nep-mac New Economics Papers
on Macroeconomics
Issue of 2009‒11‒27
89 papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Evaluating Monetary Policy By Svensson, Lars E O
  2. Monetary-Fiscal Policy Interactions and Fiscal Stimulus By Davig, Troy; Leeper, Eric M.
  3. Decomposing Federal Funds Rate forecast uncertainty using real-time data By Martin Mandler
  4. Inflation Targeting and Business Cycle Synchronization By Flood, Robert P; Rose, Andrew K
  5. Expectations, Deflation Traps and Macroeconomic Policy By Evans, George W.; Honkapohja, Seppo
  6. Inflation Targeting at 20: Achievements and Challenges By Scott Roger
  7. Macroeconomic Patterns and Monetary Policy in the Run-up to Asset Price Busts By Pau Rabanal; Prakash Kannan; Alasdair Scott
  8. Monetary Policy Analysis and Forecasting in the World Economy: A Panel Unobserved Components Approach By Francis Vitek
  9. Money in monetary policy design: Monetary cross-checking in the New-Keynesian model By Beck, Günter; Wieland, Volker
  10. Countering the Cycle - The Effectiveness of Fiscal Policy in Korea By Leif Lybecker Eskesen
  11. Keynesian government spending multipliers and spillovers in the euro area By Cwik, Tobias; Wieland, Volker
  12. Monetary Policy and the Lost Decade: Lessons from Japan By Daniel Leigh
  13. Monetary and Macroprudential Policy Rules in a Model with House Price Booms By Pau Rabanal; Prakash Kannan; Alasdair Scott
  14. Delegating Optimal Monetary Policy Inertia By Bilbiie, Florin Ovidiu
  15. Monetary Policy, Velocity, and the Equity Premium By Gust, Christopher; López-Salido, J David
  16. The Taylor Rule and Interest Rate Uncertainty in the U.S. 1970-2006 By Martin Mandler
  17. Monetary Policy and the Financing of Firms By De Fiore, Fiorella; Teles, Pedro; Tristani, Oreste
  18. Hybrid Inflation Targeting Regimes By Jorge Restrepo; Carlos Garcia; Scott Roger
  19. The Fed’s perceived Phillips curve: Evidence from individual FOMC forecasts By Peter Tillmann
  20. Estimated Interest Rate Rules: Do they Determine Determinacy Properties? By Jensen, Henrik
  21. Pursuing Inflation Targeting Policy Framework in the Midst of Inflationary Pressures and Fiscal Constraint in Indonesia By Siregar, Reza
  22. DSGE-CH: A dynamic stochastic general equilibrium model for Switzerland By Cuche-Curti, Nicolas A.; Dellas, Harris; Natal, Jean-Marc
  23. Depression Econometrics: A FAVAR Model of Monetary Policy During the Great Depression By Ahmadi, Pooyan Amir; Ritschl, Albrecht
  24. Fiscal Deficits and Current Account Deficits By Michael Kumhof; Douglas Laxton
  25. Macroeconomic Effects of Financial Shocks By Jermann, Urban; Quadrini, Vincenzo
  26. Has the SARB Become More Effective Post Inflation Targeting? By Rangan Gupta; Alain Kabundi; Mampho P. Modise
  27. "Optimal monetary policy when asset markets are incomplete" By Richard Anton Braun; Tomoyuki Nakajima
  28. Political Constraints on Monetary Policy During the U.S. Great Inflation By Weise, Charles L.
  29. Macroeconomic Forecasting and Structural Change By D Agostino, Antonello; Gambetti, Luca; Giannone, Domenico
  30. A Banking Explanation of the US Velocity of Money: 1919-2004 By Benk, Szilárd; Gillman, Max; Kejak, Michal
  31. Empirical Evidence on the Aggregate Effects of Anticipated and Unanticipated U.S. Tax Policy Shocks By Mertens, Karel; Ravn, Morten O.
  32. Three Cycles: Housing, Credit, and Real Activity By Alain N. Kabundi; Deniz Igan; Marcelo Pinheiro; Francisco Nadal-De Simone; Natalia T. Tamirisa
  33. The Macroeconomic Costs and Benefits of the EMU and other Monetary Unions: An Overview of Recent Research By Beetsma, Roel; Giuliodori, Massimo
  34. Empirical evidence on the aggregate effects of anticipated and unanticipated US tax policy shocks By Karel Mertens; Morten O. Ravn
  35. Nowcasting, Business Cycle Dating and the Interpretation of New Information when Real-Time Data are Available By Lee, Kevin; Olekalns, Nils; Shields, Kalvinder K
  36. How Large Are the Effects of Tax Changes? By Favero, Carlo A; Giavazzi, Francesco
  37. Accounting for Japanese Business Cycles: a Quest for Labor Wedges By Keisuke Otsu
  38. Low-frequency determinants of inflation in the euro area By Sven Schreiber
  39. Fiscal Stimulus to the Rescue? Short-Run Benefits and Potential Long-Run Costs of Fiscal Deficits By Michael Kumhof; Dirk Muir; Charles Freedman; Susanna Mursula; Douglas Laxton
  40. Inflation and Welfare in Long-Run Equilibrium with Firm Dynamics By Janiak, Alexandre; Monteiro, Paulo Santos
  41. On Quality Bias and Inflation Targets By Schmitt-Grohé, Stephanie; Uribe, Martín
  42. Optimal Time-Invariant Monetary Policy By Charles Brendon
  43. Conventional and Unconventional Monetary Policy By Cúrdia, Vasco; Woodford, Michael
  44. Monetary Policy Implementation and Overnight Rate Persistence By Dieter Nautz; Jan Scheithauer
  45. Fiscal Policy Can Reduce Unemployment: But There is a Better Alternative By Farmer, Roger E A
  46. Optimal Monetary Policy and Firm Entry By V. LEWIS
  47. Equilibrium Asset Prices and Investor Behavior in the Presence of Money Illusion By Basak, Suleyman; Yan, Hongjun
  48. Foreign Demand for Domestic Currency and the Optimal Rate of Inflation By Schmitt-Grohé, Stephanie; Uribe, Martín
  49. Global Liquidity Trap: A Simple Analytical Investigation By Ippei Fujiwara; Nao Sudo; Yuki Teranishi
  50. International Business Cycle Accounting By Keisuke Otsu
  51. Understanding the Aggregate Effects of Anticipated and Unanticipated Tax Policy Shocks By Mertens, Karel; Ravn, Morten O.
  52. The Role of Financial Variables in Predicting Economic Activity in the Euro Area By Raphael A. Espinoza; Fabio Fornari; Marco Lombardi
  53. Adding Indonesia to the Global Projection Model By Charles Freedman; Michal Andrle; Danny Hermawan; Haris Munandar; Roberto Garcia-Saltos; Douglas Laxton
  54. Real and Nominal Rigidities in Price Setting: A Bayesian Analysis Using Aggregate Data By Fang Yao
  55. Cross-border spillovers from fiscal stimulus By Corsetti, Giancarlo; Meier, André; Müller, Gernot
  56. From Great Depression to Great Credit Crisis: Similarities, Differences and Lessons By Miguel Almunia; Agustín S. Bénétrix; Barry Eichengreen; Kevin H. O'Rourke; Gisela Rua
  57. Aggregate Labor Market Outcomes: The Role of Choice and Chance By Krusell, Per; Mukoyama, Toshihiko; Rogerson, Richard; Sahin, Aysegul
  58. Growing Up in a Recession: Beliefs and the Macroeconomy By Giuliano, Paola; Spilimbergo, Antonio
  59. Inefficient employment decisions, entry costs, and the cost of fluctuations By Den Haan, Wouter; Sedlacek, Petr
  60. A Rule-Based Medium-Term Fiscal Policy Framework for Tanzania By Mika Saito; Daehaeng Kim
  61. When Everyone Runs for the Exit By Pedersen, Lasse Heje
  62. Size and Composition of the Central Bank Balance Sheet: Revisiting Japanfs Experience of the Quantitative Easing Policy By Shigenori Shiratsuka
  63. A Three State Model of Worker Flows in General Equilibrium By Krusell, Per; Mukoyama, Toshihiko; Rogerson, Richard; Sahin, Aysegul
  64. International Competition and Inflation: A New Keynesian Perspective By Guerrieri, Luca; Gust, Christopher; López-Salido, J David
  65. The macroeconomics of "financialisation" and the deeper origins of the world economic crisis By Till van Treeck
  66. Money is an Experience Good: Competition and Trust in the Private Provision of Money By Marimon, Ramon; Nicolini, Juan Pablo; Teles, Pedro
  67. Demand for Currency, New Technology and the Adoption of Electronic Money: Evidence Using Individual Household Data By Hiroshi Fujiki; Migiwa Tanaka
  68. The Keynesian multiplier and the Pigou effect under substitution between private and public consumption By Corchon, Luis
  69. The Myth of Financial Innovation and the Great Moderation By Den Haan, Wouter; Sterk, Vincent
  70. What’s the Damage? Medium-term Output Dynamics After Banking Crises By Abdul Abiad; Daniel Leigh; Irina Tytell; Ravi Balakrishnan; Petya Koeva Brooks
  71. A Preferred-Habitat Model of the Term Structure of Interest Rates By Vayanos, Dimitri; Vila, Jean-Luc
  72. Rethinking Monetary and Financial Policy: Practical suggestions for monitoring financial stability while generating employment and poverty reduction By Gerald Epstein
  73. Financial Crises and Economic Activity By Cecchetti, Stephen G; Kohler, Marion; Upper, Christian
  74. Mitigating the Procyclicality of Basel II By Repullo, Rafael; Saurina, Jesús; Trucharte, Carlos
  75. Financial Choice in a Non-Ricardian Model of Trade By Katheryn N. Russ; Diego Valderrama
  76. Ricardian Equivalence and the Efficacy of Fiscal Policy in Australia By Brittle, Shane
  77. Current Account Fact and Fiction By David Backus; Espen Henriksen; Frederic Lambert; Christopher Telmer
  78. Leverage and Asset Bubbles: Averting Armageddon with Chapter 11? By Miller, Marcus; Stiglitz, Joseph E
  79. Oil Price Shocks and the Macroeconomy of Nigeria: A Non-linear Approach By Aliyu, Shehu Usman Rano
  80. Treating Intangible Inputs as Investment Goods: the Impact on Canadian GDP By Nazim Belhocine
  81. Spatial Development By Desmet, Klaus; Rossi-Hansberg, Esteban
  82. Government Purchases and the Real Exchange Rate By Kollmann, Robert
  83. Policy Uncertainty and Precautionary Savings By Francesco Giavazzi; Michael McMahon
  84. The Portfolio Effect of Pension Reforms By Bottazzi, Renata; Jappelli, Tullio; Padula, Mario
  85. The Political Economy of Redistribution in the U.S. in the Aftermath of World War II and the Delayed Impacts of the Great Depression - Evidence and Theory By Beetsma, Roel; Cukierman, Alex; Giuliodori, Massimo
  86. Taxation of Human Capital and Wage Inequality: A Cross-Country Analysis By Fatih Guvenen; Burhanettin Kuruscu; Serdar Ozkan
  87. Disasters implied by equity index options By Backus, David; Chernov, Mikhail; Martin, Ian
  88. Cross-Country Causes and Consequences of the 2008 Crisis: International Linkages and American Exposure By Rose, Andrew K; Spiegel, Mark
  89. Productivity and economic growth in Switzerland 1991-2005 By Rudolf, Barbara; Zurlinden, Mathias

  1. By: Svensson, Lars E O
    Abstract: Evaluating inflation-targeting monetary policy is more complicated than checking whether inflation has been on target, because inflation control is imperfect and flexible inflation targeting means that deviations from target may be deliberate in order to stabilize the real economy. A modified Taylor curve, the forecast Taylor curve, showing the tradeoff between the variability of the inflation-gap and output-gap forecasts can be used to evaluate policy ex ante, that is, taking into account the information available at the time of the policy decisions, and even evaluate policy in real time. In particular, by plotting mean squared gaps of inflation and output-gap forecasts for alternative policy-rate paths, it may be examined whether policy has achieved an efficient stabilization of both inflation and the real economy and what relative weight on the stability of inflation and the real economy has effectively been applied. Ex ante evaluation may be more relevant than evaluation ex post, after the fact. Publication of the interest-rate path also allows the evaluation of its credibility and the effectiveness of the implementation of monetary policy.
