Empirical determination of aggregate demand and supply curves: The example of the RWI Business Cycle Model

Macroeconometric models are often criticised for being too complex and difficult to read in theoretical terms. To overcome these difficulties, Hickman suggested the calculation of a model's implicit aggregate demand/supply (AD/AS) structure. The method helps to understand models and their main properties in theoretical terms and facilitates detailed model comparisons. This paper uses the AD/AS–IS/LM apparatus to analyse the simulation properties of the RWI (Rheinisch-Westfälisches Institut für Wirtschaftsforschung) Business Cycle Model, a medium-sized short-term macroeconometric model for Germany. The results confirm theoretical expectations for AD and AS elasticities and reveal particular reactions linked to peculiar model specifications such as an endogenous government sector. The results are also much in line with a previous study in a multi-country model context.     

Employment changes, the structure of adjustment costs, and plant size

In this paper, we analyze the pattern of employment adjustment using a rich panel of Norwegian plants. The data suggest that the frequency of episodes of zero net employment changes is inversely related to plant size. We develop and estimate a simple “q” model of labor demand, allowing for the presence of fixed, linear and quadratic components of adjustment costs. The econometric evidence supports the existence of purely fixed components, unrelated to plant size. As a result, the range of inaction is wider for smaller plants. The quadratic component of costs is also always important. In most specifications fixed costs are higher for employment contractions. The quadratic component is higher during employment contractions compared to expansions for small plants, while this is not true for larger plants.     

A Comparison of Alternative Non-parametric Estimators of the Short Rate Diffusion Coefficient

In this paper we discuss the estimation of the diffusion coefficient in one-factor models for the short rate via non-parametric methods. We test the estimators proposed by Ait-Sahalia (1996) , Stanton (1997) and Bandi and Phillips (2003) on Monte Carlo simulations of the Vasicek and CIR model. We show that the Ait-Sahalia estimator is not applicable for values of the mean reversion coefficient typically displayed by interest rate data, while the Stanton and Bandi–Phillips estimators perform better. Each of the three estimators depends crucially on the choice of the bandwidth parameter. Our analysis shows that the estimators give different results for both the data set analysed by Ait-Sahalia (1996) and by Stanton (1997) . Finally we show that the data sets used by Ait-Sahalia and Stanton are inherently different and, in particular, that very short-term data exhibit characteristics which are inconsistent with a diffusion.     

Moving costs, nondurable consumption and portfolio choice

The substantial adjustment cost for housing affects nondurable consumption and portfolio allocations, as well as the frequency of housing transactions. A simple theoretical model, roughly calibrated, is used to assess the quantitative impact of adjustment costs on those decisions. The impact on portfolios is found to be significant, suggesting that housing wealth should be useful in empirical studies of portfolio choice. The welfare loss from the transaction cost is also substantial. The effect on nondurable consumption is small, however, so adjustment costs can explain only a small part of the equity premium puzzle.     

Real-time forecasts of economic activity for Latin American economies

Macroeconomic policy decisions in real-time are based on the assessment of current and future economic conditions. Crucially, these assessments are made difficult by the presence of incomplete and noisy data. The problem is more acute for emerging market economies, where most economic data are released infrequently with a (sometimes substantial) lag. This paper evaluates nowcasts and forecasts of real GDP growth using five models for ten Latin American countries. The results indicate the flow of monthly data helps to improve forecast accuracy, and the dynamic factor model consistently produces more accurate nowcasts and forecasts relative to other model specifications, across most of the countries we consider.     

Stabilizing and destabilizing mechanisms: A new perspective to understand business cycles

Economists believe that economic fluctuations can be smoothed by stabilization mechanisms, such as price adjustment, embedded in the economy. While price adjustment can be seen as a stabilization mechanism, are there mechanisms that can destabilize an economy? We find that as early as 1939, Harrod discussed a destabilization mechanism, the firm's investment adjustment, illustrated in his knife-edge puzzle. We build a macro-dynamic model with investment and price as the core macroeconomic variables. Our analysis shows that the interaction between the stabilization mechanism (price adjustment) and the destabilization mechanism (investment adjustment) generates fluctuations and cycles. However, due to price stickiness, the price adjustment mechanism may not be enough to stabilize the economy. In this case, a government stabilization policy is necessary for further stabilization. As this paper also addresses the microfoundations of Keynesian quantity theory, including the choice of output and investment in optimization, it can be related to traditional Keynesian economics, with a new perspective to understand business cycles.     

ECONOMIC GROWTH AND PUBLIC EXPENDITURE COMPOSITION: OPTIMAL ADJUSTMENT USING THE GRADIENT METHOD

Previous studies have looked at how the components of fiscal spending affect economic growth. However, we explicitly enquire into how to adjust the components in order to achieve the highest rate of economic growth starting from the present shares of components, by introducing a gradient method. The resulting optimal adjustment shares are proportional to the deviations from the average over elements of a gradient vector. The optimal adjustment share is completely estimated by using linear regression with any choice of omitted variable. The paper also provides an illustrative example taken from the annual panel data for the Japanese prefectural governments.     

