nep-mac New Economics Papers
on Macroeconomics
Issue of 2007‒05‒26
forty-one papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. The Expenditure Composition Hypothesis: Empirical Evidence and Implications for Monetary Policy. By Carlos Pestana Barros; Luis A. Gil-Alana; Pedro Leão
  2. Distortionary Tax Instruments and Implementable Monetary Policy By Zagaglia, Paolo
  3. Rule of Thumb Consumers Meet Sticky Wages By Colciago, Andrea
  4. Inflation persistence and optimal positive long-run inflation By Pontiggia, Dario
  5. Macroeconomic Policy in a Heterogeneous Monetary Union By Oliver Grimm; Stefan Ried
  6. Monetary policy and stock market booms and busts in the 20th century By Michael D. Bordo; Michael J. Dueker; David C. Wheelock
  7. Central Bank Quasi-Fiscal Losses and High Inflation in Zimbabwe: A Note By Sonia Munoz
  8. To React or Not? Fiscal Policy, Volatility and Welfare in the EU-3 By Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
  9. Unit Roots in Inflation and Aggregation Bias By Joseph Byrne; Alexandros Kontonikas; Alberto Montagnoli
  10. Russia from Bust to Boom: Oil, Politics or the Ruble? By B. MERLEVEDE; K. SCHOORS; B. VAN AARLE
  11. Cyclical Bias in Government Spending: Evidence from New EU Member Countries By Jan Zápal
  13. Do Markets Care Who Chairs the Central Bank? By Kenneth N. Kuttner; Adam S. Posen
  14. Some simple tests of the globalization and inflation hypothesis By Jane Ihrig; Steven B. Kamin; Deborah Lindner; Jaime Marquez
  15. Analysis of Financial Stability By C.A.E Goodhart; D.P. Tsomocos
  16. Time-to-Degree and the Business Cycle By Dolores Messer; Stefan C. Wolter
  17. Looking Beyond the Fiscal: Do Oil Funds Bring Macreconomic Stability? By Nadeem Ilahi; Ghiath Shabsigh
  18. Lessons from High Inflation Epidsodes for Stabilizing the Economy in Zimbabwe By Norbert Funke; Jens R. Clausen; Sonia Munoz; Bakar Ould-Abdallah; Sharmini Coorey
  19. Time preference and cyclical endogenous growth By Gomes, Orlando
  21. Lumpy Price Adjustments: A Microeconometric Analysis By Emmanuel Dhyne; Catherine Fuss; M. Hashem Pesaran; Patrick Sevestre
  22. Inequality reduction through self-employment under high inflation periods: the Mexican experience By Mirenitzia Cárdenas; Héctor J. Villarreal
  23. Intervention Policy of the BoJ: a Unified Approach. By Michel Beine; Oscar Bernal; Jean-Yves Gnabo; Christelle Lecourt
  24. Determinants of Interest Spread in Pakistan By Idrees Khawaja; Musleh-ud Din
  25. Credit Constraints and Stock Price Volatility By Hale, Galina B; Razin, Assaf; Tong, Hui
  26. Interest Rate Spreads in English-Speaking African Countries By Joe Crowley
  27. Financing Development: The Role of Information Costs By Jeremy Greenwood; Juan M. Sanchez; Cheng Wang
  28. Does financial intermediation matter for macroeconomic efficiency? By Pierre-Guillaume Meon; Laurent Weill
  29. Daily Changes in Fed Funds Futures Prices By James D. Hamilton
  31. Multivariate contemporaneous threshold autoregressive models By Michael J. Dueker; Zacharias Psaradakis; Martin Sola; Fabio Spagnolo
  32. Pension Reform and Macroeconomic Stability in Latin America By Jorge Roldos
  33. The Joy of Giving or Assisted Living? Using Strategic Surveys to Separate Bequest and Precautionary Motives By John Ameriks; Andrew Caplin; Steven Laufer; Stijn Van Nieuwerburgh
  34. Dollarization and financial integration By Cristina Arellano; Jonathan Heathcote
  35. Fire Sales, Foreign Entry and Bank Liquidity By Acharya, Viral V; Shin, Hyun Song; Yorulmazer, Tanju
  36. Are Shocks to the Terms of Trade Shocks to Productivity? By Timothy J. Kehoe; Kim J. Ruhl
  37. U.S. external adjustment: is it disorderly? Is it unique? Will it disrupt the rest of the world? By Steven B. Kamin; Trevor A. Reeve; Nathan Sheets
  38. Das (Wasted) Kapital: Firm Ownership and Investment Efficiency in China By David Dollar; Shang-Jin Wei
  39. The Role of Immigration in Sustaining the Social Security System: A Political Economy Approach By Razin, Assaf; Sand, Edith
  40. Forecasting Exchange Rates of Major Currencies with Long Maturity Forward Rates By Zsolt Darvas; Zoltán Schepp
  41. Planning with ‘Human Face’: Tamil Nadu’s Approach towards ‘Correctives’ By K., Jothi Sivagnanam

  1. By: Carlos Pestana Barros; Luis A. Gil-Alana; Pedro Leão
    Abstract: Leão (2005) has recently proposed a new explanation for the short run variability of the velocity of money based on the changes in the composition of the expenditure that occur along the business cycle. This paper presents further empirical evidence in favour of Leão’s Expenditure Composition Hypothesis, and draws new implications of this hypothesis for monetary policy. We use a VAR model to analyze the determinants of the velocity of both M1 and M3 in the USA. The main conclusion is that increases in the weight of investment and durable consumption in total expenditure raise the velocity of both narrow and broad money. This is in line with the Expenditure Composition Hypothesis. Furthermore, we draw a new implication of this hypothesis for monetary policy. The more a central bank’s decisions on the interest rate respond to money growth, the more volatile economic growth will be. In other words, a monetary policy strategy - like that of the ECB – which puts emphasis on money growth is de-stabilizing.
