nep-mac New Economics Papers
on Macroeconomics
Issue of 2006‒07‒09
39 papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Inflation risk and optimal monetary policy By William T. Gavin; Benjamin D. Keen; Michael R. Pakko
  2. Lumpy Investment in Dynamic General Equilibrium By Ruediger Bachmann; Ricardo J. Caballero; Eduardo M.R.A. Engel
  3. Inflation targeting under imperfect knowledge By Athanasios Orphanides; John C. Williams
  4. Launching the NEUQ: The New European Union Quarterly Model, A Small Model of the Euro Area and U.K. Economies By Anna Piretti; Charles St-Arnaud
  5. Optimal Monetary Policy with Real-time Signal Extraction from the Bond Market By Kristoffer Nimark
  6. Optimal Stationary Monetary and Fiscal Policy under Nominal Rigidity By Michal Horvath
  7. Worldwide macroeconomic stability and monetary policy rules By James B. Bullard; Aarti Singh
  8. Evaluating Inflation Targeting Using a Macroeconometric Model By Ray C. Fair
  9. Adaptive Learning, Endogenous Inattention, and Changes in Monetary Policy By Wiliam Branch; John Carlson; George W. Evans; Bruce McGough
  10. Imperfect knowledge, adaptive learning and the bias against activist monetary policies By Alberto Locarno
  11. Why Has U.S. Inflation Become Harder to Forecast? By James H. Stock; Mark W. Watson
  12. Forecasting of small macroeconomic VARs in the presence of instabilities By Todd E. Clark; Michael W. McCracken
  13. Inflation as a Redistribution Shock: Effects on Aggregates and Welfare By Matthias Doepke; Martin Schneider
  14. Targeting inflation and the fiscal balance : what is the optimal policy mix? By Marcela Meirelles Aurelio
  15. Can the U.S. monetary policy fall (again) in an expectation trap? By Roc Armenter; Martin Bodenstein
  16. The reform and implementation of the Stability and Growth Pact By Richard Morris; Hedwig Ongena; Ludger Schuknecht
  17. Efficient expropriation: sustainable fiscal policy in a small open economy By Mark Aguiar; Manuel Amador; Gita Gopinath
  18. How Well Does a Small Structural Model with Sticky Prices and Wages Fit Postwar U.S. Data? By Julien Matheron; Céline Poilly
  19. Productivity and U.S. macroeconomic performance: interpreting the past and predicting the future with a two-sector real business cycle model By Peter N. Ireland; Scott Schuh
  20. Fool the markets? Creative accounting, fiscal transparency and sovereign risk premia By Kerstin Bernoth; Guntram Wolff
  21. Macroeconomic and financial stability challenges for acceding and candidate countries By Adalbert Winkler; Roland Beck
  22. Monetary policy implementation without averaging or rate corridors By William Whitesell
  23. Monetary policy, determinacy, and learnability in a two-block world economy By James B. Bullard; Eric Schaling
  24. Merging the Purchasing Power Parity and the Phillips Curve Literatures: Regional Evidence from Italy By Andrea Vaona
  25. The Evolution of the Finnish Model in the 1990s: from Depression to High-tech Boom By Jaakko Kiander
  26. Macroeconomic Models and the Determination of Crowding Out. By Lee C. Spector
  27. Intangible capital and economic growth By Carol Corrado; Charles Hulten; Daniel Sichel
  28. Revisiting the empirical evidence on firms’ money demand By Francesca Lotti; Juri Marcucci
  29. An empirical analysis of national differences in the retail bank interest rates of the euro area By Massimiliano Affinito; Fabio Farabullini
  30. Growth, Reform indicators and Policy complementarities By Macedo, Jorge Braga de; Martins, Joaquim Oliveira
  31. A General Stochastic Volatility Model for the Pricing and Forecasting of Interest Rate Derivatives By Anders B. Trolle; Eduardo S. Schwartz
  32. Finnish Household Consumption in Monetary and Physical Terms - Trends and Clarifications By Risto Sullström; Adriaan Perrels
  33. Estimating the New Keynesian Phillips Curve: a vertical production chain approach By Adam Hale Shapiro
  34. The Dissaving of the Aged Revisited: The Case of Japan By Charles Yuji Horioka
  35. Is Fiscal Policy Sustainable in Developing Economies? By Subrata Ghatak; José R. Sánchez-Fung
  36. The Lending Channel in Emerging Economics: Are Foreign Banks Different? By Marco Arena; Carmen Reinhart; Francisco Vázquez
  37. Consumption Over the Life Cycle: The Role of Annuities By Gary D. Hansen; Selahattin %u0130mrohoroglu
  38. Do Borrowing Constraints Matter? An Analysis of Why the Permanent Income Hypothesis Does Not Apply in Japan By Miki Kohara; Charles Yuji Horioka
  39. Essays on Labour Taxation and Unemployment Insurance By Pekka Sinko

  1. By: William T. Gavin; Benjamin D. Keen; Michael R. Pakko
    Abstract: This paper shows that the optimal monetary policies recommended by New Keynesian models still imply a large amount of inflation risk. We calculate the term structure of inflation uncertainty in New Keynesian models when the monetary authority adopts the optimal policy*the policy that minimizes the gap between output in the New Keynesian model and output in a flexible wage and price model. When the monetary policy rules are modified to include a small weight on a price path, the economy achieves equilibria with substantially lower long-run inflation risk. With sticky prices, the price path target reduces long-run inflation uncertainty with no measurable increase in the variability of the output gap. With sticky wages, a tradeoff exists between short-run output stabilization and long-run inflation risk.
