregate demand and can prevent an economy from settling into a steady state. In addition, the paper quantifies intangible notions such as overheating, overborrowing, and output gap. Finally, the paper shows that active policy measures can limit inefficiencies resulting from output fluctuations
    Keywords: Business Cycles, Expectation Formation, Costly Information Acquisition.
    JEL: D84 E32
    Date: 2005–11–11
  58. By: Ernest Pytlarczyk
    Abstract: This paper presents an estimated DSGE model for the European Monetary Union. Our approach, contrary to the previous studies, accounts for heterogeneity within the euro area. In the estimation we utilize disaggregated information, employing single country data, along with the aggregated EMU by Fagan et. al (2001). We also contribute to the literature by proposing a strategy for consistent estimation of the currency union model, using information available prior to the adoption of the single currency and afterwards. This approach requires the determination of two separate data generating processes - here these are theoretical DSGE models - corresponding to both current and historical monetary regimes. We emphasize the use of regime-switching models in the DSGE framework (in our case the threshold is known exactly and the switch is permanent). The approach is illustrated by developing a simple two-region DSGE model, with a particular focus on analyzing the German economy within EMU, and its Bayesian estimation on the sample 1980:q1- 2003:q4. Moreover, the paper offers: (i) a robustness check of the estimation results with respect to the alternative data approaches and various restrictions imposed on the model's structure (ii) assesments of the relative importance of various shocks and frictions for explaining the model dynamics (iii) an evaluation of the model's empirical properties
    Keywords: Bayesian econometrics, DSGE models, Euro area
    JEL: E4 E5
    Date: 2005–11–11
  59. By: Luis-Felipe Zanna; Marco Airaudo (International Finance Federal Reserve Board)
    Abstract: Using a closed economy model with a flexible-price good and a sticky-price good we study the conditions under which interest rate rules induce real determinacy and, more importantly, the MSV solution is learnable in the E-stability sense proposed by Evans and Honkapohja (2001). We show that these conditions depend not only on how aggressively the rule responds to inflation but also on the measure of inflation included in the rule and on whether the flexible-price good and the sticky-price good are Edgeworth complements, substitutes or utility separable. We consider three possible measures of inflation: the flexible-price inflation, the sticky price inflation and the core inflation; and we analyze three different types of rules: a forward-looking rule, a contemporaneous rule and a backward-looking rule. Our results suggest that in order to guarantee a unique equilibrium whose MSV representation is learnable, the government should implement a backward looking rule that responds exclusively to the sticky-price inflation. Forward-looking and contemporaneous rules that respond to either the flexible-price inflation or the core-inflation are more prone to induce multiple equilibria and E-instability of the MSV solution. More importantly backward-looking rules that react to either the flexible-price inflation or the core inflation may guarantee a unique equilibrium but in these cases the fundamental solution (MSV representation) is not learnable in the E-stability sense
    Keywords: Interest rate rules, Learning, E-stability, multiple equilibria, inflation
    JEL: E31 E52
    Date: 2005–11–11
  60. By: Peter von zur Muehlen; Robert J. Tetlow
    Abstract: In recent years, the learnability of rational expectations equilibria (REE) and determinacy of economic structures have rightfully joined the usual performance criteria among the sought after goals of policy design. And while some contributions to the literature (for example Bullard and Mitra (2001) and Evans and Honkapohja (2002)) have made significant headway in establishing certain features of monetary policy rules that facilitate learning, a comprehensive treatment of policy design for learnability has yet to surface, especially for cases in which agents have potentially misspecified their learning models. This paper provides such a treatment. We argue that since even among professional economists a generally acceptable workhorse model of the economy has not been agreed upon, it is unreasonable to expect private agents to have collective rational expectations. We assume instead that agents have an approximate understanding of the workings of the economy and that their task of learning true reduced forms of the economy is subject to potentially destabilizing errors. We then ask: can a central bank set policy that accounts for learning errors but also succeeds in bounding them in a way that allows eventual learnability of the model, given policy. For different parameterizations of a given policy rule applied to a New Keynesian model, we use structured singular value analysis (from robust control) to find the largest ranges of misspecifications that can be tolerated in a learning model without compromising convergence to an REE. A parallel set of experiments seeks to determine the optimal stance (strong inflation as opposed to strong output stabilization) that allows for the greatest scope of errors in learning without leading to expectational instabilty in cases when the central bank designs both optimal and robust policy rules with commitment. We compare the features of all the rules contemplated in the paper with those that maximize economic performance in the true model, and we measure the performance cost of maximizing learnability under the various conditions mentioned here.
    Keywords: monetary policy, learning, E-stability, model uncertainty, robustness
    JEL: C6 E5
    Date: 2005–11–11
  61. By: J. C. Parra; M. Huggett
    Abstract: We quantify the inefficiency of the retirement component of the US social security system within a model where agents receive idiosyncratic labor-productivity shocks that are privately observed
    Keywords: social security, efficient allocations, idiosyncratic shocks
    JEL: D80 D90 E21
    Date: 2005–11–11
  62. By: Matthias Paustian
    Abstract: This paper asks the following two questions: First, can a model with nominal rigidities in wage and price setting account for the average welfare costs of business cycle fluctuations identified in Gali, Gertler, and Lopez- Salido (2003)? Second, what is the role of contracting schemes for the welfare costs of business cycle fluctuations? We compute a quadratic approximation to agents expected lifetime utility and evaluate welfare for different modeling schemes of nominal rigidities that all have the same average duration of contracts. Calvo (1983) wage and price contracts can deliver sizeable welfare costs, but other contracts of the same average stickiness cannot. Calvo (1983) contracts can imply welfare costs that are up to 4 times higher than those implied by overlapping contracts in the spirit of Taylor (1980) or Wolman (1999). Furthermore, the sticky information framework of Mankiw and Reis (2002) may generate welfare costs that are even smaller. This paper calls for more research into the origins of wage and price stickiness
    Keywords: welfare, Calvo, Taylor, sticky information, costs of nominal rigidities
    JEL: E52 E32
    Date: 2005–11–11
  63. By: Volker Wieland; Keith Kuester
    Abstract: In this paper, we examine the cost of insurance against model uncertainty for the Euro area considering four alternative reference models, all of which are used for policy-analysis at the ECB. We find that maximal insurance across this model range in terms of a Minimax policy comes at moderate costs in terms of lower expected performance. We extract priors that would rationalize the Minimax policy from a Bayesian perspective. These priors indicate that full insurance is strongly oriented towards the model with highest baseline losses. Furthermore, this policy is not as tolerant towards small perturbations of policy parameters as the Bayesian policy rule. We propose to strike a compromise and use preferences for policy design that allow for intermediate degrees of ambiguity-aversion. These preferences allow the specification of priors but also give extra weight to the worst uncertain outcomes in a given context
    Keywords: model uncertainty, robustness, monetary policy rules, minimax, euro area
    JEL: E52 E58 E61
    Date: 2005–11–11
  64. By: Stefan Palmqvist; Michael F. Bryan
    Abstract: This paper considers the evidence of “near-rationality†in household inflation expectations, as described by Akerlof, Dickens, and Perry (2000), hereafter ADP. According to ADP, the economic incentive to anticipate inflation varies from agent to agent, and as inflation falls, some agents stop trying to accurately predict inflation (“hyper-rationalâ€) and either underweight it or, in the extreme, ignore it altogether (“nearly rationalâ€). A key implication of the ADP model is that a particular rate of inflation minimizes unemployment in the long-run. In this paper, we bring the idea described by ADP to detailed survey data on household inflation expectations for the U.S. and Sweden, two countries where the existence of ADP-type near-rationality has been identified in earlier research. We find that the survey data do not, in general, support the specific form of near-rationality suggested by ADP. However, we also show that inflation expectations are not distributed across households in a smooth and continuous way. Rather, households appear to hold inflation expectations that tend to discrete, and largely fixed “focal points,†suggesting that a substantial share of both Swedish and U.S. households do not form precise inflation predictions, but instead gauge inflation prospects in rather qualitative terms. We further document that in Sweden, the combination of a low inflation environment, coupled with an inflation target, has been accompanied by a disproportionately high proportion of households reporting the expectation of no inflation, consistent with one type of “nearly rational†behavior posited by ADP. However, a similarly low inflation trend in the U.S., which does not have an explicit inflation target, reveals no such rise in the proportion of households expecting no inflation. This observation suggests that how the central bank communicates its inflation objective may influence inflation expectations independently of the inflation trend they actually pursue.
