nep-mac New Economics Papers
on Macroeconomics
Issue of 2006‒07‒28
forty-four papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Money and Production, and Liquidity Trap By Pradeep Dubey; John Geanakoplos
  2. Monetary conservatism and fiscal policy By Klaus Adam; Roberto M. Billi
  3. Fiscal policy in a monetary economy with capital and finite lifetime By Barbara Annicchiarico; Nicola Giammarioli; Alessandro Piergallini
  4. House Prices and Monetary Policy in Colombia By Martha López
  5. Optimal monetary policy with uncertainty about financial frictions. By Richhild Moessner
  6. Identifying the role of labor markets for monetary policy in an estimated DSGE model. By Kai Philipp Christoffel; Keith Kuester; Tobias Linzert
  7. The impact of ECB monetary policy decisions and communication on the yield curve By Claus Brand; Daniel Buncic; Jarkko Turunen
  8. Adaptive learning, persistence, and optimal monetary policy. By Vitor Gaspar; Frank Smets; David Vestin
  9. Inflation forecast-based-rules and indeterminacy: a puzzle and a resolution. By Paul Levine; Peter McAdam; Joseph Pearlman
  10. Did capital market convergence lower the effectiveness of the interest rate as a monetary policy tool? By Jansen, Pieter W.
  11. Monetary and Fiscal Policy Interactions: The Role of the Quality of Institutions in a Dynamic Environment By Ourania Dimakou
  12. Fiscal convergence before entering the EMU By Luca Onorante
  13. Monetary and fiscal policy interactions in a New Keynesian model with capital accumulation and non-Ricardian consumers. By Campell Leith; Leopold von Thadden
  14. The economic effects of exogenous fiscal shocks in Spain: a SVAR approach. By Francisco de Castro; Pablo Hernández de Cos
  15. Nowcasting GDP and inflation: the real-time informational content of macroeconomic data releases. By David H. Small; Domenico Giannone; Lucrezia Reichlin
  16. Employment targeting By Jean-Pascal Bénassy
  17. Monetary policy rules in the pre-EMU era - Is there a common rule? By Maria Eleftheriou; Dieter Gerdesmeier; Barbara Roffia
  18. Inflation Expectations and Regime Shifts By Matti Viren
  20. Consumer price adjustment under the microscope - Germany in a period of low inflation By Johannes Hoffmann; Jeong-Ryeol Kurz-Kim
  21. Firm-specific production factors in a DSGE model with Taylor price setting. By Gregory de Walque; Frank Smets; Rafael Wouters
  22. Low inflation, a high net savings surplus and institutional restrictions keep the Japanese long-term interest rate low By Jansen, Pieter W.
  23. Private investment and financial development in a globalized world By Yongfu Huang
  24. Does information help recovering structural shocks from past observations? By Domenico Giannone; Lucrezia Reichlin
  25. Sustainability, Debt Management, and Public Debt Policy in Japan By Takero Doi; Toshihiro Ihori; Kiyoshi Mitsui
  26. The Dutch block of the ESCB multi-country model. By Matteo Ciccarelli; Elena Angelini; Frédéric Boissay
  27. Detecting and predicting forecast breakdowns. By Raffaella Giacomini; Barbara Rossi
  28. The German block of the ESCB multi-country model By Igor Vetlov; Thomas Warmedinger
  29. The Italian block of the ESCB multi-country model By Elena Angelini; Antonello D‘Agostino; Peter McAdam
  30. Public debt and long-term interest rates - the case of Germany, Italy and the USA By Paolo Paesani; Rolf Strauch; Manfred Kremer
  31. Transparency, expectations, and forecasts. By Robert A. Eisenbeis; Andy Bauer; Daniel F. Waggoner; Tao A. Zha
  32. The 90-Day DTF Interest Rate: Why Does It Remain Constant? By Peter Rowland
  33. Foreign Exchange Risk Premium Determinants: Case of Armenia By Tigran Poghosyan; Evzen Kocenda
  34. Are internet prices sticky? By Patrick Lunnemann; Ladislav Wintr
  35. The response of firms‘ investment and financing to adverse cash flow shocks - the role of bank relationships By Catherine Fuss; Philip Vermeulen
  36. Reconstructing Macroeconomics: A Perspective from Statistical Physics and Combinatorial Stochastic Processes By Masanao Aoki
  37. Employment stickiness in small manufacturing firms. By Philip Vermeulen
  38. The Theory of Money and Financial Institutions: A Summary of a Game Theoretic Approach By Martin Shubik
  39. Choosing Monetary Sequences: Theory and Experimental Evidence By Paola Manzini; Marco Mariotti; Luigi Mittone
  40. Bank Lending with Imperfect Competition and Spillover Effects By Sumru G. Altug; Murta Usman
  41. La planta de personal del Distrito. Perspectiva económica y fiscal By Edna Bonilla; Harold Cárdenas; Jorge Iván González; Santiago Grillo
  42. Bien-estar y macroeconomía 2002-2006: el crecimiento inequitativo no es sostenible By Ricardo Bonilla González; Jorge Iván González
  43. Intergenerational Mobility and Macroeconomic History Dependence By Dilip Mokherjee; Stefan Napel
  44. T&K -panostusten kansantaloudelliset vaikutukset By Olavi Rantala

  1. By: Pradeep Dubey (Dept. of Economics, Stony Brook); John Geanakoplos (Cowles Foundation, Yale University)
    Abstract: We prove the existence of monetary equilibrium in a finite horizon economy with production. We also show that if agents expect the monetary authority to significantly decrease the supply of bank money available for short term loans in the future, then the economy will fall into a liquidity trap today.
