nep-mac New Economics Papers
on Macroeconomics
Issue of 2007‒01‒13
134 papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Optimal Simple Rules for Fiscal Policy in a Monetary Union By Bernhard Herz; Werner Roeger; Lukas Vogel
  2. Global Monetary Policy Shocks in the G5: A SVAR Approach By Joao Miguel Sousa; Andrea Zaghini
  3. Credit Market and Macroeconomic Volatility By Caterina Mendicino
  4. Search, Market Power, and Inflation Dynamics By Allen Head; Beverly Lapham
  5. Monetary Policy Rules and Exchange Rates:A Structural VAR Identified by No Arbitrage By Sen Dong
  6. Inflation Shocks and Interest Rate Rules By Barbara Annicchiarico; Alessandro Piegallini
  7. Changing Patterns of Domestic and Cross-Border Fiscal Policy Multipliers in Europe and the US By Agnes Benassy-Quere; Jacopo Cimadomo
  8. Relative Price Distortions and Inflation Persistence By Tatiana Damjanovic; Charles Nolan
  9. Intertemporal disturbances By Giorgio Primiceri; Ernst Schaumburg; Andrea Tambalotti
  10. Time-Varying U.S. Inflation Dynamics and the New Keynesian Phillips Curve By Kevin J. Lansing
  11. Optimal Monetary Policy in a Channel System of Interest-Rate Control By Aleksander Berentzen; Cyril Monnet
  12. Optimal monetary policy with imperfect unemployment insurance By Tomoyuki Nakajima
  13. A Model of Money and Credit, with Application to the Credit Card Debt Puzzle By Irina A. Telyukova; Randall Wright
  14. Uncovering the Goodhart's Law: Theory and Evidence By Yosuke Takeda; Atsuko Ueda
  15. The Time Varying Volatility of Macroeconomic Fluctuations By Giorgio Primiceri; Alejandro Justiniano
  16. (Un)Employment Dynamics: The Case of Monetary Policy Shocks By Helge Braun
  17. Lower-Frequency Macroeconomic Fluctuations: Living Standards and Leisure By Ben Malin
  18. Taking Personalities out of Monetary Policy Decision Making? Interactions, Heterogeneity and Committee Decisions in the Bank of England’s MPC By Arnab Bhattacharjee; Sean Holly
  19. Business cycle accounting for the Japanese economy By Keiichiro Kobayashi; Masaru Inaba
  20. The yield curve as a predictor and emerging economies By Mehl, Arnaud
  21. Credit Market Frictions with Costly Capital Reallocation as a Propagation Mechanism By Andre Kurmann; Nicolas Petrosky-Nadeau
  22. Establishing Credibility: Evolving Perceptions of the European Central Bank By Linda S. Goldberg; Michael W. Klein
  23. Expectations and Exchange Rate Dynamics: A State-Dependent Pricing Approach By Anthony Landry
  24. Sectoral Business Cycle Synchronization in the European Union By António Afonso; Davide Furceri
  25. The Bank Capital Channel of Monetary Policy By Skander Van den Heuvel
  26. Monetary Policy Uncertainty: Is There a Difference Between Bank of England and the Bundesbank/ECB? By Iris Biefang-Frisancho Mariscal; Peter Howells
  27. The Valuation Channel of External Adjustment By Fabio Ghironi; Jaewoo Lee; Alessandro Rebucci
  28. Lumpy Investment in Dynamic General Equilibrium By Ruediger Bachmann; Eduardo Engel; Ricardo Caballero
  29. Productivity Shocks and the Business Cycle: Reconciling Recent VAR Evidence By James Costain; Beatriz de-Blas-Perez
  30. Debt and the effects of fiscal policy By Carlo Favero and Francesco Giavazzi
  31. Precautionary Balances and the Velocity of Circulation of Money By Miquel Faig; Belen Jerez
  32. Household Debt and Income Inequality, 1963-2003 By Matteo Iacoviello
  33. Welfare Costs, Long Run Consumption Risk, and a Production Economy. By Mariano M. Croce
  34. Wage Rigidity and Job Creation By Christian Haefke; Marcus Sonntag; Thijs van Rens
  35. Monetary Policy, Endogenous Inattention, and the Volatility Trade-off By William Branch; John Carlson; George W. Evans; Bruce McGough
  36. Incomplete markets and the output-inflation tradeoff By Yann Algan; Edouard Challe; Xavier Ragot
  37. Individual Wage Bargaining and Business Cycles By Monique Ebell
  38. On-the-Job Search and Labor Market Reallocation By Murat Tasci
  39. Fiscal Policy and Macroeconomic Uncertainty in Emerging Markets: The Tale of the Tormented Insurer By Enrique G. Mendoza; P. Marcelo Oviedo
  40. Optimal Fiscal Policy over the Business Cycle By Filippo Occhino
  41. The Marginal Worker and the Aggregate Elasticity of Labor Supply By Francois Gourio; Pierre-Alexandre Noual
  42. Why Did U.S. Market Hours Boom in the 1990s? By Ellen R. McGrattan; Eduard C. Prescott
  43. Efficient Propagation of Shocks and the Optimal Return of Money By Ricardo Cavalcanti; Andres Erosa
  44. Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious? By Carlos Carmona
  45. Money Illusion and Housing Frenzies By Markus K. Brunnermeier; Christian Julliard
  46. Robustifying Learnability By Robert J. Tetlow; Peter von zur Muehlen
  47. Liquidity Cycles By Matteo Iacoviello; Raoul Minetti
  48. The Baby Boom: Predictability in House Prices and Interest Rates By Robert F. Martin
  49. Credit Cycles and Macro Fundamentals By Siem Jan Koopman; Roman Kräussl; André Lucas; André Monteiro
  50. The Performance of Trimmed Mean Measures of Underlying Inflation By Andrea Brischetto; Anthony Richards
  51. Housing and Housing Finance: The View from Australia and Beyond By Luci Ellis
  52. Secular Movements in U.S. Saving and Consumption By Kaiji Chen; Ayse Imrohoroglu; Selahattin Imrohoroglu
  53. The Dynamic (In)efficiency of Monetary Policy by Committee By Alessandro Riboni; Francisco Ruge-Murcia
  54. The Young, the Old, and the Restless: Demographics and Business Cycle Volatility By Henry Siu; Nir Jaimovich
  55. Component-smoothed Inflation: Estimating the Persistent Component of Inflation in Real Time By Christian Gillitzer; John Simon
  56. General Equilibrium with NonConvexities, Sunspots and Money By Guillaume Rocheteau; Peter Rupert; Karl Shell; Randall Wright
  57. Firms' Heterogeneous Sensitivities to the Business Cycle, and the Cross-Section of Expected Returns By Francois Gourio
  58. Monetary and Exchange Rate Stability in South East Asia By Christian Bauer; Bernhard Herz
  59. The role of debt and equity finance over the business cycle By Francisco Covas; Wouter Denhaan
  60. Strategic Asset Allocation, Asset Price Dynamics, and the Business Cycle By Ivan Jaccard
  61. Bench Mark Revisions and the U.S. Personal Saving Rate By Leonard I. Nakamura; Tom Stark
  62. Divisible money with partially directed search By Dror Goldberg
  63. Transactions, Credit, and Central Banking in a Model of Segmented Markets By Stephen D. Williamson
  64. The Response of Prices, Sales, and Output to Temporary Changes in Demand By Adam Copeland; George Hall
  65. Optimal cheating in monetary policy with individual evolutionary learning By Jasmina Arifovic; Olena Kostyshyna
  66. Welfare improvement from restricting the liquidity of nominal bonds By Shouyong Shi
  67. Financial Frictions, Investment and Tobin's q By Guido Lorenzoni; Karl Walentin
  68. Asymmetric Information and Employment Fluctuations By Bjoern Bruegemann; Giuseppe Moscarini
  69. Can News About the Future Drive the Business Cycle? By Nir Jaimovich; Sergio Rebelo
  70. Net Exports, Consumption Volatility and International Real Business Cycle Models By Andrea Raffo
  71. Investment Options and the Business Cycle By Boyan Jovanovic
  72. Monetary Policy and Household Mobility: The Effects of Mortgage Interest Rats. By John Quigley
  73. Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics By Aubhik Khan; Julia K. Thomas
  74. Motelling: A Hotelling Model with Money By Dean Corbae; Borghan N. Narajabad
  75. Monetary Exchange with Multilateral Matching By Benoit Julien; John Kennes; Ian King
  76. What Does the Durables Price - Over - the Rental Cost Valuation Ratio Tell Us About Asset Prices? By Michal Pakos
  77. The Dynamic Beveridge Curve By Shigeru Fujita; Garey Ramey
  78. Selective Reductions in Labour Taxation: Labour Market Adjustments and Macroeconomic Performance By Anna Batyra; Henri R. Sneessens
  79. Impact of Public Investment Upon Economic Performance and Budgetary Consolidation Efforts in the European Union By Alfredo Marvao Pereira; Maria De Fatima Pinho
  80. Commodity Money Equilibrium in a Walrasian Trading Post Model: An Example By Ross Starr
  81. The Employment (and Output) of Nations: Theory and Policy Implications By Petro Peretto
  82. Distribution Costs and International Business Cycles By P. Marcelo Oviedo; Rajesh Singh
  83. The Nature of Regional Unemployment in Italy By Matteo Lanzafame
  84. Testing for Balance Sheet Effects in Emerging Market Countries By Uluc Aysun
  85. Search Theory; Current Perspectives By Shouyong Shi
  86. Public finances in Portugal: a brief longrun view By António Afonso
  87. Determinants and Effects of Maturity Mismatches in Emerging Markets: Evidence from Bank Level Data By Uluc Aysun
  88. An Equilibrium Model of Global Imbalances and Low Interest Rates By Ricardo J. Caballero; Emmanuel Farhi; Pierre-Olivier Gourinchas
  89. Informational Assumptions on Income Processes and Consumption in the Buffer Stock Model of Savings By Dmytro Hryshko
  90. Equilibrium Wage Dispersion: An Example By Damien Gaumont; Martin Schindler; Randall Wright
  91. The Endogeneity of the Natural Rate of Growth in the Regions of Italy By Matteo Lanzafame
  92. An Equilibrium Model of "Global Imbalances" and Low Interest Rates By Ricardo Caballero; Emmanuel Farhi; Pierre-Olivier Gourinchas
  93. The Trend in Retirement By Karen A. Kopecky
  94. On-the-Job Search and Precautionary Savings: Theory and Empirics of Earnings and Wealth Inequality By Jeremy Lise
  95. Transfers versus Public Investment: The Politics of Intergenerational Redistribution and Growth By Martin Gonzalez-Eiras; Dirk Niepelt
  96. Why Do Emerging Economies Borrow Short Term? By Fernando Broner; Guido Lorenzoni; Sergio Schmuckler
  97. The structural determinants of external vulnerability By Loayza, Norman V.; Raddatz, Claudio
  98. Modeling the Term Structure of Exchange Rate Expectations By Christian Bauer; Sebastian Horlemann
  99. Capital Tax and Minimum Wage: Implications for the Dispersion of Wages By Alok Kumar
  100. Consumption Smoothing and Liquidity Income Redistribution By Giuseppe Bertola; Winfried Koeniger
  101. Unemployment in the OECD since the 1960s. Do we really know? By T. BERGER; G. EVERAERT
  102. Indivisible Labor and Its Supply Elasticity: Do Taxes Explain European Employment? By Lars Ljungqvist; Thomas J. Sargent
  103. Demographic Transition and Industrial Revolution: A Coincidence? By Oksana Leukhina; Michael Bar
  104. Lula’s Social Policies: New Wine in Old Bottles? By Alcino Ferreira Câmara Neto; Matías Vernengo
  105. "Thermodynamic Limits of Macroeconomic or Financial Models: One-and Two-Parameter Poisson-Dirichlet Models" By Masanao Aoki
  106. Comparing Financial Systems: A structural Analysis By Sylvain Champonnois
  107. On the Consequences of Demographic Change for International Capital Flows, Rates of Returns to Capital, and the Distribution of Wealth and Welfare By Dirk Krueger; Alexander Ludwig
  108. Liquidity and the Market for Ideas By Rafael Silveira; Randall Wright
  109. Why Tax Capital? By Yili Chien; Junsang Lee
  110. Federalism and Reductions in the Federal Budget By John Quigley; Daniel Rubinfeld
  111. Is There More than One Way to be E-Stable? By Joseph Pearlman
  112. Accounting for the Heterogeneity in Retirement Wealth By Fang Yang
  113. Hiring Freeze and Bankruptcy in Unemployment Dynamics By Pietro Garibaldi
  114. A Model of Interbank Settlement By Benjamin Lester
  115. "Growth Patterns of Two Types of Macro-Models: Limiting Behavior of One-and Two-Parameter Poisson-Dirichlet Models" By Masanao Aoki
  116. Why are Married Men Working So Much? By John Knowles
  117. Globalization, Macroeconomic Performance, and the Exchange Rates of Emerging Economies By Maurice Obstfeld
  118. Financial Constraints on Investment in an Emerging Market Crisis: An Empirical Investigation of Foreign Ownership By Garrick Blalock; Paul Gertler; David I. Levine
  119. Growth-Indexed Bonds in Emerging Markets: a Quantitative Approach By Andre Faria
  121. Learning and Model Validation By In-Koo Cho; Kenneth Kasa
  122. Making Financial Markets: Contract Enforcement and the Emergence of Tradable Assets in Late Medieval Europe By Lars Boerner; Albrecht Ritschl
  123. Leasing, Ability to Repossess, and Debt Capacity By Andrea Eisfeldt; Adriano Rampini
  124. Equilibrium Portfolios in the Neoclassical Growth Model By Emilio Espino
  125. Health Insurance and Tax Policy By Karsten Jeske; Sagiri Kitao
  126. Computing General Equilibrium Models with Occupational Choice and Financial Frictions By António Antunes; Tiago Cavalcanti; Anne Villamil
  127. The Other Twins: Currency and Debt Crises By Bernhard Herz; Christian Bauer; Volker Karb
  128. Can violence be rational? An empirical analysis of Colombia. By Brosio, Giorgio; Zanola, Roberto
  129. Investment, consumption and hedging under incomplete markets By Jianjun Miao; Neng Wang
  130. Optimal Pre-Announced Tax Reforms Under Valuable And Productive Government Spending By Mathias Trabandt
  131. Aid Effectiveness and Limited Enforceable Conditionality By Almuth Scholl
  132. Education and Crime over the Life Cycle By Giulio Fella; Giovanni Gallipoli
  133. The distribution of wealth and redistributive policies By Jess Benhabib; Alberto Bisin
  134. IQ in the Ramsey Model: A Naive Calibration By Garett Jones

  1. By: Bernhard Herz; Werner Roeger; Lukas Vogel
    Abstract: The paper discusses the stabilizing potential of fiscal policy in a dynamic general-equilibrium model of monetary union. We consider a small open economy inside the currency area. We analyze the demand and supply effects of direct taxation, indirect taxation and government spending and derive optimal simple rules for fiscal stabilization of a technology shock. Fiscal policy achieves substantial macroeconomic stabilization. Simple public-expenditure rules show the highest degree of both output and inflation stabilization. The implementation lag substantially weakens output stabilization, but hardly affects the stabilization of prices. Output-oriented rules imply less instrument inertia than inflation-dominated rules. The implementation lag leads to higher coefficients for inflation relative to output in the optimal rule. Compared to the single-instrument approach the simultaneous optimization of two instrument rules implies only little additional stabilization gains.
    Keywords: Fiscal policy, monetary union, simple policy rules
    JEL: E E F
  2. By: Joao Miguel Sousa (Banco de Portugal); Andrea Zaghini (Banca d'Italia and CFS)
    Abstract: The paper constructs a global monetary aggregate, namely the sum of the key monetary aggregates of the G5 economies (US, Euro area, Japan, UK, and Canada), and analyses its indicator properties for global output and inflation. Using a structural VAR approach we find that after a monetary policy shock output declines temporarily, with the downward effect reaching a peak within the second year, and the global monetary aggregate drops significantly. In addition, the price level rises permanently in response to a positive shock to the global liquidity aggregate. The similarity of our results with those found in country studies might supports the use of a global monetary aggregate as a summary measure of worldwide monetary trends.