    Keywords: forecast Taylor curve; mean squared gaps; Monetary policy evaluation
    JEL: E52 E58
    Date: 2009–09
  2. By: Davig, Troy; Leeper, Eric M.
    Abstract: Increases in government spending trigger substitution effects - both inter- and intra-temporal - and a wealth effect. The ultimate impacts on the economy hinge on current and expected monetary and fiscal policy behavior. Studies that impose active monetary policy and passive fiscal policy typically find that government consumption crowds out private consumption: higher future taxes create a strong negative wealth effect, while the active monetary response increases the real interest rate. This paper estimates Markov-switching policy rules for the United States and finds that monetary and fiscal policies fluctuate between active and passive behavior. When the estimated joint policy process is imposed on a conventional new Keynesian model, government spending generates positive consumption multipliers in some policy regimes and in simulated data in which all policy regimes are realized. The paper reports the model’s predictions of the macroeconomic impacts of the American Recovery and Reinvestment Act’s implied path for government spending under alternative monetary-fiscal policy combinations.
    Keywords: fiscal stimulus; multipliers; zero interest rate bound
    JEL: E52 E62 E63
    Date: 2009–10
  3. By: Martin Mandler (University of Giessen, Department of Economics and Business, Licher Straße 66, D-35394 Gießen)
    Abstract: Using real-time data I estimate out-of-sample forecast uncertainty about the Federal Funds Rate. Combining a Taylor rule with a model of economic fundamentals I disentangle economically interpretable components of forecast uncertainty: uncertainty about future economic conditions and uncertainty about future monetary policy. Uncertainty about U.S. monetary policy fell to unprecedented low levels in the 1980s and remained low while uncertainty about future output and inflation declined only temporarily. This points to an important role of increased predictability of monetary policy in explaining the decline in macroeconomic volatility in the U.S. since the mid-1980s.
    Keywords: monetary policy reaction function, interest rate uncertainty, state-space model
    JEL: E52 C32 C53
    Date: 2009
  4. By: Flood, Robert P; Rose, Andrew K
    Abstract: Inflation targeting seems to have a small but positive effect on the synchronization of business cycles; countries that target inflation seem to have cycles that move slightly more closely with foreign cycles. Thus the advent of inflation targeting does not explain the decoupling of global business cycles, for two reasons. Indeed business cycles have not in fact become less synchronized across countries.
    Keywords: bilateral; data; empirical; GDP; insulation; regime
    JEL: F42
    Date: 2009–07
  5. By: Evans, George W.; Honkapohja, Seppo
    Abstract: We examine global economic dynamics under infinite-horizon learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja (2008), we find that under normal monetary and fiscal policy the intended steady state is locally but not globally stable. Unstable deflationary paths can arise after large pessimistic shocks to expectations. For large expectation shocks pushing interest rates to the zero lower bound, temporary increases in government spending can be used to insulate the economy from deflation traps.
    Keywords: Adaptive Learning; Fiscal Policy; Monetary Policy; Zero Interest Rate Lower Bound
    JEL: E52 E58 E63
    Date: 2009–08
  6. By: Scott Roger
    Abstract: This paper provides an overview of inflation targeting frameworks and macroeconomic performance under inflation targeting. Inflation targeting frameworks are generally quite similar across countries, and a broad consensus has developed in favor of "flexible" inflation targeting. The evidence shows that, although inflation target ranges are missed frequently in most countries, the inflation and growth performance under inflation targeting compares very favorably with performance under alternative frameworks. Inflation targeters also tentatively appear to be coping better with the commodity price and financial shocks in 2007-2009 than non-inflation targeters. Key issues going forward include adapting inflation targeting to emerging market and developing countries, and incorporating financial stability issues into the framework.
    Keywords: Central bank policy , Cross country analysis , Developing countries , Disinflation , Emerging markets , Financial sector , Financial stability , Inflation targeting , Monetary policy , Price stabilization , Transparency ,
    Date: 2009–10–27
  7. By: Pau Rabanal; Prakash Kannan; Alasdair Scott
    Abstract: We find that inflation, output and the stance of monetary policy do not typically display unusual behavior ahead of asset price busts. By contrast, credit, shares of investment in GDP, current account deficits, and asset prices typically rise, providing useful, if not perfect, leading indicators of asset price busts. These patterns could also be observed in the build-up to the current crisis. Monetary policy was not the main, systematic cause of the current crisis. But, with inflation typically under control, central banks effectively accommodated these growing imbalances, raising the risk of damaging busts.
    Keywords: Asset prices , Credit expansion , Housing prices , Monetary policy , Price increases , Stock prices ,
    Date: 2009–11–16
  8. By: Francis Vitek
    Abstract: This paper develops a panel unobserved components model of the monetary transmission mechanism in the world economy, disaggregated into its fifteen largest national economies. This structural macroeconometric model features extensive linkages between the real and financial sectors, both within and across economies. A variety of monetary policy analysis and forecasting applications of the estimated model are demonstrated, based on a novel Bayesian framework for conditioning on judgment.
    Keywords: Business cycles , Cross country analysis , Developed countries , Economic forecasting , Economic models , Emerging markets , Financial sector , Inflation , International financial system , Monetary policy , Monetary transmission mechanism , Real sector ,
    Date: 2009–10–28
  9. By: Beck, Günter; Wieland, Volker
    Abstract: In the New-Keynesian model, optimal interest rate policy under uncertainty is formulated without reference to monetary aggregates as long as certain standard assumptions on the distributions of unobservables are satisfied. The model has been criticized for failing to explain common trends in money growth and inflation, and that therefore money should be used as a cross-check in policy formulation (see Lucas (2007)). We show that the New-Keynesian model can explain such trends if one allows for the possibility of persistent central bank misperceptions. Such misperceptions motivate the search for policies that include additional robustness checks. In earlier work, we proposed an interest rate rule that is near-optimal in normal times but includes a cross-check with monetary information. In case of unusual monetary trends, interest rates are adjusted. In this paper, we show in detail how to derive the appropriate magnitude of the interest rate adjustment following a significant cross-check with monetary information, when the New-Keynesian model is the central bank's preferred model. The cross-check is shown to be effective in offsetting persistent deviations of inflation due to central bank misperceptions.
    Keywords: European Central Bank; monetary policy; money; New-Keynesian model; policy under uncertainty; quantity theory
    JEL: E32 E41 E43 E52 E58
    Date: 2009–10
  10. By: Leif Lybecker Eskesen
    Abstract: The Korean authorities having taken decisive and proactive fiscal measures to help stem the fallout from the current global economic and financial crisis, with the size of the fiscal stimulus well-above the average response of other G20 economies. In this context, a key question is how effective fiscal policy is as a stabilization tool, especially considering the high openness of Korea's economy. Results based on a macroeconomic model calibrated for Korea provide a strong case for using counter-cyclical fiscal policy, especially if measures appropriately focus on spending with a direct demand impact such as investment and targeted transfers. It also demonstrates the importance a complementary monetary response and the benefits to an open economy such as Korea's of global coordination of fiscal stimulus.
    Keywords: Business cycles , Consumption , Cross country analysis , Economic models , Financial crisis , Fiscal policy , Global Financial Crisis 2008-2009 , Government expenditures , Korea, Republic of , Monetary policy , National income , Public investment ,
    Date: 2009–11–12
  11. By: Cwik, Tobias; Wieland, Volker
    Abstract: The global financial crisis has lead to a renewed interest in discretionary fiscal stimulus. Advocates of discretionary measures emphasize that government spending can stimulate additional private spending --- the so-called Keynesian multiplier effect. Thus, we investigate whether the discretionary spending announced by Euro area governments for 2009 and 2010 is likely to boost euro area GDP by more than one for one. Because of modeling uncertainty, it is essential that such policy evaluations be robust to alternative modeling assumptions and different parameterizations. Therefore, we use five different empirical macroeconomic models with Keynesian features such as price and wage rigidities to evaluate the impact of fiscal stimulus. Four of them suggest that the planned increase in government spending will reduce private spending for consumption and investment purposes significantly. If announced government expenditures are implemented with delay the initial effect on euro area GDP, when stimulus is most needed, may even be negative. Traditional Keynesian multiplier effects only arise in a model that ignores the forward-looking behavioral response of consumers and firms. Using a multi-country model, we find that spillovers between euro area countries are negligible or even negative, because direct demand effects are offset by the indirect effect of euro appreciation.
    Keywords: crowding-out; fiscal policy; fiscal stimulus; government spending multipliers; New-Keynesian models
    JEL: E62 E63 H31
    Date: 2009–08
  12. By: Daniel Leigh
    Abstract: This paper investigates how monetary policy can help ward off a protracted deflationary slump when policy rates are near the zero bound by studying the experience of Japan during the "Lost Decade" which followed the asset-price bubble collapse in the early 1990s. Estimation results based on a structural model suggest that the Bank of Japan's interest-rate policy fits a conventional forward-looking reaction function with an inflation target of about 1 percent. The disappointing economic performance thus seems primarily due to a series of adverse economic shocks rather than an extraordinary policy error. In addition, counterfactual policy simulations based on the estimated structural model suggest that simply raising the inflation target would not have yielded a lasting improvement in performance. However, a price-targeting rule or a policy rule that combined a higher inflation target with a more aggressive response to output would have achieved superior stabilization results.
    Keywords: Deflation , Economic stabilization , Economic models , External shocks , Inflation targeting , Interest rate policy , Monetary policy ,
    Date: 2009–10–23
  13. By: Pau Rabanal; Prakash Kannan; Alasdair Scott
    Abstract: We argue that a stronger emphasis on macrofinancial risk could provide stabilization benefits. Simulations results suggest that strong monetary reactions to accelerator mechanisms that push up credit growth and asset prices could help macroeconomic stability. In addition, using a macroprudential instrument designed specifically to dampen credit market cycles would also be useful. But invariant and rigid policy responses raise the risk of policy errors that could lower, not raise, macroeconomic stability. Hence, discretion would be required.