    Keywords: Central bank, Inside money, Outside money, Incomplete assets, Production, Monetary equilibrium, Liquidity, Liquidity trap
    JEL: D50 D51 D52 D58 D60 E12 E31 E32 E41 E42 E43 E44 E50 E51 E52 E58 E63
    Date: 2006–07
  2. By: Klaus Adam (Corresponding author: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Roberto M. Billi (Federal Reserve Bank of Kansas City, 925 Grand Blvd, Kansas City, MO 64198, United States.)
    Abstract: Does an inflation conservative central bank à la Rogoff (1985) remain desirable in a setting with endogenous fiscal policy? To provide an answer we study monetary and fiscal policy games without commitment in a dynamic stochastic sticky price economy with monopolistic distortions. Monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility. We find that lack of fiscal commitment gives rise to excessive public spending. The optimal inflation rate internalizing this distortion is positive, but lack of monetary commitment robustly generates too much inflation. A conservative monetary authority thus remains desirable. Exclusive focus on inflation by the central bank recoups large part - in some cases all - of the steady state welfare losses associated with lack of monetary and fiscal commitment. An inflation conservative central bank tends to improve also the conduct of stabilization policy. JEL Classification: E52, E62, E63.
    Keywords: Banking, sequential non-cooperative policy games, discretionary policy, time consistent policy, conservative monetary policy.
    Date: 2006–07
  3. By: Barbara Annicchiarico (Department of Economics, University of Rome ‘Tor Vergata’, Via Columbia 2, 00133 Rome, Italy.); Nicola Giammarioli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alessandro Piergallini (Department of Economics, University of Rome ‘Tor Vergata’, Via Columbia 2, 00133 Rome, Italy.)
    Abstract: This paper develops a dynamic stochastic general equilibrium model with nominal rigidities, capital accumulation and finite lifetimes. The framework exhibits intergenerational wealth effects and is intended to investigate the macroeconomic implications of fiscal policy, which is specified by either a debt-based tax rule or a balanced-budget rule allowing for temporary deficits. When calibrated to euro area quarterly data, the model predicts that fiscal expansions generate a tradeoff in output dynamics between short-term gains and medium-term losses. It is also shown that the effects of fiscal shocks crucially depend upon the conduct of monetary policy. Simulation analysis suggests that balanced-budget requirements enhance the determinacy properties of feedback interest rate rules by guaranteeing inflation stabilization. JEL Classification: E52, E58, E63.
    Keywords: Fiscal Policy, Monetary Policy, Nominal Rigidities, Capital Accumulation, Finite Lifetime, Simulations.
    Date: 2006–07
  4. By: Martha López
    Abstract: This paper investigates the possible responses of an inflation-targeting monetary policy in the face of asset price deviations from fundamental values. Focusing on the housing sector of the Colombian economy, we consider a general equilibrium model with frictions in credit market and bubbles in housing prices. We show that monetary policy is less efficient when it responds directly to asset price of housing than a policy that reacts only to deviations of expected inflation (CPI) from target. Some prudential regulation may provide a better outcome in terms of output and inflation variability.
    Keywords: House price bubbles, interest rate rules, monetary policy, inflation Targeting.
    JEL: E32 E40 E47 E52
  5. By: Richhild Moessner (Bank of England, Threadneedle Street, London, EC2R 8AH, United Kingdom.)
    Abstract: This paper studies optimal discretionary monetary policy in the presence of uncertainty about the degree of financial frictions. Changes in the degree of financial frictions are modelled as changes in parameters of a hybrid New-Keynesian model calibrated for the UK, following Bean, Larsen and Nikolov (2002). Uncertainty about the degree of financial frictions is modelled as Markov switching between regimes without and with strong financial frictions. Optimal monetary policy is determined for different scenarios of permanent and temporary regime shifts in financial frictions, as well as for variations in financial frictions over the business cycle. Optimal monetary policy is found to be state-dependent. In each state, optimal monetary policy depends on the transition probabilities between the different regimes. JEL Classification: E52; E58; E61; E44.
    Keywords: Monetary policy; uncertainty; financial frictions.
    Date: 2006–06
  6. By: Kai Philipp Christoffel (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Keith Kuester (Goethe University Frankfurt, Senckenberganlage 31, 60054 Frankfurt am Main, Germany.); Tobias Linzert (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We focus on a quantitative assessment of rigid labor markets in an environment of stable monetary policy. We ask how wages and labor market shocks feed into the inflation process and derive monetary policy implications. Towards that aim, we structurally model matching frictions and rigid wages in line with an optimizing rationale in a New Keynesian closed economy DSGE model. We estimate the model using Bayesian techniques for German data from the late 1970s to present. Given the pre-euro heterogeneity in wage bargaining we take this as the first-best approximation at hand for modelling monetary policy in the presence of labor market frictions in the current European regime. In our framework, we find that labor market structure is of prime importance for the evolution of the business cycle, and for monetary policy in particular. Yet shocks originating in the labor market itself may contain only limited information for the conduct of stabilization policy. JEL Classification: E32; E52; J64; C11.
    Keywords: Labor market; wage rigidity; bargaining; Bayesian estimation.
    Date: 2006–06
  7. By: Claus Brand (Corresponding author: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Daniel Buncic (School of Economics, University of New South Wales, Sydney Australia.); Jarkko Turunen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We analyse high-frequency changes in the euro area money market yield curve on dates when the ECB regularly sets and communicates decisions on policy interest rates to construct different indicators of monetary policy news relating to policy decisions and to central bank communication. The indicators show that ECB communication during the press conference may result in significant changes in market expectations of the path of monetary policy. Furthermore, our results suggest that these changes have a significant and sizeable impact on medium to long-term interest rates. JEL Classification: E43, E58.
    Keywords: Money market rates, yield curve, ECB, central bank communication.
