Population ageing and inflation with endogenous money creation

This paper models a mechanism through which population ageing may induce a deflationary process. We propose an overlapping-generations model (OLG) with money created by credits (inside money) and intergenerational trade. The model links demographic factors, such as fertility rates and longevity, to prices. We show that lower fertility rates lead to smaller demand for credit and lower money creation, which in turn cause a decline in prices. Changes in longevity affect prices through real savings and the capital market. Furthermore, a few links between interest rates and inflation are addressed; they arise in the general equilibrium and are not thoroughly discussed in literature. Long-run results are derived analytically; short-run dynamics are simulated numerically.     

Will euro area house prices sharply decrease?

The long-term euro area house price equilibrium and its short-term dynamics are estimated by means of a panel error correction model. The estimates show that the short-term dynamics are essentially driven by the autoregressive term (persistence), disposable income and mortgage loans, whereas interest rates have little effect. The long-term house price equilibrium is mainly driven on the demand side by disposable income, interest rates, and mortgage loans, whereas costs (mostly land) drive the equilibrium on the supply side. The unprecedented long-lasting boom in house prices from 1997 to 2007 is thus essentially explained by a favourable macroeconomic development caused by the EMU effect and a glut of global savings. The bust phase of euro area house prices began in 2007, and the current house price might return to its equilibrium level in 2014. According to the most realistic scenario, euro area house prices will experience a smooth and soft landing in 2016 and then begin an increasing phase that will be pulled upwards by a higher equilibrium price. However, a deflationary scenario cannot be excluded if the current credit squeeze is not solved, particularly in the peripheral euro area member states.     

Money and Price Dispersion

We relax restrictions on the storage technology in a prototypical monetary search model to study price dispersion. In this case, buyers and sellers enter matches with potentially different willingness to trade. Across the distribution of possible bilateral matches, prices generally will differ even though agents have identical preferences and technologies. We provide existence conditions for a particularly simple equilibrium pattern of exchange. We prove that in the limiting case where search frictions are eliminated, equilibrium prices are uniform. We also show that a higher initial money stock can raise the average price level and increase price dispersion.     

General equilibrium and the new neoclassical synthesis

We present a general equilibrium model of the new neoclassical synthesis that has the same level of generality as the Arrow–Debreu model. This involves a stochastic multi-period economy with a monetary sector and sticky commodity prices. We formulate the notion of a sticky price equilibrium where all agents form rational expectations on prices for commodities and assets, interest rates, and rationing. We present a general result showing that monetary policy imposes no restrictions whatsoever on nominal equilibrium price levels and that the set of sticky price equilibria has a dimension equal to the number of terminal date-events. Stickiness of prices implies that this indeterminacy is real.     

Equilibrium Prices When the Sunspot Variable Is Continuous

We analyze sunspot-equilibrium prices in nonconvex economies with perfect markets and a continuous sunspot variable. Our primary result is that every sunspot equilibrium allocation can be supported by prices that, when adjusted for probabilities, are constant across states. This result extends to the case of a finite number of equally-probable states under a nonsatiation condition, but does not extend to general discrete state spaces. We use our primary result to establish the equivalence of the set of sunspot equilibrium allocations based on a continuous sunspot variable and the set of lottery equilibrium allocations. Journal of Economic Literature Classification Numbers: D51, D84, E32.     

Multiple equilibrium overnight rates in a dynamic interbank market game

We analyse a two-period model of the interbank market, i.e. the market where banks trade liquidity. We assume that banks do not take the interbank interest rate as given, but instead negotiate on interest rates and transaction volumes with each other. The solution concept applied is the Shapley value. We show that there are a multiplicity of average equilibrium interest rates of the first period so that the average interest rate in this period does not convey any information on the expected liquidity situation on the interbank market. As the banks control not only the transaction volumes, but also the interest rates, they can leave the interest rates constant and adjust the transaction volumes when, for example, a liquidity deficit becomes more likely.     