    Keywords: Velocity of money; monetary policy; business cycle.
    JEL: E12 E32 E40 E41 E52 E58
    Date: 2007
  2. By: Zagaglia, Paolo (Dept. of Economics, Stockholm University)
    Abstract: I introduce distortionary taxes on consumption, labor and capital income into a New Keynesian model with Calvo pricing and nominal bonds. I study the relation between tax instruments and optimal monetary policy by computing simple rules for monetary and fiscal policy when one tax instrument at a time varies, while the other two are fixed at their steady-state level. The optimal rules maximize the second-order approximation to intertemporal utility. Three results emerge: (a) when prices are sticky, perfect inflation stabilization is optimal independently from the tax instrument adopted; (b) the optimal degree of responsiveness of monetary policy to output varies depending on which tax instrument induces fluctuations in the average tax rate; (c) when prices are flexible, fiscal rules that prescribe unexpected variations in the price level to support debt changes are always welfare-maximizing.
    Keywords: Nominal rigidities; distortionary taxation; monetary-policy rules
    JEL: E52 E61 E63
    Date: 2007–05–21
  3. By: Colciago, Andrea
    Abstract: It has been argued that rule of thumb consumers substantially alter the determinacy properties of simple interest rate rules and the dynamics of an otherwise standard New-keynesian model. In this paper we show that nominal wage stickiness helps re-establishing standard results. Key findings are that wage stickiness i) affects the shape of determinacy regions in the parameters space, restoring the relevance of the Taylor principle for the conduct of monetary policy; ii) implies that a rise in consumption in response to an innovation in government spending is not a robust feature of the model.
    Keywords: Rule of Thumb Consumers; Sticky Wages; Determinacy; Fiscal Shocks
    JEL: E21 E4 E30
    Date: 2005–12–01
  4. By: Pontiggia, Dario
    Abstract: In this paper we prove that (I) inefficient natural level of output (Friedman (1968)), (II) central bank's desire to stabilize output around a level that is higher than the inefficient natural level of output, (III) long-run Phillips curve trade-off, and (IV) inflation persistence result in optimal positive long-run inflation. The combination of (I), (II), and (III) makes positive inflation forever in principles desirable as it would result in positive output gap forever. Optimal positive steady-state inflation obtains if and only if there is a long-run incentive for positive inflation. Inflation persistence, defined as costly, in terms of output, disinflation, generates a long-run incentive for positive inflation. Optimal positive steady-state inflation obtains in the basic neo-Wicksellian model (Woodford (2003)) with inflation persistence due to backward-looking rule-of-thumb behaviour by price setters. Optimal positive long-run inflation also obtains in what we refer to as the nonmicrofounded model. Prescinding from hyperinflation, the formula for steady-state inflation is capable of providing a positive theory of inflation.
    Keywords: Optimal monetary policy; inflation persistence
    JEL: E31
    Date: 2007–05–17
  5. By: Oliver Grimm; Stefan Ried
    Abstract: We use a two-country model with a central bank maximizing union-wide welfare and two fiscal authorities minimizing comparable, but slightly different country-wide losses. We analyze the rivalry between the three authorities in seven static games. Comparing a homogeneous with a heterogeneous monetary union, we find welfare losses to be significantly larger in the heterogeneous union. The best-performing scenarios are cooperation between all authorities and monetary leadership. Cooperation between the fiscal authorities is harmful to both the whole union’s and the country-specific welfare.
    Keywords: monetary union, heterogeneities, policy game, simultaneous policy, sequential policy, coordination, discretionary policies.
