A commonly held view is that nominal rigidities are important for the transmission of monetary policy shocks. We argue that they are also important for understanding the dynamic effects of technology shocks, especially on labor hours, wages, and prices. Based on a dynamic general equilibrium framework, our closed-form solutions reveal that a pure sticky-price model predicts correctly that hours decline following a positive technology shock, but fails to generate the observed gradual rise in the real wage and the near-constance of the nominal wage; a pure sticky-wage model does well in generating slow adjustments in the nominal wage, but it does not generate plausible dynamics of hours and the real wage. A model with both types of nominal rigidities is more successful in replicating the empirical evidence about hours, wages and prices. This finding is robust for a wide range of parameter values, including a relatively small Frisch elasticity of hours and a relatively high frequency of price reoptimization that are consistent with microeconomic evidence.
Between 1992 and 2002, the Japanese Import Price Index (IPI) registered a decline of almost 9 percent and Japan entered a period of deflation. We show that much of the correlation between import prices and domestic prices was due to formula biases. Had the IPI been computed using a pure Laspeyres index like the CPI, the IPI would have hardly moved at all. A Laspeyres version of the IPI would have risen 1 percentage point per year faster than the official index. Second we show that Chinese prices did not behave differently from the prices of other importers. Although Chinese prices are substantially lower than the prices of other exporters, they do not exhibit a differential trend. However, we estimate that the typical price per unit quality of a Chinese exporter fell by half between 1992 and 2005. Thus the explosive growth in Chinese exports is attributable to growth in the quality of Chinese exports and the increase in new products being exported by China.
This paper provides a detailed overview of China's participation in international trade using newly available data on the universe of globally engaged Chinese firms over the 2003-2005 period. We document the distribution of trade flows and product- and trade-partner intensity across both exporting and importing firms and study the relationship between firms' intensive and extensive margins of trade. We also compare trade patterns across firms of different organizational structure, distinguishing between domestic private firms, domestic state‐owned firms, foreign-owned firms, and joint ventures. We explore the variation in foreign ownership across sectors, and find results consistent with recent theoretical and empirical work on the role of credit constraints and contractual imperfections in international trade and investment. Finally, we examine the rapid expansion of China's trade over the 2003-2005 period, and decompose it into its extensive and intensive margins. We also use monthly data and study the frequent churning and reallocation of trade flows across firms and across products and trade partners within firms.
Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead,
foreigners hold greater shares of their investment portfolios in the United States if they have less-developed financial markets. The magnitude of this effect decreases with income per capita.
Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and there is no evidence that foreigners invest in the United States
based on diversification motives. The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.
We explore the implications of current account adjustment for monetary policy within a simple two country SGE model. Our framework nests Obstfeld and Rogoff's (2005) static model of exchange rate responsiveness to current account reversals. It extends this approach by endogenizing the dynamic adjustment path and by incorporating production and nominal price rigidities in order to study the role of monetary policy. We consider two different adjustment scenarios. The first is a "slow burn" where the adjustment of the current account deficit of the home country is smooth and slow. The second is a "fast burn" where, owing to a sudden shift in expectations of relative growth rates, there is a rapid reversal of the home country's current account. We examine several different monetary policy regimes under each of these scenarios. Our principal finding is that the behavior of the domestic variables (for instance, output, inflation) is quite sensitive to the monetary regime, while the behavior of the international variables (for instance, the current account and the real exchange rate) is less so. Among different policy rules, domestic inflation targeting achieves the best stabilization outcome of aggregate variables. This result is robust to the presence of imperfect pass-through on import prices, although in this case stabilization of consumer price inflation performs similarly well.
Recent models of international equity portfolios exhibit two potential weaknesses: (1) the structure of equilibrium equity portfolios is determined by the correlation of equity returns with real exchange rates, yet empirically equities don't appear to be a good hedge against real exchange rate risk; (2) Equity portfolios are highly sensitive to preference parameters. This paper solves both problems. It first shows that, in more general and realistic environments, the hedging of real exchange rate risks occurs through international bond holdings since relative bond returns are strongly correlated with real exchange rate fluctuations. Equilibrium equity positions are then optimally determined by the correlation of equity returns with the return on nonfinancial wealth, conditional on the bond returns. The model delivers equilibrium portfolios that are well-behaved as a function of the underlying preference parameters. We find reasonable empirical support for the theory for G-7 countries. We are able to explain short positions in domestic currency bonds for all G-7 countries, as well as significant levels of home equity bias for the U.S., Japan, and Canada.
Fixed transaction costs and delivery lags are important costs of international trade. These costs lead firms to import infrequently and hold substantially larger inventories of imported goods than domestic
goods. Using multiple sources of data, we document these facts. We then show that a parsimoniously parameterized model economy with importers facing an (S, s)-type inventory management problem
successfully accounts for these features of the data. Moreover, the model can account for import and import price dynamics in the aftermath of large devaluations. In particular, desired inventory
adjustment in response to a sudden, large increase in the relative price of imported goods creates a short-term trade implosion, an immediate, temporary drop in the value and number of distinct varieties imported, as well as a slow increase in the retail price of imported goods. Our study of six current account reversals following large devaluation episodes in the last decade provide strong support for the model's predictions.