    Keywords: Monetary policy ; Inflation (Finance)
    Date: 2006
  2. By: Ruediger Bachmann; Ricardo J. Caballero; Eduardo M.R.A. Engel
    Abstract: Microeconomic lumpiness matters for macroeconomics. According to our DSGE model, it explains roughly 60% of the smoothing in the investment response to aggregate shocks. The remaining 40% is explained by general equilibrium forces. The central role played by micro frictions for aggregate dynamics results in important history dependence in business cycles. In particular, booms feed into themselves. The longer an expansion, the larger the response of investment to an additional positive shock. Conversely, a slowdown after a boom can lead to a long lasting investment slump, which is unresponsive to policy stimuli. Such dynamics are consistent with US investment patterns over the last decade. More broadly, over the 1960-2000 sample, the initial response of investment to a productivity shock with responses in the top quartile is 60% higher than the average response in the bottom quartile. Furthermore, the reduction in the relative importance of general equilibrium forces for aggregate investment dynamics also facilitates matching conventional RBC moments for consumption and employment.
    JEL: E10 E22 E30 E32 E62
    Date: 2006–06
  3. By: Athanasios Orphanides; John C. Williams
    Abstract: A central tenet of inflation targeting is that establishing and maintaining well-anchored inflation expectations are essential. In this paper, we reexamine the role of key elements of the inflation targeting framework towards this end, in the context of an economy where economic agents have an imperfect understanding of the macroeconomic landscape within which the public forms expectations and policymakers must formulate and implement monetary policy. Using an estimated model of the U.S. economy, we show that monetary policy rules that would perform well under the assumption of rational expectations can perform very poorly when we introduce imperfect knowledge. We then examine the performance of an easily implemented policy rule that incorporates three key characteristics of inflation targeting: transparency, commitment to maintaining price stability, and close monitoring of inflation expectations, and find that all three play an important role in assuring its success. Our analysis suggests that simple difference rules in the spirit of Knut Wicksell excel at tethering inflation expectations to the central bank's goal and in so doing achieve superior stabilization of inflation and economic activity in an environment of imperfect knowledge.
    Date: 2006
  4. By: Anna Piretti; Charles St-Arnaud
    Abstract: The authors develop a projection model of the euro area and the United Kingdom. The model consists of two country blocks, endogenous to each other via the foreign demand channel. Each country block features an aggregate IS curve, a forward-looking Phillips curve, and an estimated forward-looking monetary policy reaction function. Potential output is estimated by means of a Hodrick-Prescott filter, conditioned by an equilibrium path generated by a structural vector autoregression (Rennison 2003 and Gosselin and Lalonde 2002). The Phillips curve is specified in terms of the output gap, and inflation dynamics are described by the polynomial adjustment cost (PAC) approach, as in Kozicki and Tinsley (2002). The model delivers relatively accurate projections at a variety of forecast horizons and provides a useful tool for policy analysis. The authors’ simulation results suggest that output and inflation exhibit a greater degree of persistence to shocks in the euro area than in the United Kingdom.
    Keywords: Economic models; Business fluctuations and cycles
    JEL: C53 E17 E37
    Date: 2006
  5. By: Kristoffer Nimark (Reserve Bank of Australia)
    Abstract: Monetary policy is conducted in an environment of uncertainty. This paper sets up a model where the central bank uses real-time data from the bond market together with standard macroeconomic indicators to estimate the current state of the economy more efficiently, while taking into account that its own actions influence what it observes. The timeliness of bond market data allows for quicker responses of monetary policy to disturbances compared to the case when the central bank has to rely solely on collected aggregate data. The information content of the term structure creates a link between the bond market and the macroeconomy that is novel to the literature. To quantify the importance of the bond market as a source of information, the model is estimated on data for the United States and Australia using Bayesian methods. The empirical exercise suggests that there is some information in the US term structure that helps the Federal Reserve to identify shocks to the economy on a timely basis. Australian bond prices seem to be less informative than their US counterparts, perhaps because Australia is a relatively small and open economy.
