Expectations, learning and macroeconomic persistence

Monetary DGSE models under rational expectations typically require large degrees of features as habit formation in consumption and inflation indexation to match the inertia of macroeconomic variables.This paper presents an estimated model that departs from rational expectations and nests learning by economic agents, habits, and indexation. Bayesian methods facilitate the joint estimation of the learning gain coefficient together with the ‘deep’ parameters of the economy.The empirical results show that when learning replaces rational expectations, the estimated degrees of habits and indexation drop closer to zero, suggesting that persistence arises in the model economy mainly from expectations and learning.     

External shocks, U.S. monetary policy and macroeconomic fluctuations in emerging markets

Estimated structural VARs show that external shocks are an important source of macroeconomic fluctuations in emerging markets. Furthermore, U.S. monetary policy shocks affect interest rates and the exchange rate in a typical emerging market quickly and strongly. The price level and real output in a typical emerging market respond to U.S. monetary policy shocks by more than the price level and real output in the U.S. itself. These findings are consistent with the idea that “when the U.S. sneezes, emerging markets catch a cold.” At the same time, U.S. monetary policy shocks are not important for emerging markets relative to other kinds of external shocks.     

Idiosyncratic production risk, growth and the business cycle

We introduce a neoclassical growth economy with idiosyncratic production risk and incomplete markets. Each agent is an entrepreneur operating her own technology with her own capital stock. The general equilibrium is characterized by a closed-form recursion in the CARA-normal case. Incomplete markets introduce a risk premium on private equity, which reduces the demand for investment. As compared to complete markets, the steady state can thus have both a lower capital stock due to investment risk, and a lower interest rate due to precautionary savings. Furthermore, the anticipation of high real interest rates in the future feeds back into high risk premia and low investment in the present, thus slowing down convergence to the steady state. Our results highlight the importance of private risk premia for capital accumulation and business cycles.     

Macroeconomic consequences of terror: theory and the case of Israel

This paper analyzes the effect of terror on the economy. Terror endangers life such that the value of the future relative to the present is reduced. Hence, due to a rise in terror activity, investment goes down, and in the long run income and consumption go down as well. Governments can offset terror by putting tax revenues into the production of security. Facing a tide in terror, a government that acts optimally increases the proportion of output spent on defense, but does not fully offset the tide. Thus, when terror peaks the long run equilibrium with an optimizing government is of lower output and welfare. Next, we show that this theory of terror and the economy, helps to understand changes in trend and business cycle of the Israeli economy. The estimates show that terror has a large impact on the aggregate economy. Continued terror, at the level of the death toll by about the same size as due to car accidents, is expected to decrease annual consumption per capita by about 5% in 2004. Had Israel not suffered from terror during the last 3 years, we estimate that the output per capita would have been 10% higher than it is today.     

Endogenous capacity utilization and macroeconomic persistence

This paper presents a monetary dynamic general equilibrium model featuring a strong internal propagation mechanism. Limited short-run factor substitutability and idiosyncratic demand uncertainty play a prominent role in the results. Firms are ex post heterogeneous and a well defined distribution of capacity utilization rates characterizes the equilibrium of the model. The economy responds gradually to aggregate shocks since firms with excess capacity can raise production without experiencing large increases in their marginal costs. The modeling framework presented in this paper offers a plausible microeconomic interpretation for reduced form mark-up shocks typically considered in the “new Keynesian” literature.     

Theory, measurement and calibration of macroeconomic models

Calibration has become a standard tool of macroeconomics. This paper extends and refines the calibration methodology along several important dimensions. First, accounting for home production is important both in measuring calibration targets and in organizing the data in a model-consistent fashion. For this reason, thinking about home production is important even if the model under consideration does not include home production. Second, investment-specific technological change is included because of its strong balanced growth parameter restrictions. Third, the measurement strategy is laid out as transparently as possible so that others can easily replicate the underlying calculations. The data and calculations used in this paper are available at http://clevelandfed.org/research/Models/rbc/Index.cfm     

Inflation and inequality

Cross-country evidence on inflation and income inequality suggests that they are positively related. This article explores the hypothesis that this correlation is the outcome of a distributional conflict underlying the determination of government policies. A political economy model is presented in which equilibrium inflation is positively related to the degree of inequality in income due to the relative vulnerability to inflation of low income households.     

