nep-mac New Economics Papers
on Macroeconomics
Issue of 2007‒11‒17
57 papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Keynesian AD-AS Vadis? By Toichiro Asada; Carl Chiarella; Peter Flaschel; Christian R. Proaño
  2. Evolving U.S. monetary policy and the decline of inflation predictability. By Luca Benati; Paolo Surico
  3. Political Business Cycles in the New Keynesian Model By Fabio Milani
  4. Convergence and anchoring of yield curves in the euro area. By Michael Ehrmann; Marcel Fratzscher; Refet S. Gürkaynak; Eric T. Swanson
  5. Inertia in Taylor Rules By John Driffill; Zeno Rotondi
  6. Great Moderation(s) and U.S. Interest Rates: Unconditional Evidence By James M. Nason; Gregor W. Smith
  7. Evaluating the Synchronisation of the Eurozone Business Cycles using Multivariate Coincident Macroeconomic Indicators By Xiaoshan Chen
  8. Measures of Monetary Policy Stance: The Case of Pakistan By Sajawal Khan; Abdul Qayyum
  9. Is Time ripe for price level path stability? By Vitor Gaspar; Frank Smets; David Vestin
  10. The Importance of Being Vigilant: Has ECB Communication Influenced Euro Area Inflation Expectations? By David-Jan Jansen; Jakob de Haan
  11. Euro Area Inflation: Aggregation Bias and Convergence By Joseph P. Byrne; Norbert Fiess
  12. Potential Growth and Business Cycle in the Spanish Economy: Implications for Fiscal Policy By Rafael Domenech; Ángel Estrada; Luis González-Calbet
  13. Canada's Pioneering Experience with a Flexible Exchange Rate in the 1950s:(Hard) Lessons Learned for Monetary Policy in a Small Open Economy By Michael D. Bordo; Ali Dib; Lawrence Schembri
  14. Inflation Targeting - a Framework for Communication By Maria Demertzis; Nicola Viegi
  15. Rent-seeking competition from state coffers in a calibrated DSGE model of the euro area By Konstantinos Angelopoulos; Apostolis Philippopoulos; Vanghelis Vassilatos
  16. RBCs and DSGEs:The Computational Approach to Business Cycle Theory and Evidence By Özer Karagedikli; Troy Matheson; Christie Smith; Shaun P. Vahey
  17. Spill-over effects of monetary policy: a progress report on interest rate convergence in Europe By Fladung, Michael
  18. Rationalizing Seven Consumption-Saving Puzzles in a Unified Framework By Kevin X.D. Huang; Frank Caliendo
  19. Does high money growth put the inflation target at further risk? By Tim Congdon
  20. Modeling Great Depressions: The Depression in Finland in the 1990s By Juan Carlos Conesa; Timothy J. Kehoe; Kim J. Ruhl
  21. Stochastic Volatility in a Macro-Finance Model of the US Term Structure of Interest Rates 1961-2004. By Peter Spencer
  22. Euro Area Inflation Differentials: Unit Roots, Structural Breaks and Non-Linear Adjustment By Alberto Montagnoli; Andros Gregoriou; Alexandros Kontonikas
  23. The long road to EMU: The Economic and Political Reasoning behind Maastricht By Francisco Torres
  24. Taxes, Benefits, and Careers: Complete Versus Incomplete Markets By Ljungqvist, Lars; Sargent, Thomas J
  25. Business Cycle Fluctuations and the Life Cycle: How Important is On-The-Job Skill Accumulation? By Gary D. Hansen; Selo Imrohoroglu
  26. What do we really know about fiscal sustainability in the EU? A panel data diagonostic. By Antonio Afonso; Christophe Rault
  27. Forecasting the South African Economy with Gibbs Sampled BVECMs By Samuel Zita; Rangan Gupta
  28. Bayesian Methods of Forecasting Inventory Investment in South Africa By Rangan Gupta
  29. Fiscal Policy, Rent Seeking and Growth under Electoral Uncertainty Theory and Evidence from the OECD By Konstantinos Angelopoulos; George Economides
  30. Zimbabwe’s Hyperinflation Money Demand Model By Albert Makochekanwa
  31. The Economic Effects of Energy Price Shocks By Kilian, Lutz
  32. The Implementation of Monetary Policy in New Zealand: What Factors Affect the 90-Day Bank Bill Rate? By Alfred V. Guender; Oyvinn Rimer
  34. Markov-Perfect Optimal Fiscal Policy: The Case of Unbalanced Budgets By Salvador Ortigueira; Joana Pereira
  35. Social value of public information - testing the limits to transparency. By Michael Ehrmann; Marcel Fratzscher
  36. What can probability forecasts tell us about inflation risks? By Juan Angel Garcia; Andres Manzanares
  37. Executive Compensation: The View from General Equilibrium By Danthine, Jean-Pierre; Donaldson, John B
  38. The FedÕs Reaction to the Stock Market During the Great Depression: Fact or Artefact? By Pierre L. Siklos
  39. Determinants of Business Cycle Synchronization in East Asia: An Extreme Bound Analysis By Toan Nguyen
  40. Measuring the Welfare Gain from Personal Computers By Jeremy Greenwood; Karen A. Kopecky
  41. Discount Window Borrowing after 2003: The Explicit Reduction in Implicit Costs By Selva Demiralp; Erhan Artuç
  42. Does public sector efficiency matter? Revisiting the relation between fiscal size and economic growth in a world sample By Konstantinos Angelopoulos; Apostolis Philippopoulos; Efthymios Tsionas
  43. Expectational coordination in a class of economic models: Strategic substitutabilities versus strategic complementarities By Roger Guesnerie; Pedro Jara-Moroni
  44. Inequality, Democracy, Institutional Quality, and Fiscal Redistribution By Alberto Chong; Mark Gradstein
  45. The Impact of Conditional Cash Transfers on Consumption and Investment in Nicaragua By John A. Maluccio
  46. Bank Failures in Theory and History: The Great Depression and Other "Contagious" Events By Charles W. Calomiris
  47. Heterogeneous Exporter Behaviour: Exploring the Evidence for Sunk-Costs and Hysteresis By Anne Marie Gleeson; Frances Ruane
  48. Political Risk and Irreversible Investment By Sumru G. Altuğ; Fanny S. Demers; Michel Demers
  49. Liquidity, Equity Premium and Participation By Benjamin Eden
  50. Incentive Conflict In Central-Bank Responses to Sectoral Turmoil in Financial Hub Countries By Edward J. Kane
  51. Central banking in the iberian peninsula: a comparison By Pablo Martin Aceña
  52. Linking Global Economic Dynamics to a South African Specific Credit Portfolio By Albert H. De Wet; Reneé Van Eyden
  53. The Extension of Social Security Coverage in Developing Countries By Chung Tran; Juergen Jung
  54. Economic performance of Vietnam, 1976-2000: New evidence from input-output model By Pham Quang Ngoc; Bui Trinh; Thanh Duc Nguyen
  55. A Dynamic Enquiry into the Causes of Hyperinflation in Zimbabwe By Albert Makochekanwa
  56. A note on global dynamics and imbalance effects in the Lucas-Uzawa model By Raouf Boucekkine; B. Martínez; J. R. Ruiz-Tamarit
  57. Can Baumol's Model of Unbalanced Growth Contribute to Explaining the Secular Rise in Health Care Expenditure? An Alternative Test By Jochen Hartwig

  1. By: Toichiro Asada (Chuo University); Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Peter Flaschel (Faculty of Economics, University of Bielefeld); Christian R. Proaño (Faculty of Economics, University of Bielefeld)
    Abstract: We formulate a dynamic AD-AS model based on gradually adjusting wages and prices, perfect foresight of current inflation rates and adaptive expectations concerning the inflation climate in which the economy operates. The model consists of a wage and a price Phillips curve, a dynamic IS curve as well as a dynamic employment adjustment equation (Okun?s law) and a Taylor interest rate rule. The model can be reduced to a 3D dynamical system by a suitable choice of the Taylor rule and implies strong stability results, in particular for an appropriately chosen interest rate policy rule. Through instrumental variables GMM system estimation with aggregate time series data for the U.K. economy, we obtain parameter estimates which support the specification of our theoretical model and its stability implications. We contrast these results with the standard (formally similarly structured) New Keynesian model with staggered wage and price setting where determinacy of the dynamics represents a severe problem and where (if determinacy can be achieved) inertia-free stability is obtained by the very choice of the solution method.
