nep-mac New Economics Papers
on Macroeconomics
Issue of 2006‒10‒21
fifty-six papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Optimal Interest Rate Stabilization in a Basic Sticky-Price Model By Matthias Paustian; Christian Stoltenberg
  2. Nominal wage rigidities in a new Keynesian model with frictional unemployment By Vincent Bodart; Gregory de Walque; Olivier Pierrard; Henri R. Sneessens; Raf Wouters
  3. Macroeconomic fluctuations and firm entry : theory and evidence By Vivien Lewis
  4. Comovements and heterogeneity in the Comovements and heterogeneity in the dynamic factor model By Eickmeier, Sandra
  5. The role of expectations in the inflation process in the euro area By Paloviita , Maritta; Virén , Matti
  6. The structural dynamics of output growth and inflation: some international evidence By Fabio Canova; Luca Gambetti; Evi Pappa
  7. Inflation persistence and price-setting behaviour in the euro area : a summary of the Inflation Persistence Network evidence By Filippo Altissimo; Michael Ehrmann; Frank Smets
  8. Robustness in monetary policymaking: a case for the Friedman rule By Kilponen, Juha; Leitemo, Kai
  9. Robust monetary policy in a small open economy By Leitemo , Kai; Söderström , Ulf
  10. A new Keynesian model with unemployment By Olivier Blanchard; Jordi Gali
  11. Labour taxation and shock propagation in a New Keynesian model with search frictions By Vanhala, Juuso
  12. Real Balance Effects, Timing and Equilibrium Determination By Christian Stoltenberg
  13. International economic spillovers and the liquidity trap By Tarkka , Juha; Kortelainen , Mika
  14. Dynamics and monetary policy in a fair wage model of the business cycle By David de la Croix; Gregory de Walque; Rafael Wouters
  15. Inflation expectations and regime shifts in the euro area By Virén , Matti
  16. Identifying the interdependence between US monetary policy and the stock market By Bjørnland , Hilde; Leitemo, Kai
  18. Producer Prices in the Transition to a Common Currency By Andrén, Niclas; Oxelheim, Lars
  19. Money market volatility, A simulation study By Kempa , Michal
  20. The Interplay between Money Market Development and Changes in Monetary Policy Operations in Small European Countries, 1980–2000 By Forssbaeck, Jens; Oxelheim, Lars
  21. Forecasting with a forward-looking DGE model: combining long-run views of financial markets with macro forecasting By Männistö , Hanna-Leena
  22. Comparing alternative Phillips curve specifications: European results with survey-based expectations By Paloviita , Maritta
  23. Bank interest rates in a small European economy: Some exploratory macro level analyses using Finnish data By Kauko , Karlo
  24. Monetary Policy and Inflation Expectations in Latin America: Long-run Effects and Volatility Spillovers By OECD
  25. Decomposing the co-movement of the business cycle: a time-frequency analysis of growth cycles in the euro area By Crowley , Patrick; Lee , Jim
  26. Simulation, estimation and welfare implications of monetary policies in a 3-country NOEM model By Joseph Plasmans; Tomasz Michalak; Jorge Fornero
  27. Fiscal Policy and Macroeconomic Uncertainty in Developing Countries: The Tale of the Tormented Insurer By Enrique G. Mendoza; P. Marcelo Oviedo
  28. Fiscal Sustainability in a New Keynesian Model By Campbell Leith and Simon Wren-Lewis
  29. How to Advance Theory with Structural VARs: Use the Sims-Cogley-Nason Approach By Patrick J. Kehoe
  30. Open market operations: beyond the new consensus By Toporowski , Jan
  31. Do fiscal variables affect fiscal expectations? Experiments with real world and lab data By Oliver Kirchkamp; Michele Bernasconi; Paolo Paruolo
  32. Why the marginal MRO rate exceeds the ECB policy rate? By Välimäki , Tuomas
  33. Fiscal policy in the 1920s and 1930s How much different it is from the post war period's policies? By Virén , Matti
  34. How hard is the euro are core? An evaluation of growth cycles using wavelet analysis By Crowley , Patrick; Maraun , Douglas; Mayes , David
  35. The effects of aging population on the sustainability of fiscal policy By Puhakka , Mikko
  36. Monetary Equilibria in a Baumol-Tobin Economy By Ingolf Schwarz
  37. Separating Quantity Shock and Quality Innovation in Relative Prices By Nguyen, Thang
  38. Shooting the Auctioneer By Roger E. A. Farmer; Andrew Hollenhorst
  39. Measuring the Cost of Economic Fluctuations with Preferences that Rationalize the Equity Premium By Angelo Melino
  40. Banking fragility and distress: An econometric study of macroeconomic determinants By Pesola , Jarmo
  41. Exchange rate volatility without the contrivance of fundamentals and the failure of PPP By Bask, Mikael
  42. Policy words and policy deeds: the ECB and the euro By Siklos, Pierre; Bohl , Martin
  43. La Curva de Retorno y el Modelo C-CAPM: Evidencia para Chile By González, Manuel
  44. Government size and output volatility: is there a relationship? By Virén , Matti
  45. The kinked demand curve and price rigidity : evidence from scanner data By Maarten Dossche; Freddy Heylen; Dirk Van den Poel
  46. Entrepreneurship in Early-Modern Europe (1450 - 1750): An Exploration of Some Unfashionable Themes in Economic History By John H. Munro
  47. A note on a new interpretation for the precautionary saving motive By M. Menegatti
  48. An intuitive guide to wavelets for economists By Crowley , Patrick
  49. The demand for money market mutual funds By Kauko , Karlo
  50. La complémentarité des banques et des microbanques dans une approche de la comptabilité des flux et des stocks By SODOKIN, Koffi
  51. Productive Public Expenditure and Imperfect Competition with Endogenous Price Markup: Comment By Luís F. Costa; Nuno Palma
  52. The Golden Age of Retirement By Bakken, Line Smart
  53. Labour and product market competition in a small open economy, Simulation results using a DGE model of the Finnish economy By Kilponen, Juha; Ripatti , Antti
  54. How wages change : micro evidence from the International Wage Flexibility Project By William T. Dickens; Lorenz Goette; Erica L. Groshen; Steinar Holden; Julian Messina; Mark E. Schweitzer; Jarkko Turunen; Melanie E. Ward
  55. Wage Structure and Public Sector Employment: Sweden versus the United States 1970-2002 By Domeij, David; Ljungqvist, Lars
  56. Ageing, interest rates, and financial flows By Saarenheimo , Tuomas

  1. By: Matthias Paustian; Christian Stoltenberg
    Abstract: This paper studies optimal monetary policy with the nominal interest rate as the single policy instrument in an economy, where firms set prices in a staggered way without indexation and real money balances contribute separately to households' utility. The optimal deterministic steady state under commitment is the Friedman rule - even if the importance assigned to the utility of money is small relative to consumption and leisure. We approximate the model around the optimal steady state as the long-run policy target. Optimal monetary policy is characterized by stabilization of the nominal interest rate instead of inflation stabilization as the predominant principle.