Fiscal Consolidation and Decentralisation: A Tale of Two Tiers*

This paper contributes to the established literature on fiscal consolidations by investigating the distinct behaviour of central and sub‐central tiers of government during general government consolidation attempts. In the light of different degrees of decentralisation across OECD countries, and the different responsibilities devolved to sub‐central tiers, we believe that this approach offers an illuminating insight into the analysis of fiscal consolidations and their success. We show that the involvement of the sub‐central tiers of government is crucial to achieving cuts in expenditure, particularly in relation to the overall size of the government wage bill. In addition, central governments appear to exert a strong influence on the expenditure of sub‐central tiers through their grant allocations, and control of these allocations appears to have a considerable impact upon the overall success of consolidation attempts. Finally, we demonstrate that there is a skewness in cuts towards sub‐central capital expenditure both when central governments cut grant allocations and when sub‐central governments engage in lone consolidation attempts.     

Payment system disruptions and the federal reserve following September 11, 2001

The monetary and payment system consequences of the September 11, 2001, terrorist attacks and the Federal Reserve's response are reviewed. Interbank payment disruptions appear to be a central feature of many US banking crises, and interbank payment disruptions seem likely to recur. Federal Reserve credit extension following September 11 succeeded in massively increasing the supply of banks’ balances to satisfy the disruption-induced increase in demand and thereby ameliorate the effects of the shock. Relatively benign banking conditions helped make Fed credit policy manageable. An interbank payment disruption that coincided with less-favorable banking conditions could be more difficult to manage, given current daylight credit policies. Paying interest on reserves would facilitate improvements in daylight credit policy.     

Nonseparable Preferences, Fiscal Policy Puzzles, and Inferior Goods

Nonseparable preferences over consumption and leisure can generate an increase in private consumption in response to government spending, as found in the data, in a frictionless business cycle model. However, the conditions on preferences required for these result to obtain hold if and only if the consumption good is inferior. Similarly, positive co-movement of consumption and hours worked occurs if and only if either consumption or leisure is inferior.     

Non-concavity problems in the dynamic macroeconomic models: A note

This note provides a method to convert the dynamic models in Cysne [Cysne, Rubens P., 2006. A note on the non-convexity problem in some shopping-time and human-capital models. Journal of Banking and Finance 30 (10), 2737–2745] and in Cysne [Cysne, Rubens P., 2008. A note on “inflation and welfare”. Journal of Banking and Finance 32 (9), 1984–1987] to concave optimization problems. We do this by introducing new control and state variables in the models. Cysne (2006, 2008) restrict attention to continuous time models and derive parametric conditions to use Arrow’s sufficiency theorem. When the sufficient conditions presented in Cysne (2006) are satisfied (but not under the sharper sufficient conditions presented in Cysne (2008)) we can rewrite these models as concave optimization problems even if time is discrete.     

Real-time macroeconomic data and ex ante stock return predictability

We report results on the ex ante predictability of monthly excess stock returns in Germany using real-time and revised macroeconomic data. Our real-time macroeconomic data cover the period 1994-2005. We report that the contribution of real-time macroeconomic data to ex ante stock return predictability is similar to that of revised macroeconomic data. Moreover, the performance of an investor who had to rely on noisy real-time macroeconomic data would have been similar to the performance of an investor who had access to revised macroeconomic data.     

The impact of foreign stock markets on macroeconomic dynamics in open economies: A structural estimation

With the increased international financial integration in recent years, bilateral financial linkages between countries may have a growing influence on their real economies. This paper employs a structural two-country New Keynesian model, which incorporates a cross-border wealth channel, to estimate the effect that foreign stock market fluctuations may have on macroeconomic variables in open economy countries.The model is estimated using Bayesian methods on a sample of open economies that can potentially be affected by changes in a larger foreign stock market: Australia, Canada, New Zealand, Ireland, Austria, and the Netherlands. The estimation allows for deviations from rational expectations and for learning by economic agents.The empirical results indicate important cross-country wealth effects for Ireland and Austria, from fluctuations in the U.S. and U.K. and in the U.S. and German stock markets, respectively; the wealth effect is largest in Ireland. The data favor, instead, specifications with no significant wealth effect for the remaining countries. Foreign stock price fluctuations, however, still play a role by affecting domestic expectations about future output gaps in all countries in the sample.     