    Keywords: Monetary Policy, Structural VAR, Global Eco
    JEL: E52 F01
    Date: 2006–12–20
  3. By: Caterina Mendicino (Department of Economics Stockholm School of Economics)
    Abstract: This paper investigate how the degree of credit market development is related to business cycle fluctuations in industrialized countries. I show that a business cycle model with collateral constraints generate a negative relation between the volatility of the cyclical component of output and the size of the credit market. I dentify the reallocation of capital as the key element in shaping out this relation. According to the model, more credit to the private sector makes output less sensitive to productivity shocks. Thus, the amplification role of credit frictions in the propagation of productivity shocks to output is greater in economies with higher degrees of credit rationing. I confront the prediction of the model with a panel of OECD countries over the last 20 years. Empirical evidence confirms that countries with a more developed credit market experience smoother fluctuations. Moreover, a greater size of the credit market dampens the propagation of productivity shocks to output and investment
    Keywords: collateral constraint, reallocation of capital, asset prices
    JEL: E21 E22 E44
    Date: 2006–12–03
  4. By: Allen Head (Department of Economics Queen's University); Beverly Lapham
    Abstract: The short-run non-neutrality of money and its implications for inflation dynamics are examined in a monetary search economy with heterogeneous agents. Lump-sum money injections affect the distribution of money holdings in equilibrium and thus generate short-run non-neutrality. The response of prices and inflation to shocks of this type depends on the changes in households' search intensity that they induce. Monetary shocks change the distribution of prices in equilibrium and thus alter the returns to search. The resulting changes in optimal search intensity affect sellers' profit maximizing markups and thus may result in sluggish price adjustment and persistent inflation despite the absence of restrictions of sellers; ability to set prices in every period
    Keywords: Price Dispersion, Inflation, Mark-ups, Dynamics
    JEL: E31 D43 E41
    Date: 2006–12–03
  5. By: Sen Dong (Finance and Ecnomomics Department Columbia University)
    Abstract: Expected exchange rate changes are determined by interest rate differentials across countries and risk premia, while unexpected changes are driven by innovations to macroeconomic variables, which are amplified by time-varying market prices of risk. In a model where short rates respond to the output gap and inflation in each country, I identify macro and monetary policy risk premia by specifying no-arbitrage dynamics of each country's term structure of interest rates and the exchange rate. Estimating the model with US/German data, I find that the correlation between the model-implied exchange rate changes and the data is over 60%. The model implies a countercyclical foreign exchange risk premium with macro risk premia playing an important role in matching the deviations from Uncovered Interest Rate Parity. I find that the output gap and inflation drive about 70% of the variance of forecasting the conditional mean of exchange rate changes
    Keywords: exchange rate, monetary policy,term structure, no arbitrage
    JEL: C13 E43 E52
    Date: 2006–12–03
  6. By: Barbara Annicchiarico (Department of Economics, University of Rome "Tor Vergata"); Alessandro Piegallini (Department of Economics, University of Rome "Tor Vergata")
    Abstract: Recent empirical evidence by Fair (2002, 2005) and Giordani (2003) shows that a positive inflation shock with the nominal interest rate held constant has contractionary effects. These results cannot be reconciled with the standard "New Synthesis" literature. This paper reconsiders the effects of inflation shocks in a simple New Keynesian framework extended to include wealth effects. It is demonstrated that, following an inflation shock, the decline of output coupled with passive interest rate rules is not puzzling.
    Keywords: Interest Rate Rules; Nominal Rigidities; Overlapping Generations; Inflation Shocks.
    JEL: E52 E58
    Date: 2006–06–01
  7. By: Agnes Benassy-Quere; Jacopo Cimadomo
    Abstract: This paper documents time variation in domestic fiscal policy multipliers in Germany, the UK and the US, and in cross-border fiscal spillovers from Germany to the seven largest European Union economies. We propose two VAR models which incorporate three “global factors” representing developments in the world economy, and we combine them with identification of fiscal shocks à la Blanchard and Perotti (2002) and Perotti (2005), to study the effects of net tax and government spending shocks on GDP, inflation and interest rates. By recursively estimating these models on different samples of data, we find that the domestic impact of tax shocks has been positive but vanishing for Germany and the US, stably not significant for the UK. Financial markets deregulations may play an important role in that since they allow households to be less dependent on disposable income and to smooth more easily consumption. Domestic government spending multipliers are found to be positive but feeble in the short-run and close to zero or slightly negative in the medium-run, implying that private consumption and investments might be crowded out. These results suggest that, in the European Monetary Union, discretionary fiscal policy “surprises” (i.e. unexpected tax cuts and government spending expansions) cannot be used by governments as substitutes for lost national monetary instruments, since they have shown to be progressively ineffective over time. Finally, we find that fiscal expansions in Germany have had beneficial (though declining) effects for neighboring countries, especially the smaller ones. This may indicate that the trade channel of transmission of fiscal policy dominates the interest rate one.
    Keywords: Fiscal policy effectiveness, fiscal shocks, spillovers, factor-augmented VAR, Great Moderation
    JEL: E30 E61 E62
    Date: 2006–12
  8. By: Tatiana Damjanovic; Charles Nolan
    Abstract: Many sticky-price models suggest that relative price distortion is one of the major costs of inflation. We show that this resource misallocation is costly even at quite low rates of inflation. This is because inflation strongly affects price dispersion which in turn has an impact on the economy qualitatively similar to, and of the order of magnitude of, a negative shift in productivity. Similarly, the utility cost of price dispersion is large. We incorporate price dispersion in a linearized model. This radically affects how shocks are transmitted through the economy. Notably, a contractionary nominal shock has a persistent, negative hump-shaped impact on inflation, but may have a positive hump-shaped impact on output. Observed persistence in the policy rate is not due to the policy rule per se.
    Keywords: Price stickiness; optimal fiscal and monetary policies; price dispersion.
    JEL: E52 E61 E63
    Date: 2006–11
  9. By: Giorgio Primiceri (Economics Northwestern University); Ernst Schaumburg; Andrea Tambalotti
    Abstract: Disturbances affecting agents' intertemporal substitution are the key driving force of macroeconomic fluctuations. We reach this conclusion exploiting the asset pricing implications of an estimated general equilibrium model of the U.S. business cycle with a rich set of real and nominal frictions
    Keywords: Business Cycle, Fluctuations, Euler equation, shocks, frictions
    JEL: E30
    Date: 2006–12–03
  10. By: Kevin J. Lansing
    Abstract: This paper introduces a form of boundedly-rational expectations into an otherwise standard New-Keynesian Phillips curve. The representative agent's forecast rule is optimal (in the sense of minimizing mean squared forecast errors), conditional on a perceived law of motion for inflation and observed moments of the inflation time series. The perceived law of motion allows for both temporary and permanent shocks to inflation, the latter intended to capture the possibility of evolving shifts in the central bank's inflation target. In this case, the agent's optimal forecast rule defined by the Kalman filter coincides with adaptive expectations, as shown originally by Muth (1960). I show that the perceived optimal value of the gain parameter assigned to the last observed inflation rate is given by the fixed point of a nonlinear map that relates the gain parameter to the autocorrelation of inflation changes. The model allows for either a constant gain or variable gain, depending on the length of the sample period used by the agent to compute the autocorrelation of inflation changes. In the variable-gain setup, the equilibrium law of motion for inflation is nonlinear and can generate time-varying inflation dynamics similar to those observed in long-run U.S. data. The model's inflation dynamics are driven solely by white-noise fundamental shocks propagated via the expectations feedback mechanism; all monetary policy-dependent parameters are held constant
    Keywords: Inflation Expectations, Phillips Curve, Time-Varying Persistence & Volatility
    JEL: E31 E37
    Date: 2006–12–03
  11. By: Aleksander Berentzen (University of Basel); Cyril Monnet
    Abstract: This paper studies optimal interest-rate policies when the central bank operates a channel system of interest-rate control. We conduct our analysis in a dynamic general equilibrium model with infinitely-lived agents who are subject to idiosyncratic trading shocks which generate random liquidity needs. In response to these shocks agents either borrow against collateral or deposit money at the central bank at the specified rates. We show that it is optimal to have a strictly positive interest-rate corridor if the opportunity cost of holding collateral is strictly positive and that the optimal corridor is strictly decreasing in the collateral's real return
    Keywords: Optimal Monetary Policy, Channel System, Interest Rate Rule, Essential Money
    JEL: E4 E5
    Date: 2006–12–03
  12. By: Tomoyuki Nakajima (Kyoto University)
    Abstract: We consider an efficiency-wage model with the Calvo-type sticky prices and analyze optimal monetary policy when unemployment insurance is not perfect. With imperfect risk sharing, strict zero-inflation policy is no longer optimal even if the zero-inflation steady-state equilibrium is assumed to be (conditionally) efficient. Quantitative result depends on how idiosyncratic earning losses, measured by the (inverse of the) relative income of the unemployed to the employed, vary over business cycles. If idiosyncratic income losses are acyclical, optimal policy differs very little from the zero-inflation policy. However, if they vary countercyclically, as evidence suggests, the deviation of optimal policy from complete price stabilization becomes quantitatively significant. Furthermore, optimal policy in such a case involves stabilization of output to a much larger extent
    Keywords: optimal monetary policy, efficiency wage, unemployment, nominal rigidities
    JEL: E3 E5
    Date: 2006–12–03
  13. By: Irina A. Telyukova; Randall Wright
    Abstract: Many individuals simultaneously have significant credit card debt and money in the bank. The so-called credit card debt puzzle is, given high interest rates on credit cards and low interest rates on bank accounts, why not pay down this debt? Economists have gone to some lengths to explain this. As an alternative, we present a natural extension of the standard model in monetary economics to incorporate consumer debt, which we think is interesting in its own right, and which shows that the coexistence of debt and money in the bank is no puzzle
    Keywords: Money, credit, monetary search models, credit card debt puzzle
    JEL: E44 E51
    Date: 2006–12–03
  14. By: Yosuke Takeda (Sophia University public); Atsuko Ueda
    Abstract: This paper addresses the Goodhart's Law in a cash-in-advance economy with monetary policy regime switching. Using the Japanese data of the money velocity, we found that although our cash-credit model fails to generate a downward trend in the actual velocity, the model succeeds in terms of velocity's variation and correlations with money growth rates or nominal interest rates, with procyclicality of velocity unpredictable.
    Keywords: Goodhart' Law; velocity of money; Taylor rule; Markov regime swiching; cash-credit model
    JEL: E41 E52
    Date: 2006–12–03
  15. By: Giorgio Primiceri; Alejandro Justiniano (Board of Governors of the Federal Reserv public)
    Abstract: In this paper we investigate the sources of the important shifts in the volatility of U.S. macroeconomic variables in the postwar period. To this end, we propose the estimation of DSGE models allowing for time variation in the volatility of the structural innovations. We apply our estimation strategy to a large-scale model of the business cycle and …nd that investment speci…c technology shocks account for most of the sharp decline in volatility of the last two decades
    Keywords: Great Moderation, Stochastic Volatility, Investment Specific Technology Shock, Relative Price of Investment, DSGE Models
    JEL: E32 C32
    Date: 2006–12–03
  16. By: Helge Braun (Department of Economics Northwestern University)
    Abstract: This paper estimates an identified VAR on US data to gauge the dynamic response of the job finding rate, the worker separation rate, and vacancies to monetary policy shocks. I develop a general equilibrium model that can account for the large and persistent responses of vacancies, the job finding rate, the smaller but distinct response of the separation rate, and the inertial response of inflation. The model incorporates labor market frictions, capital accumulation, and nominal price rigidities. Special attention is paid to the role of different propagation mechanisms and the impact of search frictions on marginal costs. Estimates of selected parameters of the model show that wage rigidity, moderate search costs, and a high value of non-market activities are important in explaining the dynamic response of the economy. The analysis extends to a broader set of aggregate shocks and can be used to understand and design monetary, labor market, and other policies in the presence of labor market frictions
    Keywords: Unemployment, Inflation, Labor Market Frictions
    JEL: E30 J63 J64
    Date: 2006–12–03
  17. By: Ben Malin (Economics Stanford University)
    Abstract: Although it is well known that aggregate variables have slow-moving stochastic components, research on macroeconomic fluctuations has focused primarily on high-frequency movements of the data. I document some interesting lower-frequency facts in U.S. postwar data and investigate whether dynamic stochastic general equilibrium (DSGE) models can explain these facts. One fact of particular interest is that hours worked per capita is negatively correlated with both output per capita and total factor productivity at lower frequencies, in stark contrast to the positive comovement of these three variables at high frequencies. I show that this lower-frequency fact is puzzling for many DSGE models and explore a variety of candidate solutions to the puzzle. I demonstrate that preferences which depend on a time-varying reference level of consumption ("living standards") can rationalize the observed patterns. Finally, I discuss the relative merits of the "living standards" interpretation of the model to other alternatives
    Keywords: Aggregate Fluctuations, Lower Frequency, Labor Hours
    JEL: E32 E10
    Date: 2006–12–03
  18. By: Arnab Bhattacharjee; Sean Holly
    Abstract: The transparency of the monetary policymaking process at the Bank of England has provided very detailed data on both the votes of individual members of the Monetary Policy Committee and the information on which they are based. In this paper we consider interval censored responses of individual committee members in the context of a model in which inflation forecast targeting is used but there is both heterogeneity and interaction among the members of the committee. We find substantial heterogeneity in the policy reaction function across members. Further, we identify significant interactions between individual decisions of the committee members. The nature of these interdependencies inform about information sharing and strategic interactions within the Bank of England’s Monetary Policy Committee.
    Keywords: Monetary policy; Interest rates; Committee decision making; Expectation-Maximisation Algorithm; Spatial Weights Matrix; Spatial Error Model.
    JEL: E42 E43 E50 E58 C31 C34
    Date: 2006–12
  19. By: Keiichiro Kobayashi (Research division RIETI); Masaru Inaba
    Abstract: We conducted business cycle accounting (BCA) using the method developed by Chari, Kehoe, and McGrattan (2002a) on data from the 1980s--1990s in Japan and from the interwar period in Japan and the United States. The contribution of this paper is twofold. First, we find that labor wedges may have been a major contributor to the decade-long recession in the 1990s in Japan. We argue that the deterioration of the labor wedge may have been caused by sticky wages and monetary contraction, and it may have been prolonged by the continuation of asset-price declines through binding collateral constraints. Second, we performed an alternative BCA exercise using the capital wedge instead of the investment wedge to check the robustness of BCA implications for financial frictions. The accounting results with the capital wedge imply that financial frictions may have had a large depressive effect during the 1930s in the United States. This implication is the opposite of that from the original BCA findings.
    Keywords: Business cycle accounting; Japanese economy; capital wedge; Great Depression.
    JEL: E32 E37 O47
    Date: 2006–12–03
  20. By: Mehl, Arnaud (BOFIT)
    Abstract: This paper investigates the extent to which the slope of the yield curve in emerging economies predicts domestic inflation and growth. It also examines international financial linkages and how the US and euro area yield curves help to predict. It finds that the domes-tic yield curve in emerging economies contains in-sample information even after control-ling for inflation and growth persistence, at both short and long forecast horizons, and that it often improves out-of-sample forecasting performance. Differences across countries are seemingly linked to market liquidity. The paper further finds that the US and euro area yield curves also contain in- and out-of-sample information for future inflation and growth in emerging economies. In particular, for emerging economies with exchange rates pegged to the US dollar, the US yield curve is often found to be a better predictor than the domes-tic curves and to causally explain their movements. This suggests that monetary policy changes and short-term interest rate pass-through are key drivers of international financial linkages through movements at the low end of the yield curve.
    Keywords: emerging economies; yield curve; forecasting; international linkages
    JEL: C50 E44 F30
    Date: 2006–12–20
  21. By: Andre Kurmann (Economics UQAM); Nicolas Petrosky-Nadeau
    Abstract: Empirical evidence suggests that capital separation is an important phenomenon over and beyond depreciation and that reallocation is a costly and time-consuming process. In addition, both separation and reallocation rates display substantial variation over the business cycle. We build a dynamic general equilibrium model where capital separation occurs endogenously because of credit constraints and capital (re)allocation is costly due to search frictions and capital specificity. Compared to the frictionless counterpart but also compared to models of financial frictions without costly capital reallocation, our model matches surprisingly well the persistence in U.S. output growth. Furthermore, our model implies that productive capital stocks vary more than reported in the data, which has the potential to substantially reduce the volatility of technology shocks inferred from the Solow residual
    Keywords: Credit Market Frictions, Capital Reallocation, Investment, Business Cycles, Output Growth Persistence
    JEL: E22 E32
    Date: 2006–12–03
  22. By: Linda S. Goldberg; Michael W. Klein
    Abstract: The perceptions of a central bank’s inflation aversion may reflect institutional structure or, more dynamically, the history of its policy decisions. In this paper, we present a novel empirical framework that uses high frequency data to test for persistent variation in market perceptions of central bank inflation aversion. The first years of the European Central Bank (ECB) provide a natural experiment for this model. Tests of the effect of news announcements on the slope of yield curves in the euro-area, and on the euro/dollar exchange rate, suggest that the market’s perception of the policy stance of the ECB during its first six years of operation significantly evolved, with a belief in its inflation aversion increasing in the wake of its monetary tightening. In contrast, tests based on the response of the slope of the United States yield curve to news offer no comparable evidence of any change in market perceptions of the inflation aversion of the Federal Reserve.
