nep-mac New Economics Papers
on Macroeconomics
Issue of 2006‒08‒26
sixty-one papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Optimal Simple and Implementable Monetary and Fiscal Rules: Expanded Version By Stephanie Schmitt-Grohé; Martín Uribe
  2. Endogenous Monetary Policy Regime Change By Troy Davig; Eric M. Leeper
  3. Market Power, Price Adjustment, and Inflation By Allen Head; Alok Kumar; Beverly Lapham
  4. Non-Separability, Heterogeneous Labor Supply, Investment, and the Business Cycle By Pablo A. Guerron
  5. Monetary Equilibria in a Cash-in-Advance Economy with Incomplete Financial Markets By Jinhui H. Bai; Ingolf Schwarz
  6. The Role of the Housing Market in Monetary Transmission By Gergely Kiss; Gábor Vadas
  7. Noisy Macroeconomic Announcements, Monetary Policy, and Asset Prices By Roberto Rigobon; Brian Sack
  8. Fiscal and monetary policy in the enlarged European Union. By Sabina Pogorelec
  9. The EMU after Three Years: Lessons and Challenges By Peter Bofinger
  10. The Brevity and Violence of Contractions and Expansions By Alisdair McKay; Ricardo Reis
  11. Real Exchange Rate, Monetary Policy and Employment By Roberto Frenkel; Lance Taylor
  12. What Determines the Demand for Money in the Asian-Pacific Countries? An Empirical Panel Investigation By Valadkhani, Abbas
  13. A New Macroeconomic Time Series: Business Profitability in Twentieth-Century Australia By Ville, Simon; Merrett, David
  14. Time-Dependent Portfolio Adjustment: Yet Another Look at the Dynamics By Pablo A. Guerron
  15. Price Rigidity and Flexibility: Recent Theoretical Developments By Daniel Levy
  16. The expected effect of the euro on the Hungarian monetary transmission By Gábor Orbán; Zoltán Szalai
  17. International Real Business Cycles By Mario J. Crucini
  18. Housing Wealth and Aggregate Consumption in Sweden By Chen, Jie
  19. What is the Most Effective Monetary Policy for Aid-Receiving Countries? By Alessandro Prati; Thierry Tressel
  20. The frequency of price adjustment and New Keynesian business cycle dynamics By Richard Dennis
  21. Can Central Banks Target Bond Prices? By Kenneth Kuttner
  22. Structural challenges towards the euro: fiscal policy By Gábor P. Kiss; Péter Karádi; Judit Krekó
  23. Reflections on One Year at the Bank of Israel By Stanley Fischer
  24. Modern macroeconomics in practice: how theory is shaping policy By V. V. Chari; Patrick J. Kehoe
  25. The Comovement between Fuel Prices and the General Price level in Australia By Lei Lei Song
  26. Expectations, Asset Prices, and Monetary Policy: The Role of Learning By Simon Gilchrist; Masashi Saito
  27. Money and capital as competing media of exchange By Ricardo Lagos; Guillaume Rocheteau
  28. The Consumption-Tightness Puzzle By Morten O. Ravn
  29. The y-Theory of Investment By Thomas Philippon
  30. Understanding the Long-Term Growth Performance of the East European and CIS Economies By Rumen Dobrinsky; Dieter Hesse; Rolf Traeger
  31. Unemployment Conundrum in Iran By Valadkhani, Abbas
  32. The Interplay Between the Thai and Several Other International Stock Markets By Valadkhani, Abbas; Chancharat, Surachai; Harvie, Charles
  33. Stochastic Components of Individual Consumption: A Time Series Analysis of Grouped Data By Orazio Attanasio; Margherita Borella
  34. Does Unemployment Hysteresis Equal Employment Hysteresis? By Gustavsson, Magnus; Österholm, Pär
  35. Consumption Over the Life Cycle: A Selected Literature Review By Päivi Kankaanranta
  36. ICT-Producing Sector on Business Activity By Hoon Hian Teck; Edmund S. Phelps
  37. Trade Liberalization and Employment By Eddy Lee
  38. Recursive Competitive Equilibrium By Rajnish Mehra
  39. Cyclical Wages in a Search-and-Bargaining Model with Large Firms By Julio J. Rotemberg
  40. Why do Central Bankers Intervene in the Foreign Exchange Market? Some New Evidence and Theory By Pablo A. Guerron
  41. Can tax evasion tame Leviathan governments? By Manfred Gärtner; Frode Brevik
  42. Can we identify the relative price between consumption and investment? By Joao Ejarque; Stephen McKnight
  43. A Survey of Housing Equity Withdrawal and Injection in Australia By Carl Schwartz; Tim Hampton; Christine Lewis; David Norman
  44. On the Consequences of Demographic Change for Rates of Returns to Capital, and the Distribution of Wealth and Welfare By Dirk Krueger; Alexander Ludwig
  45. Sectoral Explanations of Employment in Europe: The Role of Services By Antonello D’Agostino; Roberta Serafini; Melanie Ward
  46. Market, Social Cohesion, and Democracy By José Antonio Ocampo
  47. The Direct Substitution Between Government and Private Consumption in East Asia By Yum K. Kwan
  48. Consumption Commitments and Risk Preferences By Raj Chetty; Adam Szeidl
  50. Employer Matching and 401(k) Saving: Evidence from the Health and Retirement Study By Gary V. Engelhardt; Anil Kumar
  51. E-Stability vis-a-vis Determinacy Results for a Broad Class of Linear Rational Expectations Models By Bennett T. McCallum
  53. Addressing the Challenge of HIV/AIDS: Macroeconomic, Fiscal and Institutional Issues By Maureen Lewis
  54. Business Environment and Comparative Advantage in Africa: Evidence from the Investment Climate Data By Benn Eifert; Alan Gelb; Vijaya Ramachandran
  55. Optimal Taxation of Entrepreneurial Capital with Private Information By Stefania Albanesi
  56. Is Cash Flow a Proxy for Financing Constraints in the Investment Equation? The Case of Unlisted Japanese Firms By Yuzo Honda; Kazuyuki Suzuki
  57. The Equity Premium in India By Rajnish Mehra
  58. Approximately Normal Tests for Equal Predictive Accuracy in Nested Models By Kenneth D. West; Todd Clark
  59. Persistence in Law-Of-One-Price Deviations: Evidence from Micro-Data By Mario J. Crucini; Mototsugu Shintani
  60. Food Security in Indonesia: Current Challenges and the Long-Run Outlook By Peter Timmer
  61. The Dollar and Development By Dick Sabot

  1. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper computes welfare-maximizing monetary and fiscal policy rules in a real business cycle model augmented with sticky prices, a demand for money, taxation, and stochastic government consumption. We consider simple feedback rules whereby the nominal interest rate is set as a function of output and inflation, and taxes are set as a function of total government liabilities. We implement a second-order accurate solution to the model. Our main findings are: First, the size of the inflation coefficient in the interest-rate rule plays a minor role for welfare. It matters only insofar as it affects the determinacy of equilibrium. Second, optimal monetary policy features a muted response to output. More importantly, interest rate rules that feature a positive response to output can lead to significant welfare losses. Third, the welfare gains from interest-rate smoothing are negligible. Fourth, optimal fiscal policy is passive. Finally, the optimal monetary and fiscal rule combination attains virtually the same level of welfare as the Ramsey optimal policy.