    JEL: E52 E61 F42
    Date: 2007–05
  6. By: Michael D. Bordo; Michael J. Dueker; David C. Wheelock
    Abstract: This paper examines the association between monetary policy and stock market booms and busts in the United States, United Kingdom, and Germany during the 20th century. Booms tended to arise when output growth was rapid and inflation was low, and end within a few months of an increase in inflation and monetary policy tightening. Latent variable VAR analysis of post-war data finds that inflation has had a particularly strong impact on market conditions, with disinflation shocks moving the market toward a boom and positive inflation shocks moving the market toward a bust. We conclude that central banks can contribute to financial market stability by minimizing unanticipated changes in inflation.
    Date: 2007
  7. By: Sonia Munoz
    Abstract: Zimbabwe's failure to address continuing central bank quasi-fiscal losses has interfered with both monetary management and the independence and credibility of the Reserve Bank of Zimbabwe (RBZ). Realized quasi-fiscal losses are estimated to have amounted to about 75 percent of GDP in 2006. Because they were financed by creating money creation or issuing RBZ securities, they contributed to the four-digit inflation reached in 2006. The remedy for the current situation is clearly to eliminate the causes of losses by implementing measures to improve the cash-flow of the bank and restore its financial position.
    Date: 2007–04–27
  8. By: Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
    Abstract: This paper develops a dynamic stochastic general equilibrium model to examine the quantitative macroeconomic implications of countercyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity which is the particular market failure justifying policy intervention. We subject the model to productivity shocks and use either government consumption or investment to react to the output gap or the public debt-to-output ratio. If the object of fiscal policy is purely to stabilize output or debt volatility, then our results suggest substantial reductions can be obtained, especially with respect to output. In stark contrast, however, a formal general equilibrium welfare assessment of the volatility implications of these alternative instrument/target combinations reveals the welfare gains from active policy, measured as a share of consumption, to be very modest.
  9. By: Joseph Byrne; Alexandros Kontonikas; Alberto Montagnoli
    Abstract: In this paper, we examine whether UK inflation is characterized by aggregation bias using three sets of increasingly disaggregated inflation data and a battery of univariate and panel unit root tests. Our results support the existence of aggregation bias since while the unit root hypothesis cannot be rejected for aggregate inflation, it can be rejected for some of its sectoral components, with the rejection frequencies increasing when we use more disaggregate data. Results from structural break analysis indicate that monetary policy shifts are the main factor behind breaks in UK inflation. The panel results typically indicate that when sectoral inflation rates are pooled the unit root hypothesis can be rejected. Our results have important implications for applied econometric analysis, macroeconomic theory and for the conduct of monetary policy.
    Keywords: Inflation, Unit Root, Disaggregation, Structural Breaks, Panel Data
    JEL: C22 C23 E31
    Date: 2007–05
    Abstract: This paper develops and estimates a small macroeconomic model of the Russian economy. The model is tailored to analyze the impact of the oil price, the exchange rate, private sector confidence and fiscal policy on economic performance. The model does very well in explaining Russia’s recent economic history in the period 1995-2004. Simulations suggest that the Russian economy is vulnerable to downward oil price shocks. We substantiate two mechanisms that mitigate the economic effects of oil price shocks, namely the stabilisation brought by the Oil Stabilisation Fund and the Dutch disease effect. The negative effect of a shock in private sector confidence on real GDP is comparable to the effect of an oil price shock, although the transmission of both shocks runs along different channels. The fiscal policies of the Putin administration temper economic fluctuations caused by oil price shocks, but it remains to be seen whether these policies will be continued.
    Keywords: Russia, Macroeconomic Modeling, Macroeconomic stabilization
    JEL: C70 E17 E58 E63
    Date: 2007–04
  11. By: Jan Zápal (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Economics Department, London School of Economics, University of London)
    Abstract: This paper focuses on dynamics of government spending over the business cycle. The literature on this topic has yet mainly focused on the issue of anti- or pro- cyclicality of fiscal policy. Only recently some researchers brought up a notion that response of fiscal policy might display great deal of asymmetry with respect to economic upturns and downturns. This is known as cyclical bias which arises when government expenditure increases more in cyclical downturns than it decreases in cyclical upturns, or vice versa. Empirical estimates of the sign and degree of cyclical bias show strong evidence in favour of the hypothesis that fiscal authorities do react with a great deal of asymmetry. Among other things, the presence of cyclical bias in government spending has been proposed as an explanation or mechanism which lies behind its unprecedented increase in most OECD countries over the last several decades. The aim of this paper is to show that a similar asymmetry of government spending dynamics can also be found in fiscal data of new EU member countries. We estimate the sign and degree of cyclical bias and compare it to estimates from other countries. Finally, we tackle the question of whether there is any statistically significant influence of political economy variables on the estimated degree of asymmetry.