    Keywords: Asset prices , Capital markets , Central banks , Credit controls , Credit demand , Credit risk , Economic models , External shocks , Household credit , Housing prices , Monetary policy , Price increases ,
    Date: 2009–09–23
  14. By: Bilbiie, Florin Ovidiu
    Abstract: This paper shows that absent a commitment technology, central banks can nevertheless achieve the (timeless-)optimal commitment equilibrium if they are delegated with an objective function that is different from the societal one. In a prototypical forward-looking New Keynesian model, I develop a general linear-quadratic method to solve for the optimal delegation parameters that generate the optimal amount of inertia in a Markov-perfect equilibrium. I study the optimal design of some policy regimes that are nested within this framework: inflation, output-gap growth and nominal income growth targeting; and inflation and output-gap contracts. Notably, since the timeless-optimal equilibrium is time-consistent, so is any delegation scheme that implements it.
    Keywords: inflation, output gap growth and nominal income growth targeting.; discretion and commitment; inertia; optimal delegation; stabilization bias; time inconsistency; timeless-optimal policy
    JEL: C61 C73 E31 E52 E61
    Date: 2009–10
  15. By: Gust, Christopher; López-Salido, J David
    Abstract: We develop a DSGE model in which monetary policy generates endogenous movements in risk. The key feature of our model is that households rebalance their financial portfolio allocations infrequently, as they face a fixed cost of transferring cash across accounts. We show that the model can account for the mean returns on equity and the risk-free rate,and generates countercyclical movements in the equity premium that help explain the response of stock prices to monetary shocks. While stimulative monetary policy can lower risk in equity markets, it is also associated with higher inflation expectations and inflation risk premia. The model gives rise to periods in which the zero lower bound constraint on the nominal interest rate binds and demand for liquidity jumps, leading to procyclical movements in velocity.
    Keywords: equity premium; monetary policy; velocity
    JEL: E44 E52
    Date: 2009–08
  16. By: Martin Mandler (University of Giessen, Department of Economics and Business, Licher Straße 62, D-35394 Gießen)
    Abstract: This paper shows how to estimate forecast uncertainty about future short-term interest rates by combining a time-varying Taylor rule with an unobserved components model of economic fundamentals. Using this model I separate interest rate uncertainty into economically meaningful components that represent uncertainty about future economic conditions and uncertainty about future monetary policy. Results from estimating the model on U.S. data suggest important changes in uncertainty about future short-term interest rates over time and highlight the relative importance of the different elements which underlie interest rate uncertainty for the U.S.
    Keywords: Monetary policy, reaction functions, state-space models, output-gap forecasts, inflation forecasts
    JEL: E52 C32 C53
    Date: 2009
  17. By: De Fiore, Fiorella; Teles, Pedro; Tristani, Oreste
    Abstract: How should monetary policy respond to changes in financial conditions? In this paper we consider a simple model where firms are subject to idyosincratic shocks which may force them to default on their debt. Firms' assets and liabilities are denominated in nominal terms and predetermined when shocks occur. Monetary policy can therefore affect the real value of funds used to finance production. Furthermore, policy affects the loan and deposit rates. We find that maintaining price stability at all times is not optimal; that the optimal response to adverse financial shocks is to lower interest rates, if not at the zero bound, and engineer a short period of inflation; that the Taylor rule may implement allocations that have opposite cyclical properties to the optimal ones.
    Keywords: bankruptcy costs; debt deflation; Financial stability; optimal monetary policy; price level volatility; stabilization policy.
    JEL: E20 E44 E52
    Date: 2009–08
  18. By: Jorge Restrepo; Carlos Garcia; Scott Roger
    Abstract: This paper uses a DSGE model to examine whether including the exchange rate explicitly in the central bank's policy reaction function can improve macroeconomic performance. It is found that including an element of exchange rate smoothing in the policy reaction function is helpful both for financially robust advanced economies and for financially vulnerable emerging economies in handling risk premium shocks. As long as the weight placed on exchange rate smoothing is relatively small, the effects on inflation and output volatility in the event of demand and cost-push shocks are minimal. Financially vulnerable emerging economies are especially likely to benefit from some exhange rate smoothing because of the perverse impact of exchange rate movements on activity.
    Keywords: Central bank policy , Demand , Developing countries , Economic models , Exchange rates , External shocks , Inflation targeting , Monetary policy , Risk premium ,
    Date: 2009–10–26
  19. By: Peter Tillmann (Justus Liebig University Gießen, Department of Economics, Licher Straße 62, D-35394 Gießen)
    Abstract: This note uncovers the Phillips curve trade-off perceived by U.S. monetary policymakers. For that purpose we use data on individual forecasts for unemployment and inflation submitted by each individual FOMC member, which was recently made available for the period 1992-1998. The results point to significant changes in the perceived trade-off over time with the Phillips curve flattening and the implied NAIRU falling towards the second half of the sample. Hence, the results suggest that policymakers were aware of these changes in real-time.
    Keywords: inflation forecast, NAIRU, Phillips curve, monetary policy, Federal Reserve
    JEL: E43 E52
    Date: 2009
  20. By: Jensen, Henrik
    Abstract: No. I demonstrate that econometric estimations of nominal interest rate rules may tell little, if anything, about an economy's determinacy properties. In particular, correct inference about the interest-rate response to inflation provides no information about determinacy. Instead, it could reveal whether optimal monetary policymaking is performed under discretion or commitment.
    Keywords: Equilibrium determinacy; Estimated Taylor rules; Interest rate rules; Monetary policy; Rules vs. discretion.
    JEL: E52 E58
    Date: 2009–11
  21. By: Siregar, Reza
    Abstract: Pushing for a higher and a more robust growth while maintaining price stability within a target range of inflation continue to be core tasks for the macroeconomic policy management in Indonesia in recent years. Whilst inflation was successfully kept below the target of 7 percent at the end of 2007, the monthly year on year inflation has already gone above 10 percent by May 2008 and is expected to reach 11 percent by end of 2008. Fiscal policy continues to be relatively marginalized and lacks of stimulus, with a significant share of the current expenditure of the 2008 budget has to be allocated to finance subsidy and debt service. Our study investigates the commitment of the country to its inflation targeting (IT) policy in the midst of fiscal constraint and the urgent need to push for higher growth rate. It examines preliminary outcomes of the IT policy and highlights dilemmas and potential policy trade-offs.
    Keywords: Inflation Targeting Policy; Expenditure Policy; Inflation; and Fiscal Constraint
    JEL: E62 E31 E52
    Date: 2009–01–30
  22. By: Cuche-Curti, Nicolas A. (Swiss National Bank); Dellas, Harris (University of Bern); Natal, Jean-Marc (Swiss National Bank)
    Abstract: This paper presents a DSGE (dynamic stochastic general equilibrium) model of the Swiss economy used since 2007 in the monetary policy decision process at the Swiss National Bank. In addition to forecasting the likely course of main macro variables under various scenarios for the Swiss economy, the model DSGE-CH serves as a laboratory for studying business cycles and examining the effects of actual and hypothetical monetary policies. The microfounded model DSGE-CH represents Switzerland as a small open economy with optimizing economic agents facing several real and nominal rigidities and exogenous foreign and domestic shocks. The comparison of the model’s implications with the real world indicates that DSGE-CH performs well along standard dimensions. It captures the overall stochastic structure of the Swiss economy as represented by the moments of its key macroeconomic variables; furthermore, it has appropriate dynamic properties, as judged by its impulse response functions. Finally, it quite accurately replicates the historical path of major Swiss variables.
    Keywords: DSGE; forecasting; small open economy; Switzerland
    JEL: E27 E52 E58
    Date: 2009–10–01
  23. By: Ahmadi, Pooyan Amir; Ritschl, Albrecht
    Abstract: The prominent role of monetary policy in the U.S. interwar depression has been conventional wisdom since Friedman and Schwartz [1963]. This paper presents evidence on both the surprise and the systematic components of monetary policy between 1929 and 1933. Doubts surrounding GDP estimates for the 1920s would call into question conventional VAR techniques. We therefore adopt the FAVAR methodology of Bernanke, Boivin, and Eliasz [2005], aggregating a large number of time series into a few factors and inserting these into a monetary policy VAR. We work in a Bayesian framework and apply MCMC methods to obtain the posteriors. Employing the generalized sign restriction approach toward identification of Amir Ahmadi and Uhlig [2008], we find the effects of monetary policy shocks to have been moderate. To analyze the systematic policy component, we back out the monetary policy reaction function and its response to aggregate supply and demand shocks. Results broadly confirm the Friedman/Schwartz view about restrictive monetary policy, but indicate only moderate effects. We further analyze systematic policy through conditional forecasts of key time series at critical junctures, taken with and without the policy instrument. Effects are again quite moderate. Our results caution against a predominantly monetary interpretation of the Great Depression.
    Keywords: Bayesian FAVAR; Dynamic Factor Model; Friedman Schwartz Hypothesis; Great Depression; Monetary policy
    JEL: C11 C53 E37 E47 E52 N12
    Date: 2009–11
  24. By: Michael Kumhof; Douglas Laxton
    Abstract: The effectiveness of recent fiscal stimulus packages significantly depends on the assumption of non-Ricardian savings behavior. We show that, under the same assumption, fiscal deficits can have worrisome implications if they turn out to be permanent. First, if they occur in large countries they significantly raise the world real interest rate. Second, they cause a short run current account deterioration equal to around 50 percent of the fiscal deficit deterioration. Third, the longer run current account deterioration equals almost 75 percent for a large economy such as the United States, and almost 100 percent for a small open economy.
    Keywords: Budget deficits , Business cycles , Current account deficits , Economic models , Fiscal policy , Fiscal sustainability , Gross domestic product , Monetary policy , Private sector , Public debt , Savings ,
    Date: 2009–10–28
  25. By: Jermann, Urban; Quadrini, Vincenzo
    Abstract: In this paper we document the cyclical properties of U.S. firms' financial flows. Equity payouts are procyclical and debt payouts are countercyclical. We develop a model with explicit roles for debt and equity financing and explore how the observed dynamics of real and financial variables are affected by `financial shocks', that is, shocks that affect the firms' capacity to borrow. Standard productivity shocks can only partially explain the movements in real and financial variables. The addition of financial shocks brings the model much closer to the data. The recent events in the financial sector show up clearly in our model as a tightening of firms' financing conditions causing the GDP decline in 2008-09. Our analysis also suggests that the downturns in 1990-91 and 2001 were strongly influenced by changes in credit conditions.
