An Endogenous Growth Model of a Financially Repressed Small Open Economy

The paper develops a monetary endogenous growth model of a financially repressed small open economy, characterized by curb markets, capital mobility, transaction costs in domestic and foreign capital markets, and a flexible exchange rate system, to analyze the impact of financial liberalization – interest rate deregulation and lower multiple reserve requirements – on growth and inflation. When the model is calibrated to match world figures, we find that interest rate deregulation enhances growth and reduces inflation in steady-state. For relatively smaller transaction costs in the curb market, the above result is, however, reversed. Under such circumstances, lowering the transaction costs in the foreign capital market tends to restore the growth-enhancing (inflation-reducing) capabilities of interest rate deregulation. Lower reserve requirements, though, always ensures lower (higher) steady-state inflation (growth).     

THE PUZZLING DIVERGENCE OF RENTS AND USER COSTS, 1980–2004

This paper demonstrates that, in the context of U.S. housing data, rents and ex ante user costs diverge markedly—in both growth rates and levels—for extended periods of time, a seeming failure of arbitrage and a puzzle from the perspective of standard capital theory. The tremendous volatility of even appropriately‐smoothed ex ante annual user cost measures implies that such measures are unsuitable for inclusion in official price statistics. The divergence holds not only at the aggregate level, but at the metropolitan‐market level as well, and is robust across different house price and rent measures. But transactions costs matter: the large persistent divergences did not imply the presence of unexploited profit opportunities. In particular, even though detached housing is readily moved between owner and renter markets, and the detached‐unit rental market is surprisingly thick, transactions costs would have prevented risk‐neutral investors from earning expected profits by buying a property to rent out for a year, and would have prevented risk‐neutral homeowners from earning expected profits by selling their homes and becoming renters for a year. Finally, computing implied appreciation as a residual yields a house price forecast with huge errors; but either longer‐horizon or no‐real‐capital‐gains forecasts—which turn out to have similar forecast errors—imply a far less divergent user cost measure which might ultimately be useful for official price statistics. Some conjectures are offered.     

The true story of wine and cloth, or: building blocks of an evolutionary political economy of international trade

Standard trade theory is a theory about the structure of international production which emerges from an international arbitrage equilibrium. It is not a theory about the activity of trading which is simply taken for granted or which is treated implicitly in the concept of exogenous trade costs. This paper proposes an alternative evolutionary framework based on networks as structures of non-price interactions into which price/quantity-interactions are embedded. These networks manifest different levels with specific problems of coordination and communication, i.e. levels of market transactions, of transaction-enabling transactions, of markets for market access rights, and of the respective transaction-enabling transactions. Furthermore, the theory is based on the analysis of capabilities to trade, resting upon competitive advantage, which cannot be imitated. The exploitation of competitive advantage presupposes the capability to control network interactions, identified as social capital. Finally, the security of market access reflects power balances among countries.

(In)determinacy, increasing returns, and the optimality of the Friedman rule in an endogenously growing open economy

This paper sets up a monetary endogenous growth model with Benhabib–Farmer production externalities for an open economy, and then uses it to investigate the possibility of indeterminacy. Moreover, the paper examines how the monetary authorities will set its optimal anchor of the money growth rate from the viewpoint of welfare maximization. Several main findings emerge from the analysis. First, when investment does not involve adjustment costs, the monetary equilibrium is locally determinate regardless of the strength of the labor externality and the extent of world capital market imperfections. Second, in the presence of investment adjustment costs, the monetary equilibrium may exhibit indeterminacy when the aggregate increasing returns-to-scale in production is sufficiently strong. Third, in the presence of world capital market imperfections, the Friedman rule of a zero nominal interest rate fails to be optimal. Fourth, in the face of perfect world capital markets, the optimal nominal money growth rate is maintained at the rate that is conformable to the Friedman rule, regardless of whether investment involves adjustment costs or not.     