South Korea's growth miracle has been well documented. A large set of institutional and policy reforms in the early 1960s is thought to have contributed to the country's extraordinary performance. In this paper, we assess the importance of one key set of policies, the trade policy reforms in Korea, as well as the concurrent GATT tariff reductions. We develop a model of neoclassical growth and trade that highlights two forces by which lower trade barriers can lead to increased per worker GDP: comparative advantage and specialization, and capital accumulation. We calibrate the model and simulate the effects of three sets of tariff reductions that occurred between the early 1962 and 1995. Our main finding is that the model can explain up to 32 percent of South Korea's catch-up to the G7 countries in output per worker in the manufacturing sector. We find that the effects of the tariff reductions taken together are about twice as large as the sum of each reduction applied individually.
This paper addresses two substantive issues: (1) Does the magnitude of the expectation effect of regime switching in monetary policy depend on a particular policy regime? (2) Under which regime is the expectation effect quantitatively important? Using two canonical DSGE models, we show that there exists asymmetry
in the expectation effect across regimes. The expectation effect under the dovish policy regime is quantitatively more important than that under the hawkish regime. These results suggest that the possibility of regime shifts in monetary policy can have important effects on rational agents' expectation formation and on equilibrium
dynamics. They offer a theoretical explanation for the empirical possibility that a policy shift from the dovish regime to the hawkish regime may not be the main source of substantial reductions in the volatilities of inflation and output.
In this paper I show that discretionary policymaking can be superior to timeless perspective policymaking and identify model features that make this outcome more likely. Developing a measure of conditional loss that treats the auxiliary state variables that characterize the timeless perspective equilibrium appropriately, I use a New Keynesian DSGE model to show that discretion can dominate timeless perspective policymaking when the Phillips curve is relatively flat, due, perhaps, to firm-specific capital (or labor) and/or Kimball (1995) aggregation in combination with nominal price rigidity. These results suggest that studies applying the timeless perspective might also usefully compare its performance to discretion, paying careful attention to how policy performance is evaluated.
We make use of micro-level data for over 45,000 private bonds issued by over 5000 firms from 22 countries in 1990-2006 to analyze the impact that the launch of the EMU had on the currency
denomination of the bond issues. To our knowledge, ours is the first systematic analysis of issue at the micro level. The use of the micro data allows us to distinguish between the response to the advent of the euro by new and seasoned bond issuers, and to condition on other issue characteristics. We find that the impact on new issuers is larger than on seasoned issuers and that most of the increase in the euro-denominated bond issuance was along the "extensive"
margin. Insofar as new entrants to the bond market will define the overall currency composition in the long run, these results imply that aggregate studies might be underestimating the euro effect. We also find that to a large extent the increase in euro issuance was "at the expense" of U.S. dollar issuance, suggesting that euro competes with the U.S. dollar as a currency of choice for international financial transactions.
The use of subjective well-being (SWB) data for investigating the nature of individual preferences has increased tremendously in recent years. There has been much debate about the cross-sectional and time series patterns found in these data, particularly with respect to the relationship between SWB and relative
status. Part of this debate concerns how well SWB data measures true utility or preferences. In a recent paper, Daly, Wilson, and Johnson (2007) propose using data on suicide as a revealed preference (outcome-based) measure of well-being and find strong evidence that reference-group income negatively affects suicide risk. In this paper, we compare and contrast the empirical patterns of SWB and suicide data. We find that the two have very little in common in aggregate data (time series and cross-sectional),
but have a strikingly strong relationship in terms of their determinants in individual-level, multivariate regressions.
This latter result cross-validates suicide and SWB micro data as useful and complementary indicators of latent utility.
This study explores the macroeconomic implications of adaptive expectations in a standard growth model. We show that the self-confirming equilibrium under adaptive expectations is the same as the steady state rational expectations equilibrium for all admissible parameter values, but that dynamics around the steady state are substantially different between the two equilibria. The differences
are driven mainly by the dampened wealth effect and the strengthened intertemporal substitution effect, not by escapes emphasized by Williams (2003). Consequently, adaptive expectations can be an important source of frictions that amplify and propagate technology shocks and seem promising for generating plausible labor market dynamics.
Previous research suggests that loan officers play a critical role in relationship lending by producing soft information about SMEs. For the first time, we empirically confirm this hypothesis We also examine whether the role of loan officers differs from small to large banks as predicted by Stein (2002). While we find that small banks produce more soft information, the capacity and manner in which loan officers produce soft information does not seem to differ
between large and small banks. This suggests that, although large banks may produce more soft information, they likely tend to concentrate their resources on transactions lending.
This paper assesses whether partial exchange rate pass-through to trade prices has important implications for the prospective adjustment of global external imbalances. To address this question, we develop and estimate an open-economy DGE model in which pass-through is incomplete due to the presence of local currency pricing, distribution services, and a variable demand elasticity that leads to fluctuations in optimal markups. We find that the overall magnitude of trade adjustment is similar in a low and high pass-through world with more adjustment in a low pass-through world occurring through a larger response of the exchange rate and terms of trade rather than real trade flows.
