nep-mac New Economics Papers
on Macroeconomics
Issue of 2011‒04‒23
forty-nine papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Business Management

  1. The Financial Accelerator Under Learning and The Role of Monetary Policy By Rodrigo Caputo; Juan Pablo Medina; Claudio Soto.
  2. Robust monetary policy in a new Keynesian model with imperfect interest rate pass-through By Gerke, Rafael; Hammermann, Felix
  3. Sovereign Default and the Stability of Inflation Targeting Regimes By Andreas Schabert; Sweder J.G. van Wijnbergen
  4. Fiscal policy consistence and implications for macroeconomic aggregates: the case of Uganda By Hisali, Eria
  5. An Estimated (Closed Economy) Dynamic Stochastic General Equilibrium Model for the Philippines: Are There Credibility Gains from Committing to an Inflation Targeting Rule? By Majuca, Ruperto P.
  6. Macroeconomic implications of downward wage rigidities By Mirko Abbritti; Stephan Fahr
  7. Anchors Away: How Fiscal Policy Can Undermine "Good" Monetary Policy By Eric Leeper
  8. The Credit Channel and Monetary Transmission in Brazil and Chile: A Structural VAR Approach By Luis Catão;; Adrian Pagan
  9. Fiscal Deficits, Debt, and Monetary Policy in a Liquidity Trap By Michael Devereux
  10. The accuracy of a forecast targeting central bank By Falch, Nina Skrove; Nymoen, Ragnar
  11. Cyclical risk aversion, precautionary saving and monetary policy By De Paoli, Bianca; Zabczyk, Pawel
  12. Ramsey Policies in a Small Open Economy with Sticky Prices and Capital By Stéphane Auray; Beatriz de Blas; Aurélien Eyquem
  13. FiMod - a DSGE model for fiscal policy simulations By Stähler, Nikolai; Thomas, Carlos
  14. Floats, Pegs and the Transmission of Fiscal Policy. By Giancarlo Corsetti; Keith Kuester; Gernot J. Müller
  15. Evidence on the variability of the monetary policy inertia for inflation-targeting countries By Benjamín García
  16. Chile’s Structural Fiscal Surplus Rule: a Model – Based Evaluation By Michael Kumhof; Douglas Laxton
  17. Monetary Policy after the Crisis: Some Issues Regarding Targets and Instruments By Rodrigo Vergara
  18. The implications of dynamic financial frictions for DSGE models By Uluc Aysun
  19. Seigniorage and Distortionary Taxation in a Model with Heterogeneous Agents and Idiosyncratic Uncertainty By Sofía Bauducco
  20. Monetary Policy Under Financial Turbulence: an Overview By Luis Felipe Céspedes; Roberto Chang; Diego Saravia
  21. Price Level Targeting and Inflation Targeting: a Review By Sofía Bauducco; Rodrigo Caputo
  22. A Monetary Theory with Non-Degenerate Distributions By Guido Menzio; Shouyong Shi; Hongfei Sun
  23. The impact of fiscal policy on economic activity over the business cycle - evidence from a threshold VAR analysis By Baum, Anja; Koester, Gerrit B.
  24. A Revision of the US Business-Cycles Chronology 1790–1928 By Charles Amélie; Darné Olivier; Claude Diebolt
  25. Investigating Business Cycle Synchronization in West Africa By Simeon Coleman
  26. A Solution to Fiscal Procyclicality: the Structural Budget Institutions Pioneered by Chile By Jeffrey Frankel
  27. Inflation Targeting in Financially Stable Economies: Has it been Flexible Enough? By Mauricio Calani; Kevin Cowan; Pablo García S.
  28. Long-run growth expectations and 'global imbalances' By Hoffmann, Mathias; Krause, Michael; Laubach, Thomas
  29. Structural reforms and macroeconomic performance in the euro area countries: a model-based assessment By Sandra Gomes; Pascal Jacquinot; Matthias Mohr; Massimiliano Pisani
  30. Does linearity in the dynamics of inflation gap and unemployment rate matter? By Roque Montero
  31. Product Market Competition and Inflation Dynamics: Evidence from a Panel of OECD Countries By Monica Correa Lopez; Agustin Garcia Serrador; Ana Cristina Mingorance
  32. Business cycle synchronisation: disentangling trade and financial linkages By Stéphane Dées; Nico Zorell
  33. Fiscal Policy: Lessons from the Crisis By Daniele Franco (editor)
  34. The Liquidation of Government Debt By Carmen M.; M. Belen Sbrancia
  35. The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment By James D. Hamilton; Jing Cynthia Wu
  36. Firm Dynamics in News Driven Business Cycle: The Role of Endogenous Survival Rate By Xu, Zhiwei; Fan, Haichao
  37. Sustainability of Government Debt in the EU By Lejour, Arjan; Lukkezen, Jasper; Veenendaal, Paul
  38. Interest Rates and Inflation By Michael Coopersmith
  39. Propagation of Inflationary Shocks in Chile and an International Comparison of Progagation of Shocks to food and Energy Prices. By Michael Pedersen
  40. Nowcasting inflation using high frequency data By Michele Modugno
  41. Flexible inflation targets, forex interventions and exchange rate volatility in emerging countries By Juan Carlos Berganza; Carmen Broto
  42. GDP Modelling with Factor Model: an Impact of Nested Data on Forecasting Accuracy By Bessonovs, Andrejs
  43. Market-specific and Currency-specific Risk During the Global Financial Crisis: Evidence from the Interbank Markets in Tokyo and London By Shin-ichi Fukuda
  44. The Portuguese Stock Market Cycle: Chronology and Duration Dependence By Vítor Castro
  45. Consumption Smoothing and Portfolio Rebalancing: The Effects of Adjustment Costs By Yosef Bonaparte; Russell Cooper; Guozhong Zhu
  46. The Greek financial crisis: growing imbalances and sovereign spreads By Heather D. Gibson; Stephan G. Hall; George S. Tavlas
  47. Multiple Layers of Credit and Mortgage Crises By Paula Hernandez-Verme
  48. Causes of and Remedies for the People’s Republic of China’s External Imbalances: The Role of Factor Market Distortion By Huang, Yiping; Tao, Kunyu
  49. Trade Adjustment and Productivity in Large Crises By Gita Gopinath; Brent Neiman

  1. By: Rodrigo Caputo; Juan Pablo Medina; Claudio Soto.
    Abstract: Financial frictions have been shown to play an important role amplifying business cycles fluctuations. In this paper we show that the financial accelerator mechanism, analyzed by Bernanke, Gertler and Gilrchrist (1999), combined with adaptive learning can amplify business cycle fluctuations significantly as the balance sheet channel interacts with the presence of endogenous asset price “bubbles”. These large business cycle fluctuations are amplified in a non-linear way by the size of the shocks and by the degree of financial fragility in the economy determined by its leverage. Our preliminary results indicate that even in the presence of endogenous bubbles, responding aggressively to inflation reduces output and inflation volatility. If the central bank adjusts its policy instrument in response to asset price fluctuations, it may reduce output volatility and even inflation volatility in the short run. However, that monetary policy conduct leads to a surge in inflation several periods after the shocks. A policy that aggressively responds to changes in asset prices may marginally reduce output volatility with respect to a policy that reacts aggressively to inflation, but also at the cost of generating inflationary pressures.