    Keywords: business cycle; debt and equity; Financial frictions
    JEL: E32 G10
    Date: 2009–09
  26. By: Rangan Gupta (Department of Economics, University of Pretoria); Alain Kabundi (Department of Economics and Econometrics, University of Johannesburg); Mampho P. Modise (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa)
    Abstract: This paper assesses the impact of a monetary policy shock on 15 key macroeconomic variables of South Africa, in the pre- and post-inflation targeting periods. For this purpose, we use a Factor-Augmented Vector Autoregressive (FAVAR) model comprising of 107 monthly time series over two equal sub-samples of 1989:01-1997:12 and 2000:01-2008:12. The results, based on impulse response functions, are in line with economic theory and indicate no puzzling effects often observed with small-scale monetary Vector Autoregressive (VAR) models. More importantly, we find that the ability of monetary policy in affecting key macroeconomic variables, including inflation, has increased in the post-targeting period. But, majority of the effects are insignificant, which could, however, also be due to the shorter-lengths of the sub-samples relative to the number of variables used in this study, rather than depicting the inability of monetary policy to significantly affect the South African economy.
    Keywords: Monetary Policy Shock, Inflation Targeting, Impulse Response Functions, FAVAR
    JEL: C32 E52 E58
    Date: 2009–11
  27. By: Richard Anton Braun (Faculty of Economics, University of Tokyo); Tomoyuki Nakajima (Institute of Economic Research, Kyoto University)
    Abstract: This paper considers the properties of an optimal monetary policy when households are subject to countercyclical uninsured income shocks. We develop a tractable incompletemarkets model with Calvo price setting. Incomplete markets creates a new distortion and that distortion is large in the sense that the welfare cost of business cycles is large in our model. Nevertheless, the optimal monetary policy is very similar to the optimal policy that emerges in the representative agent framework and calls for nearly complete stabilization of the price-level.
    Date: 2009–10
  28. By: Weise, Charles L.
    Abstract: This paper argues that the Federal Reserve’s failure to control inflation during the 1970s was due to constraints imposed by the political environment. Members of the Fed understood that a serious attempt to tackle inflation would be unpopular with the public and would generate opposition from Congress and the Executive branch. The result was a commitment to the policy of gradualism, under which the Fed would attempt to reduce inflation with mild policies that would not trigger an outright recession, and premature abandonment of anti-inflation policies at the first sign of recession. Alternative explanations, in particular misperceptions of the natural rate of unemployment and misunderstandings of the nature of inflation, do not provide a complete explanation for Fed policy at key turning points during the Great Inflation. Evidence for this explanation of Fed behavior is found in Minutes and Transcripts of FOMC meetings and speeches of Fed chairmen. Empirical analysis verifies that references to the political environment at FOMC meetings are correlated with the stance of monetary policy during this period.
    Keywords: Great Inflation; Federal Reserve; monetary policy
    JEL: N1 E5 E6
    Date: 2009–10–10
  29. By: D Agostino, Antonello; Gambetti, Luca; Giannone, Domenico
    Abstract: The aim of this paper is to assess whether explicitly modeling structural change increases the accuracy of macroeconomic forecasts. We produce real time out-of-sample forecasts for inflation, the unemployment rate and the interest rate using a Time-Varying Coefficients VAR with Stochastic Volatility (TV-VAR) for the US. The model generates accurate predictions for the three variables. In particular for inflation the TV-VAR outperforms, in terms of mean square forecast error, all the competing models: fixed coefficients VARs, Time-Varying ARs and the naïve random walk model. These results are also shown to hold over the most recent period in which it has been hard to forecast inflation.
    Keywords: Forecasting; Inflation; Stochastic Volatility; Time Varying Vector Autoregression
    JEL: C32 E37 E47
    Date: 2009–11
  30. By: Benk, Szilárd; Gillman, Max; Kejak, Michal
    Abstract: The paper shows that US GDP velocity of M1 money has exhibited long cycles around a 1.25% per year upward trend, during the 1919-2004 period. It explains the velocity cycles through shocks constructed from a DSGE model and annual time series data (Ingram et al., 1994). Model velocity is stable along the balanced growth path, which features endogenous growth and decentralized banking that produces exchange credit. Positive shocks to credit productivity and money supply increase velocity, as money demand falls, while a positive goods productivity shock raises temporary output and velocity. The paper explains such velocity volatility at both business cycle and long run frequencies. With filtered velocity turning negative, starting during the 1930s and the 1987 crashes, and again around 2003, results suggest that the money and credit shocks appear to be more important for velocity during less stable times and the goods productivity shock more important during stable times.
    Keywords: business cycle; credit shocks; velocity; Volatility
    JEL: E13 E32 E44
    Date: 2009–11
  31. By: Mertens, Karel; Ravn, Morten O.
    Abstract: We provide empirical evidence on the dynamic effects of tax liability changes in the United States. We distinguish between surprise and anticipated tax changes using a timing-convention. We document that pre-announced but not yet implemented tax cuts give rise to contractions in output, investment and hours worked while real wages increase. In contrast, there are no significant anticipation effects on aggregate consumption. Implemented tax cuts, regardless of their timing, have expansionary and persistent effects on output, consumption, investment, hours worked and real wages. Results are shown to be very robust. We argue that tax shocks are empirically important impulses to the U.S. business cycle and that anticipation effects have been important during several business cycle episodes.
    Keywords: anticipation effects; business cycles; fiscal policy; tax liabilities
    JEL: E20 E32 E62 H30
    Date: 2009–07
  32. By: Alain N. Kabundi; Deniz Igan; Marcelo Pinheiro; Francisco Nadal-De Simone; Natalia T. Tamirisa
    Abstract: We examine the characteristics and comovement of cycles in house prices, credit, real activity and interest rates in advanced economies during the past 25 years, using a dynamic generalized factor model. House price cycles generally lead credit and business cycles over the long term, while in the short to medium term the relationship varies across countries. Interest rates tend to lag other cycles at all time horizons. While global factors are important, the U.S. business cycle, house price cycle and interest rate cycle generally lead the respective cycles in other countries over all time horizons, while the U.S. credit cycle leads mainly over the long term.
    Keywords: Bank credit , Business cycles , Credit demand , Cross country analysis , Developed countries , Economic growth , Economic models , Household credit , Housing prices , Interest rates , Time series ,
    Date: 2009–10–22
  33. By: Beetsma, Roel; Giuliodori, Massimo
    Abstract: This article provides an overview of recent research into the macroeconomic costs and benefits of monetary unification. We are primarily interested in Europe’s monetary union. Given that unification entails the loss of a policy instrument its potential benefits have to be found elsewhere. Unification may serve as a vehicle for beneficial institutional changes. In particular, it may be a route towards an independent monetary policy, which alleviates the scope for political pressure to relax monetary policy. Unification also eliminates harmful monetary policy spill-overs and competitive devaluations. We explore how disagreement between the monetary and fiscal authorities about their policy objectives can lead to extreme macroeconomic outcomes. Further, we pay considerable attention to the desirability (or not) of fiscal constraints and fiscal coordination in a monetary union. Monetary commitment and fiscal free-riding play a key role in this regard. Similar free-riding issues also feature prominently in the analysis of how unification influences structural reforms. We end with a brief discussion of monetary unification outside Europe. The cost-benefit trade-off of unification may differ substantially between industrialized and less-developed countries, where differences in fiscal needs and, hence, the reliance on seigniorage revenues may dominate the scope for unification.
    Keywords: credibility; EMU; euro; exchange rates; fiscal constraints; fiscal policy; structural reforms
    JEL: E5 E6 F4
    Date: 2009–10
  34. By: Karel Mertens (Cornell University); Morten O. Ravn (University College London; University of Southampton; CEPR)
    Abstract: The authors provide empirical evidence on the dynamic effects of tax liability changes in the United States. We distinguish between surprise and anticipated tax changes using a timing convention. We document that pre-announced but not yet implemented tax cuts give rise to contractions in output, investment and hours worked, while real wages increase. In contrast, there are no significant anticipation effects on aggregate consumption. Implemented tax cuts, regardless of their timing, have expansionary and persistent effects on output, consumption, investment, hours worked and real wages. The findings are shown to be very robust. We argue that tax shocks are empirically important impulses to the US business cycle and that anticipation effects have been significant over several business cycle episodes
    Keywords: fiscal policy shocks, tax liabilities, anticipation effects, business cycles
    JEL: E20 E32 E62 H30
    Date: 2009–11
  35. By: Lee, Kevin; Olekalns, Nils; Shields, Kalvinder K
    Abstract: A canonical model is described which reflects the real-time informational context of decision-making. Comparisons are drawn with ‘conventional’ models that incorrectly omit market-informed insights on future macroeconomic conditions and inappropriately incorporate information that was not available at the time. It is argued that conventional models are misspecified and misinterpret news but that these deficiencies will not be exposed either by diagnostic tests applied to the conventional models or by typical impulse response analyses. This is demonstrated through an analysis of quarterly US data 1968q4-2008q4. However, estimated real-time models considerably improve out-ofsample forecasting performance, provide more accurate ‘nowcasts’ of the current state of the macroeconomy and provide more timely indicators of the business cycle. The point is illustrated through an analysis of the US recessions of 1990q3-1991q2 and 2001q1-2001q4 and the most recent experiences of 2008.
    Keywords: Business Cycles; Nowcasting; Real-Time Data; Structural Modelling
    JEL: E52 E58
    Date: 2009–09
  36. By: Favero, Carlo A; Giavazzi, Francesco
    Abstract: We use the time series of shifts in U.S. Federal tax liabilities constructed by Romer and Romer to estimate tax multipliers. Differently from the single-equation approach adopted by Romer and Romer, our estimation strategy (a Var that includes output, government spending and revenues, inflation and the nominal interest rate) does not rely upon the assumption that tax shocks are orthogonal to each other as well as to lagged values of other macro variables. Our estimated multiplier is much smaller: one, rather than three at a three-year horizon. When we split the sample in two sub-samples (before and after 1980) we find, before 1980, a multiplier whose size is never greater than one, after 1980 a multiplier not significantly different from zero. Following the findings in Bohn (1998), we also experiment with a model that includes debt and the non-linear government budget constraint. We find that, while in general not very important, the non-linearity that arises from the budget constraint makes a difference after 1980, when the response of fiscal variables to the level of the debt becomes stronger.
    Keywords: fiscal policy; government budget constraint; public debt; VAR models
    JEL: E62 H60
    Date: 2009–08
  37. By: Keisuke Otsu (Faculty of Liberal Arts, Sophia University (E-mail:
    Abstract: A key feature of the Japanese business cycles over the 1980- 2007 period is that the fluctuation of total hours worked leads the fluctuation of output. A canonical real business cycle model cannot account for this fact. This paper uses the business cycle accounting method introduced by Chari, Kehoe and McGrattan (2007) and shows that labor market distortions are important in accounting for the this feature of the Japanese labor supply fluctuation. I further discuss fundamental economic shocks that manifest themselves as labor wedges and assess their impacts on labor fluctuation.
    Keywords: Business Cycle Accounting, Japanese Labor Market
    JEL: E13 E32
    Date: 2009–11
  38. By: Sven Schreiber (Macroeconomic Policy Institute (IMK) at Hans Boeckler Foundation, Duesseldorf)
    Abstract: We use frequency-wise Granger-causality tests and error-correction models to investigate the driving forces behind longer-run inflation developments in the euro area. Employing an eclectic approach we consider various relevant theories. With a general-to-specific testing strategy we distill the unemployment rate and long-term interest rates as causal for low-frequency variations of inflation. Money growth is found to be causal for inflation only if other variables are omitted, which we therefore interpret as a spurious result.
