nep-mac New Economics Papers
on Macroeconomics
Issue of 2011‒05‒30
39 papers chosen by
Soumitra K Mallick
Indian Institute of Social Welfare and Business Management

  1. Monetary Policy Mistakes and the Evolution of Inflation Expectations By Athanasios Orphanides; John Williams
  2. Inflation in the G7: mind the gap(s)? By James Morley; Jeremy M. Piger; Robert H. Rasche
  3. An Exploration of Optimal Stabilization Policy By N. Gregory Mankiw; Matthew C. Weinzierl
  4. Monetary policy, asset prices and the real economy in China By James Laurenceson; Ceara Hui
  5. Endogenous market structures and labour market dynamics By Colciago , Andrea; Rossi, Lorenza
  6. Quantitative Easing in Japan from 2001 to 2006 and the World Financial Crisis By Yuzo Honda; Minoru Tachibana
  7. Confidence and the Transmission of Government Spending Shocks By Rüdiger Bachmann; Eric R. Sims
  8. How Do Business and Financial Cycles Interact? By Claessens, Stijn; Kose, Ayhan; Terrones, Marco E
  9. Adentification Through Heteroscedasticity in a Multicountry and Multimarket Framework By Bernd Hayo; Britta Niehof
  10. Dynamic Effects of Monetary Policy Shocks in Malawi By Harold Ngalawa; Nicola Viegi
  11. Search frictions and the labor wedge By Andrea Pescatori; Murat Tasci
  12. New Keynesian dynamics in a low interest rate environment By R. Anton Braun; Lena Mareen Körber
  13. The World Has More Than Two Countries: Implications of Multi- Country International Real Business Cycle Models By Hirokazu Ishise
  14. Varieties of capitalism and varieties of macroeconomic policy. Are some economies more procyclical than others? By Amable, Bruno; Azizi, Karim
  15. In search for yield? Survey-based evidence on bank risk taking By Buch, Claudia M.; Eickmeier, Sandra; Prieto, Esteban
  16. Jamaica: Macroeconomic Policy, Debt and the IMF By Juan Montecino; Jake Johnson
  17. How applicable are the new keynesian DSGE models to a typical low-income economy? By Senbeta , Sisay
  18. The review of financial repression policies and banking system in Iran By Dehghan Nejad, Omid
  19. International Capital Flows and Aggregate Output By von Hagen, Jürgen; Zhang, Haiping
  20. Friedman's monetary economics in practice By Edward Nelson
  21. Is there a trade-off between inflation and output stabilization? By Alejandro Justiniano; Giorgio E. Primiceri; Andrea Tambalotti
  22. Financial capital and the macroeconomy: policy considerations By Michael T. Kiley; Jae W. Sim
  23. Monetary Policy and the Exchange Rate in Colombia By Hernando Vargas Herrera
  24. Rent-seeking competition from state coffers in Greece: a calibrated DSGE model By Konstantinos Angelopoulos; Sophia Dimeli; Apostolis Philippopoulos; Vanghelis Vassilatos
  25. OPEC’s oil exporting strategy and macroeconomic (in)stability By Luís Aguiar-Conraria; Yi Wen
  26. Interest Rates and Credit Risk By González-Aguado, Carlos; Suarez, Javier
  27. Financial capital and the macroeconomy: a quantitative framework By Michael T. Kiley; Jae W. Sim
  28. Labor Market Policy in the Great Recession: Some Lessons from Denmark and Germany By John Schmitt
  29. Évaluation de la politique monétaire dans un modèle DSGE pour la zone euro By Adjemian, Stéphane; Devulder, Antoine
  30. Flexible inflation targets, forex interventions and exchange rate volatility in emerging countries By Berganza, Juan Carlos; Broto, Carmen
  31. On the amplification role of collateral constraints By Caterina Mendicino
  32. Impact of adverse economic shocks on the Indian child labour market and the schooling of children of poor households By B, Karan Singh
  33. New financial intermediary development indicators for developing countries By Simplice A., Asongu
  34. Asset Value, Interest Rates and Oil Price Volatility By Vipin Arora
  35. Arbitrage and the Price of Oil By Vipin Arora
  36. The Euro area's macroeconomic balancing act By Guntram B. Wolff
  37. The Choice of CES Production Techniques and Balanced Growth By Miguel A. Leon-Ledesma; Mathan Satchi
  38. More Alike than Different: The Spanish and Irish Labour Markets Before and After the Crisis By Agnese, Pablo; Salvador, Pablo F.
