nep-mac New Economics Papers
on Macroeconomics
Issue of 2008‒07‒14
forty-five papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Money in the Inflation Equation: the Euro Area Evidence By Fourçans, André; Vranceanu, Radu
  2. Inflation Target Shocks and Monetary Policy Inertia in the Euro Area By FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
  3. Estimating open economy Phillips curves for the euro area with directly measured expectations By Paloviita, Maritta
  4. Optimal monetary and fiscal policies in a search theoretic model of monetary exchange By Pere Gomis-Porqueras; Adrian Peralta-Alva
  5. Monetary Persistence and the Labor Market: A New Perspective By Lechthaler, Wolfgang; Merkl, Christian; Snower, Dennis J.
  6. Are long-run inflation expectations anchored more firmly in the Euro area than in the United States? By Meredith J. Beechey; Benjamin K. Johannsen; Andrew T. Levin
  7. Inflation dynamics with search frictions : a structural econometric analysis By Michael U. Krause; Thomas A. Lubik; David López-Salido
  8. Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia By Kajuth, Florian; Watzka, Sebastian
  9. Reconsideration of the P-Bar Model of Gradual Price Adjustment By Bennett T. McCallum
  10. Roles of Fiscal Policy in New Zealand By Felicity C Barker; Robert A Buckle; Robert W St Clair
  11. Managing Disinflation under Uncertainty By Mewael F. Tesfaselassie; Eric Schaling
  12. The Implementation of Monetary Policy in Canada By Walter Engert, Toni Gravelle, and Donna Howard
  13. "The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus" By James K. Galbraith
  14. Real interest rate persistence: evidence and implications By Christopher J. Neely; David E. Rapach
  15. On the Sources of the Great Moderation By Jordi Gali; Luca Gambetti
  16. "The Return of Fiscal Policy Can the New Developments in the New Economic Consensus Be Reconciled with the Post-Keynesian View?" By Pavlina R. Tcherneva
  17. "Capital Structure Over The Business Cycle" By David Amdur
  18. Term premiums and inflation uncertainty: empirical evidence from an international panel dataset By Jonathan H. Wright
  19. Automatic Stabilisation, Discretionary Policy and the Stability Pac By Jerome Creel; Francesco Saraceno
  20. Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices By Stefania D'Amico; Don H. Kim; Min Wei
  21. Short and long run causality measures: theory and inference By Jean-Marie Dufour; Abderrahim Taamouti
  22. Updating empirical evidence on business cycles synchronization between CEECs and the euro area : How important is the recent period By Sandrine Levasseur
  23. A Comparison of Debt and Primary-deficit Constraints By Beetsma, Roel; Ribeiro, Marcos Poplawski; Schabert, Andreas
  24. Asset Prices and Assymetries in the Fed's Interest Rate Rule : a Financial Approach By Romaniuk, Katarzyna; Vranceanu, Radu
  25. Stress Testing of Probability of Default of Individuals By Petr Kadeřábek; Aleš Slabý; Josef Vodička
  26. Regional development and monetary policy : a review of the role of monetary unions, capital mobility and locational effects By Ridhwan, M.M.; Nijkampa, P.; Rietveld, P.
  27. A Univariate Model of Aggregate Labour Productivity By Robert Dixon; G. C. Lim
  28. "The Keynesian Roots of Stock-flow Consistent Macroeconomic Models Peering Over the Edge of the Short Period" By Antonio Carlos Macedo e Silva; Claudio H. Dos Santos
  29. Trade and quality: theoretical and empirical evidence for the euro zone By Massimiliano Serati
  30. Measuring Sustainability with Macroeconomic Data for India By Purnamita Dasgupta; Shikha Gupta
  31. Informality and Macroeconomic Fluctuations By Fiess, Norbert M.; Fugazza, Marco; Maloney, William F.
  32. Determinacy, Learnability, and Plausibility in Monetary Policy Analysis: Additional Results By Bennett T. McCallum
  33. A macroeconomic analysis of obesity By Pere Gomis-Porqueras; Adrian Peralta-Alva
  34. Lifecycle dynamics of income uncertainty and consumption By James Feigenbaum; Geng Li
  35. Uncertainty and the Politics of Employment Protection By Vindigni, Andrea
  36. Speculative growth and overreaction to technology shocks By Kevin J. Lansing
  37. The Nature of Occupational Unemployment Rates in the United States: Hysteresis or Structural? By Candelon, Bertrand; Dupuy, Arnaud; Gil-Alana, Luis A.
  38. Complexity and Macro Pedagogy: The Complexity Vision as a Bridge between Graduate and Undergraduate Macro By David Colander; Casey Rothschild
  39. Edgeworth Cycles Revisited By Joseph J. Doyle, Jr.; Erich Muehlegger; Krislert Samphantharak
  40. Return to fundamentals: perpetuities, common wisdom and the use of the gordon constant growth model By Ignacio Velez-Pareja
  41. Starting small and ending big -- the effect of monetary incentives on response rates in the 2003 Survey of Small Business Finances: an observational experiment By Traci L. Mach; Lieu N. Hazelwood; John D. Wolken
  42. Cyclical Movements in Unemployment and Informality in Developing Countries By Bosch, Mariano; Maloney, William F.
  43. Ownership concentration and market discipline in European banking: Good monitoring but bad influence? By Tristan AUVRAY (LEREPS-GRES); Olivier BROSSARD (LEREPS-GRES)
  44. Outsourcing and Labor Taxation in Dual Labor Markets By Koskela, Erkki; Poutvaara, Panu
  45. Good Governance and Good Aid Allocation By Epstein, Gil S.; Gang, Ira N.

  1. By: Fourçans, André (ESSEC Business School); Vranceanu, Radu (ESSEC Business School)
    Abstract: The ECB is the only major central bank that still emphasizes the role of money in monetary policy management. In this paper, we bring some support to this approach. Taking into account Euro area data from the period between 1999 and 2007, we demonstrate that a steady 10 per cent increase in M3 may result in an inflation rate of approximately 2½ percentage points. A negative output gap would have a short term offsetting effect, and vice versa.