    JEL: E52 E61 E63
    Date: 2006–08
  2. By: Troy Davig; Eric M. Leeper
    Abstract: This paper makes changes in monetary policy rules (or regimes) endogenous. Changes are triggered when certain endogenous variables cross specified thresholds. Rational expectations equilibria are examined in three models of threshold switching to illustrate that (i) expectations formation effects generated by the possibility of regime change can be quantitatively important; (ii) symmetric shocks can have asymmetric effects; (iii) endogenous switching is a natural way to formally model preemptive policy actions. In a conventional calibrated model, preemptive policy shifts agents' expectations, enhancing the ability of policy to offset demand shocks; this yields a quantitatively significant "preemption dividend."
    JEL: E31 E32 E52 E58
    Date: 2006–08
  3. By: Allen Head (Queen's University); Alok Kumar (University of Victoria); Beverly Lapham (Queen's University)
    Abstract: We study the responses of real and nominal prices to random flutuations in costs and money growth using a monetary search economy in which there are no costs or temporal restrictions on sellers' ability to change prices. The economy exhibits a form of price stickiness in that the price level may react incompletely to either type of shock as a result of endogenous changes in the average mark-up driven by movements in consumers' search intensity. The average mark-up falls as inflation rises, a finding consistent with emprical observations. As a result of this reduction in market power, prices become more responsive to shocks as inflation rises. Our results are consistent with empirical findings that the degree of price adjustment in response to both cost and money growth shocks is increasing in the average rate of inflation, that the variance of inflation increases with its average level, and that positive and negative shocks to money growth have asymmetric effects.
    Keywords: Search, Mark-up, Inflation, Price Dispersion, Pass-through
    JEL: E31 D43 E42
    Date: 2006–01
  4. By: Pablo A. Guerron (Department of Economics, North Carolina State University)
    Abstract: I study the effects of a monetary shock in an economy characterized by heterogenous labor schedules and non-separability between consumption and labor in the utility function. To that end, I develop a simple method to deal with household heterogeneity arising from wealth differentials. Compared to competing models in the literature, the estimated version of my model fits better the responses of output, consumption, and wages after a monetary shock. Notably, my model requires no adjustment cost in investment, and smaller degrees of habit formation preference for consumption, and wage stickiness than other standard models. Furthermore, I show that non-separability is an important source of amplification of the effects of a monetary shock on output and investment.
    Keywords: Heterogeneous Choices, Impulse Responses, Monetary Policy
    JEL: E3 E4 E5
    Date: 2006–05
  5. By: Jinhui H. Bai; Ingolf Schwarz (Department of Economics, Georgetown University)
    Abstract: The general equilibrium model with incomplete financial markets (GEI) is extended by adding fiat money, fiscal and monetary policy and a cash-in-advance constraint. The central bank either pegs the interest rate or money supply while the fiscal authority sets a Ricardian or a non-Ricardian fiscal plan. We prove the existence of equilibria in all four scenarios. In Ricardian economies, the conditions required for existence are not more restrictive than in standard GEI. In non-Ricardian economies, the sufficient conditions for existence are more demanding. In the Ricardian economy, neither the price level nor the equivalent martingale measure is determinate. Classification-JEL Codes: D52; E40; E50
    Keywords: Money; Incomplete Markets; Fiscal Policy; Indeterminacy
  6. By: Gergely Kiss (Magyar Nemzeti Bank); Gábor Vadas (Magyar Nemzeti Bank)
    Abstract: As part of the monetary transmission studies of the Magyar Nemzeti Bank, this paper attempts to analyse the role of the housing market in the monetary transmission mechanism of Hungary. The housing market can influence monetary transmission through three channels, namely, the nature of the interest burden of mortgage loans, asset (house) prices, and the credit channel. The study first summarises the experiences of developed countries, paying special attention to issues arising from the monetary union. It then examines the developments in the Hungarian housing and mortgage markets in the last 15 years, as well as the expected developments and changes attendant to the adoption of the euro. Using panel econometric techniques, the study investigates the link between macroeconomic variables and house prices in Hungary, and the effect of monetary policy on housing investment and consumption through the wealth effect and house equity withdrawal.
    Keywords: Housing, Monetary transmission, Mortgage market, Panel econometrics.
    JEL: E52
    Date: 2005
  7. By: Roberto Rigobon; Brian Sack
    Abstract: The current literature has provided a number of important insights about the effects of macroeconomic data releases on monetary policy expectations and asset prices. However, one puzzling aspect of that literature is that the estimated responses are quite small. Indeed, these studies typically find that the major economic releases, taken together, account for only a small amount of the variation in asset prices—even those closely tied to near-term policy expectations. In this paper we argue that this apparent detachment arises in part from the difficulties associated with measuring macroeconomic news. We propose two new econometric approaches that allow us to account for the noise in measured data surprises. Using these estimators, we find that asset prices and monetary policy expectations are much more responsive to incoming news than previously believed. Our results also clarify the set of facts that should be captured by any model attempting to understand the interactions between economic data, monetary policy, and asset prices.
    JEL: E44 E47 E52
    Date: 2006–08
  8. By: Sabina Pogorelec (European Investment Bank, 100 boulevard Konrad Adenauer, L-2950 Luxembourg, Luxembourg.)
    Abstract: I build a quantitative two-country DSGE model of the European Union (EU) and investigate whether there are welfare gains from fiscal policy cooperation between the new EU members and the euro area (EMU). Fiscal cooperation is defined in terms ofjoint maximization of the weighted average of households’ welfare. I find that fiscal policy cooperation is welfare-reducing for both groups of countries. This result depends on a realistic assumption about the presence of foreign ownership of firms in the new EU countries. When there is no foreign ownership in the new EU countries, the euro area is indifferent between cooperating and not cooperating, but the new EU members still prefer not to cooperate with EMU in terms of fiscal policy. JEL Classification: E63; F42.
    Keywords: Fiscal policy cooperation; Foreign ownership of firms; Fiscal-monetary interactions; Enlarged European Union; Central and eastern European countries.
    Date: 2006–07
  9. By: Peter Bofinger (University of Wuerzburg)
    Abstract: The paper provides an analysis of the first three years of the European Monetary Union. It discusses the changeover to Euro notes, the performance of monetary policy in terms of price stability and real growth, the establishment of credibility for the ECB, and the two pillar strategy. The weakness of the euro's exchange value during the first three years is explained. Some aspects of the eastern enlargement of the eurozone are examined especially the problems that may be associated with the lack of real convergence. Other issues such as the importance of a Balassa-Samuelson effect and the need for appropriate fiscal policies are discussed.
    Keywords: European Monetary Union, European Central Bank, Euro, monetary policy
    JEL: E42 E58 E60
  10. By: Alisdair McKay; Ricardo Reis
    Abstract: Early studies of business cycles argued that contractions in economic activity were briefer (shorter) and more violent (rapid) than expansions. This paper systematically investigates this claim and in the process discovers a robust new business cycle fact: expansions and contractions in output are equally brief and violent but contractions in employment are briefer and more violent than expansions. The difference arises because employment typically lags output around peaks but both series roughly coincide in their troughs. We discuss the performance of existing business cycle models in accounting for this fact, and conclude that none can fully account for it. We then show that a simple model that combines three familiar ingredients–labor hoarding, a choice of when to scrap old technologies, and job training or job search–can account for the business cycle fact.
    JEL: E32 E23 E24 J60
    Date: 2006–08
  11. By: Roberto Frenkel; Lance Taylor
    Abstract: The exchange rate affects the economy through many channels and, consequently, has diverse macroeconomic and development impacts. Five are analysed in this paper: resource allocation, economic development, finance, external balance and inflation. The use of the exchange rate as a developmental tool in conjunction with its other uses (often in coordination with monetary policy) is at the focus of the discussion.