    Keywords: money growth, Granger causality, quantity theory
    JEL: E31 E40
    Date: 2009
  39. By: Michael Kumhof; Dirk Muir; Charles Freedman; Susanna Mursula; Douglas Laxton
    Abstract: This paper uses the IMF's Global Integrated Monetary and Fiscal Model to compute shortrun multipliers of fiscal stimulus measures and long-run crowding-out effects of higher debt. Multipliers of two-year stimulus range from 0.2 to 2.2 depending on the fiscal instrument, the extent of monetary accommodation and the presence of a financial accelerator mechanism. A permanent 0.5 percentage point increase in the U.S. deficit to GDP ratio raises the U.S. tax burden and world real interest rates in the long run, thereby reducing U.S. and rest of the world output by 0.3-0.6 and 0.2 percent, respectively.
    Date: 2009–11–17
  40. By: Janiak, Alexandre (University of Chile); Monteiro, Paulo Santos (University of Warwick)
    Abstract: We analyze the welfare cost of inflation in a model with cash-in-advance constraints and an endogenous distribution of establishments' productivities. Inflation distorts aggregate productivity through firm entry dynamics. The model is calibrated to the United States economy and the long-run equilibrium properties are compared at low and high inflation. We find that, when the period over which the cash-in-advance constraint is binding is one quarter, an annual inflation rate of 10 percent leads to a decrease in the steady-state average productivity of roughly 0.5 percent compared to the optimum's steady-state. This decrease in productivity is not innocuous: it leads to a doubling of the welfare cost of inflation.
    Keywords: firm dynamics, productivity, inflation, welfare
    JEL: E40 E50 L16 O40
    Date: 2009–11
  41. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: This paper studies whether the central bank should adjust its inflation target to account for the systematic upward bias in measured inflation due to quality improvements in consumption goods. We show that the answer to this question depends on what prices are assumed to be sticky. If nonquality-adjusted prices are assumed to be sticky, then the inflation target should not be corrected. If, on the other hand, quality-adjusted (or hedonic) prices are assumed to be sticky, then the inflation target should be raised by the magnitude of the bias.
    Keywords: Inflation Targets; Quality Bias; Ramsey Policy
    JEL: E52 E6
    Date: 2009–11
  42. By: Charles Brendon
    Abstract: This paper investigates how best to determine time-invariant policy rules in macroeconomic models with forward-looking constraints, where fully optimal policy is known to be time-inconsistent. It proposes a new ‘coefficient optimisation’ approach that improves upon the timeless perspective method of Woodford (2003) in deterministic problems, and on average in stochastic problems, without resorting to asymptotic (‘unconditional’) loss comparisons.
    Keywords: Timeless perspective, Time consistency, Optimal monetary policy, Time-invariant policy
    JEL: E31 E52 E58 E61
    Date: 2009
  43. By: Cúrdia, Vasco; Woodford, Michael
    Abstract: We extend a standard New Keynesian model to incorporate heterogeneity in spending opportunities and two sources of (potentially time-varying) credit spreads, and to allow a role for the central bank's balance sheet in equilibrium determination. We use the model to investigate the implications of imperfect financial intermediation for familiar monetary policy prescriptions, and to consider additional dimensions of central-bank policy --- variations in the size and composition of the central bank's balance sheet, and payment of interest on reserves --- alongside the traditional question of the proper choice of an operating target for an overnight policy rate. We also give particular attention to the special problems that arise when the zero lower bound for the policy rate is reached. We show that it is possible to provide criteria for the choice of policy along each of these possible dimensions, within a single unified framework, and to provide policy prescriptions that apply equally when financial markets work efficiently and when they are subject to substantial disruptions, and equally when the zero bound is reached and when it is not a concern.
    Keywords: credit frictions; credit spread; interest on reserves; quantitative easing
    JEL: E52
    Date: 2009–10
  44. By: Dieter Nautz; Jan Scheithauer
    Abstract: Overnight money market rates are the predominant operational target of monetary policy. As a consequence, central banks have re- designed the implementation of monetary policy to keep the deviations of the overnight rate from the key policy rate small and short-lived. This paper uses fractional integration techniques to explore how the operational framework of four major central banks affects the persis- tence of overnight rates. Our results suggest that a well-communicated and transparent interest rate target of the central bank is a particu- larly important condition for a low degree of overnight rate persistence.
    Keywords: Controllability and Persistence of Interest Rates; Oper- ational Framework of Central Banks; Long Memory and Fractional Integration
    JEL: E52 C22
    Date: 2009–11
  45. By: Farmer, Roger E A
    Abstract: This paper uses a model with a continuum of equilibrium unemployment rates to explore the effectiveness of fiscal policy. The existence of multiple steady states is explained by a model of costly search and recruiting that leads to a situation of bilateral monopoly. Using this framework, I explain the current financial crisis as a shift to a high unemployment equilibrium, induced by the self-fulfilling beliefs of market participants about asset prices. Using this model, I ask two questions. 1) Can fiscal policy help us out of the crisis? 2) Is there an alternative to fiscal policy that is less costly and more effective? The answer to both questions is yes.
    Keywords: Financial crisis; Fiscal policy; Unemployment
    JEL: E24 E44
    Date: 2009–11
  46. By: V. LEWIS
    Abstract: This paper characterises optimal short-run monetary policy in an economy with monopolistic competition, endogenous firm entry, a cash-in-advance constraint and preset wages. Firms must make profits to cover entry costs; thus the markup on goods prices is efficient. However, a distortion results from the absence of a markup on leisure. This distortion affects the investment margin due to the labour requirement in entry. In the absence of fiscal instruments such as labour income subsidies, the optimal monetary policy under sticky wages achieves higher welfare than under flexible wages. The policy maker uses the money supply instrument to raise the real wage - the cost of leisure - above its flexible-wage level, in response to expansionary shocks. This induces a rise in labour hours and more production of goods and new firms.
    Keywords: entry, optimal policy
    JEL: E52 E63
    Date: 2009–08
  47. By: Basak, Suleyman; Yan, Hongjun
    Abstract: This article analyzes the implications of money illusion for investor behavior and asset prices in a securities market economy with inflationary fluctuations. We provide a belief-based formulation of money illusion which accounts for the systematic mistakes in evaluating real and nominal quantities. The impact of money illusion on security prices and their dynamics is demonstrated to be considerable even though its welfare cost on investors is small in typical environments. A money-illusioned investor's real consumption is shown to generally depend on the price level, and specifically to decrease in the price level. A general-equilibrium analysis in the presence of money illusion generates implications that are consistent with several empirical regularities. In particular, the real bond yields and dividend price ratios are positively related to expected inflation, the real short rate is negatively correlated with realized inflation, and money illusion may induce predictability and excess volatility in stock returns. The basic analysis is generalized to incorporate heterogeneous investors with differing degrees of illusion.
    Keywords: Asset Pricing; Bounded Rationality; Equilibrium; Expected Inflation; Money Illusion; New Keynesian
    JEL: C60 D50 D90 G12
    Date: 2009–08
  48. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: More than half of U.S. currency circulates abroad. As a result, much of the seignorage income of the United States is generated outside of its borders. In this paper we characterize the Ramsey-optimal rate of inflation in an economy with a foreign demand for its currency. In the absence of such demand, the model implies that the Friedman rule---deflation at the real rate of interest---maximizes the utility of the representative domestic consumer. We show analytically that once a foreign demand for domestic currency is taken into account, the Friedman rule ceases to be Ramsey optimal. Calibrated versions of the model that match the range of empirical estimates of the size of foreign demand for U.S. currency deliver Ramsey optimal rates of inflation between 2 and 10 percent per year. The domestically benevolent government finds it optimal to impose an inflation tax as a way to extract resources from the rest of the world in the form of seignorage revenue.
    Keywords: Foreign demand for Currency; Friedman Rule; Optimal Inflation Rate
    JEL: E41
    Date: 2009–11
  49. By: Ippei Fujiwara (Director, Institute for Monetary and Economic Studies (currently, Financial Markets Department), Bank of Japan. (E-mail:; Nao Sudo (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:; Yuki Teranishi (Deputy Director, Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:
    Abstract: How should monetary policy cooperation be designed when more than one country simultaneously faces zero lower bounds on nominal interest rates? To answer this question, we examine monetary policy cooperation with both optimal discretion and commitment policies in a two- country model. We reach the following conclusions. Under discretion, monetary policy cooperation is characterized by the intertemporal elasticity of substitution (IES), a key parameter measuring international spillovers, and no history dependency. On the other hand, under commitment, monetary policy features history dependence with international spillover effects.
    Keywords: Optimal Monetary Policy Cooperation, Zero Lower Bound
    JEL: E52 F33 F41
    Date: 2009–11
  50. By: Keisuke Otsu (Faculty of Liberal Arts, Sophia University (E-mail:
    Abstract: In this paper, I extend the business cycle accounting method a la Chari, Kehoe and McGrattan (2007) to a two-country international business cycle model and quantify the effect of the disturbances in relevant markets on the business cycle correlation between Japan and the US over the 1980-2008 period. This paper finds that disturbances in the labor market and production efficiency are important in accounting for the recent increase in the cross-country output correlation. If international financial market integration is important for considering the recent increase in cross-country output correlation, it must operate through an increase in the cross-country correlation of disturbances in the labor market and production efficiency, and not in the domestic investment market.
    Keywords: Business Cycle Accounting, International Business Cycles
    JEL: E32 F41
    Date: 2009–11
  51. By: Mertens, Karel; Ravn, Morten O.
    Abstract: We evaluate the extent to which a dynamic stochastic general equilibrium model can account for the impact of "surprise" and "anticipated" tax shocks estimated from U.S. time-series data. In U.S. data, surprise tax cuts have expansionary and persistent effects on output, consumption, investment and hours worked. Anticipated tax liability tax cuts give rise to contractions in output, investment and hours worked before their implementation while thereafter giving rise to an economic expansion. A DSGE model with changes in tax rates that may be anticipated or not, is shown to be able to account for the empirically estimated impact of tax shocks. The important features of the model include adjustment costs, variable capacity utilization and consumption habits. We derive Hicksian decompositions of the consumption and labor supply responses and show that substitution effects are key for understanding the impact of tax shocks. When allowing for rule-of-thumb consumers, we find that the estimate of their share of the population is only around 10-11 percent.