    Keywords: ECB; Inflation; Monetary Policy; Money
    JEL: E31 E51 E58
    Date: 2008–05
  2. By: FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
    Date: 2008–06
  3. By: Paloviita, Maritta (Bank of Finland Research)
    Abstract: This paper examines euro area inflation dynamics by estimating open economy New Keynesian Phillips curves based on the assumption that all imports are intermediate goods. Instead of imposing rational expectations a priori, Consensus Economics survey data and OECD inflation forecasts are used to proxy inflation expectations. The results suggest that, compared with a closed economy New Keynesian Phillips curve, euro area inflation dynamics are better captured by the open economy specification. Moreover, in the open economy context, and even if we allow for persistence in expectations, the hybrid specification of the New Keynesian Phillips curve is needed in order to capture the euro area inflation process properly. We also provide some evidence that in recent years of low and stable inflation, euro area inflation dynamics have become more forward-looking and the link between inflation and domestic demand has weakened (ie the euro area Phillips curve has flattened). On the other hand, in low-inflation euro area countries the inflation process seems to have been more forward-looking already since the early 1980s.
    Keywords: New Keynesian Phillips curve; open economy; expectations; euro area
    JEL: C52 E31 F41
    Date: 2008–06–25
  4. By: Pere Gomis-Porqueras; Adrian Peralta-Alva
    Abstract: In this paper we study optimal monetary and fiscal policies, and the welfare costs of inflation, within the Lagos and Wright (2005) framework. Monetary equilibria may be inefficient without fiscal policy tools due to bargaining frictions. We show that subsidies in decentralized markets can be implemented to alleviate underproduction, while money is still essential. Deviations from the Friedman rule may be large, and having fiscal and monetary policies in place results in considerable welfare gains. When fiscal policies are held constant, the welfare costs of increasing inflation may be as high as 8% of lifetime consumption. When lump sum monetary transfers are not available, a positive production subsidy may be inflationary and welfare reducing. However, sales taxes in the decentralized market and production taxes in the centralized market may increase welfare. The optimality of the Friedman rule in this case depends crucially on the bargaining power of the buyer, and equilibria are not first best.
    Keywords: Monetary policy ; Fiscal policy
    Date: 2008
  5. By: Lechthaler, Wolfgang (Kiel Institute for the World Economy); Merkl, Christian (Kiel Institute for the World Economy); Snower, Dennis J. (Kiel Institute for the World Economy)
    Abstract: It is common knowledge that the standard New Keynesian model is not able to generate a persistent response in output to temporary monetary shocks. We show that this shortcoming can be remedied in a simple and intuitively appealing way through the introduction of labor turnover costs (such as hiring and firing costs). Assuming that it is costly to hire and fire workers implies that the employment rate is slow to converge to its steady state value after a monetary shock. The after-effects of a shock continue to exert an effect on the labor market even long after the shock is over. The sluggishness of the labor market translates to the product market and thus the output effects of the monetary shock become more persistent. Under reasonable calibrations our model generates hump-shaped output responses. In addition, it is able to replicate the Beveridge curve relationship and a negative correlation between job creation and job destruction.
    Keywords: monetary persistence, labor market, hiring and firing costs
    JEL: E24 E32 E52 J23
    Date: 2008–05
  6. By: Meredith J. Beechey; Benjamin K. Johannsen; Andrew T. Levin
    Abstract: This paper compares the recent evolution of long-run inflation expectations in the euro area and the United States, using evidence from financial markets and surveys of professional forecasters. Survey data indicate that long-run inflation expectations are reasonably well-anchored in both economies, but also reveal substantially greater dispersion across forecasters' long-horizon projections of U.S. inflation. Daily data on inflation swaps and nominal-indexed bond spreads--which gauge compensation for expected inflation and inflation risk--also suggest that long-run inflation expectations are more firmly anchored in the euro area than in the United States. In particular, surprises in macroeconomic data releases have significant effects on U.S. forward inflation compensation, even at long horizons, whereas macroeconomic news only influences euro area inflation compensation at short horizons.
    Date: 2008
  7. By: Michael U. Krause; Thomas A. Lubik; David López-Salido
    Abstract: The New Keynesian Phillips curve explains inflation dynamics as being driven by current and expected future real marginal costs. In competitive labor markets, the labor share can serve as a proxy for the latter. In this paper, we study the role of real marginal cost components implied by search frictions in the labor market. We construct a measure of real marginal costs by using newly available labor market data on worker finding rates. Over the business cycle, the measure is highly correlated with the labor share. Estimates of the Phillips curve using GMM reveal that the marginal cost measure remains significant, and that inflation dynamics are mainly driven by the forward-looking component. Bayesian estimation of the full new Keynesian model with search frictions helps us disentangle which shocks are driving the economy to generate the observed unit labor cost dynamics. We find that mark-up shocks are the dominant force in labor market fluctuations.
    Keywords: Inflation (Finance)
    Date: 2008
  8. By: Kajuth, Florian; Watzka, Sebastian
    Abstract: We provide a critical assessment of the method used by the Cleveland Fed to correct expected inflation derived from index-linked bonds for liquidity and inflation risk premia and show how their method can be adapted to account for time-varying inflation risk premia. Furthermore, we show how sensitive the Cleveland Fed approach is to different measures of the liquidity premium. In addition we propose an alternative approach to decompose the bias in inflation expectations derived from index-linked bonds using a state-space estimation. Our results show that once one accounts for time-varying liquidity and inflation risk premia current 10-year U.S. inflation expectations are lower than estimated by the Cleveland Fed.
