Equality of interest rates revisited: the multi‐country evidence

One influential aspect of international integration of financial markets is the possibility of reducing divergences between domestic interest rates and foreign interest rates or increasing the degree to which yields in different financial markets move together over time. In this study, we investigate the convergence of the real interest rates using the Kalman filter. Applying the modified Hall et al. () approach, we model the risk premium and convergence of real interest rates using the time‐varying parameter estimation techniques. We present evidence of risk premium and convergence for two blocks of countries—The Asian‐Pacific countries including the US, Japan, Taiwan and South Korea and the US‐European group including France, the UK, Germany and the US.     

How elastic are national corporate income tax bases in OECD countries? The role of domestic and foreign tax rates

Abstract To what extent do reductions in corporate income tax (CIT) rates attract foreign tax bases? What are the revenue implications of a unilateral tax reduction when tax bases are internationally mobile? These questions are explored using annual data from 17 OECD countries spanning the period 1982 to 2005. Controlling for fixed country effects, year effects, and country time trends, and subjecting our results to an extensive robustness analysis, we find (i) a country’s aggregate reported corporate profits are negatively and significantly affected by CIT rate reductions in neighbouring countries; (ii) a unilateral reduction in the domestic CIT rate results in lower domestic CIT revenues.     

Bi‐currency versus Single‐currency Targeting: Lessons from the Russian Experience

This paper examines how the 2005 shift in Russian exchange rate policy from US dollar (USD) single‐currency to USD–EUR (euro) bi‐currency targeting has impacted domestic interest rates. The finding show that this policy shift has disconnected Russian interest rates from US dollar‐denominated interest rates, while instead linking them to a synthetic interest rate composed of USD and EUR rates at the same proportion as that of these two currencies in the currency basket against which the ruble's exchange rate is set. The Russian experience shows that while the adoption of bi‐currency targeting may help ensure that domestic interest rates are less dependent on the monetary cycle of a single country, these rates are instead likely to reflect financial developments in all countries whose currencies are included in the currency basket. This insight is likely to be relevant for other countries that pursue basket‐targeting policies.     

Uncovered Interest Parity at Long Horizons: Evidence on Emerging Economies*

This paper estimates uncovered interest parity (UIP) at long horizons using bilateral US dollar rates vis‐à‐vis mature economy and emerging market currencies. The paper finds support in favor of UIP for dollar rates vis‐à‐vis major mature economy currencies, but far less against emerging market currencies. There are also signs that political risk and the exchange risk premium help explain the empirical failure of UIP for these latter currencies. This suggests that whether UIP holds depends more on the currency than on the horizon.     

IS TIGHTER FISCAL POLICY EXPANSIONARY UNDER FISCAL DOMINANCE?: HYPERCROWDING OUT IN LATIN AMERICA

Hypercrowding out occurs when fiscally dominated governments' domestic credit demands are so intrusive to a nation's financial system that a move toward fiscal surplus lowers interest rates and increases growth. We sample nine Latin American countries to test for these relationships. The impulse‐response results of vector error correction models, six nations test positive for these two connections, suggesting market concern despite recent efforts toward fiscal balance. (JEL E430, E620, O230, O540)     

The Macroeconomics of Financial Crises: How Risk Premiums and Liquidity Traps Affect Policy Options

The paper offers an overview of what structural models of the IS-LM and Mundell-Fleming variety can tell about the macroeconomics of economic crises. In addition to demonstrating how the emergence of risk premiums in money and capital markets can generate liquidity traps at positive interest rates and may drive economies into recessions, it shows the following: (1) Fiscal policy works even in a small, open economy under flexible exchange rates when the country is stuck in a liquidity trap; (2) Near the fringe of liquidity traps, there may be perfect traps, in which neither monetary nor fiscal policy works when used in isolation but policy coordination is called for; and (3) Massive financial crises in the domestic money market may even destabilize the economy.     

Commodity Prices and the Dynamics of Inflation in Commodity‐Exporting Nations: Evidence from Australia and Canada*

A commodity‐price boom is under way. What does this boom mean for inflation in countries with substantial net commodity exports? The answer depends on movements in commodity prices, changes in foreign exchange rates and the determinants of domestic price inflation. We estimate equations to provide indications of the strength of each of these forces for both Australia and Canada. The results show that world commodity prices move pro‐cyclically with world industrial production and that rates of change in commodity prices are directly related to domestic inflation in both countries. However, there is an offsetting impact of exchange‐rate changes, which is strong enough in the case of Australia, but not Canada, to substantially eliminate the inflationary impact of a commodity‐price boom.     

