Markov switching in disaggregate unemployment rates

We develop a dynamic factor model with Markov switching to examine secular and business cycle fluctuations in the U.S. unemployment rates. We extract the common dynamics amongst unemployment rates disaggregated for 7 age groups. The framework allows analysis of the contribution of demographic factors to secular changes in unemployment rates. In addition, it allows examination of the separate contribution of changes due to asymmetric business cycle fluctuations. We find strong evidence in favor of the common factor and of the switching between high and low unemployment rate regimes. We also find that demographic adjustments can account for a great deal of secular changes in the unemployment rates, particularly the abrupt increase in the 1970s and 1980s and the subsequent decrease in the last 18 years. First Version Received: December 2000/Final Version Received: June 2001     

Financial systems and the cost channel transmission of monetary policy shocks

We study the role of financial systems for the cost channel transmission of monetary policy in a calibrated business cycle model. We characterize financial systems by the share of bank-dependent firms and by the degree of the pass-through from policy to bank lending rates, for which we provide empirical estimates for the euro area and the US. For plausible calibrations of the dynamics of the lending rate we find that the cost effects directly related to interest rate movements have only a limited effect on the transmission mechanism.     

The Role of Productivity and Financial Frictions in the Business Cycles of a Small Open Economy: Hong Kong 1984–2011

This paper analyzes the business cycle properties of the Hong Kong economy during the 1984–2011 period, which includes the financial crisis experienced in 1997/98 and the economic crisis of 2008–2010. We show that the volatility respectively, of output, of the growth rate of output and of real interest rates in Hong Kong are higher than the corresponding average volatility among developed economies. Furthermore, interest rates are countercyclical. We build a stochastic neoclassical small open‐economy model estimated with a Bayesian likelihood approach that seeks to replicate the main business cycle characteristics of Hong Kong, and through which we try to quantify the role played by exogenous total factor productivity (TFP) shocks (transitory and permanent), real interest rate shocks and financial frictions. The main finding is that financial frictions, jointly with the assumption that the country spread is endogenous, seem important in explaining the countercyclicality of the real interest rates.     

MONEY,CAPITAL, AND EXCHANGE RATE FLUCTUATIONS*

We explore how the informational frictions underlying monetary exchange affect international exchange rate dynamics. Our perfectly flexible price model is capable of producing endogenously rigid international relative prices in response to technology and monetary shocks. The model is capable of accounting for the empirical regularities that the real and nominal exchange rates are more volatile than U.S. output, and that the two are positively and perfectly correlated. The model is also consistent with other standard real business cycle facts for the United States.     

The role of financial frictions during the crisis: An estimated DSGE model

After the recent banking crisis in 2008, financial market conditions have turned out to be a relevant factor for economic fluctuations. This paper provides a quantitative assessment of the impact of financial frictions on the U.S. business cycle. The analysis compares the original Smets and Wouters model (2003, 2007) with an alternative version augmented with the financial accelerator mechanism á la Bernanke, Gertler and Gilchrist (1996, 1999). Both versions are estimated using Bayesian techniques over a sample extended to 2012. The analysis supports the role of financial channels, namely the financial accelerator mechanism, in transmitting dysfunctions from financial markets to the real economy.The Smets and Wouters model, augmented with the financial accelerator mechanism, is suitable to capture much of the historical developments in U.S. financial markets that led to the financial crisis. The model can account for the output contraction in 2008, as well as the widening in corporate spreads, and supports the argument that financial conditions have amplified the U.S. business cycle and the intensity of the recession.     

Financial cycle and business cycle: An empirical analysis based on the data from the U.S

In this paper, we first study the relationship between the financial cycle and the business cycle in the time and frequency domain. Then we also explore the interactions and dynamic mechanisms of the financial cycle, the business cycle, real interest rate and exchange rate by the VAR model. The empirical results show that the financial cycle is closely related to the business cycle, especially at medium-term frequencies (8–30 years), the business cycle leads the financial cycle with a high positive correlation. However, the relationship between them is not significant during the Great Moderation at business-cycle (2–4 years). In addition, the financial cycle not only becomes a main driver of real interest rate, the financial cycle and the business cycle, but also serves as an important source of the business cycle fluctuations. In general, our results lay some theoretical foundation for the policy practice of financial and economic stability.     

The equity price channel in a New-Keynesian DSGE model with financial frictions and banking

This paper studies the role of the equity price channel in business cycle fluctuations, and highlights the equity price channel as a different aspect to general equilibrium models with financial frictions and, as a result, emphasizes the systemic influence of financial markets on the real economy. We develop a canonical dynamic general equilibrium model with a tractable role for the equity market in banking, entrepreneur and household economic activities. The model is estimated with Bayesian techniques using U.S. data over the sample period 1982Q01–2015Q01. We show that a dynamic general equilibrium model with an equity price channel well mimics the U.S. business cycle. The model reproduces the strong procyclicality of the equity price. The equity price channel significantly exacerbates business cycle fluctuations through both financial accelerator and bank capital channels. Our results support the increasing emphasis on common equity capital in Basel III regulations. This is beneficial in terms of financial stability, but amplifies and propagates shocks to the real economy.     