    Keywords: anticipation effects; fiscal policy; structural estimation; tax liabilities
    JEL: E20 E32 E62 H30
    Date: 2009–10
  52. By: Raphael A. Espinoza; Fabio Fornari; Marco Lombardi
    Abstract: The U.S. business cycle typically leads the European cycle by a few quarters and this can be used to forecast euro area GDP. We investigate whether financial variables carry additional information. We use vector autoregressions (VARs) which include the U.S. and the euro area GDPs as a minimal set of variables as well as growth in the Rest of the World (an aggregation of seven small countries) and selected combinations of financial variables. Impulse responses (in-sample) show that shocks to financial variables influence real activity. However, according to out-of-sample forecast exercises using the Root Mean Square Error (RMSE) metric, this macro-financial linkage would be weak: financial indicators do not improve short and medium term forecasts of real activity in the euro area, even when their timely availability, relative to GDP, is exploited. This result is partly due to the 'average' nature of the RMSE metric: when forecasting ability is assessed as if in real time (conditionally on the information available at the time of the forecast), we find that models using financial variables would have been preferred, ex ante, in several episodes, in particular between 1999 and 2002. This result suggests that one should not discard, on the basis of RMSE statistics, the use of predictive models that include financial variables if there is a theoretical prior that a financial shock is affecting growth.
    Keywords: Asset prices , Business cycles , Cross country analysis , Economic forecasting , Economic growth , Economic models , Euro Area , Financial crisis , Financial sector , Global Financial Crisis 2008-2009 , Stock markets ,
    Date: 2009–09–14
  53. By: Charles Freedman; Michal Andrle; Danny Hermawan; Haris Munandar; Roberto Garcia-Saltos; Douglas Laxton
    Abstract: This is the fifth of a series of papers that are being written as part of a larger project to estimate a small quarterly Global Projection Model (GPM). The GPM project is designed to improve the toolkit to which economists have access for studying both own-country and cross-country linkages. In this paper, we add Indonesia to a previously estimated small quarterly projection model of the US, euro area, and Japanese economies. The model is estimated with Bayesian techniques, which provide a very efficient way of imposing restrictions to produce both plausible dynamics and sensible forecasting properties.
    Keywords: Economic growth , Economic models , Emerging markets , External shocks , Indonesia , Inflation targeting , Monetary policy ,
    Date: 2009–10–06
  54. By: Fang Yao
    Abstract: This paper uses the Bayesian approach to solve and estimate a New Keynesian model augmented by a generalized Phillips curve, in which the shape of the price reset hazards can be identi…ed using aggregate data. My empirical result shows that a constant hazard function is easily rejected by the data. The empirical hazard function for post-1983 periods in the U.S. is consistent with micro evidence obtained using data from similar periods. The hazard for pre-1983 periods, however, exhibits a remarkable increasing pattern, implying that pricing decisions are characterized by both time- and state-dependent aspects. Additionally, real rigidity plays an important role, but not as big a role as found in empirical studies using limited information methods.
    Keywords: Real rigidity, Nominal rigidity, Hazard function, Bayesian estimation
    JEL: E12 E31
    Date: 2009–11
  55. By: Corsetti, Giancarlo; Meier, André; Müller, Gernot
    Abstract: The global recession of 2008-09 has revived interest in the international repercussions of domestic policy choices. This paper focuses on the case of fiscal stimulus, investigating cross-border spillovers from an increase in exhaustive government spending on the basis of a two-country business cycle model. Our model allows spillovers to be affected by a range of features, including trade elasticities, the size and openness of economies, as well as financial imperfections. Beyond these well-known determinants, however, we highlight the central importance of policy frameworks, notably the medium-term debt consolidation regime. We consider the plausible case in which a temporary debt-financed increase in government spending gives rise to higher future taxes along with some reduction in spending over time. The anticipated spending reversal not only strengthens the domestic stimulus effect but also enhances positive cross-border spillovers through its impact on global long-term interest rates. Thus, our findings lend support to the notion that coordinated short-term stimulus policies are most effective when coupled with credible medium-term consolidation plans featuring at least some spending restraint.
    Keywords: debt consolidation; Fiscal policy; international spillovers; monetary policy
    JEL: E62 F42
    Date: 2009–11
  56. By: Miguel Almunia; Agustín S. Bénétrix; Barry Eichengreen; Kevin H. O'Rourke; Gisela Rua
    Abstract: The Great Depression of the 1930s and the Great Credit Crisis of the 2000s had similar causes but elicited strikingly different policy responses. It may still be too early to assess the effectiveness of current policy responses, but it is possible to analyze monetary and fiscal policies in the 1930s as a “natural experiment” or “counterfactual” capable of shedding light on the impact of recent policies. We employ vector autoregressions, instrumental variables, and qualitative evidence for a panel of 27 countries in the period 1925-1939. The results suggest that monetary and fiscal stimulus was effective – that where it did not make a difference it was not tried. The results also shed light on the debate over fiscal multipliers in episodes of financial crisis. They are consistent with multipliers at the higher end of those estimated in the recent literature, consistent with the idea that the impact of fiscal stimulus will be greater when banking system are dysfunctional and monetary policy is constrained by the zero bound.
    JEL: E63 F16 N10 N27
    Date: 2009–11
  57. By: Krusell, Per; Mukoyama, Toshihiko; Rogerson, Richard; Sahin, Aysegul
    Abstract: Commonly used frictional models of the labor market imply that changes in frictions have large effects on steady state employment and unemployment. We use a model that features both frictions and an operative labor supply margin to examine the robustness of this feature to the inclusion of a empirically reasonable labor supply channel. The response of unemployment to changes in frictions is similar in both models. But the labor supply response present in our model greatly attenuates the effects of frictions on steady state employment relative to the simplest matching model, and two common extensions. We also find that the presence of empirically plausible frictions has virtually no impact on the response of aggregate employment to taxes.
    Keywords: labour market frictions; labour Supply; taxes
    JEL: E24 J22 J64
    Date: 2009–08
  58. By: Giuliano, Paola; Spilimbergo, Antonio
    Abstract: Do generations growing up during recessions have different socio-economic beliefs than generations growing up in good times? We study the relationship between recessions and beliefs by matching macroeconomic shocks during early adulthood with self-reported answers from the General Social Survey. Using time and regional variations in macroeconomic conditions to identify the effect of recessions on beliefs, we show that individuals growing up during recessions tend to believe that success in life depends more on luck than on effort, support more government redistribution, but are less confident in public institutions. Moreover, we find that recessions have a long-lasting effect on individuals’ beliefs.
    Keywords: belief formation; macroeconomic shocks; recession; role of the governement
    JEL: E60 P16 Z13
    Date: 2009–08
  59. By: Den Haan, Wouter; Sedlacek, Petr
    Abstract: Fluctuations in firms' revenues reduce firms' viability and are costly from a social welfare point of view even when agents are risk neutral if (i) the decision to continue operating a firm is not efficient at the margin so that fluctuations shorten firms' life expectancy (because they increase the chance revenue levels are such that discontinuation is unavoidable) and (ii) the shortening of the life expectancy reduces entry. Welfare consequences are large, even for moderate fluctuations: Implied estimates for the per period costs of business cycles can easily be equal to several percentage points of GDP. These estimates are based on a direct measurement of cyclical changes in the value added generated by workers that recently were not employed. This extensive margin measure of the cyclical change in output is of independent interest.
    Keywords: business cycles; frictions
    JEL: E24 E32
    Date: 2009–09
  60. By: Mika Saito; Daehaeng Kim
    Abstract: A zero net domestic financing (NDF) target has served Tanzania well in recent years, contributing to prudent expenditure policy, improved fiscal sustainability, and macroeconomic stability. Moving to a more flexible fiscal policy, however, may serve Tanzania better. The "diamond rule" proposed in this paper incorporates a permanent hard ceiling on debt and annual benchmark limits on NDF, expenditure growth, and nonconcessional external financing. This rule would provide flexibility for countercyclical policy and help define the fiscal space for infrastructure spending that is consistent with longrun fiscal sustainability. An illustrative simulation shows that Tanzania has considerable fiscal space for development spending.
    Keywords: Budgetary policy , Budgeting , Cross country analysis , Debt sustainability , External borrowing , External debt , Fiscal policy , Fiscal sustainability , Government expenditures , Public investment , Revenues , Tanzania ,
    Date: 2009–11–09
  61. By: Pedersen, Lasse Heje
    Abstract: The dangers of shouting ``fire'' in a crowded theater are well understood, but the dangers of rushing to the exit in the financial markets are more complex. Yet, the two events share several features, and I analyze why people crowd into theaters and trades, why they run, what determines the risk, whether to return to the theater or trade when the dust settles, and how much to pay for assets (or tickets) in light of this risk. These theoretical considerations shed light on the recent global liquidity crisis and, in particular, the quant event of 2007.
    Keywords: asset pricing; crisis; liquidity risk; quant; risk management; run; unconventional monetary policy
    JEL: E2 E44 E52 G1 G11 G12 G2
    Date: 2009–08
  62. By: Shigenori Shiratsuka (Associate Institute for Monetary and Economic Studies, Bank of Japan (
    Abstract: This paper re-examines Japanfs experience of the quantitative easing policy in light of the policy responses against the current financial and economic crisis. Central banks use various unconventional measures in the range of financial assets being purchased and in the scale of such purchases. As the scope of such unconventional measures expands, it is often emphasized that the U.S. Federal Reserve policy reactions focus more on the asset side of its balance sheet, the so- called credit easing. By contrast, the Bank of Japanfs quantitative easing policy from 2001 to 2006 set a target for the current account balances, the liability side of its balance sheet. It is crucial to understand that central banks combine the two elements of their balance sheets, size and composition, to enhance the overall effects of unconventional policy measures, given constraints on policy implementation.
    Keywords: Quantitative easing, Credit easing, Unconventional monetary policy, Central bank balance sheet
    JEL: E44 E52 E58
    Date: 2009–11
  63. By: Krusell, Per; Mukoyama, Toshihiko; Rogerson, Richard; Sahin, Aysegul
    Abstract: We develop a simple model featuring search frictions and a nondegenerate labor supply decision along the extensive margin. The model is a standard version of the neoclassical growth model with indivisible labor with idiosyncratic shocks and frictions characterized by employment loss and employment opportunity arrival shocks. We argue that it is able to account for the key features of observed labor market flows for reasonable parameter values. Persistent idiosyncratic productivity shocks play a key role in allowing the model to match the persistence of the employment and out of the labor force states found in individual labor market histories.
    Keywords: Labor Market Frictions; Labor Supply; Taxes
    JEL: E24 J22 J64
    Date: 2009–08
  64. By: Guerrieri, Luca; Gust, Christopher; López-Salido, J David
    Abstract: We develop and estimate an open economy New Keynesian Phillips curve (NKPC) in which variable demand elasticities give rise to movements in desired markups in response to changes in competitive pressure from abroad. A parametric restriction on our specification yields the standard NKPC, in which the elasticity is constant, and there is no role for foreign competition to influence domestic inflation. By comparing the unrestricted and restricted specifications, we provide evidence that foreign competition plays an important role in accounting for the behavior of inflation in the traded goods sector. Our estimates suggest that foreign competition accounted for more than half of a 4 percentage point decline in domestic goods inflation in the 1990s. Our results also provide evidence against demand curves with a constant elasticity in the context of models of monopolistic competition.