  39. The two-sided effect of financial globalization on output volatility By Meller, Barbara

  1. By: Athanasios Orphanides; John Williams
    Abstract: What monetary policy framework, if adopted by the Federal Reserve, would have avoided the Great Inflation of the 1960s and 1970s? We use counterfactual simulations of an estimated model of the U.S. economy to evaluate alternative monetary policy strategies. We show that policies constructed using modern optimal control techniques aimed at stabilizing inflation, economic activity, and interest rates would have succeeded in achieving a high degree of economic stability as well as price stability only if the Federal Reserve had possessed excellent information regarding the structure of the economy or if it had acted as if it placed relatively low weight on stabilizing the real economy. Neither condition held true. We document that policymakers at the time both had an overly optimistic view of the natural rate of unemployment and put a high priority on achieving full employment. We show that in the presence of realistic informational imperfections and with an emphasis on stabilizing economic activity, an optimal control approach would have failed to keep inflation expectations well anchored, resulting in high and highly volatile inflation during the 1970s. Finally, we show that a strategy of following a robust first-difference policy rule would have been highly effective at stabilizing inflation and unemployment in the presence of informational imperfections. This robust monetary policy rule yields simulated outcomes that are close to those seen during the period of the Great Moderation starting in the mid-1980s.
    JEL: E52
    Date: 2011–05
  2. By: James Morley; Jeremy M. Piger; Robert H. Rasche
    Abstract: We investigate the importance of trend inflation and the real-activity gap for explaining observed inflation variation in G7 countries since 1960. Our results are based on a bivariate unobserved-components model of inflation and unemployment in which inflation is decomposed into a stochastic trend and transitory component. As in recent implementations of the New Keynesian Phillips Curve, it is the transitory component of inflation, or “inflation gap”, that is driven by the real-activity gap, which we measure as the deviation of unemployment from its natural rate. Even when allowing for changes in the contributions of trend inflation and the inflation gap, we find that both are important determinants of inflation variation at business cycle horizons for all G7 countries throughout much of the past 50 years. Also, the real-activity gap explains a large fraction of the variation in the inflation gap for each country, both historically and in recent years. Taken together, the results suggest the New Keynesian Phillips Curve, once augmented to include trend inflation, is an empirically relevant model for the G7 countries. We also provide new estimates of trend inflation for the G7 that incorporate information in the real-activity gap for identification and, through formal model comparisons, new statistical evidence regarding structural breaks in the variability of trend inflation and the inflation gap.
    Keywords: Inflation (Finance) ; Phillips curve
    Date: 2011
  3. By: N. Gregory Mankiw; Matthew C. Weinzierl
    Abstract: This paper examines the optimal response of monetary and fiscal policy to a decline in aggregate demand. The theoretical framework is a two-period general equilibrium model in which prices are sticky in the short run and flexible in the long run. Policy is evaluated by how well it raises the welfare of the representative household. While the model has Keynesian features, its policy prescriptions differ significantly from textbook Keynesian analysis. Moreover, the model suggests that the commonly used "bang for the buck" calculations are potentially misleading guides for the welfare effects of alternative fiscal policies.
    JEL: E52 E62 E63
    Date: 2011–05
  4. By: James Laurenceson (School of Economics, The University of Queensland); Ceara Hui
    Abstract: The Global Financial Crisis served to refocus attention on the potential for monetary policy to exert an impact on asset prices. In turn, asset price fluctuations were shown to exert a powerful impact on the real economy. In this paper we consider these linkages in the case of China. Using SVAR modelling techniques, our results indicate that a monetary policy shock has a significant impact on asset prices, particularly share prices, and notably more so than on general goods and services prices. However, a shock to asset prices has little impact on the real economy. Policy implications are discussed.
    Date: 2011
  5. By: Colciago , Andrea (University of Milano-Bicocca, Department of Economics); Rossi, Lorenza (University of Pavia, Department of Economics)
    Abstract: We propose a flexible prices model where endogenous market structures and search and matching frictions in the labour market interact endogenously. The interplay between firms’ endogenous entry, strategic interactions among producers and labour market frictions represents a strong amplification channel for technology shocks on labour market variables and helps in addressing the unemployment- volatility puzzle. Consistently with US evidence, new firms create a large fraction of new jobs and grow faster than more mature firms, net entry of firms is procyclical and the price mark-up is countercyclical.
    Keywords: endogenous market structures; firms’ entry; search and matching; friction
    JEL: E24 E32 L11
    Date: 2011–05–19
  6. By: Yuzo Honda (Kansai University); Minoru Tachibana (Osaka Prefecture University)
    Abstract: The Bank of Japan adopted the Quantitative Easing (QE) Policy from March 2001 to March 2006. This paper investigates whether or not this QE had an effect in stimulating real economy in Japan. The identification of policy effect in the above Japanese case enables us to evaluate indirectly the effectiveness of the non-traditional monetary policy employed by US Federal Reserve Board (FRB) or the Bank of England (BOE) just after the collapse of Lehman Brothers. We extend vector autoregression analysis by Honda, Kuroki, and Tachibana (2007, 2010; HKT), including monthly samples before and after the period of QE, but at the same time fully exploiting prior information on the structural change of operating targets of monetary policy from call rate to bank reserve during the period of QE. There are two main results. First, this paper reconfirms our qualitative findings in HKT. That is, increases in bank reserve balances boost stock prices first, and then industrial production. Secondly, an increase in bank reserve balances by 1 trillion yen led to the rise of stock prices by the range of 0.2% to 0.9%, and to the increase of industrial production by the range of 0.03% to 0.18%. Finally, FRB called their policy after the Lehman shock gcredit easingh policy, but their policy includes both aspects of credit easing and QE. The results of the present paper suggest that even the QE aspect alone of the non-traditional monetary policy by FRB or BOE should have significant stimulating policy effects.