    Keywords: monetary policy; imperfect information; bond market; term structure of interest rates
    JEL: E32 E43 E52
    Date: 2006–06
  6. By: Michal Horvath
    Abstract: Several papers have recently argued that price stickiness implies non-stationarity in models of monetary-fiscal interactions. The policy implication is that policy makers should allow a permanent drift in variables such as public debt or the tax rate in response to shocks. At the same time, a growing volume of literature advocates formulating optimal policies by minimizing expected welfare losses over unconditional rather than conditional expectations. We demonstrate that policies that maximize the unconditional expectation of the welfare objective in a forward-looking linear-quadratic framework necessarily imply mean reversion for all policy-relevant endogenous variables. This has important practical and theoretical implications.
    Keywords: Optimal monetary and fiscal policy, timeless perspective, unconditional expectation, time consistency.
    JEL: C61 E52 E61 E63
    Date: 2006–06
  7. By: James B. Bullard; Aarti Singh
    Abstract: We study the interaction of multiple large economies in dynamic stochastic general equilibrium. Each economy has a monetary policymaker that attempts to control the economy through the use of a linear nominal interest rate feedback rule. We show how the determinacy of worldwide equilibrium depends on the joint behavior of policymakers worldwide. We also show how indeterminacy exposes all economies to endogenous volatility, even ones where monetary policy may be judged appropriate from a closed economy perspective. We construct and discuss two quantitative cases. In the 1970s, worldwide equilibrium was characterized by a two-dimensional indeterminacy, despite U.S. adherence to a version of the Taylor principle. In the last 15 years, worldwide equilibrium was still characterized by a one-dimensional indeterminacy, leaving all economies exposed to endogenous volatility. Our analysis provides a rationale for a type of international policy coordination, and the gains to coordination in the sense of avoiding indeterminacy may be large.
    Keywords: Keynesian economics ; Monetary policy ; Inflation (Finance)
    Date: 2006
  8. By: Ray C. Fair
    Abstract: Inflation targeting is evaluated in this paper using a structurally estimated macroeconometric model, denoted the MC model. This model differs substantially from the New Keynesian (NK) model, which is currently the workhorse macro model in the literature. Section 2 compares the two models and argues that the NK model is unlikely to be a good approximation of the economy and that one of its key features regarding the effects of monetary policy on the economy seems wrong. Section 3 then examines inflation targeting using the MC model. Various interest rate rules are tried with differing weights on inflation and output, and various optimal control problems are solved using differing weights on inflation and output targets. Price-level targeting is also considered. The results show that 1) there are output costs to inflation targeting, especially for price shocks, 2) price-level targeting is dominated by inflation targeting, 3) the estimated interest rate rule of the Fed (in Table 3) is consistent with the Fed placing equal weights on inflation and unemployment in a loss function, 4) the estimated interest rate rule does a fairly good job at lowering variability, and 5) considerable economic variability is left after the Fed has done its best. Overall, the results suggest that the Fed should continue to behave as it has in the past and not switch to inflation targeting.
    Keywords: Inflation targeting, Interest rate rules, Optimal control
    JEL: E52
    Date: 2006–06
  9. By: Wiliam Branch (University of Californis - Irvine); John Carlson (Federal Reserve Bank of Cleveland); George W. Evans (University of Oregon Economics Department); Bruce McGough (Oregon State University)
    Abstract: This paper develops an adaptive learning formulation of an extension to the Ball, Mankiw and Reis (2005) sticky information model that incorporates endogenous inattention. We show that, following an exogenous increase in the policymaker's preferences for price vs. output stability, the learning process can converge to a new equilibrium in which both output and price volatility are lower.
    Keywords: expectations, optimal monetary policy, bounded rationality, economic stability, adaptive learning.
    JEL: E52 E31 D83 D84
    Date: 2006–06–22
  10. By: Alberto Locarno (Banca d'Italia)
    Abstract: When the economy is subject to recurrent structural shifts, the monetary authority cannot credibly commit to a systematic approach to policy, since consistency between promises and actions is not easily verifiable; moreover, since agents have incomplete knowledge of the surrounding environment, they form expectations that may deviate substantially from the full-information case. The present paper studies the implications for the effectiveness of discretionary monetary policymaking of departing from the benchmark of rational expectations and assuming instead that agents learn adaptively. It focuses on two issues, namely whether imperfect knowledge generates a bias against stabilisation policies and whether the optimal monetary strategy takes the form of an inflation cap. Rules featuring an inflation cap are not only justified on theoretical grounds, but are also appealing because they seem appropriate to deal with imperfect knowledge and learning: by setting explicit bounds on inflation, they seem better suited to restrain expectations from drifting significantly away from target, thus removing one of the main sources of policy ineffectiveness. The main findings of the paper are the following. First, when agents do not possess complete knowledge on the structure of the economy and rely on an adaptive learning technology, a bias toward conservativeness arises. Second, a policy that involves a cap on inflation is helpful in reducing output and inflation variability, but it is not uniformly superior to a strategy aimed at minimising a quadratic loss function. Third, the bias against stabilisation policies and towards conservativeness does not depend on whether agents have finite or infinite memory.