    Keywords: Central Banking, European Central Bank, Federal Reserve, inflation, exchange rate, monetary policy, credibility, yield curve
    Date: 2007–01–05
  23. By: Anthony Landry (Economics Federal Reserve Bank of Dallas)
    Abstract: We introduce elements of state-dependent pricing and strategic complementarity into an otherwise standard New Open Economy Macroeconomics (NOEM) model. Relative to previous NOEM work, there are striking new implications for the dynamics of real and nominal economic activity: complementarity in the timing of price adjustment dramatically alters an open economy's response to monetary disturbances. Using a two-country Producer-Currency-Pricing environment, our framework replicates key international features following a domestic monetary expansion: (i) a high international output correlation relative to consumption correlation, (ii) a delayed overshooting of exchange rates, (iii) a J-curve dynamic in the domestic trade balance, and (iv) a delayed surge in inflation across countries. Overall, the model is consistent with many empirical aspects of international economic fluctuations, while stressing pricing behavior and exchange rate effects highlighted in the traditional work of Mundell, Fleming, and Dornbusch
    Keywords: international monetary policy transmission
    JEL: F41 F42
    Date: 2006–12–03
  24. By: António Afonso; Davide Furceri
    Abstract: This paper analyses sectoral business cycle synchronization in an enlarged European Union using annual data for the period 1980-2005. In particular, we try to identify which sector for each country is driving the aggregate output business cycle synchronization. Overall, the sectors that provide the most relevant contribution are Industry, Building and Construction, and Agriculture, Fishery and Forestry. In contrast, the Services sector, the largest one in terms of valued added share, shows a relative low business cycle synchronization and volatility, implying that it contributes only marginally to the aggregate output business cycle synchronization.
    Keywords: EMU Enlargement; Stabilisation; Synchronization; Sectoral Business Cycle.
    JEL: E32 F15 F41 F42
  25. By: Skander Van den Heuvel (Finance Department University of Pennsylvania)
    Abstract: This paper examines the role of bank lending in the transmission of monetary policy in the presence of capital adequacy regulations. I develop a dynamic model of bank asset and liability management that incorporates risk-based capital requirements and an imperfect market for bank equity. These conditions imply a failure of the Modigliani-Miller theorem for the bank: its lending will depend on the bank’s financial structure, as well as on lending opportunities and market interest rates. Combined with a maturity mismatch on the bank’s balance sheet, this gives rise to a ‘bank capital channel’ by which monetary policy affects bank lending through its impact on bank equity capital. This mechanism does not rely on any particular role of bank reserves and thus falls outside the conventional ‘bank lending channel’. I analyze the dynamics of the new channel. An important result is that monetary policy effects on bank lending depend on the capital adequacy of the banking sector; lending by banks with low capital has a delayed and then amplified reaction to interest rate shocks, relative to well-capitalized banks. Other implications are that bank capital affects lending even when the regulatory constraint is not momentarily binding, and that shocks to bank profits, such as loan defaults, can have a persistent impact on lending
    Keywords: Monetary Policy, Bank Capital, Capital Requirements, Bank Lending Channel
    JEL: E44 E52 G28
    Date: 2006–12–03
  26. By: Iris Biefang-Frisancho Mariscal; Peter Howells (School of Economics, University of the West of England)
    Abstract: It is widely believed that institutional arrangements influence the quality of monetary policy outcomes. Judged on its ‘transparency’ characteristics, therefore the Bank of England should do better than both the Bundesbank and ECB. However, studies based on market evidence show that on average, agents anticipate policy moves by both banks equally well. Since benefits from transparency should also show in a narrowing of the diversity in cross sectional forecasts, this paper extends the existing literature in an attempt to reconcile the contradictory evidence on ‘transparency’ of both banks. We show that the diversity in interest rate forecasts is greater under the Bundesbank/ECB than the Bank of England. Other factors than ‘transparency’ do not seem to affect interest rate uncertainty in Germany. Increasing difficulty in forecasting inflation appears to explain in part UK interest rate forecast dispersion.
    Keywords: transparency, yield curve, forecasting uncertainty, Bank of England, Bundesbank, ECB
    JEL: E58
    Date: 2006–11
  27. By: Fabio Ghironi; Jaewoo Lee; Alessandro Rebucci (Research Department International Monetary Fund)
    Abstract: This paper explores the valuation channel of external adjustment in a two-country dynamic stochastic general equilibrium model (DSGE) with international equity trading. The theoretical model we set up matches key moments of the data for the United States at business cycle frequency at least as well as standard models of international real business cycles (RBCs). In our theoretical analysis, we find that two-asset trading is necessary for a valuation channel of external adjustment to emerge. However, other features of the economy, such as on the nature of the shock that generates the external imbalance and other features of the economy – the extent of nominal rigidity and the size of finacial frictions – determine the magnitude and significance of this channel of adjustment. The relative importance of the valuation channel is larger the higher the degree of nominal rigidity and the higher finacial intermediation costs. Monetary policy shocks have no valuation effects with flexible prices and trade only in equity. Specifying the theoretical model with net foreign assets different from zero in necessary to start matching satisfactorily empirical moments of changes in the US net foreign asset position.
    Keywords: External adjustment, Portfolio Models, Valuation Channel, SDGE Models
    JEL: F32 F41
    Date: 2006–12–03
  28. By: Ruediger Bachmann (Department of Economics Yale University); Eduardo Engel; Ricardo Caballero
    Abstract: Microeconomic lumpiness matters for macroeconomics. According to our DSGE model, it is responsible for 92 percent of the smoothing in the investment response to aggregate shocks, and it introduces important nonlinearities and history dependance in business cycles and policy sensitivity. General equilibrium forces are responsible for the remaining 8 percent of smoothing and attenuate, but do not eliminate, aggregate nonlinearities. Not only is the lumpy model better micro-founded than the frictionless model, it also represents an improvement in terms of its ability to match conventional RBC moments, since it raises the volatility of consumption and employment to the levels observed in US data. The model also has distinct implications for the economy's response to large shocks and policy interventions. We illustrate these mechanisms by simulating the dynamics of an investment overhang episode. Our main methodological contribution is to develop a calibration procedure that combines data at different levels of aggregation (sectoral and aggregate)
    Keywords: Lumpy investment, RBC model,$(S,s)$ model, idiosyncratic and aggregate shocks, sectoral shocks, adjustment costs, inertia, nonlinearities and history dependence, moments matching.
    JEL: E10 E22 E30
    Date: 2006–12–03
  29. By: James Costain (Economics Universidad Carlos III de Madrid); Beatriz de-Blas-Perez
    Abstract: Gali (1999) used a VAR with productivity and hours worked to argue that technology shocks are negatively correlated with labor and are unimportant for the business cycle. More recently, Beaudry and Portier (2003) studied a VAR in productivity and stock prices. Remarkably, they found that the component which has a permanent impact on productivity is almost identical to that which has no immediate impact on productivity. Moreover, either of these components explains most business cycle variation. Like Gali's results, these observations are inconsistent with early RBC models, but on the other hand they contradict Gali's claim that technology shocks are unimportant for cycles. In this paper, we study trivariate VARs in productivity, hours worked, and stock prices to see how these apparently contradictory results can be reconciled. We find one VAR specification that qualitatively and quantitatively matches the findings of Gali (so that long-run technology shocks drive hours down), and a second specification that matches the main findings of Beaudry and Portier (so that long-run technology shocks increase hours, are similar to the short-run shock to stock prices, and play a major role in generating business cycles). Surprisingly, the difference between these two specifications has nothing to do with estimating in levels or in differences, or with running VARs or VECMs, or with the ordering of variables. The only difference between the two specifications lies in which productivity variable is used: labor productivity (to generate results like Gali's) or TFP (to generate results like those of Beaudry and Portier). Both the original Beaudry and Portier estimations, as well as our findings on the productivity specification, add to the evidence that Gali's findings are not robust. Apparently the cyclical role of technology shocks is only picked up when a sufficiently cyclical productivity series is used in the estimation.
    Keywords: Technology shocks, business cycles, news shocks
    JEL: E32
    Date: 2006–12–03
  30. By: Carlo Favero and Francesco Giavazzi
    Abstract: Empirical investigations of the effects of fiscal policy shocks share a common weakness: taxes, government spending and interest rates are assumed to respond to various macroeconomic variables but not to the level of the public debt; moreover the impact of fiscal shocks on the dynamics of the debt-to-GDP ratio are not tracked. We analyze the effects of fiscal shocks allowing for a direct response of taxes, government spending and the cost of debt service to the level of the public debt. We show that omitting such a feedback can result in incorrect estimates of the dynamic effects of fiscal shocks. In particular the absence of an effect of fiscal shocks on long-term interest rates—a frequent finding in research based on VAR’s that omit a debt feedback—can be explained by their mis-specification, especially over samples in which the debt dynamics appears to be unstable. Using data for the U.S. economy and the identification assumption proposed by Blanchard and Perotti (2002) we reconsider the effects of fiscal policy shocks correcting for these shortcomings.
  31. By: Miquel Faig (Department of Economics University of Toronto); Belen Jerez
    Abstract: The low velocity of circulation of money implies that households hold more money than they normally spend. This behavior is explained if households face uncertain expenditure needs, so that they have a precautionary motive for holding money. We investigate this motive in a search model where households are subject to preference shocks. The model predicts that the velocity is not only low but also interest elastic. The model closely fits United States data on velocity and interest rates (1892-2003). The empirical analysis reveals a dramatic reduction in precautionary balances towards the end of our sample, which is important for policy issues
    Keywords: Precautionary Balances, Velocity of Circulation of Money, Demand for Money
    JEL: E41 E52
    Date: 2006–12–03
  32. By: Matteo Iacoviello (Economics Boston College)
    Abstract: I construct a heterogeneous agents economy that mimics the time-series behavior of the US earnings distribution from 1963 to 2003. Agents face aggregate and idiosyncratic shocks and accumulate real and financial assets. I estimate the shocks driving the model using data on income inequality, on aggregate income and on measures of financial liberalization. I show how the model economy can replicate two empirical facts: the trend and cyclical behavior of household debt, and the diverging patterns in consumption and wealth inequality over time. In particular, I show that, while short-run changes in household debt can be accounted for by aggregate fluctuations, the rise in household debt of the 1980s and the 1990s can be quantitatively explained only by the concurrent increase in income inequality
    Keywords: Household Debt, Income Inequality, Incomplete Markets, Borrowing Constraints
    JEL: E31 E32 E44
    Date: 2006–12–03
  33. By: Mariano M. Croce (economics nyu)
    Abstract: The main goal of this paper is to measure the welfare costs of business cycles in a production economy in which the representative agent has low risk aversion and - at the same time - the equity premium and the co-movements of aggregate quantities and market returns are comparable to what observed in historical data. In order to do so, I consider a production economy in which the representative agent has Epstein-Zin-Weil(1989) preferences, productivity has a Long Run Risk component and there are capital adjustment costs. In this way, I try to bridge the gap between the current Long Run Risk asset pricing literature, in which quantities are taken as exogenous, and the standard macroeconomic business cycle models. Preliminary results from a benchmark exchange economy suggest that when there is a Long Run Consumption Risk and the representative agent prefers early resolution of uncertainty, the implied total welfare costs of the consumption uncertainty range from 12\% to 20\%. (JEL classification: E20, E32, G12, D81)
    Keywords: Production Economy, Long-Run Risk, Asset Pricing,
    JEL: E20 E32 G12
    Date: 2006–12–03
  34. By: Christian Haefke; Marcus Sonntag; Thijs van Rens
    Abstract: Shimer (2005) and Hall (2005) have documented the failure of standard labor market search models to match business cycle fluctuations in employment and unemployment. They argue that it is likely that wages are not adjusted as regularly as suggested by the model, which would explain why employment is more volatile than the model predicts. We explore whether this explanation is consistent with the data. The main insight is that the relevant wage data for the search model are not aggregate wages, but wages of newly hired workers. Preliminary results show that wages for those workers are much more volatile than aggregate wages, suggesting that other (real) frictions might be more important than wage stickiness
    Keywords: search model, cyclical properties, wage rigidities, volatility, wages
    JEL: E32 J30
    Date: 2006–12–03
  35. By: William Branch (Economics University of California, Irvine); John Carlson; George W. Evans; Bruce McGough
    Abstract: This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the `Great Moderation' that began in the 1980's
    Keywords: optimal policy, expectations, adaptive learning
    JEL: E52 E31 D83
    Date: 2006–12–03
  36. By: Yann Algan; Edouard Challe; Xavier Ragot
    Abstract: This paper analyses the short-run effect of inflation shocks in an economy with incomplete markets, idiosyncratic unemployment risk, and fully flexible prices. Inflation shocks redistribute wealth from the cash-rich employed to the cash-poor unemployed, thereby forcing the former to work more in order to maintain their desired levels of consumption and precautionary savings. The reduced-form dynamics of the model is a textbook "output-inflation trade-off" equation where inflation shocks raise output contemporaneously, the effect being stronger the higher is idiosyncratic unemployment risk. We find that the data provides support for this short-run non-neutrality mechanism based on incomplete markets.
    Date: 2006
  37. By: Monique Ebell
    Abstract: This paper examines the business cycle properties of business cycle models with search frictions and wage bargaining which rely not only on labor, but also on capital in the production function. In the presence of capital, the choice of bargaining framework matters, even under perfect competition and constant returns to scale. In particular, under individual bargaining, the welfare theorems do not hold, due to a hold-up effect in capital and a hiring externality, so that solving a planner's problem is not sufficient. I examine the business cycle properties of the decentralized model with individual bargaining under alternative calibration strategies
    Keywords: Business Cycles, Wage Bargaining, Search Frictions, Capital
    JEL: E3 J2 J3
    Date: 2006–12–03
  38. By: Murat Tasci
    Abstract: This paper studies amplification of productivity shocks in labor markets through on-the-job-search. There is incomplete information about the quality of the employee-firm match which provides persistence in employment relationships and the rationale for on-the-job search. Amplification arises because productivity changes not only affect firms' probability of contacting unemployed workers but also of contacting already employed workers. Since higher productivity raises the value of all matches, even low quality matches become productive enough to survive in expansions. Therefore the measure of workers in low quality matches is greater when productivity is high, implying a higher probability of switching to another match. In other words, firms are more likely to meet employed workers in expansions and those they meet are more likely to accept firm's job offer because they are more likely to be employed in a low quality match. This introduces strongly procyclical labor market reallocation through procyclical job-to-job transitions. Simulations with a productivity process that is consistent with average labor productivity in the U.S. show that standard deviations for unemployment, vacancies and market tightness (vacancy-unemployment ratio) match the U.S. data. The model also reconciles the presence of endogenous separation with the negative correlation of unemployment and vacancies over business cycle frequencies (i.e. it is consistent with the Beveridge curve)
    Keywords: On-the-Job Search; Amplification; Business Cycles; Job-to-Job Flows
    JEL: E24 E32 J41
    Date: 2006–12–03
  39. By: Enrique G. Mendoza (University of Maryland); P. Marcelo Oviedo
    Abstract: Governments in emerging markets often behave like a "tormented insurer", trying to use non-state-contingent debt instruments to avoid sharp adjustments in their payments to private agents despite sharp fluctuations in public revenues. In the data, their ability to sustain debt is inversely related to the variability of their revenues, and their primary balances and current expenditures follow a procyclical pattern that contrasts sharply with the evidence from industrial countries. This paper proposes an equilibrium model of a small open economy with incomplete markets and aggregate uncertainty that can rationalize this behavior. In the model, a fiscal authority that chooses optimal expenditure and debt plans given stochastic revenues interacts with private agents that also make optimal consumption and asset accumulation plans. The competitive equilibrium of this economy is solved numerically as a Markov perfect equilibrium using parameter values calibrated to Mexican data. If perfect domestic risk pooling were possible, the ratio of public-to-private expenditures would be constant. With incomplete markets, however, this ratio fluctuates widely and results in welfare losses that dwarf previous estimates of the benefits of risk sharing and consumption smoothing. The model also yields a negative relationship between average public debt and revenue variability similar to the one observed in the data, and a correlation between output and government purchases that matches Mexican data
    Keywords: optimal debt, fiscal solvency, procyclical fiscal policy, incomplete markets
    JEL: E62 F34 H63
    Date: 2006–12–03
  40. By: Filippo Occhino
    Abstract: How should taxes, government expenditures, the primary and fiscal surpluses and government liabilities be set over the business cycle? We assume that the government chooses expenditures and taxes to maximize the utility of a representative household, utility is increasing in government expenditures, only distortionary labor income taxes are available, and the cycle is driven by exogenous technology shocks. We first consider the commitment case, and characterize the Ramsey equilibrium. In the case that the utility function is constant elasticity of substitution between private and public consumption and separable between the composite consumption good and leisure, taxes, government expenditures and the primary surplus should all be constant positive fractions of production, and both government liabilities and the fiscal surplus should be positively correlated with production. Then, we relax the commitment assumption, and we show how to determine numerically whether the Ramsey equilibrium can be sustained by the threat to revert to a Markov perfect equilibrium. We find that, for realistic values of the preferences discount factor, the Ramsey equilibrium is sustainable.
    Keywords: Fiscal policy, Commitment, Time-consistency, Ramsey equilibrium, Markov perfect equilibria, Sustainable equilibria.