    Keywords: Quantitative easing; Money injection; Portfolio rebalancing; Stock price channel; Vector autoregression
    JEL: E44 E52
    Date: 2011–05
  7. By: Rüdiger Bachmann; Eric R. Sims
    Abstract: There seems to be a widespread belief among economists, policy-makers, and members of the media that the "confidence'" of households and businesses is a critical component in the transmission of fiscal policy shocks into economic activity. We take this proposition to the data using standard structural VARs with government spending and aggregate output augmented to include empirical measures of consumer or business confidence. We also estimate non-linear VAR specifications to allow for differential impacts of government spending in "normal'' times versus recessions. In normal times confidence does not react significantly to unexpected increases in government spending and spending multipliers are in the neighborhood of one; during recessions confidence rises and spending multipliers are significantly larger. We then quantify the importance of the systematic response of confidence to spending shocks for the spending multiplier and find that, in normal times, confidence is irrelevant for the transmission of government spending shocks to output, but during periods of economic slack it is important. We argue and present evidence that it is not confidence per se – in the sense of pure sentiment – that matters for the transmission of spending shocks during downturns, but rather that the composition of spending during a downtown is different. In particular, spending shocks during downturns predict future productivity improvements through a persistent increase in government investment relative to consumption, which is in turn reflected in higher measured confidence.
    JEL: E00 E3 E62
    Date: 2011–05
  8. By: Claessens, Stijn; Kose, Ayhan; Terrones, Marco E
    Abstract: This paper analyzes the interactions between business and financial cycles using an extensive database of over 200 business and 700 financial cycles in 44 countries for the period 1960:1-2007:4. Our results suggest that there are strong linkages between different phases of business and financial cycles. In particular, recessions associated with financial disruption episodes, notably house price busts, tend to be longer and deeper than other recessions. Conversely, recoveries associated with rapid growth in credit and house prices tend to be stronger. These findings emphasize the importance of developments in credit and housing markets for the real economy.
    Keywords: asset busts; booms; credit crunches; financial crises; recessions; recoveries
    JEL: E32 E44 E51 F42
    Date: 2011–05
  9. By: Bernd Hayo (University of Marburg); Britta Niehof (University of Marburg)
    Abstract: This paper formally proves that Rigobon and Sack (2004)'s approach of identifying monetary policy shocks through heteroscedasticity can be extended to a multimarket and multicountry framework. Applying our multivariate framework allows deriving consistent estimators of monetary policy effects. The advantage of our extended approach is illustrated by applying it to European nancial markets. We analyse monetary policy actions of the European Central Bank (ECB), the Bank of England, the Swiss National Bank, and the Swedish Riksbank on major stock indices. First, in line with the Rigobon and Sack (2004) approach, we nd an increase in the variance of European stock and money market returns on days when monetary policy committee meetings are held. Second, monetary policy actions have a significant impact on nancial markets. Third, we discover that ECB monetary policy moves have spillover eects on the British and Swiss financial markets, but find no evidence of reverse causality.
    Keywords: Financial markets, instrumental variable estimation, identification through heteroscedasticity, spillover effects
    JEL: E44 E52 G15
    Date: 2011
  10. By: Harold Ngalawa; Nicola Viegi
    Abstract: This paper sets out to investigate the process through which monetary policy affects economic activity in Malawi. Using innovation accounting in a structural vector autoregressive model, it is established that monetary authorities in Malawi employ hybrid operating procedures and pursue both price stability and high growth and employment objectives. Two operating targets of monetary policy are identified, viz., bank rate and reserve money, and it is demonstrated that the former is a more effective measure of monetary policy than the latter. The study also illustrates that bank lending, exchange rates and aggregate money supply contain important additional information in the transmission process of monetary policy shocks in Malawi. Furthermore, it is shown that the floatation of the Malawi Kwacha in February 1994 had considerable effects on the country’s monetary transmission process. In the post-1994 period, the role of exchange rates became more conspicuous than before although its impact was weakened; and the importance of aggregate money supply and bank lending in transmitting monetary policy impulses was enhanced. Overall, the monetary transmission process evolved from a weak, blurred process to a somewhat strong, less ambiguous mechanism.
