nep-mac New Economics Papers
on Macroeconomics
Issue of 2011‒03‒26
29 papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Business Management

  1. Leaning Against Boom-Bust Cycles in Credit and Housing Prices By Luisa Lambertini; Caterina Mendicino; Maria Teresa Punzi
  2. The optimal inflation rate revisited By Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola
  3. Does Money Help Predict Inflation? An Empirical Assessment for Central Europe By Roman Horvath; Lubos Komarek; Filip Rozsypal
  4. Endogenous Market Structures and the Business Cycle By colciago , andrea; Rossi, Lorenza
  5. Labor market imperfections, real wage rigidities and financial shocks By Acocella Nicola; Bisio Laura; Di Bartolomeo Giovanni; Pelloni Alessandra
  6. A New Keynesian Phillips curve for Tunisia : Estimation and analysis of sensitivity By Ben Ali, Samir
  7. Spatial Propagation of Macroeconomic Shocks in Europe By Romain Houssa
  8. Money cycles By Andrew Clausen; Carlo Strub
  9. The Implementation of Scenarios Using DSGE Models By Igor Vetlov; Ricardo Mourinho Félix; Laure Frey; Tibor Hlédik; Zoltán Jakab; Niki Papadopoulou; Lukas Reiss; Martin Schneider
  10. Price-level targeting versus inflation targeting over the long-term By Hatcher, Michael C.
  11. A Bayesian approach to optimal monetary policy with parameter and model uncertainty By Cogley, Timothy; de Paoli, Bianca; Matthes, Christian; Nikolov, Kalin; Yates, Tony
  12. News, Intermediation Efficiency and Expectations-driven Boom-bust Cycles By Christopher M. Gunn; Alok Johri
  13. Money, Financial Stability and Efficiency By Franklin Allen; Elena Carletti; Douglas Gale
  14. Inflation expectations, real rates, and risk premia: evidence from inflation swaps By Joseph G. Haubrich; George Pennacchi; Peter Ritchken
  15. On the (non-)equivalence of capital adequacy and monetary policy: A response to Cechetti and Kohler By Stan du Plessis; Gideon du Rand
  16. The gains from delegation revisited: price-level targeting, speed-limit and interest rate smoothing policies By Blake, Andy; Kirsanova, Tatiana; Yates, Tony
  17. Uncertainty about Welfare Effects of Consumption Fluctuations By Romain Houssa
  18. Fiscal policy and growth with complementarities and constraints on government By Misch, Florian; Gemmell, Norman; Kneller, Richard
  19. Exchange rate pass-through to consumer prices in Ghana: Evidence from structural vector auto-regression By Sanusi, Aliyu Rafindadi
  20. Kaleckian vs. Marxian specifications of the investment function: Some empirical evidence for the US By Schoder, Christian
  21. Extracting deflation probability forecasts from Treasury yields By Jens H. E. Christensen; Jose A. Lopez; Glenn D. Rudebusch
  22. The impact of oil prices, real effective exchange rate and inflation on economic activity: Novel evidence for Vietnam By Le Viet Trung; Nguyen Thi Thuy Vinh
  23. Does International Trade Really Lead to Business Cycle Synchronization?−A panel data approach By Michael Artis; Toshihiro Okubo
  24. Deconstructing Structural Unemployment By John Schmitt; Kris Warner
  25. The Optimum Currency Area. Is the Euro Zone an Optimum Currency Area? By Geza, Paula; Giurca Vasilescu, Laura
  26. Retirement Flexibility and Portfolio Choice in General Equilibrium By Yvonne Adema; Jan Bonenkamp; Lex Meijdam
  27. To switch or not to switch - Can individual lending do better in micronance than group lending? By Helke Waelde
  28. Capital Regulation and Tail Risk By Enrico Perotti; Lev Ratnovski; Razvan Vlahu
  29. Financial liberalization and contagion with unobservable savings By Panetti, Ettore

  1. By: Luisa Lambertini (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland); Caterina Mendicino; Maria Teresa Punzi
    Abstract: This paper studies the potential gains of monetary and macro-prudential policies that lean against news-driven boom-bust cycles in housing prices and credit generated by expectations of future macroeconomic developments. First, we find no trade-off between the traditional goals of monetary policy and leaning against boom-bust cycles. An interest-rate rule that completely stabilizes inflation is not optimal. In contrast, an interest-rate rule that responds to financial variables mitigates macroeconomic and financial cycles and is welfare improving relative to the estimated rule. Second, counter-cyclical Loan-to-Value rules that respond to credit growth do not increase inflation volatility and are more effective in maintaining a stable provision of financial intermediation than interest-rate rules that respond to financial variables. Heterogeneity in the welfare implications for borrowers and savers make it difficult to rank the two policy frameworks.
