nep-mac New Economics Papers
on Macroeconomics
Issue of 2006‒03‒25
forty papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Output and Inflation in Models of the Business Cycle with Nominal Rigidities: Some Counterfactual Evidence By Páez-Farrell, Juan
  2. Assessing Sticky Price Models Using the Burns and Mitchell Approach By Páez-Farrell, Juan
  3. Forecasting inflation with an uncertain output gap By Hilde C. Bjørnland; Leif Brubakk; Anne Sofie Jore
  4. Wage Indexation, Inflation Inertia, and the Cost of Disinflation - New version By Javier Gómez
  5. Determinants of business cycle synchronisation across euro area countries By Uwe Böwer; Catherine Guillemineau
  6. Maximising Seigniorage and Inflation Tax: The Case of Belarus By D r. (elect.) Julia Korosteleva
  7. Sunspots and Monetary Policy By Jagjit S. Chadha; Luisa Corrado
  8. Monetary Policy and Financial Sector Reform For Employment Creation and Poverty Reduction in Ghana By Gerald Epstein; James Heintz
  9. Consistent Targets and Optimal Monetary Policy: A Note By Stephen M. Miller; Huiping Yuan
  10. Estonia’s Accession to the EMU By Mart Sõrg
  11. Does Monetary Policy Help Least Those Who Need It Most? By Michael S. Hanson; Erik Hurst; Ki Young Park
  12. Endogenous Labor Market Participation and the Business Cycle By Christian Haefke; Michael Reiter
  13. Robustifying learnability By Robert J. Tetlow; Peter von zur Muehlen
  14. Partisan Theory and the New Keynesian and Sticky-Information Phillips Curves By Frode Brevik; Manfred Gärtner
  15. The Dynamic (In)efficiency of Monetary Policy by Committee By RIBONI, Alessandro; RUGE-MURCIA, Francisco
  16. Rational inattention, inflation developments and perceptions after the euro cash changeover By Michael Ehrmann
  17. Forecasting economic aggregates by disaggregates By David F. Hendry; Kirstin Hubrich
  18. The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy By Huiping Yuan; Stephen M. Miller
  19. The Belarusian Case of Transition: Whither Financial Repression? By Dr. (elect.) Julia Korosteleva and Dr. Colin Lawson
  20. Fiscal Shocks, the Current Account, and the Exchange Rate By Faik Koray; W. Douglas McMillin
  21. The Making of Optimal and Consistent Policy: An Analytical Framework for Monetary Models By Huiping Yuan; Stephen M. Miller; Langnan Chen
  22. Dutch households' perceptions of economic growth and inflation By Céline Christensen; Peter van Els; Maarten van Rooij
  23. Non-linear dynamics in the euro area demand for M1 By Alessandro Calza; Andrea Zaghini
  24. Credit Cycles and Macro Fundamentals By Siem Jan Koopman; Roman Kraeussl; Andre Lucas; Andre Monteiro
  25. Investigating M3 Money Demand in the Euro Area : New Evidence Based on Standard Models By Christian Dreger; Jürgen Wolters
  26. Macroeconomic Instability in the European Monetary System? By Amalia Morales Zumaquero; Simón Sosvilla Rivero
  27. One Sector Models, Indeterminacy, and Productive Public Spending By Sergey Slobodyan
  28. What Banks Do and Markets Don't: Cross-subsidization By Thorsten Koeppl; James MacGee
  29. Escape Dynamics: A Continuous—Time Approximation By Dmitri Kolyuzhnov; Anna Bogomolova; Sergey Slobodyan
  30. Equity Return and Short-Term Interest Rate Volatility: Level Effects and Asymmetric Dynamics By Olan T. Henry; Nilss Olekalns; Sandy Suardi
  31. Macroeconomic impacts of the reform of public services in Uruguay - A CGE analysis By María Inés Terra; Alvaro Forteza; Gabriel Katz; Andrés Pereyra
  32. Illegal Market of Cigarettes in Estonia By Evelin Ahermaa
  34. Indeterminacy and Stability in a Modified Romer Model: A General Case By Sergey Slobodyan
  35. Does Entrepreneurship create enough Jobs in Europe? A Note By Miltiades N. Georgiou
  36. Online Appendix for "Coordination and Policy Traps" (March 2006) By Christian Hellwig
  37. A Dynamic Model of Settlement By Thorsten Koeppl; Cyril Monnet; Ted Temzelides
  38. Why Are Capital Income Taxes So High? By Floden, Martin
  39. Differentiability of the Efficient Frontier when Commitment to Risk Sharing is Limited By Thorsten Koeppl
  40. On Intertemporal Dependent Preferences with regard Environmental Goods and Services By José Manuel Madeira Belbute

  1. By: Páez-Farrell, Juan (Cardiff Business School)
    Abstract: This paper examines the relationship between cyclical output and inflation in models commonly used for monetary policy analysis. This includes models that incorporate the New Keynesian, Fuhrer-Moore and backward-looking Phillips curves. The main finding is that these models imply a strong negative relationship between inflation and output, a result that is at odds with the data. The fact that New Keynesian models yield counterfactual implications is not new; the novelty of the paper lies in the fact that the finding extends to the other variants, such as the backward-looking Phillips Curve, which has been put forward as displaying superior dynamics.