    Keywords: Optimal monetary policy, commitment, timeless perspective, optimal steady state, staggered price setting, monetary friction, Friedman's rule
    JEL: E32 E52 E58
    Date: 2006–10
  2. By: Vincent Bodart (Department of Economics, Université catholique de Louvain); Gregory de Walque (National Bank of Belgium, Research department; Department of Economics, University of Namur); Olivier Pierrard (Department of Economics, Université catholique de Louvain; Banque centrale du Luxembourg); Henri R. Sneessens (Department of Economics, Université catholique de Louvain); Raf Wouters (National Bank of Belgium, Research department)
    Abstract: In this paper, we propose a search and matching model with nominal stickiness à la Calvo in the wage bargaining. We analyze the properties of the model, first, in the context of a typical real business cycle model driven by stochastic productivity shocks and second, in a fully specified monetary DSGE model with various real and nominal rigidities and multiple shocks. The model generates realistic statistics for the important labor market variables
    Keywords: DSGE, Search and Matching, Nominal Wage Rigidity, Monetary Policy
    JEL: E31 E32 E52 J64
    Date: 2006–10
  3. By: Vivien Lewis (Center for Economic Studies, Catholic University Leuven)
    Abstract: This paper studies the behaviour of firm entry and exit in response to macroeconomic shocks. We formulate a dynamic stochastic general equilibrium model with an endogenous number of producers. From the calibrated model, we derive a minimum set of robust sign restrictions to identify four kinds of macroeconomic shocks in a vector autoregression, namely supply, demand, monetary and entry cost shocks. The variables entering the VAR are output, inflation, the nominal interest rate, profits and firm entry. The response of firm entry to the various shocks is freely estimated. Our main finding is that entry responds significantly to all types of shocks. The results also show a crowding-in of firm entry following an exogenous rise in demand, consistent with the effect of a consumption preference shock predicted by the model
    Keywords: firm entry, VAR, business cycles
    JEL: E30 E32
    Date: 2006–10
  4. By: Eickmeier, Sandra
    Abstract: This paper seeks to assess comovements and heterogeneity in the euro area by fitting a nonstationary dynamic factor model (Bai and Ng, 2004), augmented with a structural factor setup (Forni and Reichlin, 1998), to a large set of euro-area macroeconomic variables observed between 1982 and 2003. This framework allows us to estimate stationary and non-stationary common factors and idiosyncratic components, to identify the structural shocks behind the common factors and assess their transmission to individual EMU countries. Our most important findings are the following. EMU countries share five common trends. However, the source of non-stationarity of individual countries’ key macroeconomic variables is not only pervasive. Instead, most countries’ output and inflation are also affected by long-lasting idiosyncratic shocks. Unweighted dispersion is primarily due to idiosyncratic shocks rather than the asymmetric spread of common shocks. However, the latter seems to be the main driving force of weighted dispersion of output at the end of the 1980s and the beginning of the 1990s and again from 1999 on and of inflation in the mid-1980s and the mid-1990s. To examine the transmission of common shocks to individual EMU countries in more detail, we identify five structural common shocks, namely two euro-area supply shocks, one euro-area demand shock, one common monetary policy shock and a US shock. We find similar output and inflation responses across countries (with some exceptions), and similarity generally increases with the horizon.
    Keywords: Dynamic factor models, sign restrictions, common trends, common cycles, international business cycles, EMU, output and inflation differentials
    JEL: C3 E32 E5 F00
    Date: 2006
  5. By: Paloviita , Maritta (Bank of Finland Research); Virén , Matti (University of Turku)
    Abstract: This paper analyses the role of inflation expectations in the euro area. On one hand, the question is how inflation expectations affect both inflation and output, and, on the other hand, how inflation expectations reflect developments in these variables. The analyses make use of a simple VAR model of inflation, inflation expectations and the output gap that allows for an analysis of the dynamic interrelationship between these variables. This model is estimated on aggregate euro area data, pooled euro area country data and individual country data for the period 1979–2003. The empirical results give strong support for the idea that inflation expectations are the key ingredient of the inflationary process for the whole euro area and for most individual countries as well. Inflation expectations also have a significant negative impact on output. As for the determination of inflation expectations, it turns out that they are relatively persistent, almost as persistent as output. Even so, and especially in the medium term, inflation expectations adapt to developments in both output and (actual) inflation.
    Keywords: inflation; expectations; monetary policy; Phillips curve
    JEL: E31 E52
    Date: 2005–02–13
  6. By: Fabio Canova; Luca Gambetti; Evi Pappa
    Abstract: We examine the dynamics of output growth and inflation in the US, Euro area and UK using a structural time varying coe¢ cient VAR. There are important similarities in structural inflation dynamics across countries; output growth dynamics differ. Swings in the magnitude of inflation and output growth volatilities and persistences are accounted for by a combination of three structural shocks. Changes over time in the structure of the economy are limited and permanent variations largely absent. Changes in the volatilities of structural shocks matter
    Keywords: Variability, Persistence, Transmission, Structural time varying VARs
    JEL: C11 E12 E32 E62
    Date: 2006–04
  7. By: Filippo Altissimo (European Central Bank); Michael Ehrmann (European Central Bank); Frank Smets (European Central Bank)
    Abstract: This paper provides a summary of current knowledge on inflation persistence and price stickiness in the euro area, based on research findings that have been produced in the context of the Inflation Persistence Network. The main findings are: i) Under the current monetary policy regime, the estimated degree of inflation persistence in the euro area is moderate; ii) Retail prices in the euro area are more sticky than in the US; iii) There is significant sectoral heterogeneity in the degree of price stickiness; iv) Price decreases are not uncommon. The paper also investigates some of the policy implications of these findings
    Keywords: price-setting; inflation persistence; monetary policy; EMU
    JEL: E31 E42 E52
    Date: 2006–10
  8. By: Kilponen, Juha (Bank of Finland Research); Leitemo, Kai (Norwegian School of Management (BI))
    Abstract: Inflation targeting involves using all available information in stabilizing inflation around some target rate (Svensson, 2003). Inflation is typically at the very end of the transmission mechanism and hence its de-termination is subject to much model uncertainty which the central bank will want to guard against using robust policies. Such robustness comes however with the cost of increased social loss under the most likely description of the economy. We show that with a sufficiently high degree of model uncertainty, ad-herence to the Friedman rule of increasing the money stock by k percent will be superior as the price paid for robustness is smaller.
    Keywords: policy robustness; money growth targeting; inflation targeting; Friedman rule
    JEL: E42 E52 E58 E61
    Date: 2006–04–19
  9. By: Leitemo , Kai (Norwegian School of Management (BI)); Söderström , Ulf (Department of Economics and IGIER, Università Bocconi)
    Abstract: This paper studies how a central bank’s preference for robustness against model misspecification affects the design of monetary policy in a New-Keynesian model of a small open economy. Due to the simple model structure, we are able to solve analytically solve the optimal robust policy rule, and separately ana-lyze the effects of robustness against misspecification concerning the determination of inflation, output and the exchange rate. We show that an increased central bank preference for robustness makes monetary policy respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification.
    Keywords: Knightian uncertainty; model uncertainty; robust control; min-max policies
    JEL: E52 E58 F41
    Date: 2005–10–11
  10. By: Olivier Blanchard (MIT; NBER); Jordi Gali (Barcelona, Universitat Pompeu Fabra (UPF), Centre de Recerca en Economia Internacional (CREI); CEPR; NBER)
    Abstract: We develop a utility based model of fluctuations, with nominal rigidities, and unemployment. In doing so, we combine two strands of research: the New Keynesian model with its focus on nominal rigidities, and the Diamond-Mortensen-Pissarides model, with its focus on labor market frictions and unemployment. In developing this model, we proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and we draw the implications for optimal monetary policy
    Keywords: new Keynesian model, labor market frictions, search model, unemployment, sticky prices, real wage rigidities
    JEL: E32 E50
    Date: 2006–10
  11. By: Vanhala, Juuso (Bank of Finland Research)
    Abstract: This paper studies the implications of labour taxation in determining the sensitivity of an economy to macroeconomic shocks. We construct a New Keynesian business cycle model with matching frictions of the labour market, where sluggish employment adjustment implies a key role for labour markets in de-termining shock propagation. We consider three policy instruments to analyze the steady state and dy-namic effects of tax reforms: the marginal tax rate and replacement ratio amplify shock responses whereas employment subsidies weaken them. The tax instruments affect the degree to which the wage absorbs shocks. We show that the relative effects of the tax instruments and thus the effects of tax pro-gression are sensitive to the initial degree of tax progression in the economy. Increasing tax progression when taxation is initially progressive is harmful for steady state employment and output, and amplifies the sensitivity of macroeconomic variables to shocks. When taxation is initially proportional, increasing progression is beneficial for output and employment and dampens shock responses of macroeconomic variables.