    Keywords: Adaptive learning, optimal degree of monetary policy discretion, bias against activist policies
    JEL: E52 E31 D84
    Date: 2006–05
  11. By: James H. Stock; Mark W. Watson
    Abstract: Forecasts of the rate of price inflation play a central role in the formulation of monetary policy, and forecasting inflation is a key job for economists at the Federal Reserve Board. This paper examines whether this job has become harder and, to the extent that it has, what changes in the inflation process have made it so. The main finding is that the univariate inflation process is well described by an unobserved component trend-cycle model with stochastic volatility or, equivalently, an integrated moving average process with time-varying parameters; this model explains a variety of recent univariate inflation forecasting puzzles. It appears currently to be difficult for multivariate forecasts to improve on forecasts made using this time-varying univariate model.
    JEL: C53 E37
    Date: 2006–06
  12. By: Todd E. Clark; Michael W. McCracken
    Abstract: Small-scale VARs have come to be widely used in macroeconomics, for purposes ranging from forecasting output, prices, and interest rates to modeling expectations formation in theoretical models. However, a body of recent work suggests such VAR models may be prone to instabilities. In the face of such instabilities, a variety of estimation or forecasting methods might be used to improve the accuracy of forecasts from a VAR. These methods include using different approaches to lag selection, observation windows for estimation, (over-) differencing, intercept correction, stochastically time--varying parameters, break dating, discounted least squares, Bayesian shrinkage, detrending of inflation and interest rates, and model averaging. Focusing on simple models of U.S. output, prices, and interest rates, this paper compares the effectiveness of such methods. Our goal is to identify those approaches that, in real time, yield the most accurate forecasts of these variables. We use forecasts from simple univariate time series models, the Survey of Professional Forecasters and the Federal Reserve Board's Greenbook as benchmarks.
    Keywords: Economic forecasting ; Time-series analysis
    Date: 2006
  13. By: Matthias Doepke; Martin Schneider
    Abstract: Episodes of unanticipated inflation reduce the real value of nominal claims and thus redistribute wealth from lenders to borrowers. In this study, we consider redistribution as a channel for aggregate and welfare effects of inflation. We model an inflation episode as an unanticipated shock to the wealth distribution in a quantitative overlapping-generations model of the U.S. economy. While the redistribution shock is zero sum, households react asymmetrically, mostly because borrowers are younger on average than lenders. As a result, inflation generates a decrease in labor supply as well as an increase in savings. Even though inflation-induced redistribution has a persistent negative effect on output, it improves the weighted welfare of domestic households.
    JEL: D31 D58 E31 E50
    Date: 2006–06
  14. By: Marcela Meirelles Aurelio
    Abstract: This paper identifies optimal policy rules in the presence of explicit targets for both the inflation rate and public debt. This issue is investigated in the context of a dynamic stochastic general equilibrium model that describes a small open economy with capital accumulation, distortionary taxation and nominal price rigidities. The model is solved using a second-order approximation to the equilibrium conditions. Optimal policy features a strong anti-inflation stance and strict fiscal discipline. Targeting a domestic inflation index - as opposed to CPI - improves welfare because it reduces the inefficiencies that stem from both price stickiness and income taxes.
    Keywords: Inflation (Finance) ; Prices ; Fiscal policy
    Date: 2006
  15. By: Roc Armenter; Martin Bodenstein
    Abstract: We provide a tractable model to study monetary policy under discretion. We focus on Markov equilibria. For all parametrizations with an equilibrium inflation rate around 2%, there is a second equilibrium with an inflation rate just above 10%. Thus the model can simultaneously account for the low and high inflation episodes in the U.S. We carefully characterize the set of Markov equilibria along the parameter space and find our results to be robust.
    Keywords: Inflation (Finance) ; Econometric models ; Equilibrium (Economics) ; Monetary policy
    Date: 2006
  16. By: Richard Morris (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Hedwig Ongena (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Ludger Schuknecht (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: Fiscal rules are instrumental for restraining deficit and spending biases in euro area Member States that could threaten the smooth functioning of Economic and Monetary Union (EMU). Ideally, fiscal rules should combine characteristics such as sufficient flexibility to allow for appropriate policy choices with the necessary simplicity and enforceability to actually discipline government behaviour. The Maastricht Treaty and the Stability and Growth Pact established such a rules-based framework for fiscal polices in EMU. However, the implementation of the Pact was less than fully satisfactory. One year ago, the Pact was reviewed and a reformed version adopted which emphasises more flexible rules and procedures, including more explicit room for judgement and discretion than in its original form. While its proponents argued that these revisions would strengthen commitment and implementation of the rules, others emphasised the risk of weakening the EU fiscal framework. A year on from the SGP reform, this paper takes stock of how the EU fiscal rules have evolved and how they have been implemented from the Maastricht Treaty to the present day, including initial experiences with the implementation of the reformed Pact. The first indications are of a smoother and consistent implementation, but with consolidation requirements that are rather lenient while fiscal targets and projections point to only slow and back-loaded progress towards sound public finances in many countries. The assessment of the implementation of the revised rules is therefore mixed. It is of the essence that the provisions of the revised SGP be rigorously implemented in order to ensure fiscal sustainability. JEL Classification: E61, E62, H6.
