nep-mac New Economics Papers
on Macroeconomics
Issue of 2010‒05‒02
sixty-nine papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Bussiness Management

  1. Sources of Unemployment Fluctuations in the USA and in the Euro Area in the Last Decade By Antonio Ribba
  2. Inflation Expectations and Monetary Policy in India: An Empirical Exploration By Michael Debabrata Patra; Partha Ray
  3. Reading the Recent Monetary History of the U.S., 1959-2007 By Jesús Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez
  4. Labor market institutions and the business cycle: Unemployment rigidities vs. real wage rigidities By Mirko Abbritti; Sebastian Weber
  5. The external finance premium in the euro area A useful indicator for monetary policy? By Paolo Gelain
  6. Monetary policy, housing booms and financial (im)balances By Sandra Eickmeier; Boris Hofmann
  7. Financial Crisis, Global Liquidity and Monetary Exit Strategies By Ansgar Belke
  9. Fiscal deficits, debt, and monetary policy in a liquidity trap By Michael B. Devereux
  10. Monetary Policy and Trade Globalization By Dudley Cooke
  11. Inventories and Optimal Monetary Policy By Thomas A. Lubik; Wing Leong Teo
  12. Fiscal and Monetary Policy Interaction: a simulation based analysis of a two-country New Keynesian DSGE model with heterogeneous households By Marcos Valli; Fabia A. de Carvalho
  13. Strategic Forecasting on the FOMC By Peter Tillmann
  14. Anchors for Inflation Expectations By Maria Demertzis; Massimiliano Marcellino; Nicola Viegi
  15. Macroeconomic forecasting and structural change By Antonello D’Agostino; Luca Gambetti; Domenico Giannone
  16. Bank Liquidity, Interbank markets, and Monetary Policy By Freixas, X.; Martin, A.; Skeie, D.
  17. Medium-run macrodynamics and the consensus view of stabilization policy By Kai D. Schmid
  18. Market power and fiscal policy in OECD countries By António Afonso; Luís F. Costa
  19. Price Setting in a Model with Production Chains: Evidence from Sectoral Data By Maral Shamloo
  20. Interpreting the Unconventional U.S. Monetary Policy of 2007-09 By Ricardo Reis
  21. Evolving Phillips trade-off By Luca Benati
  22. Correlated Disturbances and U.S. Business Cycles By Vasco Curdia; Ricardo Reis
  23. Too Much to Lose, or More to Gain? Should Sweden Join the Euro? By J James Reade; Ulrich Volz
  24. Nominal and real wage rigidities. In theory and in Europe By Markus Knell
  25. Fiscal policy in Colombia and a prospective analysis after the 2008 financial crisis By Ignacio Lozano
  26. Credit supply: Identifying balance-sheet channels with loan applications and granted loans By Gabriel Jiménez; Steven Ongena; José-Luis Peydró; Jesús Saurina
  27. Simple rules versus optimal policy: what fits? By Ida Wolden Bache; Leif Brubakk; Junior Maih
  28. Using a projection method to analyze inflation bias in a micro-founded model By Gary S. Anderson; Jinill Kim; Tack Yun
  29. Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices By Stefania D'Amico; Don H. Kim; Min Wei
  30. Real-time model uncertainty in the United States: 'Robust' policies put to the test By Robert J. Tetlow
  31. Estimating The Inflation-Growth Nexus - A Smooth Transition Model By Raphael A. Espinoza; Ananthakrishnan Prasad; H. L. Leon
  32. How Much Fiscal Backing Must the ECB Have?: The Euro Area Is Not the Philippines By Ansgar Belke
  33. Globalization and the Output-Inflation Tradeoff: New Time Series Evidence By Eijffinger, S.C.W.; Qian, Z.
  34. Effects of Fiscal Stimulus in Structural Models By Michael Kumhof; Günter Coenen; Dirk Muir; Charles Freedman; Susanna Mursula; Christopher J. Erceg; Davide Furceri; René Lalonde; Jesper Lindé; Annabelle Mourougane; John Roberts; Werner Roeger; Carlos de Resende; Stephen Snudden; Mathias Trabandt; Jan in ‘t Veld; Douglas Laxton
  35. Did the Crisis Affect Potential Output? By Makram El-Shagi
  36. Expectations Traps and Coordination Failures:Selecting Among Multiple Discretionary Equilibria By Richard Dennis; Tatiana Kirsanova
  37. Leverage constraints and the international transmission of shocks By Michael B. Devereux
  38. Monetary Policy and Excessive Bank Risk Taking By Agur, I.; Demertzis, M.
  39. How Accurate are Government Forecasts of Economic Fundamentals? The Case of Taiwan By Chia-Lin Chang; Philip Hans Franses; Michael McAleer
  40. Monetary Policy Committees, Learning, and Communication By Anke Weber
  41. Inventories, Inflation Dynamics and the New Keynesian Phillips Curve By Thomas A. Lubik; Wing Leong Teo
  42. Evaluating Macroeconomic Forecasts: A Review of Some Recent Developments By Philip Hans Franses; Michael McAleer; Rianne Legerstee
  43. Business Cycle Dynamic in the CEE Countries: A Political Economy Approach By Muge Adalet; Sumru Oz
  44. The effect of question wording on reported expectations and perceptions of inflation By Wändi Bruine de Bruin; Wilbert van der Klaauw; Julie S. Downs; Baruch Fischhoff; Giorgio Topa; Olivier Armantier
  45. Offshore production and business cycle dynamics with heterogeneous firms By Andrei Zlate
  46. A Thermodynamic Approach to Monetary Economics. A Revision. An application to the UK Economy 1969-2006 and the USA Economy 1966-2006 By John Bryant
  47. Interest on excess reserves as a monetary policy instrument: the experience of foreign central banks By David Bowman; Etienne Gagnon; Mike Leahy
  48. Beyond the Crisis: Revisiting Emerging Europe's Growth Model By Ruben Atoyan
  49. Boom-Bust Cycle, Asymmetrical Fiscal Response and the Dutch Disease By Rabah Arezki; Kareem Ismail
  50. The Procyclical Effects of Bank Capital Regulation By Repullo, R.; Suarez, J.
  51. Tax Revenue Response to the Business Cycle By Cemile Sancak; Ricardo Velloso; Jing Xing
  52. The Lender of Last Resort: Liquidity Provision Versus the Possibility of Bail-out By Nijskens, R.G.M.; Eijffinger, S.C.W.
  53. The impact of numerical expenditure rules on budgetary discipline over the cycle By Fédéric Holm-Hadulla; Sebastian Hauptmeier; Philipp Rother
  54. Employment Cycles, Low Income Work and the Dynamic Impact of Minimum Wages. A Macro Perspective By Peter Flaschel; Alfred Greiner; Camille Logeay; Christian Proano
  55. Credit Conditions and Recoveries from Recessions Associated with Financial Crises By Prakash Kannan
  56. Absorption Boom and Fiscal Stance: What Lies Ahead in Eastern Europe? By Jesmin Rahman
  57. Employment fluctuations in a dual labor market By James Costain; Juan F. Jimeno; Carlos Thomas
  58. How did a domestic housing slump turn into a global financial crisis? By Steven B. Kamin; Laurie Pounder DeMarco
  59. Size, openness, and macroeconomic interdependence By Alexander Chudik; Roland Straub
  60. Crises in Asia: Recovery and Policy Responses By Hong, Kiseok; Tang, Hsiao Chink
  61. Fiscal Objectives in the Post IMF Program World: The Case of Albania By Jiri Jonas
  62. All together now: Do international factors explain relative price co-movements? By Özer Karagedikli; Haroon Mumtaz; Misa Tanaka
  63. Multi-period fixed-rate loans, housing and monetary policy in small open economies By Jaromír Beneš; Kirdan Lees
  64. Sustainable Capitalism: Full-Employment Flexicurity Growth with Real Wage Rigidities By Toichiro Asada; Peter Flaschel; Alfred Greiner; Christian Proano
  65. Are earthquakes needed to shake economics? By Ronald Schettkat
  66. Threshold Pricing in a Noisy World By Timo Henckel; Gordon D. Menzies; Daniel J. Zizzo
  67. General-Equilibrium Effects of Investment Tax Incentives By Rochelle M. Edge; Jeremy B. Rudd
  68. Repo Runs By Martin, A.; Skeie, D.; Thadden, E.L. von
  69. General Equilibrium Restrictions for Dynamic Factor Models By David de Antonio Liedo

  1. By: Antonio Ribba
    Abstract: The aim of this paper is to investigate the role played by macroeconomic shocks in shaping unemployment fluctuations, both in the USA and in the Euro area, in the recent, European Monetary Union, period. The task is accomplished by estimating a VAR model which jointly considers US and European variables. We identify the structural disturbances through sign restrictions on the dynamic response of variables. Our results show that there are real effects of monetary policy shocks and of non-monetary policy, financial shocks in both economic areas. Moreover, a significant role is also exerted by business cycle, adverse aggregate demand shocks. We provide an estimation of the relative importance of the identified structural shocks in explaining the variability of inflation and unemployment. Not surprisingly, in the last decade an important role has been played by financial shocks.