    Keywords: inflation; New Keynesian Phillips curve; variable markups
    JEL: E31 E32 F41
    Date: 2009–11
  65. By: Till van Treeck (IMK at the Hans Boeckler Foundation)
    Abstract: In recent years, the interdisciplinary literature on financialisation has become one of the most quickly developing areas in the social sciences, including (Post Keynesian) macroeconomics. We discuss the relevance of the financialisation hypothesis in a non-technical manner from a macroeconomic perspective. Our interpretation of financialisation allows one to analyse the fundamental changes that the US and other economies have undergone over the past three decades or so. In particular, it helps to understand how the US economy has turned from a "debt-led" system, combining relatively weak physical investment activity, strong consumer spending, high income inequality and increasing indebtedness of firms and private households, to a "debt-burdened" system. In light of the current world economic crisis, the Keynesian financialisation hypothesis now seems to be increasingly shared among policy makers and economists.
    Date: 2009
  66. By: Marimon, Ramon; Nicolini, Juan Pablo; Teles, Pedro
    Abstract: We study the interplay between competition and trust as efficiency-enhancing mechanims in the private provision of money. With commitment, trust is automatically achieved and competition ensures efficiency. Without commitment, competition plays no role. Trust does play a role but requires a lower bound on efficiency. Stationary inflation must be positive and, therefore, the Friedman rule cannot be achieved. The quality of money can only be observed after its purchasing capacity is realized. In that sense money is an experience good. We show that the two problems, the time-inconsistency in the private provision of money and moral-hazard in the provision of experience goods, are isomorphic, and therefore the same results are attained in both settings.
    Keywords: Currency competition; Experience goods; Inflation; Trust
    JEL: E40 E50 E58 E60
    Date: 2009–08
  67. By: Hiroshi Fujiki (Associate Director-General and Senior Monetary Affairs Department, Bank of Japan (E-mail: hiroshi.fujiki; Migiwa Tanaka (Assistant Professor, Department of Economics, School of Business and Management, The Hong Kong University of Science and Technology (E-mail:
    Abstract: Accurate information on money demand is essential for evaluation of monetary policy. In this regard, it is important to study the effect of financial innovation to money demand. We investigate the effect of a new form of such technology, electronic money, to money demand. Specifically, we estimate currency demand functions conditional on electronic money adoption using unique household-level survey data from Japan. We obtain the following results. First, currency demand indicates that average cash balances do not decrease with the adoption of electronic money. Rather, it seems to increase under some specifications. Second, households at the lowest quantile of the cash balance distribution tend to have higher cash balances after adopting of electronic money. These findings indicate that consumers do not significantly substitute cash holding with e-money holding despite the rapid diffusion of electronic money among households.
    Keywords: Currency Demand, Transaction Demands for Money, Electronic Money
    JEL: E41
    Date: 2009–11
  68. By: Corchon, Luis
    Abstract: In this paper we present a fixprice model in which private and public consumption show some degree of substitution. We offer formulae for the Keynesian multiplier which depend on this degree of substitution. We also show that there is a Pigou effect and that, sometimes, this effect is larger than the Keynesian multiplier.
    Keywords: Disequilibrium Multiplier Pigou Effect
    JEL: E62 E12
    Date: 2009–04–21
  69. By: Den Haan, Wouter; Sterk, Vincent
    Abstract: Financial innovation is widely believed to be at least partly responsible for the recent financial crisis. At the same time, there are empirical and theoretical arguments that support the view that changes in financial markets played a role in the "great moderation". If both are true, then the price of reducing the likelihood of another crisis, e.g., through new regulation, could be giving up another episode of sustained growth and low volatility. However, this paper questions empirical evidence supporting the view that innovation in consumer credit and home mortgages reduced cyclical variations of key economic variables. We find that especially the behaviour of aggregate home mortgages changed less during the great moderation than is typically believed. For example, aggregate home mortgages declined during monetary tightenings, both before and during the great moderation. A remarkable change we do find is that monetary tightenings became episodes during which financial institutions other than banks increased their holdings in mortgages. Once can question the desirability of such strong substitutions of ownership during economic downturns.
    Keywords: consumer credit; impulse response functions; mortgages
    JEL: E32 E44 G21
    Date: 2009–10
  70. By: Abdul Abiad; Daniel Leigh; Irina Tytell; Ravi Balakrishnan; Petya Koeva Brooks
    Abstract: This paper investigates the medium-term behavior of output following banking crises, and its association with pre- and post-crisis conditions and policies. We find that output tends to be depressed substantially following banking crises, with no rebound to the precrisis trend. However, growth does eventually tend to return to its precrisis rate, with substantial crosscountry variation in outcomes. The depressed path of output typically results from reductions of roughly equal proportions in the employment rate, the capital-to-labor ratio, and total factor productivity. Initial conditions that are strongly associated with medium-run output losses include the short-run change in output, the occurrence of a joint banking-and-currency crisis, and a high precrisis level of investment. Short-run fiscal and monetary stimulus is associated with smaller medium-run deviations of output and growth from the precrisis trend.
    Keywords: Asset management , China, People's Republic of , Governance , Investment policy , Pension funds , Pension supervision , Savings promotion ,
    Date: 2009–11–09
  71. By: Vayanos, Dimitri; Vila, Jean-Luc
    Abstract: We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and risk-averse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles' demand for bonds affect the term structure---and constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitrage-free, demand effects satisfy no-arbitrage restrictions and can be quite different from the underlying shocks. We show that the preferred-habitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to short-rate expectations, the economic role of carry trades, and the transmission of monetary policy.
    Keywords: Bond risk premia; Carry trades; Limited arbitrage; Preferred habitat; Term structure of interest rates
    JEL: E4 E5 G1
    Date: 2009–11
  72. By: Gerald Epstein
    Abstract: <p> As the world financial crisis deepens, the task of generating decent employment has taken on more urgency, yet now faces even more obstacles then before. Of course, a key component of the solution to the current crisis will be massive expansionary fiscal actions on the part of the rich countries, preferably in a coordinated fashion, but individually if necessary. More aid and support from the rich countries and international institutions to the developing world will also be necessary to avoid a very serious, negative shock for the world's poorest and most vulnerable. In the short and medium run, as before the recent crisis, the key will be to generate large scale increases in decent work if developing countries and the world are to avoid a downward spiral into depression. But what macroeconomic policy frameworks should be used to design policies to address this crises both in the short and in the medium terms?   </p><p>What is clear is that to design and carry out these employment-oriented macroeconomic policies, the old neo-libereal orthodoxy must be abandoned, and policy makers must look for other policy frameworks to inform their macroeconomic and financial policies.   </p><p>In this paper, Epstein summarize employment oriented macroeconomic and financial policies that governments in developing countries can adopt to help promote more and better employment as a key to reducing poverty over the medium to long run. </p>
    Date: 2009
  73. By: Cecchetti, Stephen G; Kohler, Marion; Upper, Christian
    Abstract: We study the output costs of 40 systemic banking crises since 1980. Most, but not all, crises in our sample coincide with a sharp contraction in output from which it took several years to recover. Our main findings are as follows. First, the current financial crisis is unlike any others in terms of a wide range of economic factors. Second, the output losses of past banking crises were higher when they were accompanied by a currency crisis or when growth was low at the onset of the crisis. When accompanied by a sovereign debt default, a systemic banking crisis was less costly. And, third, there is a tendency for systemic banking crises to have lasting negative output effects.
    Keywords: Cost of Crisis; Crises; Output loss; Recovery; Systemic Banking Crisis
    JEL: E32 E44
    Date: 2009–11
  74. By: Repullo, Rafael; Saurina, Jesús; Trucharte, Carlos
    Abstract: This paper compares alternative procedures to mitigate the procyclicality of the new risk-sensitive bank capital regulation (Basel II). We estimate a model of the probabilities of default (PDs) of Spanish firms during the period 1987-2008, and use the estimated PDs to compute the corresponding series of Basel II capital requirements per unit of loans. These requirements move significantly along the business cycle, ranging from 7.6% (in 2006) to 11.9% (in 1993). The comparison of the different procedures is based on the criterion of minimizing the root mean square deviations of each smoothed series with respect to the Hodrick-Prescott trend of the original series. The results show that the best procedures are either to smooth the inputs of the Basel II formula by using through-the-cycle PDs or to smooth the output with a multiplier based on GDP growth. Our discussion concludes that the latter is better in terms of simplicity, transparency, and consistency with banks’ risk pricing and risk management systems. For the portfolio of Spanish commercial and industrial loans and a 45% loss given default (LGD), the multiplier would amount to a 6.5% surcharge for each standard deviation in GDP growth. The surcharge would be significantly higher with cyclically-varying LGDs.
    Keywords: Bank capital regulation; Basel II; Business cycles; Credit crunch; Procyclicality
    JEL: E32 G28
    Date: 2009–07
  75. By: Katheryn N. Russ; Diego Valderrama
    Abstract: We join the new trade theory with a model of choice between bank and bond financing to show the differential effects of financial policy on the distribution of firm size, welfare, aggregate output, gains from trade, and the real exchange rate in a small open economy. Increasing bank efficiency and reducing bond transaction costs both increase welfare but have opposite effects on the extensive margin of trade, aggregate exports, and the real exchange rate. Increasing the degree of trade openness increases firms' relative demand for bond versus bank financing. We identify a financial switching channel for gains from trade where increasing access to export markets allows firms to overcome high fixed costs of bond issuance to secure a lower marginal cost of capital.
    JEL: E44 F12 F4 F41 G1
    Date: 2009–11
  76. By: Brittle, Shane (University of Wollongong)
    Abstract: This paper examines the growing gap between the theoretical and empirical growth literature and policy needs of the developing economies. Growth literature has focused mainly on long term growth outcomes, but policy makers of the developing economies need rapid improvements in the short to medium term growth rates; see Pritchett (2006). In this paper we argue that this gap can be reduced by distinguishing between the short to medium term dynamic effects of policies from their long run equilibrium effects. With data from Singapore, Malaysia and Thailand, we show that an extended version of the Solow (1956) model is well suited for this purpose. We find that the short to medium term growth effects of the investment ratio are quite significant and they may persist for up to 10 years.
    Keywords: Ricardian equivalence, fiscal policy, cointegration, structural breaks.
    JEL: E21 E62 C22 H62
    Date: 2009
  77. By: David Backus; Espen Henriksen; Frederic Lambert; Christopher Telmer
    Abstract: With US trade and current account deficits approaching 6% of GDP, some have argued that the country is "on the comfortable path to ruin" and that the required "adjustment'' may be painful. We suggest instead that things are fine: although national saving is low, the ratios of household and consolidated net worth to GDP remain high. In our view, the most striking features of the world at present are the low rates of investment and growth in some of the richest countries, whose surpluses account for about half of the US deficit. The result is that financial capital is flowing out of countries with low investment and growth and into the US and other fast-growing countries. Oil exporters account for much of the rest.