    Date: 2006–07
  8. By: Vitor Gaspar (Banco de Portugal, 148 Rua do Comercio, P - 1101 Lisbon Codex, Portugal.); Frank Smets (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); David Vestin (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We show that, when private sector expectations are determined in line with adaptive learning, optimal policy responds persistently to cost-push shocks. The optimal response is stronger and more persistent, the higher is the initial level of perceived inflation persistence by the private sector. Such a sophisticated policy reduces inflation persistence and inflation volatility at little cost in terms of output gap volatility. Persistent responses to cost-push shocks and stability of inflation expectations resemble optimal policy under commitment and rational expectations. Nevertheless, it is clear that the mechanism at play is very different. In the case of commitment it relies on expectations of future policy actions affecting inflation expectations; in the case of sophisticated central banking it relies on the reduction in the estimated inflation persistence parameter based on inflation data generated by shocks and policy responses. JEL Classification: E52.
    Keywords: Adaptive learning; rational expectations; policy rules; optimal policy.
    Date: 2006–06
  9. By: Paul Levine (University of Surrey - Department of Economics, Guildford, Surrey GU2 7XH, United Kingdom.); Peter McAdam (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Joseph Pearlman (London Metropolitan University, Department of Economics, Finance and International Business, 31Jewry Street, London EC3N 2EY, United Kingdom.)
    Abstract: We examine an interesting puzzle in monetary economics between what monetary authorities claim (namely to be forward-looking and pre-emptive) and the poor stabilization properties routinely reported for forecast-based-rules. Our resolution is that central banks should be viewed as following 'Calvo-type' inflation-forecast-based(IFB)interest rate rules which depend on a discounted sum of current and future rates of inflation. Such rules might be regarded as both within the legal frame- works, and potentially mimicking central bankers' practice. We find that Calvo-type IFB interest rate rules are first - less prone to indeterminacy than standard rules with a finite forward horizon. Second, for such rules in difference form, the indeterminacy problem disappears altogether. Third, optimized forms have good stabilization properties as they become more forward-looking, a property that sharply contrasts that of standard IFB rules. Fourth, they appear data coherent when incorporated into a well-known estimated DSGE model of the Euro-area. JEL Classification: E52; E37; E58.
    Keywords: Inflation-forecast-based interest rate rules; Calvo-type interest rate rules.
    Date: 2006–06
  10. By: Jansen, Pieter W. (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics)
    Abstract: International capital market convergence reduces the ability for monetary authorities to set domestic monetary conditions. Traditionally, monetary policy transmission is channelled through the short-term interest rate. Savings and investment decisions are effected through the response of the bond yield to changes in the short-term interest rate. We find that capital market integration increased correlation between long-term interest rates across countries. Short-term interest rates also show more integration across countries and the correlation with the international business cycle has increased. A stronger linkage between international economic conditions and bond yields has important implications for the effectiveness of monetary policy. Monetary policy makers, especially in small countries, will face more difficulties in influencing domestic conditions in the bond market when they apply the traditional monetary policy framework in case of a country specific shock.
    Keywords: Monetary policy; Term structure of interest rates; International capital market convergence
    JEL: E43
    Date: 2006
  11. By: Ourania Dimakou (School of Economics, Mathematics & Statistics, Birkbeck)
    Abstract: This paper analyses the interaction between fiscal and monetary policy using the original Barro and Gordon (1983) model extended to include fiscal policy, dynamics and the level of institutional quality, measured as bureaucratic corruption. It is found that delegating monetary policy to an independent central bank (i.e. not fiscally dominated) the second best solution of the model is achievable only if there is no bureaucratic corruption. Otherwise, when institutional quality is not optimal, unless a less conservative than the government, regarding output considerations, independent central bank is delegated, the second best is not restored. The government has the incentive to increase debt strategically in an attempt to increase second period inflation. This result is augmented by the quality of institutions and poses difficulties on the achievement of both price stability and a balanced debt process. Quality of institutions, hence, can provide an explanation for the poorer inflation performance, due to debt boosts, of countries with lower institutional quality despite the introduction of central bank independence.
    Keywords: Monetary and Fiscal policy, time-inconsistency, independent central bank, corruption
    JEL: E58 E61 E63
    Date: 2006–07
  12. By: Luca Onorante (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The monetary integration of the acceding countries will proceed in several distinct steps, starting with membership in the European Union (EU), followed by participation in the so-called Exchange Rate Mechanism (ERM) II and ultimately entry into the euro area. This paper addresses the question of whether a reduction of public deficits, such as imposed by the Maastricht fiscal criteria, is a necessary or useful step on the road to the adoption of the euro. The question is addressed by examining the interaction of monetary, fiscal and wage policies and their effects on prices in a monetary union hit by economic shocks. The theoretical model shows that fiscal activism is related with both entry in monetary union and with structural differences in the national labour markets, and analyses in detail the effect of both factors. As for acceding countries, the conclusion is that the process of deficit reduction should be completed before entry, as suggested by the Maastricht criteria. The chapter also suggests that fiscal constraints on government deficits appear essential in a monetary union when the wage formation is taken into due consideration. JEL Classification: E61, E62, H30.
    Keywords: Fiscal policy, monetary policy, European Monetary Union, fiscal rules.
    Date: 2006–07
  13. By: Campell Leith (University of Glasgow, Department of Economics, Adam Smith Building, Glasgow G12 8RT, Scotland, United Kingdom.); Leopold von Thadden (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper develops a small New Keynesian model with capital accumulation and government debt dynamics. The paper discusses the design of simple monetary and fiscal policy rules consistent with determinate equilibrium dynamics in the absence of Ricardian equivalence. Under this assumption, government debt turns into a relevant state variable which needs to be accounted for in the analysis of equilibrium dynamics. The key analytical finding is that without explicit reference to the level of government debt it is not possible to infer how strongly the monetary and fiscal instruments should be used to ensure determinate equilibrium dynamics. Specifically, we identify in our model discontinuities associated with threshold values of steady-state debt, leading to qualitative changes in the local determinacy requirements. These features extend the logic of Leeper (1991) to an environment in which fiscal policy is non-neutral. Naturally, this non-neutrality increases the importance of fiscal aspects for the design of policy rules consistent with determinate dynamics. JEL Classification: E52; E63.