    Keywords: AS-AD; wage and price Phillips curve; real wage dynamics; stability; monetary policy
    JEL: E24 E31 E32
    Date: 2007–11–01
  2. By: Luca Benati (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Paolo Surico (External Monetary Policy Committee Unit, Bank of England, Threadneedle Street, London, EC2R 8AH, United Kingdom.)
    Abstract: Using a structural VAR with time-varying parameters and stochastic volatility on post-WWII U.S. data, we document a striking negative correlation between the evolution of the long-run coefficient on inflation in the monetary rule and the evolution of the persistence and predictability of inflation relative to a trend component. Using a standard sticky-price model, we show that a more aggressive policy stance towards inflation causes a decline in inflation predictability, providing a possible interpretation for the findings of the structural VAR. JEL Classification: E37, E52, E58.
    Keywords: Bayesian time-varying VARs, sign restrictions, frequency domain, Great Inflation, predictability.
    Date: 2007–10
  3. By: Fabio Milani (Department of Economics, University of California-Irvine)
    Abstract: This paper tests various Political Business Cycle theories in a New Keynesian model with a monetary and fiscal policy mix. All the policy coefficients, the target levels of inflation and the budget deficit, the firms' frequency of price setting, and the standard deviations of the structural shocks are allowed to depend on 'political' regimes: a pre-election vs. post-election regime, a regime that depends on whether the President (or the Fed Chairman) is a Democrat or a Republican, and a regime under which the President and the Fed Chairman share party affiliation in pre-election quarters or not. The model is estimated using full-information Bayesian methods. The assumption of rational expectations is relaxed: economic agents can learn about the effect of political variables over time. The results provide evidence that several coefficients depend on political variables. The best-fitting specification is one that allows coefficients to depend on a pre-election vs. non-election regime. Monetary policy becomes considerably more inertial before elections and fiscal policy deviations from a simple rule are more common. The results overall support the view of an independent Fed that avoids taking policy decisions right before elections. There is some evidence, however, that policies become more expansionary before elections, but this evidence seems to disappear in the post-1985 sample. The estimates also indicate that firms similarly delay their price-setting decisions until after the upcoming Presidential election.
    Keywords: Political Business Cycles; Opportunistic Cycles; Partisan Cycles; Monetary and Fiscal Policy; Adaptive Learning; Bayesian Estimation
    JEL: C11 D72 E32 E52 E58 E63
    Date: 2007–11
  4. By: Michael Ehrmann (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Refet S. Gürkaynak (CEPR and Bilkent University, 06800 Bilkent, Ankara, Turkey.); Eric T. Swanson (Federal Reserve Bank of San Francisco, 101 Market Street, San Francisco, CA 94105, USA.)
    Abstract: We study the convergence of European bond markets and the anchoring of inflation expectations in euro area countries using high-frequency bond yield data for France, Germany, Italy and Spain. We find that Economic and Monetary Union (EMU) has led to substantial convergence in euro area sovereign bond markets in terms of interest rate levels, unconditional daily fluctuations, and conditional responses to major macroeconomic data announcements. Our findings also suggest a substantial increase in the anchoring of long-term inflation expectations since EMU, particularly for Italy and Spain, which since monetary union have seen their long-term interest rates become much lower, much less volatile, and much better anchored in response to news. Finally, the reaction of far-ahead forward interest rates to macroeconomic announcements has converged substantially across euro area countries and even been eliminated over time, thus underlining not only market integration but also the credibility that financial markets attach to monetary policy in the euro area. JEL Classification: E52, E58.
    Keywords: Bond markets, euro area, EMU, convergence, anchoring, credibility, monetary policy.
    Date: 2007–10
  5. By: John Driffill (School of Economics, Mathematics & Statistics, Birkbeck); Zeno Rotondi
    Abstract: The inertia found in econometric estimates of interest rate rules is a continuing puzzle. Many reasons for it have been offered, though unsatisfactorily, and the issue remains open. In the empirical literature on interest rate rules, inertia in setting interest rates is typically modeled by specifying a Taylor rule with the lagged policy rate on the right hand side. We argue that inertia in the policy rule may simply reflect the inertia in the economy itself, since optimal rules typically inherit the inertia present in the model of the economy. Our hypothesis receives some support from US data. Hence we agree with Rudebusch (2002) that monetary inertia is, at least partly, an illusion, but for different reasons.
    Keywords: Monetary Policy, Interest Rate Rules, Taylor rule, Interest Rate Smoothing, Monetary Policy Inertia, Predictability of Interest Rates, Term Structure, Expectations Hypothesis
    JEL: E52 E58
    Date: 2007–11
  6. By: James M. Nason (Federal Reserve Bank of Atlanta); Gregor W. Smith (Queen's University)
    Abstract: The US economy experienced a Great Moderation sometime in the mid-1980s -- a fall in the volatility of output growth -- at the same time as a fall in both the volatility of inflation and the average rate of inflation. We put this moderation in historical perspective by comparing it to the post-WWII moderation. According to theory, the statistical moments -- both real and nominal -- that shift during these moderations in turn influence interest rates. We examine the predictions for shifts in the unconditional average of US interest rates. A central finding is that such shifts probably were due to changes in average inflation rather than to those in the variances of inflation and consumption growth.
    Keywords: great moderation, asset pricing
    JEL: E32 E43 N12
    Date: 2007–11
  7. By: Xiaoshan Chen (Dept of Economics, Loughborough University)
    Abstract: This paper offers an insight into the optimality of the European Economic and Monetary Union (EMU) and its common monetary policies by evaluating the degree of business cycle synchronisation among the EMU member states with respect to the Eurozone aggregate. Business cycles for each country, defined by turning points, are extracted from multivariate coincident macroeconomic variables by using both classical and modern business cycle dating procedures, including the Bry-Boschan Quarterly (BBQ) algorithm, the multivariate dynamic-factor model and the multivariate dynamic-factor Markov-switching (DFMS) model. The degree of cycle synchronisation between the EMU members and the Eurozone aggregate is measured using the index of concordance, the mean corrected index of concordance and correlation-coefficients. The inference provided by the pairwise correlation-coefficients of the smoothed recession probabilities in the dynamic-factor Markov-switching model is also used to indicate cycle corrections. Overall, close cycle correlations are found between the Eurozone aggregate and the core EMU countries. A catching-up process of cycle convergence is observed in some of the peripheral countries (Spain and Finland), perhaps as a result of participating in the ERM and the EMU. To date there have been few studies measuring cycle synchronisation using business cycles extracted from multivariate coincident macroeconomic indicators for the EMU countries. This paper contributes to this area.
    Keywords: Business Cycle Turning Point, Markov-Switching, Dynamic-factor model
    JEL: C14 C22 C32 E32
    Date: 2007–11
  8. By: Sajawal Khan (Pakistan Institute of Development Economics, Islamabad.); Abdul Qayyum (Pakistan Institute of Development Economics, Islamabad.)