    Keywords: Cyclical Bias; New EU member states; Fiscal policy
    JEL: E32 E62 H30 H50
    Date: 2007–05
  12. By: Marta Gomez-Puig (Faculty of Economics, University of Barcelona.)
    Abstract: Yield spreads over 10-year German government securities of the EU-15 countries converged dramatically in the seven years after the beginning of Monetary Integration. In this paper, we investigate the relative influence of systemic and idiosyncratic risk factors on their behaviour. Our conclusions suggest that in EMU-countries the relative importance of domestic risk factors (both credit and liquidity risk factors) is higher than that of international factors, which appear to play a secondary but significant role in non-EMU countries.
    Keywords: Monetary integration, sovereign securities markets, systemic, idiosyncratic risk.
    JEL: E44 F36 G15
    Date: 2007–05
  13. By: Kenneth N. Kuttner (Oberlin College, Department of Economics); Adam S. Posen (Peterson Institute for International Economics)
    Abstract: This paper assesses the effects of central bank governor appointments on financial market expectations of monetary policy. To measure these effects, we assemble a new dataset of appointment announcements from 15 countries, and conduct an event study analysis on exchange rates, bond yields, and stock prices. The analysis reveals a significant reaction of exchange rates and bond yields to unexpected appointments. The reactions are not unidirectional, and thus do not suggest new governors suffer from a generic credibility problem. Federal Reserve chairman appointments stand out in terms of their unusually pronounced effects on financial markets.
    Keywords: Central banking, Monetary policy, Credibility, Financial markets, Event study analysis
    JEL: E58 E61 G14
    Date: 2007–05
  14. By: Jane Ihrig; Steven B. Kamin; Deborah Lindner; Jaime Marquez
    Abstract: This paper evaluates the hypothesis that globalization has increased the role of international factors and decreased the role of domestic factors in the inflation process in industrial economies. Toward that end, we estimate standard Phillips curve inflation equations for 11 industrial countries and use these estimates to test several predictions of the globalization and inflation hypothesis. Our results provide little support for that hypothesis. First, the estimated effect of foreign output gaps on domestic consumer price inflation is generally insignificant and often of the wrong sign. Second, we find no evidence that the trend decline in the sensitivity of inflation to the domestic output gap observed in many countries owes to globalization. Finally, and most surprisingly, our econometric results indicate no increase over time in the responsiveness of inflation to import prices for most countries. However, even though we find no evidence that globalization is affecting the parameters of the inflation process, globalization may be helping to stabilize real GDP and hence inflation. Over time, the volatility of real GDP growth has declined by more than the volatility of domestic demand, suggesting that net exports increasingly are acting to buffer output from fluctuations in domestic demand.
    Date: 2007
  15. By: C.A.E Goodhart; D.P. Tsomocos
    Abstract: On the macro-economic policy side of Central Banking a remarkable consensus has been emerging over the last two decades. This covers both the applicable theoretical framework for analysing the transmission mechanism of monetary policy and also the appropriate institutional structure for the Central Bank to deploy its macro-economic policies. There is no such consensus on the appropriate theoretical framework for the analysis of financial stability. Indeed some would claim that there is no proper theoretical framework for this function in being at all. However, we propose one such framework based on the work of Goodhart, Sunirand and Tsomocos (2004, 2005, 2006a and b).
    Date: 2007
  16. By: Dolores Messer (University of Bern); Stefan C. Wolter (Swiss Coordination Centre for Research in Education, University of Bern, CESifo and IZA)
    Abstract: When students themselves enjoy large degrees of freedom in determining the duration of their studies, it results in a fairly large degree of interindividual variance in terms of time-todegree. This paper investigates individual time-to-degree in a model where students determine the optimum time-to-degree whilst weighing up the cost against the consumption benefit accruing from an additional semester of studies. According to this model, the cost level and consumption benefit depend, in turn, on the general economic environment during the study period. An empirical investigation using a data set based on Swiss university graduates from 1981 to 2001 shows that changes in the unemployment rate, real interest rate, wage levels, and economic growth have a significant impact on individual time-todegree. These results are consistent with the conclusions derived from the theoretical model.
    Keywords: time-to-degree, business cycle, consumption benefit
    JEL: C81 E32 I2 I23
    Date: 2007–05
  17. By: Nadeem Ilahi; Ghiath Shabsigh
    Abstract: Oil funds have become increasingly popular in oil exporting countries during the recent surge in oil prices. However, the literature on the contribution is small, tends to focus narrowly on their fiscal benefits, and concludes that they are redundant of such funds-in other words, that well designed fiscal management and policy are adequate substitutes for oil funds. This paper argues that a broader focus is needed in judging the effectiveness of such funds. We test whether oil funds help reduce macroeconomic volatility. The econometric estimation results from a 30-year panel data set of 15 countries with and without oil funds suggest that oil funds are associated with reduced volatility of broad money and prices and lower inflation. However, there is a statistically weak negative association between the presence of an oil fund and volatility of the real exchange rate.