    Keywords: Expectations-driven cycles, Macro-prudential policy, Monetary policy, Welfare analysis
    JEL: E32 E44 E52
    Date: 2011–03
  2. By: Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola
    Abstract: We challenge the widely held belief that New Keynesian models cannot predict an optimal positive inflation rate. In fact we find that even for the US economy, characterized by relatively small government size, optimal trend inflation is justified by the Phelps argument that the inflation tax should be part of an optimal (distortionary) taxation scheme. This mainly happens because, unlike standard calibrations of public expenditures that focus on public consumption-to-GDP ratios, we also consider the diverse, highly distortionary effect of public transfers to households. Our prediction of the optimal inflation rate is broadly consistent with recent estimates of the Fed inflation target. We also contradict the view that the Ramsey-optimal policy should minimize inflation volatility over the business cycle and induce near-random walk dynamics of public debt in the long run. In fact optimal fiscal and monetary policies should stabilize long-run debt-to-GDP ratios in order to limit tax (and inflation) distortions in steady state. This latter result is strikingly similar to policy analyses in the aftermath of the 2008 financial crisis.
    Keywords: Trend inflation, monetary and fiscal policy, Ramsey plan
    JEL: E52 E58 J51 E24
    Date: 2011–03
  3. By: Roman Horvath; Lubos Komarek; Filip Rozsypal
    Abstract: This paper investigates the predictive ability of money for future inflation in the Czech Republic, Hungary, Poland, and Slovakia. We construct monetary indicators similar to those the ECB regularly uses for monetary analysis. We find some in-sample evidence that money matters for future inflation at the policy horizons that central banks typically focus on, but our pseudo out-of-sample forecasting exercise shows that money does not in general improve the inflation forecasts vis-à-vis some benchmark models, such as the autoregressive process. Since at least some models containing money improve the inflation forecasts in certain periods, we argue that money still serves as a useful cross-check for monetary policy analysis.
    Keywords: Central Europe, forecasting, inflation, money.
    JEL: E41 E47 E52
    Date: 2010–12
  4. By: colciago , andrea; Rossi, Lorenza
    Abstract: We propose a flexible prices model where endogenous market structures and search and matching frictions in the labor market interact endogenously. The interplay between firms endogenous entry, strategic interactions among producers and labor market frictions represents a strong amplification channel of technology shocks on labor market variables, and helps addressing the unemployment-volatility puzzle. Consistently with U.S. evidence, new firms create a large fraction of new jobs and grow faster than more mature firms, net firms' entry is procyclical and the price mark up is countercyclical.
    Keywords: Endogenous Market Structures; Firms' Entry; Search and Matching Frictions
    JEL: E32 L11 E24
    Date: 2011–02
  5. By: Acocella Nicola; Bisio Laura; Di Bartolomeo Giovanni; Pelloni Alessandra
    Abstract: By using the recent Gertler and Kiyotaki's (2010) setup, this paper explores the interaction between real distortions stemming from the labor market institutions and financial shocks. We find that neither labor market imperfections nor fiscal institutions determining tax wedges have an impact on the volatility of the real economy induced by a financial shock. By contrast, real wage rigidities matter as they amplify the financial shock effects. Thus, economies with larger imperfections will not systematically observe larger or smaller recessions, unless a causality between imperfections and real wage rigidities is introduced.
    Keywords: Financial accelerator, credit frictions, wage-setters, business cycle, volatility
    JEL: E32 E44
    Date: 2011–03
  6. By: Ben Ali, Samir
    Abstract: In this paper, we study some empirical issues in the estimation of a New-Keynesian Phillips curve for Tunisia. In this purpose, we compare the performance of the strict and hybrid forms in the validation of data. In addition, we try to establish the sensitivity of the Phillips curve estimation to some empirical speci…cations. It includes the measures to be used for the output gap variable, as well as the implementation of the generalized method of moments for the estimation of this curve.