    Abstract: In this paper we construct two measures of the monetary policy stance. The stance of monetary policy, regarded as a quantitative measure of whether the policy is too tight, neutral, or too loose relative to objectives of stable prices and output growth, is useful and important for at least two reasons. First, it helps the authority (central bank) to determine the course of monetary policy needed to keep the objective (goals) within the target range. Secondly, a quantitative measure of the stance is important for an empirical study of the transmission of monetary policy actions through the economy. Measuring the stance of the monetary policy free from any criticism, however, is not an easy task. As pointed out by Gecchetti (1994), “there seems to be no way to measure monetary actions that does not raise serious objections”. Our results show that an individual coefficient Monetary Condition Index (MCI) performs better than both the summarised MCI coefficient and the Overall measure proposed by Bernanke and Mihov (1998). The results show that in the 21-year period from 1984 to 2004, the demand shocks have dominated for about eight years. The MCI (IS-Individual coefficient) can explain six of them. However, it indicates the negative demand shock in two years as neutral. The other two measures, however, fail to capture demand shocks most of the time. This analysis suggests that the MCI (IS-Individual coefficient) plays an important role in determining output and inflation when the economy is not dominated by supply shocks. The results also show that supply shocks are dominant in the case of Pakistan. Furthermore, the exchange rate channel is more important than the interest rate channel.
    Keywords: Monetary Policy Measures, Monetary Condition Index, Composite Measures
    JEL: E42 E52 E58
    Date: 2007
  9. By: Vitor Gaspar (Banco de Portugal, R. Francisco Ribeiro, 2, 1150-165 Lisboa, Portugal.); Frank Smets (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); David Vestin (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: In the paper, we provide a critical and selective survey of arguments relevant for the assessment of the case for price level path stability (PLPS). Using a standard hybrid new Keynesian model we argue that price level stability provides a natural framework for monetary policy under commitment. There are two main arguments in favour of a PLPS regime. First, it helps overall macroeconomic stability by making expectations operate like automatic stabilizers. Second, under a price level path stability regime, changes in the price level operate like an intertemporal adjustment mechanism, reducing the magnitude of required changes in nominal interest rates. Such a property is particularly relevant as a means to alleviate the importance of the zero bound on nominal interest rates. We also review and discuss the arguments against price level path stability. Finally, we also found, using the Smets and Wouters (2003) model which includes a wide variety of frictions and is estimated for the euro area, that the price level is stationary under optimal policy under commitment. The results obtain when the quasi-difference of inflation is used in the loss function, as in the hybrid new Keynesian model. Overall, the arguments in favour of or against price level path stability depend on the degree of dependence of private sector expectations on the characteristics of the monetary policy regime. JEL Classification: E52, D83.
    Keywords: Price Level Stability, Expectations, Adaptive Learning.
    Date: 2007–10
  10. By: David-Jan Jansen; Jakob de Haan
    Abstract: Using daily data on inflation-indexed bonds, we find evidence of a negative relationship between ECB communication regarding risks to price stability - measured on the basis of the frequency and strength of the keyword ‘vigilance' - and changes in euro area break-even inflation. However, this result is only found for the second half of 2005. At that time, the start of a tightening of ECB monetary policy was increasingly likely. This suggests that communication should be closely in line with policy actions before it can be effective. Still, we also find that the economic significance of this type of communication has been small.
    Keywords: central bank communication; ECB; inflation expectations 
    JEL: C71 C78 E52
    Date: 2007–10
  11. By: Joseph P. Byrne; Norbert Fiess
    Abstract: EMU monetary policy targets aggregate Euro Area inflation. Concerns are growing that a focus on aggregate inflation may cause national inflation rates to diverge. While different explanations for diverging aggregate Euro Area inflation have been brought forward, the very impact of aggregation on divergence has however not been studied. We find a striking difference in convergence depending on the level of aggregation. While aggregate national inflation rates are diverging, disaggregate inflation rates are converging. We find that aggregation appears to bias evidence towards non-convergence. Our results are consistent with prominent theoretical and empirical evidence on aggregation bias
    Keywords: Euro Area Inflation; Aggregation Bias; Convergence
    JEL: C12 C22 E31
    Date: 2007–10
  12. By: Rafael Domenech (Economic Bureau of the Prime Minister, Spain. University of Valencia, Spain); Ángel Estrada (Economic Bureau of the Prime Minister, Spain); Luis González-Calbet (Economic Bureau of the Prime Minister, Spain)
    Abstract: An accurately estimation of the cyclical position of an economy is a necessary condition for the success of fiscal stabilisation policies. In this paper we show that the estimation of the output gap by means of decomposing a production function produces similar results to univariate and multivariate methods, increasing their robustness and allowing us to conclude that most of the information on the economic cycle is included in the cyclical component of the unemployment rate. The results also indicate that there is reduced uncertainty about the periods when the Spanish economy has clearly been in a deep recession or in a sharp expansion. These periods have been limited and of relatively short duration. Fiscal policy should pay particular attention to these episodes, when discretionary stabilisation policies make most sense.
    Keywords: potential growth, business cycle, speed-limit policies
    JEL: C32 E32
    Date: 2007–11
  13. By: Michael D. Bordo; Ali Dib; Lawrence Schembri
    Abstract: This paper revisits Canada's pioneering experience with floating exchange rate over the period 1950-1962. It examines whether the floating rate was the best option for Canada in the 1950s by developing and estimating a New Keynesian small open economy model of the Canadian economy. The model is then used to conduct a counterfactual analysis of the impact of different monetary policies and exchange rate regimes. The main finding indicates that the flexible exchange rate helped reduce the volatility of key macro-economic variables. The Canadian monetary authorities, however, clearly did not understand all of the implications of conducting monetary policy under a flexible exchange rate and a high degree of capital mobility. The paper confirms that monetary policy was more volatile in the post-1957 period and Canada's macroeconomic performance suffered as a result.
    JEL: E32 E37 F31 F32 N01
    Date: 2007–11
  14. By: Maria Demertzis; Nicola Viegi
    Abstract: More than a monetary policy strategy, we interpret inflation targeting as a framework for communication. We model monetary policy as an information game between the Bank and private agents. Our analysis shows how the provision of an explicit numerical inflation objective overcomes potential information imperfections by providing a focal point for agents who form expectations. Furthermore, the combination of the target and the tolerance bands around it communicated, provide a very clear framework with which to evaluate monetary policy outcomes. A successful Central Bank then builds up credibility and a credible Central Bank is in a better position to be successful in subsequent periods. We show how (and when) inflation targeting exploits this self-reinforcing loop to help the Central Bank endure large and long-lasting shocks. Last, we show that a trade-off emerges when choosing the band-width: too narrow bands provide a focal point but reduce the likelihood of inflation being ‘successful'. Too wide bands on the other hand, lead easier to success but at the risk of failing to provide a clear focal point. We thus derive the optimal band-width for different scenarios.
    Keywords: Monetary Policy; Communication; Focal Points; Credibility; Optimal Band-Width.
    JEL: C71 C78 E52
    Date: 2007–10
  15. By: Konstantinos Angelopoulos; Apostolis Philippopoulos; Vanghelis Vassilatos
    Abstract: We incorporate an uncoordinated redistributive struggle for extra fiscal privileges into an otherwise standard dynamic stochastic general equilibrium model. The main aim is to get model-consistent quantitative evidence of the extent of rent seeking. Our work is motivated by the common belief that interest groups compete with each other for privileged transfers, subsidies and tax treatments at the expense of the general public interest. The model is calibrated to the euro area as a whole, and to individual euro member-countries, over the period 1980-2003. We find that an important proportion of tax revenue is appropriated by rent seekers and that the introduction of rent seeking moves the model in the right direction vis-à-vis the data
    Keywords: Fiscal policy, real business cycles, rent seeking.
    JEL: E62 E32 O17
    Date: 2007–09
  16. By: Özer Karagedikli; Troy Matheson; Christie Smith; Shaun P. Vahey (Reserve Bank of New Zealand)
    Abstract: Real Business Cycle (RBC) and Dynamic Stochastic General Equilibrium (DSGE) methods have become essential components of the macroeconomist’s toolkit. This literature review stresses recently developed (often Bayesian) techniques for computation and inference, providing a supplement to the Romer (2006) textbook treatment which stresses theoretical issues. Many computational aspects are illustrated with reference to the simple divisible labour RBC model familiar to graduate students from King, Plosser and Rebelo (1988), Christiano and Eichenbaum (1992), Campbell (1994) and Romer (2006). Code and US data to replicate the computations are provided on the Internet, together with a number of appendices providing background details.