    Date: 2010–09
  2. By: Gerke, Rafael; Hammermann, Felix
    Abstract: We use robust control to study how a central bank in an economy with imperfect interest rate pass-through conducts monetary policy if it fears that its model could be misspecified. The effects of the central bank's concern for robustness can be summarised as follows. First, depending on the shock, robust optimal monetary policy under commitment responds either more cautiously or more aggressively. Second, such robustness comes at a cost: the central bank dampens volatility in the inflation rate preemptively, but accepts higher volatility in the output gap and the loan rate. Third, if the central bank faces uncertainty only in the IS equation or the loan rate equation, the robust policy shifts its concern for stabilisation away from inflation. --
    Keywords: optimal monetary policy,commitment,model uncertainty
    JEL: E44 E58 E32
    Date: 2011
  3. By: Andreas Schabert (TU Dortmund University , University of Amsterdam); Sweder J.G. van Wijnbergen (University of Amsterdam)
    Abstract: We analyse the impact of interactions between monetary and fiscal policy on macroeconomic stability. We find that in the presence of sovereign default beliefs a monetary policy, which aims to stabilize inflation through an active interest rate policy, will destabilize the economy if the feedback from debt surprises back to the primary surplus is too weak. This result, which relies on endogenous changes in the default premium, is at odds with the results in an environment without default risk, where an active monetary policy guarantees macroeconomic stability. The results are highly relevant for the design of fiscal and monetary policy in emerging markets where sovereign credibility is not well established. Recent debt developments in Western Europe and in the US suggest these results might become relevant for more mature financial markets too.
    Keywords: Inflation targeting; fiscal-monetary policy interactions; sovereign default risk; foreign debt
    JEL: E52 E63 F41
    Date: 2011–04–12
  4. By: Hisali, Eria
    Abstract: The relationship between growth in monetary aggregates and price changes continues to be a subject of considerable debate both in the academic and policy circles. Whereas the more âconservativeâ policy makers hold that growth in monetary aggregates bear proportionately on prices, âliberalsâ on the other hand suggest a fairly weak relationship and instead mainly attribute sustained price changes to other innovations (including structural weaknesses and poor productive capacity). This study employed vector autoregression techniques (and its variants) to examine both short term as well as long term interactions between selected macroeconomic aggregates with particular focus on the relationship between money growth and price changes. Results from both the reduced form vector autoregression specification and the contemporaneous structural vector autoregression show a weak causation from growth in monetary aggregates to price changes, but the link between changes in monetary aggregates and prices becomes stronger in the long run. The results also point to a strong relationship between price changes on the one hand and exchange rate depreciation, and past inflation outcomes on the other. The results imply a potential for increased revenue from monetisation, at least up to some feasible as well as the need to focus on other possible sources of price variations. In general, whereas it is possible for the relationship between prices and money to weaken, budget deficits beyond âcertain financeable limitsâ will clearly negate the possibility of attaining other objectives of macroeconomic policy. A natural concern that arises in such a context is one of sustainability and compatibility of the budget deficit with other macroeconomic targets. We also employed the government budget accounting framework to analyse sustainability of Ugandaâs current fiscal stance. The results show that the consolidated deficit is consistent with attainment of target outcomes for other macroeconomic variables, most notably the rates of inflation and GDP growth rates. The inflation target has however, been achieved at the cost of an unsustainable domestic debt. From a policy perspective, issuing domestic debt at such a high real interest rates will allow lower money growth but at the cost of future increases in debt service obligations and thus future budget deterioration.
    Keywords: fiscal stance, macroeconomic aggregates, structural vector autogression, budget accounting approach, EPRC, Agricultural Finance, Financial Economics, Labor and Human Capital, Production Economics, Productivity Analysis, H62, H63, H69,
    Date: 2010–06
  5. By: Majuca, Ruperto P.
    Abstract: <p>We use Bayesian methods to estimate a medium-scale closed economy dynamic stochastic general equilibrium (DSGE) model for the Philippine economy. Bayesian model selection techniques indicate that among the frictions introduced in the model, the investment adjustment costs, habit formation, and the price and wage rigidity features are important in capturing the dynamics of the data, while the variable capital utilization, fixed costs, and the price and wage indexation features are not important.</p> <p>We find that the Philippine macroeconomy is characterized by more instability than the U.S. economy. An analysis of the several subperiods in Philippine economic history also reveals some quantitative evidence that risk aversion increases during crisis periods. Also, we find that the inflation targeting (IT) era is associated with a more stable economy: the standard deviations of the technology shock, the risk-premium shock, and the investment-specific technology shock have significantly lower variability than the pre-IT era, with the last two shocks being reduced by a factor of 5.6 and 2.3, respectively. The IT era is also associated with lower risk aversion. We also find that the adoption of inflation targeting is associated with interest rate smoothing in the monetary reaction function. With a more inertial reaction function, the Bangko Sentral ng Pilipinas (BSP) had achieved greater credibility and consequently, it was able to manage the expectations of forward-looking economic actors, and thereby achieved greater responses of the goal variables to the policy rates, even if the size of interest rates changes are smaller.</p> <p>However, we also find that BSP`s conduct of monetary policy appears to be more procyclical than countercyclical, particularly during the Asian financial crisis, and the recent global financial and economic crisis.</p>
    Keywords: new Keynesian model, Bayesian estimation
    Date: 2011
  6. By: Mirko Abbritti (Universidad de Navarra.); Stephan Fahr (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Growth of wages, unemployment, employment and vacancies exhibit strong asymmetries between expansionary and contractionary phases. In this paper we analyze to what degree downward wage rigidities in the bargaining process affect other variables of the economy. We introduce asymmetric wage adjustment costs in a New-Keynesian DSGE model with search and matching frictions in the labor market. We find that the presence of downward wage rigidities strongly improves the fit of the model to the skewness of variables and the relative length of expansionary and contractionary phases even when detrending the data. Due to the asymmetry, wages increase more easily in expansions, which limits vacancy posting and employment creation, similar to the flexible wage case. During contractions nominal wages decrease slowly, shifting the main burden of adjustment to employment and hours worked. The asymmetry also explains the differing transmission of positive and negative demand shocks from wages to inflation. Downward wage rigidities help explaining the asymmetric business cycle of many OECD countries where long and smooth expansions with low growth rates are followed by sharp but short recessions with large negative growth rates. JEL Classification: E31, E52, C61.