    Keywords: matching; income taxation; business cycles
    JEL: E24 E32 J64
    Date: 2006–06–12
  12. By: Christian Stoltenberg
    Abstract: This paper examines whether the existence and the timing of real balance effects contribute to the determination of the absolute price level, as suggested by Patinkin (1949,1965), and if they affect conditions for local equilibrium uniqueness and stability. I show that there exists a unique price level sequence that is consistent with an equilibrium under interest rate policy, only if beginning-of-period money yields transaction services. Predetermined real money balances can then serve as a state variable, implying that interest rate setting must be passive - a violation of the Taylor-principle - for unique, stable, and non-oscillatory equilibrium sequences. On the contrary, when the end-of-period money stock facilitates transactions, the equilibrium displays nominal indeterminacy and equilibrium uniqueness requires an interest rate setting consistent with the Taylor-principle.
    Keywords: Real balance effects, predetermined money, price level determination, real determinacy, monetary policy rules, flexible prices
    JEL: E32 E41 E52
    Date: 2006–10
  13. By: Tarkka , Juha (Bank of Finland Research); Kortelainen , Mika (Bank of Finland Research)
    Abstract: We study the effect of the zero bound constraint of interest rates on international transmission of eco-nomic policy and supply shocks. After some preliminary analysis with a simple theoretical model, we ap-ply a rich two-country simulation model to the problem. The model framework consists of EDGE, Bank of Finland’s dynamic equilibrium model for the euro area, linked to a similar model calibrated to resem-ble the US economy. The models have new Keynesian properties because of price rigidities and forward-looking pricing, consumption and investment behaviour. We assume freely floating exchange rates. Monetary policies are modelled with Taylor type policy rules, taking into account the zero bound con-straint for interest rates. We find that effects of policy and supply side shocks differ significantly from the ‘normal’ situation if one of the countries is in the ‘liquidity trap’, ie if the interest rate is constrained by the zero bound. Being in the liquidity trap amplifies the domestic effects of fiscal policy, but mitigates its spillover to abroad. Changing the long run inflation target, which does not have international spillovers in the normal case, does have effects abroad if the country where the target is changed is in a temporary li-quidity trap. The effects of supply shocks are also very different in the liquidity trap case compared to the normal case.
    Keywords: zero bound; liquidity trap; international spillovers; edge
    JEL: F42 F47
    Date: 2005–07–11
  14. By: David de la Croix (Department of economics, Université catholique de Louvain; CORE); Gregory de Walque (National Bank of Belgium, Research department; Department of Economics, University of Namur); Rafael Wouters (National Bank of Belgium, Research department)
    Abstract: We first build a fair wage model in which effort varies over the business cycle. This mechanism decreases the need for other sources of sluggishness to explain the observed high inflation persistence. Second, we confront empirically our fair wage model with a New Keynesian model based on the standard assumption of monopolistic competition in the labor market. We show that, in terms of overall fit, the fair wage model outperforms the New Keynesian one. The extension of the fair wage model with lagged wage is judged insignificant by the data, but the extension based on a rent sharing argument including firm’s productivity gains in the fair wage is not. Looking at the implications for monetary policy, we conclude that the additional trade-off problem created by the inefficient real wage behavior significantly affects nominal interest rates and inflation outcomes
    Keywords: Efficiency wage, effort, inflation persistence, monetary policy
    JEL: E4 E5
    Date: 2006–10
  15. By: Virén , Matti (Bank of Finland and University of Turku)
    Abstract: This paper focuses on the determination of inflation expectations. The following two questions are exam-ined: 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 assump-tion 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 expecta-tions 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 de-rived 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: 2005–10–11
  16. By: Bjørnland , Hilde (University of Oslo, Department of Economics); Leitemo, Kai (Department of Economics, Norwegian School of Management BI)
    Abstract: We estimate the interdependence between US monetary policy and the S&P 500 using structural VAR methodology. A solution is proposed to the simultaneity problem of identifying monetary and stock price shocks by using a combination of short-run and long-run restrictions that maintains the qualitative proper-ties of a monetary policy shock found in the established literature (CEE 1999). We find great interde-pendence between interest rate setting and stock prices. Stock prices immediately fall by 1.5 per cent due to a monetary policy shock that raises the federal funds rate by ten basis points. A stock price shock in-creasing stock prices by one per cent leads to an increase in the interest rate of five basis points. Stock price shocks are orthogonal to the information set in the VAR model and can be interpreted as non-fundamental shocks. We attribute a major part of the surge in stock prices at the end of the 1990s to these non-fundamental shocks.
    Keywords: VAR; monetary policy; asset prices; identification
    JEL: E43 E52 E61
    Date: 2005–07–11
  17. By: Hsiao Chink Tang
    Abstract: This paper investigates the relative strength of four monetary policy transmission channels (exchange rate, asset price, interest rate and credit) in Malaysia using a 12-variable open economy VAR model. By comparing the baseline impulse response with the constrained impulse response where a particular channel is being switched off, the interest rate channel is found to be the most important in influencing output and inflation in the horizon of about two years, and the credit channel beyond that. The asset price channel is also relevant in the shorter-horizon, more so than the exchange rate channel, particularly in influencing output. For inflation, the exchange rate channel is more relevant than the asset price channel.
    Date: 2006–08
  18. By: Andrén, Niclas (Institute of Economic Research); Oxelheim, Lars (Research Institute of Industrial Economics)
    Abstract: We analyze producer price developments in the transition from a national exchange rate regime to a monetary union. The focus is on the European Economic and Monetary Union (EMU). Stylized facts witness about an exploding gaps in producer-price inflation during the years immediately following the completion of the EMU. Price convergence is found to be an important driver throughout the entire euro period (1999-2005), but with no significant differences in speed compared to the pre euro period. Productivity growth had its primary effect in the first years and effective exchange-rate changes in the later years of the euro period.
    Keywords: Producer prices; Relative prices; Price convergence; Euro; Balassa-Samuelson
    JEL: E31 E44 F15 F23 G34
    Date: 2006–09–22
  19. By: Kempa , Michal (RUESG, University of Helsinki and Bank of Finland)
    Abstract: This paper analyses different operational central bank policies and their impact on the behaviour of the money market interest rate. The model combines profit maximising behaviour by commercial banks with the central bank supplying the liquidity that keeps the market rate on target. It seems that frequent liquid-ity supplying operations represent an efficient tool to control money market rates. An averaging provision reduces the use of standing facilities and interest rates volatility in all days except for the last day of the maintenance period. Whenever banks have different maintenance horizons both the spikes in volatility and use of standing facilities disappear. The paper also compares two different liquidity supply policies and finds that the level of liquidity necessary to keep the rates on target depends on not only the aggregate but also assets values of individual banks.
    Keywords: Interbank market; interest rate volatility; central bank procedures; open market operations
    JEL: E43 E44 E52
    Date: 2006–06–12
  20. By: Forssbaeck, Jens (Lund Institute of Economics Research); Oxelheim, Lars (Research Institute of Industrial Economics)
    Abstract: We study the interplay between money market development and changes in monetary policy operating procedures in 11 European countries from c. 1980 up to the launch of EMU. Aspects of money market development such as the size and structure of different market segments, and institutional and regulatory changes, are addressed. We recount and empirically examine the extent of reorientation of monetary policy instruments away from quantitative direct control instruments toward indirect market-based instruments. The process of financial deregulation is uniform across the countries. The path of money market development varies substantially, whereas changes in central bank instruments show both similarities and differences. We hypothesise a relationship between the two processes and provide tentative evidence.