    JEL: E62
    Date: 2006–12–03
  41. By: Francois Gourio; Pierre-Alexandre Noual (Department of Economics University of Chicago)
    Abstract: This paper attempts to reconcile the high apparent aggregate elasticity of labor supply with small micro estimates. We elaborate on Rogerson's seminal work (1988) and show that his results rely neither on complete markets nor on lotteries, but rather on the indivisibility and the fact that the workforce is homogeneous at the margin. We derive two robust implications of a setup with indivisible labor but without lotteries, using either a complete markets model or an incomplete markets model (solved numerically). (1) Agents with reservation wages far above or below the market wage are less responsive (in labor supply) to the business cycle than agents whose reservation wage is around the market wage. (2) The aggregate elasticity is given by the marginal homogeneity of the workforce. We test implication (1) using the PSID and find support for it. We build an incomplete markets model and calibrate it to cross-sectional moments of hours worked. We show that it can reproduce the feature (1). This allows us to use the model to evaluate the importance of feature (2), i.e. to estimate the aggregate elasticity of labor supply implied by the marginal homogeneity.
    Keywords: indivisible labor, reservation wage distribution, labor supply, business cycles
    JEL: E24 E32
    Date: 2006–12–03
  42. By: Ellen R. McGrattan; Eduard C. Prescott (Federal Reserve Bank of MInneapolis)
    Abstract: During the 1990s, market hours in the United States rose dramatically. The rise in hours occurred as gross domestic product (GDP) per hour was declining relative to its historical trend, an occurrence that makes this boom unique, at least for the postwar U.S. economy. We find that expensed plus sweat investment was large during this period and critical for understanding the movements in hours and productivity. Expensed investments are expenditures that increase future profits but, by national accounting rules, are treated as operating expenses rather than capital expenditures. Sweat investments are uncompensated hours in a business made with the expectation of realizing capital gains when the business goes public or is sold. Incorporating expensed and sweat equity into an otherwise standard business cycle model, we find that there was rapid technological progress during the 1990s, causing a boom in market hours and actual productivity.H
    Keywords: 1990 U.S. Hours Boom; Productivity
    JEL: E01 E32
    Date: 2006–12–03
  43. By: Ricardo Cavalcanti; Andres Erosa
    Abstract: We show that price stickiness is predicted by the theory of second best, applied to a random- matching model of money. The economy is hit with iid, aggregate, preference shocks, and allocations are allowed to be history dependent. Due to individual anonymity and lack of commitment, implementable allocations must satisfy participation constraints. Price stickiness becomes necessary for optimality, in terms of average, ex-ante welfare, when aggregate uncen- tainty is present but not too severe, and the degree of patience is neither too low or too high. By applying mechanism design to an alternative economy with centralized markets, we also Þnd important that macroeconomic policies, such as the taxation of money holdings, are unable to implement the Þrst best for price stckiness to have a social role
    Keywords: Mechanism Design, monetary theory, history dependence
    JEL: E10 E50
    Date: 2006–12–03
  44. By: Carlos Carmona (University of California, San Diego)
    Abstract: Inflation forecasts of the Federal Reserve systematically under-predicted inflation before Volcker and systematically over-predicted it afterward. Furthermore, under quadratic loss, commercial forecasts have information not contained in those forecasts. To investigate the cause, this paper recovers the loss function implied by Federal Reserve's forecasts. It finds that the cost of having inflation above an implicit time-varying target was larger than the cost of having inflation below it for the period since Volcker, and that the opposite was true for the pre-Volcker era. Once these asymmetries are taken into account, the Federal Reserve is found to be rational. (JEL C53, E52)
    Keywords: Inflation Forecasts, Asymmetric Loss, Federal Reserve,
    Date: 2005–07–01
  45. By: Markus K. Brunnermeier; Christian Julliard
    Abstract: A reduction in inflation can fuel run-ups in housing prices if people suffer from money illusion. For example, investors who decide whether to rent or buy a house by simply comparing monthly rent and mortgage payments do not take into account that inflation lowers future real mortgage costs. We decompose the price-rent ratio in a rational component -- meant to capture the proxy effect and risk premia -- and an implied mispricing. We find that inflation and nominal interest rates explain a large share of the time-series variation of the mispricing, and that the tilt effect is unlikely to rationalize this finding.
    JEL: G12 R2
    Date: 2006–12
  46. By: Robert J. Tetlow (Division of Research and Statistics Federal Reserve Board); Peter von zur Muehlen
    Abstract: In recent years, the learnability of rational expectations equilibria (REE) and determinacy of economic structures have rightfully joined the usual performance criteria among the sought-after goals of policy design. Some contributions to the literature, including Bullard and Mitra (2001) and Evans and Honkapohja (2002), have made significant headway in establishing certain features of monetary policy rules that facilitate learning. However a treatment of policy design for learnability in worlds where agents have potentially misspecified their learning models has yet to surface. This paper provides such a treatment. We begin with the notion that because the profession has yet to settle on a consensus model of the economy, it is unreasonable to expect private agents to have collective rational expectations. We assume that agents have only an approximate understanding of the workings of the economy and that their learning the reduced forms of the economy is subject to potentially destabilizing perturbations. The issue is then whether a central bank can design policy to account for perturbations and still assure the learnability of the model. Our test case is the standard New Keynesian business cycle model. For different parameterizations of a given policy rule, we use structured singular value analysis (from robust control theory) to find the largest ranges of misspecifications that can be tolerated in a learning model without compromising convergence to an REE. In addition, we study the cost, in terms of performance in the steady state of a central bank that acts to robustify learnability on the transition path to REE.
    Keywords: monetary policy, learnability, indeterminacy, robust control
    JEL: C6 E5
    Date: 2006–12–03
  47. By: Matteo Iacoviello; Raoul Minetti (Economics Michigan State University)
    Abstract: We study an economy where firms face credit constraints tied to the value of their assets and financiers differ in their information on the market for firms' assets. Financiers with poor information on the asset market make mistakes in asset liquidation, hoarding assets during booms and trading them during recessions. We find that asset liquidity and the composition -informed versus uninformed- of firms' financiers breed each other in a cumulative fashion and that their interaction generates cycles in asset values and output
    Keywords: Asset Liquidity, Business Fluctuations, Firm Financing
    JEL: E44
    Date: 2006–12–03
  48. By: Robert F. Martin (International Finance Federal Reserve Board)
    Abstract: This paper explores the baby boom's impact on U.S. house prices and interest rates in the post-war 20th century and beyond. Using a simple Lucas asset pricing model, I quantitatively account for the increase in real house prices, the path of real interest rates, and the timing of low-frequency fluctuations in real house prices. The model predicts that the primary force underlying the evolution of real house prices is the systematic and predictable changes in the working age population driven by the baby boom. The model is calibrated to U.S. data and tested on international data. One surprising success of the model is its ability to predict the boom and bust in Japanese real estate markets around 1974 and 1990.
    Keywords: asset pricing, yield curve, moderation
    JEL: E21 E31 G12 R21
    Date: 2006–12–03
  49. By: Siem Jan Koopman (Vrije Universiteit Amsterdam and Tinbergen Institute Amsterdam); Roman Kräussl (Vrije Universiteit Amsterdam and CFS); André Lucas (Vrije Universiteit Amsterdam and Tinbergen Institute Amsterdam); André Monteiro (Vrije Universiteit Amsterdam and Tinbergen Institute Amsterdam)
    Abstract: We study the relation between the credit cycle and macro economic fundamentals in an intensity based framework. Using rating transition and default data of U.S. corporates from Standard and Poor’s over the period 1980–2005 we directly estimate the credit cycle from the micro rating data. We relate this cycle to the business cycle, bank lending conditions, and financial market variables. In line with earlier studies, these variables appear to explain part of the credit cycle. As our main contribution, we test for the correct dynamic specification of these models. In all cases, the hypothesis of correct dynamic specification is strongly rejected. Moreover, accounting for dynamic mis-specification, many of the variables thought to explain the credit cycle, turn out to be insignificant. The main exceptions are GDP growth, and to some extent stock returns and stock return volatilities. Their economic significance appears low, however. This raises the puzzle of what macro-economic fundamentals explain default and rating dynamics.
    Keywords: Credit Cycles, Business Cycles, Bank Lending Conditions, Unobserved Component Models, Intensity Models, Monte Carlo Likelihood
    JEL: G11 G21
    Date: 2007–01–02
  50. By: Andrea Brischetto (Reserve Bank of Australia); Anthony Richards (Reserve Bank of Australia)
    Abstract: This paper uses data for Australia, the United States, Japan and the euro area to examine the relative performance of the headline CPI, exclusion-based ‘cores’, and trimmed means as measures of underlying inflation. Overall, we find that trimmed means tend to outperform headline and exclusion measures on a range of different criteria, indicating that they can be thought of as having better signal-to-noise ratios. We also find that there is a wide range of trims that perform well. One innovation for the United States is to break up the large implicit rent component in the US CPI into four regional components, which improves the performance of trimmed means, especially large trims such as the weighted median. The results lend support to the use of trimmed means as useful measures of underlying inflation at the current juncture where the growth of China and other emerging markets is having two offsetting effects on global inflation. Whereas some central banks have tended to focus on headline inflation and others have focused more on exclusion measures, our results provide some justification for a middle path, namely using trimmed mean measures which deal with outliers at both ends of the distribution of price changes in a symmetric manner.
    Keywords: underlying inflation; core inflation; trimmed means; Australia; United States; Japan; euro area
    JEL: E31 E52 E58
    Date: 2006–12
  51. By: Luci Ellis (Reserve Bank of Australia)
    Abstract: This paper draws together themes from work at the RBA, other national central banks, the BIS and elsewhere on recent developments in housing and housing finance. The general conclusion is that financial and macroeconomic developments have increased the demand for the stock of housing. Because the stock of housing is inherently slow to adjust, this has increased its relative price. Although this is a global trend, individual country institutions have affected outcomes, sometimes in ways that are not obvious. The resulting expansion in both sides of the household balance sheet is an important development for policy-makers to monitor, but it is probably not of itself a cause of financial instability.
    Keywords: housing; housing finance; economic geography; cross-country
    JEL: E21 E44 R21
    Date: 2006–12
  52. By: Kaiji Chen (Economics University of Oslo); Ayse Imrohoroglu; Selahattin Imrohoroglu
    Abstract: The U.S. national saving rate has been declining since the 1960s while the share of consumption in output has been increasing. We explore if a standard growth model can explain the secular movements observed in this time period. Our quantitative findings indicate that the standard neoclassical growth model is able to generate saving rates and consumption that are remarkably similar to the data during 1960-2004
    Keywords: U.S. consumption, saving, TFP
    JEL: E21
    Date: 2006–12–03
  53. By: Alessandro Riboni; Francisco Ruge-Murcia (Economics University of Montreal)
    Abstract: This paper develops a model where the value of the monetary policy instrument is selected by a heterogenous committee engaged in a dynamic voting game. Committee members differ in their institutional power and, in certain states of nature, they also differ in their preferred instrument value. Preference heterogeneity and concern for the future interact to generate decisions that are dynamically inefficient and inertial around the previously-agreed instrument value. This model endogenously generates autocorrelation in the policy variable and provides an explanation for the empirical observation that the nominal interest rate under the central bank's control is infrequently adjusted
    Keywords: Committees, status-quo bias, interest-rate smoothing, dynamic voting
    JEL: E58 D02
    Date: 2006–12–03
  54. By: Henry Siu (Department of Economics University of British Columbia); Nir Jaimovich
    Abstract: In this paper we investigate the consequences of demographic change for business cycle analysis. We find that changes in the age composition of the labor force account for a significant fraction of the variation in business cycle volatility observed in the US and other G7 economies. During the postwar period, these countries have experienced dramatic demographic change, though details regarding extent and timing differ from place to place. Using panel data methods, we exploit this variation to show that the age composition of the workforce has a large and statistically significant effect on cyclical volatility. We conclude by relating these findings to the recent decline in US business cycle volatility. Through simple quantitative accounting exercises, we find that demographic change accounts for a significant part of this moderation
    Keywords: business cycles
    JEL: E20
    Date: 2006–12–03
  55. By: Christian Gillitzer (Reserve Bank of Australia); John Simon (Reserve Bank of Australia)
    Abstract: This paper presents a new measure of underlying inflation: component-smoothed inflation. It approaches the problem of determining underlying inflation from a different direction than previous methods. Rather than excluding or trimming out volatile CPI items, it smoothes components of the CPI based on their volatility – CPI expenditure weights are maintained for all items. Items such as rent are smoothed a little, if at all, while volatile series such as fruit, vegetables and automotive fuel are smoothed a lot. This removes much of the temporary volatility in the CPI while retaining most of the persistent signal. Because our underlying inflation measure includes all CPI items at all times, it is robust to sustained relative price changes and is unbiased in the long run. A potential cost of this approach is that, unlike other measures, it places weight on lagged as well as contemporaneous prices for volatile series. An evaluation of the balance between the costs and benefits of this approach remains an open question.
    Keywords: CPI; core inflation; underlying inflation; Australia; United States
    JEL: E31 E52
    Date: 2006–12
  56. By: Guillaume Rocheteau (Federal Reserve Bank of Cleveland public); Peter Rupert; Karl Shell; Randall Wright
    Abstract: We study general equilibrium with nonconvexities. In these economies there exist sunspot equilibria without the usual assumptions needed in convex economies, and they have good welfare properties. Moreover, in these equilibria, agents act as if they have quasi-linear utility. Hence wealth effects vanish. We use this to construct a new model of monetary exchange. As in Lagos-Wright, trade occurs in both centralized and decentralized markets, but while that model requires quasi-linearity, we have general preferences. Given our specification looks much like the textbook Arrow-Debreu model, we think this constitutes progress on the classic problem of integrating money and general equilibrium theory. We also use the model to discuss another classic issue: the relation between inflation and unemployment
    Keywords: Money, Indivisibilities, Sunspots.
    JEL: E40 E50
    Date: 2006–12–03
  57. By: Francois Gourio
    Abstract: In this paper, I propose and test a simple technology-based theory of firms' sensitivities to aggregate shocks. I show that when the elasticity of substitution between capital and labor is below unity, low profitability firms are more sensitive to aggregate shocks, i.e. to the business cycle. Since the wage is smoother than productivity, revenues are more procyclical than costs, making profits, the residual procyclical. Firms with low profitability are more procyclical since the residual is smaller and the amplification greater. I study the asset pricing implications of this technology and find that it can explain the riskiness of small and “value†firms (Fama and French 1996). These firms are less profitable and are thus more procyclical. I find empirically that the cross-section of expected returns is well explained by differences in sensitivities of firms’ earnings to GDP growth, or by differences in profitability. The model yields rich empirical implications by linking a firm’s real behavior (the elasticity of output, employment and profits to an aggregate shock) to its financial characteristics (the firm's betas and its average return). I next embed my partial equilibrium model in a full DSGE model to conduct a GE analysis. Empirically I show that firms with low margins are indeed more sensitive to the business cycle in their employment, sales or profits
    Keywords: Cross-section of returns, book-to-market, value premium, productivity heterogeneity
    JEL: E44 G12
    Date: 2006–12–03
  58. By: Christian Bauer; Bernhard Herz
    Abstract: Regaining exchange rate stability has been a major monetary policy goal of East Asian countries in the aftermath of the 1997/98 currency crisis. While most countries have abstained from re-establishing a formal US Dollar peg, they have typically managed the US Dollar exchange rate de facto. We show that most of these countries were able to regain their monetary credibility within a relatively short time period. The Argentine crisis in 2001 caused a minor setback in this process for some countries. We measure the credibility of monetary policy by separating the fundamental and excess volatility of the exchange rate on the basis of a chartist fundamentalist model. The degree of excess volatility is interpreted as the ability of the central bank to manage the exchange rate via the coordination channel.
    Keywords: monetary policy, exchange rate policy, credibility, technical trading, East Asia
    JEL: D84 E42 F31
  59. By: Francisco Covas; Wouter Denhaan (Economics Subject Area London School of Economics)
    Abstract: Net equity issuance occurs frequently and is quantitatively important for both small and large publicly traded firms. Moreover, we show that net equity and net debt issuance are positively correlated and both are procyclical for small firms. For large firms net equity issuance is neither cyclical nor correlated with debt issuance. We extend the existing business cycle models with agency costs in two ways. First, we relax the standard assumptions of linearity and full depreciation. Consequently, variables such as the default probability and leverage will depend on firm size. It also means that an increase in net worth reduces the default probability (instead of leaving it unchanged). Second, we relax the standard assumption that firms cannot attract outside equity. In our model, aggregate shocks are propagated as in the model without equity issuance, but in contrast to the standard model they are also magnified and the default rate is countercyclical. Moreover, our model is consistent with the observed cyclical behavior of firms' financing sources for both small and large firms.