This paper investigates the changing pattern and efficacy of sterilization within emerging market countries as they liberalize markets and integrate with the world economy. We estimate the marginal propensity to sterilize foreign asset accumulation associated with net balance of payments inflows, across countries and over time. We find that the extent of sterilization of foreign reserve inflows has risen in recent years to varying degrees in Asia
as well as in Latin America, consistent with greater concerns about the potential inflationary impact of reserve inflows. We also find that sterilization depends on the composition of balance of payments inflows.
Modern corporate finance theory argues that although bank monitoring is beneficial to borrowers, it also allows banks banks to use the private information they gain through monitoring to "hold-up" borrowers for higher interest rates. In this paper, we seek empirical evidence for this information hold-up cost. Since new information about a firm's credit-worthiness is revealed at the time of its first issue in the public bond market, it follows that after firms undertake their bond IPO, banks with an exploitable information advantage will be forced to adjust their loan interest rates downwards, particularly for firms that are revealed to be safe. Our findings show that firms are able to borrow from banks at lower interest rates after they issue for the first time in the public bond market and that the magnitude of these savings is larger for safer firms. We further find that among safe firms, those that get their first credit rating at the time of their bond IPO benefit from larger interest rate savings than those that already had a credit rating when they entered the bond market. Since more information is revealed at the time of the bond IPO on the former firms and since this information will increase competition from uninformed banks, these findings provide support for the hypothesis that banks price their informational monopoly. Finally, we find that while entering the public bond market may reduce these informational rents, it is costly to firms because they have to pay higher underwriting costs on their IPO bonds. Moreover, IPO bonds are subject to more underpricing than subsequent bonds when they first trade in the secondary bond market.
Recent research suggests that there has been a decline in the extent to which firms “pass through” changes in exchange rates to prices. Beyond providing further evidence in support of this claim, this paper proposes an explanation for the phenomenon. It then presents empirical evidence of a structural break during the 1990s in the relationship between the real exchange rate and CPI inflation for a set of fourteen OECD countries. It is suggested that the recent reduction in the real exchange rate pass-through can be attributed
in part to the low-inflation environment of the 1990s.
We use a hedonic framework to estimate and simulate the impact of global warming on real estate prices at North American ski resorts. To do so, we combine data on resort-area housing prices from two sources--data on average prices for U.S. Census tracts across a broad swath of the western U.S. and data on individual home sales for four markets in the western U.S. and Canada, each available over multiple decades--with detailed weather data and characteristics of ski resorts in those areas. Our OLS and fixed-effects models of changes in house prices with respect to medium-run changes in the share of snowfall in winter precipitation yield precise and consistent estimates of positive snowfall effects on housing values in both data sources. We use our estimates to simulate the impact of likely climate shifts on house prices in coming decades and find substantial variation across resort areas based on climatic characteristics such as longitude, elevation, and proximity to the Pacific Ocean. Resorts that are unfavorably located face likely large negative effects on home prices due to warming, unless adaptive measures are able to compensate for the deterioration of conditions in the ski industry.
A number of studies have recently noted that monetary integration in the European Monetary Union (EMU) has been accompanied by increased financial integration. This paper examines the channels through which monetary union increased financial integration, using international panel data on bilateral international commercial bank claims from 1998-2006. I decompose the relative increase in bilateral commercial bank claims among union members following
monetary integration into three possible channels: A "borrower effect," as a country's EMU membership may leave its borrowers more creditworthy in the eyes of foreign lenders; a "creditor effect," as membership in a monetary union may increase the attractiveness of a nation's commercial banks as intermediaries, perhaps through increased scale economies enjoyed by commercial banks themselves or through an improved regulatory environment after the advent
of monetary union; and a "pairwise effect," as joint membership in a monetary union increases the quality of intermediation between borrowers and creditors when both are in the same union. This pairwise effect could be attributed to mitigated currency risk stemming from monetary integration, but may also indicate that monetary union integration increases borrowing capacity. I decompose the data into a series of difference-in-differences specifications to isolate these three channels and find that the pairwise effect is the primary source of increased financial integration. This result is robust to a number of sensitivity exercises used to address concerns frequently associated with difference-in-differences specifications, such as serial correlation and issues associated with the timing of the intervention.
The literature appears to have reached a consensus that financial globalization has had a "disciplining effect" on monetary policy, as it has reduced the returns from--and hence the temptation for--using monetary policy to stabilize output. As a result, monetary policy over
recent years has placed more emphasis on stabilizing inflation, resulting in reduced inflation and greater output stability. However, this consensus has not been accompanied by convincing empirical evidence that such a relationship exists. One reason is likely to be that de facto measures of financial globalization are endogenous, and that instruments for financial globalization are elusive. In this paper, I introduce a new instrument, financial remoteness, as a plausibly exogenous instrument for financial openness. I examine the relationship between financial globalization and median inflation levels over an 11 year cross-section from 1994 through 2004, as
well as a panel of 5-year median inflation levels between 1980 and 2004. The results confirm a negative relationship between median inflation and financial globalization in the base specification, but this relationship is sensitive to the inclusion of conditioning variables or country fixed effects, precluding any strong inferences.
This paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations formation and uncertainty about the natural rates of interest and unemployment. We assume that agents have imperfect knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We also allow for central bank uncertainty regarding the natural rates of interest and unemployment. We find that the optimal control policy derived under the assumption of
perfect knowledge about the structure of the economy can perform poorly when knowledge is imperfect. These problems are exacerbated by natural rate uncertainty, even when the central bank's estimates of natural rates are efficient. We show that the optimal control approach can be made more robust to the presence of imperfect knowledge by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to the presence of imperfect knowledge about the economy provides an incentive to employ a "conservative" central banker. We
then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to the alternative models of learning that we study and natural rate uncertainty and outperform the optimal control policy and generally perform as well as the robust optimal control policy that places less weight on stabilizing economic activity and interest rates.
This paper develops a stochastic endogenous growth model that exhibits “excess volatility” of equity prices because speculative agents overreact to observed technology shocks. When making forecasts about the future, speculative agents behave like rational agents with very low risk aversion. The speculative forecast rule alters the dynamics of the model in a way that tends to confirm the stronger technology response. For moderate levels of risk aversion, the forecast errors observed by the speculative agent are close to white noise, making it difficult for the agent to detect a misspecification of the forecast rule. In model simulations, I show that this type of behavior gives rise to intermittent asset price bubbles that coincide with improvements in technology, investment and consumption booms, and faster trend growth, reminiscent of the U.S. economy during the late 1920s and late 1990s. The model can also generate prolonged periods where the price-dividend ratio remains in the vicinity of the fundamental value. The welfare cost of speculation (relative to rational behavior) depends crucially on parameter values. Speculation can improve welfare if actual risk aversion is low and agents underinvest relative to the socially optimal level. But for higher levels of risk aversion, the welfare cost of speculation is large, typically exceeding one percent of per-period consumption.
The Svensson generalization of the popular Nelson-Siegel term structure model is widely used by practitioners and central banks. Unfortunately, like the original Nelson-Siegel specification, this generalization, in its dynamic form, does not enforce arbitrage-free consistency over time. Indeed, we show that the factor loadings of the Svensson generalization cannot be obtained in a standard finance arbitrage-free affine term structure representation. Therefore, we introduce a closely related generalized Nelson-Siegel model on which the no-arbitrage condition can be imposed. We estimate this new arbitrage-free generalized Nelson-Siegel model and demonstrate its tractability and good in-sample fit.
Empirical evidence indicates that the elasticity of capital-labor substitution for the aggregate U.S. economy is below unity. In contrast, the existing indeterminacy literature has mostly restricted attention to a Cobb-Douglas production function which assumes a higher substitution elasticity than is implied by the data. This short paper examines the quantitative relationship between capital-labor substitution and the conditions needed for equilibrium indeterminacy (and belief-driven fluctuations) in a plausibly-calibrated, one-sector growth model. We find that capital-labor substitution has little quantitative impact on the threshold degree of increasing returns for local indeterminacy. Our results suggest that the Cobb-Douglas specification is a satisfactory approximation for local indeterminacy analysis.
This paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations. We assume that agents have imperfect knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We find that the optimal control policy derived under the assumption of rational expectations can perform poorly when expectations deviate modestly from rational expectations. We then show that the optimal control policy can be made more robust by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to learning provides an incentive to employ a "conservative" central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to empirically plausible parameterizations of the learning models and perform about as well or better than optimal control
policies.
At the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions--including the introduction of a new term auction facility (TAF)--to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.
This paper provides an empirical analysis of the determination of capital tax policy by U.S. states based on new panel data, a new econometric technique, and a new theoretical model. The analysis is undertaken with a panel data set covering all 48 contiguous states for the period 1969 to 2004 and is guided by the theory of strategic tax competition. The latter suggests that capital tax policy is a function of out-of-state tax policy, in-state and out-of-state economic
conditions, and, perhaps most importantly, preferences for government services. Using the Common Correlated Effects Pooled estimator to account for cross-section dependence, and time
lags to account for delayed responses, we estimate this reaction function for three state capital tax instruments: the investment tax credit rate, the corporate income tax rate, and the state's capital weight in its multi-state income apportionment formula. We find the slope of the reaction function--i.e., the equilibrium response of in-state to out-of-state tax policy--is negative, contrary to many prior empirical results. We document that a positive slope is obtained when either aggregate time effects or time lags are omitted. We show that the positive slope found in misspecified models is the result of synchronous responses among states to common shocks
rather than competitive responses to out-of-state tax policy. While striking given prior findings in the literature, these results are not surprising. The negative sign is fully consistent with qualitative and quantitative implications of the theoretical model developed in this paper. Rather than "racing to the bottom," our findings suggest that states are "riding on a seesaw."