    Keywords: Monetary policy operations; Money market; European Union; Deregulation
    JEL: E52 E58 G28 N24
    Date: 2006–09–22
  21. By: Männistö , Hanna-Leena (Bank of Finland Research)
    Abstract: To develop forecasting procedures with a forward-looking dynamic general equilibrium model, we built a small New-Keynesian model and calibrated it to euro area data. It was essential in this context that we allowed for long-run growth in GDP. We brought additional asset price equations based on the expecta-tions hypothesis and the Gordon growth model, into the standard open economy model, in order to extract information on private sector long-run expectations on fundamentals, and to combine that information into the macro economic forecast. We propose a method of transforming the model in forecasting use in such a way, as to match, in an economically meaningful way, the short-term forecast levels, especially of the model's jump-variables, to the parameters affecting the long-run trends of the key macroeconomic variables. More specifically, in the model we have used for illustrative purposes, we pinned down the long-run inflation expectations and domestic and foreign potential growth-rates using the model's steady state solution in combination with, by assumption, forward looking information in up-to-date financial market data. Consequently, our proposed solution preserves consistency with market expectations and results, as a favourable by-product, in forecast paths with no initial, first forecast period jumps. Further-more, no ad hoc re-calibration is called for in the proposed forecasting procedures, which clearly is an advantage from point of view of transparency in communication.
    Keywords: forecasting; New Keynesian model; DSGE model; rational expectations; open economy
    JEL: E17 E30 E31 F41
    Date: 2005–10–11
  22. By: Paloviita , Maritta (Bank of Finland Research)
    Abstract: This paper examines inflation dynamics in Europe. Econometric specification tests with pooled European data are used to compare the empirical performance of the New Classical, New Keynesian and Hybrid specifications of the Phillips curve. Instead of imposing any specific form of expectations formation, di-rect measures, ie Consensus Economics survey data are used to proxy economic agents’ inflation expecta-tions. According to the results, the New Classical Phillips curve has satisfactory statistical properties. Moreover, the purely forward-looking New Keynesian Phillips curve is clearly outperformed by the New Classical and Hybrid Phillips curves. We interpret our results as indicating that the European inflation process is not purely forward-looking, and inflation cannot instantaneously adjust to changes in expecta-tions. Consequently, even allowing for possible non-rationality in expectations, a lagged inflation term enters the New Keynesian Phillips curve for inflation dynamics in Europe.
    Keywords: Phillips curve; expectations; Europe
    JEL: C52 E31
    Date: 2005–10–11
  23. By: Kauko , Karlo (Bank of Finland Research)
    Abstract: This paper presents econometric analyses on the determination of bank deposit and lending rates using longitudinal Finnish data. Interest rate pass-through is very strong, possibly complete, in the case of lending rates; in the case of deposit rates the pass-through is far from complete, even in the long term. The monetary union has benefited customers by decreasing the average rate on new loans. Credit and interest rate risk premiums are clearly observable in banks' lending rates. The impact of money market rates on loan stock rates seems to have been non-linear; no obvious explanation for this phenomenon has been found.
    Keywords: banking; interest rates
    JEL: E43 E44 G21
    Date: 2005–05–11
  24. By: OECD
    Abstract: The current monetary policy framework in several Latin American countries, combining inflation targeting and a floating exchange-rate regime, has contributed to disinflation by anchoring expectations around low, stable levels. This paper uses co-integration analysis to estimate simultaneously a monetary reaction function and the determinants of expected inflation for Brazil, Chile, Colombia and Mexico in the post-1999 period. It also tests for the presence of volatility spillovers between the monetary stance and inflation expectations based on M-GARCH modelling. The results of the empirical analysis show that: i) there are long-term relationships between the interest rate, expected inflation and the inflation target, suggesting that monetary policy has been conducted in a forward-looking manner and helped anchor inflation expectations in the countries under examination, and ii) greater volatility in the monetary stance leads to higher volatility in expected inflation in Brazil, Colombia and Mexico, suggesting that interest-rate smoothing contributes to reducing inflation expectations volatility. No volatility spillover effect was detected in the case of Chile. <P>Politique monétaire et anticipations d'inflation en Amérique latine : Effets à long terme et spillovers de volatilité <BR>Le cadre courant de la politique monétaire dans plusieurs pays d'Amérique latine, qui combine un ciblage d'inflation et un régime de taux de change flottant, a contribué à la désinflation par ancrage des anticipations d'inflation à un niveau bas et stable. Ce document utilise une analyse de co-intégration pour estimer simultanément une fonction de réaction da la politique monétaire et les déterminants des anticipations d'inflation pour le Brésil, le Chili, la Colombie et le Mexique depuis 1999. Des tests sont aussi présentés sur la présence d'effets de spillover de volatilité entre la politique monétaire et les anticipations d'inflation, en s'appuyant sur le modèle M-GARCH. Les résultats de l'analyse empirique montrent que : i) il existe des relations de long terme entre le taux d'intérêt, les anticipations d'inflation et la cible d'inflation. Cela suggère que la politique monétaire a été conduite selon une méthode prospective et a assuré l'ancrage des anticipations d'inflation; et ii) une plus grande volatilité de la politique monétaire entraîne une plus importante volatilité des anticipations d'inflation au Brésil, en Colombie et au Mexique, cela laisse penser qu'un lissage des taux d'intérêt contribue à une réduction de la volatilité des anticipations d'inflation. Aucun spillover de volatilité n'a été détecté dans le cas du Chili.
    Keywords: Mexico, Mexique, Brazil, Brésil, inflation target, cible d'inflation, Chile, Chili, Colombia, Colombie, multiple co-integration, co-intégration multiple, volatility spillover, spillover de volatilité, M-GARCH modelling, M-GARCH
    JEL: C22 E52 O54
    Date: 2006–10–04
  25. By: Crowley , Patrick (Bank of Finland Research and College of Business, Texas A&M University); Lee , Jim (College of Business, Texas A&M University)
    Abstract: This article analyses the frequency components of European business cycles using real GDP by employ-ing multiresolution decomposition (MRD) with the use of maximal overlap discrete wavelet transforms (MODWT). Static wavelet variance and correlation analysis is performed, and phasing is studied using co-correlation with the euro area by scale. Lastly dynamic conditional correlation GARCH models are used to obtain dynamic correlation estimates by scale against the EU to evaluate synchronicity of cycles through time. The general findings are that euro area members fall into one of three categories: i) high and dynamic correlations at all frequency cycles (eg France, Belgium, Germany), ii) low static and dy-namic correlations, with little sign of convergence occurring (eg Greece), and iii) low static correlation but convergent dynamic correlations (eg Finland and Ireland).
    Keywords: business cycles; growth cycles; European Union; multiresolution analysis; wavelets; co-correlation; dynamic correlation
    JEL: C65 E32 O52
    Date: 2005–05–11
  26. By: Joseph Plasmans (Department of Economics, University of Antwerp); Tomasz Michalak (Department of Economics, University of Antwerp); Jorge Fornero (Department of Economics, University of Antwerp)
    Abstract: In this paper we derive a microfounded macro New Keynesian model for open economies, be them large or small. We consider habit formation in consumption, sectoral linkages, domestic and foreign governments, tradable and non-tradable final and intermediate goods and imperfect pass-through in these sectors. Sticky nominal prices and wages are modeled in a Calvo way. The model economy is composed of a continuum of infinitely-lived consumers and producers for three regions (countries). Numerical simulations and econometric estimations are presented with a focus on a small open economy member of the EMU. Welfare implications of the involved price and wage rigidities are discussed
    Keywords: New Keynesian open economy model, tradable and non-tradable sectors, final and intermediate goods, monetary policy rules, numerical simulations, Bayesian estimation, welfare implications
    JEL: E31 D21 F41 P24
    Date: 2006–10
  27. By: Enrique G. Mendoza; P. Marcelo Oviedo
    Abstract: Governments in emerging markets often behave like a "tormented insurer," trying to use non-state-contingent debt instruments to avoid cuts in payments to private agents despite large fluctuations in public revenues. In the data, average public debt-GDP ratios decline as the variability of revenues increases, primary balances and current expenditures follow cyclical patterns sharply at odds with the countercyclical patterns of industrial countries, and the cyclical variability of public expenditures exceeds that of private expenditures by a wide margin. This paper proposes a model of a small open economy with incomplete markets that can rationalize this behavior. In the model a fiscal authority makes optimal expenditure and debt plans given shocks to output and revenues, and private agents make optimal consumption and asset accumulation plans. Quantitative analysis of the model calibrated to Mexico yields a negative relationship between average public debt and revenue variability similar to the one observed in the data. The model mimics Mexico's GDP correlations of government purchases and the primary balance. The ratio of public-to-private expenditures fluctuates widely and the implied welfare costs dwarf conventional estimates of negligible benefits of risk sharing and consumption smoothing.