    Keywords: Monetary policy; fiscal regimes.
    Date: 2006–06
  14. By: Francisco de Castro (Banco de Espana, Alcala 50, E-28014 Madrid, Spain.); Pablo Hernández de Cos (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper estimates the effects of exogenous fiscal policy shocks in Spain in a VAR framework. Government expenditure expansionary shocks are found to have positive effects on output in the short-term at the cost of higher inflation and public deficits and lower output in the medium and long term. Tax increases are found to drag economic activity in the medium term while entailing an only temporary improvement of the public budget balance. The application of these results to the analysis of fiscal policy in Spain since the mid-nineties points to the conclusion that the consolidation process does not seem to have involved costs in terms of output growth. Moreover, the stance of fiscal policy has become more counter-cyclical in that period. JEL Classification: E62; H30.
    Keywords: VAR; fiscal shocks; fiscal multipliers.
    Date: 2006–06
  15. By: David H. Small (Federal Reserve Board - Monetary Studies Section, 20th and C Streets, NW, Washington , DC 20551, United States.); Domenico Giannone (Free University of Brussels (VUB/ULB), European Center for Advanced Research in Economics and Statistics (ECARES), Ave. Franklin D Roosevelt, 50 - C.P. 114, B-1050 Brussels, Belgium.); Lucrezia Reichlin (Free University of Brussels (VUB/ULB), European Center for Advanced Research in Economics and Statistics (ECARES), Ave. Franklin D Roosevelt, 50 - C.P. 114, B-1050 Brussels, Belgium.)
    Abstract: This paper formalizes the process of updating the nowcast and forecast on output and inflation as new releases of data become available. The marginal contribution of a particular release for the value of the signal and its precision is evaluated by computing news on the basis of an evolving conditioning information set. The marginal contribution is then split into what is due to timeliness of information and what is due to economic content. We find that the Federal Reserve Bank of Philadelphia surveys have a large marginal impact on the nowcast of both inflation variables and real variables and this effect is larger than that of the Employment Report. When we control for timeliness of the releases, the effect of hard data becomes sizeable. Prices and quantities affect the precision of the estimates of inflation while GDP is only affected by real variables and interest rates. JEL Classification: E52; C33; C53.
    Keywords: Forecasting; monetary policy; factor model; real time data; large data sets; news.
    Date: 2006–05
  16. By: Jean-Pascal Bénassy
    Abstract: Many recent discussions on the conduct of monetary policy through interest rate rules have given a very central role to inflation, both as an objective and as an intermediate instrument. We want to show that other variables like employment can be as important or even more. For that we construct a dynamic stochastic general equilibrium (DSGE) model where the economy is subject to demand and supply shocks. We compute closed form solutions for the optimal interest rate rules and find that they can be function of employment only, which then dominates inflation for use in the policy rule.
    Date: 2006
  17. By: Maria Eleftheriou (European University Institute, Economics Department.); Dieter Gerdesmeier (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Barbara Roffia (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Despite the great importance and final success of the convergence process that led to the establishment of the European Monetary Union, there is no clear agreement regarding the monetary policy pursued in the member countries during the convergence process. This paper contributes to the literature with an empirical analysis of the period from 1993 to 1998 that encompasses eleven EMU countries. In particular, Taylor-type interest rate rules are estimated with monthly national data to find that, despite certain similarities and exceptions, the rule followed by each country is distinct and differs substantially from the standard Taylor rule. However, for most countries, the parameter estimates reflect the principles proclaimed by the monetary policy authorities and, in addition, it is shown that in most cases the estimated rules reproduce the policy setting quite closely. JEL Classification: E58, F41.
    Keywords: Taylor rule, ERM, output gap, monetary policy.
    Date: 2006–07
  18. By: Matti Viren (Department of Economics, University of Turku)
    Abstract: This paper focuses on the determination of inflation expectations. The following two questions are examined: How much do inflation expectations reflect different economic and institutional regime shifts and in which way do inflation expectations adjust to past inflation? The basic idea in the analysis is an assumption that inflation expectations do not mechanically reflect past inflation as may econometric specification de facto assume but rather they depend on the relevant economic regime. Also the adjustment of expectations to past inflation is different in different inflation regimes. The regime analysis is based on panel data from EMU/EU countries for the period 1973–2004, while the inflation adjustment analysis mainly uses the Kalman filter technique for individual countries for the same period. Expectations (forecasts) are derived from OECD data. Empirical results strongly favour the regime-sensitivity hypothesis and provide an explanation for the poor performance of conventional estimation procedures in the context of Phillips curves
    Keywords: inflation expectations, Kalman filter, stability
    JEL: E32 E37
    Date: 2006–04
  19. By: Timo Henckel
    Abstract: Some authors have argued that multiplicative uncertainty may be beneficial to society as the cautionary move reduces the inflation bias. Contrary to this claim, I show that, when there are non-atomistic wage setters, an increase in multiplicative uncertainty rises the real wage premium and unemployment and hence may reduce welfare. Furthermore, since central bank preferences also affect real variables, delegating policy to an independent central banker with an optimal degree of conservatism cannot, in general, deliver a second-best outcome.
    JEL: E52
    Date: 2006–07
  20. By: Johannes Hoffmann (Deutsche Bundesbank, Economics Department, Wilhelm-Epstein-Straße 14, D-60431 Frankfurt am Main, Germany.); Jeong-Ryeol Kurz-Kim (Deutsche Bundesbank, Economics Department, Wilhelm-Epstein-Straße 14, D-60431 Frankfurt am Main, Germany.)