    Keywords: exchange rate, development policy
    JEL: F3 F4 O2
    Date: 2006–02
  12. By: Valadkhani, Abbas (University of Wollongong)
    Abstract: This paper examines the long- and short-run determinants of the demand for money in six countries in the Asian-Pacific region using panel data (1975-2002). Various country-specific coefficients are allowed to capture inter-country heterogeneities. Consistent with theoretical postulates, it is found that (a) the demand for money in the long-run positively responds to real income and inversely to the interest rate spread, inflation, the real effective exchange rate, and the US real interest rate; (b) the long-run income elasticity is greater than unity; and (c) both the currency substitution and capital mobility hypotheses hold only in the long run.
    Keywords: Demand for Money; Money and Interest Rate Spread; Panel Data
    JEL: E41 E52 C33 O11
    Date: 2006
  13. By: Ville, Simon (University of Wollongong); Merrett, David (University of Melbourne)
    Keywords: Macroeconomic time series, business profitability, Australia
    Date: 2006
  14. By: Pablo A. Guerron (Department of Economics, North Carolina State University)
    Abstract: The interest semi-elasticity of money demand has been a long standing puzzle in the monetary economics literature. Researchers consistently have estimated low short-run semi-elasticities, usually around 1, and high long-run semi-elasticities of 10. Given the crucial role of interest semi-elasticity in determining the welfare costs of inflation and the effectiviness of tax cuts, we must understand why these short- and long-run estimates are so different. To explore this issue, I formulate and estimate a model of the demand for money that simultaneously accounts for low short- and high long-run semi-elasticities. In my formulation, re-balancing money holdings between money for purchases and money for financial investment is costly. I model this re-balancing cost by assuming that households re-optimize their money holdings subject to an exogenous probability. In the log-linearized version of my model, velocity depends on both its own past value and households' present and future expectations of the interest rate. I use this equilibrium condition to estimate my model's parameters by employing generalized method of moments. My estimates for the short-run and long-run interest semi-elasticities are 0.96 and 12.62, respectively. When I apply my model of money demand to explain the increase in the volatility of real balances after 1980, my model indicates that the late-1970s financial innovations, which facilitated portfolio re-balancing, lie behind this rise.
    Keywords: Interest Semi-Elasticity of Money Demand, Time-Dependent Portfolio Adjustment, Volatility, GMM.
    JEL: C32 E41 E47
    Date: 2006–01
  15. By: Daniel Levy
    Abstract: The price system, the adjustment of prices to changes in market conditions, is the primary mechanism by which markets function and by which the three most basic questions get answered; what to produce, how much to produce and for whom to produce. To the behaviour of price and price system, therefore, have fundamental implications for many key issues in microeconomics and industrial organization, as well as in macroeconomics and monetary economics. In microeconomics, managerial economics, and industrial organization, economists focus on the price system efficiency. In macroeconomics and monetary economics, economists focus on the extent to which nominal prices fail to adjust to changes in market conditions. Nominal price rigidities play particularly important role in modern monetary economics and in the conduct of monetary policy because of their ability to explain short-run monetary non-neutrality. The behaviour of prices, and in particular the extent of their rigidity and flexibility, therefore, is of central importance in economics.
    Date: 2006–08
  16. By: Gábor Orbán (Magyar Nemzeti Bank); Zoltán Szalai (Magyar Nemzeti Bank)
    Abstract: The most important mechanism through which monetary policy affects the real economy in Hungary is the exchange rate channel. With euro adoption, this mechanism will largely disappear and the impact of monetary policy will be transmitted via the interest rate channel, presently seen as rather weak. This has raised concerns that the influence of monetary policy on the real economy in Hungary could be very limited after euro adoption. On top of this, other concerns have been voiced as regards potential asymmetries in the wage-setting behaviour, the exchange rate and credit channels. Based on the experience of today’s euro area participating countries and the structural characteristics of the Hungarian economy, this paper argues that after euro adoption 1) we may expect a broadening of the scope of the interest rate channel of monetary policy after euro adoption, 2) there are no institutional obstacles in the way of the effective functioning of the expectations channel in Hungary 3) substantially different monetary conditions from that in the euro area as a result of a different trade orientation are unlikely, and, finally 4) some asymmetries in the balance sheet channel may continue to exist for some time between Hungary and the core euro area countries but its effect will be significantly smaller after euro zone entry.
    Keywords: monetary transmission mechanism, transmission channels, EMU participation.
    JEL: E52 E58
    Date: 2005
  17. By: Mario J. Crucini (Department of Economics, Vanderbilt University)
    Abstract: This paper is a non-technical review of research developments in the international real business cycle literature. International business cycle facts are summarize with particular attention to the sources of output variance from the expenditure side of the NIPA and the production side, using a familiar neoclassical production function. Theoretical developments focus on the how consumption smoothing and investment dynamics shape the current account; the search for sources and propagation mechanisms of international business cycle comovement and key facets of relative price determination (the real exchange rate and the terms of trade).
    Keywords: International business cycles, current account, real exchange rates
    JEL: A1 F4 E3
    Date: 2006–07
  18. By: Chen, Jie (The Institute for Housing and Urban Research, Uppsala University)
    Abstract: This paper extends the VECM cointegration model and PT (permanent-transitory) variance decomposition framework proposed by Lettau & Ludvigson (2004) and applies them on the Swedish data spanning from 1980q1 to 2004q4. There are strong statistical evidences that the movements of aggregate consumption, disposable income, housing wealth and financial wealth are tied together. However, it also suggests that the short run variations in the Swedish housing market are largely dissociated with consumer spending. Meanwhile, it is shown that the strength of the linkage between consumption and housing wealth is not sensitive to different model specifications and various measures of key variables.
    Keywords: housing wealth; consumption; wealth effect; VECM; PT decomposition
    JEL: E21 E32 E44 R31
    Date: 2006–06–10
  19. By: Alessandro Prati; Thierry Tressel
    Abstract: This paper analyses how monetary policy can enhance the effectiveness of volatile aid fl ows. We find that monetary policy is effective in reducing trade balance volatility. We propose the following taxonomy, excluding the case of emergency assistance. Monetary policy should slow down consumption growth and build up international reserves when aid is abundant and deplete them to finance imports and support consumption when aid is scarce. If foreign aid also affects productivity growth, monetary policy should take this productivity effect into account in responding to aid flows.
    Keywords: Aid effectiveness, monetary policy, real exchange rate, Dutch disease
    JEL: O11 O4 O23 E5 F35
    Date: 2006–02
  20. By: Richard Dennis
    Abstract: The Calvo pricing model that lies at the heart of many New Keynesian business cycle models has been roundly criticized for being inconsistent both with time series data on inflation and with micro-data on the frequency of price changes. In this paper we show that a modified version of the Gali and Gertler (1999) model, which allows for "rule-ofthumb" price setters, and whose structure can be interpreted in terms of menu costs and information gathering/processing costs, largely resolves both criticisms. Moreover, the resulting Phillips curve shares the explanatory power of the partial-indexation model and dominates the full-indexation model and the Calvo model. Estimating a small-scale New Keynesian business cycle model, our results indicate that the share of firms that change prices each quarter is just over 60 percent, broadly in line with the Bils and Klenow (2004) study of Bureau of Labor Statistics price data. Reflecting the importance of information gathering/processing costs, we find that most firms that change prices are rule-of-thumb price setters. Finally, compared to specifications containing either the Calvo model or the full-indexation model, the data provide much greater support for the Gali-Gertler model.
