The composition of government spending and the multiplier at the zero lower bound

We investigate the size of the multiplier at the ZLB in a New Keynesian model. It ranges from around −0.25 to +1.5, depending on the extent to which the government spending is productive, substitutable or not for private consumption.     

Price level targeting and the delegation issue in an open economy

A weight-conservative central banker setting policy with discretion and stabilizing the real exchange-rate-adjusted (REX) price level and the output gap can replicate the behavior of the rate of REX inflation and the output gap under policy from a timeless perspective.     

When does financial integration matter for fiscal policy in a currency union? A welfare-based approach

We use a two-country new open economy macroeconomics model describing a currency union with imperfect financial integration. We assume that household preferences are biased towards the goods produced within the country. We use this setup to show how the degree of financial integration and the home bias affect the welfare efficiency of fiscal policy. This is particularly important for the implications of a fiscal policy launched by a member of the euro zone where the home bias is in a decreasing trend due to higher goods market integration and where there are explicit efforts to enhance financial integration. The results show in particular how the effects of an increasing financial integration on the impact of a fiscal policy can be mitigated or amplified by a decreasing home-product bias. Moreover, under certain conditions, the degree of financial integration has no effect on the welfare efficiency of fiscal policy despite its non-negligible effects on the components of welfare.     

Investment-specific shocks and external balances in a small open economy model

Abstract.  We set up a standard small open economy business cycle model driven by government spending shocks, neutral productivity (TFP) shocks, and investment-specific shocks. The model is calibrated to quarterly Canadian data and its predicted moments and sample paths are compared with their Canadian counterparts. We find that the model captures the dynamics in investment and in the trade balance better than special cases of the model where either one of the productivity shocks is omitted. More specifically, the model matches the variance of the trade balance-output ratio, its correlation with output and its autocorrelation. It also matches the output-investment correlation.     

A dynamic small open economy model with involuntary unemployment

Abstract It is well known that real business cycle small open economy (SOE) models rely on Greenwood, Hercowitz, and Huffman (1988) preferences to match the countercyclical trade balance observed in open economies, as well as other second moments, while standard preferences à la King, Plosser, and Rebelo (1988) are commonly labelled ‘ineffective,’ owing to their inability to yield the countercyclical trade balance. In this paper, I show that an SOE model with standard preferences and ‘involuntary’ unemployment with efficient risk sharing can obtain a countercyclical trade balance and match main empirical regularities in small open economies.     

Optimal monetary policy for a small open economy

This paper focuses on the design of monetary policy rules for a small open economy. The model features optimizing behavior, general equilibrium and price stickiness. The real exchange rate is shown to affect the firm's real marginal cost, aggregate supply and aggregate demand. The welfare objective depends on the openness of the economy, and the optimal policy rule differs from that which obtains in a closed economy. The inflation versus output gap stabilization trade-off is caused by the real exchange rate. The implied optimal monetary policy regime is domestic inflation target coupled with controlled floating of the real exchange rate.     

Re‐vitalizing money demand in the Euro area. Still valid at the zero‐lower bound

The analysis of monetary developments has always been a cornerstone of the ECB's monetary analysis and, thus, of its overall monetary policy strategy. In this respect, money demand models provide a framework for explaining monetary developments and assessing price stability over the medium term. It is a well‐documented fact in the literature that, when interest rates are at the zero‐lower bound, the analysis of money stocks become even more important for monetary policy. Therefore, this paper re‐investigates the stability properties of M3 demand in the euro area in the light of the recent economic crisis. A cointegration analysis is performed over the sample period 1983 Q1 and 2015 Q1 and leads to a well‐identified model comprising real money balances, income, the long‐term interest rate and the own rate of M3 holdings. The specification appears to be robust against the Lucas critique of a policy dependent parameter regime, in the sense that no signs of breaks can be found when interest rates reach the zero‐lower bound. Furthermore, deviations of M3 from its equilibrium level do not point to substantial inflation pressure at the end of the sample. Excess liquidity models turn out to outperform the autoregressive benchmark, as they deliver more accurate CPI inflation forecasts, especially at the longer horizons. The inclusion of unconventional monetary policy measures does not contradict these findings.     