    Abstract: We analyse the adjustment of retail and services prices in a period of low inflation, using a set of individual price data from the German Consumer Price Index that covers the years 1998 to 2003. We strong find evidence of time- and statedependent price adjustment. Most importantly, the differences in “unconditional” sectoral price flexibility are found to be linked to input price volatility. JEL Classification: E31, D43, L11.
    Keywords: Price rigidity, price flexibility, Consumer Price Index, Germany.
    Date: 2006–07
  21. By: Gregory de Walque (National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.); Frank Smets (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Rafael Wouters (National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.)
    Abstract: This paper compares the Calvo model with a Taylor contracting model in the context of the Smets-Wouters (2003) Dynamic Stochastic General Equilibrium (DSGE) model. In the Taylor price setting model, we introduce firm-specific production factors and discuss how this assumption can help to reduce the estimated nominal price stickiness. Furthermore, we show that a Taylor contracting model with firm-specific capital and sticky wage and with a relatively short price contract length of four quarters is able to outperform, in terms of empirical fit, the standard Calvo model with homogeneous production factors and high nominal price stickiness. In order to obtain this result, we need very large real rigidities either in the form of a huge (constant)elasticity of substitution between goods or in the form of an elasticity of substitution that is endogenous and very sensitive to the relative price. JEL Classification: E1-E3.
    Keywords: Inflation persistence; DSGE models.
    Date: 2006–06
  22. By: Jansen, Pieter W. (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics)
    Abstract: This paper explains that the interest rate on long-term Japanese government bonds is low in comparison with other industrialised countries for four main reasons: lower inflation, net savings surplus, institutional restrictions and home bias. Monetary policy and institutionalised purchases of government bonds by semi-government agencies keep the market demand for bonds high. We find that since the 1970s Japanese interest rate movements are better explained by the current account balance than in other industrialised countries. This is caused by sizeable net oversavings and institutional reasons increased the impact of oversavings as such on the long-term interest rate for Japan. Hence, the institutional reasons increase the coefficient value of the savings-investment balance. A reason for the existence of the high national net savings surplus could be that unsustainable budgetary deficits in Japan called for a Ricardian response. We doubt whether Ricardian equivalence is here the driving factor: household savings have actually fallen over the nineties. Corporate savings, in response to overcapacity and poor investment outlook, have risen more strongly. This has kept the private and national savings balance positive. There is also some indication that ageing has contributed to the structural current account surplus for Japan.
    Keywords: Long-term interest rate; Current account balance; Japan; Ricardian equivalence; Ageing
    JEL: E43
    Date: 2006
  23. By: Yongfu Huang
    Abstract: Using recently developed panel data techniques on data for 43 developing countries over the period 1970-98, this paper provides an exhaustive analysis of causality between aggregate private investment and financial development. GMM estimation on averaged data, and a common factor approach on annual data allowing for global interdependence and heterogeneity across countries suggest positive causal effects going in both directions. The finding has rich implications for the development of financial markets and the conduct of macroeconomic policies in developing countries in an integrated global economy.
    Keywords: Private Investment, Financial Development, Global Interdependence, Common Factor Analysis, Panel Unit Root Test, Panel Cointegration Test
    JEL: F36 F41 E22 E44
    Date: 2006–07
  24. By: Domenico Giannone (Free University of Brussels (VUB/ULB), European Center for Advanced Research in Economics and Statistics (ECARES), Ave. Franklin D Roosevelt, 50 - C.P. 114, B-1050 Brussels, Belgium.); Lucrezia Reichlin (Free University of Brussels (VUB/ULB), European Center for Advanced Research in Economics and Statistics (ECARES), Ave. Franklin D Roosevelt, 50 - C.P. 114, B-1050 Brussels, Belgium.)
    Abstract: This paper asks two questions. First, can we detect empirically whether the shocks recovered from the estimates of a structural VAR are truly structural? Second, can the problem of nonfundamentalness be solved by considering additional information? The answer to the first question is “yes” and that to the second is “under some conditions”. JEL Classification: C32; C33; E00; E32; O3.
    Keywords: Identification; information; invertibility; structural VAR.
    Date: 2006–05
  25. By: Takero Doi; Toshihiro Ihori; Kiyoshi Mitsui
    Abstract: The purpose of this paper is to analyze sustainability issues of Japan’s fiscal policy and then to discuss the debt management policy using the theoretical models and numerical studies. We also investigate the desirable coordination of fiscal and monetary authorities toward fiscal reconstruction. We include a potential possibilities of the government bonds in our theoretical model. The public bonds, therefore, cannot be sold when the issuance leads the amount of debt outstanding to be more than a certain level. In this respect, the fiscal authority has to take into account the upper limit of stocks of public debt. This possibility of debt default provides the fiscal authority to issue public bonds strategically in an earlier period. A strategic behavior of fiscal authority induces the monetary authority, in a later period, to boost output and raise seigniorage revenues to eliminate the distortion of resource allocation due to the limitation on debt issuance. Therefore, the monetary policy in a later period suffers from an inflation bias from the ax ante point of view. There are two ways to eliminate this distortion toward successful fiscal restoration. One of them is to make the monetary authority more conservative than society in the sense that the price stability weight of monetary authority is higher than that of society. The other way of eliminating the distortion of the resource allocation is to design an institutional ceiling on the debt issuance. The direct ceiling can provide a binding constraint of the public bond issuance for the fiscal authority of Japan because it has accumulated the debt outstanding much more than other countries.