    Keywords: nominal rigidities; monetary policy; Phillips Curve; Output; Inflation; Correlation
    JEL: E20 E31 E32 E52 E61
    Date: 2006–03
  2. By: Páez-Farrell, Juan (Cardiff Business School)
    Abstract: This paper evaluates sticky-price models using the methods proposed by Burns and Mitchell, focusing on the monetary aspects of the business cycle. Recent research has emphasised the responses of models to shocks at the expense its systematic component. Whereas sticky-price models have been successful at replicating impulse response functions from VARs, this paper highlights that they are unable to mimic the data for nominal variables. Moreover, the results are robust to the specification of the Phillips curve, including its backward-looking variant; calibrated values and the inclusion of fiscal policy shocks. Since being able to mimic the data is the lowest hurdle a model must pass, these results pose a challenge for New Keynesian-type models.
    Keywords: New Keynesian Models; Business Cycles; Correlations; Burns and Mitchell
    JEL: E32 E52 E58
    Date: 2006–03
  3. By: Hilde C. Bjørnland (University of Oslo and Norges Bank (Central Bank of Norway)); Leif Brubakk (Norges Bank (Central Bank of Norway)); Anne Sofie Jore (Norges Bank (Central Bank of Norway))
    Abstract: The output gap (measuring the deviation of output from its potential) is a crucial concept in the monetary policy framework, indicating demand pressure that generates inflation. The output gap is also an important variable in itself, as a measure of economic fluctuations. However, its definition and estimation raise a number of theoretical and empirical questions. This paper evaluates a series of univariate and multivariate methods for extracting the output gap, and compares their value added in predicting inflation. The multivariate measures of the output gap have by far the best predictive power. This is in particular interesting, as they use information from data that are not revised in real time. We therefore compare the predictive power of alternative indicators that are less revised in real time, such as the unemployment rate and other business cycle indicators. Some of the alternative indicators do as well, or better, than the multivariate output gaps in predicting inflation. As uncertainties are particularly pronounced at the end of the calculation periods, assessment of pressures in the economy based on the uncertain output gap could benefit from being supplemented with alternative indicators that are less revised in real time.
    Keywords: Output gap, real time indicators, forecasting, Phillips curve
    JEL: C32 E31 E32 E37
    Date: 2006–03–17
  4. By: Javier Gómez
    Abstract: A Statement of the Colombian Consitutional Court has mandated wage indexation on the basis of past inflation. A simple model with a wage price system, a real block, and an inflation targeting interest rule is calibrated to resemble price setting in the colombian economy and to analize the differing slope of the output inflation trade off for diferent specifications of wage indexation. The disinflation experiments show that backward looking indexation increases inflation inertia, decreases the effect of monetary policy, and increases the cost of disinflation. Shorter wage contracts and more frequent wage negotiations do not appear to have important effects on the cost of disinflation. Higher central bank credibility and the use of forward looking inflation expectations in wage negotiations decrease the cost of disinflation and may eventually lead to a boom.
    JEL: E1 E17 E52 E27 J30
  5. By: Uwe Böwer (University of Munich, Munich Graduate School of Economics, Kaulbachstr. 45, 80539 Munich, Germany.); Catherine Guillemineau (The Conference Board, 845 Third Avenue, New York, NY 10022-6679, USA)
    Abstract: We investigate the key factors underlying business cycle synchronisation in the euro area applying the extreme-bounds analysis. We examine both traditional determinants and new, EMU-specific policy and structural indicators over the past 25 years. Our evidence seems to support the endogeneity hypothesis of the optimum currency area criteria. The implementation of the single market intensified bilateral trade across euro area countries and contributed to higher business cycle symmetry. The introduction of the single currency led to an intensification of intra-industry trade which has become the main driving force ensuring the coherence of business cycles. In addition, the set of robust determinants of business cycle synchronisation has varied over time, depending on the difference phases of the European construction, with fiscal policy, in addition to industrial and financial structures, playing a greater role during the completion of the Single Market, while short-term interest rate differentials and cyclical services have become more determinant since Economic and Monetary Union.
    Keywords: business cycle synchronisation; extreme-bounds analysis; Economic and Monetary Union; trade.