    Keywords: Prices ; Inflation (Finance)
    Date: 2006
  21. By: Kenneth Kuttner
    Abstract: This paper addresses the possible role of bond prices as operating or intermediate targets for monetary policy. The paper begins with a brief review of the mechanisms through which a central bank could, in theory, influence long-term interest rates, and continues with a brief narrative overview of debt management policies in the U.S., tracing their effects on the maturity distribution of outstanding publicly-held Treasury debt and the composition of the assets held by the Federal Reserve System. The empirical section presents new econometric evidence on the effects of these policies on expected excess holding returns (“term premia”), demonstrating that changes in the Fed’s holdings of long-term securities have had statistically significant and economically meaningful effects on the term premia associated with Treasury securities with maturities in the two- to five-year range.
    JEL: E43 E58 E63
    Date: 2006–08
  22. By: Gábor P. Kiss (Magyar Nemzeti Bank); Péter Karádi (Magyar Nemzeti Bank, at the time of writing the study); Judit Krekó (Magyar Nemzeti Bank)
    Abstract: Broad theoretical consensus and vast empirical evidence reinforce the view that prudent fiscal policy – also advocated by the fiscal institutions of the eurozone – can support the stable long term growth. After presenting some general principles of the optimal fiscal policy, the paper analyses the questions of fiscal convergence necessary for the successful eurozone entry and membership of Hungary. The paper calculates the consolidation necessary to reach the 2008 deficit target set by the Convergence Program. Taking into account of not only the level of the government debt but also the relatively progressed state of the interest rate convergence, the potential reduction attainable in the interest balance is moderate. The main result of the paper is that the necessary consolidation measures are required to reduce the primary balance by approximately 3 percent. In case of cutting public expenditure it would require approximately 4 percent reduction taking into account the revenue content of those expenditures. The structure of macroeconomic growth is not expected to facilitate fiscal consolidation – as wage and consumption growth, which have major influence on the development of relevant tax-bases, are expected to be moderate – and no improvements in the balance are expected as a result of the EU accession. International experience, especially fiscal consolidations of eurozone member states, however, show that structural – i.e. quality-improving and sustainable – measures and the reform of the institutional framework are essential determinants of successful consolidations. Temporary measures and deficit reductions by creative accounting do not foster macroeconomic stabilization and their eventual reversal is highly probable.
    Keywords: Fiscal Consolidation, Optimal Debt Policy, Maastricht Criteria.
    JEL: E61 E62 H62 H63
    Date: 2005
  23. By: Stanley Fischer
    Abstract: In this paper I reflect on my first year as Governor of the Bank of Israel, which I joined in May 2005. I start by describing the current state of the Israeli economy and monetary policy and economic developments during the past year. I then review a series of issues that have arisen during the past year. Among them are: the monetary mechanism, which is unusual because exchange rate changes have a very rapid impact on prices; the role of inflation and interest rate expectations in policy decisions; the role of the interest rate gap with the US; the role of the Governor as chief economic adviser to the Government; banking supervision; and management and political issues.
    JEL: E50 E65
    Date: 2006–08
  24. By: V. V. Chari; Patrick J. Kehoe
    Abstract: Theoretical advances in macroeconomics made in the last three decades have had a major influence on macroeconomic policy analysis. Moreover, over the last several decades, the United States and other countries have undertaken a variety of policy changes that are precisely what macroeconomic theory of the last 30 years suggests. The three key developments that have shaped macroeconomic policy analysis are the Lucas critique of policy evaluation due to Robert Lucas, the time inconsistency critique of discretionary policy due to Finn Kydland and Edward Prescott, and the development of quantitative dynamic stochastic general equilibrium models following Finn Kydland and Edward Prescott.
    Date: 2006
  25. By: Lei Lei Song (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)
    Abstract: This paper examines the relationship between the general price level and the relative price of fuel by measuring correlation from VAR forecast errors. The results suggest a significant positive correlation between quarterly changes in the relative price of fuel and the CPI, at least in the short to medium term from two to four years. The finding has important implications for measuring the long-term trend in inflation as relative price changes in fuel contain important information about future inflation.
    JEL: E31 E37
    Date: 2006–08
  26. By: Simon Gilchrist; Masashi Saito
    Abstract: This paper studies the implications of financial market imperfections represented by a countercyclical external finance premium and the gradual recognition of changes in the drift of technology growth for the design of an interest rate rule. Asset price movements induced by changes in trend growth influence balance-sheet conditions that determine the external finance premium. Such movements are magnified when the private sector is imperfectly informed regarding the trend growth rate of technology. The presence of financial market imperfections provides a motivation for responding to the gap between the observed asset prices and the potential level of asset prices in addition to responding strongly to inflation. This is because the asset price gap represents distortions in the resource allocation induced by financial market imperfections more distinctly than inflation. The policymaker's imperfect information about the drift of technology growth renders imprecise the calculation of the potential and thus reduces the benefit of responding to the asset price gap. A policy that responds to the level of asset prices which does not take into account changes in potential tends to be welfare reducing.
    JEL: E44 E52 O41
    Date: 2006–08
  27. By: Ricardo Lagos; Guillaume Rocheteau
    Abstract: We construct a model in which capital competes with fiat money as a medium of exchange, and establish conditions on fundamentals under which fiat money can be both valued and socially beneficial. When the socially efficient stock of capital is too low to provide the liquidity agents need, they overaccumulate productive assets to use as media of exchange. When this is the case, there exists a monetary equilibrium that dominates the nonmonetary one in terms of welfare. Under the Friedman rule, fiat money provides just enough liquidity so that agents choose to accumulate the same capital stock a social planner would.
    Keywords: Money
    Date: 2006
  28. By: Morten O. Ravn
    Abstract: This paper introduces a labor force participation choice into a labor market matching model embedded in a dynamic stochastic general equilibrium set-up with production and savings. The participation choice is modelled as a tradeoff between forgoing the expected benefits of being search active and engaging in costly labor market search. The model induces a symmetry in firms’ and workers’ search decision since both sides of the labor market vary search effort at the extensive margins. We show that this set-up is of considerable analytical convenience and that it gives rise to a linear relationship between labor market tightness and the marginal utility of consumption. We refer to the latter as the “consumption - tightness puzzle” because (a) it gives rise to a number of counterfactual implications, and (b) it is a robust implication of theory. Amongst the counterfactual implications are very low volatility of tightness, procyclical unemployment, and a positively sloped Beveridge curve. These implications all derive from procyclical variations in participation rates that follow from allowing for the extensive search margin.
    JEL: E24 E32 J20 J41 J64
    Date: 2006–08
  29. By: Thomas Philippon
    Abstract: I propose a new implementation of the q-theory of investment using corporate bond yields instead of equity prices. In q-theory, the optimal investment rate is a function of risk-adjusted discount rates and of future marginal profitability. Corporate bond prices also depend on these variables. I show that, when aggregate shocks are small, aggregate q is a linear combination of risk free rates and average yields on risky corporate debt. The yield-theory of investment, unlike its equity-based counter part, is empirically successful: it can account for more than half of the volatility of investment in post-war US data, it drives out cash flows from the investment equation, and it delivers sensible estimates for the parameters of the adjustment cost function.
    JEL: E0 E44 G31
    Date: 2006–08
  30. By: Rumen Dobrinsky (United Nations Economic Commission for Europe); Dieter Hesse (United Nations Economic Commission for Europe); Rolf Traeger (United Nations Economic Commission for Europe)
    Abstract: The paper analyses the determinants of long-term economic performance of east European and CIS economies in two periods: 1960-1989 (the era of central planning) and 1990-2005 (the transition to the market economy system). Throughout the 1960s and 1970s economic growth in eastern Europe progressively weakened and during the 1980s most of these economies plunged into a prolonged stagnation or recession, which contributed to the collapse of communism and central planning. The transition from plan to market began with the transformational recession, which persisted until the mid-1990s in eastern Europe, but was longer and deeper in the CIS. Since then, the east European and CIS economies have embarked on a path of strong economic growth. The recovery has been accompanied by a surge in fixed investment, often complemented by large inflows of FDI. Despite robust output growth, however, there has not been - at least so far - a noteworthy recovery in employment. The main feature of the recent strong economic growth in the region has been a remarkable upturn in both labour productivity and total factor productivity. The considerable gains in productive efficiency and rapid technological change were triggered by wide-ranging market reforms and the modernization of the capital stock. Gains in aggregate output per person employed have outpaced by a large margin increases in real GDP per capita. In terms of average productivity and real per capita income levels relative to those of the more developed, industrialized countries, the east European and CIS economies still face a long catching up process.