    JEL: C11 C22 E17 E32 E52
    Date: 2007–11
  17. By: Fladung, Michael
    Abstract: This study examines differences in the interest rate response to an ECB policy impulse in the euro area, the new EU-member states, and in the other non-eurozone EU countries in order to gauge the degree of interest rate alignment in Europe. To this end, PANIC, a Panel Analysis of Non-stationarity in I diosyncratic and Common components, is employed in a structural factor set-up. Under the assumption that the ECB sets the short end of the yield curve, the analysis shows that : (i) The response of Europe’s money and government bond markets to new information can be summarized by two common stochastic trends and one stationary common factor, which together explain more than 68% of the overall variation of the two market segments; (ii) one of the factor innovations can be associated with the ECB’s policy stance, which strongly affects the short end of the euro area’s yield curve; (iii) compared to the euro area, the short-term market segments in the new EU-member states react, on average, 12% more weakly to the monetary policy signal, whereas these countries’ long-term government bond yields respond up to 25% more strongly to such a common innovation.
    Keywords: Factor Models, Common Stochastic Trends, Interest Rate Channel, New Member States, Mixed Data Sampling
    JEL: C33 E52 G15
    Date: 2007
  18. By: Kevin X.D. Huang (Department of Economics, Vanderbilt University); Frank Caliendo (Department of Economics, Utah State University)
    Abstract: Empirical evidence suggests that it may cost time, effort, and resources to properly implement a saving plan, though such cost may differ across individual consumers. We document seven facts on macroeconomic consumption and saving over the life cycle, and we enrich a simple life-cycle model by costly saving implementation to explain these facts. This friction is the sole and common mechanism in our model for rationalizing this series of facts, as the model abstracts from all existing mechanisms that are known to help explain some of them. The implementation costs in our model are small, yet they help resolve these macroeconomic consumption and saving puzzles in a simple and unified way.
    Keywords: Overconfidence, consumption, life cycle, time inconsistency, hump shape, elasticity of intertemporal substitution <br><br>
    JEL: C61 D91 E21
    Date: 2007–10
  19. By: Tim Congdon
    Date: 2007–10
  20. By: Juan Carlos Conesa; Timothy J. Kehoe; Kim J. Ruhl
    Abstract: This paper is a primer on the great depressions methodology developed by Cole and Ohanian (1999, 2007) and Kehoe and Prescott (2002, 2007). We use growth accounting and simple dynamic general equilibrium models to study the depression that occurred in Finland in the early 1990s. We find that the sharp drop in real GDP over the period 1990-93 was driven by a combination of a drop in total factor productivity (TFP) during 1990-92 and of increases in taxes on labor and consumption and increases in government consumption during 1989-94, which drove down hours worked in Finland. We attempt to endogenize the drop in TFP in variants of the model with an investment sector and with terms-of-trade shocks but are unsuccessful.
    JEL: E13 E32 E50 F41 F59
    Date: 2007–11
  21. By: Peter Spencer
    Abstract: This paper generalizes the standard homoscedastic macro-finance model by allowing for stochastic volatility, using the ‘square root’ specification of the mainstreamfinance literature. Empirically, this specification dominates the standard model because it is consistent with the square root volatility found in macroeconomic time series. Thus it establishes an important connection between the stochastic volatility of the mainstream finance model and macroeconomic volatility of the Okun (1971) - Friedman (1977) type. This research opens the way to a richer specification of both macroeconomic and term structure models, incorporating the best features of both macro-finance and mainstream-finance models.
    Keywords: Macro-finance, affine term structure, heteroscedasticity
    Date: 2007–11
  22. By: Alberto Montagnoli; Andros Gregoriou; Alexandros Kontonikas
    Abstract: This paper examines the time series properties of inflation differentials in twelve EMU countries. We compute three alternative measures of inflation differentials using deviations from the policy reference value implied by the Maastricht Treaty, the ECB target, and deviations from the EMU average inflation. The evidence from standard linear unit root tests indicate that inflation differentials are highly persistent. However, when we account for endogenously determined structural breaks, we obtain greater support for stationarity. In addition, when we allow for the possibility that inflation differentials can be charterised by a non-linear mean reverting process we find evidence of stationarity. Our empirical results suggest that once we allow for structural breaks or non-linearities, inflation differentials do not consistently intensify real divergence in the euro area
    Keywords: EMU, ESTAR models; Inflation; Structural break; Unit root tests
    JEL: C22 E31
    Date: 2007–06
  23. By: Francisco Torres (IEE - Universidade Católica Portuguesa and INA)
    Abstract: This paper aims to examine whether the economic and political reasoning behind Maastricht is consistent with earlier approaches to monetary integration. In doing so, it revisits the intellectual debate on monetary integration in Europe at different stages. It concludes that Economic and Monetary Union (EMU) as agreed at Maastricht reflected a compromise between two different but converging preferences, in the context of the experience of the European Monetary System (EMS) and other developments in national and European politics as well as in economic thought, on the role of monetary policy and institutions; the fall of the Berlin Wall may have added a new political dimension that might have made it easier to agree on the blueprint and on the calendar for the realisation of EMU. The various (political and economic) motivations for the convergence of initially different views on the role of monetary policy and successive interpretations of the objectives of EMU are discussed within the wider context of the process of European integration.
    Keywords: Economic and Monetary Union; Bretton Woods; European integration; Werner plan; European Monetary System; inflation; convergence of preferences; epistemic communities; currency crisis; monetary sovereignty; Maastricht treaty; convergence requirements.
    JEL: N14 E52 E58 E61 E65
    Date: 2007–11
  24. By: Ljungqvist, Lars; Sargent, Thomas J
    Abstract: An incomplete markets life-cycle model with indivisible labour makes career lengths and human capital accumulation respond to labour tax rates and government supplied non-employment benefits. We compare aggregate and individual outcomes in this individualistic incomplete markets model with those in a comparable collectivist representative family with employment lotteries and complete insurance markets. The incomplete and complete market structures assign leisure to different types of individuals who are distinguished by their human capital and age. These microeconomic differences distinguish the two models in terms of how macroeconomic aggregates respond to some types of government supplied non-employment benefits, but remarkably, not to labor tax changes.
    Keywords: benefits; career; complete markets; employment lotteries; human capital; incomplete markets; indivisible labour; labour supply elasticity; retirement; taxes
    JEL: E24 E62 J21 J26
    Date: 2007–11
  25. By: Gary D. Hansen; Selo Imrohoroglu
    Abstract: We study the effects of on-the-job skill accumulation on average hours worked by age and the volatility of hours over the life cycle in a calibrated general equilibrium model. Two forms of skill accumulation are considered: learning by doing and on-the-job training. In our economy with learning by doing, individuals supply more labor early in the life cycle and less as they approach retirement than they do in an economy without this feature. The impact of this feature on the volatility of hours over the life cycle depends on the value of the intertemporal elasticity of labor supply. When individuals accumulate skills by on-the-job training, there are only weak effects on both the steady-state labor supply and its volatility over the life cycle.
    JEL: E32 J22 J24
    Date: 2007–11
  26. By: Antonio Afonso (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Christophe Rault (Université d’Orléans, LEO, CNRS, UMR 6221, Rue de Blois-B.P.6739, 45067 Orléans Cedex 2, France.)