    Keywords: labor market, unemployment, downward wage rigidity, asymmetric adjustment costs, non—linear dynamics.
    Date: 2011–04
  7. By: Eric Leeper
    Abstract: Slow moving demographics are aging populations around the world and pushing many countries into an extended period of heightened fiscal stress. In some countries, taxes alone cannot or likely will not fully fund projected pension and health care expenditures. If economic agents place sufficient probability on the economy hitting its ”fiscal limit” at some point in the future, after which further tax revenues are not forthcoming, it may no longer be possible for “good” monetary policy—behavior that obeys the Taylor principle—to control inflation or anchor inflation expectations. In the period leading up to the fiscal limit, the more aggressively that monetary policy leans against inflationary winds, the more expected inflation becomes unhinged from the inflation target. Problems confronting monetary policy are exacerbated when policy institutions leave fiscal objectives and targets unspecified and, therefore, fiscal expectations unanchored. In light of this theory, the paper contrasts monetary-fiscal policy frameworks in the United States and Chile.
    Date: 2010–05
  8. By: Luis Catão;; Adrian Pagan
    Abstract: We use an expectation-augmented SVAR representation of an open economy New Keynesian model to study monetary transmission in Brazil and Chile. The underlying structural model incorporates key structural features of Emerging Market economies, notably the role of a bank-credit channel. We find that interest rate changes have swifter effects on output and inflation in both countries compared to advanced economies and that exchange rate dynamics plays an important role in monetary transmission, as currency movements are highly responsive to changes in policy-controlled interest rates. We also find the typical size of credit shocks to have large effects on output and inflation in the two economies, being stronger in Chile where bank penetration is higher.
    Date: 2010–05
  9. By: Michael 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.
    Date: 2010–05
  10. By: Falch, Nina Skrove; Nymoen, Ragnar
    Abstract: This paper evaluates inflation forecasts made by Norges Bank which is recognized as a successful forecast targeting central bank. It is reasonable to expect that Norges Bank produces inflation forecasts that are on average better than other forecasts, both 'naïve' forecasts, and forecasts from econometric models outside the central bank. The authors find that the superiority of the Bank's forecast cannot be asserted, when compared with genuine ex-ante real time forecasts from an independent econometric model. The 1-step Monetary Policy Report forecasts are preferable to the 1-step forecasts from the outside model, but for the policy relevant horizons (4 to 9 quarters ahead), the forecasts from the outsider model are preferred with a wider margin. An explanation in terms of too high speed of adjustment to the inflation target is supported by the evidence. Norges Bank's forecasts are convincingly better than 'naïve' forecasts over the second half of our sample, but not over the whole sample, which includes a change in the mean of inflation. --
    Keywords: inflation forecasts,monetary policy,forecast comparison,forecast targeting central bank,econometric models
    JEL: C32 C53 E37 E44 E47 E52 E58 E65
    Date: 2011
  11. By: De Paoli, Bianca (Bank of England); Zabczyk, Pawel (Bank of England)
    Abstract: This paper analyses the conduct of monetary policy in an environment in which cyclical swings in risk appetite affect households’ propensity to save. It uses a New Keynesian model featuring external habit formation to show that taking note of precautionary saving motives justifies an accommodative policy bias in the face of persistent, adverse disturbances. Equally, policy should be more restrictive following positive shocks.
    Keywords: Precautionary saving; monetary policy; cyclical risk aversion; macro-finance; DSGE models.
    JEL: E32 G12
    Date: 2011–04–12
  12. By: Stéphane Auray (CNRS, THEMA, EQUIPPE, Universités Lille Nord de France (ULCO),Université de Sherbrooke (GREDI) and CIRPEE, Canada.); Beatriz de Blas (Universidad Autonoma de Madrid, Departamento de Analisis Economico, T. et H. Economico, Campus de Cantoblanco, 28049 Madrid, Spain.); Aurélien Eyquem (Université de Lyon, Lyon, F-69003, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France)
    Abstract: This paper analyzes jointly optimal fiscal and monetary policies in a small open economy with capital and sticky prices. We allow for trade in consumption goods under perfect international risk sharing. We consider balanced-budget fiscal policies where authorities use distortionary taxes on labor and capital together with monetary policy using the nominal interest rate. First, as long as a symmetric equilibrium is considered, the steady state in an open economy is isomorphic to that of a closed economy. Second, whereas sticky prices allocations are almost indistinguishable from flexible prices allocations, the open economydimension delivers results that are qualitatively similar to those of a closed economy but with significant quantitative changes. Fluctuations in terms of trade implied by complete international financial markets affect (i) consumption through changes in the consumption price index (CPI), (ii) hours through changes in the CPI-based real wage and (iii) capital accumulation through the relative price of capital goods. These wedges affect the volatility and persistence of optimal tax rates, and resulting allocations are quite different, as compared to a closed economy.