    Keywords: monetary policy; New Keynesian Phillips curve; Inflation; sensitivity;Tunisia
    JEL: E31 E52 C22
    Date: 2010–11–10
  7. By: Romain Houssa (Center for Research in the Economics of Development, University of Namur)
    Abstract: This paper develops a Spatial Vector Auto-Regressive (SpVAR) model that takes into account both the time and the spatial dimensions of economic shocks. We apply this framework to analyze the propagation through space and time of macroeconomic (inflation, output gap and interest rate) shocks in Europe. The empirical analysis identifies an economically and statistically significant spatial component in the transmission of macroeconomic shocks in Europe.
    Keywords: Macroeconomics, Spatial Models, VAR
    JEL: E3 E43 E52 C51 C33
    Date: 2010–04
  8. By: Andrew Clausen; Carlo Strub
    Abstract: Classical models of money are typically based on a competitive market without capital or credit. They then impose exogenous timing structures, market participation constraints, or cash-in-advance constraints to make money essential. We present a simple model without credit where money arises from a fixed cost of production. This leads to a rich equilibrium structure. Agents avoid the fixed cost by taking vacations and the trade between workers and vacationers is supported by money. We show that agents acquire and spend money in cycles of finite length. Throughout such a “money cycle,” agents decrease their consumption which we interpret as the hot potato effect of inflation. We give an example where money holdings do not decrease monotonically throughout the money cycle. Optimal monetary policy is given by the Friedman rule, which supports efficient equilibria. Thus, monetary policy provides an alternative to lotteries for smoothing out non-convexities.
    Date: 2011–03
  9. By: Igor Vetlov (Bank of Lithuania); Ricardo Mourinho Félix (Banco de Portugal); Laure Frey (Banque de France); Tibor Hlédik (Czech National Bank); Zoltán Jakab (Office of the Fiscal Council, Republic of Hungary); Niki Papadopoulou (Central Bank of Cyprus); Lukas Reiss (Oesterreichische Nationalbank); Martin Schneider (Oesterreichische Nationalbank)
    Abstract: The new generation of dynamic stochastic general equilibrium (DSGE) models seems particularly suited for conducting scenario analysis. These models formalise the behaviour of economic agents on the basis of explicit micro-foundations. As a result, they appear less prone to the Lucas critique than more traditional macroeconometric models. DSGE models provide researchers with powerful tools, which allow for the designing of a broad range of scenarios and tackling a large range of issues, offering at the same time an appealing structural interpretation of the scenario specification and simulation results. The paper provides illustrations on some of the modelling issues that often arise when implementing scenarios using DSGE models in the context of projection exercises or policy analysis. These issues reflect the sensitivity of DSGE model-based analysis to scenario assumptions, which in more traditional models are apparently less critical, such as, for example, scenario event anticipation and duration, treatment of monetary and fiscal policy rules.
    Keywords: business fluctuations, monetary policy, fiscal policy, forecasting and simulation
    JEL: E32 E52 E62 E37
    Date: 2010–08–25
  10. By: Hatcher, Michael C. (Cardiff Business School)
    Abstract: This paper investigates the long-term impact of price-level targeting on social welfare in an overlapping generations model in which the young save for old age by investing in productive capital and indexed and nominal government bonds. A key feature of the model is that the extent of bond indexation is determined endogenously in response to monetary policy as part of an optimal commitment Ramsey policy. Due to the absence of base-level drift under price-level targeting, long-term inflation risk is reduced by an order of magnitude compared to inflation targeting. Consequently, real bond returns are stabilised somewhat, and consumption volatility for old generations is reduced by around 15 per cent. The baseline welfare gain from price- level targeting is equivalent to a permanent increase in aggregate consumption of only 0.01 per cent, but this estimate is strongly sensitive on the upside.