    Keywords: Inflation expectations, inflation targeting, survey data
    JEL: E31 E52
    Date: 2005–11–11
  65. By: James Stodder
    Abstract: Centralized exchange has a worst-case size-complexity many orders of magnitude lower than decentralized monetary exchange for the same number of agents and goods. A more rapid approach to competitive equilibrium may therefore be possible through centralized exchange. An additional benefit of centralized exchanges is macroeconomic stability: their volume of financial activity can be shown to vary inversely with the business cycle. This counter-cyclical tendency is shown by error-correction models, based on twenty-five years of data from a US exchange (the International Reciprocal Trade Association) and fifty-five years of data from a Swiss bank (WIR). This combination of computational efficiency and counter-cyclical activity suggests that the forms of exchange and credit enabled by these centralized exchanges may promote both microeconomic efficiency and macroeconomic stability. The financial activities of such exchanges, therefore, can complement a central bank’s monetary policy, although they do diminish its direct control of the money supply itself.
    Keywords: size-complexity, centralized exchange, countercyclical policy
    JEL: D83 E52 G14
    Date: 2005–11–11
  66. By: Fiorella De Fiore (Directorate General Research, European Central Bank, Postfach 160319, 60066 Frankfurt am Main, Germany); Harald Uhlig (School of Business and Economics,WiPol 1, Humboldt University, Spandauer Str. 1, 10178 Berlin, Germany)
    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 efficiency 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: 2005–11
  67. By: Christopher Erceg; Luca Guerrieri
    Abstract: In this paper, we use an open economy DGE model (SIGMA) to assess the quantitative effects of fiscal shocks on the trade balance in the United States. We examine the effects of two alternative fiscal shocks: a rise in government consumption, and a reduction in the labor income tax rate. Our salient finding is that a fiscal deficit has a relatively small effect on the U.S. trade balance, irrespective of whether the source is a spending increase or tax cut. In our benchmark calibration, we find that a rise in the fiscal deficit of one percentage point of GDP induces the trade balance to deteriorate by less than 0.2 percentage point of GDP. Noticeably larger effects are only likely to be elicited under implausibly high values of the short-run trade price elasticity
    Keywords: DGE Models, Open-Economy Macroeconomics
    JEL: F32 F41 E62
    Date: 2005–11–11
  68. By: Paolo Surico; Antonello D'Agostino; Luca Sala
    Abstract: The Fed closely monitors the stock market and the stock market continuously forms expectations about the Fed decisions. What does this imply for the relation between the fed funds rate and the S&P500? We find that the answer depends on the conditions prevailing on the financial market. During periods of high (low) volatility in asset price inflation an unexpected 5 fall in the stock market index implies that the Fed cuts the interest rate by 19 ($6$) basis points while an unanticipated policy tightening of 50 basis points causes a 4.7 (2.3) decline in the S&P500. The Fed reaction to asset price return is however statistically different from zero only in the high volatility regime, whereas the fall in asset price return following an interest rate rise is highly significant during normal times only
    Keywords: asset price volatility, nonlinear policy, threshold SVAR, system GMM.
    JEL: E44 E52 E58
    Date: 2005–11–11
  69. By: Laurent Cellarier
    Abstract: Cyclical or chaotic competitive equilibria that do not exist under perfect foresight are shown to occur in a decentralized growth model under constant gain adaptive learning. This paper considers an economy populated by boundedly rational households making one-period ahead constant gain adaptive input price forecasts, and using simple expectation rules to predict long-run physical capital holdings and consumption. Under these hypotheses, lifetime decisions are derived as time unfolds, and analytical solutions to the representative household's problem exist for a standard class of preferences. Under various characteristics of the model's functional forms, competitive equilibrium trajectories under learning may exhibit opposite local stability properties depending whether the underlying information set accommodates all contemporary data. Calibrated to the U.S. economy, the model with boundedly rational households may exhibit endogenous business cycles around the permanent regime which is a saddle point under perfect foresight
    Keywords: bounded rationality, constant gain adaptive learning, endogenous business cycles
    JEL: C61 D83 E32
    Date: 2005–11–11
  70. By: James Mitchell (NIESR NIESR, London)
    Abstract: Recent work has found that, without the benefit of hindsight, it can prove difficult for policy-makers to pin down accurately the current position of the output gap; real-time estimates are unreliable. However, attention primarily has focused on output gap point estimates alone. But point forecasts are better seen as the central points of ranges of uncertainty; therefore some revision to real-time estimates may not be surprising. To capture uncertainty fully density forecasts should be used. This paper introduces, motivates and discusses the idea of evaluating the quality of real-time density estimates of the output gap. It also introduces density forecast combination as a practical means to overcome problems associated with uncertainty over the appropriate output gap estimator. An application to the Euro area illustrates the use of the techniques. Simulated out-of-sample experiments reveal that not only can real-time point estimates of the Euro area output gap be unreliable, but so can measures of uncertainty associated with them. The implications for policy-makers use of Taylor-type rules are discussed and illustrated. We find that Taylor-rules that exploit real-time output gap density estimates can provide reliable forecasts of the ECB's monetary policy stance only when alternative density forecasts are combined
    Keywords: Output gap; Real-Time; Density Forecasts; Density Forecast Combination; Taylor Rules
    JEL: E32 C53
    Date: 2005–11–11
  71. By: Tatsuma Wada; Pierre Perron
    Abstract: Recent work on trend-cycle decompositions for US real GDP yields the following puzzling features: method based on Unobserved Components models, the Beveridge-Nelson decomposition, the Hodrick-Prescott filter and others yield very different cycles which bears little resemblance to the NBER chronology, ascribes much movements to the trend leaving little to the cycles, and some imply a negative correlation between the noise to the cycle and the trend. We argue that these features are artifacts created by the neglect of the presence of a change in the slope of the trend function in real GDP in 1973. Once this is properly accounted for, the results show all methods to yield the same cycle with a trend that is non-stochastic except for a few periods around 1973. This cycle is more important in magnitude than previously reported, it accords very well with the NBER chronology and imply no correlation between the trend and cycle, since the former is non-stochastic. We propose a new approach to univariate trend-cycle decompositions using a generalized Unobserved Components models with errors having a mixture of Normals distribution for both the slope of the trend function and the cycle components. It can account endogenously for infrequent changes such as level shifts and change in slope, as well as different variances for expansions and recessions. It yields a decomposition that accords very well with common notions of the business cycles
    Keywords: Trend-Cycle Decomposition, Structural Change, Non Gaussian Filtering, Unobserved Components Model, Beveridge-Nelson Decomposition
    JEL: C22 E32
    Date: 2005–11–11
  72. By: Fabrizio Zampolli; Andrew P. Blake (Monetary Assessment and Strategy Bank of England)
    Abstract: In this paper we consider the quadratic optimal control problem with regime shifts and forward-looking agents. This extends the results of Zampolli (2003) who considered models without forward-looking expectations. Two algorithms are presented: The first algorithm computes the solution of a rational expectation model with random parameters or regime shifts. The second algorithm computes the time-consistent policy and the resulting Nash-Stackelberg equilibrium. The formulation of the problem is of general form and allows for model uncertainty and incorporation of policymaker’s judgement. We apply these methods to compute the optimal (non-linear) monetary policy in a small open economy subject to (symmetric or asymmetric) risks of change in some of its key parameters such as inflation inertia, degree of exchange rate pass-through, elasticity of aggregate demand to interest rate, etc.. We normally find that the time-consistent response to risk is more cautious. Furthermore, the optimal response is in some cases non-monotonic as a function of uncertainty. We also simulate the model under assumptions that the policymaker and the private sector hold the same beliefs over the probabilities of the structural change and different beliefs (as well as different assumptions about the knowledge of each other’s reaction function).
    Keywords: monetary policy, regime switching, model uncertainty, time consistency
    JEL: E52 D81
    Date: 2005–11–11
  73. By: Christoph Schleicher; Francisco Barillas
    Abstract: This paper examines evidence of long- and short-run co-movement in Canadian sectoral output data. Our framework builds on a vector-error-correction representation that allows to test for and compute full-information maximum-likelihood estimates of models with codependent cycle restrictions. We find that the seven sectors under consideration contain five common trends and five codependent cycles and use their estimates to obtain a multivariate Beveridge-Nelson decomposition to isolate and compare the common components. A forecast error variance decomposition indicates that some sectors, such as manufacturing and construction, are subject to persistent transitory shocks, whereas other sectors, such as financial services, are not. We also find that imposing common feature restrictions leads to a non-trivial gain in the ability to forecast both aggregate and sectoral output. Among the main conclusions is that manufacturing, construction, and the primary sector are the most important sources of business cycle fluctuations for the Canadian economy.