    JEL: C21 E32 F15
    Date: 2006–02
  6. By: D r. (elect.) Julia Korosteleva
    Abstract: While most Central European countries, realising the inflationary potential of money creation, had by the mid-1990s switched to market instruments based monetary policy, Belarus continued to use money emission, so gaining seigniorage and inflation tax. The productivity of the inflation tax can be analysed by comparing the revenue actually raised from inflation tax with the revenue that could be raised if the quantity of money had risen at a constant rate. The present paper, based on Cagan’s (1956) seminal work ‘Monetary Dynamics of Hyperinflation’, analyses the effect of inflation on seigniorage revenue in Belarus and draws conclusions about the effectiveness of monetary policy in 1995-2002, and about the consequences of inflationary financing.
    JEL: C12 C22 E42 E52 G28
  7. By: Jagjit S. Chadha; Luisa Corrado
    Abstract: A monetary economy subject to expectational sunspots is prone to instability, in the sense of multiple rational expectations equilibria. We show how to modify the policy rule to guarantee stability in the presence of expectational sunspots. The policy-maker must co-ordinate inflation dynamics by targeting each of lagged, current and expected inflation. We show that this solution maps directly into the timeless perspective by Woodford. Finally, we trace the responses in an artificial sunspot economy to the adoption of our rule and illustrate the extent to which macroeconomic persistence is reduced.
    Keywords: Sunspots; Indeterminacy; Monetary Policy Rules; Expectation Based Timeless Perspective.
    JEL: C63 C62 E00
    Date: 2006–01
  8. By: Gerald Epstein; James Heintz
    Abstract: This report summarizes the findings of a UNDP-sponsored study on the structure of the financial sector, central bank policy, and employment outcomes in Ghana. The financial sector is the primary conduit through which monetary policy affects real economic outcomes, and monetary policy determines the resources available to financial institutions. Therefore, monetary policy must be coordinated with financial sector reforms in order to improve employment opportunities, reduce poverty and support human development. The report develops a critique of financial programming and inflation targeting, presents a series of empirical estimates on the impact of monetary policy variables in Ghana, and describes the elements of an alternative monetary policy. In addition, the report documents the institutional and structural constraints currently operating in the financial system which prevent the sector from facilitating investment, growth, and improved employment opportunities. Econometric estimates of the determinants of investment explicitly link financial variables to real economic activity. The report summarizes a series of financial sector reforms that would improve the financial sector's capacity to move Ghana onto an employment-intensive growth path.
    Keywords: Monetary policy, financial programming, inflation-targeting, financial reform, Ghana, employment
    JEL: E22 E24 E52 E58 O11
    Date: 2006
  9. By: Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas); Huiping Yuan (Xiamen University)
    Abstract: Kydland and Prescott (1977) develop a simple model of monetary policy making, where the central bank needs some commitment technique to achieve optimal monetary policy over time. Although not their main focus, they illustrate the difference between consistent and optimal policy in a sequential-decision one-period world. We employ the analytical method developed in Yuan and Miller (2005), whereby the government appoints a central bank with consistent targets or delegates consistent targets to the central bank. Thus, the central bank s welfare function differs from the social welfare function, which cause consistent policy to prove optimal.
    JEL: E42 E52 E58
    Date: 2005–12
  10. By: Mart Sõrg (Institute of Finance and Accounting, University of Tartu)
    Abstract: CEE countries have passed the process of transition to market economy and eight of them, including Estonia, joined the European Union in 2004. Estonia has been very successful in the transition process, mainly owing to the currency board-based monetary system, which serves as a signal of commitment to prudent monetary policy and as a guarantee of sound money during the transition period. The current paper discusses the thirteen years of experience in operating the currency board-based monetary system in Estonia. Estonia’s accession to the European Union will soon be accompanied by membership of the Economic and Monetary Union (EMU). Here it is also explained why Estonia wants to join the EMU as fast as possible and what the prospects are to do it on time, at the beginning of 2007.
    Keywords: monetary systems, monetary policy, Economic and Monetary Union
    JEL: E42 E5 F33
    Date: 2005
  11. By: Michael S. Hanson (Economics Department, Wesleyan University); Erik Hurst (University of Chicago GSB, and NBER); Ki Young Park (University of Chicago)
    Abstract: We estimate the impact of U.S. monetary policy on the cross-sectional distribution of state economic activity for a 35-year panel. Our results indicate that the effects of policy have a significant history dependence, in that relatively slow growth regions contract more following contractionarymonetary shocks. Moreover, policy is asymmetric, in that expansionary shocks have less of a beneficial impact upon relatively slow growth areas. As a result, we conclude that monetary policy on average widens the dispersion of growth rates among U.S. states, and those locations initially at the low end of the cross-sectional distribution benefit least from any given change inmonetary policy.