Market institutions and economic evolution

Our cognitive limitations cause us to rely on institutions to guide reasonable behaviour; market institutions reduce the costs of search, negotiation, and monitoring entailed in making single transactions. The making of markets requires an investment of immaterial capital, the major share of which typically is provided by those who expect to be very active on one side of the market. This `external organisation' provides producers with information for the development of new products; by simplifying transactions it also allows consumers greater scope for developing consumption capabilities. Thus the evolution of institutions guides the evolution of goods and services.     

The Effects of Capital Controls on Exchange Rate Volatility and Output *

This paper extends the Dornbusch model of overshooting exchange rates to discuss both exchange rate and output effects of capital controls that involve additional costs for International asset transactions.We show that, on the one hand, such capital controls have the merit of reducing the volatility of exchange rate volatility in the sort run and induces costs for the real sector in the form of lower equilibrium output levels. [F32, F41]     

Liquidity of secondary capital markets: Allocative efficiency and the maturity composition of the capital stock

Summary We investigate the function of liquid financial markets for the allocation of productive capital. We consider an economy where agents endogenously choose among capital production technologies with differing gestation periods. Long-gestation capital investments must be rolled-over in secondary capital markets. The use of such investment technologies therefore requires the support of liquid financial markets. We investigate how changes in the liquidity of these markets (i.e., in the costs of transacting) affect (a) the choice of capital production technology, (b) per capita income and the per capita capital stock, (c) the level of financial market activity, (d) the real return on savings and (e) welfare in a steady state equilibrium. Improvements in financial market liquidity raise rates of return on savings, and favor the increased use of long gestation capital investments. However, such improvements may or may not lead to higher levels of real activity or steady state welfare. We describe conditions under which various outcomes occur.We have benefited from the comments of seminar participants at the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of Minneapolis, the International Monetary Fund, Berkeley, Boston College, Boston University, Brown, Chicago, Illinois, Miami, UC San Diego, Simon Fraser, University of British Columbia, University of Washington, Yale, the Canadian Macro Study Group Meetings, the Murrary S. Johnson Conference (University of Texas/Federal Reserve Bank of Dallas), and the Far West Rotating Economic Theory Conference. We would also like to thank John Bryant, Andreas Hornstein, Dan Peled, Bill Schworm, Karl Shell, Bart Taub and an anonymous referee for their comments on an earlier draft of the paper.     

Did Open Access Integrate Natural Gas Markets? An Arbitrage Cost Approach

Several studies, using analyses that measure the correlation between prices in various markets, have argued that deregulation of natural gas pipeline contracts has reduced the transaction costs between natural gas markets. Correlations approaches, however, have potentially serious problems. Given these problems, this article estimates transactions costs directly. Deregulation is found to have lowered transactions costs to and from the Louisiana, Oklahoma, and Texas regions, but increased transactions costs from the Rocky Mountain area. Deregulation of pipeline contracts, by lowering the cost of using the market and therefore increasing demand for pipeline capacity, may therefore have differential impacts upon transactions costs between markets. This study implies that the transactions cost approach may be able to overcome several difficulties inherent in the correlations approach.     

Information Technology,Transactions Costs and Patterns Of Globalization in Developing Countries

Though there are a number of mechanisms through which information technology promotes globalization, what is common to these mechanisms is that they can all be interpreted as a reduction in transactions costs between the trading partners. Thus interpreted, we show that developing countries differ in the extent to which, via reductions in transactions costs, they gain from increased trade and foreign investment as ratios to total output.     