    Keywords: agency costs, frictions
    JEL: E32 E44
    Date: 2006–12–03
  60. By: Ivan Jaccard
    Abstract: The main contribution of this work is to provide a dynamic general equilibrium model of asset allocation, allowing to reconcile economic theory with several puzzling contradictions recently pointed out in the literature: (i) the asset allocation puzzle, (ii) the observed time-variation in aggregate portfolio holdings, and (iii) the occurrence of twin peaks in equity and house prices. In this approach, compared to the existing literature, the main difference stems from the fact that, in addition to consumption and dividends, both prices and portfolio decisions are allowed to be endogenously determined within a general equilibrium framework. Secondly, real estate is introduced into the analysis, labor supply is allowed to be endogenously determined and macroeconomic shocks are the main source of riskiness.
    Keywords: strategic asset allocation, real estate, house prices, business cycle, general equilibrium
    JEL: E20 G11 G12
    Date: 2006–12–03
  61. By: Leonard I. Nakamura (Federal Reserve Bank of Phildelphia); Tom Stark
    Abstract: Initially published estimates of the personal saving rate from 1965 Q3 to 1999 Q2, which averaged 5.3 percent, have been revised up 2.8 percentage points to 8.1 percent, as we document. We show that much of the initial variations in personal saving rate across time was pure noise. Nominal disposable personal income has been revised upward an average of 8.3 percent: one dollar in twelve was originally missing. We use both conventional and real-time estimates of the personal saving rate to forecast real disposable income, gross domestic product, and personal consumption and show that using the personal saving rate in real-time would have almost invariably made forecasts worse. Thus while the personal saving rate may contain information about later consumption once we know the true saving rate, as Campbell (1987) and Ireland(1995) have shown, as a practical matter, noise in the U.S. personal saving rate makes it uninformative for forecasting purposes
    Keywords: Permanent Income, Saving, Real-time data
    JEL: E01 E21 C82
    Date: 2006–12–03
  62. By: Dror Goldberg (Department of Economics Texas A&M University)
    Abstract: Monetary search models are difficult to analyze unless the distribution of money holdings is made degenerate. Popular techniques include using an infinitely large household (Shi 1997) and adding a centralized market with quasi-linear utility (Lagos and Wright 2005). Wallace (2002) suggests as an alternative to have two-member households who can somehow direct their search, thus creating a degenerate distribution in a different way. This idea is modelled here for the first time by modifying the partially directed search model of Goldberg (forthcoming). The Friedman rule is optimal, but the costs of deviating from it are different from the above mentioned models
    Keywords: directed search, Friedman rule
    JEL: E31 E40 E50
    Date: 2006–12–03
  63. By: Stephen D. Williamson (Department of Economics University of Iowa)
    Abstract: A segmented markets model is constructed in which transactions are conducted using credit and currency. Goods market segmentation plays an important role, in addition to the role played by conventional segmentation of asset markets. An important novelty of the paper is to show how the diffusion of a money injection by the central bank depends not only on the interaction of agents in exchanging money for goods, but on the arrangements for clearing and settlement of credit instruments. The model permits open market operations, daylight overdrafts, reserve-holding, and overnight lending and borrowing, allowing us to consider a rich array of central banking arrangements and their implications
    Keywords: Money, Segmented Markets, Credit, Central Banking
    JEL: E4
    Date: 2006–12–03
  64. By: Adam Copeland; George Hall (Department of Economics Brandeis University)
    Abstract: We determine empirically how the Big Three automakers accommodate shocks to demand. They have the capability to change prices, alter labor inputs through temporary layoffs and overtime, or adjust inventories. These adjustments are interrelated, non-convex, and dynamic in nature. Combining weekly plant-level data on production schedules and output with monthly data on sales and transaction prices, we estimate a dynamic profit-maximization model of the firm. Using impulse response functions, we demonstrate that when an automaker is hit with a demand shock sales respond immediately, prices respond gradually, and production responds only after a delay. The size of the immediate sales response is linear in the size of the shock, but the delayed production response is non-convex in the size of the shock. For sufficiently large shocks the cumulative production response over the product cycle is an order of magnitude larger than the cumulative price response. We examine two recent demand shocks: the Ford Explorer/Firestone tire recall of 2000, and the September 11, 2001 terrorist attacks.
    Keywords: automobile pricing, inventories, revenue management, indirect inference
    JEL: D21 D42 E22
    Date: 2006–12–03
  65. By: Jasmina Arifovic; Olena Kostyshyna
    Abstract: We study individual evolutionary learning in the setup developed by Deissenberg and Gonzalez (2002). They study a version of the Kydland-Prescott model in which in each time period monetary authority optimizes weighted payoff function (with selfishness parameter as a weight on its own and agent's payoffs) with respect to inflation announcement, actual inflation and the selfishness parameter. And also each period agent makes probabilistic decision on whether to believe in monetary authority's announcement. The probability of how trustful the agent should be is updated using reinforcement learning. The inflation announcement is always different from the actual inflation, and the private agent chooses to believe in the announcement if the monetary authority is selfish at levels tolerable to the agent. As a result, both the agent and the monetary authority are better off in this model of optimal cheating. In our simulations, both the agent and the monetary authority adapt using a model of individual evolutionary learning (Arifovic and Ledyard, 2003): the agent learns about her probabilistic decision, and the monetary authority learns about what level of announcement to use and how selfish to be. We performed simulations with two different ways of payoffs computation - simple (selfishness weighted payoff from Deissenberg/Gonzales model) and "expected" (selfishness weighted payoffs in believe and not believe outcomes weighted by the probability of agent to believe). The results for the first type of simulations include those with very altruistic monetary authority and the agent that believes the monetary authority when it sets announcement of inflation at low levels (lower than critical value). In the simulations with "expected" payoffs, monetary authority learned to set announcement at zero that brought zero actual inflation. This Ramsey outcome gives the highest possible payoff to both the agent and the monetary authority. Both types of simulations can also explain changes in average inflation over longer time horizons. When monetary authority starts experimenting with its announcement or selfishness, it can happen that agent is better off by changing her believe (not believe) action into the opposite one that entails changes in actual inflation
    JEL: C63 E5
    Date: 2005–11–11
  66. By: Shouyong Shi (University of Toronto public)
    Abstract: In this paper I examine whether a society can improve welfare by imposing a legal restriction to forbid the use of nominal bonds as a means of payments for goods. To do so, I integrate a microfounded model of money with the framework of limited participation. While the asset market is Walrasian, the goods market is decentralized and the legal restriction is imposed only in a fraction of the trades. I show that the legal restriction can improve the society's welfare. This essential role of the legal restriction persists even in the steady state, in contrast to the one-period role established in the literature. Also in contrast to the literature, the essential role of the legal restriction does not rely on households' ability to trade unmatured bonds for money after observing the taste (or endowment) shocks. Thus, the role cannot be mimicked or replaced with other policies such as discount windows
    Keywords: Nominal bonds, search, money, efficiency
    JEL: E40
    Date: 2006–12–03
  67. By: Guido Lorenzoni; Karl Walentin (Research Division Sveriges Riksbank (Bank of Sweden))
    Abstract: We develop a model of investment with financial constraints and use it to investigate the relation between investment and Tobin’s q. A firm is financed partly by insiders, who control its assets, and partly by outside investors. When insiders’ wealth is scarce, they earn a rate of return higher than the market rate of return, i.e. insiders earn a quasi-rent on invested capital. This rent is priced into the value of the firm, so Tobin’s q is driven by two forces: changes in the value of invested capital, and changes in the value of the insiders’ future rents. The second effect weakens the correlation between q and investment. We calibrate the model and show that, thanks to this effect, the model can generate realistic correlations between investment, q and cash flow
    Keywords: Financial constraints, Tobin's q, limited enforcement, investment, optimal capital structure
    JEL: E22 E30 E44 E51
    Date: 2006–12–03
  68. By: Bjoern Bruegemann (Yale University); Giuseppe Moscarini
    Abstract: Shimer (2005) showed that a standard search and matching model of the labor market fails to generate fluctuations of unemployment and vacancies of the magnitude observed in US data in response to shocks to average labor productivity of plausible magnitude. He also suggested that wage determination through Nash bargaining may be the culprit. In this paper we pursue two objectives. First, we identify those properties of Nash bargaining that limit the ability of the model to generate a large response of unemployment and vacancies to a shock to average labor productivity. In light of these properties, cast in terms of a general model of wage determination, we reinterpret some of the specific solutions proposed so far to this problem. Second, we examine whether asymmetric information may help to violate those properties and to provide amplification. We assume that the firm has private information about the job's productivity, the worker about the amenity of the job, and aggregate labor productivity shocks do not change the distribution of private information around their mean. In this environment, we consider the monopoly (or monopsony) solution, namely a take-it-or-leave-it offer, and the constrained efficient allocation. We find that our key properties are satisfied for the first model essentially under all circumstances. They frequently (for commonly used specific distributions of beliefs) also apply to the constrained efficient allocation
    Keywords: Unemployment, Vacancies, Business Cycle, Asymmetric Information
    JEL: E24 J41 J63
    Date: 2006–12–03
  69. By: Nir Jaimovich (Economics UCSD); Sergio Rebelo
    Abstract: In this paper we propose a model that generates an expansion in response to good news about future total factor productivity (TFP) or investment-specific technical change. The model has three key elements: variable capital utilization, adjustment costs to investment, and preferences that exhibit a weak short-run income effect on the labor supply. These preferences nest, as special cases, the two classes of utility functions most widely used in the business cycle literature. Even though our model abstracts from negative productivity shocks, it generates recessions that resemble those in the post-war U.S. economy. Recessions are caused not by contemporaneous negative shocks but by lackluster news about the future TFP or investment-specific technical change
    Keywords: News, Future Shocks, Business Cycle
    JEL: E3
    Date: 2006–12–03
  70. By: Andrea Raffo (Economic Research Federal Reserve Bank, Kansas City)
    Abstract: Conventional two-country RBC models interpret countercyclical net exports as reflecting, in large part, the dynamics of capital. I show that, quantitatively, theoretical economies rely on counterfactual terms of trade effects: trade fluctuations, on the contrary, are driven primarily by consumption smoothing, thus generating procyclical net trade in goods. I then consider a class of preferences that embeds home production in a reduced form: consumption volatility increases so that countercyclical net exports reflect primarily a strong relation between import of goods and income, as in the data. The major discrepancy between theory and data concerns the variability of international prices.
    Keywords: Net exports; Home production; Consumption volatility.
    JEL: E32 F32 F41
    Date: 2006–12–03
  71. By: Boyan Jovanovic (Economics New York University)
    Abstract: A firm has investment options that it may use up immediately, or store for future use. A patent, e.g., is an option to implement an idea via a product or process innovation. Other investment options are protected by secrecy. An investment option is a profit opportunity that requires an investment to implement. Because investment options are scarce, Tobin’s q is always above unity. When the stock of these options rises, the value of stock market falls, a result that exactly invalidates the use of the stock market as a positive indicator of the stock of intangibles. Finally, the stock market alone ensures that equilibrium is efficient
    Keywords: Volatility, Tobin's q
    JEL: E32
    Date: 2006–12–03
  72. By: John Quigley (University of California, Berkeley)
    Abstract: This paper tests the "lock−in" effect of mortgage contract terms and establishes the link between changes in market interest rates and homeowner mobility. The analysis is based on the Panel Study of Income Dynamics during 1990−1993, when mortgage interest rates declined by almost 30 percent.
    Keywords: Households, Mortgage,
    Date: 2006–06–27
  73. By: Aubhik Khan; Julia K. Thomas (Department of Economics University of Minnesota)
    Abstract: We examine a model of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity, and nonconvex adjustment costs lead them to pursue generalized (S,s) investment rules. We allow persistent heterogeneity in both capital and total factor productivity alongside low-level investments exempt from adjustment costs to develop the first model consistent with available evidence on establishment-level investment rates. Reassessing the implications of lumpy investment for aggregate dynamics in this setting, we find that they remain substantial when factor supply considerations are ignored, but are quantitatively irrelevant in general equilibrium. The substantial implications of general equilibrium extend beyond the dynamics of aggregate series. While the presence of idiosyncratic shocks makes the time-averaged distribution of plant-level investment rates largely invariant to market-clearing movements in real wages and interest rates, we show that the dynamics of plants' investments differ sharply in their presence. Thus, model-based estimations of capital adjustment costs involving panel data may be quite sensitive to the assumption about equilibrium. Our analysis also offers new insights about how nonconvex adjustment costs influence investment at the plant. When establishments face large and weakly persistent idiosyncratic productivity shocks consistent with existing estimates, we find that nonconvex costs do not cause lumpy investments, but act to eliminate them
    Keywords: (S,s) policies, lumpy investment, quantitative general equilibrium
    JEL: E32 E22
    Date: 2006–12–03
  74. By: Dean Corbae (University of Texas); Borghan N. Narajabad
    Abstract: We apply a mechanism design approach to a trading post environment where the household type space (tastes over variety) is continuous and it is costly to set up shops that trade differentiated goods. In this framework, we address Hotelling's <cite>Hot</cite> venerable question about where shops will endogenously locate in variety space across environments with and without money. Money has a role in our environment due to anonymity. Our specific question is whether monetary exchange leads to more product variety than an environment without money (i.e. a barter economy). We show that an efficient monetary mechanism does in fact lead to more product variety available to households provided the discount factor is sufficiently high, costs of operating shops are sufficiently low, and there is sufficient heterogeneity in tastes and abilities. We then show how this allocation can be implemented in a trading post economy with money. The paper is an attempt to integrate monetary theory and industrial organization
    Keywords: Matching Models of Money, Trading Posts
    JEL: E4
    Date: 2006–12–03
  75. By: Benoit Julien (Economics Australian Graduate School of Management); John Kennes; Ian King
    Abstract: This paper analyzes monetary exchange in a search model allowing for multilateral matches to be formed, according to a standard urn-ball process. We consider three physical environments: indivisible goods and money, divisible goods and indivisible money, and divisible goods and money. We compare the results with Kiyotaki and Wright (1993), Trejos and Wright (1995), and Lagos and Wright (2005) respectively. We …nd that the multilateral matching setting generates very simple and intuitive equilibrium allocations that are similar to those in the other papers, but which have important di¤erences. In particular, sur- plus maximization can be achieved in this setting, in equilibrium, with a positive money supply. Moreover, with ‡exible prices and directed search, the …rst best allocation can be attained through price posting or through auctions with lotteries, but not through auctions without lotteries. Finally, analysis of the case of divisible goods and money can be performed without the assumption of large families (as in Shi (1997)) or the day and night structure of Lagos and Wright (2005)
    Keywords: Matching, Money, Directed Search
    JEL: C78 D44 E40
    Date: 2006–12–03
  76. By: Michal Pakos (Finance Tepper School of Business CMU)
    Abstract: I propose a new valuation ratio: durables price over the rental cost of capital, which is a direct analogue of the price-dividend ratio. I show that it is a rational forecast of future discount rates and future growth rates of the rental cost. In order to impute the unobservable rental cost, I develop a dynamic rational expectations economy with Beckerian household production. Investors' preferences are defined over the nondurables and the services flow from the household capital, the stock of durables. I assume investors "produce" services flow in the household sector. I carefully model the sector's returns to scale and find decreasing returns to scale in the household capital, ceteris paribus. The result is crucial as specifications used in the previous literature lead to a misspecified rental cost of capital, and thus errors-in-variables problems in predictive regressions. In contrast to price-dividend ratio, I construct the durables price-rental cost valuation ratio as an affine function of a co-integrating residual. I evaluate its predictive power and discover that it strongly forecasts excess returns on 25 Fama-French portfolios, especially small and value stocks. In particular, I can predict small-minus-big portfolio (SMB) with $R^2$ around 30\% at 4 year horizon
    Keywords: Predictability, Durable Goods, Household Production, Price Dividend Ratio
    JEL: E13 E21 E32 E44
    Date: 2006–12–03
  77. By: Shigeru Fujita (Research Department Federal Reserve Bank of Philadelphia); Garey Ramey
    Abstract: In aggregate U.S. data, exogenous shocks to labor productivity induce highly persistent and hump-shaped responses to both the vacancy-unemployment ratio and employment. We show that the standard version of the Mortensen-Pissarides matching model fails to replicate this dynamic pattern due to the rapid responses of new job openings. We extend the model by introducing a sunk cost for creating job positions, motivated by the well-known fact that worker turnover exceeds job turnover. In the matching model with sunk costs, new job openings react sluggishly to shocks, leading to highly realistic dynamics
    Keywords: Unemployment, Vacancies, Labor Adjustment, Matching
    JEL: E32 J63 J64
    Date: 2006–12–03
  78. By: Anna Batyra (Currently: Eitan Berglas School of Econ. IRES/ECON/Catholic University of Louvain); Henri R. Sneessens
    Abstract: Significant differences in unemployment incidence in Europe have been observed across skill groups, with the least skilled suffering the highest and most persistent unemployment rates. To identify policies alleviating this problem, we study the impact of reductions in employer social security contributions. We construct a general equilibrium model with three types of heterogeneous workers and firms, matching frictions, wage bargaining and a rigid minimum wage. We find evidence in favour of narrow tax cuts targeted at the minimum wage but we argue that it is most important to account for the effects of such reductions on both job creation and job destruction. The failure to do so may explain the gap between macro- and microeconometric evaluations of such policies in France and Belgium. Policy impact on welfare and inefficiencies induced by job competition, ladder effects and on-the-job search are discussed.