    Keywords: common features, business cycles, vector autoregressions
    JEL: C15 C22 C32
    Date: 2005–11–11
  74. By: Andrea Carriero (Universitá Bocconi)
    Abstract: In this paper we propose a new way of modelling the expectations Hypothesis(EH) of the term structure of interest rates and provide striking evidence validating it on both statistical and economic grounds. The idea is to model the EH as a noisy relation, allowing for temporary departures from it. We do so using a Bayesian framework in which the EH can be viewed as a prior on a gaussian VAR. Importantly, our approach is very general and comprises the traditional framework as a special case. Once the EH is modeled as a noisy relation it is strongly supported by the data and is entirely consistent with the behavior of the U.S. 10-year rate from the seventies onwards. Moreover, our evidence explains the common result of rejection and the anomaly found by Campbell and Shiller (1987). Finally, our approach allows to extract additional information from the term structure and then to significantly increase the accuracy of a Taylor-rule based model in predicting future short term rates.
    Keywords: Bayesian VARs, Expectations Theory, Term Structure, Uncertain Restrictions
    JEL: C11 E43 E44 E47
    Date: 2005–11–11
  75. By: Giancarlo Marini (University of Rome II - Faculty of Economics); Alessandro Piergallini (University of Rome II; University of Rome II - Faculty of Economics; University of London - School of Oriental and African Studies (SOAS))
    Abstract: This paper presents an indirect approach to investigate the possible existence of measurement error bias in the Harmonized Index of Consumer Prices for the UK and Italy. Our empirical results show that there is no significant evidence for a bias in the UK, nor for Italy prior to the introduction of the Euro. Since January 2002, however, the inflation rate in Italy has been underestimated by at least 6 percentage points.
    Keywords: Inflation, Measurement bias
    JEL: C22 C43 D14 E31
    Date: 2004–10–14
  76. By: Ivan Baboucek; Martin Jancar
    Abstract: The paper concerns macro-prudential analysis. It uses an unrestricted VAR model to empirically investigate transmission involving a set of macroeconomic variables describing the development of the Czech economy and the functioning of its credit channel in the past eleven years. Its novelty lies in the fact that it provides the first systematic assessment of the links between loan quality and macroeconomic shocks in the Czech context. The VAR methodology is applied to monthly data transformed into percentage change. The out-of-sample forecast indicates that the most likely outlook for the quality of the banking sector’s loan portfolio is that up to the end of 2006 the share of non-performing loans in it will follow a slightly downward trend below double-digit rates. The impulse response is augmented by stress testing exercises that enable us to determine a macroeconomic early warning signal of any worsening in the quality of banks’ loans. The paper suggests that the Czech banking sector has attained a considerable ability to withstand a credit risk shock and that the banking sector’s stability is compatible both with price stability and with economic growth. Despite being devoted to empirical investigation, the paper pays great attention to methodological issues. At the same time it tries to present both the VAR model and its results transparently and to openly discuss their weak points, which to a large degree can be attributed to data constraints or to the evolutionary nature of an economy in transition.
    Keywords: Czech Republic, Macro-prudential analysis, Non-performing loans, VAR model.
    JEL: G18 G21 C51
  77. By: Philippe Michel (Division Monetary Policy Strategy European Central Bank); Leopold von Thadden; Jean-Piere Vidal
    Abstract: Unstable government debt dynamics can typically be corrected by various fiscal instruments, like appropriate adjustments in government spending, public transfers, or taxes. This paper investigates properties of state-contingent debt targeting rules which link stabilizing budgetary adjustments around a target level of long-run debt to the state of the economy. The paper establishes that the size of steady-state debt is a key determinant of whether it is possible to find a rule of this type which can be implemented under all available fiscal instruments. Specifically, considering linear feedback rules, the paper demonstrates that there may well exist a critical level of debt beyond which this is no longer possible. From an applied perspective, this finding is of particular relevance in the context of a monetary union with decentralized fiscal policies. Depending on the level of long-run debt, there might be a conflict between a common fiscal framework which tracks deficit developments as a function of the state of the economy and the unrestricted choice of fiscal policy instruments at the national level
    Keywords: Fiscal regimes, overlapping generations
    JEL: E63 H62
    Date: 2005–11–11
  78. By: Masashi Saito (Economics Boston University)
    Abstract: Growth rates of macro aggregates are more persistent than technology growth in data. We develop a theory that accounts for this observation. In the model there are two types of shocks affecting the growth rate of technology, one transitory and another persistent, but agents do not observe them separately and form a belief about their relative contribution. The process of belief updating serves as a propagation mechanism enabling the model to generate movements in macro growth rates more persistent than that of the driving force
    Keywords: real business cycle model, imperfect information, regime switching
    JEL: E1 E3
    Date: 2005–11–11
  79. By: Evi Pappa; Zheng Liu
    Abstract: This paper presents a new argument for international monetary policy coordination based on considerations of structural asymmetries across countries. In a two-country world with a traded and a non-traded sector in each country, optimal independent monetary policy cannot replicate the natural-rate allocations. There are potential welfare gains from coordination since the planner under a cooperating regime internalizes a terms-of-trade externality that independent central banks tend to overlook. Yet, with symmetric structures across countries, the gains are quantitatively small. If the size of the traded sector differs across countries, the gains can be sizable and increase with the degree of asymmetry. The planner's optimal policy not only internalizes the terms-of-trade externality, it also creates a terms-of-trade bias in favor the country with a larger traded sector. Further, the planner tries to balance the terms-of-trade bias against the need to stabilize fluctuations in the terms-of-trade gap.
    Keywords: International Policy Coordination; Optimal Monetary Policy; Asymmetric Structures; Terms-of-Trade Bias
    JEL: E52 F41 F42
    Date: 2005–11–11
  80. By: Marc P. Giannoni; Jean Boivin
    Abstract: Standard practice for the estimation of dynamic stochastic general equilibrium (DSGE) models maintains the assumption that economic variables are properly measured by a single indicator, and that all relevant information for the estimation is adequately summarized by a small number of data series, whether or not measurement error is allowed for. However, recent empirical research on factor models has shown that information contained in large data sets is relevant for the evolution of important macroeconomic series. This suggests that conventional model estimates and inference based on estimated DSGE models are likely to be distorted. In this paper, we propose an empirical framework for the estimation of DSGE models that exploits the relevant information from a data-rich environment. This framework provides an interpretation of all information contained in a large data set through the lenses of a DSGE model. The estimation involves Bayesian Markov-Chain Monte-Carlo (MCMC) methods extended so that the estimates can, in some cases, inherit the properties of classical maximum likelihood estimation. We apply this estimation approach to a state-of-the-art DSGE monetary model. Treating theoretical concepts of the model --- such as output, inflation and employment --- as partially observed, we show that the information from a large set of macroeconomic indicators is important for accurate estimation of the model. It also allows us to improve the forecasts of important economic variables
    Keywords: DSGE models, model estimation, measurement error, large data sets, factor models, MCMC techniques, Bayesian estimation
    JEL: E52 E3 C32
    Date: 2005–11–11
  81. By: Marcelo Sánchez (Correspondence to: European Central Bank, Postfach 160319, 60066 Frankfurt am Main, Germany)
    Abstract: The link between exchange rates and interest rates features prominently in the theoretical and empirical literature on small open economies. This paper revisits this relationship using a simple model that incorporates the role of exchange rate pass-through into domestic prices and distinguishes between cases of expansionary and contractionary depreciations. The model results show that the correlation between exchange rates and interest rates, conditional on an adverse risk premium shock, is negative for expansionary depreciations and positive for contractionary ones. For this type of shock, interest rates are found to be raised to prevent the contractionary effect of a depreciation regardless of whether the latter effect is strong or mild. Interest rates are predicted to also rise in response to an adverse net export shock in contractionary depreciation cases, and to be lowered in the case of expansionary ones.
    Keywords: Transmission mechanism; Emerging market economies; Exchange rate; Monetary policy.
    JEL: E52 E58 F31 F41
    Date: 2005–11
  82. By: Matthew Chambers (Economics Towson University); Carlos Garriga
    Abstract: After 40 years of stability, the homeownership rate -- a target for housing policy -- has steadily increased since 1995. We attempt to understand this increase using a quantitative model to evaluate various suggested explanations. We find that the increase can be explained by mortgage-market innovations that have reduced initial downpayments
    JEL: E E2
    Date: 2005–11–11
  83. By: L Christopher Plantier; Ozer Karagedikli
    Abstract: The output gap plays a crucial role in thinking and actions of many central banks but real time measurements undergo substantial revisions as more data become available (Orphanides (2001), Orphanides and van Norden (forthcoming)). Some central banks augment, such as the Bank of Canada and the Reserve Bank of New Zealand, the Hodrick and Prescott (1997) filter with conditioning structural information to mitigate the impact of revisions to the output gap estimates. In this paper, we use a state space Kalman filter framework to examine whether the augmented (so-called “multivariate filtersâ€) achieve this objective. We find that the multivariate filters are no better than the Hodrick-Prescott filter for real-time NZ data. The addition of structural equations increase the number of signal equations, but at the same time adds more unobserved trend/equilibrium variables to the system. We find that how these additional trends/equilibrium values are treated matters a lot, and they increase the uncertainty around the estimates. In addition, the revisions from these models can be as large as a univariate Hodrick-Prescott filter.