    Keywords: Monetary policy, asymmetric effects, state dependence, regional business cycles
    JEL: E32 E59 R10
    Date: 2006–01
  12. By: Christian Haefke (Instituto de Análisis Económico, CSIC and IZA Bonn); Michael Reiter (Universitat Pompeu Fabra)
    Abstract: Existing models of equilibrium unemployment with endogenous labor market participation are complex, generate procyclical unemployment rates and cannot match unemployment variability relative to GDP. We embed endogenous participation in a simple, tractable job market matching model, show analytically how variations in the participation rate are driven by the cross-sectional density of home productivity near the participation threshold, and how this density translates into an extensive-margin labor supply elasticity. A calibration of the model to macro data not only matches employment and participation variabilities but also generates strongly countercyclical unemployment rates. With some wage rigidity the model also matches unemployment variations well. Furthermore, the labor supply elasticity implied by our calibration is consistent with microeconometric evidence for the US.
    Keywords: matching models, labor market participation, labor supply elasticity, time aggregation
    JEL: E24 E32 J21 J64
    Date: 2006–03
  13. By: Robert J. Tetlow (Federal Reserve Board, 20th and C Streets, NW, Washington, D.C. 20551, USA.); Peter von zur Muehlen (von zur Muehlen & Associates, Vienna, VA 22181, USA.)
    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. Some contributions to the literature, including Bullard and Mitra (2001) and Evans and Honkapohja (2002), have made significant headway in establishing certain features of monetary policy rules that facilitate learning. However a treatment of policy design for learnability in worlds where agents have potentially misspecified their learning models has yet to surface. This paper provides such a treatment. We begin with the notion that because the profession has yet to settle on a consensus model of the economy, it is unreasonable to expect private agents to have collective rational expectations. We assume that agents have only an approximate understanding of the workings of the economy and that their learning the reduced forms of the economy is subject to potentially destabilizing perturbations. The issue is then whether a central bank can design policy to account for perturbations and still assure the learnability of the model. Our test case is the standard New Keynesian business cycle model. For different parameterizations of a given policy rule, we use structured singular value analysis (from robust control theory) to find the largest ranges of misspecifications that can be tolerated in a learning model without compromising convergence to an REE. In addition, we study the cost, in terms of performance in the steady state of a central bank that acts to robustify learnability on the transition path to REE.
    Keywords: monetary policy; learning, E-stability; learnability; robust control.
    JEL: C6 E5
    Date: 2006–02
  14. By: Frode Brevik; Manfred Gärtner
    Abstract: This paper attempts two things: First, to modernize partisan theory by merging the idea of partisan differences in macroeconomic preferences with recent, optimizing models of aggregate supply that account for sluggish nominal adjustment. This aids in resolving some puzzles posed by the current state of partisan theory research. Second, to exploit partisan patterns for a comparison of the empirical performance of the new Keynesian Phillips curve with that of a recent challenger, the sticky-information Phillips curve. It turns out that the sticky-information Phillips curve clearly outperforms its better established rival: in accounting for econometric estimates of partisan patterns in OECD countries, and in tracking post-war experience in the US.
    JEL: E0 E3 E6
    Date: 2005–12
  15. By: RIBONI, Alessandro; RUGE-MURCIA, Francisco
    Abstract: This paper develops a model where the value of the monetary policy instrument is selected by a heterogenous committee engaged in a dynamic voting game. Committee members differ in their institutional power and, in certain states of nature, they also differ in their preferred instrument value. Preference heterogeneity and concern for the future interact to generate decisions that are dynamically ineffcient and inertial around the previously-agreed instrument value. This model endogenously generates autocorrelation in the policy variable and provides an explanation for the empirical observation that the nominal interest rate under the central bank’s control is infrequently adjusted.
    Keywords: Committees, status-quo bias, interest-rate smoothing, dynamic voting
    JEL: E58
    Date: 2006
  16. By: Michael Ehrmann (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: This paper uses the euro cash changeover to test theories of finite informationprocessing capacities on the side of consumers. It argues that the denomination of prices in a new currency has increased the information-processing requirements for consumers by more than for sellers, a wedge that can lead to price increases. The size of the wedge should depend on the complexity of the currency conversion rates. In line with this theory, the paper finds that the evolution of prices for food products around the cash changeover varied across countries, depending on the complexity of conversion rates. These changeover effects are found in particular for goods with prices below one euro sold in mid-priced stores. The paper also finds that cross-country differences in the mismatch of perceived and actual inflation in the aftermath of the cash changeover are linked to differences in the complexity of conversion rates.
    Keywords: rational inattention; perceived inflation; euro cash changeover
    JEL: D84 E31 E58 L11
    Date: 2006–02
  17. By: David F. Hendry (Department of Economics, Oxford University, Manor Road Building, Manor Road, Oxford, OX1 3UQ, United Kingdom); Kirstin Hubrich (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: We suggest an alternative use of disaggregate information to forecast the aggregate variable of interest, that is to include disaggregate information or disaggregate variables in the aggregate model as opposed to first forecasting the disaggregate variables separately and then aggregating those forecasts or, alternatively, using only lagged aggregate information in forecasting the aggregate. We show theoretically that the first method of forecasting the aggregate should outperform the alternative methods in population. We investigate whether this theoretical prediction can explain our empirical findings and analyse why forecasting the aggregate using information on its disaggregate components improves forecast accuracy of the aggregate forecast of euro area and US inflation in some situations, but not in others.