    JEL: E52 E58
    Date: 2011
  11. By: Andrea Pescatori; Murat Tasci
    Abstract: This paper assesses whether labor market frictions, in the form of searching and matching, can help explain movements in the labor wedge--the gap between the marginal rate of substitution (MRS) and the marginal productivity of labor in a perfectly competitive business cycle model. Results suggest that those frictions are not able to explain fluctuations in the labor wedge, per se. However, the introduction of extensive and intensive margin shows that measuring the MRS in terms of total hours artificially introduces procyclicality in the MRS. When the MRS is correctly measured in terms of hours per worker, the labor wedge obtained is less variable than the one of the perfectly competitive model. A Frisch elasticity of 2.8, as in most macro models, implies a 20 percent decline in the variability of the labor wedge. A Frisch elasticity closer to micro estimates implies an even higher reduction. Finally, we show that it is possible to measure a strongly procyclical labor wedge as in CKM (2007) even if the actual data generating process does not have any labor wedge but has search frictions that allow for movements in both labor margins.
    Keywords: Labor market ; Business cycles
    Date: 2011
  12. By: R. Anton Braun; Lena Mareen Körber
    Abstract: Recent research has found that the dynamic properties of the New Keynesian model can be very different when the nominal interest rate is zero. Improvements in technology and reductions in the labor tax rate lower economic activity, and the size of the government purchase output multiplier can be well above one. This paper provides evidence that the focus on specifications of the New Keynesian model that produce unorthodox results in a liquidity trap may be misplaced. We show that a prototypical New Keynesian model fit to Japanese data exhibits orthodox dynamics during Japan's episode with zero interest rates. We then demonstrate that this specification is more consistent with outcomes in Japan than alternative specifications that have unorthodox properties.
    Date: 2011
  13. By: Hirokazu Ishise (Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: The cross-country correlations of international real business cycle models depend critically on the number of countries in the models. A positive productivity shock in one country will stimulate investment in the country that has experienced the shock, while reducing internal investment in the other countries, which will then simultaneously experience a slump. This comovement mechanism is absent in two-country models.
    Keywords: International Real Business Cycles, Cross-Country Correlations, Multi-Country, Country Size
    JEL: E32 F41
    Date: 2011–05
  14. By: Amable, Bruno; Azizi, Karim
    Abstract: The role of macroeconomic policy in the different varieties of capitalism has been largely ignored. Recent contributions to the literature have argued that nonliberal economies should be expected to have less accommodating (i.e., less countercyclical) macroeconomic policies than liberal varieties. Using time-series cross-section data on 18 OECD countries between 1980 and 2002, this paper tests that hypothesis and, more particularly, whether the reaction of discretionary fiscal policy to macroeconomic shocks is conditioned by variables that differentiate liberal from nonliberal varieties of capitalism: the degree of generosity of the social protection system, the degree of coordination of wage bargaining, and the fragmentation of the political party system. The test results do not support the conclusion that nonliberal economies' macroeconomic policy would be less countercyclical than that of liberal economies. On the contrary, discretionary fiscal policy has been more countercyclical in countries with a fragmented political system or a generous social protection system. -- Die Rolle makroökonomischer Politik in unterschiedlichen kapitalistischen Systemen wurde bisher nur selten eingehend untersucht. Eine neuere Argumentation vertritt die These, dass die makroökonomische Politik in nichtliberalen Ökonomien weniger antizyklisch ausfällt als in liberalen Ökonomien. Das Papier prüft diese These anhand einer gekreuzten Längs- und Querschnittanalyse für 18 OECD-Länder im Zeitraum von 1980 bis 2002. Dabei widmet es sich im Besonderen der Frage, inwieweit finanzpolitische Reaktionen auf makroökonomische Schocks von jenen Variablen beeinflusst werden, die liberale von nichtliberalen Ökonomien unterscheiden: die Generosität des Wohlfahrtssystems, das Ausmaß der Koordinierung von Lohnverhandlungen und der Grad der Fragmentierung des Parteiensystems. Das Ergebnis bestätigt die These nicht, sondern zeigt, dass eine diskretionäre Fiskalpolitik in jenen Ländern antizyklischer ausfällt, die über ein fragmentiertes Parteiensystem oder ein generöses Wohlfahrtssystem verfügen.
    Date: 2011
  15. By: Buch, Claudia M.; Eickmeier, Sandra; Prieto, Esteban
    Abstract: There is growing consensus that the conduct of monetary policy can have an impact on stability through the risk-taking incentives of banks. Falling interest rates might induce a 'search for yield' and generate incentives to invest into risky activities. This paper provides evidence on the link between monetary policy, commercial property prices, and bank risk taking. We use a factor-augmented vector autoregressive model (FAVAR) for the U.S. for the period 1997-2008. We include standard macroeconomic indicators and factors summarizing information provided in the Federal Reserve's Survey of Terms of Business Lending. These data allow modeling the reactions of banks' new lending volumes and prices as well as the riskiness of new loans. We do not find evidence for increased risk taking for the entire banking system after a monetary policy loosening or an unexpected increase in property prices. This masks, however, important differences across banking groups. Small domestic banks increase their exposure to risk, foreign banks lower risk, and large domestic banks do not change their risk exposure. --
    Keywords: FAVAR,bank risk taking,macro-finance linkages,monetary policy,commercial property prices
    JEL: E44 G21
    Date: 2011
  16. By: Juan Montecino; Jake Johnson
    Abstract: This paper looks at Jamaica’s recent history of indebtedness, its experience during the global economic downturn, and examines its current agreement with the International Monetary Fund (IMF). It finds that Jamaica’s economic and social progress has suffered considerably from the burden of an unsustainable debt; and that even after the debt restructuring of 2010, this burden remains unsustainable and very damaging. Pro-cyclical macroeconomic policies, implemented under the auspices of the IMF, have also damaged Jamaica’s recent and current economic prospects.