    Keywords: output gap, real time, multivariate filters
    JEL: C32 E32
    Date: 2005–11–11
  84. By: Michael R. Wickens (University of York (UK) - Department of Economics and Related Studies Heslington; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research); University of York (UK) - Department of Economics and Related Studies)
    Abstract: n this paper we develop a new way of modelling time variation in term premia. This is based on the stochastic discount factor model of asset pricing with observable macroeconomic factors. The joint distribution of excess holding period US bond returns of different maturity and the fundamental macroeconomic factors is modelled using multivariate GARCH with conditional covariances in the mean to capture the term premia. We show how by testing the assumption of no arbitrage we can derive a specification test of our model. We estimate the contribution made to the term premia at different maturities by real and nominal macroeconomic sources of risk. From the estimated term premia we recover the term structure of interest rates and examine how it varies through time. Finally, we examine whether the large number of reported failures of the rational expectations hypothesis of the term structure can be attributed to an omitted time-varying term premium.
    Keywords: term structure, the stochastic discount factor model, term premia, GARCH
    JEL: C5 E4 G1
    Date: 2004–11–26
  85. By: Christian Richter; Andrew Hughes Hallett (Economics Loughborough University)
    Abstract: The dating of a possible European business cycle has been inconclusive. At this stage, there is no consensus on the existence of such a cycle, or of its periodicity and amplitude, or of the relationship of individual member countries to that cycle. Yet cyclical convergence is the key consideration for countries that wish to be members of the currency union. The confusion over whether and to what degree the UK is converging on the cycles of her European partners, or whether her cycle is more in line with the US, is an example of this lack of consensus. We show that countries will vary in the components and characteristics that make up their output cycles, as well as in the state of their cycle at any point of time. Next, we show how to decompose a business cycle in a time-frequency framework. This allows us to decompose movements in output, both at the European level and in member countries, into their component cycles and allows those component cycles to vary in importance and cyclical characteristics over time. It also allows us to determine if the inconclusive convergence results so far have appeared because member countries have some cycles in common, but diverge at other frequencies
    Keywords: Time-Frequency Analysis, Coherence, Growth Rates, Business Cycle
    JEL: C22 C29 C49
    Date: 2005–11–11
  86. By: Schaling,Eric (Tilburg University, Center for Economic Research)
    Abstract: South Africa's 40 years of experience with capital controls on residents and non-residents (1961-2001) reads like a collection of examples of perverse unanticipated effects of legislation and regulation. We show that the presence of capital controls on residents and non-residents, enabled the South African Reserve Bank (SARB) to target domestic interest rates (and or the exchange rate) via interventions in the (commercial) foreign exchange market. This provides an early rationale for anchoring SA monetary policy via the exchange rate, rather than via domestic interest rates. This suggests not only that the capital controls themselves exhibited substantial institutional inertia, but that this same institutional inertia also applied to the monetary policy regime. A plausible reason for this is that for most of the 20th century in South Africa (partial) capital controls and exchange rate based monetary policies were like Siamese twins; almost impossible to separate.
    Keywords: capital controls;exchange rate mechanism
    JEL: E42 E61 E65 F32 F33 F41
    Date: 2005
  87. By: Steven Ambler (Université du Québec à Montréal public); Florian Pelgrin
    Abstract: This paper shows how to use optimal control theory to derive time-consistent optimal government policies in nonlinear dynamic general equilibrium models. It extends the insight of Cohen and Michel (1988), who showed that in _linear_ models time-consistent policies can be found by imposing a linear relationship between predetermined state variables and the costate variables from private agents' maximization problems. We use an analogous procedure based on the Den Haan and Marcet (1990) technique of parameterized expectations, which replaces nonlinear functions of expected future costates by flexible functions of current states. This leads to a nonlinear relationship between current state and costate variables, which is verified in equilibrium to an arbitrarily close degree of approximation. The optimal control problem of the government is recursive, unlike the Ramsey (1927) problem which is common in the optimal taxation literature. We use a model of public investment to illustrate the technique
    Keywords: Optimal government policy; Time consistent control
    JEL: E61 E62 C63
    Date: 2005–11–11
  88. By: Arabinda Basistha; Richard Startz
    Abstract: Standard estimates of the NAIRU or natural rate of unemployment are subject to considerable uncertainty. We show in this paper that using multiple indicators to extract an estimated NAIRU cuts in half uncertainty as measured by variance. The inclusion of an Okun’s Law relation is particularly valuable. We estimate the NAIRU as an unobserved component in a state-space model and show that using multiple indicators reduces both parametric uncertainty and filtering uncertainty. Additionally, our multivariate approach overcomes the “pile-up†problem observed by other investigators
    Keywords: NAIRU, parametric uncertainty, filtering uncertainty
    JEL: C32 E31 E32
    Date: 2005–11–11
  89. By: Barbara Annicchiarico (University of Bristol - Department of Economics); Giancarlo Marini (University of Rome II - Faculty of Economics)
    Abstract: This paper analyses the issue of price level determinacy in an optimising general equilibrium model with overlapping generations. It is shown that under a pure interest rate peg, wealth effects rule out nominal indeterminacy but give rise to multiple equilibria.
    Keywords: Price Level Determination, Interest Rate Pegging, Multiple Equilibria
    JEL: E31 E63
    Date: 2005–02–04
  90. By: Frédérick Demers; David Dupuis
    Abstract: The authors investigate whether the aggregation of region-specific forecasts improves upon the direct forecasting of Canadian GDP growth. They follow Marcellino, Stock, and Watson (2003) and use disaggregate information to predict aggregate GDP growth. An array of multivariate forecasting models are considered for five Canadian regions, and single-equation models are considered for direct forecasting of Canadian GDP. The authors focus on forecasts at 1-, 2-, 4-, and 8-quarter horizons, which best represent the monetary policy transmission framework of long and variable lags. Region-specific forecasts are aggregated to the country level and tested against aggregate country-level forecasts. The empirical results show that Canadian GDP growth forecasts can be improved by indirectly forecasting the GDP growth of the Canadian economic regions using a multivariate approach, namely a vector autoregression and moving average with exogenous regressors (VARMAX) model.
    Keywords: Econometric and statistical methods
    JEL: E17 C32 C53
    Date: 2005
  91. By: Giorgio Basevi (University of Bologna - Department of Economics); Lorenzo Pecchi (University of Rome II; University of Rome II)
    Abstract: In 1975 Niels Thygesen, together with eight other economists - one of us among them - published in The Economist a "manifesto" proposing a new common currency for Europe (Basevi et al., 1975). His co-operation on this subject was pursued within a smaller group, and resulted in the publication of two reports for the EU Commission (Optica Report '75, Optica Report 1976). The proposal in the "manifesto" was ironically re-titled, by The Economist, "The All Saints' day manifesto for European monetary union". In fact it had been published on 1st November, and the "Saints" should have been, according to The Economist, the European Governments if they had adopted and adhered to the proposal. This amounted to launching a new currency that should have circulated in parallel to the national ones, related to them by flexible exchange rates, due to the constraint that such new currency, the "Europa", had to be kept by an automatic formula at fixed purchasing power. In fact the Europa was to be indexed to the inflation rates in the participating countries, according to the weights of their national currencies in what at that time was called the European Unit of Account. As for the two other reports, Optica '75 proposed again a parallel currency, but less than fully inflation-proof, since its standing in terms of purchasing power would have been the same as that of the currency of the member country with the lowest inflation rate. In the Optica 1976 Report, while reiterating the proposal of a parallel currency along the lines of Optica '75, the focus was on designing a joint management of intra-European exchange rates on the basis of inflation differentials. The proposals contained in the three documents where premature, perhaps visionary. On 7 July 1978 the European Council met in Bremen and drew the lines of the European Monetary System, which started on 13 March 1979, on the basis, among other things, of a new quasi-currency - the European Currency Unit (ECU) - composed of a basket of national currencies. Since then, it took almost twenty years before the euro was introduced, replacing the ECU on 1st January 1999. Comparing the euro to such proposals, we note at least two differences. The euro (a) did not start as a parallel currency, but replaced with a pre-announced schedule the national currencies of the countries participating in the monetary union, and (b) it was not conceived as an automatically inflation-proof currency, but one issued by a Central Bank bound by a monetary policy aimed at price stability.