    Keywords: Structural VARs; Euro Area; Monetary Policy; Unemployment
    JEL: C32 E40
    Date: 2010–04
  2. By: Michael Debabrata Patra; Partha Ray
    Abstract: This paper pursues a computationally intensive approach to generate future inflation, followed by an exploration of the determinants of inflation expectations by estimating a new Keynesian type Phillips curve that takes into account country-specific characteristics, the stance of monetary and fiscal policies, marginal costs and exogenous supply shocks. The empirical results indicate that high and climbing inflation could easily seep into people’s anticipation of future inflation and linger. There is a reputational bonus for monetary policy to act against inflation now rather than going for cold turkey when societal compulsions reach a critical mass.
    Keywords: Central bank policy , Economic models , Fiscal policy , India , Inflation , Inflation targeting , Monetary policy , Price increases , Supply-side policy ,
    Date: 2010–04–01
  3. By: Jesús Fernández-Villaverde (Department of Economics, University of Pennsylvania); Pablo Guerrón-Quintana (Federal Reserve Bank of Philadelphia); Juan F. Rubio-Ramírez (Department of Economics, Duke University)
    Abstract: In this paper we report the results of the estimation of a rich dynamic stochastic general equilibrium (DSGE) model of the U.S. economy with both stochastic volatility and parameter drifting in the Taylor rule. We use the results of this estimation to examine the recent monetary history of the U.S. and to interpret, through this lens, the sources of the rise and fall of the great American inflation from the late 1960s to the early 1980s and of the great moderation of business cycle fluctuations between 1984 and 2007. Our main findings are that while there is strong evidence of changes in monetary policy during Volcker’s tenure at the Fed, those changes contributed little to the great moderation. Instead, changes in the volatility of structural shocks account for most of it. Also, while we find that monetary policy was different under Volcker, we do not find much evidence of a big difference in monetary policy among Burns, Miller, and Greenspan. The difference in aggregate outcomes across these periods is attributed to the time- varying volatility of shocks. The history for inflation is more nuanced, as a more vigorous stand against it would have reduced inflation in the 1970s, but not completely eliminated it. In addition, we find that volatile shocks (especially those related to aggregate demand) were important contributors to the great American inflation.
    Keywords: DSGE models, Stochastic volatility, Parameter drifting, Bayesian methods.
    JEL: E10 E30 C11
    Date: 2010–04–15
  4. By: Mirko Abbritti (Universidad de Navarra, Graduate Institute of International Studies.); Sebastian Weber (Graduate Institute of International Studies.)
    Abstract: This paper investigates the importance of labor market institutions for inflation and unemployment dynamics. Using the New Keynesian framework we argue that labor market institutions should be divided into those institutions that cause Unemployment Rigidities (UR) and those that cause Real Wage Rigidities (RWR). The two types of institutions have opposite effects and their interaction is crucial for the dynamics of inflation and unemployment. We estimate a panel VAR with deterministically varying coefficients and find that there is a profound difference in the responses of unemployment and inflation to shocks under different constellations of the labor market. JEL Classification: E32, E24, E52.
    Keywords: Labor Market Search, Real Wage Rigidity, Unemployment, Business Cycle, Monetary Policy.
    Date: 2010–04
  5. By: Paolo Gelain (School of Economics and Finance – University of St Andrews – Castlecliffe, The Scores, Fife, United Kingdom, KY1 9AL,)
    Abstract: In this paper I estimate a New Keynesian Dynamic Stochastic General Equilibrium model for the Euro Area, which closely follows the structure of the model developed by Smets and Wouters (2003, 2005, 2007), with the addition of the so-called financial accelerator mechanism developed in Bernanke, Gertler and Gilchrist (1999). The main aim is to obtain a time series for the unobserved external finance premium that entrepreneurs pay on their loans, with the further aim of providing a dynamic analysis of it. Results confirm in general what was recently found for the US by De Graeve (2008), namely that (1) the model incorporating financial frictions can generate a series for the premium, without using any financial macroeconomic aggregates, that is highly correlated with available proxies for it, (2) the estimated premium is not necessarily counter-cyclical (this depends on the shock considered). Nevertheless, although in addition the model with financial frictions better describes Euro Area data than the model without them, the former is not satisfactory in many other respects. For instance, the accelerator effect turns out to be statistically not significant. However, this does not impede financial frictions from remaining a key ingredient to model. In fact, I found that the estimated premium is a very powerful predictor of inflation. It overcomes, in terms of the Mean Squared Forecast Error, the traditional output gap measure in a Phillips curve specification. JEL Classification: E4, E5, E37.
    Keywords: NK DSGE, Euro Area External Finance Premium, Financial Accelerator, Bayesian Estimation, Inflation Forecast
    Date: 2010–04
  6. By: Sandra Eickmeier (Deutsche Bundesbank, Economic Research Center, Wilhelm-Epstein-Straße 14, 60431 Frankfurt am Main, Germany.); Boris Hofmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper uses a factor-augmented vector autoregressive model (FAVAR) estimated on U.S. data in order to analyze monetary transmission via private sector balance sheets, credit risk spreads and asset markets in an integrated setup and to explore the role of monetary policy in the three imbalances that were observed prior to the global financial crisis: high house price inflation, strong private debt growth and low credit risk spreads. The results suggest that (i) monetary policy shocks have a highly significant and persistent effect on house prices, real estate wealth and private sector debt as well as a strong short-lived effect on risk spreads in the money and mortgage markets; (ii) monetary policy shocks have contributed discernibly, but at a late stage to the unsustainable developments in house and credit markets that were observable between 2001 and 2006; (iii) financial shocks have influenced the path of policy rates prior to the crisis, and the feedback effects of financial shocks via lower policy rates on property and credit markets are found to have probably been considerable. JEL Classification: E52, E44, C3, E3, E43.
    Keywords: Monetary policy, asset prices, housing, private sector balance sheets, financial crisis, factor model.
    Date: 2010–04
  7. By: Ansgar Belke
    Abstract: We develop a roadmap of how the ECB should further reduce the volume of money (money supply) and roll back credit easing in order to prevent inflation. The exits should be step-by-step rather than one-off. Communicating about the exit strategy must be an integral part of the exit strategy. Price stability should take precedence in all decisions. Due to vagabonding global liquidity, there is a strong case for globally coordinating monetary exit strategies. Given unsurmountable practical problems of coordinating exit with asymmetric country interests, however, the ECB should go ahead - perhaps joint with some Far Eastern economies. Coordination of monetary and fiscal exit would undermine ECB independence and is also technically out of reach within the euro area.
    Keywords: Exit strategies, international policy coordination and transmission, open market operations, unorthodox monetary policy
    JEL: E52 E58 F42 E63
    Date: 2010
    Abstract: We examine the sources of macroeconomic economic fluctuations by es- timating a variety of medium-scale DSGE models within a unified framework that incorporates regime switching both in shock variances and in the inflation target. Our general framework includes a number of different model features studied in the liter- ature. We propose an efficient methodology for estimating regime-switching DSGE models. The model that best fits the U.S. time-series data is the one with synchro- nized shifts in shock variances across two regimes and the fit does not rely on strong nominal rigidities. We find little evidence of changes in the inflation target. We identify three types of shocks that account for most of macroeconomic fluctuations: shocks to total factor productivity, wage markup, and the capital depreciation rate.
    Date: 2010–04
  9. By: Michael B. Devereux
    Abstract: The macroeconomic response to the economic crisis has revived old debates about the usefulness of monetary and fiscal policy in fighting recessions. Without the ability to further lower interest rates, policy authorities in many countries have turned to expansionary fiscal policies. Recent literature argues that government spending may be very effective in such environments. But a critical element of the stimulus packages in all countries was the use of deficit financing and tax reductions. This paper explores the role of government debt and deficits in an economy constrained by the zero bound on nominal interest rates. Given that the liquidity trap is generated by a large increase in the desire to save on the part of the private sector, the wealth effects of government deficits can provide a critical macroeconomic response to this. Government spending financed by deficits may be far more expansionary than that financed by tax increases in such an environment. In a liquidity trap, tax cuts may be much more effective than during normal times. Finally, monetary policies aimed at directly increasing monetary aggregates may be effective, even if interest rates are unchanged.
    Keywords: Fiscal policy ; Recessions ; Deficit financing ; Debts, Public ; Government spending policy ; Monetary policy ; Taxation ; Liquidity (Economics)
    Date: 2010
  10. By: Dudley Cooke (Trinity College Dublin ,Hong Kong Institute for Monetary Research)
    Abstract: I develop a two country general equilibrium model with heterogeneous price-setting firms to understand how shocks to monetary policy and aggregate labor productivity impact trade integration, which I capture through the (inverse) average productivity of exporting firms. A contractionary domestic monetary policy shock raises the average productivity of domestic exporting firms but lowers the average productivity of foreign exporting firms. The magnitude of these changes is greater when governments target domestic price inflation as opposed to consumer price inflation. A positive shock to domestic labor productivity generates positive - although quantitatively small - changes in the average productivity of all exporting firms when consumer price inflation is targeted. When domestic price inflation is targeted, the same shock causes a fall in the average productivity of domestic exporting firms, and a far larger rise in the productivity of foreign exporting firms.