Prices, Delay, and the Dynamics of Trade

We characterize the dynamics of trading patterns and market composition when trade is bilateral, finding a trading partner is costly, prices are determined by bargaining, and preferences are private information. We show that equilibrium is inefficient and exhibits delay as sellers price discriminate between buyers with different values. As frictions vanish, transaction prices are asymptotically competitive and the welfare loss of inefficient trading approaches zero, even though the trading patterns continue to be inefficient and delay persists. Journal of Economic Literature Classification Numbers: D40, D50.     

Tax-motivated transfer pricing and US intrafirm trade prices

This paper analyzes monthly data on US international trade prices between 1997 and 1999 in order to investigate the impact of tax influences on intrafirm trade prices. Results indicate that there is substantial evidence of tax-motivated transfer pricing in US intrafirm trade prices. There is a strong and statistically significant relationship between countries’ tax rates and the prices of intrafirm transactions. Controlling for other variables that affect trade prices, as country tax rates are lower, US intrafirm export prices are lower, and US intrafirm import prices are higher. This finding is consistent with theoretical predictions regarding tax-motivated income shifting behavior.     

Equilibrium real interest rates and the financial cycle: Empirical evidence for Euro area member countries

We estimate the equilibrium real interest rate for nine Euro area member countries and the Euro area as a whole using quarterly data from 1995 to 2015. We expand the standard model of estimating real equilibrium interest rates to incorporate the financial cycle for the private sector. We show that adding the financial cycle indeed alters the equilibrium real interest rate estimates and, in line with previous studies, that there is a fall in the equilibrium real interest rate over time. Our results indicate that in most member countries the real rate is lower than its equilibrium level. Hence, they should not worry about secular stagnation now. This is because secular stagnation is likely to occur when real interest rates are higher than their equilibrium levels. This result can serve as a starting point for further research in this field, e.g. by adding public sector financial cycles or disentangling the roles of households, corporations and the government.     

Carbon Abatement and International Spillovers

Carbon abatement policies in large open economies affect both the allocation of domestic resources and international market prices. A change in international prices implies an indirect secondary burden or benefit for all trading countries. Based on simulations with a large-scale computable general equilibrium model of global trade and energy use, we show that international spillovers have important welfare implications for carbon abatement policies designed to meet exogenous emission reduction targets. We present a decomposition of the total welfare effect of carbon abatement policies into a primary domestic market effect (at constant international prices) and a secondary international spillover impact as a result of changes in international prices. This decomposition reveals the extent to which domestic abatement costs are increased or decreased as a result of the impact of carbon abatement on international prices.     

A Welfare Ranking of Multilateral Reductions in Real and Tariff Trade Barriers when Firms are Heterogenous

Trade liberalization comes about through reductions in various types of trade barriers. This paper introduces, apart from the customary real trade costs (i.e. iceberg and fixed export costs), two revenue generating trade barriers (i.e. an ad valorem tariff and a trade license) into a standard heterogeneous‐firms‐trade model with Pareto distributed productivities. We derive analytical welfare rankings of all four liberalization channels for an equal effect on two openness measures, for any trade cost level and while all four barriers are simultaneously present, i.e. for any initial equilibrium. We show that when openness is measured at retail prices, not border prices, the welfare rankings are sensitive to the degree of efficiency in revenue redistribution, e.g. the share of tariff revenues wasted on rent‐seeking activities. As a result, multilateral tariff reductions can switch from the least to the most preferred mode of liberalization. Among the other three barriers we establish a universal welfare ranking for any strictly positive level of revenue redistribution and for either measure of openness.     

Trade flows,relative prices,and effective exchange rates: a VAR on Ethiopian data

The dynamic response of trade flows to price and effective exchange rate changes is examined via VAR using quarerly data from Ethiopia for the period 1973(i)–1985(iv). The results show one-way Granger-causality running from prices and exchange rates to imports and exports without significant feedback. Imports and exports exhibit similar response patterns to unexpected changes in relative prices and exchange rates. The responses of imports and exports are larger and the adjustment takes longer when relative prices rather than exchange rates caused a change in international prices. In the long-run, changes in prices account for a larger percentage of the forecast error variances in imports and exports than exchange rate changes. It is shown that devaluation may have an initial adverse effect on the trade balance.     