    Keywords: inflation targeting; price-level targeting; optimal indexation; government bonds
    JEL: E52 E58
    Date: 2011–03
  11. By: Cogley, Timothy (New York University); de Paoli, Bianca (Bank of England); Matthes, Christian (Universitat Pompeu Fabra); Nikolov, Kalin (European Central Bank); Yates, Tony (Bank of England)
    Abstract: This paper undertakes a Bayesian analysis of optimal monetary policy for the United Kingdom. We estimate a suite of monetary policy models that include both forward and backward-looking representations as well as large and small-scale models. We find an optimal simple Taylor-type rule that accounts for both model and parameter uncertainty. For the most part, backward-looking models are highly fault tolerant with respect to policies optimised for forward-looking representations, while forward-looking models have low fault tolerance with respect to policies optimised for backward-looking representations. In addition, backward-looking models often have lower posterior probabilities than forward-looking models. Bayesian policies therefore have characteristics suitable for inflation and output stabilisation in forward-looking models.
    Date: 2011–03–02
  12. By: Christopher M. Gunn; Alok Johri
    Abstract: The years leading up to the "great recession" were a time of rapid innovation in the financial industry. This period also saw a fall in interest rates, and a boom in liquidity that accompanied the boom in real activity, especially investment. In this paper we argue that these were not unrelated phenomena. The adoption of new financial products and practices led to a fall in the expected costs of intermediation which in turn engendered the flood of liquidity in the financial sector, lowered interest rate spreads and facilitated the boom in economic activity. When the events of 2007-2009 led to a re-evaluation of the effectiveness of these new products, agents revised their expectations regarding the actual efficiency gains available to the financial sector and this led to a withdrawal of liquidity from the financial system, a reversal in interest rates and a bust in real activity. We treat the efficiency of the financial sector as an exogenous process and study the impact of "news shocks" regarding this process. Following the expectations driven business cycle literature, we model the boom and bust cycle in terms of an expected future efficiency gain which is eventually not realized. The build up in liquidity and economic activity in expectation of these efficiency gains is then abruptly reversed when agent's hopes are dashed. The model generates counter-cyclical movements in the spread between lending rates and the risk-free rate which are driven purely by expectations, even in the absence of any exogenous movement in intermediation costs.
    Keywords: externalities; expectations-driven business cycles, intermediation shocks, credit shocks, financial intermediation, financial innovation, news shocks, business cycles.
    JEL: E3
    Date: 2011–03
  13. By: Franklin Allen; Elena Carletti; Douglas Gale
    Abstract: Most analyses of banking crises assume that banks use real contracts. However, in practice contracts are nominal and this is what is assumed here. We consider a standard banking model with aggregate return risk, aggregate liquidity risk and idiosyncratic liquidity shocks. We show that, with non-contingent nominal deposit contracts, the first-best efficient allocation can be achieved in a decentralized banking system. What is required is that the central bank accommodates the demands of the private sector for fiat money. Variations in the price level allow full sharing of aggregate risks. An interbank market allows the sharing of idiosyncratic liquidity risk. In contrast, idiosyncratic (bank-specific) return risks cannot be shared using monetary policy alone; real transfers are needed.
    Date: 2011
  14. By: Joseph G. Haubrich; George Pennacchi; Peter Ritchken
    Abstract: This paper develops a model of the term structures of nominal and real interest rates driven by state variables representing the short-term real interest rate, expected inflation, inflation’s central tendency, and four volatility factors that follow GARCH processes. We derive analytical solutions for nominal bond yields, yields on inflation-indexed bonds that have an indexation lag, and the term structure of expected inflation. Unlike prior studies, the model’s parameters are estimated using data on inflation swap rates, as well as nominal yields and survey forecasts of inflation. The volatility state variables fully determine bonds’ time-varying risk premia and allow for stochastic volatility and correlation between bond yields, yet they have small effects on the cross section of nominal yields. Allowing for time-varying volatility is particularly important for real interest rate and expected inflation processes, but long-horizon real and inflation risk premia are relatively stable. Comparing our model prices of inflation-indexed bonds to those of Treasury Inflation Protected Securities (TIPS) suggests that TIPS were significantly underpriced prior to 2004 and again during the 2008-2009 financial crisis.