    Keywords: Inflation expectations; liquidity risk premium; inflation risk premium; treasury inflation-protected securities (TIPS); state-space model
    JEL: E31 E52 G12
    Date: 2008–07–10
  9. By: Bennett T. McCallum
    Abstract: This paper compares the P-bar model of price adjustment with the currently dominant Calvo specification. Theoretically, the P-bar model is more attractive as it depends upon adjustment costs for physical quantities rather than nominal prices, while incorporating a one-period information lag. Furthermore, the resulting adjustment relation is more completely free of "money illusion," in terms of dynamic relationships, and therefore satisfies the natural rate hypothesis of Lucas (1972), which is not satisfied by the Calvo model in any of its variants. Along the way, it shows that both the P-bar and Calvo models can be formulated in distinct versions in which current real wages are, or are not, allocative. Quantitatively, for a given calibration of the demand parameters, the implied time series properties of the inflation rate, output gap, and nominal interest rate are determined for various policy parameters, and are compared with quarterly data for the U.S. economy. Neither model dominates but, overall, the comparison seems somewhat more favorable to the P-bar model and certainly does not provide support for the dominant position held by the Calvo model in current monetary policy analysis.
    JEL: E30 E52
    Date: 2008–07
  10. By: Felicity C Barker; Robert A Buckle; Robert W St Clair (The Treasury)
    Abstract: Economic growth is one of the objectives of the current government. Fiscal policy, encompassing government expenditure and taxation decisions, can significantly impact on economic growth. This paper proposes a framework which views fiscal policy through three lenses and applies this approach to consider how fiscal policy affects economic growth. The three lenses are: fiscal sustainability, fiscal structure and fiscal stabilisation. The paper reviews international literature pertaining to these three lenses and discusses the extent to which these lenses are incorporated into New Zealand’s current fiscal framework. Contemporary New Zealand fiscal challenges are discussed and, in light of these challenges, the paper concludes with consideration of areas to investigate which may yield improvements to the New Zealand fiscal framework.
    Keywords: Fiscal policy, sustainability, stability, structure, taxation, government spending, economic growth
    JEL: E6 E61 E62 E63
    Date: 2008–06
  11. By: Mewael F. Tesfaselassie; Eric Schaling
    Abstract: In this paper we analyze disinflation policy when a central bank has imperfect information about private sector inflation expectations but learns about them from economic outcomes, which are in part the result of the disinflation policy. The form of uncertainty is manifested as uncertainty about the effect of past disinflation policy on current output gap. Thus current as well as past policy actions matter for output gap determination. We derive the optimal policy under learning (DOP) and compare it two limiting cases---certainty equivalence policy (CEP) and cautionary policy (CP). It turns out that under the DOP inflation stay between the levels implied by the CEP and the CP. A novel result is that this holds irrespective of the initial level of inflation. Moreover, while at high levels of inherited inflation the DOP moves closer to the CEP, at low levels of inherited inflation the DOP resembles the CP
    Keywords: Learning, Inflation Expectations, Disinflation Policy, Separation Principle, Kalman Filter, Optimal Control
    JEL: C53 E42 E52 F33
    Date: 2008–06
  12. By: Walter Engert, Toni Gravelle, and Donna Howard
    Abstract: The authors present a detailed discussion of the Bank of Canada's framework for the implementation of monetary policy. As background, they provide a brief overview of the financial system in Canada, including a discussion of the financial services industry and the money market. Key features of the large-value payments system, which is integral to the implementation of monetary policy, are also explained. The authors then discuss in some detail the operating framework for the implementation of monetary policy. An assessment of the effectiveness of the Bank of Canada's framework is also provided, including an analysis of monetary policy implementation in the period of financial market stress beginning in August 2007.
    Keywords: Financial institutions; Financial markets; Monetary policy implementation; Payment, clearing, and settlement systems
    JEL: E52 E58 G21
    Date: 2008
  13. By: James K. Galbraith
    Abstract: What in monetarism, and what in the "new monetary consensus," led to a correct or even remotely relevant anticipation of the extraordinary financial crisis that broke over the housing sector, the banking system, and the world economy in August 2007 and that has continued to preoccupy central bankers ever since? Absolutely nothing, says Senior Scholar James K. Galbraith. In this new Policy Note, Galbraith reevaluates monetary policy in light of the collateral damages inflicted by the subprime mortgage crisis. He provides a critique of monetarism--what Milton Friedman famously defined as the proposition that "inflation is everywhere and always a monetary phenomenon"--and of the "new monetary consensus" on which Federal Reserve Chairman Ben Bernanke's ostensible doctrine of inflation targeting rests. Given the current economic crisis, Galbraith says, the Fed would do well to embrace the intellectual victory of John Maynard Keynes, John Kenneth Galbraith, and Hyman P. Minsky--and act accordingly.
    Date: 2008–05
  14. By: Christopher J. Neely; David E. Rapach
    Abstract: The real interest rate plays a central role in many important financial and macroeconomic models, including the consumption-based asset pricing model, neoclassical growth model, and models of the monetary transmission mechanism. We selectively survey the empirical literature that examines the time-series properties of real interest rates. A key stylized fact is that postwar real interest rates exhibit substantial persistence, shown by extended periods of time where the real interest rate is substantially above or below the sample mean. The finding of persistence in real interest rates is pervasive, appearing in a variety of guises in the literature. We discuss the implications of persistence for theoretical models, illustrate existing findings with updated data, and highlight areas for future research.
    Keywords: Interest rates
    Date: 2008
  15. By: Jordi Gali; Luca Gambetti
    Abstract: The remarkable decline in macroeconomic volatility experienced by the U.S. economy since the mid-80s (the so-called Great Moderation) has been accompanied by large changes in the patterns of comovements among output, hours and labor productivity. Those changes are reflected in both conditional and unconditional second moments as well as in the impulse responses to identified shocks. Among other changes, our findings point to (i) an increase in the volatility of hours relative to output, (ii) a shrinking contribution of non-technology shocks to output volatility, and (iii) a change in the cyclical response of labor productivity to those shocks. That evidence suggests a more complex picture than that associated with "good luck" explanations of the Great Moderation.