The optimal choice of monetary policy instruments in a small open economy

Abstract.  This paper studies how the nature of shocks affects the optimal choice of monetary policy instruments in a small open economy. Three classic rules, fixed exchange rates, monetary targeting, and inflation targeting are studied and ranked by comparing with the optimal monetary policy under commitment. We find that the ranking of the simple rules can be mapped to the terms-of-trade variability that the rule allows relative to what a particular shock optimally calls for. It turns out that inflation targeting dominates the other two rules under productivity or velocity shocks, whereas monetary targeting is the best performer under fiscal shocks.     

Introduction: macroeconomic implications of capital flows in a global economy

The papers in this volume address issues raised by the wave of financial crises that hit emerging markets since the mid 1990s. Several of the papers examine the role that different credit market frictions may have played in triggering the crises, or in determining the effects of policies aimed at containing them. Other papers ask more general questions about the implications of international financial integration for business cycles, risk sharing, and sovereign lending.     

On indeterminacy and growth under progressive taxation and productive government spending

We examine the theoretical interrelations between equilibrium (in)determinacy and economic growth in a one‐sector representative‐agent model of endogenous growth with progressive taxation of income and productive flow of public spending. We analytically show that, if the demand‐side effect of government purchases is weaker, the economy exhibits an indeterminate balanced‐growth equilibrium and belief‐driven growth fluctuations when the tax schedule is sufficiently progressive or regressive. If the supply‐side effect of public expenditures is weaker, indeterminacy and sunspots arise under progressive income taxation. In sharp contrast to traditional Keynesian‐type stabilization policies, our analysis finds that raising the tax progressivity may destabilize an endogenously growing economy with fluctuations driven by agents’ self‐fulfilling expectations.     

Trend inflation and macroeconomic stability in a small open economy

This paper estimates a small open economy New Keynesian model for Australia with positive trend inflation while allowing for multiple equilibria. We first show the extent to which positive trend inflation can shrink the determinacy region. We then conduct a Bayesian estimation over two separate periods: from 1983Q1 to 1993Q1, covering the pre-inflation-targeting regime, and from 1993Q2 to 2018Q4, covering the inflation-targeting regime. We find that Australian monetary policy before the adoption of inflation-targeting permitted multiple equilibria and self-fulfilling inflation expectations to arise, resulting in exacerbated macroeconomic volatility. The implementation of inflation-targeting in Australia in the early 1990s successfully eradicated equilibrium multiplicity and sunspot shocks, and thereby drove the economy towards greater stability.     

Wage rigidities and unemployment fluctuations in a small open economy

This study analyzes the implications of the monetary policy for the unemployment rate in a small open economy. We introduce nominal wage rigidities and unemployment into the small open economy version of the dynamic stochastic general equilibrium model. We derive three main findings. First, under nominal wage rigidities, the cyclical properties of the calibrated model, in response to a productivity shock, are consistent with the empirical evidence on a decrease in employment and an increase in real wages. Second, for all the variables considered, the Taylor rule tracks the optimal policy better than the simple rule with unemployment as an argument. Third, regardless of the output or unemployment gap being targeted, it is not optimal that central banks respond to nominal exchange rate variations.     

ENDOGENOUS FLUCTUATIONS IN TWO‐COUNTRY MODELS*

This paper investigates the interlinkage in the business cycles of large‐country economies in a free‐trade equilibrium. We consider a two‐country, two‐good, two‐factor general equilibrium model with Cobb‐Douglas technologies and linear preferences. We also assume decreasing returns to scale in the consumption good sector. We first identify the determinants of each country's global accumulation pattern in autarky equilibrium, and secondly we show how a country's business cycles may spread throughout the world once trade opens. We thus give capital intensity conditions for local and global stability of competitive equilibrium paths.     