    Keywords: Inflation (Finance) ; Interest rates ; Asset pricing
    Date: 2011
  15. By: Stan du Plessis (Department of Economics, University of Stellenbosch); Gideon du Rand (Department of Economics, University of Stellenbosch)
    Abstract: The instrument problem in monetary policy is back on the agenda. Until recently interest rate policy was widely thought to be sufficient for the attainment of appropriate monetary policy goals. No longer. In the wake of the international financial crisis there is much pressure on monetary authorities to incorporate the goal of financial stability more explicitly in policy. This requires an expansion of the instruments typically used by central banks. Cechetti and Kohler (2010) recently considered this new version of the instrument problem in monetary policy by analysing the distinct role and potential for co-ordinating (i) interest rates and (ii) capital adequacy requirements. In this paper we connect this modern debate with an earlier version of the instrument problem, famously discussed by Poole (1970). Then, as now (we claim), the main message of the analysis is the non-equivalence of these instruments and the structural features of the economy on the basis of which one would prefer a particular combination of these instruments. These results are demonstrated with a set of simulations. We also offer a theoretical criticism of the modelling approach used by Cechetti and Kohler (2010).
    Keywords: Monetary policy, Instrument problem, Interest rates, Alternative monetary policy instruments, Balance sheet operations, Policy co-ordination
    JEL: E52 E58 E61
    Date: 2011
  16. By: Blake, Andy (Bank of England); Kirsanova, Tatiana (University of Exeter); Yates, Tony (Bank of England)
    Abstract: A commonly held view is that the life of a monetary policy maker forced to operate under discretion can be improved by the authorities delegating monetary policy objectives that are different from the social welfare function (including interest rate smoothing, price-level targeting and speed-limit objectives). We show that this holds with much less generality than previously realised. The reason is that in monetary policy models with capital accumulation (or similar variables) there may be multiple equilibria under discretion. Delegating modified objectives to the monetary policy maker does not change this. We find that the best equilbria under delegation are sometimes inferior to the worse ones without delegation. In general the welfare benefits of schemes like price-level targeting must be regarded as ambiguous.
    Date: 2011–03–15
  17. By: Romain Houssa (Center for Research in the Economics of Development, University of Namur)
    Abstract: This paper proposes Bayesian estimates for welfare e¤ects of consumption fluctuations and growth. Annual data from 82 developed and developing countries indicate a large degree of uncertainty as regards point estimates. Moreover, the comparison between the welfare gain from consumption stabilization and the welfare gain from growth yields inconclusive results for many developed and developing countries. These ?ndings suggest the need for caution in drawing policy conclusions from point estimates.
    Keywords: Business Cycles, Growth Welfare
    Date: 2011–01
  18. By: Misch, Florian; Gemmell, Norman; Kneller, Richard
    Abstract: This paper considers the implications of complementarity in private production and constraints on government for optimal fiscal policy. Using an endogenous growth model with public finance, it derives three central results which modify findings in the literature under standard assumptions. First, it shows that optimal public spending composition and taxation are interrelated so that first- and second-best fiscal policies differ. Second, it shows that the growth-maximizing fiscal policy is affected by preference parameters. Third, it shows that with budget rigidities and informational limitations, knowledge about the optimal fiscal policy parameter values is not necessary for growth-enhancing fiscal policy adjustments. --
    Keywords: Imperfect Knowledge,Economic Growth,Productive Public Spending,Optimal Fiscal Policy
    JEL: E62 H21 H50 O40
    Date: 2011
  19. By: Sanusi, Aliyu Rafindadi
    Abstract: This paper develops a Structural Vector Autoregression (SVAR) model for the Ghanaian economy to estimate the pass-through effects of exchange rate changes to consumer prices. The model incorporates the special features of the Ghanaian economy, especially its dependence on foreign aid and primary commodity exports for foreign exchange earnings. The findings show that the pass-through to consumer prices, although incomplete, is substantially large. This suggests that exchange rate depreciation is a potentially important source of inflation in Ghana. Using variance decomposition analyses, it is found that monetary expansion has been more important in explaining Ghana’s actual inflationary process than the exchange rate depreciation. One policy implication of these findings is that policies that aim at lowering inflation must focus on monetary and exchange rate stability.