    Date: 2007–04–24
  18. By: Norbert Funke; Jens R. Clausen; Sonia Munoz; Bakar Ould-Abdallah; Sharmini Coorey
    Abstract: Zimbabwe has currently the highest rate of inflation in the world (an annual rate of 1,730 percent in February, 2007). The high rates of inflation have contributed to the contraction of the economy, which has declined by about 30 percent since 1999. This paper examines the stabilization experience of countries that experienced similar rates of inflation (above 1,000 percent) during 1980-2005 and draws lessons for Zimbabwe. First, with appropriate stabilization policies, the fall in inflation can be very rapid and output normally recovers within the first year or two of stabilization. Second, while reforms need to be comprehensive, a strong upfront fiscal consolidation, including elimination of quasi-fiscal activities, is a critical element of a successful stabilization program. Third, although stabilization itself can be done without significant external financing in the first year, most countries benefited from external policy advice and technical support, including from the IMF, during stabilization and from an increase in financial assistance in subsequent years.
    Date: 2007–05–01
  19. By: Gomes, Orlando
    Abstract: The paper develops an AK endogenous growth model with an endogenously determined rate of intertemporal preference. Following some of the related literature, we assume that the degree of impatience that is revealed by the representative agent, regarding future consumption, depends on income. To be precise, the proposed framework establishes a link between the output gap and the discount rate attached to the sequence of future utility functions. We analyze both local and global dynamics. From a local analysis point of view, a variety of stability results is possible to obtain, depending on parameter values. The study of global dynamics allows to find endogenous business cycles under some reasonable circumstances. On a second stage, the model is extended to include the role of leisure.
    Keywords: Time preference; Endogenous growth; Endogenous fluctuations; Quasiperiodic orbits.
    JEL: O41 C61 E32
    Date: 2007–05
  20. By: ZHANG, AIHUA; Korn, Ralf; Ewald, Christian-Oliver
    Abstract: Due to the increasing risk of inflation and diminishing pension benefits, insurance companies have started selling in°ation-linked products. Selling such products the insurance company takes over some or all of the inflation risk from their customers. On the other side financial derivatives which are linked to inflation such as inflation linked bonds are traded on financial markets and appear to be of increasing popularity. The insurance company can use these products to hedge its own inflation risk. In this article we study how to optimally manage a pension fund taking positions in a money market account, a stock and an inflation linked bond, while financing investments through a continuous stochastic income stream such as the plan member's contributions. We use the martingale method in order to compute an analytic expression for the optimal strategy and express it in terms of observable market variables.
    Keywords: Pension mathematics; in°ation; long-term investment; stochastic optimal control; martingale method
    JEL: E44 G12 C61
    Date: 2007
  21. By: Emmanuel Dhyne (Banque Nationale de Belgique and Université de Mons-Hainaut); Catherine Fuss (Banque Nationale de Belgique and Université Libre de Bruxelles); M. Hashem Pesaran (CIMF, Cambridge University, University of Southern California and IZA); Patrick Sevestre (Paris School of Economics, Université Paris 1 Panthéon-Sorbonne and Banque de France)
    Abstract: This paper presents a simple model of state-dependent pricing that allows identification of the relative importance of the degree of price rigidity that is inherent to the price setting mechanism (intrinsic) and that which is due to the price’s driving variables (extrinsic). Using two data sets consisting of a large fraction of the price quotes used to compute the Belgian and French CPI, we are able to assess the role of intrinsic and extrinsic price stickiness in explaining the occurrence and magnitude of price changes at the outlet level. We find that infrequent price changes are not necessarily associated with large adjustment costs. Indeed, extrinsic rigidity appears to be significant in many cases. We also find that asymmetry in the price adjustment could be due to trends in marginal costs and/or desired mark-ups rather than asymmetric cost of adjustment bands.
    Keywords: sticky prices, nominal intrinsic and extrinsic rigidities, micro non-linear panels
    JEL: C51 C81 D21
    Date: 2007–05
  22. By: Mirenitzia Cárdenas; Héctor J. Villarreal
    Abstract: We propose self-employment as an explanation for the observed reduction in inequality occurring after the Mexican economic crisis of 1995. The evidence appears as a contradiction to the labour-hoarding hypothesis, which states that inequality was expected to increase because the only asset of the poor was labour. Self-employment has been an escape to inflation and staggered wages bringing as a consequence reduced inequality. Therefore, individuals will be pushed into self employment as a means of survival if they lost their jobs in the formal sector, or pulled into self employment attracted by higher potential earnings if their wages were losing purchasing power.