    Keywords: Monetary Policy, Heterogeneous Firms, Trade Globalization
    JEL: E31 E52 F41
    Date: 2010–02
  11. By: Thomas A. Lubik; Wing Leong Teo
    Abstract: We introduce inventories into a standard New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to study the effect on the design of optimal monetary policy. The possibility of inventory investment changes the transmission mechanism in the model by decoupling production from final consumption. This allows for a higher degree of consumption smoothing since firms can add excess production to their inventory holdings. We consider both Ramsey optimal monetary policy and a monetary policy that maximizes consumer welfare over a set of simple interest rate feedback rules. We find that in contrast to a model without inventories, Ramsey-optimal monetary policy in a model with inventories deviates from complete inflation stabilization. In the standard model, nominal price rigidity is a deadweight loss on the economy, which an optimizing policymaker attempts to remove. With inventories, a planner can reduce consumption volatility and raise welfare by accumulating inventories and letting prices change as an equilibrating mechanism. We find also find that the application of simple rules comes very close to replicating Ramsey optimal outcomes.
    JEL: E24 E32 J64
    Date: 2010–02
  12. By: Marcos Valli; Fabia A. de Carvalho
    Abstract: This paper models a fiscal policy that pursues primary balance targets to stabilize the debt-to-GDP ratio in an open and heterogeneous economy where firms combine public and private capital to produce their goods. The model extends the European NAWM presented in Coenen et. al. (2008) and Christoffel et. al. (2008) by broadening the scope for fiscal policy implementation and allowing for heterogeneity in labor skills. The domestic economy is also assumed to follow a forward looking Taylor-rule consistent with an inflation targeting regime. We correct the NAWM specification of the final-goods price indices, the recursive representation of the wage setting rule, and the wage distortion index. We calibrate the model for Brazil to analyze some implications of monetary and fiscal policy interaction and explore some of the implications of fiscal policy in this class of DSGE models.
    Date: 2010–04
  13. By: Peter Tillmann (Justus Liebig University Gießen)
    Abstract: The Federal Open Market Committee (FOMC) of the Federal Reserve consists of voting- and non-voting members. Apart from deciding about interest rate policy, members individually formulate regular inflation forecasts. This paper uncovers systematic differences in individual inflation forecasts submitted by voting and non-voting members. Based on a data set with individual forecasts recently made available it is shown that non-voters systematically overpredict inflation relative to the consensus forecast if they favor tighter policy and underpredict inflation if the favor looser policy. These findings are consistent with non-voting member following strategic motives in forecasting, i.e. non-voting members use their forecast to influence policy deliberation.
    Keywords: inflation forecast, forecast errors, monetary policy, monetary committee, Federal Reserve
    JEL: E43 E52
    Date: 2010
  14. By: Maria Demertzis; Massimiliano Marcellino; Nicola Viegi
    Abstract: We identify credible monetary policy with first, a disconnect between inflation and inflation expectations and second, the anchoring of the latter at the inflation target announced by the monetary authorities. We test empirically whether this is the case for a number of countries that have an explicit inflation target and therefore include the Euro Area. We find that for the last 10 year period, the two series are less dependent on each other and that announcing inflation targets help anchor expectations at the right level. Keywords: Inflation Targets, Measures of Credibility.
    Keywords: Inflation Targets; measures of Credibility.
    JEL: E52 E58
    Date: 2009–11
  15. By: Antonello D’Agostino (Central Bank and Financial Services Authority of Ireland – Economic Analysis and Research Department, PO Box 559 – Dame Street, Dublin 2, Ireland.); Luca Gambetti (Office B3.174, Departament d’Economia i Historia Economica, Edifici B, Universitat Autonoma de Barcelona, Bellaterra 08193, Barcelona, Spain.); Domenico Giannone (ECARES Université Libre de Bruxelles, 50, Avenue Roosevelt CP 114 Brussels, Belgium.)
    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 na¨ıve random walk model. These results are also shown to hold over the most recent period in which it has been hard to forecast inflation. JEL Classification: C32, E37, E47.
    Keywords: Forecasting, Inflation, Stochastic Volatility, Time Varying Vector Autoregression.
    Date: 2010–04
  16. By: Freixas, X.; Martin, A.; Skeie, D. (Tilburg University, Center for Economic Research)
    Abstract: A major lesson of the recent financial crisis is that the interbank lending market is crucial for banks facing large uncertainty regarding their liquidity needs. This paper studies the efficiency of the interbank lending market in allocating funds. We consider two different types of liquidity shocks leading to di¤erent implications for optimal policy by the central bank. We show that, when confronted with a distribu- tional liquidity-shock crisis that causes a large disparity in the liquidity held among banks, the central bank should lower the interbank rate. This view implies that the traditional tenet prescribing the separation between prudential regulation and mon- etary policy should be abandoned. In addition, we show that, during an aggregate liquidity crisis, central banks should manage the aggregate volume of liquidity. Two di¤erent instruments, interest rates and liquidity injection, are therefore required to cope with the two di¤erent types of liquidity shocks. Finally, we show that failure to cut interest rates during a crisis erodes financial stability by increasing the risk of bank runs.
    Keywords: bank liquidity;interbank markets;central bank policy;financial fragility;bank runs
    JEL: G21 E43 E44 E52 E58
    Date: 2010
  17. By: Kai D. Schmid
    Abstract: Policy implications of the present consensus view of stabilization policy depend on specific assumptions with regard to the equilibrium level of production. Thereby, the interpretation of equilibrium output rests on a separation of supply-side and demandside adjustment to macroeconomic shocks promoting a dichotomy of short-term and long-term macrodynamics. In contrast to this, there are several channels that promote procyclical stimulus of aggregate demand and a changing factor utilization to the accumulation and efficiency of an economy’s productive capacity. Medium-run macrodynamics call for a rather endogenous explanation of production capacity and challenge the uniqueness of long-term equilibria.
    Keywords: Monetary policy, medium-run macrodynamics, long-term nonneutrality, capacity utilization.
    JEL: E2 E3 E5
    Date: 2010–04
  18. By: António Afonso (ISEG (School of Economics and Management), Technical University of Lisbon, Rua do Quelhas 6, 1200-781 Lisboa, Portugal.); Luís F. Costa (ISEG (School of Economics and Management), Technical University of Lisbon, Rua do Quelhas 6, 1200-781 Lisboa, Portugal.)
    Abstract: We compute average mark-ups as a measure of market power throughout time and study their interaction with fiscal policy and macroeconomic variables in a VAR framework. From impulse-response functions the results, with annual data for a set of 14 OECD countries covering the period 1970-2007, show that the mark-up (i) depicts a pro-cyclical behaviour with productivity shocks and (ii) a mildly counter-cyclical behaviour with fiscal spending shocks. We also use a Panel Vector Auto-Regression analysis, increasing the efficiency in the estimations, which confirms the countryspecific results. JEL Classification: D4, E0, E3, H6.
    Keywords: Fiscal Policy, Mark-up, VAR, Panel VAR.
    Date: 2010–04
  19. By: Maral Shamloo
    Abstract: Reconciling the high frequency of price changes at the micro level and their apparent rigidity at the aggregate level has been the subject of considerable debate in macroeconomics recently. In this paper I show that incorporating production chains in a standard New- Keynesian model replicates two stylized facts about the data. First, sectoral prices respond with significantly different speeds to aggregate shocks. Meanwhile, the responses to sectorspecific shocks are similar. Second, the standard price setting models are unable to quantitatively match the amount of monetary non-neutrality observed in the data. I argue, First, that the input-output linkages in production generate different responses to aggregate shocks across sectors. Second, calibrating this model to the US data can create five times more monetary non-neutrality in response to nominal shocks compared to an equivalent homogeneous economy with intermediate inputs. Finally, the model implies that upstream industries respond faster to aggregate shocks compared to downstream industries. I show that this prediction is supported by the data.
    Keywords: Economic models , External shocks , Monetary policy , Price adjustments , Price structures , Production ,
    Date: 2010–03–31
  20. By: Ricardo Reis (Columbia University - Department of Economics)
    Abstract: This paper reviews the unconventional U.S. monetary policy responses to the financial and real crises of 2007-09, divided into three groups: interest rate policy, quantitative policy, and credit policy. To interpret interest rate policy, it compares the Federal Reserve's actions with the literature on optimal policy in a liquidity trap. This comparison suggests that policy has been in the direction indicated by theory, but it has not gone far enough. To interpret quantitative policy, the paper reviews the determination of inflation under different policy regimes. The main danger for inflation from current actions is that the Federal Reserve may lose its policy independence; a beneficial side effect of the crisis is that the Friedman rule can be implemented by paying interest on reserves. To interpret credit policy, the paper presents a new model of capital market imperfections with different financial institutions and a role for securitization , leveraging, and mark-to-market accounting. The model suggests that providing credit to traders in securities markets is a more effective response than extending credit to the originators of loans.