    Keywords: Skill Bias, Minimum Wage, Job Creation, Job Destruction, Job Competition, Search Unemployment, Taxation
    JEL: E24 J64
    Date: 2006–12–03
  79. By: Alfredo Marvao Pereira; Maria De Fatima Pinho
    Abstract: In an period of heightened concern about fiscal consolidation in the Euro zone, a politically expedient way of dealing with the situation is to cut public investment. A critical question, however, is whether or not political expediency comes at a cost, in terms of both long-term economic performance and future budgetary consolidation efforts. In fact, one would expect any type of investment, including public investment, to improve the long-term economic performance. Moreover, to the extent that public investment increases output in the long-term, it also expands the tax base and, therefore, tax revenues in the long term. It is conceivable that public investment has such strong effects on output, that over time it generates enough additional tax revenues to pay for itself. It is equally plausible that the effects on output although positive are not strong enough for the public investment to pay for itself. In the first case, cuts in public investment hurt long-term growth and make the future budgetary situation worse. In the second case, cuts in public investment hurt the long-term economic performance without hurting the future budgetary situation. In this paper we investigate this question empirically in the context of a number of countries in the Euro zone using a vector auto-regressive/error correction mechanism approach to determine the effects of aggregated public investment on output, employment and private investment. Our ultimate objective is to determine in which regime do the different countries seem to fit and determine to what extent cuts in public investment may turn out to be counter-productive in the long-term from a budgetary perspective. JEL Classification: C32, E62, H54, O52
    Date: 2006–08
  80. By: Ross Starr (University of California, San Diego)
    Abstract: This paper posits an example of Walrasian general competitive equilibrium in an exchange economy with commodity-pairwise trading posts and transaction costs. Budget balance is enforced for each transaction at each trading post separately. Commodity-denominated bid and ask prices at each post allow the post to cover transaction costs through the bid/ask spread. In the absence of double coincidence of wants, the lower transaction-cost commodity (with the narrowest bid/ask spread) becomes the common medium of exchange, commidty money. Selection of the monetary commodity and adoption of a monetary pattern of trad results from price-guided equilibrium without central direction, fiat, or government
    Keywords: Transaction cost, bid/ask spread, money, Arrow-Debreu general equilibrium,
    Date: 2006–06–01
  81. By: Petro Peretto (Duke University)
    Abstract: I study a model where firms bargain with unions over wages and employment levels. This interaction generates unemployment. Households take unemployment risk as given in making their participation decisions. I am thus able to study the interactions of product and labor market institutions in a three-states representation of the labor market. Unemployment matters because is inserts a wedge between labor supply (participation) and employment. Employment matters because it determines output. I uncover two feedback mechanisms, each reinforced by endogenous participation. The firt exploits the endogeneity of the number of firms to amplify the adverse effects on output of regulations and frictions that raise labor costs, work practice rigidities and the bargaining power of workers. The second exploits the endogeneity of market size to amplify the adverse effects of product market frictions that raise the costs of entry or of operation for firms. The multiplier effects due to these feedback mechanisms have interesting implications for the current policy debate. Labor market reforms that reduce the cost of labor are actually more attractive when one considers the endogenous structure of the product market. Similarly, pro-competitive product market reforms are more attractive when one considers the positive feedback on market structure that runs through the labor market
    Keywords: product market, labor market, employment, unemployment
    JEL: E6 J23
    Date: 2006–12–03
  82. By: P. Marcelo Oviedo; Rajesh Singh (Economics Iowa State University)
    Abstract: Backus, Kehoe, and Kydland (International Real Business Cycles, JPE, 100(4),1992) documented several discrepancies between the observed post-war business cycles of developed countries and the predictions of a two-country, complete-market model. The main discrepancy termed as the “quantity anomaly†that cross-country consumption correlations are higher than that of output in the model as opposed to data, has remained a central puzzle in international economics. In order to resolve this puzzle mainly two strategies: restrictions on asset trade, and introducing non-traded goods in the model, have been employed by researchers. While these extensions have been successful in closing the gap to some extent, the ordering of correlations has stayed unchanged: consumption correlations still exceed that of output. This paper attempts to resolve the quantity puzzle by introducing non-traded distribution costs in the retailing of traded goods. In a standard two-good model traded output and traded consumption, by definition, are identical goods. With distribution costs, traded output and consumption are two distinct entities as each unit of final traded consumption good incorporates a unit of traded good and a fixed amount of non-traded goods. Thus, effectively, the model with distribution costs can be viewed as a model without distribution costs but with a modified utility function that has a substantially stronger complementarity between traded and non-traded goods. In a simple two-good extension of the Backus, Kehoe, and Kydland model, it is shown that the cross-country consumption and output correlations are 0.55 and 0.30, respectively, whereas with distribution costs consumption correlation reduces to 0.09, output correlation to 0.23. Incorporating distribution costs, in addition, improves the model’s performance in matching the volatility of real exchange rates and the correlation of net exports with output. These improvements are achieved without sacrificing the model's performance in any other dimension.
    Keywords: open economy business cycles; quantity puzzle; distribution costs
    JEL: F32 F34 F41
    Date: 2006–12–03
  83. By: Matteo Lanzafame
    Abstract: Taking as a starting point the evidence of growing disparities in the 1977-2003 years, the paper investigates the pure hysteresis hypothesis for regional unemployment rates in Italy. Relying both on univariate and panel unit-root rests, we can confidently reject the unit-root hypothesis. The implication of this result is that, however persistent, shocks to regional unemployment will be temporary. We, then, proceed to estimate the NAIRU for each of the 20 Italian regions. Our estimates of the regional NAIRUs turn out to be fairly precise and allow us to draw two interesting conclusions. Firstly, the hypothesis of constant regional NAIRUs between 1977 and 2003 is supported by the data. Secondly, we find that there is a significant degree of heterogeneity among the regional NAIRUs. Finally, we investigate the cyclical behaviour of regional unemployment and find that region-specific demand shocks play a major role.
    Keywords: Endogenous growth; Okun's Law, Italian regions
    JEL: C33 E24 R10
    Date: 2006–12
  84. By: Uluc Aysun (University of Connecticut)
    Abstract: This paper tests the presence of balance sheets effects and analyzes the implications for exchange rate policies in emerging markets. The results reveal that the emerging market bond index (EMBI) is negatively related to the banks. foreign currency leverage, and that these banks. foreign currency exposures are relatively unhedged. Panel SVAR methods using EMBI instead of advanced country lending rates find, contrary to the literature, that the amplitude of output responses to foreign interest rate shocks are smaller under relatively fixed regimes. The findings are robust to the local projections method of obtaining impulse responses, using country specific and GARCH-SVAR models.
    Keywords: EMBI, bank balance sheets, leverage, country risk premium, exchange rates.
    JEL: E44 F31 F41
    Date: 2006–08
  85. By: Shouyong Shi
    Abstract: In this article I briefly review recent developments in search theory. Particular attention is given to the framework of directed search. I first illustrate the inefficiency that arises in the equilibrium of standard (undirected) search models. Then I provide a formulation of directed search and show that the resulting equilibrium eliminates the inefficiency. Examples of directed search with price posting and auction are provided both for the market with a finite number of individuals and for a large market. After describing the application of search models in monetary theory, I conclude with a remark on the future research.
    Keywords: Search; Efficiency; Unemployment
    JEL: C78 E10
    Date: 2006–12–12
  86. By: António Afonso
    Abstract: This paper provides a succinct overview of long-run developments regarding public finances in Portugal with an emphasis on the spending side. Issues addressed are the excessive deficit experiences of Portugal, the past experience with fiscal consolidations, and labour cost competitiveness. It is fair to stay that public spending control has been a problem in Portugal, and fiscal consolidations in the 1980s and 1990s have been shorttermed and mostly not successful. Additionally, the compensation of general government employees diverged vis-à-vis the EU15 after EU entry.
    Keywords: public finances; Portugal; fiscal consolidations; compensation of employees.
    JEL: E62 E65 H6
  87. By: Uluc Aysun (University of Connecticut)
    Abstract: Despite the extensive work on currency mismatches, research on the determinants and effects of maturity mismatches is scarce. In this paper I show that emerging market banks. maturity mismatches are negatively affected by capital inflows and price volatilities. Furthermore, I find that banks with low maturity mismatches are more profitable during crisis periods but less profitable otherwise. The later result implies that banks face a tradeoff between higher returns and risk, hence channeling short term capital into long term loans is caused by cronyism and implicit guarantees rather than the depth of the financial market. The positive relationship between maturity mismatches and price volatility, on the other hand, shows that the banks of countries with high exchange rate and interest rate volatilities can not, or choose not to hedge themselves. These results follow from a panel regression on a data set I constructed by merging bank level data with aggregate data. This is advantageous over traditional studies which focus only on aggregate data.
    Keywords: mergentonline, bank level data, maturity mismatches, liquidity, profitability and debt structure ratios, price volatility.
    JEL: E44 F32 F34 F41
    Date: 2006–08
  88. By: Ricardo J. Caballero; Emmanuel Farhi (Economics Massachusetts Institute of Technology); Pierre-Olivier Gourinchas
    Abstract: Three of the most important recent facts in global macroeconomics — the sustained rise in the US current account deficit, the stubborn decline in long run real rates, and the rise in the share of US assets in global portfolio — appear as anomalies from the perspective of conventional wisdom and models. Instead, in this paper we provide a model that rationalizes these facts as an equilibrium outcome of two observed forces: a) potential growth differentials among different regions of the world and, b) heterogeneity in these regions’ capacity to generate financial assets from real investments. In extensions of the basic model, we also generate exchange rate and FDI excess returns which are broadly consistent with the recent trends in these variables. Unlike the conventional wisdom, in the absence of a large change in(a) or (b), our model does not augur any catastrophic event. More generally, the framework is flexible enough to shed light on a range of scenarios in a global equilibrium environment
    Keywords: Current account deficits, capital flows, interest rates, global portfolios and equilibrium, growth and financial development asymmetries, exchange rates, FDI, intermediation rents.
    JEL: E0 F3 F4 G1
    Date: 2006–12–03
  89. By: Dmytro Hryshko (Economics University of Houston)
    Abstract: Idiosyncratic household income is typically assumed to consist of several components. While the total income is observed and is often modelled as an integrated moving average process, individual components are not observed directly. In the literature, econometricians typically assume that household income is the sum of a random walk permanent component and a transitory component, with uncorrelated permanent and transitory shocks. This characterization is not innocuous since households may have better information on individual income components than econometricians do. I show that, for the same reduced form model of income, different models for the income components lead to sizeably different estimates of the marginal propensity to consume (MPC) out of shocks to current and lagged income, and the volatility of consumption changes relative to income changes in data generated by an infinite horizon buffer stock model. I further suggest that the MPC out of shocks to current and lagged income estimated from empirical micro data should help identify parameters of individual components of the income process, including the correlation between transitory and permanent shocks. I use the method of simulated moments (MSM) and data from the Panel Study of Income Dynamics (PSID) and the Consumer Expenditure Survey (CEX) to estimate a structural life cycle model of consumption. I also jointly estimate the parameters governing the income process. I find statistically significant negative contemporaneous correlation between permanent and transitory shocks to income and reasonable, precisely estimated values for the time discount factor and the relative risk aversion parameter
    Keywords: Buffer stok model of savings, method of simulated moments, income processes, unobserved components models
    JEL: C61 D91 E21
    Date: 2006–12–03
  90. By: Damien Gaumont; Martin Schindler (IMF); Randall Wright
    Abstract: Search models with posting and match-specific heterogeneity generate wage dispersion. Given K values for the match-specific variable, it is known that there are K reservation wages that could be posted, but generically never more than two actually are posted in equilibrium. What is unknown is when we get two wages, and which wages are actually posted. For an example with K = 3, we show equilibrium is unique; may have one wage or two; and when there are two, the equilibrium can display any combination of posted reservation wages, depending on parameters. We also show how wages, profits, and unemployment depend on productivity
    Keywords: Search equilibrium, wage posting, wage dispersion, labor theory
    JEL: D83 E24 J31
    Date: 2006–12–03
  91. By: Matteo Lanzafame
    Abstract: Following León-Ledesma and Thirlwall (2002a), this paper investigates the extent to which the natural rate of growth of the Italian regions is endogenous, in the sense that it is affected by actual growth. The estimation framework is based on one version of the cyclical relationship between unemployment and output growth known as Okun's Law [Okun (1962)]. Econometrically, the main hypothesis being examined regards the presence of non-linearities in Okun's Law, which can be interpreted as structural shifts in the natural growth rate. Using annual data over the period 1977-2003, we find strong support for the endogeneity hypothesis when applying the theory-based estimation methodology proposed by LLT. The results are less clear-cut when we switch to a data-driven approach centred on the Hansen's (1997) testing procedure for threshold models. Furthermore, in line with recent findings in the literature, our analysis provides evidence of asymmetries in Okun's Law, suggesting that unemployment turns from counter-cyclical when growth is slow to acyclical or even (in some cases) pro-cyclical in booms.
    Keywords: Endogenous growth; Okun's Law, Italian regions
    JEL: O40 O18 E23 E10
    Date: 2006–12
  92. By: Ricardo Caballero (MIT and NBER); Emmanuel Farhi (MIT); Pierre-Olivier Gourinchas (Berkeley and NBER)
    Abstract: Three of the most important recent facts in global macroeconomics -- the sustained rise in the US current account deficit, the stubborn decline in long run real rates, and the rise in the share of US assets in global portfolio -- appear as anomalies from the perspective of conventional wisdom and models. Instead, in this paper we provide a model that rationalizes these facts as an equilibrium outcome of two observed forces: a) potential growth differentials among different regions of the world and, b) heterogeneity in these regions' capacity to generate financial assets from real investments. In extensions of the basic model, we also generate exchange rate and FDI excess returns which are broadly consistent with the recent trends in these variables. More generally, the framework is flexible enough to shed light on a range of scenarios in a global equilibrium environment.
    Keywords: current account deficits, capital flows, interest rates, global portfolios and equilibrium, growth and financial development asymmetries, exchange rates, FDI, intermediation rents,
    Date: 2006–12–06
  93. By: Karen A. Kopecky (Economics University of Rochester)
    Abstract: A model with leisure production and endogenous retirement is used to explain the declining labor-force participation rates of elderly males. Using the Health and Retirement Study, the model is calibrated to cross-sectional data on the labor-force participation rates of elderly US males by age and their average drop in market consumption in the year 2000. Running the calibrated model for the period 1850 to 2000, a prediction of the evolution of the cross-section is obtained and compared with data. The model is able to predict both the increase in retirement since 1850 and the observed drop in market consumption at the moment of retirement. The increase in retirement is driven by rising real wages and a falling price of leisure goods over time
    Keywords: retirement, leisure, home production, consumption-drop, technological progress
    JEL: E13 J26 O11
    Date: 2006–12–03
  94. By: Jeremy Lise
    Abstract: In this paper, I develop and estimate a model of the labor market that can account for both the inequality in earnings and the much larger inequality in wealth observed in the data. I show that an equilibrium model of on-the-job search, augmented to account for saving decisions of workers, provides a direct and intuitive link between the empirical earnings and wealth distributions. The mechanism that generates the high degree of wealth inequality in the model is the dynamic of the ``wage ladder'' resulting from the search process. There is an important asymmetry between the incremental wage increases generated by on-the-job search (climbing the ladder) and the drop in income associated with job loss (falling off the ladder). This feature of the model generates differential savings behavior at different points in the earnings distribution. The wage growth expected by low wage workers, combined with the fact that their earnings are not much higher than unemployment benefits, causes them to dis-save. As a worker's wage increases, the incentive to save increases: the potential for wage growth declines and it becomes increasingly important to insure against the large income reduction associated with job loss. The fact that high wage and low wage workers have such different savings behavior generates an equilibrium wealth distribution that is much more unequal than the equilibrium wage distribution. I estimate the structural parameters of the model by simulation-based methods using the 1979 youth cohort of the NLSY. The estimates indicate that the micro-level search and savings behavior---estimated from the dynamics of individuals' labor market histories and wealth accumulation decisions---aggregates to replicate the cross-sectional inequality in earnings and wealth for this cohort.