    Keywords: Stability and Growth Pact, Fiscal policy, Fiscal rules, EMU.
    Date: 2006–06
  17. By: Mark Aguiar; Manuel Amador; Gita Gopinath
    Abstract: We study a small open economy characterized by two empirically important frictions— incomplete financial markets and an inability of the government to commit to policy. We characterize the best sustainable fiscal policy and show that it can amplify and prolong shocks to output. In particular, even when the government is completely benevolent, the government’s credibility not to expropriate capital varies endogenously with the state of the economy and may be “scarcest” during recessions. This increased threat of expropriation depresses investment, prolonging downturns. It is the incompleteness of financial markets and the lack of commitment that generate investment cycles even in an environment where first-best capital stock is constant.
    Keywords: Fiscal policy
    Date: 2006
  18. By: Julien Matheron (Banque de France, DGEI-DIR-RECFIN); Céline Poilly (THEMA, Department of Economics, Cergy-Pontoise University; Banque de France, DGEI-DIR-RECFIN)
    Abstract: In this paper, we ask whether a small structural model with sticky prices and wages, embedding various modelling devices designed to increase the degree of strategic complementarity between price-setters, can fit postwar US data. To answer this question, we resort to a two-step empirical evaluation of our model. In a first step, we estimate the model by minimizing the distance between theoretical autocovariances of key macroeconomic variables and their VAR-based empirical counterparts. In a second step, we resort to Watson's (1993) test [Measures of fit for calibrated models. Journal of Political Economy 101 (6), 1011--1041] to quantify the model's goodness-of-fit. Our main result is that the combination of sticky prices and sticky wages is central in order to obtain a good empirical fit. Our analysis also reveals that a model with only sticky wages is completely rejected by Watson's test while a model with only sticky prices is not overwhelmingly rejected.
    Keywords: Sticky prices, sticky wages, strategic complementarities, Watson's test
    JEL: C52 E31 E32
    Date: 2006–04
  19. By: Peter N. Ireland; Scott Schuh
    Abstract: A two-sector real business cycle model, estimated with postwar U.S. data, identifies shocks to the levels and growth rates of total factor productivity in distinct consumption- and investment-goods- producing technologies. This model attributes most of the productivity slowdown of the 1970s to the consumption-goods sector; it suggests that a slowdown in the investment-goods sector occurred later and was much less persistent. Against this broader backdrop, the model interprets the more recent episode of robust investment and investment-specific technological change during the 1990s largely as a catch-up in levels that is unlikely to persist or be repeated anytime soon.
    Keywords: Business cycles ; Productivity
    Date: 2006
  20. By: Kerstin Bernoth; Guntram Wolff
    Abstract: We investigate the effects of official fiscal data and creative accounting signals on interest rate spreads between bond yields in the European Union. Our model predicts that risk premia contained in government bond spreads should increase in both, the official fiscal position and the expected ”creative” part of fiscal policy. The relative importance of these two signals depends on the transparency of the country. Greater transparency reduces risk premia. The empirical results confirm the hypotheses. Creative accounting increases the spread. The increase of the risk premium is stronger if financial markets are unsure about the true extent of creative accounting. Fiscal transparency reduces risk premia. Instrumental variable egressions confirm these results by addressing potential reverse causality problems and measurement bias.
    Keywords: Risk premia; government bond yields; creative accounting; stock-flow adjustments; gimmickry; transparency
    JEL: G12 E43 E62 H6 F34
    Date: 2006–06
  21. By: Adalbert Winkler (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Roland Beck (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper – based on a report by a Task Force established by the International Relations Committee (IRC) of the European System of Central Banks (ESCB) – reviews macroeconomic and financial stability challenges for acceding (Bulgaria and Romania) and candidate countries (Croatia and Turkey). In an environment characterised by strong growth and capital inflows, the main macroeconomic challenges relate to the recent pick-up of inflation and the large and widening current account deficits. Moreover, rapid credit growth has been a recent feature of financial development in all countries and thus constitutes the main financial stability challenge. In general, monetary authorities have responded to these challenges by tightening monetary conditions and prudential standards, with concrete measures also reflecting the different monetary and exchange rate regimes in the region. The paper also highlights four specific features of financial development in the countries under review, namely the dominance of banks in financial intermediation, the strong participation of foreign-owned banks, the widespread use of foreign currencies and the strengthening of supervisory frameworks. JEL Classification: E65, G21, G38, O16, P27.
    Keywords: South-East Europe, macroeconomic performance, credit growth, financial stability.