    Date: 2010
  21. By: Luca Benati (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We characterise the evolution of the U.S. unemployment-inflation trade-off since the late XIX century era via a Bayesian time-varying parameters structural VAR. The Great Inflation episode appears as historically unique along several dimensions. In particular, the shape of the ‘Phillips loop’–which is defined in terms of the impulse-response functions of inflation and unemployment’s deviations from equilibrium–was, during those years, clearly out of line with respect to the rest of the sample period for all structural innovations except money demand shocks. During the Great Depression, on the other hand, the Phillips trade-off did not exhibit any peculiar qualitative feature, so that, when seen through these lenses, the 1930s only stand out because of the sheer size of the macroeconomic fluctuation. The historical evolution of the Phillips trade-off exhibits virtually no connection with the evolution of the extent of trade openness of the U.S. economy. Although, by itself, this does not rule out a possible impact of globalisation on the slope of the trade-off in recent years, it clearly suggests that, historically, the evolution of the trade-off has been dominated by factors other than trade openness. JEL Classification:
    Keywords: Phillips trade-off, Lucas critique, Bayesian VARs, time-varying parameters, stochastic volatility, identified VARs, Great Inflation, Great Depression, globalisation.
    Date: 2010–04
  22. By: Vasco Curdia (Federal Reserve Bank of New York); Ricardo Reis (Columbia University - Department of Economics)
    Abstract: The dynamic stochastic general equilibrium (DSGE) models that are used to study business cycles typically assume that exogenous disturbances are independent autoregressions of order one. This paper relaxes this tight and arbitrary restriction, by allowing for disturbances that have a rich contemporaneous and dynamic correlation structure. Our first contribution is a new Bayesian econometric method that uses conjugate conditionals to make the estimation of DSGE models with correlated disturbances feasible and quick. Our second contribution is a re-examination of U.S. business cycles. We find that allowing for correlated disturbances resolves some conflicts between estimates from DSGE models and those from vector autoregressions, and that a key missing ingredient in the models is countercyclical fiscal policy. According to our estimates, government spending and technology disturbances play a larger role in the business cycle than previously ascribed, while changes in markups are less important.
    JEL: E30 E10
    Date: 2010
  23. By: J James Reade; Ulrich Volz
    Abstract: This paper considers the costs and benefits of Sweden joining the European Economic and Monetary Union (EMU). We pay particular attention to the costs of abandoning the krona in terms of a loss of monetary policy independence. For this purpose, we apply a cointegrated VAR framework to examine the degree of monetary independence that the Sveriges Riksbank enjoys. Our results suggest that Sweden has in fact relatively little to lose from joining EMU, at least in terms of monetary independence. We complement our analysis by looking into other criteria affecting the cost-benefit calculus of monetary integration, which, by and large, support our positive assessment of Swedish EMU membership.
    Keywords: Swedish EMU membership, Monetary Policy independence, European monetary integration
    JEL: E52 E58 F41 F42 C32
    Date: 2010–04
  24. By: Markus Knell (Oesterreichische Nationalbank, Economic Studies Division, Otto-Wagner-Platz 3, POB-61, A-1011 Vienna, Austria.)
    Abstract: In this paper I study the relation between real wage rigidity (RWR) and nominal price and wage rigidity. I show that in a standard DSGE model RWR is mainly affected by the interaction of the two nominal rigidities and not by other structural parameters. The degree of RWR is, however, considerably influenced by the modelling assumption about the structure of wage contracts (Calvo vs. Taylor) and about other institutional characteristics of wage-setting (clustering of contracts, heterogeneous contract length, indexation). I use survey evidence on price- and wage-setting for 15 European countries to calculate the degrees of RWR implied by the theoretical model. The average levels of RWR are broadly in line with empirical estimates based on macroeconomic data. In order to be able to also match the observed cross-country variation in RWR it is, however, essential to move beyond the country-specific durations of price and wages and to take more institutional details into account. JEL Classification: E31, E32, E24, J51.
    Keywords: Inflation Persistence, Real Wage Rigidity, Nominal Wage Rigidity, DSGE models, Staggered Contracts.
    Date: 2010–04
  25. By: Ignacio Lozano
    Abstract: The purpose of this study is twofold: First, it provides an empirical characterization of fiscal policy in Colombia over the last decades, by assessing the three most relevant macroeconomic factors: the behavior of fiscal policy over the business cycle; whether it has been coherent with the long-term debt sustainability; and, whether it has been a significant source of macroeconomic volatility. The results are compared internationally. Second, it evaluates the fiscal stance of the Colombian authorities during the 2008 global financial crisis, and examines the adoption of a fiscal rule as an appropriate tool to manage public finances beyond the recovery phase.
    Date: 2010–04–20
  26. By: Gabriel Jiménez (Banco de España, PO Box 28014, Alcalá 48, Madrid, Spain.); Steven Ongena (CentER - Tilburg University and CEPR, PO Box 90153, NL 5000 LE Tilburg, The Netherlands.); José-Luis Peydró (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Jesús Saurina (Banco de España, PO Box 28014, Alcalá 48, Madrid, Spain.)
    Abstract: To identify credit availability we analyze the extensive and intensive margins of lending with loan applications and all loans granted in Spain. We find that during the period analyzed both worse economic and tighter monetary conditions reduce loan granting, especially to firms or from banks with lower capital or liquidity ratios. Moreover, responding to applications for the same loan, weak banks are less likely to grant the loan. Our results suggest that firms cannot offset the resultant credit restriction by turning to other banks. Importantly the bank-lending channel is notably stronger when we account for unobserved time-varying firm heterogeneity in loan demand and quality. JEL Classification: E32, E44, E5, G21, G28.
    Keywords: non-financial and financial borrower balance-sheet channels, financial accelerator, firm borrowing capacity, credit supply, business cycle, monetary policy, credit channel, net worth, capital, liquidity, 2007-09 crisis.
    Date: 2010–04
  27. By: Ida Wolden Bache (Norges Bank (Central Bank of Norway)); Leif Brubakk (Norges Bank (Central Bank of Norway)); Junior Maih (Norges Bank (Central Bank of Norway))
    Abstract: We estimate a small open-economy DSGE model for Norway with two specifications of monetary policy: a simple instrument rule and optimal policy based on an intertemporal loss function. The empirical fit of the model with optimal policy is as good as the model with a simple rule. This result is robust to allowing for misspecification following the DSGE-VAR approach proposed by Del Negro and Schorfheide (2004). The interest rate forecasts from the DSGE-VARs are close to Norges Bank's official forecasts since 2005. One interpretation is that the DSGE-VAR approximates the judgment imposed by the policymakers in the forecasting process.
    Keywords: DSGE models, forecasting, optimal monetary policy
    JEL: C53 E52
    Date: 2010–04–07
  28. By: Gary S. Anderson; Jinill Kim; Tack Yun
    Abstract: Since Kydland and Prescott (1977) and Barro and Gordon (1983), most studies of the problem of the inflation bias associated with discretionary monetary policy have assumed a quadratic loss function. We depart from the conventional linear-quadratic approach to the problem in favor of a projection method approach. We investigate the size of the inflation bias that arises in a microfounded nonlinear environment with Calvo price setting. The inflation bias is found to lie between 1% and 6% for a reasonable range of parameter values, when the bias is defined as the steady-state deviation of the discretionary inflation rate from the optimal inflation rate under commitment.
    Date: 2010
  29. By: Stefania D'Amico; Don H. Kim; Min Wei
    Abstract: TIPS breakeven inflation rate, defined as the difference between nominal and TIPS yields of comparable maturities, is potentially useful as a real-time measure of market inflation expectations. In this paper, we provide evidence that a fairly large TIPS liquidity premium existed until recently, using a multifactor no-arbitrage term structure model estimated with nominal and TIPS yields, inflation and survey forecasts of interest rates. Ignoring the TIPS liquidity premiums leads to counterintuitive implications for inflation expectations and inflation risk premium, and produces large pricing errors for TIPS. In contrast, models incorporating a TIPS liquidity factor generate much better fit for these variables and reveal a TIPS liquidity premium that was until recently quite large (~1%) but has come down in recent years, consistent with the common perception that TIPS market grew and liquidity conditions improved. Our results indicate that after taking proper account of the liquidity conditions in the TIPS market, the movement in TIPS breakeven inflation rate can provide useful information for identifying real yields, expected inflation and inflation risk premium.
    Date: 2010
  30. By: Robert J. Tetlow
    Abstract: I study 46 vintages of FRB/US, the principal macro model used by Federal Reserve Board staff for forecasting and policy analysis, as measures of real-time model uncertainty. I also study the implications of model uncertainty for the robustness of commonly applied, simple monetary policy rules. I first document that model uncertainty poses substantial challenges for policymakers in that key model properties differ in important ways across model vintages. Then I show that the parameterization of optimized simple policy rule--rules that are intended to be robust with respect to model uncertainty--also differ substantially across model vintages. Included in the set of rules are rules that eschew feedback on the output gap, rules that target nominal income growth, and rules that allow for time variation in the equilibrium real interest rate. I find that many rules, which previous research has shown to be robust in artificial economies, would have failed to provide adequate stabilization in the real-time, real-world environment seen by the Fed staff. However, I do identify certain policy rules that would have performed relatively well, and I characterize the key features of those rules to draw more general lessons about the design of monetary policy under model uncertainty.
    Date: 2010
  31. By: Raphael A. Espinoza; Ananthakrishnan Prasad; H. L. Leon
    Abstract: Motivated by the global inflation episode of 2007-08 and concern that high levels of inflation could undermine growth, this paper uses a panel of 165 countries and data for 1960-2007 to revisit the nexus between inflation and growth. We use a smooth transition model to investigate the speed at which inflation beyond a threshold becomes harmful to growth, an important consideration in the policy response to rising inflation as the world economy recovers. We estimate that for all country groups (except for advanced countries) inflation above a threshold of about 10 percent quickly becomes harmful to growth, suggesting the need for a prompt policy response to inflation at or above the relevant threshold. For the advanced economies, the threshold is much lower. For oil exporting countries, the estimates are less robust, possibly reflecting heterogeneity among oil producers, but the effect of higher inflation for oil producers is found to be stronger.