    JEL: E32
    Date: 2008–07
  16. By: Pavlina R. Tcherneva
    Abstract: The monetarist counterrevolution and the stagflation period of the 1970s were among the theoretical and practical developments that led to the rejection of fiscal policy as a useful tool for macroeconomic stabilization and full employment determination. Recent mainstream contributions, however, have begun to reassess fiscal policy and have called for its restitution in certain cases. The goal of this paper is to delimit the role of and place for fiscal policy in the New Economic Consensus (NEC) and to compare it to that of Post-Keynesian theory, the latter arguably the most faithful approach to the original Keynesian message. The paper proposes that, while a consensus may exist on many macroeconomic issues within the mainstream, fiscal policy is not one of them. The designation of fiscal policy within the NEC is explored and contrasted with the Post-Keynesian calls for fiscal policy via Abba Lerner's "functional finance" approach. The paper distinguishes between two approaches to functional finance--one that aims to boost aggregate demand and close the GDP gap, and one that secures full employment via direct job creation. It is argued that the mainstream has severed the Keynesian link between fiscal policy and full employment--a link that the Post-Keynesian approach promises to restore.
    Date: 2008–07
  17. By: David Amdur (Department of Economics, Georgetown University)
    Abstract: Why are aggregate equity payouts and debt issued positively correlated over the business cycle in U.S. data? Standard real business cycle (RBC) models have few predictions about capital structure, because they assume that nancial markets are frictionless. On the other hand, the tradeo theory of capital structure argues that nancial frictions determine rms' optimal mix of debt and equity nancing. We develop an RBC model with nancial frictions and use it to explain some stylized facts about aggregate U.S. debt and equity ows. We document that debt issued and equity payouts are (i) positively correlated with output, (ii) positively correlated with investment, and (iii) positively correlated with each other. Our model can account for these stylized facts. We also calibrate the model to the periods 1952 { 1983 and 1984 { 2007 in order to explain the nding that real variables have become less volatile in the later subperiod, while nancial variables have become more volatile. By varying both the scale of technology shocks and the degree of nancial frictions, we are able to account for both results. Classification-JEL Codes: E32, G32, G35
    Keywords: Debt-equity nance, RBC models, business cycle moderation, corporate nance, capital structure, tradeo theory, payout policy
    Date: 2008–08–03
  18. By: Jonathan H. Wright
    Abstract: This paper provides cross-country empirical evidence on term premia, inflation uncertainty, and their relationship. It has three components. First, I construct a panel of zero-coupon nominal government bond yields spanning ten countries and eighteen years. From these, I construct forward rates and decompose these into expected future short-term interest rates and term premiums, using both statistical methods (an affine term structure model) and using surveys. Second, I construct alternative measures of time-varying inflation uncertainty for these countries, using actual inflation data and survey expectations. I discuss some possible determinants of inflation uncertainty. Finally, I use panel data methods to investigate the relationship between term premium estimates and inflation uncertainty measures, and find a strong positive relationship. The economic determinants of term premia remain mysterious; but this evidence points to uncertainty about intermediate- to long-run inflation rates being a substantial part of the explanation for why yield curves slope up.
    Date: 2008
  19. By: Jerome Creel (Observatoire Français des Conjonctures Économiques; ESCP-EAP); Francesco Saraceno (Observatoire Français des Conjonctures Économiques)
    Abstract: This paper describes recent trends on the efficiency of stabilisers in the European Union. Using both macro evidence on the cyclical sensitivity of budget deficit to economic activity, and micro evidence on the tax and expenditure profiles, we conclude, in agreement with the recent literature, that the importance of automatic stabilisation has decreased. After remarking that this trend is contradictory with the current economic institutions of Europe relying exclusively on automatic stabilisation for the conduct of fiscal policy, we argue that increasing flexibility, one alternative way to reduce cyclical fluctuations, does not seem a viable path. The paper concludes defending the appropriateness of discretionary fiscal policy. We argue by means of a simple model that the theoretical arguments against its use are not conclusive, and we describe a recent stream of literature, based on structural VAR models, that concludes rather robustly for the effectiveness of discretionary fiscal policy in the short and long run.
    Keywords: Automatic stabilisers, progressivity, unemployment benefits, discretionary fiscal policy, European fiscal institutions
    JEL: E60 H20 H30 H60
    Date: 2008
  20. By: Stefania D'Amico; Don H. Kim; Min Wei
    Abstract: We examine the informational content of TIPS yields from the viewpoint of a general 3-factor no-arbitrage term structure model of inflation and interest rates. Our empirical results indicate that TIPS yields contained a "liquidity premium" that was until recently quite large (~ 1%). Key features of this premium are difficult to account for in a rational pricing framework, suggesting that TIPS may not have been priced efficiently in its early years. Besides the liquidity premium, a time-varying inflation risk premium complicates the interpretation of the TIPS breakeven inflation rate (the difference between the nominal and TIPS yields). Nonetheless, high-frequency variation in the TIPS breakeven rates is similar to the variation in inflation expectations implied by the model, lending support to the view that TIPS breakeven inflation rates are a useful proxy for inflation expectations.