Unemployment insurance and the business cycle*

An equilibrium model is developed to study the interaction of the business cycle, unemployment insurance (UI), and the labor market for young men in Canada. The model combines optimal job offer, layoff, and recall decisions within a numerically solved and restricted Bayesian–Nash equilibrium. We consider the long‐run implications of changes made to unemployment insurance in Canada during the 1990s. The changes lead to equilibrium increases in average rates of unemployment, layoffs, and recalls. Eliminating UI lowers the equilibrium unemployment rate and average observed earnings. UI policy affects the timing of cycles of endogenous outcomes relative to the productivity cycle.     

The effect of the tax reform act of 1986 on the location of assets in financial services firms

This paper examines the effects of the Tax Reform Act of 1986 on the international location decisions of U.S. financial services firms. The Act included rule changes that made it substantially more difficult for U.S. firms to defer U.S. taxes on overseas financial services income held in low-tax jurisdictions. We use information from the tax returns of U.S. corporations to examine how local taxes affect the allocation of financial assets held abroad by financial services firms. We find that, before the Act, the location of reported assets in financial subsidiaries was responsive to differences in host country tax rates across jurisdictions. However, after the Act, differences in host country tax rates no longer explain the distribution of assets held in financial services subsidiaries abroad. Our results suggest that the tightening of the anti-deferral provisions applicable to financial services companies has been successful in diminishing the effect of host country income taxes on asset location decisions.     

Australian financial firms’ exposures to the level,slope, and curvature of the interest rate term structure

This study examines the risk exposure of Australian financial firms to changes in the term structure of interest rates. Non-linearity in the interest rate term structure is captured by the three-factor model of interest rate level, slope, and curvature. We observe that financial firms have negative exposures to the interest rate level, while non-financial firms have positive exposures. This finding suggests that financial firms need to hedge against rising interest rates, while non-financial firms need to hedge against falling interest rates. Small banks and insurance companies have a positive risk exposure to the slope factor, while real estate firms have a negative risk exposure to the curvature factor. Though the interest rate level is the most important factor, ignoring the slope and curvature factors could lead to underestimating a financial firm’s overall interest rate risk exposure. These findings are robust to controlling for the orthogonalized market return, time-varying equity risk premium, and the global financial crisis. This study offers practical tools to regulators, such as the Reserve Bank of Australia and Australian Prudential Regulatory Authority for assessing interest rate risk exposures of the financial and non-financial sectors.     

The Influence of Financial Factors on Corporate Investment

Abstract
Recent theoretical developments have shown that cash flows and the structure of a firm's balance sheet may have an important influence on investment. Establishing a link between cash flows, leverage and investment provides insights into the way that monetary policy and cyclical factors more generally influence the corporate sector. If cash flows are an important determinant of investment then changes in monetary policy (by changing interest rates) will influence investment through a cash flow effect as well as through altering the rate at which the returns to investment are discounted. If this is the case, the higher leverage of the corporate sector implies, other things being equal, that monetary policy may have a larger impact on investment than in the past .
In this article we use panel-data analysis to examine the impact of financial factors on investment decisions of firms in the Australian corporate sector. We find strong support for the influence of financial factors on investment decisions. Leverage, internally generated cash flows, and the stock of cash and liquid financial assets are all important influences on investment behaviour, particularly for smaller firms, highly leveraged firms, and firms with high retention ratios .     

Risk sharing and export performance with firm heterogeneity

We investigate how market uncertainty affects the export performance of a firm through financial frictions. We first extend Melitz's (2003) heterogeneous firm trade model by incorporating demand shocks, linking the demand uncertainties to the financing costs of firms. In this extension, the default probability is endogenously determined by a firm's productivity and demand uncertainty. Hence, firms with higher productivity or lower market uncertainty are offered lower interest rates and thus show better export performance. As an application, we also show that a risk-sharing mechanism, that pools default risk for a certain group of firms, lowers the default risk. This mechanism allows banks to charge lower interest rates to the member firms and therefore ultimately improves their export performance in both extensive and intensive margins. We find a real-world example of such a mechanism from business groups in Korea. Using Korean firm-level data, we show that the more diversified the business group, the greater the likelihood that its member firms export and the bigger their export revenues. We also show that our results are robust to alternative explanations for Korean business groups’ export competitiveness.     

RESIDUAL WAGE DISPARITY AND COORDINATION UNEMPLOYMENT*

How much of residual wage dispersion can be explained by an absence of coordination among firms? To answer, we construct a dynamic directed search model with identical workers where firms can create high‐ or low‐productivity jobs and are uncoordinated in their offers to workers, calibrated to the U.S. economy. Workers can exploit ex post opportunities once approached by firms, and can conduct on‐the‐job search. The stationary equilibrium wage distribution is hump‐shaped, skewed significantly to the right, and, with baseline parameters, generates residual dispersion statistics 75–90% of those found empirically. However, the model underestimates the average duration of unemployment.     