    Keywords: small open economy, Sticky prices, optimal monetary and fiscal policies
    JEL: E52 E62 E63 F41
    Date: 2011
  13. By: Stähler, Nikolai; Thomas, Carlos
    Abstract: This paper develops a medium-scale dynamic, stochastic, general equilibrium (DSGE) model for fiscal policy simulations. Relative to existingmodels of this type, our model incorporates a two-country monetary union structure, which makes it well suited to simulate fiscal measures by relatively large countries in a currency area. We also provide a notable degree of disaggregation on the government expenditures side, by explicitly distinguishing between (productivity-enhancing) public investment, public purchases and the public sector wage bill. Finally, we consider a labor market characterized by search and matching frictions, which allows to analyze the response of equilibrium unemployment to fiscal measures. In order to illustrate some of its applications, and motivated by recent policy debate in the Euro Area, we calibrate the model to Spain and the rest of the area and simulate a number of fiscal consolidation scenarios. We find that, in terms of output and employment losses, fiscal consolidation is the least damaging when achieved by reducing the public sector wage bill, whereas it is most damaging when carried out by cutting public investment. --
    Keywords: General Equilibrium,Fiscal Policy Simulations,Labor Market Search
    JEL: E24 E32 E62 H20 H50
    Date: 2011
  14. By: Giancarlo Corsetti; Keith Kuester; Gernot J. Müller
    Abstract: According to conventional wisdom, fiscal policy is more effective under a fixed exchange rate regime than under a flexible one. In this paper we reconsider the transmission of shocks to government spending across these regimes within a standard new-Keynesian model of a small open economy. Because of the stronger emphasis on intertemporal optimization, the new-Keynesian framework requires a precise specification of fiscal and monetary policies, and their interaction, at both short and long horizons. We derive an analytical characterization of the transmission mechanism of expansionary spending policies under a peg, showing that the long-term real interest rate necessarily rises if inflation rises on impact, in response to an increase in government spending. This drives down private demand even though short-term real rates fall. As this need not be the case under floating exchange rates, the conventional wisdom needs to be qualified. Under plausible medium-term fiscal policies, government spending is not necessarily less expansionary in a floating regime.
    Date: 2011–01
  15. By: Benjamín García
    Abstract: In this paper we develop an alternative Taylor rule where the level of inertia depends on the gap between the actual and desired interest rates. This rule is estimated for six inflation-targeting countries, namely Chile, Colombia, Mexico, New Zealand, Peru, and South Korea. Evidence of a varying inertia is found for all the tested countries. While for the sample with stable interest rate movements this rule exhibits a fit similar to a classic Taylor rule, it provides a better fit for the post financial crisis sub-sample.
    Date: 2010–09
  16. By: Michael Kumhof; Douglas Laxton
    Abstract: The paper analyzes Chile’s structural surplus fiscal rule in the face of shocks to the world copper price. Two results are obtained. First, Chile’s current fiscal rule performs well if the policymaker (i) puts a premium on avoiding excessive volatility in fiscal instruments, and (ii) puts a relatively small weight on output volatility relative to inflation volatility in his/her objective function. A more aggressive countercyclical fiscal rule can attain lower output volatility, but there is a trade-o¤ with somewhat higher inflation volatility and much higher instrument volatility. The ranking of instruments between government spending and labor income taxes depends mainly on the instrument volatility the policymaker will tolerate. Second, given its then current stock of government assets, Chile’s adoption of a 0.5% surplus target starting in 2008 was desirable because the earlier 1% target would have required significant further asset accumulation that could only have been accomplished at the expense of greater volatility in fiscal instruments and therefore in macroeconomic variables.
    Date: 2010–12
  17. By: Rodrigo Vergara
    Date: 2010–10
  18. By: Uluc Aysun (University of Connecticut)
    Abstract: This paper shows that when financial frictions are dynamically modeled, broader inferences can be drawn from DSGE models with asymmetric information costs. By embedding a partial equilibrium framework of bankruptcy proceedings in a dynamic New Keynesian model I find, for example, that financial liberalization episodes are only effective in countries with an efficient judicial system. More generally, I find that the response of output to various shocks depends on the duration of bankruptcy proceedings. These relationships, however, are not strictly unidirectional. The responses to adverse shocks are amplified (mitigated) when the shocks also generate an increase (a decrease) in real interest rates and an increase (decrease) in the stock of bankruptcy cases. I find empirical support for one prediction of the model by investigating macroeconomic and foreclosure data from U.S. states; monetary policy is more effective in states that have longer foreclosure proceedings.
    Keywords: Foreclosure, DSGE, financial frictions, court efficiency.
    JEL: C63 E44 E52
    Date: 2011–04
  19. By: Sofía Bauducco
    Abstract: In this paper we study the optimal monetary and fiscal policy mix in a model in which agents are subject to idiosyncratic uninsurable shocks to their labor productivity. We identify two main effects of anticipated inflation absent in representative agent frameworks. First, inflation stimulates saving for precautionary reasons. Hence, a higher level of anticipated inflation implies a higher capital stock in steady state, which translates into higher wages and lower taxes on labor income. This benefits poor, less productive agents. Second, inflation acts as a regressive consumption tax, which favors rich and productive agents. We calibrate our model economy to the U.S. economy and compute the optimal policy mix. We find that, for a utilitarian government, the Friedman rule is optimal even when we allow for the presence of heterogeneity and uninsurable idiosyncratic risk. Although the aggregate welfare costs of inflation are small, individual costs and benefits are large. Net winners from inflation are poor, less productive agents, while middle-class and rich households are always net losers.
    Date: 2011–02
  20. By: Luis Felipe Céspedes; Roberto Chang; Diego Saravia
    Abstract: The last financial crisis revealed that financial imperfections and institutions play a more important role than the literature has assigned them for a long time, and it is possible to ascertain strongly that in the coming years macroeconomic research will be dominated by the study of the relationships between financial frictions, financial systems and aggregate fluctuations. This paper conducts a selective review of existing literature on monetary policy and its interaction with financial variables. It then examines frontier research presented at the XIII Annual Conference of the Central Bank of Chile, which gathers new theoretical results and empirical evidence applicable both in developed countries and in the Chilean economy
    Date: 2010–09
  21. By: Sofía Bauducco; Rodrigo Caputo
    Abstract: In this paper we discuss the arguments for and against the adoption of price-level targeting. We review recent theoretical contributions, and illustrate the main differences between price-level targeting and inflation targeting in a simple New Keynesian model. We conclude that, contrary to conventional wisdom, price-level targeting can, in some circumstances, deliver better outcomes than inflation targeting. Its main advantage lies on the fact that it acts as a commitment device when the Central Bank is unable to commit to its future actions. However, even in the circumstances under which price-level targeting performs better, there are three caveats to be considered. First, a higher proportion of backward-looking price setters reduces the effectiveness of price-level targeting, because it weakens the expectational channel through which price-level targeting operates. Second, communicating a price-level target may be a difficult task for the Central Bank. Finally, price-level targeting itself is not immune to considerations of time-inconsistency.