    Keywords: self employment, self-employment, inequality, crisis of 1995, informality, labour-hoarding
    JEL: E31 E32 J21 J22
    Date: 2006–01
  23. By: Michel Beine (CREFI-LSF, Luxembourg University, Luxembourg School of Finance, Luxembourg and DULBEA, Université Libre de Bruxelles, Brussels.); Oscar Bernal (DULBEA, Université Libre de Bruxelles, Brussels.); Jean-Yves Gnabo (; Christelle Lecourt (FUNDP, Namur)
    Abstract: Intervening in the FX market implies a complex decision process for central banks. Monetary authorities have to decide whether to intervene or not, and if so, when and how. Since the successive steps of this procedure are likely to be highly interdependent, we adopt a nested logit approach to capture their relationships and to characterize the prominent features of the various steps of the intervention decision. Our findings shed some light on the determinants of central bank interventions, on the so-called secrecy puzzle and on the identification of the variables influencing the detection of foreign exchange transactions by market traders.
    Keywords: FX intervention, Secrecy Puzzle, Market Detection, Nested Logit.
    JEL: E58 F31 G15
    Date: 2007–03
  24. By: Idrees Khawaja (Pakistan Institute of Development Economics, Islamabad.); Musleh-ud Din (Pakistan Institute of Development Economics, Islamabad.)
    Abstract: Interest spread of the Pakistan’s banking industry has been on the rise for the last two years. The increase in interest spread discourages savings and investments on the one hand, and raises concerns on the effectiveness of bank lending channel of monetary policy on the other. This study examines the determinants of interest spread in Pakistan using panel data of 29 banks. The results show that inelasticity of deposit supply is a major determinant of interest spread whereas industry concentration has no significant influence on interest spread. One reason for inelasticity of deposits supply to the banks is the absence of alternate options for the savers. The on-going merger wave in the banking industry will further limit the options for the savers. Given the adverse implications of banking mergers for a competitive environment, we argue that to maintain a reasonably competitive environment, merger proposals may be subjected to review by an antitrust authority with the central bank retaining the veto over merger approval.
    Keywords: Banks, Determination of Interest Rates, Mergers, Acquisitions
    JEL: G21 E43 G34
    Date: 2007
  25. By: Hale, Galina B; Razin, Assaf; Tong, Hui
    Abstract: This paper addresses how creditor protection affects the volatility of stock market prices. Credit protection reduces the probability of oscillations between binding and non-binding states of the credit constraint; thereby lowering the rate of return variance. We test this prediction of a Tobin’s q model, by using cross-country panel regression on stock price volatility in 40 countries over the period from 1984 to 2004. Estimated probabilities of a liquidity crisis are used as a proxy for the probability that credit constraints are binding. We find support for the hypothesis that institutions that help reduce the probability of oscillations between binding and non-binding states of the credit constraint also reduce asset price volatility.
    Keywords: binding credit constraints; liquidity crises; Tobin-q investment model
    JEL: E4 F3 G0
    Date: 2007–05
  26. By: Joe Crowley
    Abstract: This paper examines interest rate spreads in English-speaking African countries. Higher spreads were found to be associated with lower inflation, a greater number of banks, and greater public ownership of banks. Higher deposit interest rates were found to be associated with lower interest rate spreads, but higher net interest margins. A large increase in spreads in the late 1980s and 1990s may be explained by a strengthening of financial sector supervision. Limited data suggested that poor governance, weak regulatory frameworks and property rights, and higher required reserve ratios are associated with higher spreads.
    Date: 2007–05–01
  27. By: Jeremy Greenwood; Juan M. Sanchez; Cheng Wang
    Abstract: How does technological progress in financial intermediation affect the economy? To address this question a costly-state verification framework is embedded into a standard growth model. In particular, financial intermediaries can invest resources to monitor the returns earned by firms. The inability to monitor perfectly leads to firms earning rents. Undeserving firms are financed, while deserving ones are under funded. A more efficient monitoring technology squeezes the rents earned by firms. With technological advance in the financial sector, the economy moves continuously from a credit-rationing equilibrium to a perfectly efficient competitive equilibrium. A numerical example suggests that finance is important for growth.
    JEL: E44 O11 O16 O43
    Date: 2007–05
  28. By: Pierre-Guillaume Meon (DULBEA, Université Libre de Bruxelles, Brussels.); Laurent Weill (LARGE, Université Robert Schuman, Institut d'Etudes Politiques, France)
    Abstract: This paper investigates whether financial intermediary development influences macroeconomic technical efficiency on a sample of 47 countries, both developed and developing, over 1980-1995. We do so by applying Battese and Coelli (1995)’s method at the aggregate level. It is found that financial intermediary development, except financial depth, is on average associated with more efficiency. However we find strong evidence that this relationship is conditional on the level of economic development. The lower economic development the weaker is the impact of financial development on efficiency. That impact can even become negative in the poorest countries.
    Keywords: financial development, income, aggregate productivity, efficiency.