Randomized double auctions: gains from trade,trader roles,and price discovery

Experimental double-auction commodity markets are known to exhibit robust convergence to competitive equilibria under stable or cyclical supply and demand conditions, but little is known about their performance in truly random environments. We provide a comprehensive study of double auctions in a stochastic setting where the equilibrium prices, trading volumes and gains from trade are highly variable across periods, and with commodity traders who may buy or sell their goods depending on market conditions and their individual outcomes. We find that performance in this stochastic environment is sensitive to underlying market conditions. Efficiency is higher and convergence to the competitive equilibrium stronger when the potential gains from trade are high and when the equilibrium spans a wide range of quantities, implying a large number of marginal trades. Speculative re-trading is prevalent, especially among those who have little to gain under equilibrium pricing. Those with the largest expected gains typically earn far less than predicted, while those with little or no predicted earnings gain modestly from speculation, leading to some redistribution of gains from high to low expected earners. Excessive trading volumes are associated with negative efficiencies in markets with low gains from trade, but not in the high-gains markets, where zero-sum trading and re-trading appear to enforce efficiency and near-equilibrium pricing. Buyers earn more relative to their competitive equilibrium benchmark than sellers do. Introducing trader specialization leads to fewer trading errors and higher market efficiency, but it does not eliminate zero-sum trading and re-trading.

     

Interest Rates,Local Housing Markets and House Price Over‐reactions

Understanding the effects of interest rates on city‐specific house price to household income ratios is important for managing local housing markets. In particular, there is concern that keeping interest rates at sufficiently low levels can distort the relationship between local house prices and fundamentals. We use house price to income ratios across capital cities in Australia to investigate this issue and show that there is a national interest rate ‘transition’ point below which housing dynamics can become unstable. This result lends support to the presence of a duration‐dependent threshold effect (hitherto mainly explored in theoretical models).     

Fiscal Spending,Relative‐Price Dynamics,and Welfare in a World Economy*

This paper analyzes the dynamics of a 2 × 2 × 2 Heckscher–Ohlin model where foreign asset holdings and capital accumulation are independently determined by optimizing agents. Each country has two production sectors, both of whose products are used for consumption, and an investment sector, which uses one of the two commodities to accumulate real capital. In this setting we examine the effects of fiscal spending on the equilibrium paths of interest rates and prices and each country's lifetime utility. The welfare effect is found to consist of the static terms‐of‐trade effect, the dynamic foreign asset effect and the direct income‐loss effect.     

Trade prices and supply in the UK economy

Current account imbalances are a major source of instability in the world monetary and trading system. Measures to correct these imbalances have largely involved adjustments to exchange rates. In the international trade literature, when the current account is in deficit, the Marshall-Lerner condition is sufficient for a successful devaluation. However, this partial equilibrium condition — apart from being based on the assumption that supply elasticities are infinite — abstracts from how the domestic economy responds to the change in relative prices. In this paper we develop a model of price and output determination in an open economy with imperpectly competitive markets, and draw a distinction between goods which are exported and those which are supplied to the domestic market. This means that we have to determine jointly both export prices and the domestic price of house sales. We show that as long as there is no money illusion in the labour market a fall in the nominal exchange rate raises domestic and export prices proportionally and leaves trade volumes unaffected. However, shifts in domestic absorption relative to overseas demand — by changing relative prices — cause shifts in the relative supply of exports and domestically sold goods and affect the trade balance. Thus fiscal and monetary measures directed towards reducing domestic absorption are more likely to be successful in correcting current account imbalances than exchange rate depreciation.     