    Date: 2010–12
  22. By: Guido Menzio (Department of Economics, University of Pennsylvania); Shouyong Shi (Department of Economics, University of Toronto); Hongfei Sun (Department of Economics, Queens University)
    Abstract: Dispersion of money balances among individuals is the basis for a range of policies but it has been abstracted from in monetary theory for tractability reasons. In this paper, we fill in this gap by constructing a tractable search model of money with a non-degenerate distribution of money holdings. We assume search to be directed in the sense that buyers know the terms of trade before visiting particular sellers. Directed search makes the monetary steady state block recursive in the sense that individuals’ policy functions, value functions and the market tightness function are all independent of the distribution of individuals over money balances, although the distribution affects the aggregate activity by itself. Block recursivity enables us to characterize the equilibrium analytically. By adapting lattice-theoretic techniques, we characterize individuals’ policy and value functions, and show that these functions satisfy the standard conditions of optimization. We prove that a unique monetary steady state exists. Moreover, we provide conditions under which the steady-state distribution of buyers over money balances is non-degenerate and analyze the properties of this distribution.
    Keywords: Money; Distribution; Search; Lattice-Theoretic
    JEL: E00 E4 C6
    Date: 2011–03–11
  23. By: Baum, Anja; Koester, Gerrit B.
    Abstract: Does the state of the business cycle matter for the effects of fiscal policy shocks on GDP? This study analyses quarterly German data from 1976 to 2009 in a threshold SVAR, expanding the SVAR approach by Blanchard and Perotti (2002). In a linear benchmark SVAR, the analysis finds that hiking spending yields a short-term fiscal multiplier of around 0.70, while the fiscal multiplier resulting from an increase in taxes and social security contributions is -0.66. In addition, the threshold model derives fundamentally new insights on the effects of shocks, depending on when in the business cycle they occur, their size and their direction. Most importantly, fiscal spending multipliers are much larger in times of a negative output gap but have only a very limited effect in times of a positive output gap. Discretionary revenue policies, on the other hand, have a generally more limited impact. Our findings have important implications for the optimal fiscal policy mix over different stages of the business cycle. Various robustness checks, including a different threshold specification, do not influence these implications substantially. --
    Keywords: fiscal policy,business cycle,nonlinear analysis,fiscal multipliers
    JEL: E62 E32
    Date: 2011
  24. By: Charles Amélie (Audencia Nantes, School of Management, 8 route de la Jonelière, 44312 Nantes Cedex 3, France.); Darné Olivier (EMNA, University of Nantes, IEMN–IAE, Chemin de la Censive du Tertre, BP 52231, 44322 Nantes, France.); Claude Diebolt (BETA/CNRS, Université de Strasbourg, France.)
    Date: 2011
  25. By: Simeon Coleman
    Abstract: This paper contributes to the discussion on the long term sustainability of the embryonic second monetary union in Africa, the West African Monetary Zone (WAMZ). We analyse the level of economic and monetary integration in West Africa by analysing the degree of growth cycle synchronisation between five candidate countries over the past thirty years. Our empirical approach improves on the standard Pearson Correlation between trend and cyclical components of GDP by analyzing a measure of co-movement at higher frequencies between computed z-scores for all possible pairings of the candidate countries. Our results indicate a lack of a consistent pattern of synchronized growth cycles, which raises concerns about the economic sustainability of the WAMZ, as it implies that members may face significant stabilisation costs. Some policy implications are discussed.
    Keywords: Business cycles, monetary unions
    JEL: E32 E61 F42
    Date: 2011–04
  26. By: Jeffrey Frankel
    Abstract: Historically, many countries have suffered a pattern of procyclical fiscal policy: spending too much in booms and then forced to cut back in recessions, thereby exacerbating the business cycle. This problem has especially plagued Latin American commodity-producers. Since 2000, fiscal policy in Chile has been governed by a structural budget rule that has succeeded in implementing countercyclical fiscal policy. The key innovation is that the two most important estimates of the structural versus cyclical components of the budget – trend output and the 10-year price of copper – are made by expert panels and thus insulated from the political process. Chile’s fiscal institutions could usefully be emulated everywhere, but especially in other commodityexporting countries. This paper finds statistical support for a series of hypotheses regarding forecasts by official agencies that have responsibility for formulating the budget. 1) Official forecasts of budgets and GDP in a sample of 33 countries are overly optimistic on average. 2) The bias toward over-optimism is stronger the longer the horizon 3) The bias is greater among European governments that are politically subject to the budget rules in the Stability and Growth Pact. 4) The bias is greater at the extremes of the business cycle, particularly in booms. 5) In most countries, the real growth rate is the key macroeconomic input for budget forecasting. In Chile it is the price of copper. 6) Real copper prices mean-revert in the long run, but this is not always readily perceived. 7) Chile’s official forecasts are not overly optimistic on average. 8) Chile has apparently avoided the problem of official forecasts that unrealistically extrapolate in boom times. The conclusion is that official forecasts, if not insulated from politics, tend to be overly optimistic and that the problem can be worse when the government is formally subject to a budget rule. The key innovation that has allowed Chile in general to achieve countercyclical fiscal policy, and in particular to run surpluses in booms, is not just a structural budget rule in itself, but rather the regime that entrusts to panels of independent experts the responsibility for estimating the extent to which contemporaneous copper prices and GDP have departed from their long-run averages.
    Date: 2011–01
  27. By: Mauricio Calani; Kevin Cowan; Pablo García S.
    Abstract: The events surrounding the financial crisis and recession of 2008-2009 required significant policy responses by central banks. For formal inflation targeters (IT) a natural question arises about whether IT frameworks were flexible enough to address this unprecedented policy environment. In this paper we tackle this question by assessing the policy responses to the crisis of nine IT central banks that did not face systemic problems in their banking or financial systems. We first document substantial deviations of actual policy responses from prescriptions of conventional monetary policy reaction functions, beginning in the second half of 2008. Although several explanations for the deviations are offered, highlighting the extreme challenges at the time, we can more easily reconcile the findings with a decline in the persistence of monetary policy, again, in all cases. Second, we document the banks’ non-monetary-policy measures adopted at the time, and estimate their impact on local money markets (both in local currency and US dollars) and on exchange rates. While these measures helped broadly to normalize markets, firm conclusions on the effectiveness of specific measures are elusive, owing to the difficulty in comparing the different mix of measures adopted across countries and the significant heterogeneity in specific economies’ responses to these non-monetary policy measures.