    Keywords: Disaggregate information; predictability; forecast model selection; VAR; factor models
    JEL: C51 C53 E31
    Date: 2006–02
  18. By: Huiping Yuan (Xiamen University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the social loss function cannot serve as a direct loss function for the central bank. Accordingly, we employ implementation theory to design a central bank loss function (mechanism design) with consistent targets, while the social loss function serves as a social welfare criterion. That is, with the correct mechanism design for the central bank loss function, optimal policy and consistent policy become identical. In other words, optimal policy proves implementable (consistent).
    JEL: E42 E52 E58
    Date: 2006–02
  19. By: Dr. (elect.) Julia Korosteleva and Dr. Colin Lawson
    Abstract: The present paper examines the financial development of Belarus over the past decade with a particular focus on 1996-2002, when the financial sector was restrained through pervasive government controls in the form of interest rate ceilings, directed credit and preferential loans schemes, high reserve requirements, multiple exchange rates and capital controls. Belarus is of particular interest, as, despite no economic restructuring, the growth has averaged seven per cent per annum since 1997. While explanations of this ‘miracle’ abound, no empirical work has been done on the role of the financial system, particularly on the effects of pervasive government intervention. It has been argued that monetary stimulation of investment activity through interest rate ceilings and directed credit and preferential loans revived growth. This paper investigates whether financial policy led to financial deepening and increased the share of savings to be allocated to investment.
    JEL: C12 C22 E42 E44 G21 G28 O16
  20. By: Faik Koray; W. Douglas McMillin
    Abstract: This paper investigates empirically, using a VAR model, the response of the exchange rate and the current account to fiscal policy shocks for the U.S. economy during the period 1981:3-2005:3. The results indicate that positive shocks to real government purchases generate a persistent increase in the budget deficit, a transitory expansionary effect on output, and a long-lived positive effect on the price level, but reduce the real interest rate. Simultaneously, and consistent with interest parity, the real exchange rate depreciates, and the current account improves. Negative shocks to net taxes also generate a persistent increase in the budget deficit, and the effects on the model variables are generally in the same direction, but are almost never significant. Our results indicate it is inappropriate to attribute rising current account deficits to expansionary fiscal policy shocks, even though these shocks generate long-lived increases in the budget deficit.
  21. By: Huiping Yuan (Xiamen University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas); Langnan Chen (Sun Yat-sen University)
    Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the central bank should adopt a loss function that differs from the social loss function. Carefully designing the central bank s loss function with consistent targets can harmonize optimal and consistent policy. This desirable result emerges from two observations. First, the social loss function reflects a normative process that does not necessarily prove consistent with the structure of the microeconomy. Thus, the social loss function cannot serve as a direct loss function for the central bank. Second, an optimal loss function for the central bank must depend on the structure of that microeconomy. In addition, this paper shows that control theory provides a benchmark for institution design in a game-theoretical framework.
    JEL: E42 E52 E58
    Date: 2006–02
  22. By: Céline Christensen; Peter van Els; Maarten van Rooij
    Abstract: This paper analysis the results of a survey on qualitative and quantitative perceptions and expectations of past, current and future macroeconomic developments among a representative household panel (DNB Household Survey). Perceptions of economic growth and inflation show a large dispersion. For the median respondents, however, the quantitative perceptions were found to be quite accurate. There is some evidence that the concept of economic growth is a more abstract notion for the general public than inflation. The results on qualitative and quantitative perceptions of current inflation could be interpreted as the Dutch public having a high level of inflation aversion. Those who have declared themselves more knowledgeable are also more actively involved in dealing with financial issues. The empirical evidence seems to corroborate that individuals with higher self-assessed knowledge levels are better informed indeed and have more accurate quantitative perceptions of economic growth and inflation. The survey also provides further insights on the connection between perceptions of current and past economic developments on the one hand, and expectations of future developments on the other. At the individual level there is a strong and robust correlation between expected growth and inflation for the next year and the perceptions of the current situation (rule of thumb behavior). But short-term expectations are also influenced by the views individuals hold on longer-term developments. Moreover, the results confirm the observed persistence in annual acroeconomic growth and inflation figures.
    Keywords: individual consumer perceptions and expectations; empirical knowledge of inflation and economic growth; rule of thumb behavior; DNB Household survey
    JEL: D12 D84 E30
    Date: 2006–03
  23. By: Alessandro Calza (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Andrea Zaghini (Banca d’Italia, Servizio Studi, Via Nazionale 91, 00184 Rome, Italy.)