    Date: 2008
  21. By: Jean-Marie Dufour; Abderrahim Taamouti
    Abstract: The concept of causality introduced by Wiener (1956) and Granger (1969) is defined in terms of predictability one period ahead. This concept can be generalized by considering causality at a given horizon h, and causality up to any given horizon h [Dufour and Renault (1998)]. This generalization is motivated by the fact that, in the presence of an auxiliary variable vector Z, it is possible that a variable Y does not cause variable X at horizon 1, but causes it at horizon h > 1. In this case, there is an indirect causality transmitted by Z. Another related problem consists in measuring the importance of causality between two variables. Existing causality measures have been defined only for the horizon 1 and fail to capture indirect causal effects. This paper proposes a generalization of such measures for any horizon h. We propose nonparametric and parametric measures of unidirectional and instantaneous causality at any horizon h. Parametric measures are defined in the context of autoregressive processes of unknown order and expressed in terms of impulse response coefficients. On noting that causality measures typically involve complex functions of model parameters in VAR and VARMA models, we propose a simple method to evaluate these measures which is based on the simulation of a large sample from the process of interest. We also describe asymptotically valid nonparametric confidence intervals, using a bootstrap technique. Finally, the proposed measures are applied to study causality relations at different horizons between macroeconomic, monetary and financial variables in the U.S. These results show that there is a strong effect of nonborrowed reserves on federal funds rate one month ahead, the effect of real gross domestic product on federal funds rate is economically important for the first three months, the effect of federal funds rate on gross domestic product deflator is economically weak one month ahead, and finally federal fundsrate causes the real gross domestic product until 16 months.
    Keywords: Time series, Granger causality, Indirect causality, Multiple horizon causality, Causality measure, Predictability, Autoregressive model, Vector autoregression, VAR, Bootstrap, Monte Carlo, Macroeconomics, Money, Interest rates, Output, Inflation
    JEL: C1 C12 C15 C32 C51 C53 E3 E4 E52
    Date: 2008–07
  22. By: Sandrine Levasseur (Observatoire Français des Conjonctures Économiques)
    Date: 2008
  23. By: Beetsma, Roel; Ribeiro, Marcos Poplawski; Schabert, Andreas
    Abstract: This paper compares constraints on the public debt with constraints on the primary deficit. The analysis takes into account how an optimizing government reacts to the different constraints when deciding on a spending and borrowing plan. We find that the economy behaves similarly under both constraints, although for our benchmark calibration welfare is higher under the debt constraint. Further, the debt constraint is more robust against changes in the interest rate. Our results lend support to the enhanced focus on the public debt after the recent reform of the Stability and Growth Pact.
    Keywords: fiscal constraints; myopia; social welfare; Stability and Growth Pact
    JEL: E62 H30 H60
    Date: 2008–07
  24. By: Romaniuk, Katarzyna (University of Paris 1 Panthéon-Sorbonne, PRISM); Vranceanu, Radu (ESSEC Business School)
    Abstract: Financial Newspapers have for long suggested that the Fed tends to provide additional Liquidity when the Stock Market thumbs. We provide a theoretical Explanation for this Behaviour that builds on the Methodology developed by Romaniuk (2008) for a central Banker with two main Goals, Output and Price stability. In this Paper, the Policymaker behaves as a Portfolio Manager who aims at stabilizing Output, Goods Prices, as well as Asset Prices. An optimal, Time-varying Interest Rate Rule is obtained as the Merton's (1971) continuous Time Solution to the Portfolio Manager's Problem. In a second Step, we infer the optimal Interest Rate Rule of a central Bank that can react differently to positive and negative Variations in the Stock Market.
    Keywords: Optimal Interest Rate Rule; Portfolio Choice; Fed; Asset Prices; Options Theory
    JEL: C61 E58 G11
    Date: 2008–03
  25. By: Petr Kadeřábek (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Komerční banka, a.s); Aleš Slabý (Komerční banka, a.s); Josef Vodička (Komerční banka, a.s; Société Genérale, Paris)
    Abstract: This paper introduces a model for stress testing of probability of default of individuals. The model rests on assumption that the individual defaults if his savings fall below zero. The probability of default is then described as a function of several macroeconomic indicators such as wages, unemployment and interest rates. Stress testing is carried out by applying exogenous stress scenarios for development of these indicators. The model implies that sensitivity of probability of default to the stress is mainly driven by Installment to Income Ratio and for mortgages also by loan maturity. Hence Installment to Income ratio is suggested as the appropriate tool to manage credit risk of retail portfolios.
    Keywords: banking; credit risk; stress testing; probability of default
    JEL: G21 E32 E21
    Date: 2008–07
  26. By: Ridhwan, M.M. (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics); Nijkampa, P.; Rietveld, P.
    Abstract: Standard economic theory assumes money to be neutral, at least in the long run, driven by interregional arbitrage and perfect capital mobility. This may easily be used as a justification for regional economists to ignore monetary factors. However, in a world with market imperfections, such arguments are no longer valid. This paper provides a critical review of theoretical arguments and empirical evidence on the issue. Special attention is devoted to asymmetric information problems caused by geographical factors. We conclude that monetary policy and financial markets can have a potentially important role to play in promoting regional development especially in less-developed countries.
    Keywords: Regional Finance; Monetary Union; Capital Mobility; Asymmetric Regional Finance; Monetary Union; Capital Mobility; Asymmetric;Information; Economic Geography
    JEL: R51 R58 G14 E44 F15
    Date: 2008
  27. By: Robert Dixon (Department of Economics, The University Melbourne); G. C. Lim (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)
    Abstract: In this paper, we set out a model of labour productivity which distinguishes between shocks which change productivity permanently and shocks which have transient affects on productivity. We show that this model is a type of unobserved components model –a random walk with drift plus noise model. The advantage of this approach is that it provides a coherent framework to identify the deterministic trend growth component and also the productivity-enhancing (or technology-related) stochastic components. The model is applied to aggregate labour productivity in Australia and the time series of technology shocks extracted is used to shed some light on the contributions of policy reforms to productivity.
    Date: 2008–05
  28. By: Antonio Carlos Macedo e Silva; Claudio H. Dos Santos
    Abstract: This paper argues that institutionally rich stock-flow consistent models—that is, models in which economic agents are identified with the main social categories/institutional sectors of actual capitalist economies, the short period behavior of these agents is thoroughly described, and the "period by period" balance sheet dynamics implied by the latter is consistently modeled—are (1) perfectly compatible with John Maynard Keynes's theoretical views, (2) the ideal tool for rigorous post-Keynesian analyses of the medium run, and (3) therefore crucial to the consolidation of the broad post-Keynesian research program.