    Date: 2006–07
  22. By: William Whitesell
    Abstract: Most central banks now implement monetary policy by trying to hit a target overnight interest rate using one of two types of frameworks. The first involves arrangements for depository institutions to hold a minimum account balance over a multi-day averaging period. The second uses the central bank's lending rate as a ceiling and its deposit rate as a floor for overnight interest rates. Either averaging or a rate corridor can help a central bank hit a target interest rate, but each framework can also have weaknesses in achieving that goal and, in some cases, other associated drawbacks. This paper discusses an alternative possible policy implementation regime, involving a specially designed facility for the payment of interest on a daily basis on balances held at the central bank. This new type of regime could potentially allow smooth monetary policy implementation without the problems associated with averaging or a rate corridor.
    Date: 2006
  23. By: James B. Bullard; Eric Schaling
    Abstract: We study how determinacy and learnability of worldwide rational expectations equilibrium may be affected by monetary policy in a simple, two country, New Keynesian framework under both fixed and flexible exchange rates. We find that open economy considerations may alter conditions for determinacy and learnability relative to closed economy analyses, and that new concerns can arise in the analysis of classic topics such as the desirability of exchange rate targeting and monetary policy cooperation.
    Keywords: Monetary policy ; Foreign exchange
    Date: 2006
  24. By: Andrea Vaona (Dipartimento di Scienze economiche (Università di Verona))
    Abstract: The main purpose of this paper is to merge together two strands of the literature regarding, either directly or indirectly, infation: the PPP and the Phillips curve ones. In order to accomplish this task, this contribution applies the tools of the Empirical Growth Literature and of Dynamic Panel Data estimation on a sample of 81 Italian provinces from the year 1986 to the year 1998, exploiting cross-sectional variation to avoid to use instruments not directly connected with the inflation generating process. This research strategy allows to conclude that inflation is characterized by a low degree of persistence and by conditional B-convergence across provinces. Its most suitable driving vari- able is the unemployment rate and there are long-term non neutralities at the regional level.
    Keywords: Phillips Curve, Regions, Inflation
    JEL: E31 E32 R10
    Date: 2006–06
  25. By: Jaakko Kiander
    Abstract: Finland has recently got much admiration due to economic success reflected in rankings of competitiveness, technology, education and economic growth. This success has largely been embodied in the growth of Nokia group and ICT sector. Yet the economic boom and the success of the Finnish high tech industries is a relatively new phenomenon, starting from the mid-1990s. In fact, the years of good economic performance were preceded by an exceptionally deep recession in the beginning of the 1990s. This paper discusses the roots of the crisis of the Finnish economy, and the factors which helped it to recover and to create the technology-driven growth of the last decade. The focus is both on macroeconomic issues and on institutional change and the role of public policy. The main conclusion of this paper is that the institutional reforms (or the absence of them) seem to have played only minor role in the emergence of unemployment and in the subsequent employment revival in Finland in the 1990s. In addition to the breakthrough of ICT technologies, more traditional macroeconomic factors like changes in monetary policy and exchange rate, and pro-cyclical fiscal policy may have been of great importance. In spite of the severe economic shocks and industrial restructuring, the Finnish political governance and corporatist institutions have remained relatively stable. Political decision making has all the time been largely based on national consensus building like before. The structures of welfare state survived the fiscal crisis of the mid-1990s though the welfare state was forced to go through many small incremental changes, which reduced many entitlements. The central labour market institutions ? strong trade unions with high unionization rate, and centralized incomes policy ? have remained almost intact.
    Keywords: Finland, economic growth, social corporatism, structural change
    JEL: E60 J00 E32 O10 F00
    Date: 2004–12–15
  26. By: Lee C. Spector (Department of Economics, Ball State University)
    Abstract: The importance of crowding out has been an ongoing question in the Economics literature for many years. Some economists believe that deficits replace private spending while other economists feel that most of this crowding out is offset by Ricardian equivalence. In an attempt to resolve this controversy, many economists have formulated macroeconomic models and have used these models to empirically test the notion of crowding out. This paper revisits this methodology. It examines four useful macroeconomic models and shows the relationship between the model assumed, the empirical results obtained and the conclusions concerning crowding out. We demonstrate that the same empirical results may be obtained from different models, but can yield very different conclusions concerning crowding out. It is concluded that the answer to this controversy involves, in part, a more complete understanding of the structural foundations of the macroeconomic models being tested.
    Date: 2005–12
  27. By: Carol Corrado; Charles Hulten; Daniel Sichel
    Abstract: Published macroeconomic data traditionally exclude most intangible investment from measured GDP. This situation is beginning to change, but our estimates suggest that as much as $800 billion is still excluded from U.S. published data (as of 2003), and that this leads to the exclusion of more than $3 trillion of business intangible capital stock. To assess the importance of this omission, we add intangible capital to the standard sources-of-growth framework used by the BLS, and find that the inclusion of our list of intangible assets makes a significant difference in the observed patterns of U.S. economic growth. The rate of change of output per worker increases more rapidly when intangibles are counted as capital, and capital deepening becomes the unambiguously dominant source of growth in labor productivity. The role of multifactor productivity is correspondingly diminished, and labor's income share is found to have decreased significantly over the last 50 years.