Regulating collateral-requirements when markets are incomplete

In this paper we examine the effects of default and collateral on risk sharing. We assume that there is a large set of assets which all promise a risk less payoff but which distinguish themselves by their collateral requirements. In equilibrium agents default, the assets have different payoffs, and there are as many linearly independent assets available for trade as there are states of the world. We derive necessary and sufficient conditions for equilibria to be Pareto-efficient in the presence of uncertainty. We explore some examples for which the collateral equilibrium allocation is identical to the Arrow–Debreu allocation, either when agents have a high preference for the durable good, or when the endowment distribution of the durable good is relatively homogeneous. We examine a series of examples to understand which collateral-levels prevail in equilibrium and under which conditions there is scope for regulating margin-requirements, that is, restricting the sets of tradable assets through government intervention. In these examples equilibrium is always sub-optimal but regulation never leads to a Pareto-improvement. While the competitive equilibria are constrained efficient, there do exist regulations which make large groups of agents in the economy better off. These regulations typically restrict all trades to take place in the low-collateral loans and benefit the poor and the rich agents in the economy through their effects on the equilibrium interest rate and the equilibrium prices of the durable goods.     

The Heath, Jarrow, Morton Model

Equilibrium models of the term structure of interest rates, such as Vasicek (1977) and Cox et al. (1985) , hereafter CIR, determine the equilibrium yield curve by modelling the dynamics of the short-term interest rate, specifying the market price of risk, and solving the resulting partial differential equation for bond prices. Several multi-factor extensions of the Vasicek and CIR framework have been advanced in the recent term structure literature using as additional factors different variables, such as the volatility of interest rates (see, e.g. Longstaff and Schwartz, 1992 ; Dai and Singleton, 2000 ), the slope of the term structure ( Brennan and Schwartz, 1979 ; Schaefer and Schwartz, 1984 ), monetary policy rates ( Bakshi and Chen, 1996 ), and inflation ( Pennacchi, 1991 ; Sun, 1992 ). Since a no-arbitrage condition must hold in equilibrium, this brief article starts from the stated law of motion for bond prices to tersely show how their implied instantaneous forward rates have an evolution under the pricing measure that is fully characterized by the forward rate volatilities. Thus, the outcome of the article is the fundamental equation of the classic model contributed by Heath et al. (1992) , hereafter HJM, which sets off with the study of the forward rates' no-arbitrage dynamics. By doing so, it shows that, despite its different angle and its apparent complex structure, the HJM model is fully consistent and has a clear link with standard equilibrium set-ups like those of the Vasicek and CIR type. This note was written in 1994 .     

Price signaling and the strategic benefits of price rigidities

We analyze trade between a perfectly informed price setting party (seller) and an imperfectly informed price taker (buyer). Differently from most of the literature, we focus on the case in which, under full information, it would be inefficient to trade goods of sufficiently poor quality. We show that the unique equilibrium surviving D1 is characterized by market breakdown, although trade would be mutually beneficial in some state of nature. This occurs independently of the precision of the information available to the buyer. The model thus implies that signaling through prices may exacerbate the effect of adverse selection rather than mitigate it. Under D1, the seller would always benefit from committing to prices that do not reveal her information. We develop this intuition by analyzing the strategic advantages of price rigidities. We show that price rigidities help restore trade and could even enhance effectiveness of prices as signals of quality.     

International finance in general equilibrium

Our purpose in this paper is to unify international trade and finance in a single general equilibrium model. Our model is rich enough to include multiple commodities (including traded and nontraded goods), heterogeneous consumers in each country, multiple time periods, multiple credit markets, and multiple currencies. Yet our model is simple enough to be effectively computable. We explicitly calculate the financial and real effects of changes in tariffs, productivity, and preferences, as well as the effects of monetary and fiscal policy.We maintain agent optimization, rational expectations, and market clearing (i.e. perfect competition with flexible prices) throughout. But because of the important role money plays, and because of the heterogeneity of markets and agents, we find that fiscal and monetary policy both have real effects. The effects of policy on real income, long-term interest rates, and exchange rates are qualitatively identical to those suggested in Mundell-Fleming (without the small country hypothesis), although our equilibrating mechanisms are different. However, because the Mundell-Fleming model ignores expectations and relative price changes, our model predicts different effects on the flow of capital, the balance of trade, and real exchange rates in some circumstances.