    Date: 2008–07
  29. By: Massimiliano Serati (Cattaneo University (LIUC))
    Abstract: Since the contribution of Linder (1961) product quality is considered as a factor potentially boosting exports, especially for the most industrialized countries. However, being quality difficult to be measured, the macro-econometric studies on its role are not numerous and have not produced clear-cut results. In this paper we shed some light on the theoretical and empirical impact of product quality on the export performance of the EU-12 area. To avoid problems of mis-specification and endogeneity usual in the empirical literature on trade equations, we model exports as jointly endogenous with GDP, inflation and exchange rate. For this purpose we modify and enlarge a New Keynesian open economy model à la Clarida, Galì and Gertler (2001) to adapt it to a large open economy. Sign restrictions, based on theoretical impact multipliers, enable the identification of quality as one of the structural shocks of the corresponding Bayesian VAR, avoiding drawbacks connected to the choice of an incomplete, partial or biased proxy of the phenomenon. The empirical evidence shows that a quality upgrade might reinforce the EU competitiveness leading to an improvement of the current account, without any unfavourable effect on terms of trade.
    Date: 2008–02
  30. By: Purnamita Dasgupta (Indian Council for Research on International Economic Rela); Shikha Gupta (Indian Council for Research on International Economic Rela)
    Abstract: This paper investigates certain macro data on the Indian economy to draw inferenceson the sustainability of the economic growth experienced over the last couple ofdecades. Interpreting sustainability in terms of the maintenance of different forms ofcapital to ensure that future consumption levels are at least as high as current levels,estimates of investment have been made using theoretically consistent models anddata relevant to the Indian context. Subsequently, the paper investigates the extent towhich the investment that has taken place over a thirty year period (from 1976-77 to2004-05) has been aligned with the consumption path. Investment estimates are foundto be a reliable indicator of sustainability of the future consumption path and averagefuture consumption is likely to be higher than current consumption. The findingsreveal that while capital formation in manufactured assets has been fuelling wealthaccumulation in the economy, there has been a rise in the degradation of natural capital stocks. However, considering the aggregate picture, taking note of investmentin human capital, produced capital and the depreciation of natural capital, there hasbeen net wealth accumulation in the economy. Per capita wealth has been rising overthe period, with a sharp rise observed from the mid 1990s onwards.
    Keywords: Sustainable Development, Investment, Future Consumption, Per Capita Wealth, Human and Natural capital
    JEL: Q56 O11
    Date: 2008–05
  31. By: Fiess, Norbert M. (University of Glasgow); Fugazza, Marco (UNCTAD); Maloney, William F. (World Bank)
    Abstract: This paper examines the adjustment of developing country labor markets to macroeconomic shocks. It models as having two sectors: a formal salaried (tradable) sector that may or may not be affected by union or legislation induced wage rigidities, and an informal (nontradable) self-employment sector facing liquidity constraints to entry. This is embedded in a standard small economy macro model that permits the derivation of patterns of comovement among relative salaried/self-employed incomes, salaried/self-employed sector sizes and the real exchange rate with respect to different types of shocks in contexts with and without wage rigidities. The paper then explores time series data from Argentina, Brazil, Colombia and Mexico to test for cointegrating relationships corresponding to the patterns predicted by theory. We confirm episodes of expansion of informal self-employment consistent with the traditional segmentation views. However, we also identify episodes consistent with the sectoral expansion being driven by relative demand or productivity shocks to the nontradables sector that lead to “procyclical” behavior of the informal self-employed sector.
    Keywords: informality, labor market dynamics, self-employment, real exchange rates
    JEL: F41 J21 J24 J31 O17
    Date: 2008–05
  32. By: Bennett T. McCallum
    Abstract: In a very broad class of dynamic linear models, if agents possess knowledge of current endogenous variables in a least-squares learning process, determinacy of a rational expectations (RE) equilibrium is sufficient but not necessary for learnability of that equilibrium. Thus, since learnability is an attractive necessary condition for plausibility of any equilibrium, there may exist a single plausible RE solution even in cases of indeterminacy. This paper proposes and outlines a distinct criterion that plausible models should possess, termed "well formulated" (WF), which rules out infinite discontinuities in the implied impulse response functions. The paper explores the relationship between this WF property and learnability, under the information assumption mentioned above, and finds that they often agree but neither strictly implies the other. Extending the P-matrix requirement, implied for specified matrices by the WF property, to one that demands positive dominant-diagonal matrices would guarantee both WF and learnability, but a suitable rationale has not been found. Finally, under a second information assumption, which gives the agents only lagged information on endogenous variables during the learning process, the situation is less favorable in the sense that learnability can be guaranteed only under special assumptions.
    JEL: C62 E30 E52
    Date: 2008–07
  33. By: Pere Gomis-Porqueras; Adrian Peralta-Alva
    Abstract: This paper tries to understand the underlying causes of the rapid increase in obesity rates over recent decades. In particular, we propose a dynamic general equilibrium model to derive the quantitative implications of a decline in the relative (monetary and time) cost of food prepared away from home on the caloric intake of the average American adult over the last forty years. Two channels that lower this relative cost are considered. First, productivity improvements in the production of food prepared away from home. We and that this channel is qualitatively consistent with expenditure trends in food items, but falls short of accounting for the magnitude of the observed changes. We then consider actual declines in income taxes and in the gender wage gap, which increase the cost of preparing food at home from scratch. Our model accounts for three quarters of the observed changes in calorie consumption, and is consistent with trends in aggregate food expenditures, time use, and key macroeconomic variables. Our results indicate that changes in the relative cost of food prepared away from home play an important role in our understanding of the increased weight of the American population during the last 40 years.