    Date: 2005–04–04
  92. By: Justin Wolfers
    Abstract: Theory implies that employment protection will unambiguously decrease job flows. However, cross-country comparisons of annual rates of job reallocation seem to show that employment protection has no discernible effect on job flows. This paper presents a model that shows that employment protection does not significantly alter a firm’s response to highly persistent shocks – such as those present in annual data. By contrast, quarterly job flows will reflect highly transitory shocks – such as those associated with the seasonal cycle. It is here that employment protection should reduce job flows. Testing this hypothesis requires a consistent set of cross-country set of quarterly job flows. In the absence of such data, a novel approach is used, manipulating available household survey data. Specifically, a measure of job flows caused by the seasonal cycle is constructed. Analyzing these flows across 14 OECD countries, employment protection is shown to have significant and economically meaningful effects on job flows. Indeed, the size of the effect is sufficient to confirm Blanchard and Portugal’s hypothesis that it is employment protection that explains the different pattern of labor turnover between Portugal and the USA.
    Keywords: Employment protection, job flows, worker flows, seasonality, firing costs, labor market institutions
    JEL: E24 E32
    Date: 2005–11–11
  93. By: J. Huston McCulloch
    Abstract: Adaptive Least Squares (ALS), i.e. recursive regression with asymptotically constant gain, as proposed by Ljung (1992), Sargent (1993, 1999), and Evans and Honkapohja (2001), is an increasingly widely-used method of estimating time-varying relationships and of proxying agents’ time-evolving expectations. This paper provides theoretical foundations for ALS as a special case of the generalized Kalman solution of a Time Varying Parameter (TVP) model. This approach is in the spirit of that proposed by Ljung (1992) and Sargent (1999), but unlike theirs, nests the rigorous Kalman solution of the elementary Local Level Model, and employs a very simple, yet rigorous, initialization. Unlike other approaches, the proposed method allows the asymptotic gain to be estimated by maximum likelihood (ML). The ALS algorithm is illustrated with univariate time series models of U.S. unemployment and inflation. Because the null hypothesis that the coefficients are in fact constant lies on the boundary of the permissible parameter space, the usual regularity conditions for the chi-square limiting distribution of likelihood-based test statistics are not met. Consequently, critical values of the Likelihood Ratio test statistics are established by Monte Carlo means and used to test the constancy of the parameters in the estimated models.
    Keywords: Kalman Filter, Adaptive Learning, Adaptive Least Squares, Time Varying Parameter Model, Natural Unemployment Rate, Inflation Forecasting
    JEL: C22 E37 E31
    Date: 2005–11–11
  94. By: Joseph B. Nichols (Economics University of Maryland)
    Abstract: This paper develops a detailed partial equilibrium model of housing wealth's role over the life-cycle to explore (1) housing's dual role as a consumption and investment good; (2) the significance of the mortgage contract being in nominal and not real terms; and (3) the tax benefits associated with owner-occupied housing. The stochastic dynamic programming problem is solved using parallel processing. The baseline model is then compared with a set of alternate scenarios to explore these three key aspects of housing wealth. The results show that the ``over-investment'' in housing is not just a function of consumption demand but also can be driven by the benefits inherent in the mortgage contract. It also shows that the nominal mortgage contract results in the non-neutrality of perfectly expected inflation. Finally, the paper documents the effect of preferential tax treatment on housing demand
    Keywords: housing, mortgages, life-cycle model, parallel processing, portfolio allocation
    JEL: E21 G11 G21
    Date: 2005–11–11
  95. By: Matthieu LEMOINE; Odile CHAGNY
    Abstract: In this paper, we develop an analytical framework for the estimation of potential output and output gaps for the euro area combining multivariate filtering techniques with the production function approach. The advantage of this methodology lies in the fact that it combines a model based approach to explicit statistical assumptions concerning the estimation of the potential values of the components of the production function. We discuss the production function approach and the main issues raised by this approach. We then present the main empirical studies which have estimated production function based output gaps with multivariate filtering techniques. The production function approach will be implemented with Multivariate Hodrick-Prescott filters (HPMV). The advantage of the multivariate production function approach will also be assessed through using a variety of statistical criteria
    Keywords: potential output, output gap, production function, multivariate filters, unobserved components models.
    JEL: C32 E23 E32
    Date: 2005–11–11
  96. By: Kirstin Hubrich; David F. Hendry (Research Department European Central Bank)
    Abstract: We explore whether forecasting an aggregate variable using information on its disaggregate components can improve the prediction mean squared error over forecasting the disaggregates and aggregating those forecasts, or using only aggregate information in forecasting the aggregate. An implication of a general theory of prediction is that the first should outperform the alternative methods to forecasting the aggregate in population. However, forecast models are based on sample information. The data generation process and the forecast model selected might differ. We show how changes in collinearity between regressors affect the bias-variance trade-off in model selection and how the criterion used to select variables in the forecasting model affects forecast accuracy. We investigate why forecasting the aggregate using information on its disaggregate components improves forecast accuracy of the aggregate forecast of Euro area inflation in some situations, but not in others.
    Keywords: Disaggregate information, predictability, forecast model selection, VAR, factor models
    JEL: C32 C53 E31
    Date: 2005–11–11
  97. By: B Bhaskara Rao (University of the South Pacific)
    Abstract: This paper utilizes the growth accounting framework to derive and analyze the relationship between the rate of growth of output and the ratio of investment to output. With plausible parametric assumptions this framework is used to examine the recent controversy in Fiji on investment and growth. Our results support the concerns of some USP economists that a 5% growth rate for Fiji needs significantly higher investment rates and institutional reforms.
    Keywords: Investment ratio, Growth targets, Growth accounting, Total Factor Productivity.
    JEL: E
    Date: 2005–11–11
  98. By: Luis San Vicente Portes (Economics Georgetown University)
    Abstract: This paper develops a theoretical model to explore the relationship between openness to trade and long-term income inequality. Empirical evidence on the issue is mixed, though greater inequality is often cited as a possible cost of trade liberalization. To quantify the effect of liberalization on inequality I calibrate a two-sector (agriculture and non-agriculture) open-economy macroeconomic model to the Mexican economy. Agents in the model are subject to idiosyncratic, uninsurable labor income risk, and precautionary saving generates endogenous distributions of wealth and income. When preferences are characterized by subsistence floor for food consumption, trade liberalization implies large welfare gains for low wealth agents. At the same time, liberalization increases long-run wealth and income inequality. After liberalization land-owners are worse off since the price of land falls along with the relative price of the agricultural commodity. When tariff revenue must be replaced by an alternative instrument, higher labor taxes are preferred to higher taxes on consumption or capital
    Keywords: Free trade; inequality; agriculture
    JEL: E60 F13 F40 O13
    Date: 2005–11–11
  99. By: Carlos Barrera-Chaupis (Central Bank of Peru)
    Abstract: El presente trabajo hace una evaluación ex post de la precisión de las proyecciones de un conjunto de modelos de corto plazo para el Índice de Precios al Consumidor (IPC), el Índice de Precios al por Mayor (IPM) y el crecimiento del Producto Real (PBI) utilizando una muestra reciente de datos de Perú. Se busca determinar si la incorporación de información desagregada a nivel de rubros componentes mejora la precisión de estos modelos. Las proyecciones de corto plazo forman parte integral de un sistema de proyección puesto que suelen servir como “punto de partida” en las proyecciones que se realizan utilizando modelos estructurales. En ese sentido contar con predicciones de corto plazo más precisas ayuda a minimizar los errores de predicción de los modelos de mediano plazo. Se encuentra que utilizando información desagregada la precisión de las proyecciones del IPC mejora en el muy corto plazo pero no la de las proyecciones del IPM y del PBI para el mismo horizonte temporal, aún cuando se consideran modelos con parámetros cambiantes en el tiempo para el caso del IPM. Finalmente, para horizontes de proyección mayores a 12 meses no es posible mejorar la precisión de las proyecciones de los tres agregados utilizando información desagregada. Estos resultados están condicionados al valor informativo del agregado y a los niveles de desagregación utilizados.
    Keywords: Forecasting, Sparse VAR, Monetary Policy
    JEL: C32 C43 C53 E30
    Date: 2005–04
  100. By: Peter J. Stemp
    Abstract: Most recent studies of dynamic macroeconomic relationships focus on models derived from optimising behaviour by economic agents. In most of these models, the eigenvalues of the associated dynamical system are real-valued and so the time-path of the system exhibits monotonic or near-monotonic behaviour. While, it is well-known that linear dynamic models with complex-valued eigenvalues exhibit the property of oscillatory dynamic behaviour, limited research has been undertaken to investigate the properties of optimising models with oscillatory behaviour. In this study, we will focus on producing an example of an optimising agent whose dynamics are characterised by complex-valued eigenvalues and who thus exhibits cyclical behaviour.