    Keywords: economic growth, East Europe, CIS, transition economies
    JEL: O11 O47 O52 E22 E24 J24 N14
  31. By: Valadkhani, Abbas (University of Wollongong)
    Abstract: This paper examines the major causes of Iran’s unemployment conundrum using a simultaneous-equation model and annual time series data from 1968 to 2000. It is found that the rate of unemployment responds positively to output gap and increasing economic uncertainty and negatively to the higher growth rates of real investment and inflation, supporting the view that there exists a degree of trade-off between inflation and unemployment. However, since persistent and soaring inflation rates eventually lead to the chronic depreciation of the domestic currency and rising economic instability, it will be irrational to exploit this trade-off to fight against unemployment, particularly in the post-1979 revolution. Iran possesses one of the youngest populations in the world with approximately 40 per cent of its population less than 15 years. It is thus argued that if major tax and constitutional reforms are not undertaken, unemployment will continue to rise, depicting a sombre future for the next working age generation.
    Keywords: Unemployment, Iran
    Date: 2006
  32. By: Valadkhani, Abbas (University of Wollongong); Chancharat, Surachai (University of Wollongong); Harvie, Charles (University of Wollongong)
    Abstract: The paper analyses the effect of various international stock market price indices and some relevant macroeconomic variables on the Thai stock market price index, using a GARCH-M model and monthly data from January 1988 to December 2004. It is found, inter alia, that (a) changes in stock market returns in Singapore, Malaysia and Indonesia in the pre-1997 Asian crisis, and changes in Singapore, the Philippines and Korea in the post-1997 era instantaneously influenced returns in the Thai stock market; (b) changes in the price of crude oil negatively impacted on the Thai stock market only in the pre-Asian crisis period; (c) volatility clustering (i.e. ARCH and GARCH effects) as well as a GARCH-M model were statistically significant only in the pre-1997 era; and (d) stock markets outside the region had no significant immediate impact on monthly aggregate returns in the Thai stock market.
    Keywords: Stock market; conditional volatility; macroeconomic variables; GARCH; Thailand
    JEL: E44 G14 G15
    Date: 2006
  33. By: Orazio Attanasio; Margherita Borella
    Abstract: In this paper we propose a method to characterize the time series properties of individual consumption, income and interest rates using micro data, as studies in labour economics have characterized the time series properties of hours and earnings. Our approach, however, does not remove aggregate shocks. Having estimated the parameters of a flexible multivariate MA representation we relate the coefficients of our statistical model to structural parameters of theoretical models of consumption behaviour. Our approach offers a unifying framework that encompasses the Euler equation approach to the study of consumption and the studies that relate innovations to income to innovations to consumption, such as those that have found the so-called excess smoothness of consumption. Using a long time series of cross sections to construct synthetic panel data for the UK, we estimate our model and find that the restriction of Euler equations are typically not rejected, while the data show ‘excess smoothness’.
    JEL: C3 D1 E2
    Date: 2006–08
  34. By: Gustavsson, Magnus (Department of Economics); Österholm, Pär (Department of Economics)
    Abstract: This paper investigates if conclusions regarding labour market hysteresis differ depending on whether employment or unemployment rates are studied. Applying a range of unit-root tests to monthly data from Australia, Austria, Canada, Finland, Sweden, the U.K. and the U.S., we find results for employment rates that contrast those based on unemployment rates. In particular, rather than the mixed evidence for hysteresis found using unemployment rates, employment rates result in unequivocal evidence of hysteresis in Australia, Canada and the U.S.. These findings cast doubt on previous conclusions in the literature.
    Keywords: Labour market; Persistence; Unit root test
    JEL: C22 E24 J21
    Date: 2006–07–10
  35. By: Päivi Kankaanranta (Department of Economics, University of Turku)
    Abstract: Simple life cycle and permanent income hypotheses imply that changes in consumption should be unforecastable. Rational forward-looking agents ought to smooth consumption over the life cycle and exhaust the asset stock accumulated during the working career in retirement. Empirical observations seem not to conform to these predictions of the simple theory of intertemporal choice which has given rise to elaborations on the benchmark model. The theoretical discussion of this paper concentrates on the litareture dealing with the seemingly problematic empirical regularities and on proposed explanations. The review of literature focuses particularly on the life cycle issues of consumption behaviour.
    Keywords: consumption, life cycle, permanent income
    JEL: B22 D11 D91 E21
    Date: 2006–08
  36. By: Hoon Hian Teck (School of Economics and Social Sciences, Singapore Management University); Edmund S. Phelps (Columbia University)
    Abstract: It seems to be taken for granted by many commentators that the sharp decline in prices of computers, telecommunications equipment and software resulting from the technological improvements in the information and communications technology (ICT)-producing sector is good for jobs and is a major driving force behind the non-inflationary employment miracle and booming stock market in the latter half of the nineties in the U.S. and their recurrence since 2004. We show that, in our model, a technical improvement in the ICT-producing sector by itself cannot explain a simultaneous increase in employment and a risein firms’ valuation (or Tobin’s Q ratio). There are two cases. If the elasticity of equipment price (pI ) with respect to ICT-producing sector’s productivity is less than one, labor’s value marginal productivity increases thus pulling up the demand wage and expanding employment. However, the increased output by adding to the capital stock and thus driving down future capital rentals causes a decline in firms’ valuation, q per unit, even though Tobin’s Q (= q=pI ) is up. If the elasticity is greater than one, equipment prices fall so dramatically that labor’s value marginal productivity declines, employment in the ICT-using sector expands proportionately more than the increase in capital stock, thus raising future capital rentals, so both firms’ valuation and Tobin’s Q rise; but then real demand wage falls and employment contracts. The key to generating a booming stock market alongside employment expansion is to hypothesize that when technical improvement in the ICT-producing sector occurs, the market forms an expectation of future productivity gains to be reaped in the ICT-using sector. Then we can explain not only the stock market boom and associated rise in investment spending and employment in the period 1995-2000 but also the subsequent decline in employment, in Tobin’s Q and in investment spending in 2001, with consumption holding up well as productivity gains in the ICT-using sector were realized. An anticipation of a future TFP improvement in the ICT-using sector can once more play the role of raising the stock market.
    Keywords: Business asset valuation, Tobin’s Q, investment spending,employment
    JEL: E13 E22 E23 E24 O33
    Date: 2006–02
  37. By: Eddy Lee
    Abstract: This paper reviews both multi-country and country studies on the impact of trade liberalization on growth and employment in developing countries. These studies reveal sharply contrasting effects of trade liberalization on employment, suggesting that country-specific and contingent factors are important. In particular, differences in how trade liberalization is implemented are particularly important. In order to be successful, trade liberalization needs to be embedded within a coherent set of macroeconomic, structural and social policies.
    Keywords: employment, wage differentials, trade liberalization, developing countries
    JEL: F16 E24
    Date: 2005–10
  38. By: Rajnish Mehra
    Abstract: In this article we define a Recursive Competitive Equilibrium, provide an example and review the related literature. The article is an entry prepared for The New Palgrave: A Dictionary of Economics, 2nd Edition (Palgrave Macmillan: New York).