    Keywords: Obesity
    Date: 2008
  34. By: James Feigenbaum; Geng Li
    Abstract: Uninsurable income risk is often cited as an explanation for empirical deviations from the Lifecycle/Permanent-Income Hypothesis such as the observation that the life-cycle profile of mean consumption is hump-shaped. Most methods used for estimating income uncertainty essentially measure the cross-sectional variance of a subpopulation rather than the true uncertainty or riskiness perceived by consumers. In this paper, we employ a nonparametric approach to estimate idiosyncratic income uncertainty. We measure income uncertainties as the variance of income forecasting errors at different ages and over different time horizons. The estimated life-cycle income uncertainty profile is U-shaped and generally implies a lower degree of income uncertainty relative to the previous literature. We subsequently use these nonparametric estimates to calibrate a (time-inconsistent) lifecycle model to assess whether a consumption hump can be generated by precautionary saving given more robust measures of income uncertainty. We show that, with plausible risk aversion coefficient and discounting factors and an endogenous, rarely active borrowing limit, our refined measure of income uncertainty is large enough to generate a significant consumption hump that peaks around age 55 and closely matches with the observed magnitude of the consumption hump. We also notice that the variation in the volatility of income shocks with respect to both age and forecast horizon has a significant impact on the size and peak age of the consumption hump.
    Date: 2008
  35. By: Vindigni, Andrea (Princeton University)
    Abstract: This paper investigates the role that idiosyncratic uncertainty plays in shaping social preferences over the degree of labor market flexibility, in a general equilibrium model of dynamic labor demand where the productivity of firms evolves over time as a Geometric Brownian motion. A key result demonstrated is that how the economy responds to shocks, i.e. unexpected changes in the drift and standard deviation of the stochastic process describing the dynamics of productivity, depends on the power of labor to extract rents and on the status quo level of firing costs. In particular, we show that when firing costs are relatively low to begin with, a transition to a rigid labor market is favored by all and only the employed workers with idiosyncratic productivity below some threshold value. A more volatile environment, and a lower rate of productivity growth, i.e. “bad times,” increase the political support for more labor market rigidity only where labor appropriates of relatively large rents. Moreover, we demonstrate that when the status quo level of firing costs is relatively high, the preservation of a rigid labor market is favored by the employed with intermediate productivity, whereas all other workers favor more flexibility. The coming of better economic conditions need not favor the demise of high firing costs in rigid high-rents economies, because “good times” cut down the support for flexibility among the least productive employed workers. The model described provides some new insights on the comparative dynamics of labor market institutions in the U.S. and in Europe over the last few decades, shedding some new light both on the reasons for the original build-up of “Eurosclerosis,” and for its the persistence up to the present day.
    Keywords: employment protection, firing costs, productivity, political economy, rents, volatility, growth, institutional divergence
    JEL: D71 D72 E24 J41 J63 J65
    Date: 2008–05
  36. By: Kevin J. Lansing
    Abstract: This paper develops a stochastic endogenous growth model that exhibits “excess volatility” of equity prices because speculative agents overreact to observed technology shocks. When making forecasts about the future, speculative agents behave like rational agents with very low risk aversion. The speculative forecast rule alters the dynamics of the model in a way that tends to confirm the stronger technology response. For moderate levels of risk aversion, the forecast errors observed by the speculative agent are close to white noise, making it difficult for the agent to detect a misspecification of the forecast rule. In model simulations, I show that this type of behavior gives rise to intermittent asset price bubbles that coincide with improvements in technology, investment and consumption booms, and faster trend growth, reminiscent of the U.S. economy during the late 1920s and late 1990s. The model can also generate prolonged periods where the price-dividend ratio remains in the vicinity of the fundamental value. The welfare cost of speculation (relative to rational behavior) depends crucially on parameter values. Speculation can improve welfare if actual risk aversion is low and agents underinvest relative to the socially-optimal level. But for higher levels of risk aversion, the welfare cost of speculation is large, typically exceeding one percent of per-period consumption.
    Keywords: Asset pricing ; Technology
    Date: 2008
  37. By: Candelon, Bertrand (Maastricht University); Dupuy, Arnaud (ROA, Maastricht University); Gil-Alana, Luis A. (University of Navarra)
    Abstract: This paper provides new evidence on the nature of occupational differences in unemployment dynamics, which is relevant for the debate between the structural or hysteresis hypotheses. We develop a procedure that permits us to test for the presence of a structural break at unknown date. Our approach allows the investigation of a broader range of persistence than the 0/1 paradigm about the order of integration, usually implemented for testing the hypothesis of hysteresis in occupational unemployment. In almost all occupations, we find support for both the structuralist and the hysteresis hypotheses, but stress the importance of estimating the degree of persistence of seasonal shocks along with the degree of long-run persistence on raw data without applying seasonal filters. Indeed hysteresis appears to be underestimated when data are initially adjusted using traditional seasonal filters.
    Keywords: occupational unemployment, structuralist, hysteresis, structural break, fractional integration
    JEL: E24 C22 J62
    Date: 2008–06
  38. By: David Colander; Casey Rothschild
    Abstract: The macro economy is complex; everyone knows that. Complex systems are difficult to analyze and manage; everyone knows that too. The best approach to teaching and describing the complex macro economy is something we know much less well. Currently, in teaching macro to both graduate and undergraduate students, we don’t stress just how complex the economy really is. The argument in this paper is that we should emphasize that complexity to frame the macro question.1 Having done that, we can get on with what we do, and much of the structure of both the graduate and undergraduate macro can be taught as it currently is. But instead of seeing the approaches at the two levels as substitutes for one another, complexity helps to frame as what they really are: complementary approaches to addressing a challenging set of questions.