    Abstract: This paper investigates possible non-linearities in the dynamics of the euro area demand for the narrow aggregate M1. A long-run money demand relationship is firstly estimated over a sample period covering the last three decades. While the parameters of the relationship are jointly stable, there are indications of non-linearity in the residuals of the error-correction model. This non-linearity is explicitly modelled using a fairly general Markov switch- ing error-correction model with satisfactory results. The empirical findings of the paper are consistent with theoretical predictions stemming from "buffer stock" and "target-threshold" models and with analogous empirical evidence for European countries and the US.
    Keywords: Euro area; cointegration; non-linear error correction; demand for money.
    JEL: E41 C22
    Date: 2006–02
  24. By: Siem Jan Koopman (Vrije Universiteit Amsterdam); Roman Kraeussl (Vrije Universiteit Amsterdam); Andre Lucas (Vrije Universiteit Amsterdam); Andre Monteiro (Vrije Universiteit Amsterdam)
    Abstract: We study the relation between the credit cycle and macro-economic fundamentals in an intensity-based framework. Using rating transition and default data of U.S. corporates from Standard and Poor’s over the period 1980—2005 we directly estimate the credit cycle from the micro rating data. We relate this cycle to the business cycle, bank lending conditions, and financial market variables. In line with earlier studies, these variables appear to explain part of the credit cycle. As our main contribution, we test for the correct dynamic specification of these models. In all cases, the hypothesis of correct dynamic specification is strongly rejected. Moreover, if we account for the dynamic mis-specification, many of the variables thought to explain the credit cycle, turn out to be insignificant. The main exceptions are GDP growth, and to some extent stock returns and stock return volatilities. Their economic significance appears low, however. This raises the puzzle of which macro-economic fundamentals explain default and rating dynamics.
    Keywords: Credit cycles; Business cycles; Bank lending conditions; Unobserved component models; Intensity models
    JEL: G11 G21
    Date: 2006–03–08
  25. By: Christian Dreger; Jürgen Wolters
  26. By: Amalia Morales Zumaquero (Universidad de Málaga); Simón Sosvilla Rivero (FEDEA, UCM)
    Abstract: This paper analyses the impact of the establishment of the European Monetary System (EMS) on a number of macroeconomic variables, such as exchange rates, money, interest rates and prices for member countries participating in the Exchange Rate Mechanism (ERM). We examine the instability in terms of multiple structural breaks in the variance of the series. To that end, we employ two procedures: the OLS-based tests to detect multiple structural breaks, proposed by Bai and Perron (1998, 2003) and several procedures based on Information Criterion joint with the so called sequential procedure suggested by Bai and Perron (2003). Results indicate that there is some evidence of structural breaks in volatility across investigated variables, playing the realignments in the ERM a significant role in the reduction of volatility in some countries and sub-periods. In this sense, the results tend to support the hypothesis that the EMS has contributed to reduce the macroeconomic volatility of the member countries.
    Keywords: European Monetary System, multiple structural breaks, volatility
    JEL: C12 C22 F31 F33
    Date: 2006
  27. By: Sergey Slobodyan
    Abstract: This paper studies the influence of different modelling assumptions on the determinacy of the steady state in one—sector models of economic growth with externalities in the production function. We show that productive public spending subject to congestion, combined with variable capital utilization, can lead to indeterminacy at very low degrees of social increasing returns to scale. We perform a calibration of the model to the tax regimes observed in the USA. We shed some light on the conflicting effects of progressive taxation on the steady state stability reported in the literature. Finally, we extensively discuss the features of the model that lead to an indeterminate rather than an explosive steady state once the saddle—path stability is broken.
    Keywords: indeterminacy, absolute instability, productive public spending, progressive taxation.
    JEL: E32 E62 H41
    Date: 2006–03
  28. By: Thorsten Koeppl (Department of Economics, Queen's University); James MacGee (Department of Economics, University of Western Ontario)
    Abstract: We show that interbank markets are a poor substitute for ``broad'' banks that operate across regions or sectors. In the presence of regional or sectoral asset and liquidity shocks, interbank markets can distribute liquidity efficiently, but fail to respond efficiently to asset shocks. Broad banks can condition on the joint distribution of both shocks and, hence, achieve an efficient internal allocation of capital. This allocation involves the cross-subsidization of loans across regions or sectors. Compared to regional banks that are linked through well-functioning interbank markets, broad banks lead to higher levels of aggregate investment, higher output, and less fluctuations within regions. However, broad banks generate endogenously aggregate uncertainty.