    JEL: H63 H21 E63
    Date: 2006–07
  26. By: Matteo Ciccarelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Elena Angelini (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Frédéric Boissay (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The paper presents the Dutch country block of the ESCB Multi-Country Model(MCM) for the euro area. We show how a theoretical model is translated into an econometric specification and how this specification is in turn estimated and used in the projection exercises of the E(S)CB. The dynamic properties of the model are analyzed and the effects of six exogenous shocks to the economy discussed. The long run simulations performed deliver responses of the baseline economy in line with both macroeconomic theory and practice, from a quantitative and a qualitative point of view. JEL Classification: C3; C5; E1; E2.
    Keywords: Multi-country model; forecast; simulation; Netherlands.
    Date: 2006–06
  27. By: Raffaella Giacomini (Department of Economics, UCLA, Box 951477, Los Angeles, CA 90095-1477, USA.); Barbara Rossi (Department of Economics, Duke University, Durham NC27708, USA.)
    Abstract: We propose a theoretical framework for assessing whether a forecast model estimated over one period can provide good forecasts over a subsequent period. We formalize this idea by defining a forecast breakdown as a situation in which the out-of-sample performance of the model, judged by some loss function, is significantly worse than its in-sample performance. Our framework, which is valid under general conditions, can be used not only to detect past forecast breakdowns but also to predict future ones. We show that main causes of forecast breakdowns are instabilities in the data generating process and relate the properties of our forecast breakdown test to those of existing structural break tests. The empirical application finds evidence of a forecast breakdown in the Phillips’ curve forecasts of U.S. inflation, and links it to inflation volatility and to changes in the monetary policy reaction function of the Fed. JEL Classification: C22; C52; C53.
    Keywords: Structural change; forecast evaluation; forecast rationality testing; in-sample evaluation; out-of-sample evaluation.
    Date: 2006–06
  28. By: Igor Vetlov (Bank of Lithuania, Totoriu 4, LT-01121 Vilnius, Lithuania.); Thomas Warmedinger (Corresponding author: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The paper presents the German block of the ESCB multi-country model. It builds on previous modelling work on the Area Wide Model and other country blocks of the ESCB multicountry-model. Whilst being analogous to these models in following a common modelling approach and the same theoretical framework, the German model has also some unique features for instance with regard to the modelling of the investment components, imports and employment. The paper provides a brief overview of the theoretical framework of the model, its estimation results, and a discussion of the dynamic model properties. The model is primarily used for preparing quarterly projections for the German economy as well as for policy analysis. JEL Classification: C3, C5, E1, E2.
    Keywords: Macro-econometric Modelling, Germany.
    Date: 2006–07
  29. By: Elena Angelini (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Antonello D‘Agostino (Central Bank and Financial Services Authority of Ireland, P.O. Box 559/Dame Street, Dublin 2, Ireland.); Peter McAdam (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper documents the structure, estimation and simulation properties of the Italian block of the ESCB-multi-country model (MCM). The model is used regularly as an input into Eurosystem projection exercises and, to a lesser extent, in simulation analysis. The specification of the Italian model follows closely that of the Area-Wide Model (AWM) and indeed the other MCM country blocks (in terms of specification and accounting framework). The MCM is a quarterly estimated structural macroeconomic model that treats the economy in a relatively closed manner. It has a long-run classical equilibrium with a vertical Phillips curve but with some short-run frictions in price/wage setting and factor demands. Consequently, activity is demand-determined in the short-run but supply-determined in the longer run with employment having converged to a level consistent with an exogenously given level of equilibrium unemployment. The precise properties of the model are illustrated using a number of standard variant simulations. JEL Classification: C3, C5, E1, E2.
    Keywords: Macro-econometric Modelling, Italy.
    Date: 2006–07
  30. By: Paolo Paesani (University of Rome – Tor Vergata – Department of Economics and Institutions, Via Columbia n. 2, 00133 Rome, Italy.); Rolf Strauch (European Central Bank, Monetary Policy Strategy Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Manfred Kremer (European Central Bank, Capital Markets and Financial Structure Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The debate on the sustainability of public finances is closely related to the analysis of the financial and macroeconomic consequences of government debt accumulation. Focusing on the USA, Germany and Italy over the 1983?2003 period, the central issue addressed in this paper is how the accumulation of government debt affects long-term interest rates, both nationally and across borders. The analysis is based on a small, multivariate econometric model, which allows us to disentangle the more permanent and transitory components of interest rate developments. Empirical evidence shows that in all cases a more sustained debt accumulation leads at least temporarily to higher long-term interest rates. This transitory impact also spills-over into other countries, mainly from the US to the two European countries. JEL Classification: E6, H63.
    Keywords: Public debt, Long-Term Interest Rates, Cointegration, Common Trends.
    Date: 2006–07
  31. By: Robert A. Eisenbeis (Federal Reserve Bank of Atlanta, 1000 Peachtree Street N.E., Atlanta, GA 30309-4470, United States.); Andy Bauer (Federal Reserve Bank of Atlanta, 1000 Peachtree Street N.E., Atlanta, GA 30309-4470, United States.); Daniel F. Waggoner (Federal Reserve Bank of Atlanta, 1000 Peachtree Street N.E., Atlanta, GA 30309-4470, United States.); Tao A. Zha (Federal Reserve Bank of Atlanta, 1000 Peachtree Street N.E., Atlanta, GA 30309-4470, United States.)
    Abstract: In 1994 the FOMC began to release statements after each meeting. This paper investigates whether the public's views about the current path of the economy and of future policy have been affected by changes in the Federal Reserve's communications policy as reflected in private sector's forecasts of future economic conditions and policy moves. In particular, has the ability of private agents to predict where the economy is going improved since 1994? If so, on which dimensions has the ability to forecast improved? We find evidence that the individuals' forecasts have been more synchronized since 1994, implying the possible effects of the FOMC's transparency. On the other hand, we find little evidence that the common forecast errors, which are the driving force of overall forecast errors, have become smaller since 1994. JEL Classification: E59; C33.
    Keywords: Transparency; common errors; idiosyncratic errors.