MIGRATION, UNEMPLOYMENT, AND WAGES: THE CASE OF THE CALIFORNIA SAN JOAQUIN VALLEY

The California San Joaquin Valley labor market appears to be at odds with basic economic principles in the sense that despite higher unemployment rates and lower wages, it has continually attracted an influx of in‐migrants, domestic and international. By examining county‐level data for the last two decades, the analysis in this paper is built around two main questions. First, in what proportion does local employment growth reduce local unemployment, increase labor force participation and attract outsiders who will likely take the newly created jobs? Second, to what extent regional migration rates respond to regional relative wages and unemployment differentials? Both questions aim to gain a better understanding of the San Joanquin Valley labor market and the migrants’ decisions to move there, which might shed light in the design and implementation of development policies aimed at reducing unemployment. Results provide evidence that market forces alone are insufficient to correct regional unemployment disparities. Three main findings are offered. First, in‐migrants workers fill most of the newly created jobs. Second, migration seems unresponsive to the unemployment level but responsive to changes in farm income. Third, migration is sensitive to government‐based benefits, property crime rates and housing prices. (JEL R11, R23, R58)     

GROWTH AND WELFARE EFFECTS OF WORLD MIGRATION

Using a two‐bloc endogenous growth model calibrated to two generic sending and receiving countries of equal size, we assess the growth and welfare impact of world migration flows of different skill compositions. The sending country (East) has a lower total factor productivity and a lower endowment of skilled labour. Migration can induce two growth‐enhancing effects: an efficiency effect from the more efficient use of labour in the receiving country (West) and a sectoral reallocation effect from a fall in the host country skilled–unskilled wage rates. Despite growth gains, there are both winners (migrants, the representative Western non‐migrant household) and losers (the representative Eastern household remaining). Remittances can see the latter group joining the winners.     

The Impact of Regret on Exports

We examine optimal production and export decisions of a firm facing exchange rate uncertainty, where the firm's management is not only risk averse but also regret averse, i.e., is characterized by a utility function that includes disutility from having chosen ex post suboptimal alternatives. Experimental and empirical results support the view that managers tend to be regret averse. Under regret aversion a negative risk premium need not preclude the firm from exporting which would be the case if the firm were only risk averse. Exporting creates an implicit hedge against the possibility of regret when the realized spot exchange rate turns out to be high. The regret‐averse firm as such has a greater ex ante incentive to export than the purely risk averse firm. Finally, we use a two‐state example to illustrate that the firm optimally exports more (less) to the foreign country than in the case of pure risk aversion if the low (high) spot exchange rate is more likely to prevail. Regret aversion as such plays a crucial role in determining the firm's optimal allocation between domestic sales and foreign exports.     

EFFECTIVENESS OF MONETARY POLICY IN SWEDEN

We study whether the sensitivity of Swedish interest rates to domestic economic news was affected by the zero lower bound (ZLB) and forward guidance. We find that the sensitivity was reduced at the ZLB at short but not at longer maturities, suggesting that monetary policy remained effective at longer horizons. Moreover, it was unaffected during a later period of the ZLB/negative policy rates, suggesting that monetary policy remained effective at all horizons then. We also find that the sensitivity of interest rates to domestic news was unaffected by forward guidance, suggesting that market participants understood the conditionality of the forward guidance. (JEL E52, E58)     

Strategic competition and optimal parallel import policy

Abstract In a two‐country Hotelling type duopoly model of price competition, we show that parallel import (PI) policy can act as an instrument of strategic trade policy. The home firm’s profit is higher when it cannot price discriminate internationally if and only if the foreign market is sufficiently bigger than the domestic one. The key mechanism in the model is that the home firm’s incentive to keep its domestic price close to the optimal monopoly price affects its behavior during price competition abroad. We also analyze the welfare implications of PI policies and show that our key insights extend to quantity competition.     

NATIONAL TREATMENT AT THE WTO: THE ROLES OF PRODUCT AND COUNTRY HETEROGENEITY*

This paper analyzes the World Trade Organization's (WTO's) national treatment (NT) clause in a two‐country model where quality of goods and/or market size are heterogenous across countries. When market size is symmetric across countries, a reciprocal NT agreement (i) benefits the high‐quality country, (ii) hurts the low‐quality country, and (iii) delivers higher aggregate world welfare. However, such an agreement can arise in equilibrium if the high‐quality country's market is relatively bigger and the quality gap between goods is small (i.e., goods are sufficiently alike). The qualitative nature of these results does not change when quality is endogenously determined.     