    JEL: E21 E27
    Date: 2005–11–11
  101. By: Michael Haliassos; Michael Reiter
    Abstract: Most US credit card holders revolve high-interest debt, often combined with substantial (i) asset accumulation by retirement, and (ii) low-rate liquid assets. Hyperbolic discounting can resolve only the former puzzle (Laibson et al., 2003). Bertaut and Haliassos (2002) proposed an 'accountant-shopper'framework for the latter. The current paper builds, solves, and simulates a fully-specified accountant-shopper model, to show that this framework can actually generate both types of co-existence, as well as target credit card utilization rates consistent with Gross and Souleles (2002). The benchmark model is compared to setups without self-control problems, with alternative mechanisms, and with impatient but fully rational shoppers.
    Keywords: Credit cards, debt, self control, household portfolios
    JEL: E21 G11
    Date: 2005–11
  102. By: Min Ouyang (Economics University of Maryland at College Park)
    Abstract: This paper explores the role that recessions play in resource allocation. The conventional cleansing view, advanced by Schumpeter in 1934, argues that recessions promote more efficient resource allocation by driving out less productive units and freeing up resources for better uses. However, empirical evidence is at odds with this view: average labor productivity is procyclical, and jobs created during recessions tend to be short-lived. This paper posits an additional "scarring" effect: recessions "scar" the economy by killing off "potentially good firms". By adding learning to a vintage model, I show that as a recession arrives and persists, the reduced profitability limits the scope of learning, makes labor less concentrated on good firms, and thus pulls down average productivity. Calibrating my model using data on job flows from the U.S. manufacturing sector, I find that the scarring effect is likely to dominate the conventional cleansing effect, and can account for the observed pro-cyclical average labor productivity
    Keywords: Business Cycles, Cleansing Effect, Scarring Effect, Creative Destruction, Learning, Job Flows
    JEL: E32 L16 C61
    Date: 2005–11–11
    Abstract: Given that data indicates several countries with same, or nearly same, degree of tax evasion but widely different levels of reserve requirements, this paper analyzes the relationship between the ``optimal" degree of tax evasion and mandatory cash reserve requirements required to be held by banks using a simple overlapping generations framework. Proceeding on the initial premises that the above observation may be a fallout of the possibilities of multiple levels of tax evasion given the reserve requirements and other policy variables, or that the optimal degree of tax evasion may be completely unaffected by the movements in reserve requirements, we find the latter to be true. The model also suggests the following: (i) An economy with a less corrupt structure will have a higher steady-state of value of reported income; (ii) Increases in the penalty rates of evading taxes would induce consumers to report greater fraction of their income, while increases in the income-tax rates would cause them to evade greater fraction of their income, and ; (iii) The model does not vindicate the popular belief in the literature that, countries with lower percentage of reported income tend to have higher reserve requirements
    Keywords: Reserve requirements; Tax evasion
    JEL: E52
    Date: 2005–11–11
  104. By: Hofer, Helmut (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria); Url, Thomas (Austrian Institute of Economic Research)
    Abstract: We integrate age specific productivity differentials into a long-run neoclassical growth model for the Austrian economy with a highly disaggregated labor supply structure. We assume two life time productivity profiles reflecting either small or large hump-shaped productivity differentials and compute an average labor productivity index using three different aggregation functions: linear, Cobb-Douglas, and a nested Constant Elasticity of Substitution (CES). Model simulations with age specific productivity differentials are compared to a base scenario with uniform productivity over age groups. Depending on the aggregation function, the simulation results show only negligible or small negative effects on output and other macroeconomic key variables.
    Keywords: Age specific productivity, Demographic change, Model simulation
    JEL: O41 J11 E17
    Date: 2005–11
  105. By: Wojciech Kopczuk; Joseph Lupton
    Abstract: In this paper, we examine the effect of observed and unobserved heterogeneity in the desire to die with positive net worth. Using a structural life-cycle model nested in a switching regression with unknown sample separation, we find that roughly three-fourths of the elderly single population has a bequest motive that may or may not have an appreciable effect on spending depending on the level of resources. Both the presence and the magnitude of the bequest motive are statistically and economically significant. On average, households with a bequest motive spend about 25 percent less on consumption expenditures. We conclude that, among the elderly single households in our sample, about four-fifths of their net wealth will be bequeathed and approximately half of this is due to a bequest motive.
    JEL: D11 D12 D91 E21
    Date: 2005–11
  106. By: Pedro Cavalcanti Gomes Ferreira (EPGE/FGV); Leandro Gonçalves do Nascimento
    Date: 2005–11
  107. By: Alasdair Scott; George Kapetanios; Adrian Pagan
    Abstract: A persistent question arising in the development of models for the analysis of macroeconomic policy has been the relative role of economic theory and evidence (data) in their construction. This paper looks at some strategies for transforming a Conceptual Model to become a Data-Adjusted Model, and how to adjust further to an Operational Model for policy analysis. Using a typical dynamic GE small open economy calibrated to UK data, we examine how some simple but formal econometric tests can be applied to test the match of the CM to the data. We also use the CM as a laboratory to assess model-building strategies. Our example suggests that, since one will never be sure that the choice of variables is appropriate, it is better to start with a CM and work towards making it match the data than attempting the converse
    Keywords: economic model
    JEL: C52
    Date: 2005–11–11
  108. By: Charles Ka-Yui Leung; Sam Hak Kan Tang; Nicolaas Groenewold
    Abstract: Recent empirical evidence demonstrates that a higher level of technical progress is associated with a lower level of growth volatility and higher expected economic growth. This paper builds a simple growth model which combines the insights of Angeletos and Kollintzas (2000) and Tse (2000, 2001, 2002) with endogenous productivity growth and rent-seeking behavior to account for these stylized facts. Our model also complements the literature that focuses on the heterogeneity of different agents. Future research directions are also discussed.
    Keywords: volatility of economic growth, technical progress, rent-seeking, stabilization policy, institution.
    JEL: E30 O11 O40
    Date: 2005–11
  109. By: Mathias Hoffmann (Economics University of Dortmund)
    Abstract: The paper contributes to a recent empirical and theoretical literature that suggests that proprietors are an important group of stockholders and that entrepreneurial risk could therefore help explain time-varying risk premia on the aggregate stock market. I use the intertemporal budget constraint of the average U.S. household to derive a cointegrating relationship between consumption and income from proprietary and non-proprietary wealth. I call this cointegrating relationship the cpy -residual. I interpret cpy as an entrepreneurial risk factor, because it mainly reflects cyclical fluctuations in proprietary income and because it is highly correlated with cross-sectional measures of idiosyncratic entrepreneurial risk. The cpy residual turns out to be a potent predictor of excess returns on the aggregate stock market in postwar U.S. data. However, this predictive power has started to decline since the beginning of the 1980s as stock market participation has widened with the advent of tax-deferable employer-sponsored pension plans and as proprietary income risk has become more easily diversifiable in the wake of state level bank deregulation
    Keywords: Non-insurable background risk, entrepreneurial income, equity premium, long-horizon predictability, consumption risk sharing
    JEL: E32 G12
    Date: 2005–11–11
  110. By: Philip R. Lane (IIIS,Trinity College Dublin and CEPR)
    Abstract: We examine the bilateral composition of international bond portfolios for the euro area and the individual EMU member countries. We find considerable support for “euro area bias” - EMU member countries disproportionately invest in one another relative to other country pairs. Another striking pattern is the positive connection between trade linkages and financial linkages in explaining asymmetries across EMU member countries in terms of their outward and inward bond investments vis-à-vis external counterparties. At the aggregate level, it is those countries physically closest to the euro area that are both the most important destinations and sources for external bond investment vis-à-vis the euro area. Our empirical results support the notion that financial regionalization is the leading force underlying financial globalization.
    Keywords: EMU; bond portfolios; financial integration.
    JEL: E4 F2 F3 F4
    Date: 2005–11
  111. By: Martin Ellison; Liam Graham; Jouko Vilmunen
    Abstract: In this paper, we develop a model which explains why events in one market may trigger similar events in other markets, even though at first sight the markets appear to be only weakly related. We allow for multiple equilibria and learning dynamics in each market, and show that a jump between equilibria in one market is contagious because it more than doubles the probability of a similar jump in another market. We claim that contagion is strong since equilibrium jumps become highly synchronised across markets. Spillovers are weak because the instantaneous spillover of events from one market to another is small. To illustrate our result, we demonstrate how a currency crisis may be contagious with only weak links between countries. Other examples where weak spillovers would create strong contagion are various models of monetary policy, imperfect competition and endogenous growth
    Keywords: contagion, escape dynamics, learning, spillovers
    JEL: E5 F4
    Date: 2005–11–11
  112. By: Frank T. Denton; Byron G. Spencer
    Abstract: Simulation methods are employed to explore the effects of immigration as a control instrument to offset the economic and demographic consequences of low fertility rates and aging population distribution. A neoclassical economic growth model is coupled with a demographic projection model. The combined model is calibrated and used in a series of experiments. The experiments are designed to generate the time paths of a hypothetical but realistic economic-demographic system under alternative assumptions about immigration policy. The government seeks to optimize policy results in the model, according to a specified criterion function. The model is calibrated with Canadian data but some experiments are carried out using initial populations and fertility rates of other countries.