    Date: 2006–06
  32. By: Peter Rowland
    Abstract: Since mid-July 2002 this rate has remained more or less constant at around 7.8 percent. More importantly, it did not react to any of two 100-basis-point increases in the overnight repo rate, the main tool of monetary policy that Banco de la República has to influence domestic interest rates, which has rendered the repo rate rather inefficient as a monetary policy tool. This paper studies the DTF rate and its development over time. It shows that a significant pass-through from the overnight interest rates to the DTF rate that was present before July 2002 thereafter seems to have vanished. It also provides a number of explanations to why the DTF rate has remained constant: Overnight rates have in real terms been negative and might, therefore, have been more out of the market than the DTF rate; due to heavy government borrowing, the yield curve has been too steep to allow a further lowering of the DTF rate; competition in the financial system is low, leading to sticky interest rates; the DTF rate is not a free-market auction rate but an offer rate set by the banks; and the DTF rate is a very dominant benchmark.
  33. By: Tigran Poghosyan; Evzen Kocenda
    Abstract: This paper studies foreign exchange risk premium using the uncovered interest rate parity framework in a model economy. The analysis is performed using weekly data on foreign and domestic currency deposits in the Armenian banking system. Results of the study indicate that contrary to the established view there is a positive correspondence between exchange rate depreciation and interest rate differentials. Further, it is shown that a systematic positive risk premium required by economic agents for foreign exchange transactions increases over the investment horizon. One-factor two-currency affine term structure framework applied in the paper is not sufficient to explain the driving forces behind the positive exchange rate risk premium. GARCH approach shows that central bank interventions and deposit volumes are two factors explaining time-varying exchange rate risk premium.
    Keywords: “Forward premium” puzzle, exchange rate risk, time-varying risk premium, affine term structure models, GARCH-in-Mean, foreign and domestic deposits, transition and emerging markets, Armenia.
    JEL: E43 E58 F31 G15 O16 P20
    Date: 2006–05
  34. By: Patrick Lunnemann (Banque Central du Luxembourg, 2, boulevard Royal, L-2983 Luxembourg, Luxembourg.); Ladislav Wintr (Clark University, Worcester, MA 01610, United States.)
    Abstract: This paper studies the behaviour of Internet prices. It compares price rigidities on the Internet and in traditional brick-and-mortar stores and provides a cross-country perspective. The data set covers a broad range of items typically sold over the Internet.It includes more than 5 million daily price quotes downloaded from price comparison web sites in France, Germany, Italy, the UK and the US. The following results emerge from our analysis. First, and contrary to the recent findings for common CPI data, Internet prices in the EU countries do not change less often than online prices in the US. Second, prices on the Internet are not necessarily more flexible than prices in traditional brick-and-mortar stores. Third, there is substantial heterogeneity in the frequency of price change across shop types and product categories. Fourth, the average price change on the Internet is relatively large, but smaller than the respective values reported for CPI data. Finally, panel logit estimates suggest that the likelihood of observing a price change is a function of both state- and time-dependent factors. JEL Classification: E31; L11.
    Keywords: Price stickiness; Internet; price setting behaviour.
    Date: 2006–06
  35. By: Catherine Fuss (National Bank of Belgium, 14, bd de Berlaimont, 1000 Brussels, Belgium.); Philip Vermeulen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We test whether firms with a single bank are better shielded from loss of credit and investment cuts in periods of adverse cash flow shocks than firms with multiple bank relationships. Our estimates of the cash flow sensitivity of investment show that both types of firms are equally subject to financing constraints that bind only in the event of adverse cash flow shocks. In these periods, firms incur lower cuts in investment expenditures when they can obtain extra credit. In periods of adverse cash flow shocks, the probability of obtaining extra bank debt becomes more sensitive to the size and leverage of the firm. JEL Classification: D92.
    Keywords: Financial constraints, lending relationships, firm investment, firm financing.
    Date: 2006–07
  36. By: Masanao Aoki
  37. By: Philip Vermeulen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Small firms often do not change their number of employees from year to year. This paper investigates the role of adjustment costs and indivisibility of labor in the employment stickiness of manufacturing firms with less than 75 employees. When small firms have to adjust employment in units of at least one employee, indivisibility becomes an important source of stickiness. A structural model of dynamic labor demand with adjustment costs and indivisibility is estimated using indirect inference on a panel of small French manufacturing firms. Adjustment cost are estimated to be very small. Indivisibility explains around 50% of the stickiness of employment, adjustment costs explain the other 50%. JEL Classification: E24.
    Keywords: Indivisibility; labor adjustment costs; employment; sticky.
    Date: 2006–06
  38. By: Martin Shubik (Cowles Foundation, Yale University)
    Abstract: A game theoretic approach to the theory of money and financial institution is given utilizing both the strategic and coalitional forms for describing the economy. The economy is first modeled as a strategic market game, then the strategic form is used to calculate several cooperative forms that differ from each other in their utilization of money and credit and their treatment of threats. It is shown that there are natural upper and lower bounds to the monetary needs of an economy, but even in the extreme structures the concept of "enough money" can be defined usefully, and for large economies the games obtained from the lower and upper bounds have cores that approach the same limit that is an efficient price system. The role of disequilibrium is then discussed.