    JEL: E21 F21 F32
    Date: 2009–11
  78. By: Miller, Marcus; Stiglitz, Joseph E
    Abstract: An iconic model with high leverage and overvalued collateral assets is used to illustrate the amplification mechanism driving asset prices to ‘overshoot’ equilibrium when an asset bubble bursts - threatening widespread insolvency and what Richard Koo calls a ‘balance sheet recession’. Besides interest rates cuts, asset purchases and capital restructuring are key to crisis resolution. The usual bankruptcy procedures for doing this fail to internalise the price effects of asset ‘fire-sales’ to pay down debts, however. We discuss how official intervention in the form of ‘super’ Chapter 11 actions can help prevent asset price correction causing widespread economic disruption.
    Keywords: asset bubbles; Credit constraints; insolvency; interest rates; leverage; restructuring
    JEL: E32 G21 G32 G33 G34
    Date: 2009–09
  79. By: Aliyu, Shehu Usman Rano
    Abstract: Nowadays, the impact of oil price shocks is pervasive as it virtually affects all facets of human endeavor. As such, it is pertinent that we should know the relationship between oil price shocks and the macroeconomy. Therefore, this paper assesses empirically, the effects of oil price shocks on the real macroeconomic activity in Nigeria. Granger causality tests and multivariate VAR analysis were carried out using both linear and non-linear specifications. Inter alia, the latter category includes two approaches employed in the literature, namely, the asymmetric and net specifications oil price specifications. The paper finds evidence of both linear and non-linear impact of oil price shocks on real GDP. In particular, asymmetric oil price increases in the non-linear models are found to have positive impact on real GDP growth of a larger magnitude than asymmetric oil price decreases adversely affects real GDP. The non-linear estimation records significant improvement over the linear estimation and the one reported earlier by Aliyu (2009). Further, utilizing the Wald and the Granger multivariate and bivariate causality tests, results from the latter indicate that linear price change and all the other oil price transformations are significant for the system as a whole. The Wald test indicates that our oil price coefficients in linear and asymmetric specifications are statistically significant.
    Keywords: Oil Shocks; Macroeconomy; Granger Causality; Asymmetry; Vector Autoregressive
    JEL: E37 Q43
    Date: 2009–11–09
  80. By: Nazim Belhocine
    Abstract: This paper constructs a data set to document firms' expenditures on an identifiable list of intangible items and examines the implications of treating intangible spending as an acquisition of final (investment) goods on GDP growth for Canada. It finds that investment in intangible capital by 2002 is almost as large as the investment in physical capital. This result is in line with similar findings for the U.S. and the U.K. Furthermore, the growth in GDP and labor productivity may be underestimated by as much as 0.1 percentage point per year during this same period.
    Keywords: Canada , Capital goods , Capital transactions , Cross country analysis , Data collection , Economic growth , Gross domestic product , Investment , Labor productivity , National income accounts ,
    Date: 2009–09–10
  81. By: Desmet, Klaus; Rossi-Hansberg, Esteban
    Abstract: We present a theory of spatial development. A continuum of locations in a geographic area choose each period how much to innovate (if at all) in manufacturing and services. Locations can trade subject to transport costs and technology diffuses spatially across locations. The result is an endogenous growth theory that can shed light on the link between the evolution of economic activity over time and space. We apply the model to study the evolution of the U.S. economy in the last few decades and find that the model can generate the reduction in the employment share in manufacturing, the increase in service productivity in the second part of the 1990s, the increase in land rents in the same period, as well as several other spatial and temporal patterns.
    Keywords: Dynamic spatial models; Growth; Innovation; Land rent evolution; Structural transformation; Technology diffusion; Trade
    JEL: E32 O11 O18 O33 R12
    Date: 2009–09
  82. By: Kollmann, Robert
    Abstract: Recent empirical research documents that an exogenous rise in government purchases in a given country triggers a persistent depreciation of its real exchange rate - which raises an important puzzle, as standard macro models predict an appreciation of the real exchange rate. This paper presents a simple model with limited international risk sharing that can account for the empirical real exchange rate response. When faced with a country-specific rise in government purchases, local households experience a negative wealth effect; they thus work harder, and domestic output increases. Under balanced trade (financial autarky) this supply-side effect is so strong that the terms of trade worsen, and the real exchange rate depreciates. In a bonds-only economy, an increase in government purchases triggers a real exchange rate depreciation, if the rise in government purchases is sufficiently persistent and/or labor supply is highly elastic.
    Keywords: government purchases; limited international risk sharing; real exchange rate
    JEL: E62 F36 F41
    Date: 2009–08
  83. By: Francesco Giavazzi; Michael McMahon
    Abstract: This paper uses German micro data and a quasi-natural experiment to provide new evidence on the empirical importance of precautionary savings. Our quasi-natural experiment draws on a sharp increase in uncertainty (as reported in a survey of German citizens) observed in the run-up to the 1998 general election. Our estimates are obtained from a diff-in-diff estimator and thus overcome the identification problem that often a¤ects measures of precautionary savings. We find that household saving increases significantly following the increase in uncertainty about the future path of income, suggesting a significant precautionary savings motive. We also analyze households?response in terms of labor market choices: we find evidence of a labor supply response by workers who can use the margin offered by part-time employment. While independent of the reasons why uncertainty increased in the run-up to the election, our results are suggestive of the economic effects of "wars of attrition", i.e. situations in which reforms are delayed because political parties are unable to agree on how the burden of a reform should be shared between various groups in society. Delays in adopting a reform, or the possibilty that a reform, after it has been adopted by one government might be revoked by another, raise uncertainty and induce households to save more: consumption may fall and the economy might slow down for no other reason than political uncertainty.
    Date: 2009
  84. By: Bottazzi, Renata; Jappelli, Tullio; Padula, Mario
    Abstract: We estimate the portfolio effect of changes in social security wealth exploiting a decade of Italian pension reforms as a source of exogenous variation. The Italian Survey of Household Income and Wealth records detailed portfolio data and elicits expectations of retirement outcomes, thus allowing us to measure the expected social security wealth and to assess to what extent Italian households perceive the innovations brought about by the reforms. We find that households have responded to the cut in pension benefits mostly by increasing real estate wealth, and that the response is stronger among households that are able to estimate more accurately future social security benefits. We also compute that for the average household consumable wealth increases by 40 percent of the reduction in social security wealth.
    Keywords: Pension Reform; Portfolio Choice; Retirement Saving
    JEL: E21 H55
    Date: 2009–07
  85. By: Beetsma, Roel; Cukierman, Alex; Giuliodori, Massimo
    Abstract: The paper presents evidence of an upward ratchet in transfers and taxes in the U.S. around World-War II. This finding is explained within a political-economy framework involving an executive who sets defense spending and the median voter in the population who interacts with a (richer) agenda setter in Congress in setting redistribution. While the setter managed to cap redistribution in the pre-war period, the War itself pushed up the status-quo tax burden, raising the bargaining power of the median voter as defense spending receded. This raised the equilibrium level of redistribution. The higher share of post-War transfers may thus be interpreted as a delayed fulfilment of a, not fully satisfied, popular demand for redistribution inherited from the Great Depression.
    Keywords: agenda setter; ratchets; redistribution; taxes; transfers; World-War II
    JEL: E62 E65 N11 N12
    Date: 2009–10
  86. By: Fatih Guvenen; Burhanettin Kuruscu; Serdar Ozkan
    Abstract: Wage inequality has been significantly higher in the United States than in continental European countries (CEU) since the 1970s. Moreover, this inequality gap has further widened during this period as the US has experienced a large increase in wage inequality, whereas the CEU has seen only modest changes. This paper studies the role of labor income tax policies for understanding these facts. We begin by documenting two new empirical facts that link these inequality differences to tax policies. First, we show that countries with more progressive labor income tax schedules have significantly lower before-tax wage inequality at different points in time. Second, progressivity is also negatively correlated with the rise in wage inequality during this period. We then construct a life cycle model in which individuals decide each period whether to go to school, work, or be unemployed. Individuals can accumulate skills either in school or while working. Wage inequality arises from differences across individuals in their ability to learn new skills as well as from idiosyncratic shocks. Progressive taxation compresses the (after-tax) wage structure, thereby distorting the incentives to accumulate human capital, in turn reducing the cross-sectional dispersion of (before-tax) wages. We find that these policies can account for half of the difference between the US and the CEU in overall wage inequality and 76% of the difference in inequality at the upper end (log 90-50 differential). When this economy experiences skill-biased technological change, progressivity also dampens the rise in wage dispersion over time. The model explains 41% of the difference in the total rise in inequality and 58% of the difference at the upper end.
    JEL: E62 H2 J24 J31
    Date: 2009–11
  87. By: Backus, David; Chernov, Mikhail; Martin, Ian
    Abstract: We use prices of equity index options to quantify the impact of extreme events on asset returns. We define extreme events as departures from normality of the log of the pricing kernel and summarize their impact with high-order cumulants: skewness, kurtosis, and so on. We show that high-order cumulants are quantitatively important in both representative-agent models with disasters and in a statistical pricing model estimated from equity index options. Option prices thus provide independent confirmation of the impact of extreme events on asset returns, but they imply a more modest distribution of them.
    Keywords: cumulants; entropy; equity premium; implied volatility; pricing kernel; risk-neutral probabilities
    JEL: E44 G12
    Date: 2009–08
  88. By: Rose, Andrew K; Spiegel, Mark
    Abstract: This paper models the causes of the 2008 financial crisis together with its manifestations, using a Multiple Indicator Multiple Cause (MIMIC) model. Our analysis is conducted on a cross-section of 85 countries; we focus on international linkages that may have allowed the crisis to spread across countries. Our model of the cross-country incidence of the crisis combines 2008 changes in real GDP, the stock market, country credit ratings, and the exchange rate. We explore the linkages between these manifestations of the crisis and a number of its possible causes from 2006 and earlier. The causes we consider are both national (such as equity market run-ups that preceded the crisis) and, critically, international financial and real linkages between countries and the epicenter of the crisis. We consider the United States to be the most natural origin of the 2008 crisis, though we also consider six alternative sources of the crisis. A country holding American securities that deteriorate in value is exposed to an American crisis through a financial channel. Similarly, a country which exports to the United States is exposed to an American downturn through a real channel. Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to find strong evidence that international linkages can be clearly associated with the incidence of the crisis. In particular, countries heavily exposed to either American assets or trade seem to behave little differently than other countries; if anything, countries seem to have benefited slightly from American exposure.
    Keywords: asset; common; contagion; country; credit; cross-section; data; empirical; export; financial; international; MIMIC; model; stock; trade
    JEL: E65 F30
    Date: 2009–09
  89. By: Rudolf, Barbara (Swiss National Bank); Zurlinden, Mathias (Swiss National Bank)
    Abstract: In this paper, we analyse the sources of economic growth in Switzerland during the period 1991–2005. The results suggest that labour input and capital input contribute 0.57 pp and 0.45 pp, respectively, to the average annual GDP growth of 1.28%. The remaining 0.25 pp represent growth in multi-factor productivity, which is calculated as a residual. The estimate of growth in multi-factor productivity is lower than in previous studies because our measure of labour input takes changes in labour quality into account. Changes in labour quality explain 0.39 pp of the 0.45 pp contribution from labour input.
    Keywords: growth accounting; multi-factor productivity; capital services; constantquality labour
    JEL: E31 E37
    Date: 2009–09–01

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