Venture Capital Funds, Financial Foreign Direct Investment and the Generation of Local Comparative Advantage in the Technology Sector in Israel

The rapid development of a new comparative advantage in thehi-tech sector in Israel in the period 1995–2005 providesan example of a new form of foreign direct investment (FDI).Unlike traditional FDI, this new form of international investment,that we dubbed financial foreign direct investment (FFDI), involvescapital flows from developed countries to small countries andto the emerging markets. The providers of this capital, definedin our study as "sector-specific capital", are financial andrisk intermediaries like venture capital funds and private equityfunds. Like multinational enterprises they transfer factorsof production across borders seeking to maximize their value.In doing so, they are a part of a process of generating newcomparative advantages. We focus on the case of Israel and showthat, due to the inherent asymmetry, it takes government actionto trigger the process of importing sector-specific capitalto Israel primarily from the US capital market, but once theprocess has begun, it has led to economic growth via reducingtangible and intangible trade costs, creating trust and thusgenerating competitive advantage for innovative technology firmsfrom Israel in the global markets.     

How do market reforms affect China's responsiveness to environmental policy?

A large percentage of total investment in China is allocated by the central government at below-market interest rates in pursuit of non-economic objectives. This has resulted in low rates of return and a high number of non-performing loans, threatening the future health of the Chinese economy. As a result, reform of capital markets is a high priority of the Chinese government. At the same time, the country is implementing various environmental policies to deal with serious pollution issues. In this paper we ask how reforms of the capital market will affect the functioning of a carbon tax. This allows us to assess how China's willingness to join global efforts to reduce carbon emissions is influenced by China's current efforts to reduce investment subsidies. We compare the costs of a carbon tax in a reformed economy with the costs of a carbon tax in the current subsidized economy. We find that in the subsidized economy the tax-interaction effect dampens the effect of a carbon tax resulting in smaller reductions in emissions than what would result in a reformed economy. Importantly, we also find that the effect on economic welfare from a carbon tax is lower in the subsidized economy; in fact, for lower levels of reductions, the carbon tax is actually welfare improving. These results have important implications for an economy undergoing economic transition. The carbon tax rate required to achieve a certain level of emission reductions will be higher in an economy with capital subsidies. However, the welfare implications of the tax indicate that the current system with capital subsidies is highly distorting implying that there is a high efficiency cost for the non-economic objectives the government is pursuing by maintaining this system of subsidies.     

Housing, Land Prices, and Growth

We consider the effects of land for housingon the growth process within an overlapping generations model.Our original interest was to enquire whether the introductionof land into a growth model might account for a ``virtuous'circle in which saving-up for land (or housing) generates growthand higher land prices, generating further increases in saving,and so on. Such an account is sometimes proposed for high savingrates in East Asia, where mortgage markets are limited or absent.Our analysis does not support such a story. The user cost ofland reduces the resources available for consumption of reproduciblegoods, so that the introduction of intrinsically valuable landinto a growth model lowers the equilibrium stock of capital andraises the equilibrium interest rate. On the asset side, thepresence of land causes life-cycle savings to be reallocatedaway from productive capital towards land. The social optimumin such a model is for land to be nationalized and provided atzero rent. Land markets, far from generating saving and growth,are inimical to capital formation.     

Differences in growth with international capital markets and financial innovation

This paper presents a model in which technological progress affects the productivity of the financial sector. When technological progress moves quicky, the financial intermediation costs are low, which increases the incentives to invest in new technology. This feedback process involves two types of long-run equilibria: one with low financial intermediation costs and high growth, and the other with high financial intermediation costs and low growth. These divergences in growth rates among countries hold even in the presence of international capital markets with free capital mobility, a very unusual result in the endogenous growth literature.     

Growth,Employment and Taxation with Distortions in the Goods and Labour Market

Abstract. This paper analyses taxation in the presence of distortions in goods and labour markets in an endogenous growth model. The government disposes of capital, labour and consumption taxes. It is shown that the market solution leads to suboptimally low levels of growth and employment. However, available tax instruments are sufficient to attain the first‐best growth path in this economy. The paper further explores the relative distortion of capital and labour taxes. For plausible parametrisations of the model, lowering capital taxes dominate reductions in labour taxes in welfare terms.     

Financial reforms,product differentiation,and trade

We hypothesize that exports of differentiated products, which entail greater upfront costs, increase more as financial reforms take place. We find strong and robust empirical support of this hypothesis with a comprehensive set of measures of reforms encompassing the banking sector, interest rates, equity and international capital markets.     