    Abstract: We assess the sustainability of public finances in the EU15 over the period 1970-2006 using stationarity and cointegration analysis. Specifically, we use panel unit root tests of the first and second generation allowing in some cases for structural breaks. We also apply modern panel cointegration techniques developed by Pedroni (1999, 2004), generalized by Banerjee and Carrion-i-Silvestre (2006) and Westerlund and Edgerton (2007), to a structural long-run equation between general government expenditures and revenues. While estimations point to fiscal sustainability being an issue in some countries, fiscal policy was sustainable both for the EU15 panel set, and within subperiods (1970-1991 and 1992-2006). JEL Classification: C23, E62, H62, H63.
    Keywords: Intertemporal budget constraint, fiscal sustainability, EU, panel unit root, panel cointegration.
    Date: 2007–10
  27. By: Samuel Zita (Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: The paper uses Gibbs sampling technique to estimate a heteroscedastic Bayesian Vector Error Correction Model (BVECM) of the South African economy for the period 1970:1-2000:4, and then forecast GDP, consumption, investment, short and long term interest rates, and the CPI over the period of 2001:1 to 2005:4. We find that a tight prior produces relatively more accurate forecasts than a loose one. The out-of-sample-forecast accuracy resulting from the Gibbs sampled BVECM is compared with those generated from a Classical VECM and a homoscedastic BVECM. The homoscedastic BVECM is found to produce the most accurate out of sample forecasts.
    Keywords: Forecast Accuracy, Metical-Rand Exchange Rate, Random Walk, Sticky-Price Model, VAR Forecasts, VECM Forecasts
    JEL: B23 C22 F31 E17 E27 E37 E47
    Date: 2007–02
  28. By: Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: This paper develops a Bayesian Vector Error Correction Model (BVECM) for forecasting inventory investment in South Africa. The model is estimated using quarterly data on actual sales, production, unfilled orders, price levels and interest rates, for the period of 1978 to 2000. The out-of-sample-forecast accuracy obtained from the BVECM, over the forecasting horizon of 2001:1 to 2003:4, is compared with those generated from the Classical variant of the VAR and the VECM, the Bayesian VAR, and the ECM of inventory investment developed by Smith et al. (2006) for the South African economy. The BVECM with the most tight prior outperforms all the other models, except for a relatively tight BVAR. This BVAR model also correctly predicts the direction of change of inventory investment over the period of 2004:1 to 2006:3.
    Keywords: VECM and BVECM, VAR and BVAR Model, Forecast Accuracy, BVECM Forecasts, VECM Forecasts, BVAR Forecasts, ECM Forecasts, VAR Forecasts
    JEL: E17 E27 E37 E47
    Date: 2007–02
  29. By: Konstantinos Angelopoulos; George Economides
    Abstract: We construct a general equilibrium model of economic growth and optimally chosen fiscal policy, in which individuals compete with each other for a share of government spending and two political parties can alternate in power according to an exogenous reelection probability. The main prediction is that uncertainty about remaining in power results in increased fiscal spending, which in turn distorts incentives by pushing individuals away from productive work to rent-seeking activities; then distorted incentives hurt growth. This receives empirical support in a dataset of 25 OECD countries over the period 1982-1996. In particular, electoral uncertainty leads to larger government consumption shares in GDP, which in turn exert an adverse effect on the ICRG index measuring incentives and this is bad for growth. Actually, estimation by IV methods and confidence intervals that are robust to (potentially) weak instruments, reveal that OLS under-estimates the effects of government spending on rent extraction activities and of such activities on economic growth.
    Keywords: Fiscal policy; rent seeking; economic growth; elections.
    JEL: O43 E62 D72
    Date: 2007–09
  30. By: Albert Makochekanwa (Department of Economics, University of Pretoria)
    Abstract: The research attempts to empirically study the demand for money, especially the magnitudes of the price expectation and real cash balance adjustment for Zimbabwe. Price expectation and real cash balance adjustment models are estimated. The results show that both the interest rate and the rate of change in prices are relevant variables for explaining the variations in the demand for real cash balances in Zimbabwe. Overall, the findings suggest that the Zimbabwean hyperinflation does not appear to have been a self- generating process independent of money supply.
    Keywords: Hyperinflation, Real Cash Balances, Price Expectation, Equilibrium, Error Correction Model
    JEL: E41 P24 E51
    Date: 2007–07
  31. By: Kilian, Lutz
    Abstract: Large fluctuations in energy prices have been a distinguishing characteristic of the U.S. economy since the 1970s. Turmoil in the Middle East, rising energy prices in the U.S. and evidence of global warming recently have reignited interest in the link between energy prices and economic performance. This paper addresses a number of the key issues in this debate: What are energy price shocks and where do they come from? How responsive is energy demand to changes in energy prices? How do consumers’ expenditure patterns evolve in response to energy price shocks? How do energy price shocks affect real output, inflation, stock markets and the balance-of-payments? Why do energy price increases seem to cause recessions, but energy price decreases do not seem to cause expansions? Why has there been a surge in gasoline prices in recent years? Why has this new energy price shock not caused a recession so far? Have the effects of energy price shocks waned since the 1980s and, if so, why? As the paper demonstrates, it is critical to account for the endogeneity of energy prices and to differentiate between the effects of demand and supply shocks in energy markets, when answering these questions.
    Keywords: Asymmetry; Causality; Channels of transmission; Crude oil; Elasticity; Gasoline; Price shocks; Propagation
    JEL: E21 Q43
    Date: 2007–11
  32. By: Alfred V. Guender (University of Canterbury); Oyvinn Rimer
    Abstract: This paper discusses the implementation of monetary policy in New Zealand and its flow-on effects on the 90-day bank bill rate over the 1999-2005 period. The effects of external factors are considered as well. Our findings indicate that the maturity spectrum ratio exerted a positive effect on the 90-day rate while the allotment ratio did not. This interest rate had a tendency to revert to the level set by its Australian counterpart. No such link exists between the NZ 90-day rate and the US 90-day rate. Neither the maturity spectrum nor the allotment ratio contributed to the volatility of the New Zealand 90-day rate.
    Keywords: 90-Day Bank Bill Rate; Open-Market Operations; Allotment Ratio; Maturity Spectrum Ratio; Foreign Interest Rate Linkage
    JEL: E5
    Date: 2007–10–29
  33. By: Juan A. Lafuente (Universitat Jaume I); Javier Ordoñez (Universitat Jaume I)
    Abstract: This paper deals with the time evolution of stock market integration around the introductionof the euro. In particular we test whether the degree of integration between the main eurozonecountries increased after European monetary union. The contribution of the paper to the extantliterature is twofold: a) first, we take into account the potential long-run equilibrium relationshipbetween stock indices allowing for structural changes in the cointegration space that might capturethe effect of the introduction of the euro, and b) we formally test the existence of greater financialintegration after European monetary union across the main member countries and between thesemembers and the UK. Empirical evidence reveal the existence of long-run equilibrium relationshipsbetween European stock markets even before the introduction of the euro. Our empirical findingssuggest that financial integration is not the direct consequence of the removal of exchange rate riskdue to currency unification. Rather, it arises as a result of macroeconomic convergence. This aspectis corroborated by the nature of the principal component structure of estimated conditionalcorrelations. Este trabajo analiza la evolución del grado de integración de los mercados bursátileseuropeos en torno a la introducción del euro. En particular se contrasta si el grado de integraciónentre los principales miembros de la Unión Europea y Monetaria se ha incrementado a partir de laintroducción del euro. La contribución del trabajo es doble: a) por un lado se tiene en cuenta laposible existencia de relaciones de cointegración entre los índices bursátiles, permitiendo laexistencia de cambios estructurales en el espacio de cointegración y b) se proporciona un contrasteformal para la hipótesis nula de mayor grado de integración después de la introducción de la monedacomún. La evidencia empírica revela la existencia de relaciones de equilibrio a largo plazo entre losmercados, incluso antes de la introducción del euro. Los resultados sugieren que la integraciónfinanciera no es el resultado de la adopción de la moneda común sino que es un proceso dinámicoque se ha visto fortalecido por la unificación de la moneda. Este aspecto es corroborado por lanaturaleza de la estructura de componentes principales que se obtiene a partir de la medida deintegración considerada.