CONSUMPTION–LEISURE TRADE‐OFFS AND PERSISTENCY IN BUSINESS CYCLES

This paper studies whether non‐separabilities between consumption and leisure may help to explain the observed persistence in GNP growth. We consider an extended version of Lucas's (1988) human capital investment model that includes labour adjustment costs and compare its performance under different utility specifications with different degrees of complementarity and substitutability between consumption and leisure. We find that when consumption and leisure are complements the model succeeds in matching not only the autocorrelation of output growth but also the important trend‐reverting component found in US data. These results hold even if low adjustment costs of labour are considered. Hence, we conclude that an arguably simple margin not considered conventionally can provide useful insights into observed business cycle patterns.     

The choice of a foreign price measure in a Bayesian estimated new-Keynesian model for Israel

We estimate a small DSGE model by full information Bayesian techniques on the basis of Israeli data from 1995 to 2006. The model was first developed and estimated by means of classical GMM in Argov and Elkayam (2010), and since then it has been used at the Bank of Israel for monetary policy analysis. It is widely believed that in 2007 (out of sample year) as elsewhere worldwide, inflation rose in Israel due to high commodity prices in global markets. However, our baseline model attributes most of the high inflation in 2007 to supply shocks. One conjecture is that this model's result derives from the inappropriate original use of the unit value of imported consumer goods (which do not include unprocessed food and energy) as the main foreign price measure. We test this conjecture by re-estimating the model with various other foreign price measures that typically do reflect the global rise in commodity prices and compare the log-marginal likelihoods. We find that no other price measure outperforms the original choice in the sample period. Only the foreign trade-weighted CPI equals the performance of the original choice while improving the 2007 interpretation of inflation, and should therefore be considered the main foreign price measure. The proposed methodology for comparing the suitability of alternative measures for observable variables can be applied to any model with exogenous variables that are characterized by univariate equations.     

FISCAL EXPANSIONS,UNEMPLOYMENT, AND LABOR FORCE PARTICIPATION: THEORY AND EVIDENCE*

Structural VARs indicate that for many OECD countries labor force participation, employment, and the unemployment rate significantly increase following increases in government expenditures under a variety of specifications and identification schemes. Fiscal expansions also tend to increase real wages. Existing models have difficulties in generating such responses. We show that the empirical regularities can be reproduced with two additions into a standard New Keynesian model with matching frictions: (a) a labor force participation choice and (b) workers’ heterogeneity.     

Input cost, capacity utilization and substitution in the short run

This article studies the behavior of input cost shares in an environment where labor is costly to adjust, materials can be adjusted at no cost and capital is fixed. A model relating cost shares with relative prices and adjustment costs is proposed, allowing joint estimation of the elasticity of substitution and the adjustment cost function, which is an unknown function of the capacity utilization. Based on a panel of more than 700 manufacturing firms, we find evidence of strong input share variations according to the degree of capacity utilization. The estimated shapes of adjustment costs curves of labor are in agreement with our theoretical model, and we obtain sensible elasticities of substitution estimates. Based on such estimates, we find evidence of a negative (positive) bias in downturns (recoveries) in conventional productivity growth measures.     

Global instability in experimental general equilibrium: the Scarf example

Scarf (Int. Econ. Rev. 1 (1960) 157) proposed a model of dynamic adjustment in which the standard tatonnement price adjustment process orbits around, rather than converges to, the competitive equilibrium. Hirota (Int. Econ. Rev. 22 (1981) 461) characterized the price paths. We explore the predictions of Scarf's model in a non-tatonnement experimental double auction. The average transaction prices in each period do follow the path predicted by the Scarf and Hirota models. When the model predicts convergence the data converge; when the model predicts orbits, the data orbit in the direction predicted by the model. Moreover, we observe a weak tendency for prices within a period to follow the path predicted by the model.     

Is the Relationship between Inflation and Its Uncertainty Linear?

Abstract. We use parametric power ARCH models of the conditional variance of inflation to model the relationship between inflation and its uncertainty using monthly data for Germany, the Netherlands and Sweden over a period ranging from 1962 to 2004. For all three countries inflation significantly raises inflation uncertainty as predicted by Friedman. Increased uncertainty affects inflation in all countries but not in the same manner. For Sweden we find a negative impact in accordance with the Holland hypothesis, whereas for Germany and the Netherlands we find the opposite in support of the Cukierman–Meltzer hypothesis. In a sensitivity analysis we show that an arbitrary choice of the heteroscedasticity parameter influences this relationship significantly.     