Stabilization policy and indeterminacy in a small open economy

This paper studies the (de)stabilizing effects of income tax rules in a two-sector small open economy with production externalities. The paper shows that in the model with positive sector-specific externalities in the investment sector and negative sector-specific externalities in the consumption sector (or positive aggregate investment externalities), a regressive income tax rule can stabilize such an economy against indeterminacy, whereas a progressive income tax rule can increase the tendency for indeterminacy to occur. This paper also studies two variants that consider an imperfect world bond market and an endogenous labor supply, respectively, and shows that the qualitative results stated above remain valid. Moreover, increasing the level of sector-specific investment externalities can decrease (increase) the minimal level of tax progressivity required for indeterminacy if the investment externalities are below (above) a certain critical value and if the negative externalities in the consumption sector are taken as given.     

Analysis of shock transmissions to a small open emerging economy using a SVARMA model

Using a parsimonious structural vector autoregressive moving average (SVARMA) model, we analyse the transmission of foreign and domestic shocks to a small open emerging economy under different policy regimes. Narrower confidence bands around the SVARMA responses compared to the SVAR responses, advocate the suitability of this framework for analysing the propagation of economic shocks over time. Malaysia is an interesting small open economy that has experienced an ongoing process of economic transition and development. The Malaysian government imposed exchange rate and capital control measures following the 1997 Asian financial crisis. Historical decomposition and variance decomposition allow contrast of shocks propagating under different policy regimes. Malaysia is highly exposed to foreign shocks, particularly under the managed float exchange rate system. During the pegged exchange rate period, Malaysian monetary policymakers experienced some breathing space to focus on maintaining price and output stability. In the post-pegged period, Malaysia's exposure to foreign shocks increased and in recent times are largely driven by world commodity price and global activity shocks.     

Analysis of Output Fluctuations in Taiwan: An Application of the IS–MP–AS Model

Extending the IS–MP–AS model, this paper finds that real GDP in Taiwan is positively affected by real depreciation and stock values and negatively associated with the government deficit/GDP ratio, the U.S. federal funds rate, and the expected inflation rate. Therefore, current large and rising government deficits, recent appreciation of the New Taiwan dollar, and gradual increases in the federal funds rate would hurt real output in Taiwan.     

Amplification of shocks at the zero lower bound in a small open and large closed economy

This letter compares the consequences of hitting the zero lower bound in small open and large closed economies. I show that in a large economy shocks are modified by the zero lower bound on interest rate much more than in a small one – as a result, the large economy may suffer more.     

Financial constraints,firm entry,and exchange rate pass-through

Using a heterogeneous firm model with firm entry and endogenous markups, I study how the financial constraints of exporting firms affect exchange rate pass-through behaviors. I find that the financial constraints increase the degree of exchange rate pass-through.     

A general equilibrium open economy model for emerging markets: Monetary policy with a dualistic labor market

An optimizing model of a small open emerging market economy (SOEME) with dualistic labor markets and two types of consumers, delivers a tractable model for monetary policy. Differences between the SOEME and the SOE are derived. Parameters depend on features of the labor market and on consumption inequality, and affect the natural interest rate, terms of trade and potential output. The supply curve turns out to be flatter and more volatile, with a larger number of shift factors, including policy-determined terms of trade. A simple basic version of the model is simulated in order to compare different policy targets in response to a cost shock. Flexible domestic inflation targeting gives the lowest volatility although there are trade-offs. Exchange rate volatility is relatively lower but still makes a major contribution to controlling inflation. Flexible CPI inflation targeting performs better when combined with some kind of managed floating. Inflation targeting has to be flexible. With more backward-looking behavior the policy response to a shock is reduced.     

Measuring the Effects of Exchange Rate Changes on Investment in Australian Manufacturing Industry*

This paper examines the relationship between exchange rates and investment in Australian manufacturing between 1988 and 2001. The effects of exchange rates on investment are found to vary positively with the export share of sales and negatively with the share of imported inputs into production, with lower price‐over‐cost mark‐ups increasing the response. For Australian manufacturing, a 10 per cent real appreciation of the Australian dollar leads to an average 8.0 per cent decrease in total investment through the export share channel, and an average 3.8 per cent increase through the imported input share channel, with most of the response occurring through investment in equipment, plant and machinery.