    JEL: D5 D51 D61 D91 D92 E21 E22 E23 G12
    Date: 2006–08
  39. By: Julio J. Rotemberg
    Abstract: This paper presents a complete general equilibrium model with flexible wages where the degree to which wages and productivity change when cyclical employment changes is roughly consistent with postwar U.S. data. Firms with market power are assumed to bargain simultaneously with many employees, each of whom finds himself matched with a firm only after a process of search. When employment increases as a result of reductions in market power, the marginal product of labor falls. This fall tempers the bargaining power of workers and thus dampens the increase in their real wages. The procyclical movement of wages is dampened further if the posting of vacancies is subject to increasing returns.
    JEL: E24 E37 J64
    Date: 2006–08
  40. By: Pablo A. Guerron (Department of Economics, North Carolina State University)
    Abstract: I provide new empirical and theoretical evidence about the effectiveness of sterilized interventions on exchange rates. These new developments are particularly important to understand why central bankers from developing countries tend to intervene during periods of financial distress. In the first half of the paper, I apply a VAR formulation to measure the effects of sterilized interventions on the U.S. bilateral exchange rate. Information from the Exchange Stabilization Fund in the U.S. for the period 1974 -- 2000 is used to identify a shock that is orthogonal to the U.S. money supply and therefore mimics the role of sterilized interventions. According to my identification strategy, a sterilized intervention shock in favor of the U.S. dollar would appreciate it against a trade-weighted currency index by roughly 1 percent. This appreciation is statistically significant, lasts for about 1 year, and is robust to alternative identification strategies. Then, I devote the second part of the paper to rationalize the results from the empirical section by studying sterilized interventions within a two-country general equilibrium model. I find that if trading bonds is costly worldwide and asset markets are incomplete, a domestic government purchase of domestic bonds accompanied by a sale of foreign bonds, a sterilized intervention, appreciates the domestic currency. Accordingly, a calibrated version of the model renders similar results to those from the VAR formulation.
    Keywords: Exchange Rate, Sterilized Intervention, VAR, Open Economy
    JEL: C32 F3 E58
    Date: 2006–01
  41. By: Manfred Gärtner; Frode Brevik
    Abstract: This paper looks at how income tax rates, consumption and public spending respond as venues for tax evasion open or close. The analysis draws on a 16-generation OLG model in which tax rates are determined in a repeated game between voters and a rent-seeking Leviathan government. Key insights are: (1) Effects on any generation alive when change takes place may differ substantially from steady state effects that accrue for generations yet to be born. (2) There is considerable intergenerational diversity in these effects that is not monotonous as we move from young to old. Combined, these results suggest that the political economy of pertinent institutional change may be quite complex.
    Keywords: Leviathan government, income tax, tax evasion, public spending, rent seeking
    JEL: E2 E62 F42 H2
    Date: 2006–07
  42. By: Joao Ejarque; Stephen McKnight
    Abstract: This paper considers various AK models to investigate inference about the relative price between consumption and investment using NIPA data. We find, that depending on the model used, we can legitimately generate different time series for this price. If we successfully construct a falling price of investment, the model implies an inadmissibly low share of consumption in output. If we use an admissible share of consumption we generate investment prices which increase over time, contrary to the intuition generated by the price of equipment goods.
    Date: 2006–08–10
  43. By: Carl Schwartz (Reserve Bank of Australia); Tim Hampton (Reserve Bank of Australia); Christine Lewis (Reserve Bank of Australia); David Norman (Reserve Bank of Australia)
    Abstract: Over the past decade or so, aggregate data suggest a trend increase in housing equity withdrawal in Australia, potentially stimulating household spending. However, there has been little disaggregated information on how equity is being withdrawn and injected, the characteristics of households altering housing equity, and how funds from withdrawn equity are being used. This paper uses a survey of 4 500 households commissioned by the Reserve Bank of Australia (RBA) to address these questions. The results suggest that, during 2004, the most common method of withdrawing equity was for a household to increase the level of debt secured against a property they already owned. In contrast, most of the value of equity withdrawn was associated with property transactions, with the typical property transaction resulting in a net equity withdrawal. Turnover in the property market is therefore likely to be an important driver of cycles in aggregate housing equity withdrawal. Bivariate and logit analysis suggests a significant life-cycle influence, with the bulk of equity withdrawal being undertaken by older households, while younger households typically inject, primarily through mortgage repayments or deposits for property purchase. Finally, the results suggest that the bulk of the value of withdrawn equity was used to increase non-housing assets, although a significant proportion of households used the funds for consumption expenditure.
    Keywords: housing equity withdrawal; housing turnover; household debt
    JEL: E21 E51
    Date: 2006–08
  44. By: Dirk Krueger; Alexander Ludwig
    Abstract: This paper employs a multi-country large scale Overlapping Generations model with uninsurable labor productivity and mortality risk to quantify the impact of the demographic transition towards an older population in industrialized countries on world-wide rates of return, international capital flows and the distribution of wealth and welfare in the OECD. We find that for the U.S. as an open economy, rates of return are predicted to decline by 86 basis points between 2005 and 2080 and wages increase by about 4.1%. If the U.S. were a closed economy, rates of return would decline and wages increase by less. This is due to the fact that other regions in the OECD will age even more rapidly; therefore the U.S. is "importing" the more severe demographic transition from the rest of the OECD in the form of larger factor price changes. In terms of welfare, our model suggests that young agents with little assets and currently low labor productivity gain, up to 1% in consumption, from higher wages associated with population aging. Older, asset-rich households tend to lose, because of the predicted decline in real returns to capital.
    JEL: C68 D33 E17 E25
    Date: 2006–08
  45. By: Antonello D’Agostino (Central Bank and Financial Service Authority of Ireland); Roberta Serafini (European Central Bank and ISAE); Melanie Ward (European Central Bank and IZA Bonn)
    Abstract: This paper investigates the determinants of the service sector employment share in the EU- 15, for the aggregate service sector, four sub-sectors and twelve service sector branches. Recently, both Europe and the US have experienced an increase in the share of servicerelated jobs in total employment. Although converging in all European countries, a significant gap in the share of service jobs in Europe relative to the US persists. Understanding the main factors behind this gap is key to achieving higher employment levels in Europe. This paper focuses on the role of barriers in the EU-15 which may have hindered its ability to absorb labour supply and therefore to adjust efficiently to the sectoral reallocation of labour. We find that a crucial role in this process has been played by the institutional framework affecting flexibility in the labour market and by the mismatch between workers’ skills and job vacancies.
    Keywords: services, sectoral adjustment, employment share, Europe, US, institutions in the labour and product market
    JEL: E24 J21 J23 J24 L80
    Date: 2006–08
  46. By: José Antonio Ocampo
    Abstract: This paper offers three guiding principles for a better relationship between the economy and democracy: democracy as the extension of citizenship; democracy as diversity; and democracy as complementary to clear, strong macroeconomic rules. This view, it is argued, implies that economic and social institutions must be subject to democratic political choice. In this context, it analyses the role of both national and international institutions in improving the complementarity of the market, social cohesion and democracy. The central role of economic and social rights serves as the overarching framework for the analysis.