    JEL: C33 O11 O16 O47
    Date: 2007–04
  29. By: James D. Hamilton
    Abstract: This paper explores the properties of daily changes in the prices for near-term fed funds futures contracts. The paper finds these contracts to be excellent predictors of the fed funds rate, and shows that the claim of a nonzero term premium in the short-horizon contracts is more sensitive to outliers than previous research appears to have recognized. I find some statistically significant evidence of serial correlation in the daily changes, but this accounts for only a tiny part of the one-day movements and there is essentially zero predictability for horizons longer than one day. Settlement futures prices for each day appear to incorporate the information embodied in that day's term structure of longer-horizon Treasury securities. Previous employment growth makes a statistically significant contribution to predicting futures price changes, though again this could only account for a tiny part of the daily variance. The paper concludes that futures prices provide a very useful measure of the daily changes in the market's expectation of near-term changes in Fed policy.
    JEL: E44 E5
    Date: 2007–05
  30. By: Akhtiar Ahmed Ghumro; Ahmed Nawaz Hakro
    Abstract: The objective of this study is to understand the determinants of Foreign Direct Investment (FDI) flows and to quantify relevant policy shocks in dynamic econometric model for Pakistan economy. The study has highlighted the degree of attraction of cost related factors, investment environment factors, development strategy factors with ownership and internalization factors and other risk factors of recent FDI flows to Pakistan economy. The results show the investment environment improving factors-openness is statistically significant in short-run. While long run dynamics between FDI, openness and macro economic factors show consistency with short run results. The stable macro economic indicators, country’s risk profile followed by cost related and investment environment improving factors are real determinants to attract FDI.
  31. By: Michael J. Dueker; Zacharias Psaradakis; Martin Sola; Fabio Spagnolo
    Abstract: In this paper we propose a contemporaneous threshold multivariate smooth transition autoregressive (C-MSTAR) model in which the regime weights depend on the ex ante probabilities that latent regime-specific variables exceed certain threshold values. The model is a multivariate generalization of the contemporaneous threshold autoregressive model introduced by Dueker et al. (2007). A key feature of the model is that the transition function depends on all the parameters of the model as well as on the data. The stability and distributional properties of the proposed model are investigated. The C-MSTAR model is also used to examine the relationship between US stock prices and interest rates.
    Date: 2007
  32. By: Jorge Roldos
    Abstract: This paper reviews macroeconomic aspects of pension reforms in Latin America, focusing on financial market stability and fiscal sustainability. Concentration of pension fund portfolios in government bonds remains high, and the lack of new investment alternatives has distorted asset prices. Countries have gradually liberalized investments abroad, but remain wary of the impact on foreign currency markets. The fiscal costs of the transition to funded systems have been higher than expected, and have contributed to high debt levels. The paper highlights the importance of coordinating changes in portfolio limits with debt management policies and measures to develop securities markets.
    Date: 2007–05–04
  33. By: John Ameriks; Andrew Caplin; Steven Laufer; Stijn Van Nieuwerburgh
    Abstract: Strong bequest motives can explain low retirement spending, but so equally can strong precautionary motives. Given this identification problem, the recent tradition has been largely to ignore bequest motives. We develop a rich model of spending in retirement that allows for both motives, and introduce a "Medicaid aversion" parameter that plays a key role in determining precautionary savings. We implement a "strategic" survey to resolve the identification problem between bequest and precautionary motives. We find that strong bequest motives are too prevalent to be ignored. Moreover, Medicaid aversion is widespread, and helps explain the low spending of many middle class retirees.
    JEL: D1 D91 E21 I0 J14
    Date: 2007–05
  34. By: Cristina Arellano; Jonathan Heathcote
    Abstract: How does a country’s choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization. We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets. Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration. This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union. In each case, spreads on foreign currency government debt declined substantially around the time of regime change.
    Date: 2007
  35. By: Acharya, Viral V; Shin, Hyun Song; Yorulmazer, Tanju
    Abstract: Bank liquidity is a crucial determinant of the severity of banking crises. In this paper, we consider the effect of fire sales and foreign entry on banks' ex ante choice of liquid asset holdings, and the ex post resolution of crises. In a setting with limited pledgeability of risky cash flows and differential expertise between banks and outsiders in employing banking assets, the market for assets clears only at fire-sale prices following the onset of a crisis -- and outsiders may enter the market if prices fall sufficiently low. While fire sales make it attractive for banks to hold liquid assets, foreign entry reduces this incentive. We exhibit international evidence on foreign entry following crises and on banks' ex ante liquidity choice that are consistent with the predictions of the model. Our framework allows us to address the key welfare question as to when there is too much or too little liquidity on bank balance sheets relative to the socially optimal level.
    Keywords: crises; distress; limited pledgeability; liquidation cost; systemic risk
    JEL: D61 E58 G21 G28 G32
    Date: 2007–05
  36. By: Timothy J. Kehoe; Kim J. Ruhl
    Abstract: International trade is frequently thought of as a production technology in which the inputs are exports and the outputs are imports. Exports are transformed into imports at the rate of the price of exports relative to the price of imports: the reciprocal of the terms of trade. Cast this way, a change in the terms of trade acts as a productivity shock. Or does it? In this paper, we show that this line of reasoning cannot work in standard models. Starting with a simple model and then generalizing, we show that changes in the terms of trade have no first-order effect on productivity when output is measured as chain-weighted real gross domestic product. The terms of trade do affect real income and consumption in a country, and we show how measures of real income change with the terms of trade at business cycle frequencies and during financial crises.