    Keywords: labor search, savings, consumption, wealth inequality
    JEL: J64 E21 E24
    Date: 2006–12–03
  95. By: Martin Gonzalez-Eiras (Universidad de San Andres); Dirk Niepelt
    Abstract: In this paper we analyze tax and transfer choices in an OLG economy with capital accumulation and endogenous growth coming from public investment, such as education. We solve for a Markov perfect equilibrium when electoral competition targets the votes of young and old households. We find that when calibrating the model to match US data, it predicts levels of intergenerational transfers and of public investments that are similar to the observed ones. Furthermore the Ramsey policy for the same parameters would call for both generations to be taxed to finance public investment. If the political process internalized the benefits that public investment has on future generations, growth would be twice as high as currently observed
    Keywords: endogenous growth; intergenerational transfers; education; probabilistic voting; Markov perfect equilibrium
    JEL: E62 H55 O41
    Date: 2006–12–03
  96. By: Fernando Broner; Guido Lorenzoni (Economics MIT); Sergio Schmuckler
    Abstract: We argue that emerging economies borrow short term due to the high risk premium charged by bondholders on long-term debt. First, we present a model where the debt maturity structure is the outcome of a risk sharing problem between the government and bondholders. By issuing long-term debt, the government lowers the probability of a rollover crisis, transferring risk to bondholders. In equilibrium, this risk is re‡ected in a higher risk premium and borrowing cost. Therefore, the government faces a trade-o¤ between safer long-term debt and cheaper short-term debt. Second, we construct a new database of sovereign bond prices and issuance. We show that emerging economies pay a positive term premium (a higher risk premium on long-term bonds than on short-term bonds). During crises, the term premium increases, with issuance shifting towards shorter maturities. The evidence suggests that investor risk aversion is important to understand the debt structure in emerging economies
    Keywords: emerging market debt; financial crises; investor risk aversion
    JEL: E43 F30 F32
    Date: 2006–12–03
  97. By: Loayza, Norman V.; Raddatz, Claudio
    Abstract: The authors examine empirically how domestic structural characteristics related to openness and product- and factor-market flexibility influence the impact that terms-of-trade shocks can have on aggregate output. For this purpose, they apply an econometric methodology based on semi-structural vector auto-regressions to a panel of 90 countries with annual observations for the period 1974-2000. Using this methodology, the authors isolate and standardize the shocks, estimate their impact on GDP, and examine how this impact depends on the domestic conditions outlined above. They find that larger trade openness magnifies the output impact of external shocks, particularly the negative ones, while improvements in labor market flexibility and financial openness reduce their impact. Domestic financial depth has a more nuanced role in stabilizing the economy. It helps reduce the impact of external shocks particularly in environments of high exposure-that is, when trade and financial openness are high, firm entry is unrestricted, and labor markets are rigid.
    Keywords: Pro-Poor Growth and Inequality,Free Trade,Economic Theory & Research,Inequality,Macroeconomic Management
    Date: 2006–12–01
  98. By: Christian Bauer; Sebastian Horlemann
    Abstract: Recent approaches in international finance on exchange rates explicitly account for the maturity of interest rates. We integrate the interest parity idea into a modern microstructure model of foreign exchange and national bond markets and develop a model of the term structure of exchange rate expectations. The reaction function of the spot rate on changes of the basic economic variables such as the interest rate is generalized. This capital market model is able to reproduce standard results (e.g. overshooting) without reference to macroeconomic variables like rigid prices. In addition, the semi-elasticity of the spot exchange rate on interest rate changes depends on both the term structure of interest rates in both countries and determinants of the financial markets. The effects of interest rate changes on the spot exchange rate are diminished, if the exchange rate expectations for short and for long horizons have opposite signs. Finally, we show that there are several rational methods of building expectations which are not mutually consistent. This ambiguity of rational expectation building might contribute to explanations of the diversity of empirical results in the literature known as UIP puzzle.
    Keywords: exchange rates, expectation, term structure, interest parity
    JEL: F31 D84 E43
  99. By: Alok Kumar (Economics University of Victoria)
    Abstract: This paper analyzes the general equilibrium effects of capital tax when there is a mandated minimum wage. The analysis is conducted in an inter-temporal search model in which firms post wages as in Burdett and Mortensen (1998). A(binding) minimum wage provides alower support for the distribution of wages. A decrease in capital tax leads to an increase in wage dispersion. In contrast, when the minimum wage is not binding, a lower capital tax reduces the dispersion in wages. A binding minimum wage also magnifies the positive effects of a lower capital tax on labor supply, employment, and output. The analysis suggests that a policy change which involves an increase in minimum wage and a fall in capital tax such that unemployment rate remains constant reduces dispersion of wages
    Keywords: Labor market search, capital tax, minimum wage, labor supply, wage dispersion, wage posting, general equilibrium
    JEL: E2 E6 J3 J4
    Date: 2006–12–03
  100. By: Giuseppe Bertola (University of Turin and CFS); Winfried Koeniger (Institute for the Study of Labor (IZA))
    Abstract: We show theoretically that income redistribution benefits borrowingconstrained individuals more than is implied by standard relative-income and uninsurable-risk considerations. Empirically, we find in international opinion-survey data that younger and lower-income individuals express stronger support for government redistribution in countries where consumer credit is less easily available. This evidence supports our theoretical perspective if such individuals are more strongly affected by tighter credit supply, in that expectations of higher incomes in the future increase their propensity to borrow.
    Keywords: Consumption, Smoothing
    JEL: E21
    Date: 2007–01–02
    Abstract: Nickell, Nunziata and Ochel [Economic Journal, 2005] argue that unemployment rates cointegrate with labour market institutions in a panel of OECD countries. This paper reproduces their Maddala-Wu panel cointegration test and shows that this test is only valid when (i) the number of countries tends to infinity and (ii) the underlying country-specific cointegration tests are independent. Their finding of cointegration does not survive when small sample properties and heterogeneous cross-sectional dependencies are taken into account. This suggests that the estimated impact of institutions on unemployment is spurious.
    Keywords: unemployment, panel cointegration, bootstrapping
    JEL: C15 C33 E24
    Date: 2006–11
  102. By: Lars Ljungqvist (DEPT OF ECONOMICS STOCKHOLM SCHOOL OF ECONOMICS); Thomas J. Sargent
    Abstract: We first scrutinize and challenge Prescott's (2002, 2004) quantitative analysis of the role of differences in taxes in explaining cross-country differences in labor market outcomes, and then defend an alternative model that assigns an important role to cross-country differences in social unemployment insurance institutions that Prescott argues can be safely ignored. In the process, we explore how the assumption of indivisible labor interacts with assumptions regarding the (in)completeness of financial markets and any frictions in the labor market, to determine the labor supply elasticity.
    Keywords: Employment lotteries, indivisible labor, labor supply elasticity, taxation, unemployment, unemployment insurance
    JEL: E24 J64
    Date: 2006–12–03
  103. By: Oksana Leukhina (Economics UNC - Chapel Hill); Michael Bar
    Abstract: All industrialized countries experienced a transition from high birth rates and stagnant standards of living to low birth rates and sustained growth in per capita income. What contributed to this transformation? Were output and population dynamics driven by common or separate forces? We develop a general equilibrium model with endogenous fertility in order to quantitatively investigate the English case. We find that mortality decline significantly influences birth rates. Increased productivity has a negligible effect on birth rates but accounts for nearly all of the increase in per capita output, industrialization, urbanization, and the decline of land share in total income
    Keywords: demographic transition, industrial revolution, mortality, technological progress
    JEL: J10 O1 O4 E0
    Date: 2006–12–03
  104. By: Alcino Ferreira Câmara Neto; Matías Vernengo
    Abstract: It has become common sense to argue that the reforms of social policies after the 1988 Constitution were somehow instrumental in explaining social progress, and that Lula’s policies mark a break with the 1988 Constitution. We suggest that both propositions are misleading. We argue that the financialization of government expenditures has led to worsening income distribution, and by limiting the ability of the state to increase social spending it has limited the ability of the state to reduce social inequalities. We argue that a recovery of Keynesian ideas about full employment and the euthanasia of the rentier are central for the development of a more just and civilized society in Brazil.
    Keywords: Income Inequality, Social Policies, Keynesian Policies
    JEL: E25 H50 O54
    Date: 2006–07
  105. By: Masanao Aoki (Department of Economics, UCLA)
    Abstract: This paper examines asymptotic behavior of two types of economic or ?nancial models with manyinteracting heterogeneous agents. They are one-parameter Poisson-Dirichlet models, also called Ewens models, and its extension totwo-parameterPoisson-Dirichlet models. The total number of clusters, and the components of partition vectors (thenumberof clustersofspeci?ed sizes),both suitably normalizedby some powers of model sizes, of these classes of models are shown tobe related to the Mittag-Le?er distributions. Theirbehavior as the model sizes tend to in?nity(thermodynamic limits) are qualitativelyvery di?erent.Inthe one-parametermodels,thenumberof clusters, and components of partition vectors are both self-averaging, that is,theircoe?cientsofvariationstendto zeroasthemodelsizesbecomevery large, while in the two-parameter models they are not self-averaging, that is,theircoe?cientsofvariationsdonottendto zeroasmodel sizesbecomes large.
    Date: 2006–10
  106. By: Sylvain Champonnois (Economics Princeton University)
    Abstract: This paper investigates whether the financial markets are relatively more efficient than banks in the UK than in continental Europe. The UK channels a larger fraction of the financial flow to the firms through financial markets than continental Europe but this is explained by larger firms in the UK, not relatively more efficient markets. This conclusion is drawn from an industry-level structural estimation using data on the UK, France, Germany and Italy. The structural model is based on a novel theory of capital allocation and investment in which the decisions of heterogenous firms across financing instruments are aggregated in closed-form
    Keywords: Financial structure, bank finance, market finance, heterogenous firms, structural estimation,
    JEL: C51 E44 G31
    Date: 2006–12–03
  107. By: Dirk Krueger; Alexander Ludwig (Department of Economics Mannheim Research Institute for the Econ)
    Abstract: In all major industrialized countries the population is aging over time, reducing the fraction of the population in working age. Consequently labor is expected to be scarce, relative to capital, with an ensuing decline in real returns on capital and increases in real wages. This paper employs a large scale OLG model with intra-cohort heterogeneity to ask what are the distributional consequences of these changes in factor prices induced by changes in the demographic structure. Since these demographic changes occur at different speed in industrialized economies we develop a multi-region (the US, the European Union, the rest of the OECD and the rest of the world) openeconomy model that allows for international capital flows. This allows us to evaluate to what extent the distributional consequences of changing factor prices for the US and Europe are mitigated or accentuated by the fact that the population is aging at different rates elsewhere in the world
    Keywords: aging, capital flows, pension reform, welfare, distribution
    JEL: E27 F21 H55
    Date: 2006–12–03
  108. By: Rafael Silveira (Economics University of Pennsylvania); Randall Wright
    Abstract: We study markets where innovators can sell ideas to entrepreneurs, who may be better at implementing them. These markets are decentralized, with random matching and bargaining. Entrepreneurs hold liquid assets lest potentially profitable opportunities may be lost. We extend existing models of the demand for liquidity along several dimensions, including allowing agents to put deals on hold while they try to raise funds. We determine which ideas get traded in equilibrium, compare this to the efficient outcome, and discuss policy implications. We also discuss several special aspects of ideas, as opposed to generic consumption goods: e.g. they are intermediate inputs; they are indivisible; and they are at least partially public (nonrivalous) goods
    Keywords: entrepreneurship, liquidity, random matching, monetary policy
    JEL: E40 M13 O31
    Date: 2006–12–03
  109. By: Yili Chien; Junsang Lee (UCLA public)
    Abstract: We study optimal capital taxation in a limited commitment environment. Our environment consists of a continuum of households with idiosyncratic labor shocks, who have access to a complete contingent claims market. Financial contracts are not perfectly enforceable; as in Kehoe and Levine (1993), enforcement constraints take the form of endogenous debt limits. This market imperfection drives the endogenous discrepancy between the household and planner discount factors: households face the possibility of being debt constrained in the future, and as a result have a higher discount factor than the planner, who does not face such a constraint. In such an economy, the planner will choose an optimal capital level that is lower than that chosen by households; this di¤erence in the choice of capital motivates imposing a positive capital income tax on households to induce them to invest at the socially optimal amount
    Keywords: Capital Tax, borrowing constraint, enforcement
    JEL: E22 E62
    Date: 2006–12–03
  110. By: John Quigley (University of California, Berkeley); Daniel Rubinfeld (University of Calfornia, Berkeley)
    Abstract: (No abstract)
    Keywords: Economy,
    Date: 2006–06–27
  111. By: Joseph Pearlman
    Abstract: We initially examine two different methods for learning about parameters in a Rational Expectations setting, and show that there are conflicting E-stability results. We show that this conflict also extends to Minimum State Variable (MSV) representations. One of these methods of learning lends itself to the examination of E-stability for the generic forward-looking rational expectations model. This leads to a completely general relationship between saddlepath stability and E-stability, and a generalization of MSV results.
    Keywords: E-stability, Minimum state variable.
    JEL: C6 E00
    Date: 2007–01
  112. By: Fang Yang (University of Minnesota University of Minnesota)
    Abstract: This paper studies a quantitative dynamic general equilibrium life-cycle model where parents and their children are linked by bequests, both voluntary and accidental, and by the transmission of earnings ability. This model is able to match very well the empirical observation that households with similar lifetime incomes hold very different amounts of wealth at retirement. Income heterogeneity and borrowing constraints are essential in generating the variation in retirement wealth among low lifetime income households, while the existence of intergenerational links is crucial in explaining the heterogeneity in retirement wealth among high lifetime income households
    Keywords: Wealth Inequality, Incomplete Markets
    JEL: E21 H31 H55
    Date: 2006–12–03
  113. By: Pietro Garibaldi
    Abstract: This paper proposes a matching model that distinguishes between job creation by existing firms and job creation by firm entrants. The paper argues that vacancy posting and job destruction on the extensive margin, i.e. from firms that enter and exit the labour market, represents a potentially viable mechanism for understanding the cyclical properties of vacancies and unemployment. The model features both hiring freeze and bankruptcies, where the former represents a sudden shut down of vacancy posting at the firm level with labour downsizing governed by natural turnover. A bankrupt firm, conversely, shut down its vacancies and lay offs its stock of workers. Recent research in macroeconomics has shown that a calibration of the Mortensen and Pissarides matching model account for 10 percent of the cyclical variability of the vacancy unemployment ratio displayed by U.S. data. A calibration of the model that explicitly considers hiring freeze and bankruptcy can account for 20 to 35 percent of the variability displayed by the data
    Keywords: unemployment dynamics, matching models
    JEL: E32 J20
    Date: 2006–12–03
  114. By: Benjamin Lester (Department of Economics University of Pennsylvania)
    Abstract: A settlement system is a set of rules and procedures that govern when and how funds are transferred between banks. Perhaps the most crucial feature of a settlement system is the frequency with which settlement occurs. On the one hand, a higher frequency of settlement limits the risk of default should a bank be rendered insolvent. On the other hand, a lower frequency of settlement is less costly for banks to operate. We construct a model of the banking sector in which this trade-off between cost and risk arises endogenously. We then complete the economy with a trading sector that has a micro-founded role for credit as a media of exchange. The result is a general equilibrium model that allows for welfare and policy analysis. We parameterize the economy and study the optimal intra-day borrowing policy that the operator of a settlement system should impose on member banks. We also determine conditions under which one settlement system is more appropriate than another
    Keywords: Payment Systems, Banking, Liquidity
    JEL: E40 E50
    Date: 2006–12–03
  115. By: Masanao Aoki (Department of Economics, UCLA)
    Abstract: This paper uses novel growth models composed of clusters of heterogeneous agents,andshowsthat limitingbehaviorof one-andtwo-parameterPoisson-Dirichlet models are qualitatively very di?erent. As model sizes grow unboundedly, the coe?cients of variations of extensive variables, such as the number of total clusters, and the numbers of clusters of speci?ed sizes all approach zero in the one-parameter models, but not in the two-parameter models. In the calculations of the coe?cients of variations Mittag-Le?er distributions arise naturally. We show that the distributions of the numbers of the clusters in the models havepower-lawbehavior.
    Date: 2006–10
  116. By: John Knowles (University of Pennsylvania)
    Abstract: We document a negative trend in the leisure of men married to women aged 25-45, relative to that of their wives, and a positive trend in relative housework. We develop a simple bargaining model of marriage, divorce and allocations of leisure-time and housework. Calibration to US data shows the trend in the wage gender gap explains most of the trend in relative leisure, but has little effect on married women's labor supply, which appears to be due mainly to the trend in the price of home equipment.
    Keywords: Marriage; Marital Dissolution; Economics of Gender; Time Allocation and Labor Supply
    JEL: E13 J12 J16
    Date: 2006–12–03
  117. By: Maurice Obstfeld (University of California, Berkeley and CEPR and NBER)
    Abstract: Among the developing countries of the world, those emerging markets that have sought some degree of integration into world finance are characterized by higher per capita incomes, higher long-run growth rates, and lower output and consumption volatility. These characteristics are more likely to be causes than effects of financial integration. The measurable gains from financial integration appear to be lower for emerging markets than for higher-income countries, and appear to have been limited by recent crises. One factor limiting the gains from financial integration is the difficulty emerging economies face in resolving the open-economy trilemma. Given their structural and institutional features, many emerging economies cannot live comfortably either with fixed or with freely floating exchange rates. Most recently, the exchange rates of several emerging countries display attempts at stabilization punctuated by high volatility in periods of market stress.