    Keywords: Cross country analysis , Developed countries , Economic growth , Economic models , Emerging markets , Inflation , Monetary policy , Oil exporting countries , Production growth ,
    Date: 2010–03–24
  32. By: Ansgar Belke
    Abstract: The ECB has accepted increasing amounts of rubbish collateral since the crisis started leading to exposure to serious private sector credit risk (i.e. default risk) on its collateralised lending and reverse operations ("repo"). This has led some commentators to argue that the ECB needs "fiscal back-up" to cover any potential losses to be able to continue pursuing price stability. This Brief argues that fiscal backing is not necessary for the ECB for three reasons. Firstly, the ECB balance sheet risk is small compared to the FED and BoE as it neither increased its quasi-fiscal operations as much as the Fed or the BoE nor did it engage to a very large extent in outright bond purchases during the financial crisis. Secondly, the ECB's specific accounting principles of repo operations provide for more clarity and earlier recognition of losses. Thirdly, the ECB can draw on substantial reserves of the euro area national banks.
    Keywords: Central bank independence, central bank capital, counterparty risk, repurchase agreements, collateral, fiscal backing, liquidity, haircuts
    JEL: G32 E42 E51 E58 E63
    Date: 2010
  33. By: Eijffinger, S.C.W.; Qian, Z. (Tilburg University, Center for Economic Research)
    Abstract: Recent cross-country studies on the globalization and output-inflation tradeoff correlation find openness has no significant effect on OECD countries. Those studies assume parameter constancy across countries. In this paper, we argue that this assumption does not hold for major industrialized countries. Using individual time series analysis, we find the effect of openness on the output-inflation trade off differ in sign and size across countries. In contrast to previous cross-country studies, we find globalization has significantly changed some major industrialized countries’ output inflation tradeoff. This has important implications for future theoretical and empirical research.
    Keywords: openness;output-inflation tradeoff;Phillips curve;time inconsistency theory
    JEL: E31 E58 F10 F30 F41
    Date: 2010
  34. By: Michael Kumhof; Günter Coenen; Dirk Muir; Charles Freedman; Susanna Mursula; Christopher J. Erceg; Davide Furceri; René Lalonde; Jesper Lindé; Annabelle Mourougane; John Roberts; Werner Roeger; Carlos de Resende; Stephen Snudden; Mathias Trabandt; Jan in ‘t Veld; Douglas Laxton
    Abstract: The paper assesses, using seven structural models used heavily by policymaking institutions, the effectiveness of temporary fiscal stimulus. Models can, more easily than empirical studies, account for differences between fiscal instruments, for differences between structural characteristics of the economy, and for monetary-fiscal policy interactions. Findings are: (i) There is substantial agreement across models on the sizes of fiscal multipliers. (ii) The sizes of spending and targeted transfers multipliers are large. (iii) Fiscal policy is most effective if it has some persistence and if monetary policy accommodates it. (iv) The perception of permanent fiscal stimulus leads to significantly lower initial multipliers.
    Keywords: Budget deficits , Cross country analysis , Economic forecasting , Economic models , Europe , Fiscal policy , Government expenditures , Monetary policy , Public debt , Stabilization measures , Taxes , United States ,
    Date: 2010–03–22
  35. By: Makram El-Shagi
    Abstract: Conventional Phillips-curve models that are used to estimate the output gap detect a substantial decline in potential output due to the present crisis. Using a multivariate state space model, we show that this result does not hold if the long run role of excess liquidity (that we estimate endogeneously) for inflation is taken into account.
    Keywords: output gap, liquidity, state space models
    JEL: E3 E4
    Date: 2010–04
  36. By: Richard Dennis; Tatiana Kirsanova
    Abstract: Discretionary policymakers cannot manage private-sector expectations and cannot co- ordinate the actions of future policymakers. As a consequence, expectations traps and coordination failures can occur and multiple equilibria can arise. In order to utilize the explanatory power of models with multiple equilibria it is necessary to understand how an economy arrives to a particular equilibrium. In this paper, we employ notions of robust- ness, learnability, and the potential for policy errors to motivate and develop a suite of equilibrium selection criteria. Central among these criteria are whether the equilibrium is learnable by private agents and jointly learnable by private agents and the policymaker. We use two New Keynesian policy models to identify the strategic interactions that give rise to multiple equilibria and to illustrate our equilibrium selection methods. Impor- tantly, although the Pareto-preferred equilibrium is invariably an equilibrium identi?ed by standard numerical iterative solution methods, unless it is learnable by private agents, we ?nd little reason to expect coordination on that equilibrium.
    JEL: E52 E61 C62 C73
    Date: 2010–01
  37. By: Michael B. Devereux
    Abstract: Recent macroeconomic experience has drawn attention to the importance of interdependence among countries through financial markets and institutions, independently of traditional trade linkages. This paper develops a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained financial institutions. In the absence of leverage constraints, international portfolio diversification has no implications for macroeconomic comovements. When leverage constraints bind, however, the presence of diversified portfolios in combination with these constraints introduces a powerful financial transmission channel, which results in a high correlation among macroeconomic aggregates during business cycle downturns, quite independent of the size of international trade linkages. Conversely, the paper shows that, conditional on leverage constraints binding, international financial integration through equity markets reverses the sign of the international comovement of shocks, leading comovement to switch from negative to positive.
    Keywords: International finance ; International economic integration ; Business cycles ; Financial leverage
    Date: 2010
  38. By: Agur, I.; Demertzis, M. (Tilburg University, Center for Economic Research)
    Abstract: If monetary policy is to aim at financial stability, how would it change? To analyze this question, this paper develops a general-form model with endogenous bank risk profiles. Policy rates affect both bank incentives to search for yield and the cost of wholesale funding. Financial stability objectives are then shown to make a monetary authority more conservative and more aggressive. Conservative as it sets higher rates on average. And aggressive because, in reaction to negative shocks, cuts are deeper but shorter-lived than otherwise. Keeping cuts short is crucial as bank risk responds primarily to stable low rates. Within the short span, cuts then must be deep to achieve standard objectives.
    Keywords: Monetary policy;Financial stability
    JEL: E52 G21
    Date: 2010
  39. By: Chia-Lin Chang; Philip Hans Franses; Michael McAleer (University of Canterbury)
    Abstract: A government’s ability to forecast key economic fundamentals accurately can affect business confidence, consumer sentiment, and foreign direct investment, among others. A government forecast based on an econometric model is replicable, whereas one that is not fully based on an econometric model is non-replicable. Governments typically provide non-replicable forecasts (or, expert forecasts) of economic fundamentals, such as the inflation rate and real GDP growth rate. In this paper, we develop a methodology to evaluate non-replicable forecasts. We argue that in order to do so, one needs to retrieve from the non-replicable forecast its replicable component, and that it is the difference in accuracy between these two that matters. An empirical example to forecast economic fundamentals for Taiwan shows the relevance of the proposed methodological approach. Our main finding is that it is the undocumented knowledge of the Taiwanese government that reduces forecast errors substantially.
    Keywords: Government forecasts; generated regressors; replicable government forecasts; non- replicable government forecasts; initial forecasts; revised forecasts
    JEL: C53 C22 E27 E37
    Date: 2010–04–01
  40. By: Anke Weber
    Abstract: This paper considers optimal communication by monetary policy committees in a model of imperfect knowledge and learning. The main policy implications are that there may be costs to central bank communication if the public is perpetually learning about the committee's decision-making process and policy preferences. When committee members have heterogeneous policy preferences, welfare is greater under majority voting than under consensus decision-making. Furthermore, central bank communication under majority voting is more likely to be beneficial in this case. It is also shown that a chairman with stable policy preferences who carries significant weight in the monetary policy decision-making process is welfare enhancing.
    Keywords: Announcements , Central banks , Economic models , Monetary policy , Private sector , Public information ,
    Date: 2010–04–02
  41. By: Thomas A. Lubik; Wing Leong Teo
    Abstract: We introduce inventories into an otherwise standard New Keynesian model and study the implications for ination dynamics. Inventory holdings are motivated as a means to generate sales for demand-constrained …rms. We derive various representa- tions of the New Keynesian Phillips curve with inventories and show that one of these speci…cations is observationally equivalent to the standard model with respect to the behavior of ination when the models cross-equation restrictions are imposed. How- ever, the driving variable in the New Keynesian Phillips curve - real marginal cost - is unobservable and has to be proxied by, for instance, unit labor costs. An alternative approach is to impute marginal cost by using the models optimality conditions. We show that the stock-sales ratio is linked to marginal cost. We also estimate these various speci…cations of the New Keynesian Phillips curve using GMM. We …nd that predictive power of the inventory-speci…cation at best approaches that of the standard model, but does not improve upon it. We conclude that inventories do not play a role in explaining ination dynamics within our New Keynesian Phillips curve framework.