    Keywords: cointegración, mercados financieros, Unión Europea y Monetaria, integración financiera dinámica cointegration, dynamic financial integration, stock markets, European Monetary Union.
    JEL: C32 E44 G15
    Date: 2007–10
  34. By: Salvador Ortigueira; Joana Pereira
    Abstract: We study optimal income taxation and public debt policy in a neoclassical economy populated by infinitely-lived households and a benevolent government. The government makes sequential decisions on the provision of a valued public good, on income taxation and the issue of public debt. We characterize and compute Markov-perfect optimal fiscal policy in this economy with two payoff-relevant state variables: physical capital and public debt. We find two stable, steady-state equilibria: one with no income taxation and positive government asset holdings, and another with positive taxation and public debt issuances. We prove that the two steady states are associated with different policy rules, which implies a multiplicity of (expectation-driven) Markov-perfect equilibria.
    Keywords: Optimal taxation; optimal public debt; Markov-perfect equilibrium; Time-consistent policy
    JEL: E61 E62 H21 H63
    Date: 2007
  35. By: Michael Ehrmann (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: Transparency has become an almost universal virtue among central banks. The paper tests empirically, for the case of the Federal Reserve, two hypotheses about central bank transparency derived from the debate of Morris and Shin (2002) and Svensson (2006). First, the paper finds that the precision of communication is a key determinant of the predictability of both FOMC decisions as well as the future policy path. Second, the effectiveness of communication is found to depend on the market environment. Specifically, a given statement may enhance predictability in an environment of high market uncertainty, but may reduce it when uncertainty is low. The findings underline the limits to transparency and stress the need for communication to be flexible and adjust to market conditions in order for central banks to achieve their ultimate objectives. JEL Classification: E52, E58, D82.
    Keywords: Communication, transparency, monetary policy, predictability, effectiveness, Federal Reserve.
    Date: 2007–10
  36. By: Juan Angel Garcia (European Central Bank,Capital Markets and Financial Structure Division, Kaiserstraße 29, 60311 Frankfurt, Germany.); Andres Manzanares (European Central Bank,Risk Management Division, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: We show that international consumption risk sharing is significantly improved by capital flows, especially portfolio investment. Concomitantly, we show that poor institutions hamper risk sharing, but to an extent that decreases with openness. In particular, risk sharing is prevalent even among economies with poor institutions, provided they are open to international markets. This is consistent with the view that the prospect of retaliation may deter expropriation of foreign capital, even in institutional environments where it is possible. This deterrent is anticipated by investors, who act to diversify risk. By contrast, capital flows headed for closed economies with poor institutions are designed and constrained so as to limit the cost incurred in case of expropriation, and thus achieve little risk sharing. Finally, we show this non-linearity continues to be present in the determinants of international capital flows themselves. Institutions are crucial in attracting capital for closed economies, but are barely relevant in open ones. JEL Classification: C16, C42, E31, E47.
    Keywords: Inflation risk, inflation expectations, Survey of Professional Forecasters (SPF), skew-normal distribution, power divergence estimators.
    Date: 2007–10
  37. By: Danthine, Jean-Pierre; Donaldson, John B
    Abstract: We study the dynamic general equilibrium of an economy where risk averse shareholders delegate the management of the firm to risk averse managers. The optimal contract has two main components: an incentive component corresponding to a non-tradable equity position and a variable 'salary' component indexed to the aggregate wage bill and to aggregate dividends. Tying a manager's compensation to the performance of her own firm ensures that her interests are aligned with the goals of firm owners and that maximizing the discounted sum of future dividends will be her objective. Linking managers' compensation to overall economic performance is also required to make sure that managers use the appropriate stochastic discount factor to value those future dividends.
    Keywords: incentives; optimal contracting; stochastic discount factor
    JEL: E32 E44
    Date: 2007–11
  38. By: Pierre L. Siklos (Wilfrid Laurier University and Viessmann Research Centre Waterloo, Canada and The Rimini Centre for Economics Analysis, Italy.)
    Abstract: A notable feature of the 1920s and 1930s is the volatility in several key macroeconomic aggregates, and this feature used to econometrically identify the reaction of the Fed to stock market developments. The volatility of economic activity may have contributed to deepening the divisions among policy-makers about how the Fed ought to respond to stock price developments. Relying on the technique of Rigobon (2003), volatility is used as an instrument to estimate the FedÕs response to the stock market. Other identification assumptions based on structural VARs produce compatible results. Fed behavior appeared to have changed following the stock market crash of 1929. Consistent with the Riefler-Burgess doctrine, interest rates and stock returns are negatively related. I conclude that, prior to the stock market crash of 1929, a form of benign neglect explains Fed behavior. Thereafter, the Fed reacts only slightly more aggressively to stock market developments.
    JEL: E52 E58 C32 C52
    Date: 2007–07
  39. By: Toan Nguyen (Room 1, Engineering Building No. 4, Yoshida Honmachi, Sakyo-ku, Kyoto,Japan)
    Abstract: We investigate the determinants of business cycle synchronization in East Asia by testing the robustness of the potential candidates, using the technique of Extreme Bound Analysis in an OLS regression framework with Newey-West correction for heteroskedasticity and autocorrelation. We find that trade openness and intra-industry trade are major channels of business cycle synchronization. Although the similarity of monetary policies is statistically correlated with degree synchronization, we are unsure whether the former causes the latter or vise versa. The findings are probably good news to the proponents of the prospective currency union. If the trend of increasing openness and bilateral intra-industry trade continues in East Asia, it is expected that the costs of forming a currency union would diminish as business cycles become more synchronized.
    Keywords: Business Cycle Synchronization; East Asia; Extreme Bound Analysis; Currency Union
    Date: 2007–10
  40. By: Jeremy Greenwood; Karen A. Kopecky
    Abstract: The welfare gain to consumers from the introduction of personal computers is estimated here. A simple model of consumer demand is formulated that uses a slightly modified version of standard preferences. The modification permits marginal utility, and hence total utility, to be finite when the consumption of computers is zero. This implies that the good won't be consumed at a high enough price. It also bounds the consumer surplus derived from the product. The model is calibrated/estimated using standard national income and product account data. The welfare gain from the introduction of personal computers is about 4 percent of consumption expenditure.
    JEL: E01 E21 O33 O47
    Date: 2007–11
  41. By: Selva Demiralp (Department of Economics, Koç University); Erhan Artuç (Department of Economics, Koç University)
    Abstract: In January 2003, the Federal Reserve introduced primary credit as its main discount window lending program. The primary credit program replaced the adjustment credit program, which, subject to a number of restrictions, had generated a stigma associated with borrowing from the Fed. Eliminating or lessening the stigma of borrowing was viewed as essential for reducing the reluctance to borrow and strengthening the traditional role of the discount window as a safety valve when reserve markets tighten unexpectedly. In this paper we estimate the borrowing function prior to and after the introduction of the new facility and develop a daily model of borrowing. Using this model, we estimate the implicit cost associated with borrowing for the first time in the literature via “indirect inference” a la Gourieroux, Monfort and Renault (1993). Our results suggest that the stigma associated with borrowing from the Fed is significantly reduced in the post 2003 period.
    Keywords: Discount Window, Primary Credit, Federal Funds Market
    JEL: E40 E58
    Date: 2007–10
  42. By: Konstantinos Angelopoulos; Apostolis Philippopoulos; Efthymios Tsionas
    Abstract: This paper revisits the relationship between fiscal size and economic growth. Our work differs from the empirical growth literature because this relationship depends explicitly on the efficiency of the public sector. We use a sample of 64 countries, both developed and developing, in four 5-year time-periods over 1980-2000. Building on the work of Afonso, Schuknecht and Tanzi (2005), we construct a measure of public sector efficiency in each country and each time-period by calculating an output to input ratio. In addition, we get an estimate of technical efficiency of public spending for 52 countries for the time-period 1995-2000 by employing a stochastic frontier analysis. Using these two measures, we find evidence of a non-monotonic relation between fiscal size and economic growth that depends critically on government efficiency.