    JEL: E23 F41 F43
    Date: 2007–05
  37. By: Steven B. Kamin; Trevor A. Reeve; Nathan Sheets
    Abstract: In recent years, a number of studies have analyzed the experiences of a broad range of industrial economies during periods when their current account deficits have narrowed. Such studies identified systematic aspects of external adjustment, but it is unclear how good a guide the experience of other countries may be to the effects of a future narrowing of the U.S. external imbalance. In contrast, this paper focuses in depth on the historical experience of external adjustment in the United States. Using data from the past thirty-five years, we compare economic performance in episodes during which the U.S. trade balance deteriorated and episodes during which it adjusted. We find trade balance adjustment to have been generally benign: U.S. real GDP growth tended to fall, but not to a statistically significant extent; housing construction slumped; inflation generally rose modestly; and although nominal interest rates tended to rise, real interest rates fell. The paper then compares these outcomes to those in foreign industrial economies. We find that the economic performance of the United States during periods of external adjustment is remarkably similar to the foreign experience. Finally, we also examine the performance of the foreign industrial economies during the periods of U.S. deterioration and adjustment. Contrary to concerns that U.S. adjustment will prove injurious to foreign economies, our analysis suggests that the foreign economies fared reasonably well during past periods when the U.S. trade deficit narrowed: the growth of domestic demand and real GDP abroad generally strengthened during such episodes, although inflation and interest rates tended to rise as well.
    Date: 2007
  38. By: David Dollar; Shang-Jin Wei
    Abstract: Based on a survey that we designed and that covers a stratified random sample of 12,400 firms in 120 cities in China with firm-level accounting information for 2002-2004, this paper examines the presence of systematic distortions in capital allocation that result in uneven marginal returns to capital across firm ownership, regions, and sectors. It provides a systematic comparison of investment efficiency among wholly and partially state-owned, wholly and partially foreign-owned, and domestic privately owned firms, conditioning on their sector, location, and size characteristics. It finds that even after a quarter-of-century of reforms, state-owned firms still have significantly lower returns to capital, on average, than domestic private or foreign-owned firms. Similarly, certain regions and sectors have consistently lower returns to capital than other regions and sectors. By our calculation, if China succeeds in allocating its capital more efficiently, it could reduce its capital stock by 8 percent without sacrificing its economic growth (and hence could raise its household consumption and deliver a faster improvement to its citizens' living standard).
    JEL: E22 F21 O1
    Date: 2007–05
  39. By: Razin, Assaf; Sand, Edith
    Abstract: In the political debate people express the idea that immigrants are good because they can help pay for the old. The paper explores this idea in a dynamic political-economy setup. We characterize sub-game perfect Markov equilibria where immigration policy and pay-as-you-go (PAYG) social security system are jointly determined through a majority voting process. The main feature of the model is that immigrants are desirable for the sustainability of the social security system, because the political system is able to manipulate the ratio of old to young and thereby the coalition which supports future high social security benefits. We demonstrate that the older is the native born population the more likely is that the immigration policy is liberalized; which in turn has a positive effect on the sustainability of the social security system.
    Keywords: demographic stretegic voting; overlapping generations; social security sustainability
    JEL: E1 H3 P1
    Date: 2007–05
  40. By: Zsolt Darvas (Department of Mathematical Economics and Economic Analysis, Corvinus University of Budapest); Zoltán Schepp (University of Pécs)
    Abstract: This paper shows that error correction models assuming that long-maturity forward rates are stationary outperform the random walk in out of sample forecasting at forecasting horizons mostly above one year, for US dollar exchange rates against nine industrial countries’ currencies, using the 1990-2006 period for evaluating the out of sample forecasts. The improvement in forecast accuracy of our models is economically significant for most of the exchange rate series, and statistically significant according to a bootstrap test. Our results are robust to the specification of the error correction model and to the underlying data frequency.
    Keywords: bootstrap, forecasting performance, out of sample, random walk, VECM
    JEL: E43 F31 F47
    Date: 2007–05–18
  41. By: K., Jothi Sivagnanam
    Abstract: Achieving a high growth rate as well as a desirable level of income distribution is a goal that continues to be elusive in India. Thus, the maiden approach of the Tamil Nadu State Planning Commission to place importance on the `growth process', alongside the growth rate, is interesting and appropriate.
    Keywords: Planning - Social Sector - Growth Process -
    JEL: E62 O15 O21
    Date: 2006–12–29

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