    JEL: E24 E32 J64
    Date: 2010–04
  42. By: Philip Hans Franses; Michael McAleer (University of Canterbury); Rianne Legerstee
    Abstract: Macroeconomic forecasts are frequently produced, published, discussed and used. The formal evaluation of such forecasts has a long research history. Recently, a new angle to the evaluation of forecasts has been addressed, and in this review we analyse some recent developments from that perspective. The literature on forecast evaluation predominantly assumes that macroeconomic forecasts are generated from econometric models. In practice, however, most macroeconomic forecasts, such as those from the IMF, World Bank, OECD, Federal Reserve Board, Federal Open Market Committee (FOMC) and the ECB, are based on econometric model forecasts as well as on human intuition. This seemingly inevitable combination renders most of these forecasts biased and, as such, their evaluation becomes non-standard. In this review, we consider the evaluation of two forecasts in which: (i) the two forecasts are generated from two distinct econometric models; (ii) one forecast is generated from an econometric model and the other is obtained as a combination of a model, the other forecast, and intuition; and (iii) the two forecasts are generated from two distinct combinations of different models and intuition. It is shown that alternative tools are needed to compare and evaluate the forecasts in each of these three situations. These alternative techniques are illustrated by comparing the forecasts from the Federal Reserve Board and the FOMC on inflation, unemployment and real GDP growth.
    Keywords: Macroeconomic forecasts; econometric models; human intuition; biased forecasts; forecast performance; forecast evaluation; forecast comparison
    JEL: C22 C51 C52 C53 E27 E37
    Date: 2010–03–01
  43. By: Muge Adalet (Koc University); Sumru Oz (Koc University)
    Abstract: This paper uses a simple VAR analysis to examine 5 CEE countries (the Czech Republic, Hungary, Poland, Romania and Slovakia) in order to understand whether their business cycles are synchronized with each other and/or with the major economies that they are supposed to be linked with, namely the US, Germany and Russia. We find that there are differences across the CEE countries themselves and that there is no common CEE business cycle. Comparing the individual CEE business cycles with those of the dominant economies, we find that Hungary and Poland are related to the US business cycle, reflecting the fact that they are more integrated with the global economy, whereas Slovakia is closer to the Russian cycle. Finally, splitting the sample into the late 1990s and 2000s due to the transition nature of these economies in the former period shows that the influence of Russia on the CEE economies has declined over time. However, in contrast to the expectations that CEE countries are likely to be affected by Germany in the second half of the sample due to EU negotiations followed by full membership, among the CEE countries only the business cycle of Slovakia is synchronized with that of Germany. On the other hand the Czech Republic, Hungary and Poland are synchronized with the US business cycle, showing that globalization has decreased the importance of distance.
    Keywords: Business cycle synchronization, CEE countries, EMU
    JEL: E32 F15 F41
    Date: 2010–04
  44. By: Wändi Bruine de Bruin; Wilbert van der Klaauw; Julie S. Downs; Baruch Fischhoff; Giorgio Topa; Olivier Armantier
    Abstract: Public expectations and perceptions of inflation may affect economic decisions, and have subsequent effects on actual inflation. The Michigan Survey of Consumers uses questions about "prices in general" to measure expected and perceived inflation. Median responses track official measure of inflation, showing some tendency toward overestimation and considerable disagreement between respondents. Possibly, responses reflect how much respondents thought of salient personal experiences with specific prices when being asked about "prices in general." Here, we randomly assigned respondents to questions about "prices in general," as well as "the rate of inflation" and "price you pay." Reported expectations and perceptions were higher and more dispersed for "prices in general" than for "the rate of inflation," with "prices you pay" and "prices in general" showing similar responses patterns. Compared to questions about "the rate of inflation," questions about "prices in general" and "prices you pay" focused respondents relatively more on personal price experiences--and elicited expectations that were more strongly correlate to the expected price increases for food and transportation, which were relatively large and likely salient, but not to the expected price increases for housing, which were relatively small and likely less salient. Our results have implications for survey measures of inflation expectations.
    Keywords: Inflation (Finance) ; Consumer surveys ; Prices
    Date: 2010
  45. By: Andrei Zlate
    Abstract: Cross-country variation in production costs encourages the relocation of production facilities to other countries, a process known as offshoring through vertical foreign direct investment. I examine the effect of offshoring on the international transmission of business cycles. Unlike the existing macroeconomic literature, I distinguish between fluctuations in the number of offshoring firms (the extensive margin) and in the value added per offshoring firm (the intensive margin) as separate transmission mechanisms. The firms' decision to produce offshore depends on the firm-specific level of labor productivity, on fluctuations in the relative cost of effective labor, and on the fixed and trade costs of offshoring. The model replicates the procyclical pattern of offshoring and the dynamics along its two margins, which I document using data from U.S. manufacturing and Mexico's maquiladora sectors. Offshoring enhances the synchronization of business cycles, and dampens the real exchange rate appreciation generated by aggregate productivity differentials across countries.
    Date: 2010
  46. By: John Bryant (Vocat International)
    Abstract: This paper develops further monetary aspects of a model, first set out as part of a paper by the author published in 2007, concerning the application of thermodynamic principles to economics. The model is backed up by statistical analysis of quarterly data of the UK and USA economies. The model sets out relationships between price, output volume, velocity of circulation and money supply, and develops an equation to measure entropy gain in an economic system, linked to interest rates. This paper was first released in August 2008, but has now been revised to reflect current thinking
    Keywords: Monetary, thermodynamics, economics, entropy, interest rates
    Date: 2010–02
  47. By: David Bowman; Etienne Gagnon; Mike Leahy
    Abstract: This paper reviews the experience of eight major foreign central banks with policy interest rates comparable to the interest rate on excess reserves paid by the Federal Reserve. We pursue two main lines of inquiry: 1) To what extent have these policy interest rates been lower bounds for short-term market rates, and 2) to what extent has tightening that included increasing these policy rates been achieved without reliance on reductions in reserves or other deposits held at the central bank? The foreign experience suggests that policy rate floors can be effective lower bounds for market rates, although incomplete access to central bank accounts and interest on them weakens this result. In addition, the foreign experience suggests that tightening by increasing the interest rate paid on central bank balances can help reduce or eliminate the need to drain balances. These results are consistent with theoretical results that show that tightening without draining is possible, irrespective of whether excess reserves are large or small.
    Date: 2010
  48. By: Ruben Atoyan
    Abstract: Focusing on the nexus between economic growth and buildup of external vulnerabilities, this paper provides a systematic account of different growth strategies followed in Central and Eastern Europe in 2000-08 and then uses this growth diagnostics to derive implications for the post-crisis recovery. The main findings point to three policy lessons for improving growth sustainability. First, greater reliance on tradable sectors should be the cornerstone of the future growth model. Second, enhancing domestic sources of bank credit funding would contribute to mitigation of external vulnerabilities and make domestic financial system more resilient to global financial shocks. Third, prudential and macroeconomic policies will have to be more proactive in managing capital inflows, including funneling these inflows into investment in the export-oriented industries.
    Keywords: Bank credit , Capital controls , Capital inflows , Central and Eastern Europe , Economic growth , Economic models , Emerging markets , Fiscal policy , Monetary policy ,
    Date: 2010–04–06
  49. By: Rabah Arezki; Kareem Ismail
    Abstract: We examine the behavior of expenditure policy during boom-bust in commodity price cycles, and its implication for real exchange rate movements. To do so, we introduce a Dutch disease model with downward rigidities in government spending to revenue shock. This model leads to a decoupling between real exchange rate and commodity price movement during busts. We test our model's theoretical predictions and underlying assumptions using panel data for 32 oil-producing countries over the period 1992 to 2009. Results are threefold. First, we find that change in current spending have a stronger impact on the change in real exchange rate compared to capital spending. Second, we find that current spending is downwardly sticky, but increases in boom time, and conversely for capital spending. Third, we find limited evidence that fiscal rules have helped reduce the degree of responsiveness of current spending during booms. In contrast, we find evidence that fiscal rules are associated with a significant reduction in capital expenditure during busts while responsiveness to boosts is more muted. This raises concerns about potential adverse consequences of this asymmetry on economic performance in oil-producing countries.
    Keywords: Business cycles , Commodity price fluctuations , Economic models , Fiscal policy , Government expenditures , International trade , Natural resources , Oil exports , Oil producing countries , Political economy , Real effective exchange rates , Revenue mobilization ,
    Date: 2010–04–07
  50. By: Repullo, R.; Suarez, J. (Tilburg University, Center for Economic Research)
    Abstract: We assess the procyclical effects of bank capital regulation in a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period. Banks anticipate that shocks to their earnings as well as the cyclical position of the economy can impair their capacity to lend in the future and, as a precaution, hold capital buffers. We find that under cyclically-varying risk-based capital requirements (e.g. Basel II) banks hold larger buffers in expansions than in recessions. Yet, these buffers are insufficient to prevent a significant contraction in the supply of credit at the arrival of a recession. We show that cyclical adjustments in the confidence level underlying Basel II can reduce its procyclical effects on the supply of credit without compromising banks’ long-run solvency targets.
    Keywords: Banking regulation;Basel II;Business cycles;Capital requirements;Credit crunch;Loan defaults;Relationship banking.