    Keywords: Developing countries, emerging markets, convergence, macroeconomic volatility, exchange-rate regimes, institutions, dollarization, original sin,
    Date: 2006–06–27
  118. By: Garrick Blalock (Cornell University); Paul Gertler (University of Caifornia, Berkeley and NBER); David I. Levine (Haas School of Business, UC Berkeley)
    Abstract: JEL classification codes: O16, F23, E32, O12Abstract:We investigate whether capital market imperfections constrain investment during an emerging market financial crisis. Both large currency devaluations and widespread collapse of the banking sector characterize recent crises. Although a currency devaluation should increase exporters' competitiveness and investment, a failing banking system may limit credit to these firms. Foreign-owned firms, which have greater access to overseas financing but otherwise face the same investment prospects, provide an ideal control group for determining the effect of liquidity constraints. We test for liquidity constraints in Indonesia following the 1997 East Asian financial crisis, a period when the issuance of new domestic credit declined rapidly. Exporters' value added and employment increased after the crisis, suggesting that they profited from the devaluation and had sufficient cash flow to finance more workers. However, only exporters with foreign ownership increased their investment significantly. The failure of domestic firms to invest under profitable conditions suggests that they may have faced liquidity constraints. Investment by foreign-owned firms increased post-crisis capital stock by about 4% more than would have occurred if all the firms were domestically owned.
    Keywords: Liquidity Constraints, Foreign Direct Investment, Financial Crisis, Indonesia,
    Date: 2006–06–27
  119. By: Andre Faria (Research Department IMF)
    Abstract: In the aftermath of sovereign defaults and financial crises in the 1990s, there have been calls for the widespread use by sovereigns of equity-like financial instruments, in particular, of GDP-indexed bonds. This paper calibrates a general equilibrium model with endogenous default to a typical emerging market economy and evaluates whether the existence of a (partially) GDP-indexed bond, as proposed in the literature, is quantitatively important in what concerns spreads, debt to GDP ratios, and the likelihood of default
    Keywords: Sovereign debt, GDP-indexed bonds, Spreads, Emerging markets, Default
    JEL: D83 E43 F34
    Date: 2006–12–03
  120. By: Gilbert Koenig; Irem Zeyneloglu
    Abstract: L’article propose une revue des travaux récents de politique budgétaire effectués dans le cadre analytique et méthodologique de la nouvelle macroéconomie internationale développée à partir des contributions de Obstfeld et Rogoff (1995, 1998, 2002). La substitution de l’approche préconisée par la nouvelle macroéconomie internationale à celle des modèles agrégés du type Mundell-Fleming permet d’analyser d’une façon plus rigoureuse les thèmes traditionnels de l’efficacité d’une politique budgétaire discrétionnaire en fonction du régime de changes, du mode de financement des dépenses publiques et du degré de mobilité des capitaux. Elle permet aussi de prendre en compte des phénomènes observés, mais souvent négligés, comme la répercussion partielle des variations du taux de change sur les prix (pass-through) et le degré de substitution entre les produits. De plus, dans le cadre de modèles stochastiques, des développements récents analysent les réactions budgétaires optimales à des chocs aléatoires et les stratégies des autorités face à ces chocs. Cette nouvelle approche de la politique budgétaire ne propose pas seulement un renouvellement et un approfondissement de l’analyse des mécanismes de transmission internationale des effets de cette politique, mais aussi une modification du critère de son efficacité. Celle-ci n’est plus appréciée par ses effets sur le revenu global, mais par ses incidences sur le bien-être dont le revenu n’est que l’un des déterminants.
    Keywords: politique budgétaire, interdépendance, macroéconomie internationale.
    JEL: E62 F41 F42
    Date: 2006
  121. By: In-Koo Cho (Economics University of Illinois); Kenneth Kasa
    Abstract: This paper studies the following problem. An agent takes actions based on a possibly misspecified model. The agent is 'large', in the sense that his actions influence the model he is trying to learn about. The agent is aware of potential model misspecification and tries to detect it, in real-time, using an econometric specification test. If his model fails the test, he formulates a new better-fitting model. If his model passes the test, he uses it to formulate and implement a policy based on the provisional assumption that the current model is correctly specified, and will not change in the future. We claim that this testing and model validation process is an accurate description of most macroeconomic policy problems. Unfortunately, the dynamics produced by this process are not well understood. We make progress on this problem by relating it to a problem that is well understood. In particular, we relate it to the dynamics of constant-gain stochastic approximation algorithms. This enables us to appeal to well known results from the large deviations literature to help us understand the dynamics of testing and model revision. We show that as the agent applies an increasingly stringent specification test, the large deviation properties of the discrete model validation dynamics converge to those of the continuous learning dynamics. This sheds new light on the recent constant-gain learning literature.
    Keywords: Learning, Validation, Relative Entropy, Large Deviation
    JEL: C12 E59
    Date: 2006–12–03
  122. By: Lars Boerner; Albrecht Ritschl (Economics Humboldt-University of Berlin)
    Abstract: The emergence of medieval markets has been seen in the literature as hampered by lack of contract enforcement and institutions like merchants’ communal responsibil-ity. Merchants traveling to a different marketplace could be held liable for debts in-curred by any merchant from their hometown. We argue that communal responsibility was effective in enforcing credit contracts and enabled merchants to use bills of ex-change in long distance trade even if reputation effects were absent. We implement this in the Lagos and Wright (2005) matching model of money demand, assuming that preference shocks follow a two-state Markov chain. We derive conditions under which cash and credit in the anonymous matching market coexist. For fixed but suffi-ciently low cost of credit, agents will pay with cash in low-quality matches, and use cash and credit in high-quality matches. The use of credit reduces the money holdup in the matching market and thus leads to Pareto improvements
    Keywords: Communal responsibility, matching, money demand, credit
    JEL: N2 E41 D51
    Date: 2006–12–03
  123. By: Andrea Eisfeldt (Department of Finance Northwestern University); Adriano Rampini
    Abstract: This paper studies the role of leasing of productive assets. When capital is leased (or rented), it is more easily repossessed and hence leasing has higher debt capacity and relaxes financing constraints. However, leasing gives rise to an agency problem with regard to the care with which the leased asset is used or maintained. We show that this implies that more credit constrained firms lease capital, while less credit constrained firms buy capital. Our theory is consistent with the explanation of leasing provided by leasing firms, namely that leasing “preserves capital,†which is generally considered a fallacy in the academic literature. We provide empirical evidence that small and credit constrained firms lease a considerably larger fraction of their capital than larger and less constrained firms
    Keywords: leasing, credit constraints, investment, small firms
    JEL: D92 E22 G31 G32
    Date: 2006–12–03
  124. By: Emilio Espino
    Abstract: This paper studies equilibrium portfolios in the standard neoclassical growth model under uncertainty with heterogeneous agents and dynamically complete markets. Preferences are purposely restricted to be quasi-homothetic. The main source of heterogeneity across agents is due to different endowments of shares of the representative firm at date 0. Fixing portfolios is the optimal strategy in stationary endowment economies with dynamically complete markets. Whenever an environment displays changing degrees of heterogeneity across agents, the trading strategy of fixed portfolios cannot be optimal in equilibrium. Very importantly, our framework can generate changing heterogeneity if and only if either minimum consumption requirements are not zero or labor income is not zero and the value of human and non-human wealth are linearly independent
    Keywords: Neoclassical Growth Model, Equilibrium Portfolios, Complete Markets
    JEL: C61 D50 D90 E20
    Date: 2006–12–03
  125. By: Karsten Jeske; Sagiri Kitao (Economics New York University)
    Abstract: The U.S. tax policy on health insurance favors only those offered group insurance through their employers, and is highly regressive since the subsidy takes the form of deductions from the progressive income tax system. The paper investigates alternatives to the current policy. We find that a complete removal of the subsidy results in a significant reduction in the insurance coverage and serious welfare deterioration. There is, however, room for improving welfare and raising the coverage, by eliminating regressiveness in the group insurance subsidy and by extending refundable credits to the private insurance market. Our work is the first in highlighting the importance of studying health policy in a general equilibrium framework with an endogenous demand for the health insurance. We use the Medical Expenditure Panel Survey (MEPS) to calibrate the process for income, health expenditure shocks and health insurance offer status through employers and succeed in producing the pattern of insurance demand as observed in the data, which serves as a solid benchmark for the policy experiments
    Keywords: Income taxation, health insurance, heterogeneous agents
    JEL: H20 H31 E62
    Date: 2006–12–03
  126. By: António Antunes (Banco de Portugal, Departamento de Estudos Economicos, and Faculdade de Economia, Universidade Nova de Lisboa); Tiago Cavalcanti (Departamento de Economia, Universidade Federal de Pernambuco, INOVA, Faculdade de Economia, Universi-dade Nova de Lisboa.); Anne Villamil (Department of Economics, University of Illinois at Urbana- Champaign)
    Abstract: This paper establishes the existence of a stationary equilibrium and a procedure to compute solutions to a class of dynamic general equilibrium models with two important features. First, occupational choice is determined endogenously as a function of heterogeneous agent type, which is defined by an agent's managerial ability and capital bequest. Heterogeneous ability is exogenous and independent across generations. In contrast, bequests link generations and the distribution of bequests evolves endogenously. Second, there is a financial market for capital loans with a deadweight intermediation cost and a repayment incentive constraint. The incentive constraint induces a non-convexity. The paper proves that the competitive equilibrium can be characterized by the bequest distribution and factor prices, and uses the monotone mixing condition to ensure that the stationary bequest distribution that arises from the agent's optimal behavior across generations exists and is unique. The paper next constructs a direct, non-parametric approach to compute the stationary solution. The method reduces the domain of the policy function, thus reducing the computational complexity of the problem.
    Keywords: Existence; Computation; Dynamic general equilibrium; Non-convexity
    JEL: C62 C63 E60 G38
  127. By: Bernhard Herz; Christian Bauer; Volker Karb
    Abstract: Empirically, currency crises are more frequently accompanied by simultaneous sovereign debt crises than by banking crises. Nevertheless the phenomenon of twin currency and debt crises has so far been treated in economic literature only sparsely. We analyse the optimal policy of a government that may choose and combine two policy alternatives. She may choose at the same time whether to keep or alternatively exit an existing exchange rate peg and whether or not to default on her debt. Both parameters have a large impact not only on the public welfare but on the government’s budget as well. The resulting incentive system can generate situations with self-fulfilling expectations. In some situations an internal contagion effect arises. A crisis in the sovereign debt market spreads to the sector of exchange rate policy and causes a devaluation as well. Private investors’ default expectations thus can not only cause a sovereign debt crisis but may lead to a currency crisis as well.
    Keywords: Currency crises, internal contagion, self-fulfilling expectations and sovereign debt
    JEL: E61 F34 F41
  128. By: Brosio, Giorgio; Zanola, Roberto
    Abstract: Colombia is neither waging war against external enemies, nor has a dictatorial government engaged in a large scale repression of insurrection. However, it is possibly the most violent country of the world. Despite a number of papers focusing on the effects of violence on democracy in Colombia, the existing literature fails to sufficiently address the opposite perspective, that is, the impact of democratic government on violence. Recourse to violence appears so widespread and permanent in Colombia and extols such a high cost on the country, that it suggests that large sectors of the Colombian population may have become addicted to violence. The aim of this paper to assess whether violence in Colombia may be defined as a rational behaviour by using a pooled cross-section and time-series sample of 27 Colombian departments over the period 1990-1999. Findings do not support the addictive rational hypothesis; rather, violence appears to be a cyclical phenomenon in Colombia.
    Keywords: Colombia; violence; rational addiction; panel analysis
    JEL: C5 E6
    Date: 2006–11
  129. By: Jianjun Miao; Neng Wang (Finance and Economics Columbia Business School)
    Abstract: Entrepreneurs often face undiversifiable idiosyncratic risks from their business investments. Motivated by this observation, we extend the standard real options approach to investment to an incomplete markets environment and analyze the joint decisions of business investments, consumption-saving and portfolio selection. We show that precautionary saving motive affects the investment timing decision in an important way. When the investment payoffs are given in lump sum, risk aversion accelerates investment. Moreover, when the agent's precautionary motive is strong enough, an increase in volatility may accelerate investment, opposite to the standard real options analysis. When the agent can trade the market portfolio to partially hedge against his investment risk, the systematic volatility is compensated via the standard CAPM argument, and the idiosyncratic volatility generates a private equity premium. When the investment payoffs are given in flows, the agent's idiosyncratic risk exposure alters both the implied option value and the implied project value, causing the reversal of the results in the lump sum payoff case.
    Keywords: real options, idiosyncratic risk, precautionary saving, incomplete markets
    JEL: G11 G32 E2
    Date: 2006–12–03
  130. By: Mathias Trabandt (School of Business and Economics Humboldt University Berlin)
    Abstract: This paper analyzes optimal pre-announced capital and labor income tax reforms under valuable and productive government spending. Our baseline optimal reform reveals that these model ingredients result in a reduction of welfare losses that occur when the reform is announced before its implementation. Further, the mere existence of welfare losses from pre-announcement is due to the ability of the government to initially choose very high capital taxes and negative labor taxes. A government that instead chooses optimal long run taxes from the implementation date onwards generates sizable increases of welfare gains from pre-announcing the reform. We show that 4 years pre-announcement of this reform and the baseline optimal reform deliver similar levels of welfare gains. The underlying tax structure of both reforms, however, appears to be very different
    Keywords: Optimal taxation, pre-announcement, valuable and productive government spending, welfare
    JEL: E0 E6 H0
    Date: 2006–12–03
  131. By: Almuth Scholl (Economics, Institute of Economic Policy Humboldt University Berlin)
    Abstract: This paper analyzes optimal foreign aid policy in a neoclassical framework with a conflict of interest between the donor and the recipient government. Aid conditionality is modelled as a limited enforceable contract. We define conditional aid policy to be self-enforcing if, at any point in time, the conditions imposed on aid funds are supportable by the threat of a permanent aid cutoff from then onward. Quantitative results show that the effectiveness of unconditional aid is low while self-enforcing conditional aid strongly stimulates the economy. However, increasing the welfare of the poor comes at a high cost: to ensure aid effectiveness, less democratic political regimes have to receive permanently larger aid funds
    Keywords: foreign aid, conditionality, limited enforceable contracts, growth, sovereignty
    JEL: E13 F35 O1 O19
    Date: 2006–12–03
  132. By: Giulio Fella (Economics Queen Mary, University of London); Giovanni Gallipoli
    Abstract: This paper provides a framework within which to study the equilibrium impact of alternative policies. We develop an overlapping generation, life-cycle model with endogenous education and crime choices. Education and crime depend on different dimensions of heterogeneity, which takes the form of differences in innate ability and wealth at birth as well as employment shocks. The model is calibrated to match education enrolments, aggregate (property) crime rate and some features of the wealth distribution. In our numerical experiments we find that policies targeting crime reduction through increases in high school graduation rates are more cost-effective than simple incapacitation policies. The cost-effectiveness of high school subsidies increases significantly if they are targeted at the wealth poor. Financial incentives to high school graduation have radically different implications in general and partial equilibrium
    Keywords: Crime, Education, Life Cycle
    JEL: E26 H52 I28 K42
    Date: 2006–12–03
  133. By: Jess Benhabib; Alberto Bisin (Department of Economics New York University)
    Abstract: In this paper we study theoretically the dynamics of the distribution of wealth in an Overlapping Generation economy with bequest and various forms of redistributive taxation. We characterize the transitional dynamics of the wealth distribution and as well as the stationary distribution. We show that, in our economy, the stationary wealth distribution is a power law, a Pareto distribution in particular. Wealth is less concentrated (the Gini coefficient is lower) for both higher capital income taxes and estate taxes, but the marginal effect of capital income taxes is much stronger than the effect of estate taxes. Finally, we characterize optimal redistributive taxes with respect to an utilitarian social welfare measure. Social welfare is maximized short of minimal wealth inequality and with zero estate taxes.
    Keywords: wealth distribution
    JEL: E6 C6
    Date: 2006–12–03
  134. By: Garett Jones (Economics and Finance Southern Illinois University)
    Abstract: I show that in a conventional Ramsey model, between one-fourth and one-half of the global income distribution can be explained by a single factor: The effect of large, persistent differences in national average IQ on the private marginal product of labor. Thus, differences in national average IQ may be a driving force behind global income inequality. These persistent differences in cognitive ability--which are well-supported in the psychology literature--are likely to be somewhat malleable through better health care, better education, and especially better nutrition in the world’s poorest countries. A simple calibration exercise in the spirit of Bils and Klenow (2000) and Castro (2005) is conducted. I show that an IQ-augmented Ramsey model can explain more than half of the empirical relationship between national average IQ and GDP per worker. I provide evidence that little of the IQ-productivity relationship is likely to be due to reverse causality.
    Keywords: Human Capital, Intelligence, IQ, Economic Growth
    JEL: E13 J24 O41
    Date: 2006–12–03

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