    Keywords: Exchange Rate Pass-Through; Inflation; Structural Vector-Autoregression; Foreign Aid; Ghana
    JEL: E31 F41 F31
    Date: 2010–06
  20. By: Schoder, Christian
    Abstract: Following Lavoie et al. (2004), this paper empirically assesses four investment functions closing the Kaleckian baseline model in the long-run: (a) the Naive-Kaleckian specification without any long-run adjustment; (b) the Intermediate-Kaleckian specification with an endogenous adjustment of the normal utilization rate; (c) the Hysteresis-Kaleckian specification with an additional endogenous adjustment of autonomous investment; and (d) the French-Marxian specification with an exogenous normal utilization rate and endogenous autonomous investment. Confronting these specifications with data of the US manufacturing sector, we compare them with respect to the plausibility of the parameter estimates, the goodness of fit, the parameter stability, the out-of-sample performances and relative encompassing. We find the Intermediate-Kaleckian specification to be superior. For the Hysteresis-Kaleckian specification, we get implausible results which contradict Lavoie et al. (2004). Yet, their estimates seem to be biased due to endogeneity issues.
    Keywords: Kaleckian growth model; Marxian growth model; investment functions; post-Keynesian economics
    JEL: E12 E22 E11
    Date: 2011
  21. By: Jens H. E. Christensen; Jose A. Lopez; Glenn D. Rudebusch
    Abstract: We construct probability forecasts for episodes of price deflation (i.e., a falling price level) using yields on nominal and real U.S. Treasury bonds. The deflation probability forecasts identify two "deflation scares" during the past decade: a mild one following the 2001 recession, and a more serious one starting in late 2008 with the deepening of the financial crisis. The estimated deflation probabilities are generally consistent with those from macroeconomic models and surveys of professional forecasters, but they also provide highfrequency insight into the views of financial market participants. The probabilities can also be used to price the deflation option embedded in real Treasury bonds.
    Keywords: Deflation (Finance)
    Date: 2011
  22. By: Le Viet Trung (Research Institute for Economics and Business Administration, Kobe University); Nguyen Thi Thuy Vinh (Graduate School of Economics, Kobe University)
    Abstract: The goal of this paper is to examine the impact of oil prices on Vietnam's economic activity using vector autoregressive (VAR) modeling and cointegration techniques. We use monthly data for the period 1995 – 2009 and include inflation and the real effective exchange rate as additional determinants of economic activity. We find evidence of a long-run relationship between oil prices, inflation, exchange rate, and economic activity. The results suggest that both oil prices and the real effective exchange rates have strongly significant impact on economic activity. An increase in oil price or depreciation may enhance economic activity. Vietnamese economic activity is influenced more by changes of value of Vietnamese currency than the fluctuations of oil prices. Inflation has a positive impact on economic activity however its impact is not highly significant. This suggests that moderate inflation is helpful rather than harmful to economic activity.
    Keywords: Oil price, Economic activity, Vietnam
    JEL: E60 F41 O53 Q43 P20
    Date: 2011–03
  23. By: Michael Artis (Swansea University); Toshihiro Okubo (Research Institute for Economics and Business Administration, Kobe University)
    Abstract: This paper re-estimates the correlation between trade and business cycle synchronization. Different from other previous studies, we employ long-run GDP and trade data and use the GDP cross-correlation index a la Cerqueira and Martins (2009) rather than over-time cross-correlations. We find a positive impact of trade on business cycle synchronization particularly in the current wave of globalization, although the inter-war period sees negative impacts. The current economic integration and currency unions also positively affect business cycle synchronization.
    Keywords: business cycle synchronization, trade, panel approach
    JEL: E32 F15 F43
    Date: 2011–01
  24. By: John Schmitt; Kris Warner
    Abstract: Some economic observers argue “structural unemployment” has increased in the wake of the Great Recession, but in this paper we find little support for either of two arguments that suggest that structural unemployment has been on the rise. The first argument focuses on the large increase in unemployment among construction workers. The second argument is that falling house prices have reduced the mobility of unemployed workers — creating a “housing lock” in which unemployed workers, who would otherwise relocate to regions with jobs, are stuck in high unemployment areas.