    JEL: E62 F34 H63
    Date: 2006–10
  28. By: Campbell Leith and Simon Wren-Lewis
    Abstract: Most recent work deriving optimal monetary policy utilising New Neo-Classical Synthesis (NNCS) models abstract from the impact of monetary policy on the government’s finances, by assuming the existence of lump sum taxes. In this paper, we assume that the government does not have access to such taxes to satisfy its intertemporal budget constraint in the face of shocks. We then consider optimal monetary and fiscal policies under discretion and commitment in the face of technology, preference and cost-push shocks. We find that the optimal precommitment policy implies a random walk in the steady-state level of debt, generalising earlier results that involved only a single fiscal instrument. We also find that the time-inconsistency in the optimal precommitment policy is such that governments are tempted, given inflationary expectations, to utilise their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service. We show that this temptation is only eliminated if following shocks, the new steady-state debt is equal to the original (efficient) debt level. This implies that under a discretionary policy the random walk result is overturned: debt will always be returned to this initial steady-state even although there is no explicit debt target in the government’s objective function. Analytically and in a series of numerical simulations we show which instrument is used to stabilise the debt depends crucially on the degree of nominal inertia and the size of the debt-stock. We also show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy.
    JEL: E60
  29. By: Patrick J. Kehoe
    Abstract: The common approach to evaluating a model in the structural VAR literature is to compare the impulse responses from structural VARs run on the data to the theoretical impulse responses from the model. The Sims-Cogley-Nason approach instead compares the structural VARs run on the data to identical structural VARs run on data from the model of the same length as the actual data. Chari, Kehoe, and McGrattan (2006) argue that the inappropriate comparison made by the common approach is the root of the problems in the SVAR literature. In practice, the problems can be solved simply. Switching from the common approach to the Sims-Cogley-Nason approach basically involves changing a few lines of computer code and a few lines of text. This switch will vastly increase the value of the structural VAR literature for economic theory.
    JEL: C32 C51 C52 E13 E17 E21 E27 E32 E37
    Date: 2006–10
  30. By: Toporowski , Jan (SOAS, University of London)
    Abstract: The emergence of the New Consensus in monetary policy has been followed by a renewal of interest in central banks’ operating procedures, and specifically in the role of open market operations. There is a general view that overnight interest rates are most effectively controlled by standing or discount window facilities, rather than open market operations, and this view will probably now extend also to lender-of-last-resort intervention. The paper argues that this reduced role for open market operations is only in the context of controlling overnight rates of interest. In spite of the emphasis on control of overnight interest rates, medium and long-term interest rates remain the crucial instruments in the monetary transmission mechanism. Longer-term interest rates are susceptible to influence by open market operations, and their importance grows with financial development.
    Keywords: central banks; monetary policy; open market operations
    JEL: E52 E58
    Date: 2006–06–21
  31. By: Oliver Kirchkamp; Michele Bernasconi; Paolo Paruolo
    Abstract: We generate observable expectations about fiscal variables through laboratory experiments using real world data from several European countries as stimuli. We compare a VAR model of expectations for data which is presented in a fiscal frame with one for neutrally presented data. We find that participants understand the meaning of the fiscal variables, but also that their ability to perceive the correct characteristics of fiscal policy is limited. We tie the VAR analysis to specific models of forming expectations. We find that agents’ expectations are neither consistent with rational nor with purely adaptive expectations but, instead, follow an augmented-adaptive scheme
    Keywords: Experiments, fiscal policy, expectations, causality, cointegration, panel data.
    JEL: C91 D89 E62 H31
    Date: 2006–06
  32. By: Välimäki , Tuomas (Bank of Finland)
    Abstract: In the Eurosystem, banks’ interest rate expectations should no longer have resulted in a non-zero tender spread, the difference between marginal and minimum price for liquidity, when the ECB reformed its op-erational framework for monetary policy implementation in March 2004 so that the policy rates remain constant within reserves maintenance periods. Yet, the tender spread was wider in 2005 than in any single year after 2000, when the ECB switched from fixed to variable rate tenders. Parts of the relevant literature have argued that because of the ECB’s asymmetric preferences over deviations of the market rates up and down from the policy rate, the shortest euro interest rates persistently exceed the policy rate This paper argues, however, that when the central bank applies a quantity oriented liquidity policy, a positive tender spread may result from money market inefficiencies and banks’ risk aversion even if the central bank preferences are symmetric and the markets do not anticipate any changes in the policy rates. In such a case, the driving force behind the tender spread is banks’ uncertainty about their individual allotments at the marginal rate for the Eurosystem main refinancing operations (MROs). Furthermore, the allotment uncertainty is shown to be significantly related to the amount of liquidity supplied in each operation. Hence, the expansion in the MRO volumes experienced since 2002 may have had a major contribution to the emergence and observed growth of the tender spread.
    Keywords: main refinancing operations; liquidity; tender spread; allotments
    JEL: D44 E58
    Date: 2006–10–03
  33. By: Virén , Matti (Bank of Finland and University of Turku)
    Abstract: This paper deals with the fiscal behaviour of governments in the 1920s and 1930s. The intention is to see whether there were the same features in government behaviour as in the post-World War II era. In par-ticular, attention is paid to asymmetric fiscal policies, ie the question of whether government deficits react differently to income growth and inflation during depressions and booms. The analysis is carried out us-ing data primarily from the League of Nations. The data come from 32 countries and covers the period 1925–1938. Estimation results suggest the in pre-war period deficits were much less sensitive to output and did not show as many asymmetric features as in post-war period. Otherwise, the same regularities apply to the empirical results. In particular, this is true with the disciplinary role of government debt in terms of budget deficits.
    Keywords: fiscal policy; deficit; asymmetric behaviour
    JEL: E62 H62
    Date: 2005–07–11
  34. By: Crowley , Patrick (College of Business, Texas A&M University); Maraun , Douglas (Nonlinear Dynamics Group Physics Institute, University of Potsdam); Mayes , David (Monetary Policy and Research Department,)
    Abstract: Using recent advances in time-varying spectral methods, this research analyses the growth cycles of the core of the euro area in terms of frequency content and phasing of cycles. The methodology uses the con-tinuous wavelet transform (CWT) and also Hilbert wavelet pairs in the setting of a non-decimated discrete wavelet transform in order to analyse bivariate time series in terms of conventional frequency domain measures from spectral analysis. The findings are that coherence and phasing between the three core members of the euro area (France, Germany and Italy) have increased since the launch of the euro.
    Keywords: time-varying spectral analysis; coherence; phase; business cycles; EMU; growth cycles; Hilbert trans-form; wavelet analysis
    JEL: C19 C63 C65 E32 E39 E58 F40
    Date: 2006–09–27
  35. By: Puhakka , Mikko (Department of Economics, University of Oulu)
    Abstract: We study the effects of aging population on the sustainability of fiscal policy in overlapping generations models with government debt and a pay-as-you-go pension system. The smaller the population growth rate, the lower the maximum sustainable level of deficits. When the utility function is of a specific form, an increase in the payroll tax rate and the replacement rate decreases the level of maximum sustainable deficits; except in the case when pension depends on the wage level prevailing during the working period. The ratio of the deficits in two economies with different population growth rates is characterized with numerical examples.