    Keywords: Fiscal policy, government efficiency, growth
    JEL: H1 E6
    Date: 2007–09
  43. By: Roger Guesnerie; Pedro Jara-Moroni
    Abstract: We consider an economic model that features: 1. a continuum of agents 2. an aggregate state of the world over which agents have an infinitesimal influence. We first propose a review, based on work by Jara (2007), of the connections between the eductive viewpoint that puts emphasis on "Strongly Rational Expectations equilibrium" and the standard game-theoretical rationalizability concepts. We explore the scope and limits of this connection depending on whether standard rationalizability versus point-rationalizability, or the local versus the global viewpoint, are concerned. In particular, we define and characterize the set of "Point-Rationalizable States" and prove its convexity. Also, we clarify the role of the heterogeneity of beliefs in general contexts of expectational coordination (see Evans and Guesnerie, 2005). Then, as in the case of strategic complementarities the study of some best response mapping is a key to the analysis, in the case of "unambiguous" strategic substitutabilities the study of some second iterate, and of the corresponding two-period cycles, allows to describe the point-rationalizable states. We provide application in microeconomic and macroeconomic contexts.
    Date: 2007
  44. By: Alberto Chong (Inter-American Development Bank); Mark Gradstein (Ben Gurion University)
    Abstract: This paper studies the joint effect of economic and political inequalities on redistributive taxation and institutional quality. The theoretical model suggests that income inequality, coupled with political bias in favor of the rich, decreases redistribution and lowers institutional quality. The effect of the former is to increase productive investment, and the effect of the latter is to decrease it—with resulting ambiguous implications for economic growth. Testing these predictions empirically in a panel of countries, the paper finds that inequality has a negative effect on both institutional quality and redistribution, especially in non-democratic countries.
    Keywords: Inequality, institutions, redistribution
    JEL: D31 D90 E62 H11 O11
    Date: 2007–10
  45. By: John A. Maluccio
    Date: 2007
  46. By: Charles W. Calomiris
    Abstract: Bank failures during banking crises, in theory, can result either from unwarranted depositor withdrawals during events characterized by contagion or panic, or as the result of fundamental bank insolvency. Various views of contagion are described and compared to historical evidence from banking crises, with special emphasis on the U.S. experience during and prior to the Great Depression. Panics or "contagion" played a small role in bank failure, during or before the Great Depression-era distress. Ironically, the government safety net, which was designed to forestall the (overestimated) risks of contagion, seems to have become the primary source of systemic instability in banking in the current era.
    JEL: E5 G2 N2
    Date: 2007–11
  47. By: Anne Marie Gleeson (Trinity College Dublin); Frances Ruane (Economic and Social Research Institute (ESRI))
    Abstract: Recent economic literature suggests the importance of sunk costs and hysteresis in explaining export patterns in international trade. To explore their empirical importance, we present a new conceptual framework that distinguishes six different types of exporter behaviour, and apply this framework to a unique longitudinal data set on Irish manufacturing. Our analysis allows us to identify significant numbers of manufacturers who engage in ‘exporter re-switching behaviour’. The magnitude of these numbers leads us to question the widespread importance of sunk costs. In response to export-market shocks, we find strong evidence of both heterogeneous exporter responses and hysteresis.
    Keywords: heterogeneous exporters, sunk costs, re-switching behaviour
    JEL: E32 F14
    Date: 2007–07
  48. By: Sumru G. Altuğ (Department of Economics, Koç University; Center for Economic Policy Research, London.); Fanny S. Demers; Michel Demers
    Abstract: The objective of this paper is twofold. First, we develop a theoretical model to investigate the impact of political risk on irreversible investment. Second, we apply our model to an analysis of the effects of risk of separation of the province of Quebec from the Canadian federation. We model the probability of a regime switch using the properties of the electoral process and examine the response of investment to changes in the risk of separation. We consider the impact of investors’ perception of the risk of separation and financial market volatility separately. We show that political risk has a depressing impact on investment even if the "bad" regime has never been observed in the sample.
    Keywords: Irreversible investment, political risk, regime shifts, Quebec investment, Canada
    JEL: E22 D92 O16 O11
    Date: 2007–05
  49. By: Benjamin Eden (Department of Economics, Vanderbilt University)
    Abstract: I use price dispersion to model liquidity. Buyers may be rationed at the low price. An asset is more liquid if it is used relatively more in low price transactions and the probability that it will buy at the low price is relatively high. In the equilibrium of interest government bonds are more liquid than stocks. Agents with a relatively stable demand are willing to pay a high "liquidity premium" for holding bonds and they specialize in bonds. In equilibrium only a fraction of households (those with relatively unstable demand) hold stocks and the equity premium may be large.
    Keywords: Liquidity, sequential trade, equity premium puzzle, participation puzzle <br><br>
    JEL: E42 G12
    Date: 2007–09
  50. By: Edward J. Kane
    Abstract: National safety nets are imbedded in country-specific regulatory cultures that encompass contradictory goals of nationalistic welfare maximization, merciful treatment of distressed institutions, and bureaucratic blame avoidance. Focusing on this goal conflict, this paper develops two hypotheses. First, in times of financial-sector stress, political pressure is bound to increase the incentive force of the second and third goals at the expense of the first. Second, gaps and distortions in cross-country connections between national safety nets require improvisational responses from de facto hegemonic regulators. Reinforced by reputational concerns, the hegemons' goal conflicts dispose them to react to cross-country evidence of incipient financial-institution insolvencies in short-sighted ways. During the commercial-paper and interbank turmoil of summer 2007, de facto hegemons used repurchase agreements to transfer taxpayer funds -- implicitly but in large measure -- to several of the particular institutions whose imprudence in originating, pricing, and securitizing poorly underwritten loans led to the turmoil in the first place. The precedent established by these transfers promises to exacerbate the depth, breadth, and duration of future instances of financial-institution insolvency by confirming that institutions that underinvest in due diligence can expect taxpayers to protect them from much of the adverse consequences.
    JEL: E58 F33 G21 G28
    Date: 2007–11
  51. By: Pablo Martin Aceña
    Abstract: The paper explores the similiraties and differences between the origin, behavior and evolution of the central banks of Portugal and Spain. Portugal and Spain are two countries that share the same peninsular space in the west corner of Europe. Though different in size and population, the political, social and economic history of both nations offer more similarities than differences. In the financial sphere, he resemblances are remarkable. Both nations exhibit very low levels of financial intermediation, as measured by the ratio between total bank deposits and GDP. Another common feature of both Iberian nations is the dominance exerted by a sole institution. However, we also find some divergences between the financial structures of the two countries that are worth noting. Three differences merit our particular attention in this paper. The first diversity refers to the distinct composition of the quantity of money. The monetary regime is the second difference between the two countries (Portugal joined the gold standard while Spain remained off the gold standard). Finally, the Bank of Portugal and the Bank of Spain exhibit also significant contrasts in their behavior as central banks.