    JEL: G21 G28 E44
    Date: 2010
  51. By: Cemile Sancak; Ricardo Velloso; Jing Xing
    Abstract: This paper examines tax revenue during the business cycle by estimating the relationship between tax revenue efficiency and the output gap. We find a positive and significant relationship between these variables; results are consistent for quarterly and annual data, and across advanced and developing economies. We also find that a worsening (improvement) in the VAT C-efficiency is driven by shifts in consumption patterns and changes in tax evasion during contractions (expansions). A key implication is that, particularly during major economic booms and downturns, policy makers should look beyond simple, long-run revenue elasticities and incorporate into their analysis the effects of the economic cycle on tax revenue efficiency.
    Keywords: Business cycles , Economic forecasting , Economic models , Fiscal policy , Tax revenues , Value added tax ,
    Date: 2010–03–19
  52. By: Nijskens, R.G.M.; Eijffinger, S.C.W. (Tilburg University, Center for Economic Research)
    Abstract: Banking regulation has proven to be inadequate to guard systemic stability in the recent financial crisis. Central banks have provided liquidity and ministries of finance have set up rescue programmes to restore confidence and stability. Using a model of a systemic bank suffering from liquidity shocks, we find that the unregulated bank keeps too much liquidity and takes excessive risk compared to the social optimum. A Lender of Last Resort can alleviate the liquidity problem, but induces moral hazard. Therefore, we introduce a fiscal authority that is able to bail out the bank by injecting capital. This authority faces a trade-off: when it imposes strict bailout conditions, investment increases but moral hazard ensues. Milder bailout conditions reduce excessive risk taking at the expense of investment. This resembles the current situation on financial markets, in which banks take less risk but also provide less credit to the economy.
    Keywords: Bank Regulation;Lender of Last Resort;Liquidity;Capital;Bailout
    JEL: E58 G21 G28
    Date: 2010
  53. By: Fédéric Holm-Hadulla (European Central Bank, Kaiserstrasse 29, 60311, Frankfurt am Main, Germany.); Sebastian Hauptmeier (European Central Bank, Kaiserstrasse 29, 60311, Frankfurt am Main, Germany.); Philipp Rother (European Central Bank, Kaiserstrasse 29, 60311, Frankfurt am Main, Germany.)
    Abstract: We study the impact of numerical expenditure rules on the propensity of governments to deviate from expenditure targets in response to surprises in cyclical conditions. Theoretical considerations suggest that due to political fragmentation in the budgetary process expenditure policy might be prone to a pro-cyclical bias. However, this tendency may be mitigated by numerical expenditure rules. These hypotheses are tested against data from a panel of EU Member States. Our key findings are that (i) deviations between actual and planned government expenditure are positively related to unanticipated changes in the output gap, and (ii) numerical expenditure rules reduce this pro-cyclical bias. Moreover, the pro-cyclical spending bias is found to be particularly pronounced for spending items with a high degree of budgetary flexibility. JEL Classification: C23, E62, H50.
    Keywords: expenditure rules, fiscal discipline, stabilisation, spending bias.
    Date: 2010–04
  54. By: Peter Flaschel (Univeristy of Bielefeld, Germany); Alfred Greiner (Univeristy of Bielefeld, Germany); Camille Logeay (Macroeconomic Policy Institute (IMK) at the Hans Boeckler Foundation); Christian Proano (Macroeconomic Policy Institute (IMK) at the Hans Boeckler Foundation)
    Abstract: In this paper we investigate the macroeconomic consequences of the introduction of an unemployment benefit system and a minimum wage barrier for both skilled and unskilled workers against the background of Goodwin's (1967) model. In the analyzed framework, characterized by free "hiring" and "firing" in the first labor markets, we can show a) that large fluctuations in employment are made (at least partially) socially acceptable through the workfare nature of the unemployment benefit system and b) that minimum real wages provide additional stability to the system dynamics by decreasing the amplitude of the fluctuations in employment and income distribution (and the related degradation of the workforce skills and family structures they are otherwise subject to).
    Keywords: Distributive cycles, minimum wages, stability, combined wages, base income, workfare
    JEL: E32 E64
    Date: 2010
  55. By: Prakash Kannan
    Abstract: Recoveries from recessions associated with a financial crisis tend to be sluggish. In this paper, we present evidence that stressed credit conditions are an important factor constraining the pace of recovery. In particular, using industry-level data, we find that industries relying more on external finance grow more slowly than other industries during recoveries from recessions associated with financial crises. Additional tests, based on establishment size, on alternative definitions of financial crises, and on corporate-government interest rate spreads, support the findings. Moreover, for subsets of industries where financial frictions are more severe, we find much stronger differential growth effects.
    Keywords: Bank credit , Banking crisis , Business cycles , Credit , Developed countries , Economic models , Economic recession , Economic recovery , External financing , Financial crisis , Industrial sector , Production growth ,
    Date: 2010–03–31
  56. By: Jesmin Rahman
    Abstract: This paper estimates revenue and expenditure pro-cyclicality with respect to output and domestic absorption in new member states of the European Union and Croatia to assess whether these countries used the boom years of 2003-07 to create sufficient fiscal space. The current crisis has found many countries short of fiscal space. As these countries enter a different phase of capital inflows, some with large vulnerabilities and inflexible monetary policy options, the role of fiscal policy becomes more important. This paper also looks at these issues to see how fiscal policy can play a more effective role in demand management in these countries.
    Date: 2010–04–15
  57. By: James Costain (Banco de España); Juan F. Jimeno (Banco de España); Carlos Thomas (Banco de España)
    Abstract: In light of the huge cross-country differences in job losses during the recent crisis, we study how labor market duality - meaning the coexistence of "temporary" contracts with low firing costs and "permanent" contracts with high firing costs - affects labor market volatility. In a model of job creation and destruction based on Mortensen and Pissarides (1994), we show that a labor market with these two contract types is more volatile than an otherwise-identical economy with a single contract type. Calibrating our model to Spain, we find that unemployment fluctuates 21% more under duality than it would in a unified economy with the same average firing cost, and 33% more than it would in a unified economy with the same average unemployment rate. In our setup, employment grows gradually in booms, due to matching frictions, whereas the onset of a recession causes a burst of firing of "fragile" low-productivity jobs. Unlike permanent jobs, some newly-created temporary jobs are already near the firing margin, which makes temporary jobs more likely to be fragile and means they play a disproportionate role in employment fluctuations. Unifying the labor market makes all jobs behave more like the permanent component of the dual economy, and therefore decreases volatility. Unfortunately, it also raises unemployment; to avoid this, unification must be accompanied by a decrease in the average level of firing costs. Finally, we confirm that factors like unemployment benefits and wage rigidity also have a large, interacting effect on labor market volatility; in particular, higher unemployment benefits increase the impact of duality on volatility.
    Keywords: firing costs, temporary jobs, unemployment volatility, matching model, endogenous separation
    JEL: E32 J42 J63 J64 J65
    Date: 2010–04
  58. By: Steven B. Kamin; Laurie Pounder DeMarco
    Abstract: The global financial crisis clearly started with problems in the U.S. subprime sector and spread across the world from there. But was the direct exposure of foreigners to the U.S. financial system a key driver of the crisis, or did other factors account for its rapid contagion across the world? To answer this question, we assessed whether countries that held large amounts of U.S. mortgage-backed securities (MBS) and were highly dependent on dollar funding experienced a greater degree of financial distress during the crisis. We found little evidence of such "direct contagion" from the United States to abroad. Although CDS spreads generally rose higher and bank stocks generally fell lower in countries with more exposure to U.S. MBS and greater dollar funding needs, these correlations were not robust, and they fail to explain the lion's share of the deterioration in asset prices that took place during the crisis. Accordingly, channels of "indirect contagion" may have played a more important role in the global spread of the crisis: a generalized run on global financial institutions, given the opacity of their balance sheets; excessive dependence on short-term funding; vicious cycles of mark-to-market losses driving fire sales of MBS; the realization that financial firms around the world were pursuing similar (flawed) business models; and global swings in risk aversion. The U.S. subprime crisis, rather than being a fundamental driver of the global crisis, may have been merely a trigger for a global bank run and for disillusionment with a risky business model that already had spread around the world.
    Date: 2010
  59. By: Alexander Chudik (European Central Bank, Kaiserstrasse 29, 60311, Frankfurt am Main, Germany.); Roland Straub (European Central Bank, Kaiserstrasse 29, 60311, Frankfurt am Main, Germany.)
    Abstract: The curse of dimensionality, a problem associated with analyzing the interaction of a relatively large number of endogenous macroeconomic variables, is a prevailing issue in the open economy macro literature. The most common practise to mitigate this problem is to apply the so-called Small Open Economy Framework (SOEF). In this paper, we aim to review under which conditions the SOEF is a justifiable approximation and how severe the consequences of violation of key conditions might be. Thereby, we use a multicountry general equilibrium model as a laboratory. First, we derive the conditions that ensure the existence of the equilibrium and study the properties of the equilibrium using large N asymptotics. Second, we show that the SOEF is a valid approximation only for economies (i) that have a diversified foreign trade structure and if (ii) there is no globally dominant economy in the system. Third, we illustrate that macroeconomic interdependence is primarily related to the degree of trade diversification, and not to the extent of trade openness. Furthermore, we provide some evidence on the pattern of global macroeconomic interdependence by calculating probability impulse response functions in our calibrated multicountry model using data for 153 economies. JEL Classification: F41.