    Keywords: aging; pensions; overlapping generations; fiscal policy
    JEL: E21 E32
    Date: 2005–10–11
  36. By: Ingolf Schwarz (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This paper provides a non-steady state general equilibrium foundation for the transactions demand for money going back to Baumol (1952) and Tobin (1956). In our economy, money competes against real capital as a store of value. We prove existence of a monetary general equilibrium in which both real capital and fiat money are voluntarily held over time. The demand for money is generated by fixed transactions costs. More precisely, we assume that house-holds have two physically separated accounts. On the first account they finance consumption and might want to hold money over time. On the second account households receive their wages, hold claims on capital and earn interest income from renting capital to firms. Every transfer of wealth between the two accounts requires fixed resources. In equilibrium, households space apart the transaction dates in time. Between these transaction dates, money is held as a store of value on the first account for transactions purposes. The number of periods over which money is held is endogenous and the nonconvexity of the problem is explicitly taken into account.
    Keywords: Baumol-Tobin, Monetary Theory, General Equilibrium Theory
    JEL: D50 E40 E41
    Date: 2006–06
  37. By: Nguyen, Thang
    Abstract: The study develops a simple general equilibrium model to infer relative quality changes, and applies the method to the US services goods economy in 1946-2005. The general equilibrium framework helps separate quantity and quality e¤ects on the observable relative price and budget share which constitute double manifestation. Empirical results show that US services relative quality is increasing since 1970s, and quantity shock alone cannot fully explain the evolution of services relative price. The latter finding puts forth a warning on the missing of quality changes in some business cycle models.
    Keywords: quality innovation; quality inference; business cycles
    JEL: E31 E32
    Date: 2005–09–21
  38. By: Roger E. A. Farmer; Andrew Hollenhorst
    Abstract: Most dynamic stochastic general equilibrium models of the macroeconomy assume that labor is traded in a spot market. Two exceptions by David Andolfatto and Monika Merz combine a two-sided search model with a one-sector real business cycle model. These hybrid models are successful, in some dimensions, but they cannot account for observed volatility in unemployment and vacancies. Following suggestions by Robert Hall and Robert Shimer, this paper shows that a relatively standard DSGE model with sticky wages can account for these facts. Using a second-order approximation to the policy function we simulate moments of an artificial economy with and without sticky wages and we document the dependence of unemployment and vacancy volatility on two key parameters; the disutility of effort and the degree of wage stickiness. We compute the welfare costs of the sticky wage equilibrium and find them to be small.
    JEL: E32 J6
    Date: 2006–10
  39. By: Angelo Melino
    Abstract: Lucas (2003) argues that the potential welfare gains from stabilizing the business cycle are small. In fact, he shows that the benefits of eliminating all economic fluctuations are small, both in an absolute sense and when compared to the potential gains from other reforms. His estimates are obtained using standard preferences. In this paper, I show that a model consistent with observed data on asset returns leads to very different conclusions. Calibrating preferences to observed asset market data raises the estimated welfare gains from completely eliminating aggregate fluctuations by approximately two orders of magnitude. Most of the gains, however, come from the elimination of low frequency contributions.
    Keywords: welfare cost, fluctuations, stabilization
    JEL: E32 E61
    Date: 2006–10–08
  40. By: Pesola , Jarmo (Bank of Finland Research)
    Abstract: The macroeconomic determinants of banking sector distresses in the Nordic countries, Belgium, Ger-many, Greece, Spain and the UK are analysed using an econometric model estimated on panel data from partly the early 1980s to 2002. The dependent variable is the ratio of banks’ loan losses to lending. In ad-dition to the lagged dependent variable, the explanatory variables include a surprise change in incomes and real interest rates, both variables as a separate cross-product term with lagged aggregate indebtedness. The underlying macroeconomic account that this paper puts forward is that loan losses are basically gen-erated by strong adverse aggregate shocks under high exposure of banks to such shocks. The underlying innovations to income and real interest rates are constructed using published macro-economic forecast for these variables. According to the results, high customer indebtedness combined with adverse macroeco-nomic surprise shocks to income and real interest rates contributed to the distress in banking sector. Loan losses also display strong autoregressive behaviour which might indicate a feedback effect from loan losses back to macroeconomic level in deep recessions. The results can be used in macro stress-testing the banking sector.
    Keywords: financial fragility; shock; loan loss; banking crisis
    JEL: E44 G21
    Date: 2005–07–11
  41. By: Bask, Mikael (Bank of Finland Research)
    Abstract: Since the magnitude of exchange rate overshooting may not be the same for different exchange rates of a currency, a monetary expansion or contraction in, for example, the EMU, will affect the exchange rate between the U.S. dollar and the yen, even though there are no changes in monetary fundamentals in the U.S. or Japan. This fact is demonstrated in a sticky-price monetary model due originally to Dornbusch (1976) that is enlarged with currency traders that use Chartism in the form of moving averages. It is also demonstrated that purchasing power parity (PPP) does not necessarily hold in long-run equilibrium. The-se results are interesting since, according to the empirical literature, there are often large movements in nominal exchange rates that are apparently unexplained by macroeconomic fundamentals, and there is also a weak support for PPP.
    Keywords: Chartism; foreign exchange; macroeconomic fundamentals; moving averages; overshooting and PPP
    JEL: F31 F41
    Date: 2006–10–10
  42. By: Siklos, Pierre (Department of Economics and Viessmann Research Centre on Modern Europe, Wilfrid Laurier University); Bohl , Martin (Department of Economics, Westfälische Wilhelms University Münster)
    Abstract: This paper examines the role of the ECB communication activities on daily Eurodollar exchange rate and interest rates. We estimate the relationship between monetary policy and the exchange rate using a technique that explicitly recognises the joint determination of both the levels and volatilities of these variables. We also consider more traditional estimation strategies as a test of the robustness of our main results. We introduce a new indicator of ECB communications policies that focuses on what the ECB says about the future economic outlook for the euro area along five different economic dimensions. The impact of ECB communications policies is more apparent in the time series framework than in the heteroskedasticity estimator approach. Previous studies that conclude that news effects are significant at the daily frequency may have reached such a conclusion because the measurement of news was too highly aggregated. The endogeneity of the exchange rate – interest rate relationship is more apparent when the proxy for monetary policy is the euro area – US differential than when any other proxy for monetary policy is employed. Finally, interest rate changes generally have a much larger impact on exchange rate movements, and their volatility, than do ECB verbal pronouncements.
    Keywords: communication policy; exchange rates; interest rates; volatility
    JEL: E50 E60 F30
    Date: 2006–04–11
  43. By: González, Manuel
    Abstract: This document tries to show how the capital asset pricing model based on the consumption theory under uncertainty could reproduce the statistical moments of Chilean interest rates. In order to reach this objective a model like the one proposed by Lucas (1980) is simulated and the parameters of the model are estimated by means of the simulated method of moments. To carry out the simulations, processes for the rate of growth of endowment were specified covering AR (1), GARCH (1,1) and Markov switching specifications. Results show that the performance of the model is not the most adequate, but between the three chosen specifications, the one that allows for the coexistence of two states for the rate of growth of the endowment of the economy is the best in reproducing moments of interest rates.