    Date: 2006
  28. By: Francesca Lotti (Banca d'Italia); Juri Marcucci (Banca d'Italia)
    Abstract: In this paper we estimate the demand for liquidity by US non financial firms using data from COMPUSTAT database. In contrast to the previous literature, we consider firm-specific effects, such as cost-of-capital and wages. From the balanced and unbalanced panel estimations we infer that there are economies of scale in money demand by US business firms, because estimated sales elasticities are smaller than unity. In particular, they are lower than in previous empirical studies, suggesting that economies of scale in the demand for money are even bigger than formerly thought. In addition, it emerges that labor is not a substitute for money.
    Keywords: Panel Data, Liquidity, Demand for Money, COMPUSTAT
    JEL: E41 L60 C23
    Date: 2006–05
  29. By: Massimiliano Affinito (Banca d'Italia); Fabio Farabullini (Banca d'Italia)
    Abstract: The availability of new harmonized data on bank interest rates allows a rigorous assessment to be made of cross-country price homogeneity/heterogeneity in euro area retail credit markets. Econometric analysis shows that the banking market is still highly segmented and that the degree of integration in a single country (Italy, taken as a benchmark for integration) is greater than in the euro area. However, national differences can be partially explained by variables reflecting the characteristics of domestic depositors and borrowers (“demand side” regressors, such as risk exposure, disposable income, alternative financing sources, average firm size) and the characteristics of the banking systems (“supply side” regressors, such as banking market concentration, asset and liability structure). The euro area prices appear different because national banking products appear different or because they are differentiated by national factors. Once these factors have been controlled for, many differences disappear.
    Keywords: bank interest rates, convergence, integration
    JEL: E43 E44 G21
    Date: 2006–05
  30. By: Macedo, Jorge Braga de; Martins, Joaquim Oliveira
    Abstract: This paper discusses the design of structural policies by relating second-best results and the complementarity of reforms. It computes a complementarity index based on structural reform indicators compiled by the EBRD for transition countries, assuming that the run-up to EU integration corresponds to a nearly complete policy cycle. Using econometric panel estimates, the level of reforms and changes in their complementarity are found to be positively related to output growth, corrected for endogeneity, and given initial conditions and the extent of macroeconomic stabilisation.
    Date: 2006
  31. By: Anders B. Trolle; Eduardo S. Schwartz
    Abstract: We develop a tractable and flexible stochastic volatility multi-factor model of the term structure of interest rates. It features correlations between innovations to forward rates and volatilities, quasi-analytical prices of zero-coupon bond options and dynamics of the forward rate curve, under both the actual and risk-neutral measure, in terms of a finite-dimensional affine state vector. The model has a very good fit to an extensive panel data set of interest rates, swaptions and caps. In particular, the model matches the implied cap skews and the dynamics of implied volatilities. The model also performs well in forecasting interest rates and derivatives.
    JEL: E43 G13
    Date: 2006–06
  32. By: Risto Sullström; Adriaan Perrels
    Abstract: The present report provides an overview of the development of household consumption in Finland in the 20th century. The study has been carried out in the framework of the AESOPUS study funded by the Academy of Finland. The AESOPUS study aimed to map out the stocks and flows of nitrogen and phosphorus in Finland, as well as to analyse the man made influences on those flows. For this reason special attention was paid to the consumption of foodstuffs in the VATT study. Next to an overview of the developments during the entire 20th century, various features with respect to the last decades are discussed, based on micro-data available for years in the period 1985-2001. Apart from describing the developments in consumption, the report also highlights the evolution of main driving forces behind the consumption developments. Actual estimation of consumption functions and the construction of a simulation model are treated in a separate report.
    Keywords: consumption, households, food
    JEL: E21 D10 O10 Q18 N00
    Date: 2004–12–09
  33. By: Adam Hale Shapiro
    Abstract: It has become customary to estimate the New Keynesian Phillips Curve (NKPC) with GMM using a large instrument set that includes lags of variables that are ad hoc to the model. Researchers have also conventionally used real unit labor cost (RULC) as the proxy for real marginal cost, even though it is difficult to support its significance. This paper introduces a new proxy for the real marginal cost term as well as a new instrument set, both of which are based on the micro foundations of the vertical chain of production. I find that the new proxy, based on input prices as opposed to wages, provides a more robust and significant fit to the model. Instruments that are based on the vertical chain of production appear to be both more valid and relevant towards the model.