    Keywords: citizenship, democracy, social cohesion, market economy, inequality, property rights
    JEL: H1 H4 I3 E61 D6 F02
    Date: 2006–02
  47. By: Yum K. Kwan
    Abstract: We investigate empirically the extent to which government consumption substitutes for private consumption in nine East Asia countries. Panel cointegrating regression uncovers a significantly positive elasticity of substitution between government and private consumption, implying on average government and private consumption are substitutes in East Asia. Country-by-country analysis, however, reveals diversity in the substitutability estimates. The four North East countries – China, Hong Kong, Japan, and Korea – tend to share similar and moderate values of the substitution elasticity. For the five ASEAN countries studied in this paper, the relationship between private and government consumption vary substantially, both in the sign and magnitude of the elasticity of substitution. Private and government consumption in Malaysia and Thailand are strong substitutes, but they are found to be complements in Indonesia and Singapore. In between is the Philippines which has a near zero elasticity of substitution.
    JEL: E6 H5
    Date: 2006–08
  48. By: Raj Chetty; Adam Szeidl
    Abstract: Many households devote a large fraction of their budgets to "consumption commitments" -- goods that involve transaction costs and are infrequently adjusted. This paper characterizes risk preferences in an expected utility model with commitments. We show that commitments affect risk preferences in two ways: (1) they amplify risk aversion with respect to moderate-stake shocks and (2) they create a motive to take large-payoff gambles. The model thus helps resolve two basic puzzles in expected utility theory: the discrepancy between moderate-stake and large-stake risk aversion and lottery playing by insurance buyers. We discuss applications of the model such as the optimal design of social insurance and tax policies, added worker effects in labor supply, and portfolio choice. Using event studies of unemployment shocks, we document evidence consistent with the consumption adjustment patterns implied by the model.
    JEL: E2 H2 H5 J21 J64
    Date: 2006–08
  49. By: Francisco Alvarez-Cuadrado
    Abstract: This paper exploits a natural experiment, the large destruction of capital in continental Europe during World War II, to characterize the transitional dynamics of an economy that begins with a capital stock below its steady state level. We use these regularities as a benchmark to discriminate among competing growth specifications. A model that combines non-separabilities in preferences with a technology that restricts the degree of substitutability between inputs outperforms the widely used AK and Cobb-Douglas specifications with time-separable preferences. Our results suggest that policy evaluations based in growth models that overlook non-separabilities in preferences or impose strong restrictions on the technological structure might be grossly misleading.
    JEL: O40 E10
    Date: 2006–08
  50. By: Gary V. Engelhardt; Anil Kumar
    Abstract: Employer matching of employee 401(k) contributions can provide a powerful incentive to save for retirement and is a key component in pension-plan design in the United States. Using detailed administrative contribution, earnings, and pension-plan data from the Health and Retirement Study, this analysis formulates a life-cycle-consistent econometric specification of 401(k) saving and estimates the determinants of saving accounting for non-linearities in the household budget set induced by matching. The participation estimates indicate that an increase in the match rate by 25 cents per dollar of employee contribution raises 401(k) participation by 3.75 to 6 percentage points, and the estimated elasticity of participation with respect to matching ranges from 0.02-0.07. The parametric and semi-parametric estimates for saving indicate that an increase in the match rate by 25 cents per dollar of employee contribution raises 401(k) saving by $400-$700 (in 1991 dollars). The estimated elasticity of 401(k) saving to matching is also small and ranges from 0.09-0.12 overall, with just under half of this effect on the intensive margin. Overall, the analysis reveals that matching is a rather poor policy instrument with which to raise retirement saving.
    JEL: E21 H24 J32
    Date: 2006–08
  51. By: Bennett T. McCallum
    Abstract: It is argued that learnability/E-stability is a necessary condition for a RE solution to be plausible. A class of linear models considered by Evans and Honkapohja (2001) is shown to include all models of the form used by King and Watson (1998) and Klein (2000), which permits any number of lags, leads, and lags of leads. For this broad class it is shown that, if current-period information is available in the learning process, determinacy is a sufficient condition for E-stability. It is not a necessary condition, however; there exist cases with more than one stable solution in which the solution based on the decreasing-modulus ordering of the system’s eigenvalues is E-stable. If in such a case the other stable solution(s) are not E-stable, then the condition of indeterminacy may not be important for practical issues.
    JEL: C62 C63 D84 E00
    Date: 2006–08
  52. By: Mary MacKinnon; Chris Minns
    Abstract: We construct consumer price indices for Canada, mainly based on the expenditure records of Canada's federal penitentiaries. Regional price variation was much greater in Canada in the late nineteenth century than in the northern U.S. The new data suggest substantial price decline to 1900. Regional price variation in Canada decreased gradually to 1914, and quickly during the First World War. For 1900-14 and 1922-3, new data are largely consistent with consumer price data compiled by The Labour Gazette. The new data suggest more inflation during the First World War.
    Date: 2006–08
  53. By: Maureen Lewis
    Abstract: After decades of neglect the HIV/AIDS epidemic has rightly become one of the highest priorities on the global agenda. Funding pledges from the donors have doubled resource commitments between 2002 and 2004 to over $6 billion. That surge in funding belies the volatile nature of contributions to HIV/AIDS initiatives at the country level. The paper analyzes the impacts of abrupt HIV/AIDS funding on macroeconomic stability, fiscal health and the development of health institutions. The macroeconomic effects are ambiguous, but depend on the overall level of aid flows, as well as those for HIV/AIDS, the management of foreign exchange inflows, and effective spending policies. The fiscal ramifications revolve around the jump in external funding that reached around 1000% in Lesotho and Swaziland, and 650% in Zambia between 2002 and 2004, and the required rapid scale up if resources are to be used productively. At the same time, the new HIV/AIDS monies are swamping public health budgets in some cases exceeding 150% of the government’s total allocations for health. The vertical HIV/AIDS programs and the set aside funding threaten to undermine the very institutions that will need to carry forward the long term HIV/AIDS prevention and treatment agenda for each country. Health systems are already fragile, and governance problems and uneven productivity compound the challenges. Health institutions require funding and attention to strengthen them in the fight against HIV/AIDS. While the committed funds are desperately needed, solutions to the dilemma will require creative options to ensure the flow of funds, manage the economic implications and ensure effective service delivery. These are explored in the concluding section.
    Keywords: HIV/AIDS, health institutions, aid flows
    JEL: E0 E6 I11 I18 O11
  54. By: Benn Eifert; Alan Gelb; Vijaya Ramachandran
    Abstract: This paper ties together the macroeconomic and microeconomic evidence on the competitiveness of African manufacturing sectors. The conceptual framework is based on the newer theories that see the evolution of comparative advantage as influenced by the business climate -- a key public good -- and by external economies between clusters of firms entering in related sectors. Macroeconomic data from purchasing power parity (PPP), though imprecisely measured, estimates confirms that Africa is high-cost relative to its levels of income and productivity. This finding is compared with firm-level evidence from surveys undertaken for Investment Climate Assessments in 2000-2004. These confirm a pattern of generally low productivity, and also suggest the importance of high indirect costs and business-environment-related losses in depressing the productivity of African firms relative to those in other countries. There are differences between African countries, however, with some showing evidence of a stronger business community and better business climate. Finally, the paper adopts a political-economy perspective on the prospects for reform of Africa’s business climate, considering African attitudes to business and the fractured nature of African business sectors as between indigenous, minority and foreign investors. The latter have far higher productivity and a greater propensity to export; however, Africa’s difficult business climate and the tendency to overcome this by working in ethnic networks slows new entry and may decrease the incentives of key parts of the business community form constituting an aggressive pressure group for reform. Even though reforms are moving forward in several countries, this slows their impact and raises the possibility that countries settle into a low-productivity equilibrium. The paper concludes with a discussion of the findings for reforms to boost the competitiveness and diversification of African economies.