    Keywords: Banking Restrictions, Interbank Markets, Universal Banking, Endogenous Uncertainty
    JEL: G21 G28 D80 E44
    Date: 2005–02
  29. By: Dmitri Kolyuzhnov; Anna Bogomolova; Sergey Slobodyan
    Abstract: We extend a continuous—time approach to the analysis of escape dynamics in economic models with adaptive learning with constant gain. This approach is based on applying results of continuous—time version of large deviations theory to the diffusion approximation of the original discrete—time dynamics under learning. We characterize escape dynamics by analytically deriving the most probable escape point and mean escape time. The continuous—time approach is tested on the Phelps problem of a government controlling inflation while adaptively learning the approximate Phillips curve, studied previously by Sargent (1999) and Cho, Williams and Sargent (2002) (henceforth, CWS). We compare the results with simulations and the results obtained by CWS. We express reservations regarding applicability of escape dynamics theory to characterization of mean escape time for economically plausible values of constant gain in the model of CWS.We show that for these values of the gain simple considerations and formulae generate much better mean escape time results than the large deviations theory. We explain it by insufficient averaging near the point of self—confirming equilibrium for relatively large gains and suggest two changes which might help the approaches based on large deviation theory to work better in this gain interval.
    Keywords: Constant gain adaptive learning, E—stability, recursive least squares, large deviations theory.
    JEL: C62 C65 D83 E10 E17
    Date: 2006–01
  30. By: Olan T. Henry; Nilss Olekalns; Sandy Suardi
    Abstract: Evidence suggests that short-term interest rate volatility peaks with the level of short rates, while equity volatility responds asymmetrically to positive and negative shocks. We present an LM based test that distinguishes between level effects and asymmetry in volatility which is robust to the presence of unidentified nuisance parameters under the null. There is strong evidence of a level effect and asymmetric response in the relationship between S&P 500 Index returns and 3-month US Treasury Bills. The conditional covariance depends on the level of the short rate which has implications for hedging equity returns against short term interest rate movements.
    Keywords: Level Effects; Asymmetry; LM Tests; Davies Problem; Nonlinear Granger Causality
    JEL: C12 G12 E44
    Date: 2005
  31. By: María Inés Terra (Departmento de Economía, Facultad de Ciencias Sociales, Universidad de la República); Alvaro Forteza (Departmento de Economía, Facultad de Ciencias Sociales, Universidad de la República); Gabriel Katz (Departmento de Economía, Facultad de Ciencias Sociales, Universidad de la República); Andrés Pereyra (Departmento de Economía, Facultad de Ciencias Sociales, Universidad de la República)
    Abstract: This paper investigates the macroeconomic impacts of the reform of public services in Uruguay. A computable general equilibrium (CGE) model is used to simulate different policy scenarios, analyzing the reforms of the regulatory framework of public services, changes in their investment policies, modifications in the competitive environment and reforms in their tax structure. The results show that the macroeconomic effects of the proposed reforms are relatively small.
    Keywords: Social Accounting Matrix, Computable General Equilibrium Models, public services, public sector reform.
    JEL: E17 H11 H32 L42
    Date: 2005–12
  32. By: Evelin Ahermaa (Estonian Institute of Economic Research)
    Abstract: Tobacco products belong to a group of excise goods and an excise duty is levied on them. The latter increases the price, but there are no changes in the quality of the goods and it leads to tax frauds. There has been regular increase in the excise duties on tobacco products in Estonia; changes in tax rates have influenced legal sales, mostly of cigarettes. Consumption of cigarettes is the largest in the group of tobacco products in Estonia; therefore, the paper is especially focused on cigarettes. The purpose of the paper is to evaluate illegal market of cigarettes in Estonia, using comparison of the net of estimations. The paper introduces the method of analysis where the essential role is given to inhabitants (concerning their expert and individual opinions). Empirical evidence concerning illegal market of cigarettes in Estonia is presented by size on the example of fieldwork carried out in 2003.
    Keywords: cigarettes, excise duty, illegal market, taxation
    JEL: E62 K42
    Date: 2005
  33. By: Esteban A. Nicolini
    Abstract: This paper shows that the interaction between economic and demographic variables in England before the onset of modern economic growth did not fit some crucial assumptions of the Malthusian model. I estimated a vector autoregression for data on fertility, nuptiality, mortality and real wages over the period 1541-1840 applying a well-known identification strategy broadly used in macroeconomics. The results show that endogenous adjustment of population to real wages functioned as Malthus assumed only until the 17th century: positive checks disappeared during the 17th century and preventive checks disappeared before 1740. This implies that the endogenous adjustment of population levels to changes in real wages -one of the cornerstones of the Malthusian model- did not work during an important part of the period usually considered within the “Malthusian regime”.