Threshold effects in panel data stochastic frontier models of dairy production in Canada

One of the most enduring problems in econometrics is how to properly account for heterogeneity among firms. Threshold regression models are intuitively appealing methods to deal with this issue. We consider a fixed-effect panel data stochastic frontier model (Schmidt and Sickles, 1984; Martin-Marcos and Suarez-Galvez, 2000) and, relying on Hansen (1999, 2000a), we propose an estimator that accommodates multiple thresholds. Our model assumes absence of any unmeasured time invariant heterogeneity across firms as in Greene (2005, p. 277). Slope and threshold parameters can be estimated using a within estimator combined with a grid search over the threshold parameters. Testing for threshold effects is problematic because threshold parameters are not identified under the null hypothesis, a case of the so-called Davies' problem. We apply the bootstrap procedure proposed by Hansen (1999, 2000a) to test for the presence of thresholds. An asymptotic confidence set for the threshold parameter can be obtained by inverting an LR test, using the distribution result presented in Hansen (1999, 2000a). Our empirical application features a panel of Quebec dairy farms. We use farm size as the threshold variable. The presence of a trend in the specification matters for the determination of the number of thresholds. Technical efficiency scores and rankings of farms estimated from competing model specifications are highly correlated and do not vary significantly across groups of farm sizes defined by the threshold parameter values.     

Long-Run Links among Money, Prices and Output: Worldwide Evidence

Abstract. Starting from the quantity theory of money we analyse the dynamic relationships between money, real output and prices for an unbalanced panel of 110 economies. Complementary to trivariate analyses we also adopt a P-star model explaining inflation via an equilibrium price level (P-star), which in turn depends on potential output and money. A key issue of the paper is the cross-sectional stability of estimation and inference results. We find cointegration among the considered variables. Particularly for high inflation countries homogeneity between prices and money cannot be rejected. Given homogeneity we find evidence for an error-correction mechanism linking current price changes and the lagged price gap. Parameter estimates indicating the adjustment towards the price equilibrium are larger in absolute value for high inflation countries. The latter results indicate that central banks, even in high inflation countries, can improve price stability by controlling monetary growth.     

Persistence, Asymmetries and Interrelation in Factor Demand

A neoclassical factor demand model for structures, equipment and labour is analyzed in this paper. It incorporates a variety of dynamic specifications, such as a multi-period time-to-build for structures, internal adjustment costs for each production factor, and external investment adjustment costs. First-order conditions of the model are estimated by the generalized method of moments using manufacturing industry data from the US, Canada, West Germany, the UK (all 1960.I–1988.IV), France (1970.I–1992.II) and the Netherlands (1971.I–1990.IV). The results endorse time-to-build for structures, persistence of technology shocks and interrelations in adjustment cost dynamics.     

Another look at the linear q model: an empirical analysis of aggregate business capital spending with maintenance expenditures

Abstract .  The paper revisits the empirical investment literature, which has established that aggregate business fixed investment is not found to be related linearly to marginal or average Tobin's q . The theoretical background is extended here by developing a supply-side model where the depreciation rate of private capital is determined endogenously. The firm can either invest in 'new' capital, which adds directly to the existing capital stock at the presence of convex adjustment costs, or extend the durability of installed capital through maintenance expenditure, which affects its depreciation rate. The model shows that Tobin's q is then a positively related sufficient statistic for both components of aggregate capital expenditures. This central implication is tested empirically using aggregate time-series survey data from Canada on 'new' investment and maintenance expenditures covering the period 1956–93. The estimated relationships produce significant and plausible parameter estimates for the structural parameters of the q model.     

Discrete Choice with Social Interactions

This paper provides an analysis of aggregate behavioural outcomes when individual utility exhibits social interaction effects. We study generalized logistic models of individual choice which incorporate terms reflecting the desire of individuals to conform to the behaviour of others in an environment of noncooperative decisionmaking. Laws of large numbers are generated in such environments. Multiplicity of equilibria in these models, which are equivalent to the existence of multiple self-consistent means for average choice behaviour, will exist when the social interactions exceed a particular threshold. Local stability of these multiple equilibria is also studied. The properties of the noncooperative economy are contrasted with the properties of an economy in which a social planner determines the set of individual choices. Finally, a likelihood function based on the theoretical model is given and conditions for the econometric identifiability of the model are established.     

Shocking the eurozone

In this paper, the monetary transmission mechanism within the European Monetary Union is investigated. The impulse response functions and forecast error variance decompositions of a structural vector error correction model (SVECM) are compared with those of a New Keynesian theoretical model. The identifying restrictions of the SVECM are directly derived from the theoretical model. Two permanent shocks are identified, one having only nominal, and one having only real effects. The three transitory shocks comprise a short-term interest-rate shock, an aggregate demand shock and a money demand shock. The main conclusions are that permanently reducing the inflation objective depresses output in the first year, but has no real effects in the long run. Regarding output variability, the results indicate that aggregate demand shocks are most important during the first year, after which aggregate supply shocks dominate.     

Modeling the behaviour of inflation deviations from the target

This study tests for and models non-linearities in inflation deviations from the target in five OECD countries that adopted inflation targeting over the 1990s. Our tests reject the linearity hypothesis and we show that the exponential smooth transition autoregressive (ESTAR) model is capable of capturing the non-linear behavior of inflation misalignments. The extent of inflation deviations from the target varies across the OECD countries, with countries that consistently undershoot the target having a rapid adjustment process, whereas countries that overshoot the target have a slower revision back to equilibrium. Out-of-sample forecasts from the ESTAR model outperform the Markov regime-switching model.