    Keywords: DSGE models, Open Economy Macroeconomics, Weak and Strong Cross Section Dependence, Factor models.
    Date: 2010–04
  60. By: Hong, Kiseok (Ewha Womans University); Tang, Hsiao Chink (Asian Development Bank)
    Abstract: The goal of this paper is to provide stylized facts on recovery from economic downturns and to evaluate the role of macroeconomic policies in promoting recovery. In particular, we examine gross domestic product (GDP) recessions and financial downturns (credit contractions and stock price declines) using data from 21 Organisation for Economic Co-operation and Development (OECD) economies and 21 developing Asian economies. We find, in general, recovery from a GDP recession in Asian economies is somewhat slower than in OECD economies. However, recovery from a financial downturn is not much different between Asian and OECD economies. We also find OECD economies have been more active and effective in using counter-cyclical policies than Asian economies in the face of GDP recessions and financial downturns. Recent evidence, however, suggests Asian economies may have better success in the current global crisis.
    Keywords: Recession; Financial Crisis; Recovery; Policy Response; Asia
    JEL: E20 E30 E32
    Date: 2010–04–01
  61. By: Jiri Jonas
    Abstract: The paper discusses the challenges facing Albania's fiscal policy following the graduation from the IMF programs. It argues that Albania's public debt remains too high and needs to be reduced. Strengthening the fiscal framework, including by introducing a numerical fiscal rule, could help achieve this objective. The paper discusses two alternative rules, with the objective of achieving a gradual decline in the public debt ratio. One rule would limit nominal expenditure growth, with a correction mechanism to guard against revenue slippages and other shocks. An alternative rule would limit the growth in nominal public debt.
    Keywords: Albania , Debt reduction , Debt sustainability , Fiscal policy , Government expenditures , Post-program monitoring , Public debt , Tax administration ,
    Date: 2010–03–25
  62. By: Özer Karagedikli; Haroon Mumtaz; Misa Tanaka (Reserve Bank of New Zealand)
    Abstract: Recent research has found evidence of increasing co-movement in CPI inflation rates across industrialised countries. This paper considers whether this increased international co-movement in inflation rates can be attributed to greater global integration of product markets. To examine this question, we use a data set of 28 matched product category price indices for 14 advanced economies for 1998Q1 - 2008Q2, and decompose the inflation rates into a world factor, country-specific factors, and category-specific factors using a Bayesian dynamic factor model with Gibbs sampling. We find that the category-specific factors account for a large part of the co-movement in the prices of goods which are intensive in internationally traded primary commodities; but this is less evident for other traded goods. We also find that both the world factor and the category-specific factors become more significant in explaining the movement in the relative prices in the second half of our sample.
    JEL: E30 E52
    Date: 2010–03
  63. By: Jaromír Beneš; Kirdan Lees (Reserve Bank of New Zealand)
    Abstract: We investigate the implications of the existence of multi-period fixed-rate loans for the behaviour of a small open economy exposed to finance shocks and housing boom-and-bust cycles. To this end, we propose a simple and analytically tractable method of incorporating multi-period debt into an otherwise standard consumer problem. Our simulations show that multi-period fixed-rate contracts can help insulate the economy from the adverse effects of particular shocks. This insulating mechanism is particularly effective for countries with high debt positions exposed to foreign exchange fluctuations, or countries operating a fixed exchange rate regime.
    JEL: E5 E44 E52
    Date: 2010–03
  64. By: Toichiro Asada (Faculty of Economics, Chuo University, Tokyo, Japan); Peter Flaschel (Univeristy of Bielefeld, Germany); Alfred Greiner (Univeristy of Bielefeld, Germany); Christian Proano (Macroeconomic Policy Institute (IMK) at the Hans Boeckler Foundation)
    Abstract: In this paper we present a model of flexicurity capitalism that exhibits a second labor market with the government as an employer of first resort, where all workers not employed by firms in the private sector find meaningful employment. We show that the model exhibits a unique interior steady state which is asymptotically stable under real wage adjustment dynamics of the type considered in Blanchard and Katz (1999), and under a type of Okun's Law that links the level of utilization of firms to their hiring and firing decision. The introduction of a company pension fund can be shown to contribute to the viability of the analyzed economic system. However, when credit is incorporated in the model, in place of savings-driven supply side fluctuations in economic activity, investment-driven demand side business cycle fluctuations (of a probably much more volatile type) can take place.
    Keywords: Flexicurity, employer of ¯rst resort, Solovian growth, company pension funds, sustainability
    JEL: E3 E6 H1
    Date: 2010
  65. By: Ronald Schettkat (Schumpeter School University of Wuppertal)
    Abstract: The current crisis is like an earthquake for the theoretical foundations of economic policies, which have guided governments and central banks for the last few decades. The efficient market hypothesis and its application to labor markets –“natural rate theory”- dominated interpretations of economic trends and policy prescriptions since the 1970s. Public policy, public institutions, and regulations were generally regarded as distortions of the otherwise well functioning markets. Economic trends were filtered through the lens of the “natural rate theory,” focusing on labor market institutions only and putting blinds on macroeconomic influences. Therefore, the recipe was a reshaping of institutional arrangements intended to allow markets to operate more freely, i.e. to bring the real world closer to the idealized theoretical model. This paper confronts the economic trends with the interpretations of the “natural rate theory” and argues that they hardly fitting the facts. The paper argues that monetary policy gained importance in the 1970s and enforced deflationary policies – which, in turn reduced growth, especially in upswings – and allowed employment to recover to its initial pre-recession levels. Deflationary bias was also guiding the design of major EU institutions, reducing potential and actual growth.</FONT>
    Keywords: Economic crisis, efficient market hypothesis, natural rate theory, deflationary bias
    JEL: E00 E24 E58 E6 J3
    Date: 2010–04
  66. By: Timo Henckel; Gordon D. Menzies; Daniel J. Zizzo
    Abstract: We propose that the formation of beliefs be treated as statistical hypothesis tests, and label such beliefs inferential expectations. If a belief is overturned through the build-up of evidence, we assume agents switch to the rational expectation. We build a state dependent Phillips curve, and show that adjustments to equilibria may be contaminated by noise adverse selection, where agents in possession of extreme information are the first to adjust to changed economic circumstances. This approach is able to replicate recent micro-level evidence on firms’ pricing behavior and sheds light onto the dynamics of disaggregated prices
    JEL: E30 E50
    Date: 2010–01
  67. By: Rochelle M. Edge; Jeremy B. Rudd
    Abstract: This paper develops a new-Keynesian model with nominal depreciation allowances to consider the effects of temporary tax-based investment incentives on capital spending and real activity. In particular, we investigate the effects of a temporary expensing allowance on investment in partial and general equilibrium and challenge the conventional view, advanced by Auerbach and Summers (1979) and Judd (1985), that partial-equilibrium analyses overstate the calculated impact of such policies. We also explore two additional questions. First, we investigate a claim noted by Auerbach and Summers and analyzed by Christiano (1984) that such incentives can be destabilizing. Second, we consider the relative impact of two types of tax-based investment incentives: a temporary partial-expensing allowance and a temporary reduction in capital taxes.
    JEL: E10 E17 E22 E63 H25
    Date: 2010–02
  68. By: Martin, A.; Skeie, D.; Thadden, E.L. von (Tilburg University, Center for Economic Research)
    Abstract: This paper develops a model of financial institutions that borrow short- term and invest into long-term marketable assets. Because these financial intermediaries perform maturity transformation, they are subject to runs. We endogenize the profits of the intermediary and derive distinct liquidity and solvency conditions that determine whether a run can be prevented. We first characterize these conditions for an isolated intermediary and then generalize them to the case where the intermediary can sell assets to prevent runs. The sale of assets can eliminate runs if the intermediary is solvent but illiquid. However, because of cash-in-the-market pricing, this becomes less likely the more intermediaries are facing problems. In the limit, in case of a general market run, no intermediary can sell assets to forestall a run, and our original solvency and liquidity constraints are again relevant for the stability of financial institutions.
    Keywords: Investment banking;securities dealers;repurchase agreements;tri-party repo;runs;financial fragility.
    JEL: E44 E58 G24
    Date: 2010
  69. By: David de Antonio Liedo (Banco de España)
    Abstract: This paper proposes the use of dynamic factor models as an alternative to the VAR-based tools for the empirical validation of dynamic stochastic general equilibrium (DSGE) theories. Along the lines of Giannone et al. (2006), we use the state-space parameterisation of the factor models proposed by Forni et al. (2007) as a competitive benchmark that is able to capture weak statistical restrictions that DSGE models impose on the data. Beyond the weak restrictions, which are given by the number of shocks and the number of state variables, the behavioural restrictions embedded in the utility and production functions of the model economy contribute to achieve further parsimony. Such parsimony reduces the number of parameters to be estimated, potentially helping the general equilibrium environment improve forecast accuracy. In turn, the DSGE model is considered to be misspecified when it is outperformed by the state-space representation that only incorporates the weak restrictions.
    Keywords: dynamic and static rank, factor models, DSGE models, forecasting
    JEL: E32 E37 C52
    Date: 2010–04

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