    Date: 2008–01
  39. By: Joseph J. Doyle, Jr.; Erich Muehlegger; Krislert Samphantharak
    Abstract: Some gasoline markets exhibit remarkable price cycles, where price spikes are followed by a string of small price declines until the next price spike. This pattern is predicted from a model of competition driven by Edgeworth cycles, as described by Maskin and Tirole. We extend the Maskin and Tirole model and empirically test its predictions with a new dataset of daily station-level prices in 115 US cities. One innovation is that we also examine cycling within cities, which allows controls for city fixed effects. Consistent with the theory, and often in contrast with previous empirical work, we find that the least and most concentrated markets are much less likely to exhibit cycling behavior; and the areas with more independent retailers that have convenience stores are more likely to cycle. We also find that the average gasoline prices are relatively unrelated to cycling behavior.
    JEL: D4 L11 L70
    Date: 2008–07
  40. By: Ignacio Velez-Pareja
    Abstract: In this work we explain the proper use of perpetuities and the value of them. We consider two cases: calculating the value on period zero when the perpetuity starts with a given cash flow in period 1 and when it starts from a cash flow in period zero and it grows in period 1 at a given rate (as when we calculate a terminal or continuing value). We derive the proper expressions for the two cases. In particular we focus the analysis when there is no real growth and expected inflation is positive. We conclude that depending on which is the case we can use or not the Constant Growth Model (Gordon Model).
    Date: 2008–07–01
  41. By: Traci L. Mach; Lieu N. Hazelwood; John D. Wolken
    Abstract: In 2003, the Survey of Small Business Finances (SSBF), conducted by the Federal Reserve Board, implemented the use of incentives to increase response rates. This study examines the effects of some of the characteristics of the implementation - such as level of effort, time in queue, and consecutively-increasing incentive amounts - on unit response. Our estimates suggest that as the number of days increase between the initial screener and main interview, the probability of completion decreases. Similarly, as the number of days increases between each consecutive incentive offer the probability of completion decreases. Additional effort, as measured by additional calls, increases the probability of completion. Finally, each consecutive offer after the initial offer decreases the probability of completion.
    Date: 2008
  42. By: Bosch, Mariano (University of Alicante); Maloney, William F. (World Bank)
    Abstract: This paper analyzes the cyclical properties of worker flows in Brazil and Mexico, two important developing countries with large unregulated or “informal” sectors. It generates three stylized facts that are critical to the accurate modeling of the sector and which suggest the need to rethink the approaches to date. First, the unemployment rate is countercyclical essentially because job separations of informal workers increase dramatically in recessions. Second, the share of formal employment is countercyclical because of the difficulty of finding formal jobs from inactivity, unemployment and other informal jobs during recessions rather than because of increased separation from formal jobs. Third, flows from formality into informality are not countercyclical, but, if anything, pro-cyclical. Together, these challenge the conventional wisdom that has guided the modeling the sector that informal workers are primarily those rationed out of the formal labor market. They also offer a new synthesis of the mechanics of the cyclical adjustment process. Finally, the paper offers estimates of the moments of worker flows series that are needed for calibration.
    Keywords: gross worker flows, labor market dynamics, informality, developing countries
    JEL: J41 J42 J6
    Date: 2008–05
    Abstract: We investigate the impact of banks’ ownership concentration on the effectiveness of shareholders’ market discipline. More precisely, we first assess whether the ability of the distance to default to predict banks’ financial distress is affected by the level of ownership concentration (“monitoring” hypothesis). We also assess whether banks’ future financial situation is directly affected by ownership concentration (“influence” hypothesis). Our econometric estimates are conducted on a panel of 77 European banks observed between the first quarter of 1997 and the last quarter of 2005. We find that ownership dispersion reduces the predictive power of the distance to default. The data collected come from three sources: Bankscope, Datastream and Thomson One Banker Ownership. The econometric methodology is based on simple pooled-logit estimates corrected for the clustering effect. Several tests are then conducted to assess the robustness of the results. We also recall that theoretical results do exist to explain why banks’ ownership structure can alter market discipline and the ability of market-derived indicators to predict future financial distresses. This work finally suggests that the empirical literature dealing with market discipline should not focus only on the moral hazard potentially created by bad insurance deposit design, balance sheet opacity or the safety net: the evolution of banks ownership structure might also be an important prudential issue.
    Keywords: market discipline; ownership concentration; banks’ risk taking
    JEL: G21 G32 G34 E44 E58
    Date: 2008
  44. By: Koskela, Erkki (University of Helsinki); Poutvaara, Panu (University of Helsinki)
    Abstract: We evaluate the effects of international outsourcing and labor taxation on wage formation and equilibrium unemployment in dual labor markets. Outsourcing promotes wage dispersion between the high-skilled and low-skilled workers. Higher domestic low-skilled wage tax, higher payroll tax and lower wage tax exemption increase optimal outsourcing. Outsourcing will reduce equilibrium unemployment of low-skilled workers both in the presence and absence of labor taxation. In the presence of outsourcing, wage tax, tax exemption and payroll tax have an ambiguous effect on equilibrium unemployment. Increasing the degree of tax progression decreases the wage rate and increases the demand of low-skilled workers.
    Keywords: outsourcing, dual labor markets, labor taxation, equilibrium unemployment
    JEL: E24 J21 J31 J51 J82 H22
    Date: 2008–05
  45. By: Epstein, Gil S. (Bar-Ilan University); Gang, Ira N. (Rutgers University)
    Abstract: We model the aid allocation decision where the donor government has announced that good governance is the criterion for receiving aid. Potential recipients must compete for the aid funds. The structure of the competition is important to the donor in terms of achieving good governance, and to the recipients in terms of what they receive. The leaders of potential recipient countries look at aid availability through this contest as part of the competing objectives they face – some good, some not good. The donor country prefers a contest under which the aid will only go to one country while the leaders of the receiving countries prefer that each country obtains the proportion of aid relative to its governance quality. If poverty reduction is an independent goal as well, a poverty trap may be created. With good governance as a criterion, donors may work through both bilateral and multilateral agencies.
    Keywords: foreign aid, governance, decentralization, rent seeking
    JEL: O10 O19 F35 O11 C23 O47 E21 E22
    Date: 2008–07

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