    Date: 2010–07
  28. By: Hoffmann, Mathias; Krause, Michael; Laubach, Thomas
    Abstract: This paper examines to what extent the build-up of 'global imbalances' since the mid-1990s can be explained in a purely real open-economy DSGE model in which agents' perceptions of long-run growth are based on filtering observed changes in productivity. We show that long-run growth estimates based on filtering U.S. productivity data comove strongly with long-horizon survey expectations. By simulating the model in which agents filter data on U.S. productivity growth, we closely match the U.S. current account evolution. Moreover, with household preferences that control the wealth effect on labor supply, we can generate output movements in line with the data. --
    Keywords: open economy DSGE models,trend growth,Kalman filter,real-time data,news and business cycles,current account
    JEL: F32 E32 D83
    Date: 2011
  29. By: Sandra Gomes (Bank of Portugal, Economic Research Department, Av. Almirante Reis 71, 1150-012 Lisbon, Portugal.); Pascal Jacquinot (European Central Bank, Directorate General of Research, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.); Matthias Mohr (European Central Bank, Directorate General of Economics, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.); Massimiliano Pisani (Bank of Italy, Research Department, Via Nazionale 91, 00184 Rome, Italy.)
    Abstract: We quantitatively assess the macroeconomic effects of country-specific supply-side reforms in the euro area by simulating EAGLE, a multi-country dynamic general equilibrium model. We consider reforms in the labor and services markets of Germany (or, alternatively, Portugal) and the rest of the euro area. Our main results are as follows. First, there are benefits from implementing unilateral structural reforms. A reduction of markup by 15 percentage points in the German (Portuguese) labor and services market would induce an increase in the long-run German (Portuguese) output equal to 8.8 (7.8) percent. As reforms are implemented gradually over a period of five years, output would smoothly reach its new long-run level in seven years. Second, cross-country coordination of reforms would add extra benefits to each region in the euro area, by limiting the deterioration of relative prices and purchasing power that a country faces when implementing reforms unilaterally. This is true in particular for a small and open economy such as Portugal. Specifically, in the long run German output would increase by 9.2 percent, Portuguese output by 8.6 percent. Third, cross-country coordination would make the macroeconomic performance of the different regions belonging to the euro area more homogeneous, both in terms of price competitiveness and real activity. Overall, our results suggest that reforms implemented apart by each country in the euro area produce positive effects, cross-country coordination produces larger and more evenly distributed (positive) effects. JEL Classification: C53, E52, F47.
    Keywords: Economic policy, structural reforms, dynamic general equilibrium modeling, competition, markups, monetary policy.
    Date: 2011–04
  30. By: Roque Montero
    Abstract: This paper tests the hypothesis of linearity against a specific form of nonlinearity in the Data Generating Process (DGP) of the unemployment rate and the difference between the inflation rate (CPI and CPIX1) and the inflation target. The test is performed over each variable using time series models. Under the null hypothesis, the DGP has a linear representation (AR model) and under the alternative, a non linear specification (SETAR model). Unlike traditional ARIMA models, these models allow the endogenous variable to have different regimes across time. The main results are: it is not possible to reject linearity in the deviation of inflation from the inflation target. During the last twenty years, inflation has converged smoothly to the target without any regime switching. Finally, strong evidence is found against linearity in the unemployment rate. On the contrary, it fluctuates with high probability between states or regimes through time.
    Date: 2011–02
  31. By: Monica Correa Lopez; Agustin Garcia Serrador; Ana Cristina Mingorance
    Abstract: We analyse the impact of product market competition on the responsiveness of inflation to macroeconomic imbalances. Results based on a 20-country OECD panel estimated for the period 1961-2006 show that if product market competition is high the response of inflation to lagged inflation and unemployment is reduced, while inflation is more responsive to changes in productivity growth in countries in which competition is above the OECD average. When product market competition is measured by barriers to firms’ entry, we also find that low entry barriers dampen the effect on inflation of movements in import prices. These results are attributed to temporary mark-up changes after demand- and supplyside shocks.
    Keywords: Inflation dynamics; Product market competition; Labour market coordination; Trade union density.
    JEL: E31 J51
    Date: 2010–10
  32. By: Stéphane Dées (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany.); Nico Zorell (University of Tübingen.)
    Abstract: Drawing on a large sample of countries, this paper explores whether closer economic ties between countries foster business cycle synchronisation and disentangles the role of the various channels, including trade and financial linkages as well as the similarity in sectoral specialisation. Overall, our results confirm that trade integration fosters business cycle synchronisation. Similar patterns of sectoral specialisation also lead to closer business cycle co-movement. By contrast, it remains difficult to find a direct relationship between bilateral financial linkages and output correlation. However, our results suggest that financial integration affects business cycle synchronisation indirectly by raising the similarity in sectoral specialisation. Through this indirect link, financial integration tends to raise business cycle comovement between countries. JEL Classification: E32, F41, E44.
    Keywords: International transmission of shocks, Financial integration, International business cycle.
    Date: 2011–04
  33. By: Daniele Franco (editor) (Bank of Italy)
    Abstract: The volume collects the essays presented at the 12th Workshop on Public Finance organised by Banca d'Italia in Perugia on 25-27 March 2010. The workshop focused on the implications for fiscal policy analysis of the 2008-09 recession, the most severe at global level since the Great Depression. Session 1 examined the lessons of the crisis for the role of automatic stabilisers and discretionary fiscal policy. Session 2 investigated the effects of policy actions on the economy. Section 3 considered the impact of the crisis on fiscal policy rules and procedures. Section 4 dealt with the economic legacy of the crisis and the policy actions required in the years to come.
    Keywords: fiscal rules, fiscal policy, 2008 crisis
    JEL: E32 E62
    Date: 2011–02
  34. By: Carmen M. (Peterson Institute for International Economics); M. Belen Sbrancia (University of Maryland)
    Abstract: Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of "financial repression." Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks. In this paper, the authors describe some of the regulatory measures and policy actions that characterized the heyday of the financial repression era. In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historical standards). For the advanced economies in Reinhart and Sbrancia's sample, real interest rates were negative roughly half of the time during 1945–80. For the United States and the United Kingdom, their estimates of the annual liquidation of debt via negative real interest rates amounted on average to 3 to 4 percent of GDP a year. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum).