FIRM‐LEVEL INVESTMENT AND EXPORT DYNAMICS*

This article characterizes the complementarity between exporting and investment in physical capital. We argue that new investment allows young exporters to grow faster and survive longer in export markets while reducing their vulnerability to productivity or demand shocks across markets. We structurally estimate our model using detailed firm‐level data. We find that the choice of cost structure has a large impact on model performance and the estimated costs of exporting or investment. Using detailed capital and output tariff rates, we quantify the impact of policy change on aggregate export and investment growth.     

Dilution costs,underinvestment, and utility regulation under asymmetric information

This article addresses the problem faced by a regulated natural monopolist who must raise outside funds to finance socially desirable projects. We demonstrate that fair rate of return utility price regulation will lead to underinvestment incentives in the presence of asymmetric information between the firm and the capital markets regarding the firm's assets and future costs. This problem is especially severe when financing choice is restricted to equity. Underinvestment can be either completely eliminated by adjusting the allowed rate of return above the fair rate or reduced by switching to debt finance.Support from the Center for the Study of Regulated Industry at Georgia State University is gratefully acknowledged. We have benefited from the comments of Victor Andrews, two anonymous reviewers, and the editor, Michael A. Crew. The usual disclaimer applies.     

Superneutrality, indeterminacy and endogenous growth

In this paper, we explore the possibility of having money as a source of indeterminacy in endogenous growth models. We adopt the simple Ak model of endogenous growth to be the main analytical vehicle whose balanced growth paths do not display local indeterminacy. Money is introduced via either a general cash-in-advance (CIA) constraint or a pecuniary transactions costs (PTC) technology. It is shown that local indeterminacy of the dynamics is due to the presence of an intertemporal substitution effect on capital accumulation that works against and dominates the conventional inflation effect of Tobin [1965, Money and economical growth. Econometrica 33(4), Part 2, 671]. If money is growth-rate superneutral, then the intertemporal substitution effect is absent so that local indeterminacy cannot occur. Finally, the strength of the intertemporal substitution effect depends positively on the intertemporal elasticity of substitution in consumption.     

The effects of education and aging in an OLG model: long-run growth in France,Germany and Italy

The purpose of the paper is to provide a long-run analysis up to 2050 of the interplay between financial integration, diverging labor productivity, and the aging process in the larger European countries. We use the Prometeia overlapping generation model for Italy, Germany, and France which are modeled as open economies in capital markets. Our projections provide a core-periphery structure in which Germany, the most abundant human capital country, shows the highest but a decreasing growth rate due to pronounced aging, and finances capital accumulation processes in France and Italy. We find that financial trends are reversed in the late 2010s when Italy begins to over-save as the gap in human capital endowment, and then in productivity, becomes larger compared to the other two countries. This leads to a reduction in physical capital accumulation and innovation processes in Italy. We employ fiscal experiments to correct the long-run divergent behavior of countries in order to get a more homogeneous growth rate path among countries. We also measure the impact of taxation on net-wealth in Italy, and evaluate the internal and spillover effects.     

The cost of capital,asset prices,and the effects of monetary policy

The primary objective of this paper is to study the interaction between monetary policy, asset prices, and the cost of capital. In particular, we explore this issue in a setting where individuals face idiosyncratic risk. Incomplete information also provides a transactions role for money so that monetary policy can be studied. In contrast to standard monetary growth models which focus on the transmission of monetary policy to the demand for capital goods, we incorporate a separate capital goods sector so that the supply response to monetary policy is taken into account. Consequently, in contrast to the standard monetary growth model, monetary policy plays an important role in investment activity through the relative price of capital goods. Moreover, different sources of productivity can affect the degree of risk sharing. Although the optimal money growth rate falls in response to an increase in productivity in either sector of the economy, monetary policy should react more aggressively to the level of productivity in the capital sector.