    Keywords: jamaica, imf, debt, JDX,
    Date: 2011–05
  17. By: Senbeta , Sisay
    Abstract: This paper assesses the applicability of new Keynesian DSGE models to a typical low income economy like those in Sub Saharan Africa. To this effect, we first review the development, criticisms and recent advances in DSGE modeling. Then we assess the implications of the assumptions of the standard open economy New Keynesian DSGE model within the context of the economic environment of a typical low income economy. Our assessment shows the following two points. First, though there are many criticisms to these models, most recent advances seem to have addressed most of these criticisms. However, there are still some outstanding criticisms that are serious challenges not only to DSGE models but also to all conventional economic models. Second, the current tendency of applying these models to explain or predict economic phenomenon in low income countries without incorporating the structural specificities of these countries cannot be justified. In stead, for these models to be helpful to understand the economic events in low income countries, most of their components must be changed or modified so that these models capture some salient specificities of low income economies. In this study we identify some of these components and suggest the possible changes or modifications.
    Keywords: New Keynesian DSGE, Open economy macroeconomics, Fluctuations, Sub-Saharan Africa
    JEL: E32 O55 F41
    Date: 2011–05–16
  18. By: Dehghan Nejad, Omid
    Abstract: The methods of determining the banking interest rate are the main issues in the Iranian economy, this note provides the analysis of banking interest rate and the ways of providing and allocating financial resources in Iran and also, discusses why the financial repression policies in the monetary and banking system do not allow the Iranian economy to growth in its full capacity.
    Keywords: Banking Interest Rate; Financial Repression; Monetary and Banking System; Financial Resources
    JEL: E5
    Date: 2011–04–26
  19. By: von Hagen, Jürgen; Zhang, Haiping
    Abstract: We show in a tractable, multi-country OLG model that cross-country differences in financial development explain three recent empirical patterns of international capital flows. International capital mobility affects output in each country directly through the size of domestic investment as well as indirectly through the composition of domestic investment and the level of domestic savings. In contrast to earlier literature, our model admits the possibility that the indirect effects dominate the direct effects and international capital mobility raises output in the poor country and globally, although net capital flows are in the direction of the rich country. Our model adds to the understanding of the benefits of international capital mobility in the presence of financial frictions.
    Keywords: capital market imperfections; financial development; financial frictions; foreign direct investment; international capital movements
    JEL: E44 F41
    Date: 2011–05
  20. By: Edward Nelson
    Abstract: This paper views the policy response to the recent financial crisis from the perspective of Milton Friedman's monetary economics. Five major aspects of the policy response are: 1) discount window lending has been provided broadly to the financial system, at rates low relative to the market rates prevailing pre-crisis; 2) the Federal Reserve's holdings of government securities have been adjusted with the aim of putting downward pressure on the path of several important interest rates relative to the path of short-term rates; 3) deposit insurance has been extended, helping to insulate the money stock from credit market disruption; 4) the commercial banking system has received assistance via a recapitalization program, while existing equity holders have borne losses; and 5) an interest-on-reserves system has been introduced. These five elements of the policy response are in keeping with those that would arise from Friedman's framework, while a number of the five depart appreciably from other prominent benchmarks (such as the Bagehot-Thornton prescription for discount rate policy, and New Keynesian approaches to stabilization policy). One notable part of the policy response, the TALF initiative, draws largely on frameworks other than Friedman's. But, in important respects, the overall monetary and financial policy response to the crisis can be viewed as Friedman's monetary economics in practice.
    Date: 2011
  21. By: Alejandro Justiniano; Giorgio E. Primiceri; Andrea Tambalotti
    Abstract: Not in an estimated DSGE model of the US economy, once we account for the fact that most of the high-frequency volatility in wages appears to be due to noise, rather than to variation in workers' preferences or market power.