Financial Frictions and Risky Corporate Debt

We offer clarifications on Cooley and Quadrini (2001) regarding financial frictions and risky corporate debt pricing. Even in a frictionless world, the promised rate on corporate debt is not identical across firms and across capital structures and it is not equal to the risk-free rate. Frictions are unnecessary for credit spreads to arise. Only if the macroeconomy is in actuality risk free or risk neutral do interest rates on corporate debt reflect default probabilities. To the extent that the firm's entire financial structure is traded, a bias in credit spreads introduces an exploitable arbitrage opportunity. Re-establishing no-arbitrage, firm dynamics move in the opposite direction to Cooley and Quadrini's.     

Balance Sheet Restructuring and Investment

Abstract
This article looks at the evolution of corporate balance sheets and investment over the past few years .
We find that many companies have significantly improved their balance sheets in this time. Leverage has been reduced, and this, coupled with lower nominal interest rates, has improved the interest cover and cash flows of the corporate sector. For many firms, the process of balance sheet repair has proceeded a long way so that the extent to which the financial position of firms will impinge on investment is much lower than it was a few years ago.
Looking further ahead, it appears that the rate of return to investing in capital is relatively high, at least when judged against the standards of earlier downturns. With the recovery picking up pace we should, therefore, see firms more inclined to expand their capital expenditure and less focused on financial restructuring.     

Testing for hysteresis in unemployment an unobserved components approach

We suggest a new test for hysteresis in unemployment based on an unobserved components model. Observed unemployment rates are decomposed into a natural rate component and a cyclical component. The impact of lagged cyclical shocks on the current natural component is the measure of hysteresis. To identify the two components of unemployment, we assume that the cyclical compoentn is correlated with capacity utilization. The model is applied to U.S. and German data. We find no evidence of hysteresis in U.S. data. German unemployment rates exhibit substantial hysteresis. A shock of 1.0 percent to the current cyclical component permanently increases future German natural rates by about 0.5 percent. For both countries, natural rate shocks turn out to be an important impulse mechanism to explain movements in observed unemployment rates.     

Job Creation, Job Destruction, and the International Division of Labor

The authors incorporate equilibrium unemployment due to imperfect matching into a model of trade in intermediate inputs. Firms are assumed to be price‐takers and their size is given by technology. Firms enter the market as long as expected profits cover the search cost they incur initially; jobs are endogenously destroyed by random shocks that affect firms’ price–cost margins. Trade increases productivity in the final good and then demand for each intermediate input. Steady‐state unemployment is reduced after trade integration because the rate of job destruction is reduced, which in turn induces an indirect positive effect on job creation. A more volatile environment faced by firms does not necessarily increase unemployment. However, the rate of job destruction unambiguously rises, and rises more under free trade.     

BUSINESS FAILURES AND MACROECONOMIC FACTORS IN THE UK

We examine the interactions between business failures and macroeconomic aggregates, and specifically the accounts of policy-induced changes in the macroeconomy for the observed fluctuations of UK business failures in the period 1966–2003 using the vector error-correction model (VECM). The results demonstrate that macroeconomic aggregates, i.e., interest rate, credit, profits, inflation and business births, exert differential impacts on business failures both in the short run and in the long run. The study reveals that structural changes in the financial and real sectors during the examined period have made an impact on the way in which the macroeconomy affects business failures. In particular, business failures are increasingly reacting to monetary policy changes in the post-1980 period. Furthermore, the shocks to business failures can generate large fluctuations in macroeconomic aggregates, suggesting the importance of corporate balance sheets in financial stability and economic growth. The paper's findings carry policy implications that are related to the survival of firms in distress and finance-driven business cycles.     

Unemployment and Economic Integration for Developing Countries

While financial or trade integration between countries may increase the size of the market and aid the adoption of more advanced technologies, will it also increase the level of urban unemployment for a developing country? In this model, there is unemployment in the urban sector. Manufacturing firms engage in oligopolistic competition and choose increasing returns technologies to maximize profits. Financial firms provide capital to manufacturing firms and they also engage in oligopolistic competition. We show that an increase in the wage rate in the manufacturing sector changes neither the level of technology nor the level of employment in the manufacturing sector. While financial or trade integration between developing countries leads manufacturing firms to adopt more advanced technologies, the level and rate of employment in the manufacturing sector will not deteriorate.     

Empirical Evidence on the Austrian Business Cycle Theory

The Austrian business cycle theory suggests that a monetary shock disturbs relative prices, such as the term structure of interest rates, systematically altering profit rates across economic sectors. Resource use responds to those changes, generating a cyclical pattern of real income. The divergence of the interest rate structure, from the previous and unchanged time preferences, means that the expansion is unsustainable and must end in recession. Quarterly data for eight U.S. business cycles, 1950:1 through 1991:1 are standardized by time period and used to explore business cycle facts and relations between money, interest rates, capacity utilization and income. Results are consistent with the hypotheses of the Austrian theory of a business cycle caused by a monetary shock and propagated by relative price changes.