    Keywords: Africa, manufacturing, private sector, business climate,
    JEL: D5 D2 E3 F2
  55. By: Stefania Albanesi
    Abstract: This paper studies optimal taxation of entrepreneurial capital and financial assets in economies with private information. Returns to entrepreneurial capital are risky and depend on entrepreneurs' hidden effort. It is shown that the idiosyncratic risk in capital returns implies that the intertemporal wedge on entrepreneurial capital that characterizes constrained-efficient allocations can be positive or negative. The properties of optimal marginal taxes on entrepreneurial capital depend on the sign of this wedge. If the wedge is positive, the optimal marginal capital tax is decreasing in capital returns, while the opposite is true when the wedge is negative. Optimal marginal taxes on other assets depend on their correlation with idiosyncratic capital returns. The optimal tax system equalizes after tax returns on all assets, thus reducing the variance of after tax returns on capital relative to other assets. If entrepreneurs are allowed to sell shares of their capital to outside investors, returns to externally owned capital are subject to double taxation- at the level of the entrepreneur and at the level of the outside investors. Even if entrepreneurs can purchase private insurance against their idiosyncratic risk, optimal asset taxes are essential to implement the constrained-efficient allocation if entrepreneurial portfolios are private information.
    JEL: D82 E22 E62 G18 H2 H21 H25 H3
    Date: 2006–08
  56. By: Yuzo Honda (School of Economics, Osaka University); Kazuyuki Suzuki (Meiji University)
    Abstract: The literature maintains the statistical significance of cash flow in the investment equation. One criticism against the financing constraint interpretation of cash flow is that cash flow may be picking up information on the future profitability of a firm which Tobinfs Q fails to capture. We confine ourselves to the investment behavior of unlisted automobile parts suppliers, and use the sales of large automobile makers as an exogenous instrument. Despite the various criticisms against the financing constraint interpretation of cash flow, our statistical evidence does not disagree with the hypothesis.
    Keywords: Tobinfs Q, Investment Equation, Cash Flow, Financing Constraint, Japanese Unlisted Firms
    JEL: E22 G31
    Date: 2006–08
  57. By: Rajnish Mehra
    Abstract: In this article we examine the Equity Premium in the Indian context and review the related literature. The equity premium is the returned earned by a well-diversified stock portfolio in excess of that earned by a risk free security such as a Treasury Bill. Consistent with U.S. experience we find that the Indian equity premium has been quite high in the post 1991 period, averaging 9.7% above the corresponding risk free security. It is difficult to justify such a premium based on theoretical considerations. The article is an entry prepared for the Oxford Companion to Economics in India edited by Kaushik Basu
    JEL: E21 G1 G12
    Date: 2006–08
  58. By: Kenneth D. West; Todd Clark
    Abstract: Forecast evaluation often compares a parsimonious null model to a larger model that nests the null model. Under the null that the parsimonious model generates the data, the larger model introduces noise into its forecasts by estimating parameters whose population values are zero. We observe that the mean squared prediction error (MSPE) from the parsimonious model is therefore expected to be smaller than that of the larger model. We describe how to adjust MSPEs to account for this noise. We propose applying standard methods (West (1996)) to test whether the adjusted mean squared error difference is zero. We refer to nonstandard limiting distributions derived in Clark and McCracken (2001, 2005a) to argue that use of standard normal critical values will yield actual sizes close to, but a little less than, nominal size. Simulation evidence supports our recommended procedure.
    JEL: C22 C53 E17 F37
    Date: 2006–08
  59. By: Mario J. Crucini (Department of Economics, Vanderbilt University); Mototsugu Shintani (Department of Economics, Vanderbilt University)
    Abstract: We study the dynamics of good-by-good real exchange rates using a micro-panel of 270 goods prices drawn from major cities in 63 countries and 258 goods prices drawn from 13 major U.S. cities. We find the half-life of deviations from the Law-of-One-Price for the average good is about 1 year. The average half-life is very similar across the OECD, the LCD and within the U.S., suggesting little in the way of nominal exchange rate regime influences. The average non-traded good has a half-life of 1.9 years compared to 1.2 years for traded-goods, for the OECD, with modest differences elsewhere. Aggregating the micro-data increases persistence in the OECD by 6 months to 1.5 years, well below levels obtained using aggregate CPI data. We attribute these differences to conceptual and methodological factors and argue in favor of increased use of micro-price data in applied theory.
    Keywords: Real exchange rates, purchasing power parity, law of one price, dynamic panel
    JEL: E31 F31 D40
    Date: 2002–12
  60. By: Peter Timmer
    Abstract: In the long run-- over the past four decades--improvements in food security in Indonesia have generally been driven by pro-poor economic growth and a successful Green Revolution, led by high-yielding rice varieties, massive investments in rural infrastructure, including irrigation, and ready availability of fertilizer. In the short run, food security in the country has been intimately connected to rice prices. After more than two decades of stabilizing domestic rice prices around the long-run trend of prices in the world market, Indonesia emerged from the devastating financial crisis in 1998 with domestic rice prices much higher than world prices and much higher than long-run trends of real prices in rupiahs. Although the current political rhetoric pushing for even higher prices uses food security as the rationale (i.e., they will cause greater self-sufficiency in rice), in fact few productivity gains are now available to rice farmers, so their gains will be consumers’ loses. High rice prices have a major impact on the number of individuals living below the poverty line and on the quality of their diet. The paper reviews research on the impact of rice prices on the poor, on real wages in rural and urban areas, and on the broader macroeconomic consequences for investments in labor-intensive manufacturing. Discussion then focuses on how political and economic circumstances have changed since price stabilization, implemented by the national food agency (Bulog), balanced the needs of producers and consumers as Indonesia’s approach to food security. The most important current challenge for the country’s future food security is re-starting rapid, pro-poor growth. An additional challenge on the horizon is the “supermarket revolution,” which is rapidly changing the basic structure of Indonesia’s food marketing system. Within a decade well over half of Indonesia’s rice is likely to be sold in supermarkets, thus transferring to the private sector a supply-management role that had historically been a public sector activity.
    Keywords: food security, Indonesia, agriculture, rice, poverty
    JEL: Q18 I31 R0 J31 J43 D40 E22
    Date: 2004–11
  61. By: Dick Sabot
    Abstract: Global poverty and poverty reduction are right now, more prominent public issues in high-income countries than they have ever have been, but progress toward the eradication of global poverty is at increasingly grave risk due to global macro-economic imbalances. At the heart of the problem is the U.S. external deficit that has turned the U.S. into the world’s largest debtor nation while developing countries, most notably in East Asia, are now among the world’s largest creditors. The impact of the adjustment of the U.S. external deficit on developing country economies will depend on U.S. macro-economic policy ahead, whether growth of U.S. exports or a decline in U.S. imports accounts for most of the reduction of the external deficit, how China, and by implication the rest of East Asia, respond to what happens in the U.S., and on the speed with which the U.S. deficit is closed. A review of how the world economy came to find itself in this historically unprecedented situation is followed by three potential scenarios for the likely impact on developing country economies of a marked decline in the U.S. external deficit. In the first scenario, the decline of the U.S. external deficit is fairly slow and steady and developing countries are able to substitute domestic demand growth for external demand growth and adjust without a recession. In the second scenario, U.S. aggregate demand for imports declines more severely because of slower economic growth and a smaller contribution of U.S. export growth to the closing of the external deficit. Chinese import demand growth is adversely affected and developing countries face a decline both in U.S. and Chinese import demand. In the third and last scenario, a sudden adjustment that generates a global financial tsunami, most likely triggered by a run on the dollar that leads to a spike in interest rates in the U.S. and a sharp drop in U.S. import demand, would transmit the downturn from the U.S. to the rest of the world.
    Keywords: economic development, poverty reduction, U.S. external deficit, import, export
    JEL: F1 F4 E6

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