    JEL: E30 E52
    Date: 2011–05
  22. By: Michael T. Kiley; Jae W. Sim
    Abstract: We develop a macroeconomic model in which the balance sheet/liquidity condition of financial institutions plays an important role in the determination of asset prices and economic activity. The financial intermediaries in our model are required to make investment commitments before a complete resolution of idiosyncratic funding risk that can be addressed only by costly refinancing, forcing them to behave in a risk-averse manner. The model shows that the balance sheet condition of intermediaries can drive asset values away from their fundamentals, causing aggregate investment and output to respond to shocks to intermediaries. We use this model to evaluate several public policies designed to address balance sheet problems at financial institutions. With regard to short-run policies, we find that capital injections conditioned upon voluntary recapitalization can be a more effective tool than direct lending/asset purchases. With regard to long-run policies, we demonstrate that higher capital requirements can have sizable short-run effects on economic activity if not implemented carefully, and that a long transition period helps avoid such effects.
    Date: 2011
  23. By: Hernando Vargas Herrera
    Abstract: The role of the exchange rate and the exchange rate regime in the monetary policy decision-making process in Colombia is described. The rationale for the intervention of the Central Bank in the FX market is explained and the experience in this regard is reviewed. Special attention is given to the seemingly varying effectiveness of different types of intervention and to the challenges posed by the sterilization of purchases of foreign currency. The exchange rate regime, FX regulation and FX policy determine the resilience of the economy in the face of external shocks and allow for the possibility of countercyclical monetary policy responses. A virtuous circle is created in which the volatility present in a flexible exchange rate regime improves the conditions for the functioning of a flexible exchange rate regime.
    Date: 2011–05–12
  24. By: Konstantinos Angelopoulos (University of Glasgow); Sophia Dimeli (Athens University of Economics and Business); Apostolis Philippopoulos (Athens University of Economics and Business, University of Glasgow and Visiting Scholar at the Bank of Greece); Vanghelis Vassilatos (Athens University of Economics and Business)
    Abstract: We incorporate an uncoordinated redistributive struggle for extra fiscal privileges and favors into an otherwise standard dynamic stochastic general equilibrium model. Our aim is to quantify the extent of rent seeking and its macroeconomic implications. The model is calibrated to Greek quarterly data over 1961:1-2005:4. Our work is motivated by the rich and distorting tax-spending system in Greece, as well as the common belief that interest groups compete with each other for fiscal privileges at the expense of the general public interest. We find that (i) the introduction of rent seeking moves the model in the right direction vis-à-vis the data (ii) an important fraction of GDP is extracted by rent seekers (iii) there can be substantial welfare gains from reducing rent seeking activities.
    Keywords: Fiscal policy;rent seeking;welfare
    JEL: E62 E32 O17
    Date: 2010–11
  25. By: Luís Aguiar-Conraria; Yi Wen
    Abstract: Aguiar-Conraria and Wen (2008) argued that dependence on foreign oil raises the likelihood of equilibrium indeterminacy (economic instability) for oil importing countries. We argue that this relation is more subtle. The endogenous choices of prices and quantities by a cartel of oil exporters, such as the OPEC, can affect the directions of the changes in the likelihood of equilibrium indeterminacy. We show that fluctuations driven by self-fulfilling expectations under oil shocks are easier to occur if the cartel sets the price of oil, but the result is reversed if the cartel sets the quantity of production. These results offer a potentially interesting explanation for the decline in economic volatility (i.e., the Great Moderation) in oil importing countries since the mid-1980s when the OPEC cartel changed its market strategies from setting prices to setting quantities, despite the fact that oil prices are far more volatile today than they were 30 years ago.>
    Keywords: Organization of Petroleum Exporting Countries ; Petroleum industry and trade
    Date: 2011
  26. By: González-Aguado, Carlos; Suarez, Javier
    Abstract: This paper explores the effects of shifts in interest rates on corporate leverage and default. We develop a dynamic model in which the relationship between firms and their outside financiers is affected by a moral hazard problem and entrepreneurs' initial wealth is scarce. The endogenous link between leverage and default risk comes from the lower incentives of overindebted entrepreneurs to guarantee the survival of their firms. Firms start up with leverage typically higher than some state-contingent target leverage ratio, and adjust gradually to it through earnings retention. The dynamic response of leverage and default to cut and rises in interest rates is both asymmetric (since it is easier to adjust to a higher target leverage than to a lower one) and heterogeneously distributed across firms (since interest rates affect the burden of outstanding leverage, which differs across firms). We find that both interest rate rises and interest rate cuts increase the aggregate default rate in the short-run. Instead, higher rates produce lower default rates in the longer run since they induce lower target leverage across all firms. These results help rationalize some of the empirical evidence regarding the so-called risk-taking channel of monetary policy.