    Keywords: unemployment, structural unemployment, stimulus, Great Recession
    JEL: E E12 E2 E24 E3 E32 E5 E52 E6 E62 J J2 J6 J61 J63 J64 J65 J68
    Date: 2011–03
  25. By: Geza, Paula; Giurca Vasilescu, Laura
    Abstract: Although analyzed in terms of criteria for defining an optimum currency area, we could appreciate that EU fulfils certain criteria established within the theory of the optimum currency area. But in comparison with USA or Canada, the EU has less premises to effectively become such an area. The Economic and Monetary Union considered, from a certain point of view, the most ambitious and risky project of the European construction, is the result of a fundamental political decision within a powerful economic component. Despite the statute of sub-optimum currency area, there are still a series of arguments, both supportive and critical, for the settlement of an Economic and Monetary Union within the European space.
    Keywords: Optimum Currency Area; Monetary Integration; Currency; Economic and Monetary Union
    JEL: E42 F36
    Date: 2011–03–17
  26. By: Yvonne Adema (Erasmus University Rotterdam, and Netspar); Jan Bonenkamp (CPB Netherlands Bureau for Economic Policy Analysis, and Netspar); Lex Meijdam (University of Tilburg, and Netspar)
    Abstract: This paper explores the interaction between retirement flexibility and portfolio choice in an overlapping-generations model of a closed economy. Retirement flexibility is often seen as a hedge against capital market risks which justifies more risky asset portfolios. We show, however, that this positive relationship between risk taking and retirement flexibility is weakened - and under some conditions even turned around - if not only capital market risks but also productivity risks are considered. Productivity risk in combination with a high elasticity of substitution between consumption and leisure creates a positive correlation between asset returns and labour income, reducing the willingness of consumers to bear risk. Moreover, it turns out that general equilibrium effects can either increase or decrease the equity exposure, depending on the degree of substitutability between consumption and leisure.
    Keywords: portfolio choice; retirement (in)flexibility; productivity and depreciation risk; intratemporal substitution; general equilibrium
    JEL: E21 G11 J26
    Date: 2011–02–17
  27. By: Helke Waelde (Department of Economics, Johannes Gutenberg-Universitaet Mainz, Germany)
    Abstract: These days it has been witnessed, that banks o¤er individual loans instead of group loans and develop products based on individual liability in developing coun- tries. In order to study this surprising turn, we expand the conventional approach on decision making of individuals. A social prestige function is introduced that re- ‡ects the non-monetary impacts of group membership on the individual and on her decisions. If a borrower possesses more than a critical level of wealth, it is optimal for her to switch to individual borrowing. From a welfare perspective, a mixture of individual and group loans is desirable. However, the average borrower switches from group to individual lending too soon.
    JEL: E43 E52 E58 D44
    Date: 2011–03–07
  28. By: Enrico Perotti (University of Amsterdam, Duisenberg school of finance, and CEPR); Lev Ratnovski (International Monetary Fund); Razvan Vlahu (Dutch Central Bank)
    Abstract: The paper studies risk mitigation associated with capital regulation, in a context when banks may choose tail risk assets. We show that this undermines the traditional result that higher capital reduces excess risk-taking driven by limited liability. When capital raising is costly, poorly capitalized banks may limit risk to avoid breaching the minimal capital ratio. A bank with higher capital has less
    Keywords: Bank Regulation; Risk Shifting; Capital Requirements; Tail Risk; Systemic Risk
    JEL: E6 F3 F4 G2 G3 O16
    Date: 2011–02–17
  29. By: Panetti, Ettore
    Abstract: How do market-based channels for the provision of liquidity affect financial liberalization and contagion? In order to answer this question, I extend the Diamond and Dybvig (1983) model of financial intermediation to a two-country environment with unobservable markets for borrowing and lending and comparative advantages in the investment technologies. I demonstrate that the role of hidden markets crucially depends on the level of financial integration of the economy. Despite always imposing a burden on intermediaries, unobservable markets allow agents to partially enjoy gains from financial integration when interbank markets are autarkic. In fully liberalized systems such effect instead disappears. Similarly, in autarky the distortion created by hidden markets improve the resilience of the system to unexpected liquidity shocks. With fully integrated interbank markets, such effect again disappears, as unexpected liquidity shocks always lead to bankruptcy and contagion.
    Keywords: financial intermediation; financial liberalization; financial contagion; unobservable savings
    JEL: E44 G28 G21
    Date: 2011–03–01

This nep-mac issue is ©2011 by Soumitra K Mallick. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.