    Keywords: Consumption-CAPM Model; Simulated Method of Moments; Markov Switching Processes
    JEL: E21 E27 E43
    Date: 2004–12
  44. By: Virén , Matti (University of Turku and Bank of Finland)
    Abstract: This paper provides some further tests for the proposition that a larger public sector leads to smaller out-put volatility. Both Gali and Fatas & Mihov have provided some evidence which appears to support this proposition. Their evidence is, however, based on a relatively small sample of countries. In this study, we go beyond the OECD sample and focus on a much larger World Bank data set covering up to 208 countries for the period 1960–2002. We also seek to utilise some time series aspects of the material by using pooled cross-section time series data. Tests with different models and measures clearly indicate that the original results are not very robust and the relationship between government size and output volatility is either nonexistent or very weak at best.
    Keywords: government; fiscal policy; automatic stabilisers
    JEL: E32 E62 H30
    Date: 2005–05–11
  45. By: Maarten Dossche (National Bank of Belgium, Research Department; Ghent University, Study Hive for Economic Research and Public Policy Analysis (SHERPPA)); Freddy Heylen (Ghent University, Study Hive for Economic Research and Public Policy Analysis (SHERPPA)); Dirk Van den Poel (Marketing Department, Ghent University)
    Abstract: This paper uses scanner data from a large euro area retailer. We extend Deaton and Muellbauer's Almost Ideal Demand System to estimate the price elasticity and curvature of demand for a wide range of products. Our results support the introduction of a kinked (concave) demand curve in general equilibrium macro models. We find that the price elasticity of demand is on average higher for price increases than for price decreases. However, the degree of curvature in demand is much lower than is currently imposed. Moreover, for a significant fraction of products we observe a convex demand curve. We find no correlation between the estimated price elasticity/curvature and the observed size or frequency of price adjustment in our data
    Keywords: price setting, real rigidity, kinked demand curve, behavioral AIDS
    JEL: C33 D12 E3
    Date: 2006–10
  46. By: John H. Munro
    Abstract: Entrepreneurship, by its very essence, concerns the theory of the firm – the individual enterprise – which in turn is the essential core of micro-economics. A major theme of this study, however, is to demonstrate the interaction of micro- and macro-economic phenomena: to show how such firms or enterprises, and entrepreneurship itself, were often shaped by, and often helped shape, such macro-economic forces as demographic changes, monetary changes, price changes – in terms of both deflation and inflation – long distance trade, overseas exploration and expansion (colonialism), and indeed related changes in social institutions and socio-cultural values that were also influenced by such macro-economic changes. One generalization about macro-economic changes involving inflations and deflations has both general and considerable importance in the history of European business enterprises and entrepreneurship itself: for long-term inflations (when moderate) tend to cheapen or reduce the relative factor costs of labour, land (rent contracts), and capital (fixed interest rates in loan contracts). Similarly, long term deflations tend, in reverse fashion, in increase the real or relative factor costs of labour, land, and capital, especially with pronounced wage-stickiness, and related ‘stickiness’ in leasehold rent contracts (and more so with customary tenures), and with loan contracts -- even if the long-term trends in real interest rates was falling over this long period. At the same time, both inflations and deflations are accompanied by changes in the relative prices of key industrial inputs. The key question to be posed is this: how did entrepreneurs respond to such changes in their factor costs, both short term and long term? This study commences by demonstrating how deflation in mid-15th century Europe, in increasing the purchasing power of silver, provided the stimulus for two major technological innovations in silver-mining and smelting that led to the South German silver-copper mining boom of 1460-1540, which also meant major changes in commercial-industrial entrepreneurship and in industrial scales. That mining boom in turn laid the foundations for the 130 year inflation of the Price Revolution (1520-1650) – an inflation further fostered by a financial revolution in credit and banking institutions (from the 1520s), and then further fuelled by the influx of Spanish-American silver.. The heart of this study is on the role of inflation, and associated macro-economic changes, in producing the roots of modern capitalist entrepreneurship, during what is often called Tawney’s Century (1540-1640). We begin, however, with two famous related theses: Hamilton’s thesis of ‘Profit Inflation’ (in which wages lag behind consumer prices), a wrongly-constructed thesis that endures only because Keynes endorsed it; and Nef’s thesis of the ‘Tudor Stuart industrial revolution’ – a much ridiculed response to Hamilton – whose merit lies in revealing the capitalist entrepreneurship, major technological changes, and changes in industrial scale that resulted from the substitution of coal – the hear of modern industrialization – for every more costly wood charcoal. Tawney’s three theses themselves concern the origins of modern agrarian capitalist, the related ‘Rise of the Gentry’ debate (on the role of inflation in shifting land ownership from the aristocracy to the capitalist gentry landowners), and the Weber-Tawney thesis on Religion (Protestantism) and the Rise of Capitalism, which, I endeavour to show has its real relevance only from the late 17th century. Associated with the Price Revolution era is the Age of Overseas Expansion (involving one of the most momentous technological and entrepreneurial change of the early modern era: the development of the Full Rigged Atlantic ship, with heavy artillery). England joined that overseas commercial-colonial race rather late, in the 1550s, but in doing developed the foundations of modern capitalism in creating the joint stock company. The study ends with the following era of monetary scarcity and deflation provided another macro-economic challenge whose response was revolutionary changes in banking and financial institutions – i.e., in financial-commercial entrepreneurship. It also fostered the growth and spread of rent-seeking Mercantilist philosophies that also influenced the character of early-modern capitalist entrepreneurship.
    Keywords: Entrepreneurship; Inflation; Deflation; Factor Costs; Technological Innovations; Minind and Metallurgy; Coal-Burning Industries; Joint-Stock Company
    JEL: E31 E40 F10 G20 G21 J10 J30 L10 L71 L72 N13 N23 N33 N83
    Date: 2006–10–09
  47. By: M. Menegatti
    Abstract: This paper proposes a new interpretation for the precautionary saving motive: when future income is uncertain, agents increase saving in order to cause a reduction in the disutility due to uncertainty. Furthermore the paper shows that the usual necessary and sufficient condition for precautionary saving is the condition ensuring this effect to occur.
    Keywords: Precautionary saving, Risk aversion, Prudence
    JEL: D11 D81 E21
    Date: 2006
  48. By: Crowley , Patrick (College of Business, Texas A&M University)
    Abstract: Wavelet analysis, although used extensively in disciplines such as signal processing, engineering, medical sciences, physics and astronomy, has not yet fully entered the economics discipline. In this discussion paper, wavelet analysis is introduced in an intuitive manner, and the existing economics and finance literature that utilises wavelets is explored. Extensive examples of exploratory wavelet analysis are given, many using Canadian, US and Finnish industrial production data. Finally, potential future applications for wavelet analysis in economics are also discussed and explored.
    Keywords: statistical methodology; multiresolution analysis; wavelets; business cycles; economic growth
    JEL: C19 C65 C87 E32
    Date: 2005–01–01
  49. By: Kauko , Karlo (Bank of Finland Research)
    Abstract: This paper presents a model on the demand for money market funds (MMFs). These funds are a very close substitute for M1 deposits, except that MMFs do not satisfy immediate transaction requirements. The demand for MMFs strengthens when the intended volume of transactions is low. A high interest rate level makes it expensive to hold M1 deposits. High interest rate volatility, paradoxically, increases the risk of holding M1 deposits stronger than the risk of holding MMFs. The results are largely corroborated by Finnish data.