    Keywords: credit risk; firm dynamics; interest rates; search for yield; short-term debt
    JEL: E52 G32 G33
    Date: 2011–05
  27. By: Michael T. Kiley; Jae W. Sim
    Abstract: Financial intermediation transforms short-term liquid assets into long-term capital assets. As a result, risk taking, in the form of long-term commitments despite unresolved short-term funding risk, is an essential element of intermediation. If such funding risk must be addressed by costly recapitalization and/or distressed asset sales due to capital market frictions, an increase in uncertainty can cause a disruption in the intermediation process by forcing risk-neutral intermediaries to behave in a risk-averse manner. Our analysis examines this behavior theoretically and empirically. We first develop a dynamic macroeconomic model in which the balance sheet/liquidity condition of financial intermediaries plays an important role in the determination of asset prices and economic activity under time-varying uncertainty. Second, we present new evidence on the importance of uncertainty facing financial intermediaries for credit terms and volume and for aggregate economic activity, thereby partially quantifying the significance of capital market frictions. We adopt a structural identification strategy in which the predictions of our theory, in the form of sign restrictions, play an important role.
    Date: 2011
  28. By: John Schmitt
    Abstract: This paper reviews the recent labor-market performance of 21 rich countries, with a focus on Denmark and Germany. Denmark, which was widely seen as one of the world's most successful labor markets before the downturn, has struggled in recent years. Germany, however, has outperformed the rest of the world's rich countries since 2007, despite earlier labor-market difficulties. Labor-market institutions seem to explain the different developments in the two economies. Danish institutions – which include extensive opportunities for education, training, and placement of unemployed workers – appear to perform well when the economy is at or near full employment, but have not been effective during the downturn. German labor-market institutions, which emphasize job security by keeping workers connected to their current employers, may have drawbacks when the economy is operating at or near full employment, but have performed well in the Great Recession. The paper also discusses lessons for U.S. labor-market policy.
    Keywords: Great Recession, recession, labor, labor policy,
    JEL: E E2 E24 E3 E6 E65 J J2 J21 J3 J31 J33 J38 J6 J62 J65 J68 J8
    Date: 2011–05
  29. By: Adjemian, Stéphane; Devulder, Antoine
    Abstract: Dans cet article nous présentons de façon détaillée un modèle DSGE canonique et montrons comment celui-ci peut être simulé puis estimé. Nous proposons deux applications sur la base du modèle estimé. Dans la première nous évaluons les conséquences sur le bien être social de la forme de la politique monétaire. On montre que le bien être social est significativement dégradé si la Banque Centrale ne prend pas en compte l’écart de production. Dans la seconde, nous interrogeons le modèle sur la publicité que la Banque Centrale doit faire autour de sa politique. Nous montrons que face à un choc de productivité négatif il est préférable de ne pas annoncer une politique monétaire accommodante, afin de limiter l’ampleur des tensions inflationnistes.
    Date: 2011–05
  30. By: Berganza, Juan Carlos (BOFIT); Broto, Carmen (BOFIT)
    Abstract: Emerging economies with inflation targets (IT) face a dilemma between fulflling the theoretical conditions of "strict IT", which implies a fully flexible exchange rate, or applying a "flexible IT", which entails a de facto managed floating exchange rate with forex 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, forex interventions in some IT countries have been more effective in reducing 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: 2011–05–26
  31. By: Caterina Mendicino
    Abstract: How important are collateral constraints for the propagation and amplification of shocks? To address this question, we analyze a stochastic general equilibrium version of the model by Kiyotaki and Moore (JPE, 1997) in which all agents face concave production and utility functions and are generally identical, except for the subjective discount factor. We document that the existence of costly debt enforcement plays an important role in the endogenous amplification generated by the model. Limiting the amount of borrowing up to a reasonable fraction of the value of the collateral asset, makes the amplification generated by collateral constraints sizable and significantly larger than what we observe either in the representative agent version of the model, or in the version of the model where inefficiencies in the liquidation of the collateralized asset are neglected.
    JEL: E20 E3 E21
    Date: 2011
  32. By: B, Karan Singh
    Abstract: This paper analyses the impact of adverse economic shocks on human capital formation in the case of India. It uses the extended theoretical model of Basu and Van (1998). The study has been carried out for the period between 1999 and 2002 and covers 385 districts. The results show that during a crisis, there is a fall in the school enrollment rate and a rise in the child labour participation rate. The study also argues that in the absence of a well-functioning credit market, to mitigate the adverse economic shocks on the children of poor households, the government must provide an incremental cash/in-kind conditional transfers to poor households with children.
    Keywords: Adverse economic shock; Child labour; Poverty; Labour market; Education; Human capital formation; Mid-day meal programme
    JEL: E62 D81 B21 C33
    Date: 2011–05–17
  33. By: Simplice A., Asongu
    Abstract: Financial development indicators are often applied to countries/regions without taking into account specific financial development realities. Financial depth in the perspective of monetary base is not equal to liquid liabilities in every development context. This paper introduces complementary indicators to the existing Financial Development and Structure Database (FDSD). These new measures can easily be computed from the FDSD. We present absolute as well as relative measures which are robust to the finance-growth nexus. When all financial sectors are taken into account in the definition and usage of liquid liabilities: (1) the formal and non-formal/informal financial sectors are inherently mutually antagonistic and should not be assimilated to the monetary base without distinction; (2) equating formal banking sector liquid liabilities to monetary base significantly undermines the formal banking system elasticity of growth; (3) there is a trade-off between growth and welfare from one financial sector to another; (4) non-formal and informal financial sectors are independent significant growth determinants.