Importing technology

We look at disaggregated imports of various types of equipment to make inferences on cross-country differences in the composition of equipment investment. We make three contributions. First, we document strikingly large differences in investment composition. Second, we explain the differences as being based on each equipment type's degree of complementarity with other factors whose abundance differs across countries. Third, we show that the composition of capital has the potential to account for some of the large observed differences in TFP across countries.     

The effect of financial repression and enforcement on entrepreneurship and economic development

A general equilibrium model with heterogeneous agents (with respect to wealth and ability) shows that differences across countries in intermediation costs and enforcement generate differences in occupational choice, firm size, credit, output and income inequality. Counterfactual experiments are performed for Latin American, European, transition and high growth Asian countries, with empirical estimates of each country's financial frictions and United States values for all other parameters. The results isolate the quantitative effect of these financial frictions in explaining the performance gap between each country and the United States, and depend critically on whether a general equilibrium factor price effect is operative.     

The dynamics of government

We model income redistribution with dynamic distortions as determined by rational voting without commitment among individuals of different types and income realizations. We find that redistribution is too persistent relative to that chosen by a planner with commitment. The difference is larger, the lower is the political influence of young agents, the lower is the altruistic concern for future generations, and the lower is risk-aversion. Furthermore, there tends to be too much redistribution in the political equilibrium. Finally, smooth preference aggregation, as under probabilistic voting, produces less persistence and does not admit multiple equilibria, which occur under majority-voting aggregation.     

The innovation consequences of mandatory patent disclosures

We investigate the effect of patent disclosures on corporate innovation. Using the American Inventor's Protection Act (AIPA) as a shock that increased patent disclosures, we find an increase in innovation for firms whose rivals reveal more information after the AIPA and a decrease in innovation for firms whose own disclosures are divulged to competitors as a result of the law. These findings suggest patent disclosures generate both spillover benefits and proprietary costs. Our findings provide justification for patent disclosure requirements by demonstrating positive externalities: rivals' disclosures facilitate a firm's innovation. However, we also highlight that mandatory patent disclosures can impose proprietary costs on firms. These results broadly contribute to our understanding of the real effects of disclosure, such that forcing firms to share proprietary information can be privately costly but beneficial to other firms.     

Trust Me! I am a European Central Banker

In the aftermath of the financial crisis, the European Central Bank (ECB) has experienced an unprecedented deterioration in the level of trust. This raises the question as to what factors determine trust in central banking. We use a unique cross‐country data set that includes a rich set of socioeconomic characteristics and supplement it with variables meant to reflect a country's macroeconomic condition. We find that besides individual socioeconomic characteristics, macroeconomic conditions play a crucial role in the trust‐building process. Our results suggest that agents are boundedly rational in the trust‐building process and that current ECB market operations may even be beneficial for trust in the ECB in the long run.     

The market for new issues of municipal bonds: The roles of transparency and limited access to retail investors

I examine how transparency and interdealer trading affects prices investors pay in municipal bond offerings. Real-time trade reporting for municipal bonds started January 31, 2005. The dispersion of purchase prices fell sharply at that time. There was little impact on average markups for most trades, but they increased for purchases of more than $100,000. Bonds often pass through a series of dealers before being placed with a buy-and-hold investor. As the interdealer trades progress, trade sizes decline and trade prices rise. Markups on investor purchases increase with the amount of interdealer trading before the trade.     

The Dynamic (In)Efficiency of Monetary Policy by Committee

This paper develops a model where the value of the monetary policy instrument is selected by a heterogenous committee engaged in a dynamic voting game. Committee members differ in their institutional power, and in certain states of nature, they also differ in their preferred instrument value. Preference heterogeneity and concern for the future interact to generate decisions that are dynamically inefficient and inertial around the previously agreed instrument value. This model endogenously generates autocorrelation in the policy variable and helps explain the empirical observation that the distribution of actual interest rate changes has a mode of zero.