    Keywords: Public Debt, Financial Repression, Inflation, Interest Rates, Debt Liquidation, Default, Restructuring, Debt Reduction
    JEL: E2 E3 E6 F3 F4 H6 N10
    Date: 2011–04
  35. By: James D. Hamilton; Jing Cynthia Wu
    Abstract: This paper reviews alternative options for monetary policy when the short-term interest rate is at the zero lower bound and develops new empirical estimates of the effects of the maturity structure of publicly held debt on the term structure of interest rates. We use a model of risk-averse arbitrageurs to develop measures of how the maturity structure of debt held by the public might affect the pricing of level, slope and curvature term-structure risk. We find these Treasury factors historically were quite helpful for predicting both yields and excess returns over 1990-2007. The historical correlations are consistent with the claim that if in December of 2006, the Fed were to have sold off all its Treasury holdings of less than one-year maturity (about $400 billion) and use the proceeds to retire Treasury debt from the long end, this might have resulted in a 14-basis-point drop in the 10-year rate and an 11-basis-point increase in the 6-month rate. We also develop a description of how the dynamic behavior of the term structure of interest rates changed after hitting the zero lower bound in 2009. Our estimates imply that at the zero lower bound, such a maturity swap would have the same effects as buying $400 billion in long-term maturities outright with newly created reserves, and could reduce the 10-year rate by 13 basis points without raising short-term yields.
    JEL: E43 E52 G12 H63
    Date: 2011–04
  36. By: Xu, Zhiwei; Fan, Haichao
    Abstract: Our structural VAR shows that the new business formation in U.S. data has similar positive co-movement pattern as common aggregate variables in response to a favorable anticipated shock about technology. However, incorporating …firm dynamics into Jaimovich and Rebelo's (Jaimovich and Rebelo, 2009, American Economic Review) model cannot explain our empirical fi…nding. Even worse, the model predicts an aggregate recession instead of a boom. Then, we show that this problem can be resolved with a minor modification by introducing endogenous survival rate of the new entrants.
    Keywords: Firm Dynamics; Aggregate Co-movement; Expectation Driven Business Cycle; News Shocks
    JEL: E32 E22
    Date: 2010–11
  37. By: Lejour, Arjan; Lukkezen, Jasper; Veenendaal, Paul
    Abstract: This paper addresses the sustainability of government debt in Europe and is motivated by the recent debt increases following the crisis. We evaluate the sustainability in a time frame of ten years in which governments will be able to implement budget rules to get budget deficits under control. We develop a fiscal sustainability model for selected EMU member states that uses stochastic inputs based on historic data, closely following van Wijnbergen’s (van Wijnbergen and Budina, 2008) approach. We simulate the development of government debt as a percentage of GDP and show its expectation value including a confidence interval for a member state conditional on deficit reduction scenarios and the behaviour of other EMU member states. Using OECD projections as a baseline, we find that without additional fiscal consolidation and taking into account the public costs of ageing until the end of the projection period, budget deficits in all selected EMU countries will rise and sovereign debt is not sustainable, apart from Belgium. Even ignoring the cost of ageing, consolidation of sovereign debt is necessary for nearly all EMU countries. The consolidation proposed by the OECD would eliminate the doubts on sustainability of Belgium, Dutch, German, Italian, Portuguese and French bonds. For Ireland, Greece and Spain additional actions are required on top of the consolidation in the OECD projections. Together with a review of spillovers and stress-tests performed with our model we conclude that coordination of fiscal policies in the EMU is necessary.
    Keywords: EU; government debt; cross border spillovers; euro
    JEL: E52 E6 H71 H63
    Date: 2010–06–07
  38. By: Michael Coopersmith
    Abstract: A relation between interest rates and inflation is presented using a two component economic model and a simple general principle. Preliminary results indicate a remarkable similarity to classical economic theories, in particular that of Wicksell.
    Date: 2011–04
  39. By: Michael Pedersen
    Abstract: When a specific price is affected by a shock, this may spread to other prices and thus affect the overall inflation rate by more than the initial effect. This phenomenon is known as propagation of inflationary shocks and is the subject investigated in the present paper. It is argued that structural VAR models, with an imposed Cholesky decomposition, are suitable for the propagation analysis when the data vector includes the component affected by the initial shock and the rest of the CPI basket. The empirical analysis with annual Chilean inflation rates suggests that the propagation effects have generally diminished after the implementation of the inflation-targeting regime in September 1999. Propagation of shocks to the division including food prices, however, has increased, albeit with a delay of four months. An analysis of propagation of energy and food price shocks in seven industrialized and four Latin-American countries suggests that the effects in Chile are amongst the largest and, in the case of energy price shocks, with the longest duration.
    Date: 2010–04
  40. By: Michele Modugno (European Central Bank, DG-R/EMO, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.)
    Abstract: This paper proposes a methodology to nowcast and forecast inflation using data with sampling frequency higher than monthly. The nowcasting literature has been focused on GDP, typically using monthly indicators in order to produce an accurate estimate for the current and next quarter. This paper exploits data with weekly and daily frequency in order to produce more accurate estimates of inflation for the current and followings months. In particular, this paper uses the Weekly Oil Bulletin Price Statistics for the euro area, the Weekly Retail Gasoline and Diesel Prices for the US and daily World Market Prices of Raw Materials. The data are modeled as a trading day frequency factor model with missing observations in a state space representation. For the estimation we adopt the methodology exposed in Banbura and Modugno (2010). In contrast to other existing approaches, the methodology used in this paper has the advantage of modeling all data within a unified single framework that, nevertheless, allows one to produce forecasts of all variables involved. This offers the advantage of disentangling a model-based measure of ”news” from each data release and subsequently to assess its impact on the forecast revision. The paper provides an illustrative example of this procedure. Overall, the results show that these data improve forecast accuracy over models that exploit data available only at monthly frequency for both countries. JEL Classification: C53, E31, E37.
    Keywords: Factor Models, Forecasting, Inflation, Mixed Frequencies.
    Date: 2011–04
  41. By: Juan Carlos Berganza (Banco de España); Carmen Broto (Banco de España)
    Abstract: Emerging economies with inflation targets (IT) face a dilemma between fulfilling the theoretical conditions of "strict IT", which imply a fully flexible exchange rate, or applying a "flexible IT", which entails a de facto managed floating exchange rate with FX interventions to moderate exchange rate volatility. Using a panel data model for 37 countries we find that, although IT lead to higher exchange rate instability than alternative regimes, FX interventions in some IT countries have been more effective to lower volatility than in non-IT countries, which may justify the use of "flexible IT" by policymakers.