This paper identifies factors associated with takeoff--a sustained period of high growth following a period of stagnation. We examine a panel of 241 "stagnation episodes" from 146 countries, 54% of these episodes are followed by takeoffs. Countries that experience takeoffs average 2.3% annual growth following their stagnation episodes, while those that do not average 0% growth; 46% of the takeoffs are "sustained," i.e. lasting 8 years or longer. Using probit estimation, we find that de jure trade openness is positively and significantly associated with takeoffs. A one standard deviation increase in de jure trade openness is associated with a 55% increase in the probability of a takeoff in our default specification. We also find evidence that capital account openness encourages takeoff responses, although this channel is less robust. Measures of de facto trade openness, as well as a variety of other potential conditioning variables, are found to be poor predictors of takeoffs. We also examine the determinants of nations achieving sustained takeoffs. While we fail to find a significant role for openness in determining whether or not takeoffs are sustained, we do find a role for output composition: Takeoffs in countries with more commodity-intensive output bundles are less likely to be sustained, while takeoffs in countries that are more service-intensive are more likely to be sustained. This suggests that adverse terms of trade shocks prevalent among commodity exports may play a role in ending long-term high growth episodes.
This paper shows that proximity to major international financial centers seems to reduce business cycle volatility. In particular, we show that countries that are further from major locations of international financial activity systematically experience more volatile growth rates in both output and consumption, even after accounting for domestic financial depth, political institutions, and other controls. Our results are relatively robust in the sense that more financially remote countries are more volatile, though the results are not always statistically significant. The comparative strength of this finding is in contrast to the more ambiguous evidence found in the literature.
We evaluate the importance of three different channels for explaining the recent performance of subprime mortgages. First, the riskiness of the subprime borrowing pool may have increased. Second, pockets of regional economic weakness may have helped
push a larger proportion of subprime borrowers into delinquency. Third, for a variety of reasons, the recent history of local house price appreciation and the degree of house price deceleration may have affected delinquency rates on subprime mortgages. While we find
a role for all three candidate explanations, patterns in recent house price appreciation are far and away the best single predictor of delinquency levels and changes in delinquencies. Importantly, after controlling for the current level of house price appreciation, measures
of house price deceleration remain significant predictors of changes in subprime delinquencies. The results point to a possible role for changes in house price expectations for explaining changes in delinquencies.
Writings on the macroeconomic impact of capital account liberalization find few, if any, robust effects of liberalization on real variables. In contrast to the prevailing wisdom, I argue that the textbook theory of liberalization holds up quite well to a critical reading of this literature. The lion's share of papers that find no effect of liberalization on real variables tell us nothing about the empirical validity of the theory, because they do not really test it. This paper explains why it is that most studies do not really address the theory they set out to test. It also discusses what is necessary to test the theory and examines papers that have done so. Studies that actually test the theory show that liberalization has significant effects on the cost of capital, investment, and economic growth.
The literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is no unified theoretical framework to analyze the macroeconomic consequences of
controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a "success" and (iv) the empirical studies lack a common methodology--furthermore these are significantly "overweighted" by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to "standardize" the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Control Effectiveness Index (WCCE Index). The difference between them lies in that the WCCE controls for the differentiated degree of methodological rigor applied to draw conclusions in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well known episodes than those of Chile and Malaysia. Then, using a portfolio balance approach we model the effects of imposing short-term capital
controls. We find that there should exist country-specific characteristics for capital controls to be effective. From these simple perspective, this rationalizes why some capital controls were
effective and some were not. We also show that the equivalence in effects of price- vs. quantity-capital control are conditional on the level of short-term capital flows.
This paper examines the degree of integration into world financial markets and the impacts on several key macroeconomic variables of selected East Asian economies, and draws policy implications. According to our analysis, the degrees of integration into world financial markets in those economies are increasing. Regarding the impacts of increasing integration into world financial markets on several macroeconomic variables, we find three results. First, casual two-way plots among macroeconomic variables do not support the theoretical prediction of reduction in relative consumption volatility.
Second, the saving-investment correlation is higher than those of in Euro area economies. Third, the degrees of smoothing of idiosyncratic shock by cross-holding of financial assets are lower than Euro area economies. Those results suggest two policy
implications. First, there's some room for improvement in welfare gains in those economies by further risk sharing. Second, holding all other conditions given, the increasing integration into world financial markets alone is unlikely to provide a sound ground for a currency union in East Asia at this stage.
Most models currently used to determine optimal foreign reserve holdings take the level of international debt as given. However, given the sovereign's willingness-to-pay incentive problems, reserve accumulation may reduce sustainable debt levels. In addition, assuming constant debt levels does not allow addressing one of the puzzles behind using reserves as a means to avoid the negative effects of crisis: why do not sovereign countries reduce their sovereign debt instead? To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model calibrated to a sample of emerging markets. We obtain that the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs.