    Keywords: money market mutual funds; money demand
    JEL: E41 G23 G29
    Date: 2005–07–11
  50. By: SODOKIN, Koffi (LEG - CNRS UMR 5118 - Université de Bourgogne)
    Abstract: L'objectif de ce papier est de démontrer les relations complémentaires entre les banques officielles (les banques) et les institutions de microfinance (les microbanques) dans un modèle flux-stock initialement proposé par Godley et Lavoie. Nous montrons que les banques officielles accommodent conjointement avec les microbanques les demandes de financement des coûts de production des firmes et des microfirmes jugées solvables dans les pays en développement (P.E.D). En conséquence, dans les économies contemporaines des pays les moins avancés, le système bancaire est à deux paliers avec une structure atypique. Un premier palier constitué par la Banque Centrale qui harmonise l'ensemble du système de paiement, un second palier constitué de deux catégories de banques. La première catégorie est constituée des banques commerciales officielles (les banques) et une deuxième catégorie constituée des banques de facto (les microbanques). Les banques et les microbanques jouent un rôle central dans le processus macroéconomique de production des revenus en coordonnant conjointement les anticipations et les actions des différents secteurs économiques des P.E.D. / This paper aims to show complementary of official banks and microbanks in a stock-flow accounting framework initially proposed by Godley and Lavoie. We show that the official banks and microbanks finance the production costs of credits worthy firms and microfirms in Low Developing Countries (LDCs). Consequently, in the contemporary economies of LDCs, the banking system is at two stages with an atypical structure. At the first stage we have the Central Bank which harmonizes the whole payment system, and at the second stage, we have two categories of banks. The first category are the official commercial banks (banks) and the second category are the banks de facto (the microbanks). Banks and microbanks play a central role in the macroeconomic process of income generation by coordinate together anticipations and actions of the various economic sectors in LDs
    Keywords: Banques ; microbanques ; complémentarité ; flux-stock ; pays en développement ; Banks ; microbanks ; complementarity ; flow-stock ; West Africa ; Low developing countries.
    JEL: E40 E42 E44 E51 O11 O17
    Date: 2006–10
  51. By: Luís F. Costa; Nuno Palma
    Abstract: In a recent article Chen et al. (2005) analyse the role of government expenditure in an imperfectly competitive static model, introducing a government-expenditure externality through the production function. Our purpose in the present paper is to argue that the claim from the authors that their model generates an endogenous markup is in our view incorrect. We argue that their model does not contain an endogenous markup, but a fixed one and that their claim is based upon an incorrect interpretation of what is the marginal cost in their own model.
    Keywords: E12; E62; H54.
  52. By: Bakken, Line Smart (Dept. of Economics, University of Oslo)
    Abstract: The aim of this paper is to investigate income, saving and consumption for households around retirement age. When doing this, there are different objectives which can be analyzed. First of all it is possible to get some insight of welfare of elderly when they reach retirement. Second, it is interesting to check the predictions of the life-cycle model by investigating consumption trends of households. Register data files are used to construct households which are used in the analysis throughout the paper. Modeling was done for a particular group of Norwegian households who were tracked through their retirement transition period. For each household there are characterizations such as pension income, labor income, wealth accumulation, saving and consumption. The results show that the households increase their after tax income and consumption, and have a high level of net financial wealth. In addition is a connection between high income replacement ratio and low income before retirement found. Households who have high income replacement ratios increase consumption more than households with low income replacement. The results also suggest that retirement decisions are independent of other decision making such as consumption and saving
    Keywords: Life-cycle model; pension income; households; income replacement; retirement behavior
    JEL: E21
    Date: 2006–08–21
  53. By: Kilponen, Juha (Bank of Finland Research); Ripatti , Antti (Bank of Finland Research)
    Abstract: Using the DGE model of the Finnish Economy (the ‘Aino’ model), we study the response of the economy to reforms in both labour and product markets. The reforms are two-fold. We assume that the wage mark-up, ie the monopoly power of wage-setters is gradually reduced by 5 percentage points. At the same time, the degree of competition is increased, ie price margins are exogenously reduced by 2 percentage points. These reforms imply a very favourable outcome of the economy. Both consumption and employment in-creases permanently and the reforms are welfare enhancing. Public balances improve giving room for 1.5 percentage point cut in income taxes. Our simulation exercises clearly demonstrate that such reforms may help in financing the future fiscal burden of an ageing population.
    Keywords: competition; dynamic general equilibrium; public finance
    JEL: C68 E60
    Date: 2006–04–19
  54. By: William T. Dickens (The Brookings Institution, Washington, D.C.); Lorenz Goette (University of Zurich); Erica L. Groshen (Federal Reserve Bank of New York; Institute for the Study of Labor (IZA), Bonn); Steinar Holden (University of Oslo; Research Fellow, Center for Economic Studies--Information and Forschung Institute (CESifo), Munich); Julian Messina (European Central Bank; Universitat de Girona, Italy; Centre for Studies in Economics and Finance (CSEF), Università di Salerno, Italy); Mark E. Schweitzer (Federal Reserve Bank of Cleveland, Ohio); Jarkko Turunen (European Central Bank); Melanie E. Ward (European Central Bank; Institute for the Study of Labor (IZA), Bonn)
    Abstract: How do the complex institutions involved in wage setting affect wage changes? The International Wage Flexibility Project provides new microeconomic evidence on how wages change for continuing workers. We analyze individuals’ earnings in 31 different data sets from sixteen countries, from which we obtain a total of 360 wage change distributions. We find a remarkable amount of variation in wage changes across workers. Wage changes have a notably non-normal distribution; they are tightly clustered around the median and also have many extreme values. Furthermore, nearly all countries show asymmetry in their wage distributions below the median. Indeed, we find evidence of both downward nominal and real wage rigidities. We also find that the extent of both these rigidities varies substantially across countries. Our results suggest that variations in the extent of union presence in wage bargaining play a role in explaining differing degrees of rigidities among countries
    Keywords: Wage setting, Wage change distributions, Downward nominal wage rigidity, Downward real wage rigidity
    JEL: E3 J3 J5
    Date: 2006–10
  55. By: Domeij, David (Dept. of Economic Statistics, Stockholm School of Economics); Ljungqvist, Lars (Dept. of Economic Statistics, Stockholm School of Economics)
    Abstract: Swedish census data and tax records reveal an astonishing wage compression; the Swedish skill premium fell by more than 30 percent between 1970 and 1990 while the U.S. skill premium, after an initial decline in the 1970s, rose by 8--10 percent. Since then both skill premia have increased by around 10 percentage points in 2002. Theories that equalize wages with marginal products can rationalize these disparate outcomes when we replace commonly used measures of total labor supplies by private sector employment. Our analysis suggests that the dramatic decline of the skill premium in Sweden is the result of an expanding public sector that today comprises roughly one third of the labor force, and that expansion has largely taken the form of drawing low-skilled workers into local government jobs that service the welfare state.
    Keywords: Skill premium; employment; private sector; public sector; Sweden; United States.
    JEL: E24 J31
    Date: 2006–09–16
  56. By: Saarenheimo , Tuomas (Bank of Finland Research)
    Abstract: The median age of the global population is presently increasing by nearly three months every year. Over the next couple of decades, almost every country in the world is set to experience an unprecedented increase in the share of elderly population. This development has the potential to fundamentally affect the functioning of economic and financial systems globally. This study concentrates on the effects of ageing on the evolution of global interest rates and financial flows. The study uses a 73-cohort general equilibrium overlapping generations model of five major economic areas (USA, EU-15, Japan, China, and India). Utilising actual population data and UN population projections, the model yields predictions for major economic and financial variables up to 2050. The model predicts a decline in global equilibrium real interest rates over the next two decades, but the size of the decline depends crucially on the future evolution of public pension benefits. If the present generosity of pension systems is maintained – leading to a steep increase in the cost of the pension systems – the maximum decline of interest rates is projected to be about 70 basis points from present levels. If pension benefits are reduced to offset the increasing cost pressures, the decline in global equilibrium interest rates can be much larger, while increases in the retirement age work in the opposite direction. The results do not anticipate a ‘financial market meltdown’ – a collapse in asset prices associated with the retirement of the baby-boomers – predicted by some. On the contrary, bond prices should fare fairly well over the next three decades. The main reason for this is that increasing life expectancy at retirement creates a need for higher retirement saving – in the future, people will want to retire wealthier than they do today. This trend more than offsets the negative effect of the retirement of baby-boomers on asset demand.
    Keywords: ageing; real interest rates; financial flows; public pension systems
    JEL: E44 J11
    Date: 2005–02–13

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