    Keywords: immigration, macroeconomy, aging population, low fertility
    JEL: E17 J11 J18
    Date: 2005–10
  113. By: Giuseppina Testa
    Abstract: This paper aims at investigating the relationship between financial and economic development for two countries: the US and Japan. A great deal of theoretical and empirical studies showed the existence of a close relation between the development of the financial sector and economic growth (Greenwood and Jovanovic, 1990, Bencivenga and Smith, 1991, King and Levine, 1993, Levine et al., 2000); nevertheless many concerns still remain: it is, for instance, unclear how the development of financial markets drives economic growth and, more relevant, whether it causes or is caused by economic growth. Moreover, previous empirical studies showed that time series and cross sectional approaches lead to different results. In this paper, the long-run relationship among finance and growth is investigated through the cointegration analysis (an estimation method developed over the last decade). The cointegration analysis can help to shed light on the aforementioned issues: it helps both to examine the interactions between the variables under consideration (real GDP per capita, private credit, investment share and inflation), taking into account the non stationarity of the data, and to capture the existence of potential cointegrating links between series (being explicit a priori about their form). With this regard, the aim of our analysis is twofold: 1) to investigate whether it is possible to find a stable relationship between financial development and real GDP per capita; 2) to investigate the possible channels of transmission from financial intermediation sector to economic growth.
    Keywords: Economic growth, finance, cointegration analysis
    JEL: O16 E44 C22
    Date: 2005–11
  114. By: Sunghyun Henry Kim; Jinill Kim
    Abstract: This paper studies optimal tax policy problem by employing a two-country dynamic general equilibrium model with incomplete asset markets. We investigate the possibility of welfare-improving active, contingent tax policies (under which tax rates respond to changes in productivity) on capital and labor income and consumption. Unlike the conventional wisdom regarding stabilization policies, procyclical factor-income tax policies in general improves welfare in open economies. Procyclical tax policies generate efficiency gains by correcting asset market incompleteness. Optimal tax policy under cooperative equilibrium is similar to that under the Nash equilibrium, and welfare gains from tax policy coordination is quite small
    Keywords: optimal tax, procyclical, countercyclical, stabilization, cooperation
    JEL: F4 E6
    Date: 2005–11–11
  115. By: Professor John M. Hartwick
    Abstract: Simple operations transform Hamilton's equations for particle motion in classical mechanics into energy units. Then one obtains a single equation in location, location-changes, momenta and momenta-changes with the interpretation: income from capital, in units of energy, balances with current investment expenditure on location changes and momenta changes, also in units of energy. For the special case of periodic motion, the inflow-useflow sub-accounts for distinct position variables and for distinct momenta variables balance over the period of motion
    Keywords: particle dynamics, energy account
    JEL: E13 B41
    Date: 2005–11–11
  116. By: Thomas F. Crossley; Hamish W. Low
    Abstract: This paper shows that a power utility specification of preferences over total expenditure (ie. CRRA preferences) implies that intratemporal demands are in the PIGL/PIGLOG class. This class generates (at most) rank two demand systems and we can test the validity of power utility on cross-section data. Further, if we maintain the assumption of power utility, and within period preferences are not homothetic, then the intertemporal preference parameter is identified by the curvature of Engel curves. Under the power utility assumption, neither Euler equation estimation nor structural consumption function estimation is necessary to identify the power parameter. In our empirical work, we use demand data to estimate the power utility parameter and to test the assumption of the power utility representation. We find estimates of the power parameter larger than obtained from Euler equation estimation, but we reject the power specification of within period utility.
    Keywords: elasticity of intertemporal substitution, Euler equation estimation, demand systems
    JEL: D91 E21 D12
    Date: 2005–09
  117. By: Axel Boersch-Supan; Alexander Ludwig
    Abstract: We present a quantitative analysis of the effects of population aging and pension reform on international capital markets. First, demographic change alters the time path of aggregate savings within each country. Second, this process may be amplified when a pension reform shifts old-age provision towards more pre-funding. Third, while the patterns of population aging are similar in most countries, timing and initial conditions differ substantially. Hence, to the extent that capital is internationally mobile, population aging will induce capital flows between countries. All three effects influence the rate of return to capital and interact with the demand for capital in production and with labor supply. In order to quantify these effects, we develop a computational general equilibrium model. We feed this multi-country overlapping generations model with detailed long-term demographic projections for seven world regions. Our simulations indicate that capital flows from fast-aging regions to the rest of the world will initially be substantial but that trends are reversed when households decumulate savings. We also conclude that closed-economy models of pension reform miss quantitatively important effects of international capital mobility
    Keywords: aging; pension reform; capital mobility
    JEL: E27 F21 G15
    Date: 2005–11–11
  118. By: Eva de Francisco (Macroanalysis CBO)
    Abstract: This paper examines theoretically, using a two-country real-business-cycle model, the effects of capital-market liberalization when there is limited participation in national financial markets. It is assumed that workers cannot smooth consumption as well as do stockholders, and therefore, liberalization may hurt workers. This dynamic model evaluates some claims---made particularly by the "anti-globalization" movement---that capital movements hurt workers, while benefitting stockholders. Quantitatively, liberalization makes workers better off in the long run, since the new capital allocation and increased insurance foster capital accumulation, raising wages that offset the output fluctuations due to capital flows. However, transitional effects may overturn these long-run benefits
    Keywords: Capital Account Liberalization, Globalization and Limited Participation
    JEL: E20 F20 F30
    Date: 2005–11–11
  119. By: Kanda Naknoi; Michael Kumhof (Modeling Division, Research Department International Monetary Fund); Douglas Laxton
    Abstract: Previous efforts to compare the costs and benefits of fixed versus flexible exchange rate regimes have ignored the fact that it takes significant resources and time to develop export markets, and they have not included an analysis of the firm-level decision to enter or exit export markets. This paper develops a dynamic stochastic general equilibrium model to analyze the effects of endogenous tradedness of goods on the welfare gains from exchange rate flexibility. The actual range of traded goods in our model depends on the producers who choose to enter and exit export markets taking into account trade costs and relative productivities. A novel feature of the model is that it takes both time and resources to develop export markets and as a consequence expenditure-switching effects can be slow and will depend on a host of factors such as country size, trading costs and the competitive environment that producers face. Interestingly, because the model integrates a model of trade into a monetary business cycle model with sticky prices and wages, it is possible to study the interaction of macro and structural policies. However, in this study we focus initially on how different levels of trading costs can affect the structure of the economy and result in welfare costs of excessive exchange rate volatility
    JEL: E52 F41
    Date: 2005–11–11
  120. By: Joseph Friedman (Department of Economics, Temple University); Yochanan Shachmurove (Department of Economics, University of Pennsylvania)
    Abstract: This paper addresses the following questions: Are the major European stock markets more integrated after the introduction of the Euro? How much of the change in the stock indices in different European countries can be attributed to innovations in other markets? How fast are events occurring in one European market transmitted to other markets? Vector Auto Regression models, impulses responses and variance decomposition are used to ascertain the stock market dynamics before and after the introduction of the Euro. The paper presents evidence of further integration of the European stock markets after the introduction of the Euro.
    Keywords: Euro, Vector Auto Regression Models, Co-movements of Stock Markets, Impulse Response, Variance Decomposition
    JEL: F G C1 C3 C5 E44
    Date: 2005–10–01
  121. By: Erik Canton (CPB Netherlands Bureau for Economic Policy Analysis); Bert Minne (CPB Netherlands Bureau for Economic Policy Analysis); Ate Nieuwenhuis (CPB Netherlands Bureau for Economic Policy Analysis); Bert Smid (CPB Netherlands Bureau for Economic Policy Analysis); Marc van der Steeg (CPB Netherlands Bureau for Economic Policy Analysis)
    Abstract: Long-run per capita economic growth is driven by productivity growth. Major determinants of productivity are investments in education and research, and the intensity of competition on product markets. While these ideas have been incorporated into modern growth theories and tested in empirical analyses, they have not yet found their way to applied macroeconomic models used to forecast economic developments. In this paper, we discuss various options to include human capital, R&D and product market competition in a macroeconomic framework. We also study how policy can affect the decisions to build human capital or to perform research, and how competition policy impacts on macroeconomic outcomes. We finally sketch how these mechanisms can be implemented into the large models used at the Netherlands Bureau for Economic Policy Analysis (CPB).