    Keywords: Finance; Development; Formalization; Panel; Developing Countries
    JEL: E00 E26
    Date: 2011–05–15
  34. By: Vipin Arora
    Abstract: Simulations from a standard two-region model where producers respond to changes in interest rates are better able to match observed data than an identical model without supply-side responses. This indicates that incorporating the supply-side behaviour of oil producers is quantitatively important when endogenously modeling oil prices. These results have two implications. First, adding supply-side responses can change the oil price/output relationship, which is a continuing topic of research interest. Second, if production is unable to adjust to interest rate changes, an important explanatory factor of oil price volatility may be missing.
    JEL: E37 F47 Q43
    Date: 2011–01
  35. By: Vipin Arora
    Abstract: The model simulated in this paper shows that falling interest rates contribute to rising oil prices. This occurs because oil producers treat oil in the ground as an asset and attempt to arbitrage differences between its rate of return and the interest rate. When calibrated to match observed data over the last two decades, model results indicate that this arbitrage behaviour may have made the largest contribution to the pre-crisis boom in oil prices. Productivity driven growth shocks raise the oil price by about 70 percent, but this rises to 150 percent when falling interest rates are included.
    JEL: E37 F47 Q43
    Date: 2011–01
  36. By: Guntram B. Wolff
    Abstract: The European Systemic Risk Board (ESRB) and the proposed prevention and correction of macroeconomic imbalances regulation (EIP) are designed to avoid imbalances. However, these instruments overlap, and need clarification. Both the ESRB and the Commission, which is given certain powers by the EIP, must identify and act early on risks. Acting in the face of strong economic and political pressure is difficult. Complementing the current approach with transparent and rules-based mechanisms will reduce this problem. The EIP and ESRB can complement each other in terms of analysis and policy, and close collaboration will be vital. The EIP regulation can be used to ensure that ESRB recommendations are followed up. In the area of financial recommendations relevent to macroeconomic imbalances, the Commission should have a more formal requirement to act on ESRB recommendations. The EIP regulation would benefit from a clause allowing recommendations to be addressed not only to member states. Conflicts between the ESRB and Commission could arise. In this case, the Treaty requires the Commission to issue a recommendation even if the ESRB issues a negative finding. Legally, it might not be possible to exclude the use by the Commission of confidential information obtained in the ESRB.
    Date: 2011–05
  37. By: Miguel A. Leon-Ledesma; Mathan Satchi
    Abstract: We show that allowing firms a choice of CES production techniques (via the distribution parameter between capital and labor) can result in a new class of production functions that produces short-run capital-labor complementarity but yields a long-run unit elasticity of substitution. This is shown to occur if we provide a mathematical framework for this choice that maintains strict essentiality of the production process and satisfies the requirement of unit-invariance. The class of production functions derived are consistent with a balanced growth path even in the presence of capital-augmenting technical progress. The approach yields a simple yet powerful way of introducing CES-type production functions in macroeconomic models.
    Keywords: Balanced growth; production technique; biased technology;elasticity of substitution Multiplier; North-South Models; Global Imbalances
    JEL: E25 O33 O40
    Date: 2011–05
  38. By: Agnese, Pablo (IESE Business School); Salvador, Pablo F. (Universidad Nacional de Cuyo)
    Abstract: This paper analyses the labour markets of Spain and Ireland, which have experienced a severe downturn in the recent global crisis as reflected by the largest increases in their unemployment rates among other developed economies. Spain and Ireland might seem at first to feature very different labour markets, which go from very tight to very flexible labour conditions. Our analysis, however, goes beyond this simplistic argument and brings to light the strong commonalities that seem to have been hidden underground. We estimate a dynamic multi-equation structural model for each country, and then offer two sets of dynamic simulations which account for the swings of the unemployment rates before and after the 2007 crisis. Our results suggest looking beyond the degree of flexibility of both labour markets, just to focus instead on other variables usually neglected by more conventional approaches. In particular, such variables as the growth of capital stock, the growth of labour productivity, and demographics, succeed in explaining a great part of the changes in unemployment in both countries.
    Keywords: unemployment dynamics, structural multi-equation models, chain reaction theory, simulations, PIGS
    JEL: E24 J21 E22 C32
    Date: 2011–05
  39. By: Meller, Barbara
    Abstract: This paper provides evidence for a significant relation between international financial markets' integration and output volatility. In the framework of a threshold model, it is shown empirically that this relation depends on country's financial risk. Financial risk indicates a country's ability to pay its official, commercial and trade debts. In countries with low financial risk, financial openness decreases output volatility, while, in countries with high financial risk, financial openness increases output volatility. Extensive robustness checks confirm this result. --
    Keywords: output volatility,financial openness,financial risk
    JEL: E32 F36 F41
    Date: 2011

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