In this paper, we conduct a dynamic panel analysis of the determinants of the household saving rate in China using a life cycle model and panel data on Chinese provinces for the 1995-2004 period from China's household survey. We find that China's household saving rate has been high and rising and that the main determinants of variations over time and over space therein are the lagged saving rate, the income growth rate, and (in some cases) the real interest rate and the inflation rate. However, we find that the
variables relating to the age structure of the population usually do not have a significant impact on the household saving rate. These results provide mixed support for the life cycle hypothesis as well as the permanent income hypothesis, are consistent with the existence of inertia or persistence, and imply that China's household saving rate will remain high for some time to come.
This paper investigates the international dimension of productivity and demand shocks in the U.S. using sign restrictions based on standard theory predictions. Identifying shocks to U.S. manufacturing--our measure of tradables--we find that productivity gains have substantial aggregate demand effects, boosting U.S. consumption and investment, relative to the rest of the world, thus raising real imports; net exports and U.S. net foreign assets correspondingly decrease. At the same time, however, these shocks appreciate the U.S. real exchange rate, improve the terms of trade and raise stock prices. Shocks to the demand for U.S. manufacturing appear to have less pronounced aggregate effects, with little impact on trade and capital accounts; they lead to a (delayed) dollar appreciation, however. Our findings provide novel evidence on key channels of the international transmission of shocks, pointing to a low degree of consumption risk sharing as an essential feature of the transmission mechanism, and suggesting that strong wealth e¤ects play an important role in generating aggregate demand fluctuations across countries.
Data on international relative prices from industrialized countries show large and systematic deviations from relative purchasing power parity. We embed a model of imperfect competition and variable markups in some of the recently developed quantitative
models of international trade to examine whether such models can reproduce the main features of the fluctuations in international relative prices. We find that when our model is parameterized to match salient features of the data on international trade and market structure in the U.S., it reproduces deviations from relative purchasing power parity similar to those observed in the data because firms choose to price-to-market. We then examine how pricing-to-market depends on the presence of international trade costs and various features of market structure.
The basic inability of standard theoretical models to generate a sufficiently large and variable nominal bond risk premium has been termed the "bond premium puzzle." We show that the term premium on long-term bonds in the canonical dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is too small and stable relative to the data. We find that introducing long-memory habits in consumption as well as labor market frictions can help fit the term premium, but only by seriously distorting the DSGE model's ability to fit other macroeconomic variables, such as the real wage; therefore, the bond premium puzzle remains.
Ehrmann· Fratzscher· Gurkaynak· Swanson:: July 2007
We study the convergence of European bond markets and the anchoring of inflation expectations in euro area countries using high-frequency bond yield data for France, Germany, Italy and Spain. We find that Economic and Monetary Union (EMU) has led to substantial convergence in euro area sovereign bond markets in terms of interest rate levels, unconditional daily fluctuations, and conditional responses to major macroeconomic data announcements. Our findings also suggest a substantial increase in the anchoring of long-term inflation expectations since EMU, particularly for Italy and Spain, which since monetary union have seen their long-term interest rates become much lower, much less volatile, and much better anchored in response to news. Finally, the reaction of far-ahead forward interest rates to macroeconomic announcements has
converged substantially across euro area countries and even been eliminated over time, thus underlining not only market integration but also the credibility that financial markets attach to monetary policy in the euro area.
A common assumption in the academic literature and in the actual supervision of banking systems worldwide is that franchise value plays a key role in limiting bank risk-taking. As the underlying source of franchise value is assumed to be market power, reduced competition has been considered to promote banking stability. Boyd and De Nicolo (2005) propose an alternative view where concentration in the loan market could lead to increased borrower debt loads and a corresponding increase in loan defaults that undermine bank stability. Martinez-Miera and Repullo (2007) encompass both approaches by proposing a nonlinear relationship between competition and bank risk-taking. Using unique datasets for the Spanish banking system, we examine the empirical nature of that relationship. After controlling for macroeconomic conditions and bank characteristics, we find that standard measures of market concentration do not affect the ratio of non-performing commercial loans (NPL), our measure of bank risk. However, using Lerner indexes based on bank-specific interest rates, we find a negative relationship between loan market power and bank risk. This result provides evidence in favor of the franchise value paradigm.
Access to external finance is a key determinant of a firm's ability to develop, operate and expand. To date, the literature has examined a variety of macroeconomic and microeconomic factors that influence firm financing. In this paper, we examine access by Spanish firms to external financing, both from bank and non-bank sources. We use dynamic panel data estimation techniques to estimate our models over a sample of 60,000 firms during the period from 1992 to 2002. We find that Spanish firms are quite dependent on short-term non-bank financing (such as trade credit), which makes up about 65 percent of total firm debt. Our results indicate that this type of financing is less sensitive to firm characteristics than short-term bank financing. However, we also find that short-term bank debt seems to be accessed more during economic expansions, which may suggest a substitution away from non-bank financing as firm conditions improve. Short-term bank debt also seems to be accessed more as funding rates rise, possibly again suggesting a substitution away from higher-priced non-bank alternatives. Using data from the Spanish Credit Register maintained by the Banco de Espana, we find that the impact of funding costs on access to external financing, whether from banks or non-banks, is affected by the nature of borrowing firms' bank relationships and collateral. In particular, we provide evidence of a potential hold-up problem in loan markets. Moreover, collateral plays a key role in making long-term finance available to firms.