    Keywords: Phillips curve ; Keynesian economics
    Date: 2006
  34. By: Charles Yuji Horioka
    Abstract: In this paper, I survey the previous literature on the saving behavior of the aged in Japan and then present some survey data on the saving behavior of the aged in Japan that became available recently. To summarize the main findings of this paper, all previous studies as well as the newly available data I analyze find that the retired aged dissave and that even the working aged dissave at very advanced ages. These findings are consistent with the life cycle model and suggest that this model is highly applicable in the case of Japan.
    JEL: D12 D91 E21
    Date: 2006–07
  35. By: Subrata Ghatak; José R. Sánchez-Fung
    Abstract: This paper investigates fiscal policy sustainability in Peru, the Philippines, South Africa, Thailand, and Venezuela using competing methodologies. Standard unit roots and cointegration analyses do not endorse the validity of the intertemporal budget constraint. In contrast, to varying degree across-countries, alternative testing employing a fiscal policy reaction function indicates sustainability defined as surplus adjustments in response to higher debt to income ratios. Corresponding debt-dynamics analyses show that corrective measures were put in place to revert non-sustainable trends in government debt. However, ancillary variables in the debt modeling produce statistically weak evidence of procyclical fiscal behavior in the Latin American countries.
    Keywords: fiscal policy sustainability, fiscal policy reaction functions, developing countries
    Date: 2006–03–21
  36. By: Marco Arena; Carmen Reinhart; Francisco Vázquez
    Abstract: This paper assembles a dataset comprising 1,565 banks in 20 Asian and Latin American countries during 1989-2001 and compares the response of the volume of loans, deposits, and bank-specific interest rates on loans and deposits, to various measures of monetary conditions, across domestic and foreign banks. It also looks for systematic differences in the behavior of domestic and foreign banks during periods of financial distress and tranquil times. Using differences in bank ownership as a proxy for financial constraints on banks, the paper finds weak evidence that foreign banks have a lower sensitivity of credit to monetary conditions relative to their domestic competitors, with the differences driven by banks with lower asset liquidity and/or capitalization. At the same time, the lending and deposit rates of foreign banks tend to be smoother during periods of financial distress, albeit the differences with domestic banks do not appear to be strong. These results provide weak support to the existence of supply-side effects in credit markets and suggest that foreign bank entry in emerging economies may have contributed somewhat to stability in credit markets.
    JEL: E51 G21
    Date: 2006–06
  37. By: Gary D. Hansen; Selahattin %u0130mrohoroglu
    Abstract: We explore the quantitative implications of uncertainty about the length of life and a lack of annuity markets for life cycle consumption in a general equilibrium overlapping generations model in which markets are otherwise complete. Empirical studies find that consumption tends to rise early in life, peak around age 45-55, and to decline after that. Our calibrated model exhibits life cycle consumption that is consistent with this pattern. This follows from the fact that, due to a lack of annuity markets, households discount the future more heavily as they age and their probability of survival falls. Once an unfunded social security system is introduced, the profile is still hump shaped, but the decline in consumption does not begin until after retirement in our base case. Adding a bequest motive causes this decline to begin at a younger age.
    JEL: E2 D1
    Date: 2006–06
  38. By: Miki Kohara; Charles Yuji Horioka
    Abstract: We use micro data on young married households from the Japanese Panel Survey of Consumers in order to analyze the importance of borrowing constraints in Japan. We find (1) that 8 to 15 percent of young married Japanese households are borrowing-constrained, (2) that household assets and the husband’s educational attainment are the most important determinants of whether or not a household is borrowing-constrained, and (3) that the Euler equation implication is rejected for both the full sample and for the subsample of unconstrained households. These results suggest that the life cycle/permanent income hypothesis does not apply in Japan and that the presence of borrowing constraints is not the main reason why it does not apply.
    JEL: D1 D9 E2 G1
    Date: 2006–06
  39. By: Pekka Sinko
    Abstract: The study consists of four essays, which analyse the implications of labour taxation and unemployment insurance (UI) in the models of imperfectly competitive labour markets. The first essay studies the effects of labour taxation on unemployment and efficiency in a search equilibrium model with endogenous job destruction. It is shown that the adverse employment effect of labour taxes is mainly due to the prolonged spells of unemployment. A pure increase in the tax progression may reduce unemployment and facilitate the emergence of low-productivity jobs. In the second essay, the link between taxes and the public benefits is perceived owing to the centralised wage setting institutions. This is shown to promote wage moderation, make wages and employment less sensitive to wage taxation and reduce hours worked. The third essay considers alternative ways to organize the government subsidies in a model, where taxalike payments are collected by the industry level funds in order to finance unemployment benefits. It is shown that equilibrium unemployment is decreasing in the share of UI financed by the employed union members. The fourth essay analyses the effects of UI in a job search model with endogenous search effort. It is shown that UI with a limited potential duration induces more search effort among the long-term unemployed who have exhausted a considerable amount of the current benefits.
    Keywords: Labour taxation, unemployment insurance, trade union model, search model
    JEL: E24 J50 J30 H20
    Date: 2004–07–20

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