    Date: 2007–10
  52. By: Albert H. De Wet (First Rand Bank); Reneé Van Eyden (Department of Economics, University of Pretoria)
    Abstract: Driven by intense competition for market share banks across the globe have increasingly allowed credit portfolios to become less diversified (across all dimensions - country, industry, sector and size) and were willing to accept lesser quality assets on their books. As a result, even well capitalised banks could come under severe solvency pressure when global economic conditions turn. The banking industry have realised the need for more sophisticated loan origination, credit and capital management practices. To this end, the reforms introduced by the Bank of International Settlement through the New Basel Accord (Basel II) aim to include exposure specific credit risk characteristics within the regulatory capital requirement framework. The new regulatory capital framework still does not allow diversification and concentration risk to be fully recognised within the credit portfolio because it does not account for systematic and idiosyncratic risk in a multifactor framework. The core principle for addressing practical questions in credit portfolio management is enclosed in the ability to link the cyclical or systematic components of firm credit risk with the firm’s own idiosyncratic credit risk as well as the systematic credit risk component of every other exposure in the portfolio. Simple structural credit portfolio management approaches have opted to represent the general economy or systematic risk by a single risk factor. The systematic component of all exposures, the process generating asset values and therefore the default thresholds are homogeneous across all firms. Indeed, this Asymptotic Single Risk Factor (ASRF) model has been the foundation for Basel II. While the ASRF framework is appealing due to its analytical closed-form properties for regulatory and generally universal application in large portfolios, the single risk factor characteristic is also its major drawback. Essentially it does not allow for enough flexibility in answering real life questions. Commercially available credit portfolio models make an effort to address this by introducing more systematic factors in the asset value generating process but from a practitioner’s point of view, these models are often a “black-box” allowing little economic meaning or inference to be attributed to systematic factors. The methodology proposed by Pesaran, Schuermann, and Weiner (2004) and supplemented by Pesaran, Schuermann, Treutler and Weiner (2006) has made a significant advance in credit risk modelling in that it avoids the use of proprietary balance sheet and distance to default data, focussing on credit ratings which are more freely available. Linking an adjusted structural default model to a structural global econometric model (GVAR) credit risk analysis and portfolio management can be done through the use of a conditional loss distribution estimation and simulation process. The GVAR model used in Pesaran et al. (2004) comprises a total of 25 countries which is grouped into 11 regions and accounts for 80 per cent of world production. In the case of South Africa the GVAR model lacks applicability since it does not include an African component. In this paper we construct a country specific macro-econometric risk driver engine which is compatible with and could feed into the GVAR model and framework of PSW (2004) using vector error correcting (VECM) techniques. This will allow conditional loss estimation of a South African specific credit portfolio but also opens the door for credit portfolio modelling on a global scale as such a model can easily be linked into the GVAR model. We extend the set of domestic factors beyond those used in PSW (2004) in such a way that the risk driver model is applicable for both retail and corporate credit risk. As such, the model can be applied to a total bank balance sheet, incorporating the correlation and diversification between both retail and corporate credit exposures. Assuming statistical over-identification restrictions, our results indicate that it is possible to construct a South African component for the GVAR model and that such a component could easily be integrated into a global content. From a practical application perspective the framework and model is particularly appealing since it could be used as a theoretically consistent correlation model within a South African specific credit portfolio management tool.
    Keywords: Credit portfolio management, multifactor model, vector error correction model (VECM), credit correlations
    JEL: C32 C51 E44
    Date: 2007–09
  53. By: Chung Tran (Indiana University Bloomington); Juergen Jung (Indiana University Bloomington)
    Abstract: We investigate the effects of extending the coverage of social security to uncovered elderly individuals in the informal sector in developing countries. We use a stochastic overlapping generations framework and incorporate important characteristics of developing countries including family transfers and a sizeable informal sector. Our calibrated model predicts that the introduction of a moderately sized social assistance program decreases steady state output by up to 3.25% and labor supply by up to 2.5%. In contrast to literature focusing on developed countries, the model predicts that extending the coverage of the social security system results in welfare gains for low income households. This result indicates that the insurance function and the redistribution function of the social assistance program dominate the distortionary effects in an environment without adequate risk sharing mechanisms and high inequality.
    Keywords: Social Security Reform, Altruism, Informal Sector, Private Transfers, Savings, Labor Supply and Welfare
    JEL: E6 E21 E26 H30 H53 H55 I38 O17
    Date: 2007–11
  54. By: Pham Quang Ngoc (Development and Policies Research Center, 216 Tran Quang Khai Street, Hanoi,Vietnam); Bui Trinh (Vietnam General Statistical Office - Ministry of Planning and Investment, Vietnam); Thanh Duc Nguyen (National Graduate Institute for Policy Studies (GRIPS), Tokyo, Japan)
    Abstract: This study provides a concise introduction to the economic history of Vietnam from 1976 to present. We identify different phases of the development of the Vietnamese economy, from its unification after a Vietnam war to the current phases of the transition (1989-2000) and propose a specific pattern of transition in the case of Vietnam. This research is the first attempt to make a synthesis quantitative analysis of socio-economic aggregate data during different phases of the Vietnamese economy in 1986-2000, in which different national input-output tables (1989, 1996 and 2000) in constant prices have been employed. The economic performances are investigated from three aspects: (i) evolution of domestic final demand; (ii) evolution of international trade structure and (iii) the technological change. The analysis shows economic history of Vietnam from 1986 up to present as a continuous evolutionary process and integration in to the international market is inevitable. Government programmes only played a vital role of accommodator to the economic changes of the Vietnamese economy.
    Keywords: Input-output analysis, Vietnamese economy, Economic history, Transition economy, Macro-economic policy
    JEL: C67 N15 P27 E60
    Date: 2007–06
  55. By: Albert Makochekanwa (Department of Economics, University of Pretoria)
    Abstract: The purpose of this study is to determine the causes of hyperinflation in Zimbabwe for the period February 1999 to December 2006 using appropriate econometric techniques. Results from long run and shot run econometric models shows money supply, black market for foreign exchange (US$) and lagged values of hyperinflation to be positively correlated with the country’s hyperinflation trend. This result accords well with the various theories of hyperinflation. Surprisingly, political rights index as a determinant is negatively associated with hyperinflation, suggesting that an increase in this variable reduces hyperinflation. This is against economic theory, which expects a positive sign for this, variable. Granger causality test is also conducted between money supply and hyperinflation to empirically test the direction of causality, while sensitivity tests are done to infer the effect of money supply shock on hyperinflation trend.
    Date: 2007–07
  56. By: Raouf Boucekkine; B. Martínez; J. R. Ruiz-Tamarit
    Abstract: In the traditional literature on the Lucas-Uzawa model, it is proved that in the neighborhood of the long-run balanced growth path, human capital stock grows at a rate greater than its long-run counterpart when the ratio physical to human capi- tal is above its long run value if and only if the capital share in the production of physical good is lower than the inverse of the elasticity of intertemporal substitution in consumption. We first prove that the claim is true outside the neighborhood of balanced growth paths. More importantly, we identify a crucial asymmetry: what- ever the position of the capital share with respect to the inverse of the elasticity of intertemporal substitution, physical capital stock always grows at a rate lower than its long-run counterpart when the ratio physical to human capital is above its long run value.
    Keywords: Lucas-Uzawa, hypergeometric functions, imbalance e®ects, global dynamics.
    JEL: E20 O40 C60
    Date: 2007–09
  57. By: Jochen Hartwig (KOF Swiss Economic Institute, ETH Zurich)
    Abstract: In a recent paper I argued that Baumol’s (1967) model of ‘unbalanced growth’ offers a ready explanation for the observed secular rise in health care expenditure (HCE) in rich countries (HARTWIG 2006). Baumol’s model implies that HCE is driven by wage increases in excess of productivity growth. I tested this hypothesis empirically using data from a panel of 19 OECD countries and found robust evidence in favor of Baumol’s theory. An alternative way to test Baumol’s theory is to check whether its implication that variations in the relative price of medical care contribute significantly to explaining variations in health expenditure in the same direction has an empirical grounding. Earlier studies, although mostly not in an explicit attempt to test Baumol’s theory, have occasionally rejected this hypothesis. Despite poor data quality of the available medical price indices, I perform the alternative test using data for nine OECD countries. My findings suggest that the relative price of medical care is in fact a statistically significant explanatory variable for health expenditure, thus lending support to Baumol’s theory.
    Keywords: Rising health expenditure, ‘unbalanced growth’, medical care prices, OECD panel
    JEL: C12 C23 E31 I10 O41
    Date: 2007–11

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