We develop new techniques to assess the relationship between commercial bank performance and the economic conditions in the markets in which they operate. In the analysis, we allow for heterogeneity in the responses of banks to regional economic conditions. We find a statistically significant relationship between bank performance and shocks to the regional markets in which they operate. We find that region-specific shocks have a significant and persistent effect on the cross-sectional variance of bank performance in the market. That is, shocks affecting average performance of banks in a region also tend to increase the dispersion of their performance. We demonstrate that this effect is due to heterogeneity in the banks' exposures to their regional economies. Moreover, by allowing for this heterogeneity, we find that systematic responses to regional economic effects are notably more important in explaining the variation in bank performance than suggested by analysis in which responses are constrain to be the same for all banks.
We derive the class of arbitrage-free affine dynamic term structure models that approximate the widely-used Nelson-Siegel yield-curve specification. Our theoretical analysis relates this new class of models to the canonical representation of the three-factor arbitrage-free affine model. Our empirical analysis shows that imposing the Nelson-Siegel structure on
this canonical representation greatly improves its empirical tractability; furthermore, we find that improvements in predictive performance are achieved from the imposition of absence of arbitrage.
To conduct policy efficiently, central banks must use available data to infer, or learn, the relevant structural relationships in the economy. However, because a central bank's policy affects economic outcomes, the chosen policy may help or hinder its efforts to learn. This paper examines whether real-time learning allows a central bank to learn the economy's underlying structure and studies the impact that learning has on the performance of optimal policies under a variety of learning environments. Our main results are as follows. First, when monetary policy is formulated as an optimal discretionary targeting rule, we find that the rational expectations equilibrium and the optimal policy are real-time learnable. This result is robust to a range of assumptions concerning private sector learning behavior. Second, when policy is set with discretion, learning can lead to outcomes that are better than if the model parameters are known. Finally, if the private sector is learning, then unannounced changes to the policy regime, particularly changes to the inflation target, can raise policy loss considerably.
This paper explores how the steady trends in increasing tuition costs, college enrollment, and the college wage gap might be related to the quality of college graduates. The model shows that the signaling role of education might be an important yet largely neglected ingredient in these recent changes. I develop a special signaling model in which workers of heterogeneous abilities face the same costs, yet a larger proportion of able individuals self-select to attend college since they are more likely to get higher returns. With imperfect information, the skill premium is an outcome which depends on the equilibrium quality of college attendees and nonattendees. Incorporating a production function of college education, I discuss the properties of the college market equilibrium. A skill-biased technical change directly decreases self-selection into college, but the general equilibrium effect may overturn the direct decline, since increased enrollment and rising tuition costs increase self-selection. Higher initial human capital has an external effect on subsequent investment in school: All agents increase their education, and the higher equilibrium tuition costs increase self-selection and the college premium.
This paper uses a new dataset to study the relationship between economic output and sovereign default for the period 1820-2004. We find a negative but surprisingly weak relationship between output and default. Throughout history, countries have indeed defaulted during bad times (when output was relatively low), but they have also maintained debt service in the face of severe adverse shocks, and they have defaulted when domestic economic conditions were favorable. We show that this constitutes a puzzle for standard theories, which predict a much tighter negative relationship
as default provides partial insurance against declines in output.
For over two decades, researchers have provided evidence that the yield curve, specifically the spread between long- and short-term interest rates, contains useful information for signaling future recessions. Despite these findings, forecasters appear to have generally placed too little weight on the yield spread when projecting declines in the aggregate economy. Indeed, we show that professional forecasters appear worse at predicting recessions a few quarters ahead than a simple real-time forecasting model that is based on the yield spread. This relative forecast power of the yield
curve remains a puzzle.
Previous studies of real wage cyclicality have made only sparing use of the
microdata detail that is available in the Panel Study of Income Dynamics
(PSID). The present paper brings to bear this additional detail to investigate
the robustness of previous results and to examine whether there are
important cross-sectional and demographic differences in wage cyclicality.
Although real wages were procyclical across the entire distribution of workers from 1967 to 1991, the wages of lower-income, younger, and less-educated workers exhibited greater procyclicality. However, workers' straight-time hourly pay rates have been acyclical, suggesting that more variable pay margins such as bonuses, overtime, late shift premia, and commissions have played a substantial if not primary role in generating procyclicality.
Since bank credit lines are a major source of corporate funding and liquidity, we examine the determinants of credit line usage with a database of Spanish corporate credit lines. A line's default status is the primary factor driving its usage, which increases as a firm approaches default. Several lender characteristics suggest an important role for bank monitoring in firms' usage decisions. Credit line usage is found to be inversely related to macroeconomic conditions. Overall, while several factors influence corporate credit line usage, our analysis suggests that default and supply-side variables are the most important.