    Keywords: Human capital, R&D, competition, applied macroeconomic models
    Date: 2005–08
  122. By: Dustin Chambers (Salisbury University public)
    Abstract: The relationship between income inequality and economic growth is re-examined using a semiparametric, dynamic panel data model. Significant empirical evidence is uncovered supporting the theory that the relationship between these variables is nonlinear. Additionally, the evidence also supports the conclusion that other important economic variables, notably past inequality and the rate of investment, directly affect the relationship between base period inequality and subsequent 5-year growth. The results of this paper suggest that higher income inequality (regardless of the magnitude of change) and small reductions in income inequality both reduce subsequent growth. Interestingly, large reductions in income inequality are growth promoting. Moreover, it is found that lower investment rates mitigate the negative effects of higher inequality on growth. It is shown that these results, collectively, are consistent with both a simple political economy model with costly bargaining and an economic growth model with capital-skill complementarities and imperfect credit markets
    Keywords: Economic Growth, Income Inequality, Capital-Skill Complementarity, Semiparametric Dynamic Panel
    JEL: E22 H52 O40
    Date: 2005–11–11
  123. By: Roberto M Samaniego
    Abstract: I argue that an aggregate model in which the generation of knowledge is an important factor of economic growth can be reconciled with several otherwise puzzling empirical findings on this link if knowledge affects output through investment-specific technical change. In the model, there may be a weak empirical relationship between measures of knowledge and total factor productivity even when the generation of knowledge is the predominant channel through which economic growth takes place. The results also suggest that intertemporal spillovers in the production of knowledge are likely to be small
    Keywords: ideas' production, quasi-endogenous growth, patent stock, investment specific technical change, price of capital.
    JEL: E30 O30 O40
    Date: 2005–11–11
  124. By: A. Onatski; V. Karguine
    Abstract: Data in which each observation is a curve occur in many applied problems. This paper explores prediction in time series in which the data is generated by a curve-valued autoregression process. It develops a novel technique, the predictive factor decomposition, for estimation of the autoregression operator, which is designed to be better suited for prediction purposes than the principal components method. The technique is based on finding a reduced-rank approximation to the autoregression operator that minimizes the norm of the expected prediction error. Implementing this idea, we relate the operator approximation problem to an eigenvalue problem for an operator pencil that is formed by the cross-covariance and covariance operators of the autoregressive process. We develop an estimation method based on regularization of the empirical counterpart of this eigenvalue problem, and prove that with a certain choice of parameters, the method consistently estimates the predictive factors. In addition, we show that forecasts based on the estimated predictive factors converge in probability to the optimal forecasts. The new method is illustrated by an analysis of the dynamics of the term structure of Eurodollar futures rates. We restrict the sample to the period of normal growth and find that in this subsample the predictive factor technique not only outperforms the principal components method but also performs on par with the best available prediction methods
    Keywords: Functional data analysis; Dimension reduction, Reduced-rank regression; Principal component; Predictive factor, Generalized eigenvalue problem; Term structure; Interest rates
    JEL: C23 C53 E43
    Date: 2005–11–11
  125. By: Jaime Andrés Collazos; José Vicente Romero
    Abstract: El presente documento presenta un análisis sobre la evolución de las finanzas públicas municipales del Valle del Cauca. La información empleada corresponde a la muestra de 21 municipios del departamento, la cual es procesada por el Banco de la República siendo una de las mejores fuentes para dicho tipo de análisis en la región. Se encuentra que hasta el año 2000 el comportamiento del déficit consolidado municipal era altamente pro-cíclico y que solo hasta la llegada de la Ley 617 de 2000, los municipios comenzaron a registrar superávit, siendo este fenómeno el principal impacto de dicha ley. No obstante, la alta dependencia de las transferencias y el alto nivel de los gastos de funcionamiento se constituyen en uno de los elementos críticos de las finanzas públicas de los municipios del Valle. Asimismo, este documento realiza el cálculo de cinco indicadores de evaluación fiscalii para cada uno de los 21 municipios estudiados, los cuales fueron analizados a partir de hipótesis que intentan determinar si los decretos efectuados en la ley 617 del 2000, modificó o no estos indicadores. Para probar las hipótesis se empleo la prueba “t” para medias de dos muestras independientesiii unilateralesivv, la cual permite concluir si existe diferencias sustanciales entre las medias de dos muestras como consecuencia de la aplicación de un “tratamiento”, los decretos de la ley 617.La contribución de este estudio es importante, debido a que demostró que a pesar que la ley 617 del 2000 elimino la tendencia deficitaria experimentada entre los años 1987-2001, registrándose un superávit en los dos años siguientes, la aplicación de la prueba “t” permitió evidenciar que con la entrada de la ley 617 desminuyó en el total del consolidado municipal, la magnitud de la inversión, la dependencia de los recursos propios y la capacidad de ahorro, e incrementó la dependencia de las transferencias y el porcentaje de ingresos corrientes destinados a cubrir los gastos de funcionamiento.
    Keywords: Finanzas públicas,
    JEL: E6
    Date: 2005–03–30
  126. By: Charles Ka Yui Leung
    Abstract: Two empirical questions concerning the equity and housing have been studied extensively: (1) Are the price and return serially correlated, and (2) What is the optimal weight of housing in the portfolio? The answer to the second question crucially depends on the cross-correlation of assets. This paper complements the literature by building a simple dynamic general equilibrium with fully rational agents, and obtain closed form solutions for the implied auto- and cross-correlations. The length of time horizon, as well as the persistence of economic shock matter. Implications and future research directions are then discussed.
    Keywords: rational expectation, price and return, serial and cross correlation, market efficiency, predictability
    JEL: E30 G10 R20
    Date: 2005–11
  127. By: Clemens Sialm
    Abstract: The effective tax rate on equity securities has fluctuated considerably in the U.S. between 1917-2004. This study investigates whether personal taxes on equity securities are related to stock valuations using the time-series variation in tax burdens. The paper finds an economically and statistically significant relationship between asset valuations and personal tax rates. Consistent with tax capitalization, stock valuations tend to be relatively low when tax burdens are relatively high.
    JEL: G12 H20 E44
    Date: 2005–11
  128. By: B Bhaskara Rao (University of the South Pacific); Rup Singh (University of the South Pacific)
    Abstract: Accurate estimates of the price and income elasticities of exports are valuable for growth policies based on trade promotion. However, not sufficient attention seems to have been paid to the specification of the relative price variable in some influential empirical works. This paper estimates the export equation for Fiji to show that inappropriate specification of the relative price variable may give under estimates of the price elasticity and over estimates of the income elasticity.
    Keywords: Exports, Price and Income Elasticities, Export-lead Growth Policy.
    JEL: E
    Date: 2005–11–11
  129. By: Dennis W. Jansen; Shao-Jung Chang (Economics Texas A&M University)
    Abstract: Over the years, optimal taxation has been extensively discussed, and a major focus has been on the question of whether the optimal capital income tax rate is zero in long-run equilibrium. This paper addresses this issue in the context of a model of vintage capital with technical change and the entry and exit of new plants. It considers the optimal combinations of three taxes, including taxes on capital income, labor income, and property. The tax base for the property tax is plant value, which is determined by the plant’s productivity. Each plant is endowed with one unit of capital, which cannot be replaced or upgraded during the plant’s lifetime, although plant productivity is a combination of the vintage of capital and learning by doing. The tax base for the property tax is relatively large compared to that for capital income. There is a trade-off between these two rates in that a much lower tax rate on property is needed to satisfy a given level of government expenditure, while on the other hand the property tax rate has an effect on the exit threshold of plants and hence on the distribution of plant productivity. In this model there are two types of plants. One type is complete and able to produce the final good, while the other type is under development process and subject to a time-to-build constraint. Only the producing plant is subject to the property tax. In the steady state this paper documents interesting interactions between the capital income tax and the property tax. One special case of interest is the optimal capital income tax rate given different level of exogenous government expenditure when the property tax rate is fixed at zero. (Government expenditure is assumed to be unproductive.) Subsidies on capital income and property are considered. In addition to looking at the steady state, transitional paths including exit and entry rates of plants, and social welfare, are derived under two situations, one in which there is a shock to embodied technology, and one in which there is a shock to the path of exogenous government expenditures. Some results to date indicate that for a large range of values the steady state optimal tax rates include a positive tax on property matched with a subsidy to capital income
    JEL: E62 L16 O41
    Date: 2005–11–11

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