    Keywords: Money, Prices, Core, Threat, Market game, Strategic market game
    JEL: C71 C72 E40
    Date: 2006–07
  39. By: Paola Manzini (Queen Mary, University of London and IZA); Marco Mariotti (Queen Mary, University of London); Luigi Mittone (University of Trento)
    Abstract: In this paper we formulate and investigate experimentally a model of how individuals choose between time sequences of monetary outcomes. The theoretical model assumes that a decision-maker uses, sequentially, two criteria to screen options. Each criterion only permits a decision between some pairs of options, while the other options are incomparable according to that criterion. When the first criterion is not decisive, the decision maker resorts to the second criterion to select an alternative. This type of decision procedures has encountered the favour of several psychologists, though it is quite under-explored in the economics domain. In the experiment we find that: 1) traditional economic models based on discounting alone cannot explain a significant (almost 30%) proportion of the data no matter how much variability in the discount functions is allowed; 2) our model, despite considering only a specific (exponential) form of discounting, can explain the data much better solely thanks to the use of the secondary criterion; 3) our model explains certain specific patterns in the choices of the 'irrational’ people. We can safely reject the hypothesis that anomalous behaviour is due simply to random 'mistakes’ around the basic predictions of discounting theories: the deviations are not random and there are clear systematic patterns of association between 'irrational’ choices.
    Keywords: Time preference, Time sequences, Negative discounting
    JEL: C91 D9
    Date: 2006–07
  40. By: Sumru G. Altug; Murta Usman
    Abstract: We examine bank lending decisions in an economy with spillover effects in the creation of new investment opportunities and asymmetric information in credit markets. We examine pricesetting equilibria with horizontally differentiated banks. If bank lending takes place under a weak corporate governance mechanism and is fraught with agency problems and ineffective bank monitoring, then an equilibrium emerges in which loan supply is strategically restricted. In this equilibrium, the loan restriction, the “under-lending” strategy, provides an advantage to one bank by increasing its market share and sustaining monopoly interest rates. The bank’s incentives for doing so increase under conditions of increased volatility of lending capacities of banks, more severe borrower-side moral hazard, and lower returns on the investment projects. Although this equilibrium is not always unique, with poor bank monitoring and corporate governance, a more intense banking competition renders the bad equilibrium the unique outcome.
    Keywords: Bank lending, threshold effects, underlending equilibria, interest rate competition.
    JEL: E22 E62
    Date: 2006–07
  41. By: Edna Bonilla; Harold Cárdenas; Jorge Iván González; Santiago Grillo
    Abstract: -
    Date: 2006–03–01
  42. By: Ricardo Bonilla González; Jorge Iván González
    Abstract: El Centro de Investigaciones para el Desarrollo (CID) de la Facultad de Ciencias Económicas de la Universidad Nacional, y la Contraloría General de la República (CGR) se han preocupado por hacer una reflexión sistemática sobre el vínculo que existe entre la macro economía y el bien-estar de la población. Este es el tercer es-tudio. El término bien-estar (well being) fue utilizado por los autores clásicos (Mill, Walras, Marshall, etc.), con la convicción profunda de que la economía debe estar al servicio del bien-estar de las personas. Y si el bien-estar es la felicidad que resulta de las opciones que como agentes hacen los individuos, la economía debe estar al servicio de la felicidad. En los tres estudios hemos tratado de mostrar las interac-ciones que se presentan entre las variables macro y las condiciones de vida de la po-blación. Desde el punto de vista metodológico, el reto no es sencillo, porque las re-laciones multicausales impiden suponer que hay secuencias univocas, del tipo si A entonces B. Las variables que normalmente guían la política económica (inflación, empleo, interés, déficit fiscal, deuda, tasa de cambio, etc.) nunca son neutras en tér-minos de bien-estar. Siempre que se mueven favorecen a unos y perjudican a otros. Hemos tratado de descartar cualquier simplismo dogmático, con el fin de captar la forma como las principales decisiones gubernamentales han incidido en la vida de los hogares. El rechazo de los credos es fundamental para poder entender. Uno de los principios, derivado de los oráculos que inspiran a los banqueros centrales, dice que la reducción de la inflación es intrínsecamente buena para todos. En los tres es-tudios hemos mostrado que ello no es así. Que la menor inflación favorece a unos y perjudica a otros. El documento ha sido elaborado por el CID, así que la responsabi-lidad por lo dicho en estas páginas es nuestra y no de la CGR. El texto tiene tres partes, que corresponden a la caracterización que hemos hecho del crecimiento actual de la economía colombiana. Decimos que el crecimiento es insu-ficiente, concentrado e insostenible. Al gobierno Uribe le correspondió la fase cre-ciente del ciclo económico, beneficiándose de la recuperación posterior a la gran re-cesión de finales del siglo pasado. La actual fase de crecimiento tiene tres caracterís-ticas para el estado de bien-estar del país: a) es insuficiente, b) sigue siendo inequita-tiva, y c) es insostenible en materia de continuidad para los próximos años. El go-bierno se beneficio de un período de bonanzas conjuntas que difícilmente se pueden repetir, por lo tanto, no existe ninguna garantía de que en las actuales condiciones se genere un crecimiento sostenido a ritmos superiores al 5%.
    Date: 2006–06–30
  43. By: Dilip Mokherjee (Department of Economics, Boston University); Stefan Napel (Department of Economics, University of Hamburg)
    Abstract: That historical inequality can affect long run macroeconomic performance has been argued by a large literature on ‘endogenous inequality’ using models of indivisibilities in occupational choice, in the presence of borrowing constraints. These models are characterized by a continuum of steady states, and absence of mobility in any steady state. We augment such a model with heterogeneity in agents’ abilities in order to generate occupational mobility in steady state. Steady states with mobility are shown to be generically locally unique and finite in number. We provide forms of heterogeneity for which steady state is globally unique, and others where they are non-unique. Agent heterogeneity may also cause competitive equilibrium dynamics to fail to converge, but convergence can be restored in the presence of sufficient ‘inertia’ or occupation switching costs.
    Keywords: Intergenerational mobility, occupational choice, human capital, borrowing constraints, inequality, history-dependence
    JEL: D31 D91 E25 I21 J24 O11 O15
    Date: 2006–03
  44. By: Olavi Rantala
    Keywords: R&D, productivity, economic impacts
    JEL: D24 E27 O38
    Date: 2006–06–29

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