The composition of capital inflows to emerging market economies tends to follow a predictable dynamic pattern across the business cycle. In most emerging market economies, total inflows are
procyclical, with debt and portfolio equity flowing in first, followed later in the expansion by foreign direct investment (FDI). To understand the dynamic composition of these flows, we use a
small open economy (SOE) framework to model the composition of capital inflows as the equilibrium outcome of emerging market firms' financing decisions. We show how costly external financing and FDI search costs generate a state-contingent cost of financing such that the cheapest source of financing depends on the phase of the business cycle. In this manner, the financial frictions are able to explain the interaction between the types of flows and deliver a time-varying composition of flows, as well as other standard features of emerging market business cycles. If, as this work
suggests, flows are an equilibrium outcome of firms' financing decisions, then volatility of capital inflows is not necessarily bad for an economy. Furthermore, using capital controls to shut down one
type of flow and encourage another is certain to have both short- and long-run welfare implications.
This paper empirically assesses the importance of interpersonal income comparisons using individual level data on suicide deaths in the United States. We model suicide as a choice variable, conditional
on exogenous risk factors, reflecting an individual's assessment of current and expected future utility. Our empirical analysis considers whether suicide risk is systematically related to the income of others,
holding own income and other individual factors fixed. We estimate proportional hazards and probit models of the suicide hazard using two separate and independent data sets: (1) the National
Longitudinal Mortality Study and (2) the National Center for Health Statistics' Mortality Detail Files combined with the 5 percent Public Use Micro Sample of the 1990 decennial census. Results from
both data sources show that, controlling for own income and individual characteristics, individual suicide risk rises with reference group income. This result holds for reference groups defined broadly,
such as by county, and more narrowly by county and one demographic marker (e.g., age, sex, race). These findings are robust to alternative specifications and cannot be explained by geographic variation in cost of living, access to emergency medical care, mismeasurement of deaths by suicide, or by bias due to endogeneity of own income. Our results confirm findings using self-reported happiness data and are consistent with models of utility featuring "external habit" or "Keeping Up with the Joneses" preferences.
This paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the U.S. economy where the policymaker faces uncertainty about model parameters. Uncertainty about parameters describing preferences and technology implies uncertainty about the model’s dynamics, utility-based welfare criterion, and the "natural" rates of output and interest that would prevail absent nominal rigidities. We estimate the degree of uncertainty regarding natural rates due to parameter uncertainty. We find that optimal Taylor rules under parameter uncertainty respond less to the output gap and more to price inflation than would be optimal absent parameter uncertainty. We also show that policy rules that focus solely on stabilizing wages and prices yield welfare outcomes very close to the first-best.
This paper derives a general class of intrinsic rational bubble solutions in a standard Lucas-type asset pricing model. I show that the rational bubble component of the price-dividend ratio can evolve as a geometric random walk without drift, such that the mean of the bubble growth rate is zero. Driftless rational bubbles are part of a continuum of equilibrium solutions that involve an explicit trade-off between the mean and volatility of the bubble growth rate. I also derive a near-rational asset pricing solution in which the representative agent does not construct separate forecasts for the fundamental and bubble components of the asset price. Rather, the agent constructs only a single forecast for the total asset price that is similar in form to the corresponding rational forecast, but involves fewer parameters. The parameters of the agent's forecast rule are chosen to match the moments of observable data. In the near-rational equilibrium, the actual law of motion for the price-dividend ratio is stationary, highly persistent, and nonlinear. The agent's forecast errors exhibit near-zero autocorrelation at all lags, making it difficult for the agent to detect a misspecification of the forecast rule. Unlike a rational bubble, the near-rational solution allows the asset price to occasionally dip below its fundamental value. Under mild risk aversion, the near-rational solution generates pronounced low-frequency swings in the price-dividend ratio, positive skewness, excess kurtosis, and time-varying volatility--all of which are present in long-run U.S. stock market data. An additional contribution of the paper is to demonstrate an approximate analytical solution for the fundamental asset price that employs a nonlinear change of variables.
Model uncertainty has the potential to change importantly how monetary policy should be conducted, making it an issue that central banks cannot ignore. In this paper, I use a standard new Keynesian business cycle model to analyze the behavior of a central bank
that conducts policy with discretion while fearing that its model is misspecified. My main results are as follows. First, policy performance can be improved if the discretionary central bank implements a robust policy. This important result is obtained because the central bank's desire for robustness directs it to assertively stabilize inflation, thereby mitigating the stabilization bias associated with discretionary policymaking. In effect, a fear
of model uncertainty can act similarly to a commitment mechanism. Second, exploiting the connection between robust control and uncertainty aversion, I show that the central bank's fear of model misspecification leads it to forecast future outcomes under the belief
that inflation (in particular) will be persistent and have large unconditional variance, raising the probability of extreme outcomes. Private agents, however, anticipating the policy response, make decisions under the belief that inflation will be more closely stabilized, more tightly distributed, than under rational expectations. Third, as a technical contribution, I show how to solve an important class of linear-quadratic robust Markov-perfect Stackelberg problems.
We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess imperfect knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain
price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy's natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models
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