ASSESSING THE IMPACTS OF LABOR MARKET AND DETERRENCE VARIABLES ON CRIME RATES IN MEXICO

Many studies examine the relationship between crime rates and various economic and/or sociodemographic variables in high income countries, but similar efforts for middle and low income countries are less common. Utilizing an 8‐year panel data sample for all 32 states in Mexico, this study assesses the impact of Mexican labor market and deterrence variables on various Mexican crime rates. The principal results indicate that: (1) State gross domestic product (GDP) per capita has ambiguous effect on crime rates under different conditions. Both wages and unemployment rates are negatively linked with crime rates. (2) Although the Mexican judicial and public security systems are widely believed to be ineffective, increased federal police forces and incarceration rates are associated with lower crime rates, but higher public security expenditure per capita is associated with higher crime rates. (3) The impacts from labor market and deterrence variables presented in (1) and (2) continue to hold under the Fox administration as well as for non‐border states. Their respective impacts diminish, however, under the Calderon administration as well as for border states because of the small number of observations. Overall, the results indicate that increasing average wages, federal police forces, and incarceration rates would have significant impacts on reducing crime rates in Mexican states. (JEL O54, K42)     

Short-term eurocurrency rate behavior and specifications of cointegrating processes

This article presents empirical evidence on short-term behavior based on seven Eurocurrency market rates. Empirical analysis suggests that there is two-dimensional cointegration. First, the domestic short-term interest rate is cointegrated with longer-term interest rates within a particular country. Second, the domestic short-term interest rate is cointegrated with the comparable foreign short-term interest rate adjusted for the foreign exchange forward premium (discount). The empirical evidence confirms that an error-correction model combining both dimensional market-correcting processes better explains short-term interest rate movements.     

ON THE IMPACT OF PUBLIC DEBT ON ECONOMIC GROWTH: DOES COUNTRY RISK MATTER?

This study examines the nonlinear impacts of four country risk indices on the debt‐growth nexus for 61 countries in a panel data framework. Our results show evidence of the different debt‐growth nexus under the different degrees of country risk. Under a high‐risk environment, a country's economic growth is harmed by raising its public debt. The negative effects public debt has on economic growth become weak under low political and financial‐risk environments, while an increase in public debt could help to stimulate economic growth under low composite and economic risk environments. In addition, the differences of countries' income and debt levels also lead country risks to have different effects on the debt‐growth nexus, suggesting that a country should borrow appropriately based on its current risk environments while improving economic performance. (JEL C33, E02, H63, O43)     

UNDERSTANDING MEASURES OF NONMARITAL FERTILITY: THE ROLES OF MARRIAGE AND ACCESS TO HUMAN CAPITAL

This paper proposes an explanation for several decades of rising U.S. nonmarital birth rates and shares, and for cross‐sectional differences in black‐white fertility. Significantly, the explanation does not rely on changes over time or differences across races in individual fertility behavior. It is consistent with the rising nonmarital fertility measures observed in the United States since the mid‐1970s, higher measured fertility for unmarried blacks than whites, and differences across races in the timing of childbearing, despite nearly constant total fertility rates and increasingly similar target family sizes for blacks and whites. The explanation relies on a selection effect associated with changes in the marriage rate and on racial differences in access to human capital investment opportunities. We find strong support for the explanation using U.S. data over the period 1957–2002. Our findings suggest caution in interpreting the results of empirical studies of childbearing that examine marital and nonmarital fertility rates separately, as these studies typically ignore the selection effect of marriage. (JEL J12, J13, I38)     

A Theory of Exchange Rates and the Term Structure of Interest Rates

This paper defines the concepts of indirect and direct risk premium effects and analyzes their properties in an exchange rate model. In the model, these effects are endogenously determined in a rational expectations equilibrium. For the effect of an interest rate shock, they have the opposite signs and the indirect risk premium effect can dominate the direct risk premium effect under reasonable parameters. This means that domestic short‐term bonds and foreign bonds are complements in the model even though domestic long‐term bonds and foreign bonds are substitutes. This model, focusing on the indirect risk premium effect and on the term structure of interest rates, can be combined with a small sample bias approach to explain stylized facts about the forward premium anomaly, which is found for short‐term interest rates, but not for long‐term interest rates.     

Monetary policy before and after the euro: evidence from Greece

We model Greek monetary policy in the 1990s and use our findings to address two interrelated questions. First, how was monetary policy conducted in the 1990s so that the hitherto highest-inflation EU country managed to join the euro by 2001? Second, how compatible is the ECB monetary policy with Greek economic conditions? We find that Greek monetary policy in the 1990s was: (i) primarily determined by German/ECB interest rates, though still influenced by domestic fundamentals; (ii) involving non-linear output gap effects; (iii) subject to a deficit of credibility culminating in the 1998 devaluation. On the question of compatibility our findings depend on the value assumed for the equilibrium post-euro real interest rate and overall indicate both a reduction in the pre-euro risk premium and some degree of monetary policy incompatibility. Our analysis has policy implications for the new EU members and motivates further research on fast-growing EMU economies.