    Keywords: inflation targeting, exchange rate volatility, foreign exchange interventions, emerging economies
    JEL: E31 E42 E52 E58 F31
    Date: 2011–04
  42. By: Bessonovs, Andrejs
    Abstract: Uncertainty associated with an optimal number of macroeconomic variables to be used in factor model is challenging since there is no criteria which states what kind of data should be used, how many variables to employ and does disaggregated data improve factor model’s forecasts. The paper studies an impact of nested macroeconomic data on Latvian GDP forecasting accuracy within factor modelling framework. Nested data means disaggregated data or sub-components of aggregated variables. We employ Stock-Watson factor model in order to estimate factors and to make GDP projections two periods ahead. Root mean square error is employed as the standard tool to measure forecasting accuracy. According to this empirical study we conclude that additional information that contained in disaggregated components of macroeconomic variables could be used to enhance Latvian GDP forecasting accuracy. The efficiency gain improving forecasts is about 0.15-0.20 percentage points of year on year quarterly growth for the forecasting period 1 quarter ahead, but for 2 quarter ahead it’s about half percentage point.
    Keywords: Factor model; forecasting; nested data; RMSE.
    JEL: C53 C22 E37
    Date: 2011–04–08
  43. By: Shin-ichi Fukuda
    Abstract: This paper explores how international money markets reflected credit and liquidity risks during the global financial crisis. After matching the currency denomination, we investigate how the Tokyo Interbank Offered Rate (TIBOR) was synchronized with the London Interbank Offered Rate (LIBOR) denominated in the US dollar and the Japanese yen. Regardless of the currency denomination, TIBOR was highly synchronized with LIBOR in tranquil periods. However, the interbank rates showed substantial deviations in turbulent periods. We find remarkable asymmetric responses in reflecting market-specific and currency-specific risks during the crisis. The regression results suggest that counter-party credit risk increased the difference across the markets, while liquidity risk caused the difference across the currency denominations. They also support the view that a shortage of US dollar as liquidity distorted the international money markets during the crisis. We find that coordinated central bank liquidity provisions were useful in reducing liquidity risk in the US dollar transactions. But their effectiveness was asymmetric across the markets.
    JEL: E44 F32 F36
    Date: 2011–04
  44. By: Vítor Castro (Universidade de Coimbra and NIPE)
    Abstract: This paper tries to identify, for the first time, a chronology for the Portuguese stock market cycle and test for the presence of duration dependence in bull and bear markets. A duration dependent Markov-switching model is estimated over monthly growth rates of the Portuguese Stock Index for the period 1989-2010. Six episodes of bull/bear markets are identified during that period, as well as the presence of positive duration dependence in bear but not in bull markets.
    Keywords: stock market cycles; bull and bear markets; duration dependence; Markov-switching.
    JEL: E32 G19 C41 C24
    Date: 2011
  45. By: Yosef Bonaparte; Russell Cooper; Guozhong Zhu
    Abstract: This paper studies the dynamics of portfolio rebalancing and consumption smoothing in the presence of non-convex portfolio adjustment costs. The goal is to understand a household's response to income and return shocks. The model includes the choice of two assets: one riskless without adjustment costs and a second risky asset with adjustment costs. With these multiple assets, a household can buffer some income fluctuations through the asset without adjustment costs and engage in costly portfolio rebalancing less frequently. We estimate both preference parameters and portfolio adjustment costs. The estimates are used for evaluating consumption smoothing and portfolio adjustment in the face of income and return shocks.
    JEL: E21 G11
    Date: 2011–04
  46. By: Heather D. Gibson; Stephan G. Hall; George S. Tavlas
    Abstract: We discuss the origins of the Greek financial crisis as manifested in the growing fiscal and current-account deficits since euro-area entry in 2001. We then provide an investigation of spreads on Greek relative to German long-term government debt. Using monthly data over the period 2000 to 2010, we estimate a cointegrating relationship between spreads and their long-term fundamental determinants, and compare the spreads predicted by this estimated relationship with actual spreads. We find periods of both undershooting and overshooting of spreads compared to what is predicted by the economic fundamentals.
    Keywords: Greek financial crisis; sovereign spreads
    JEL: E63 G12
    Date: 2011–03
  47. By: Paula Hernandez-Verme (Department of Economics and Finance, Universidad de Guanajuato)
    Abstract: I examine a production economy with a financial sector that contains multiple layers of credit. Such layers are designed to constitute credit chains which are inclusive of a simple mortgage market. The focus is on the nature and contagion properties of credit chains in an economy where the financial sector plays a real allocative role and agents have a nontrivial choice of whether to default on mortgages or not. Multiple equilibria with different rates of default are observed, due to the presence of strategic complementarities. Default can trigger a financial crisis as well as constrain the purchases of factors of production, thus leading to potentially serious effects on real activity.
    Keywords: Endogenous default, Mortgage Crises, Payments System
    JEL: E44 E52 E58
    Date: 2011–04
  48. By: Huang, Yiping (Asian Development Bank Institute); Tao, Kunyu (Asian Development Bank Institute)
    Abstract: The current account surplus of the People’s Republic of China (PRC) has drawn much foreign and domestic attention. This paper focuses on the reasons and remedies for the PRC’s current account surpluses. Rather than deploying the standard explanations, we argue that asymmetric market liberalization and the related factor market distortion is the root reason for the PRC’s external imbalances. These cost distortions have artificially lowered PRC production costs, raised profits, and improved their products’ international competitiveness which has not only stimulated the economy, but also brought about severe structural risks. We completed a crude estimation for factor cost distortions in the PRC during 2000–2009 which matched its current account surpluses quite well. In order to rebalance the economy, we recommend that the PRC should adopt a comprehensive reform package focusing on removing the factor market distortions.
    Keywords: prc; current account surplus; economic rebalancing; exchange rate; factor market distortion
    JEL: E61 F32 H24 O11
    Date: 2011–04–15
  49. By: Gita Gopinath; Brent Neiman
    Abstract: We empirically characterize the mechanics of trade adjustment during the Argentine crisis using detailed firm-level customs data covering the universe of import transactions during 1996-2008. Our main findings are as follows: First, the extensive margin defined as the entry and exit of firms or of products (at the country level) plays a small role during the crisis. Second, the sub-extensive margin defined as the churning of inputs within firms plays a sizeable role in aggregate adjustment. This implies that the true increase in input costs exceeds that imputed from conventional price indices. Third, the relative importance of these margins and of overall trade adjustment varies with firm size. Motivated by these facts, we build a model of trade in intermediate inputs with heterogenous firms, fixed import costs, and round-about production to evaluate the channels through which a collapse in imports effects TFP in manufacturing. Measured aggregate productivity in the sector depends on within-firm adjustments to the varieties imported as well as the joint distribution of each firm's technology and the share of imports in its total spending on inputs. We simulate an imported input cost shock and show that these mechanisms can deliver quantitatively significant declines in manufacturing TFP.
    JEL: E32 F4 O47
    Date: 2011–04

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