    Date: 2006–02
  34. By: Sergey Slobodyan
    Abstract: This paper studies the dynamical properties of an extension of the well—known Romer model of endogenous growth introduced by Benhabib, Perli, and Xie (1994). This model differs from the Romer model by introducing complementarity of intermediate capital goods. It allows an indeterminate steady state for relatively mild degrees of the complementarity. We derive necessary and sufficient conditions for the steady state to be interior and strictly positive, which extend those discussed in Benhabib, Perli, and Xie (1994). We show that Hopf bifurcation to the absolutely stable steady state is impossible and that the steady state is determinate if the model parameter values belong to a certain set. For the set of parameter values that allows indeterminacy, we demonstrate the possibility of Hopf bifurcation using both analytical and numerical approaches. The indeterminate steady state can undergo Hopf bifurcation for a wide range of parameter values.
    Keywords: Indeterminacy, stability, Hopf bifurcation, Romer model.
    JEL: E32 O41
    Date: 2006–01
  35. By: Miltiades N. Georgiou
    Abstract: In the present note an effort will be made for a contribution to economic theory by extending the discussion paper "Entrepreneurship, Regional Development and Job Creation: The Case of Portugal" by R. Baptista, V. Escarta and P. Madruga, MPI, # 0605, in which the authors conclude (among others) that entrepreneurship creates jobs and reduces unemployment. This extension will be feasible by estimating the total economy´s entrepreneurship reward for Western European countries and relating it with the total economy's unemployment rate. A regression based on the estimation of total economy´s entrepreneurship reward will yield the same main results with the above article not only for Portugal but also for all Western European countries, that in any Western European country entrepreneurship creates enough jobs to reduce unemployment. This generalization with panel data econometric analysis is based on the discussion paper "A Practical Method to Measure Entrepreneurship's Reward: A Note" by M. N. Georgiou, MPI, #3805.
    Keywords: entrepreneurship, unemployment
    JEL: M13 E24
    Date: 2006–03
  36. By: Christian Hellwig
  37. By: Thorsten Koeppl (Department of Economics, Queen's University); Cyril Monnet (DG Research, European Central Bank); Ted Temzelides (Department of Economics, University of Pittsburgh)
    Abstract: We investigate the role of settlement in a dynamic model of a payment system where the ability of participants to perform certain welfare-improving transactions is subject to random and unobservable shocks. In the absence of settlement, the full information first-best allocation cannot be supported due to incentive constraints. In contrast, this allocation is supportable if settlement is introduced. This, however, requires that settlement takes place with a sufficiently high frequency.
    Keywords: Payment Systems, Settlement, Mechanism Design
    JEL: E40 D82 C73
    Date: 2006–02
  38. By: Floden, Martin (Dept. of Economic Statistics, Stockholm School of Economics)
    Abstract: The Ramsey optimal taxation theory implies that the tax rate on capital income should be zero in the long run. This result holds even if the social planner only cares about workers that do not hold assets, or if the planner only cares about any other group in the economy. This paper demonstrates that although all households agree that capital income taxation should be eliminated in the long run, they do not agree on how to eliminate these taxes. Wealthy households would prefer a reform that is funded mostly by higher taxes on labor income while households with little wealth would prefer a reform that is funded mostly by high taxes on initial wealth. Pareto improving reforms typically exist, but the welfare gains of such reforms are modest.
    Keywords: optimal taxation; inequality; redistribution
    JEL: E60 H21
    Date: 2006–03–08
  39. By: Thorsten Koeppl (Department of Economics, Queen's University)
    Abstract: This paper shows that the value function describing efficient risk sharing with limited commitment is not necessarily differentiable everywhere. We link differentiability of the value function to history dependence of efficient allocations and provide sufficient conditions for both properties.
    Keywords: Risk Sharing, Limited Commitment, Differentiability of Efficient Frontier
    JEL: C61 E21
    Date: 2004–12
  40. By: José Manuel Madeira Belbute (Department of Economics, University of Évora Author-Name Paulo Brito; Technical University of Lisbon – Instituto Superior de Economia e Gestão)
    Abstract: This note extends the standard theory of intertemporal consumer preferences with regard environmental goods and services. It proposes an intertemporal dependent preferences framework that generates a “persistence effect” consistent with consumer’s environmental friendly behaviours. Given the present civilizational and cultural pattern of preferences, consumers need to endure a learning-by-consuming process to full enjoy (and use) them, in order to commit himself with “green-economic behaviors" The contribution to the existing literature is two fold. First we consider the presence of habit-formation with regard the consumption of environmental goods and services in a two goods framework. Secondly, we establish a consistent preference structure that displays a bounded adjacent complementarity in the consumption of environmental goods and services and present the correspondent properties that need to bee fulfilled by the utility function. These extensions will allow new advances in environmental economics, especially in the complete characterization of the demand for environmental goods and services and for the sustainable growth debate.
    Keywords: Consumer behavior, intertemporal dependent preferences, environmental economics.
    JEL: C61 E20 D11 D81 D91 Q01
    Date: 2006

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