Financial market integration,exchange rate policy,and the dynamics of business and employment in Korea

We study the consequences of different degrees of international financial market integration and exchange rate policies in a calibrated, medium-scale model of the Korean economy. The model features endogenous producer entry into domestic and export markets and search-and-matching frictions in labor markets. This allows us to highlight the consequences of financial integration and the exchange rate regime for the dynamics of business creation and unemployment. We show that, under flexible exchange rates, access to international financial markets increases the volatility of both business creation and the number of exporting plants, but the effects on employment volatility are more modest. Pegging the exchange rate can have unfavorable consequences for the effects of terms of trade appreciation, but more financial integration is beneficial under a peg if the economy is subject to both productivity and terms of trade shocks. The combination of a floating exchange rate and internationally complete markets would be the best scenario for Korea among those we focus on.     

Preference shocks,international frictions,and international business cycles

Replicating the degree of cross-country comovements of macroeconomic aggregates, dynamics of prices and quantities of international trade, and the behavior of consumption and labor remains an important challenge in international business cycle literature. This paper incorporates preference shocks into a standard two-country model in which there exist international frictions, such as costs of transportation and restrictions to international asset trade. Country-specific preference shocks that generate fluctuations in each country's consumption and labor solve the puzzles, except for the discrepancy between theory and data regarding international trade variables. The presence or absence of international frictions plays a limited role in solving the puzzles.     

Real exchange rate misalignment and business cycle fluctuations in the Asia-Pacific

Real exchange rate (RER) misalignment, which is the deviation between the actual real exchange rate from its equilibrium, occurs frequently among developing countries. Studies have shown that RER misalignment may have negative economic implications, such as a decline in economic growth, exports, and export diversification and an increased risk of currency crises and political instability. Using quarterly data for 22 sample countries from 1990 to 2018, this paper investigates the impact of RER misalignment on business cycles in the Asia-Pacific by employing a panel vector autoregression involving consumer price index (CPI) inflation, output gap, short-term interest rates, and RER misalignment. We find that RER overvaluation may reduce CPI inflation and short-term interest rates. We also find that the Asia-Pacific region is highly heterogeneous in that the output gaps of some countries, particularly from the Southeast Asian region, are more susceptible to RER misalignment shocks.     

A COMPARATIVE ANALYSIS OF THE SYNCHRONISATION OF BUSINESS CYCLES FOR DEVELOPED AND DEVELOPING ECONOMIES WITH THE WORLD BUSINESS CYCLE

Globalisation brought about worldwide changes, including economic and financial integration between countries. The objective of this paper is to establish if there is synchronisation between developed and developing countries with the world cycle. Research results show that business cycles have become less volatile after globalisation, but there is not much consensus on whether business cycles have become less or more synchronised since globalisation. Little research has been done on co‐movement between emerging markets, such as South Africa, and the world business cycle. This paper derives common factors for developed and developing countries by applying principal component analysis (PCA) to output, consumption and investment data, which represents the countries' business cycles. The empirical analysis shows co‐movement between some countries and the world business cycle (G7 countries as proxy). The results suggest that there are idiosyncratic and globally common shocks, which play different roles over time in different countries. The paper goes on to suggest that there are clear differences in how developed and emerging markets co‐move with the world business cycle. A key finding is that the co‐movement between developing economies and the world business cycle has increased since globalisation. This research also confirms previous research that most economies follow the world business cycle when large shocks – such as the recent economic downturn – occur. This has implications for forecasting the business cycle, especially in times of economic turmoil.     

Systemic Risks Spillovers and Interdependence among Stock Markets: International Evidence with Covar‐Copulas

Empirical studies have provided ample evidence on the potential benefits of international diversification with portfolios that consist of both domestic and foreign assets. This coupled with sudden and periodic crashes in global and developed equity markets have stimulated the interest of investors to diversify across markets that have the potential to provide decorrelation with global markets during turbulent periods. At the same time, international diversification may intensify cross‐border listing of stocks with its antecedent implication of shocks transmission. The above have engendered renewed interest among researchers to explore the dependence levels and spillover effects of shocks among emerging and developed equity markets. This paper examines tail dependence structure and (extreme) systemic risks spillover effects among international equity markets using advanced econometric techniques that underpin the modelling of asset returns. We find evidence of low positive significant dependencies between all African markets and their developed counterparts, except for Egypt. Although no evidence of spillover effects to the markets in Africa was found, both unidirectional and bi‐directional causality between some African and developed equity markets is found, albeit with differences. We are unable to ascribe the dynamics in the causality structure to level of market integration. It is inferred that the degree of individual local markets interdependence with developed counterparts may reflect the relative size, liquidity and degree of foreign investors' participation.     

The assessment: business cycles

This overview paper places in context eight papers coveringa wide spectrum of views on modern business cycle modelling.Inter alia, these address some gaps in the real business cycle(RBC) literature (e.g. the extremely limited treatment of creditand asset markets) and various other anomalies (e.g. the failureto explain volatility and persistence of employment and unemployment,and the non-cyclicality of real wages). The paper then focusesfurther on two issues central to RBC models. Such models aredriven by large and persistent technology shocks. However, empiricalevidence from UK manufacturing shows that correcting for cyclicalutilization results in shocks which are small and non-persistent.The second issue is one of empirical methodology. Though theRBC approach was intended as a response to the Lucas critique,by largely assuming away government policy feedback rules, thesemodels are far from policy-relevant. The alternative vectorautoregression (VAR) approach implicitly incorporates theserules, but ignores shifts in rules. A constructive responseto the Lucas critique needs to incorporate policy rule shiftsand private-sector reactions directly, which looks hard to achieveoutside the context of structural econometric modelling.     

The impact of technology shocks on the Japanese business cycle—An empirical analysis based on Japanese industry data

In order to investigate the impacts of technology shocks on the recent Japanese business cycles, we construct an aggregate technological measure from industry-based data. Our approach is to estimate production function by industry, by controlling for the returns to scale factor and unobserved factor utilization. We find that positive technology shocks result in a contraction of labor input on impact. This result implies that the standard real business cycle (RBC) model is not supported and the new Keynesian model or the labor reallocation model is a candidate to explain the Japanese business cycles. From further empirical studies, we find that the labor reallocation model is plausible for explaining the Japanese business cycles.     

Aid Volatility and Real Business Cycles in a Developing Open Economy

This article analyzes the impact of the unpredictability of foreign aid on macroeconomic fluctuations in the recipient country. I build a small open‐economy business cycle model that accounts for foreign aid shocks, with no preference shocks. The model is calibrated to reflect the structural empirical regularities of Cote d'Ivoire, a typical aid‐dependent developing country. The parameters of the exogenous shocks are estimated using Bayesian methods and time series data for Cote d'Ivoire. The model produces business cycle patterns that are consistent with the data and key stylized facts. Specifically, the excess volatility of consumption with respect to output is successfully replicated. The results suggest that the unpredictability of foreign aid contributes to explain the volatility of business cycles in the recipient economy and has negative welfare effects.     

On the Sources of Inflation in Kenya: A Model‐Based Approach

We develop a semi‐structural new‐Keynesian open‐economy model – with separate food and non‐food inflation dynamics to study the sources of inflation in Kenya in recent years. To do so, we filter international and Kenyan data (on output, inflation and its components, exchange rates and interest rates) through the model to recover a model‐based decomposition of most variables into trends (or potential values) and temporary movements (or gaps) – including for the international and domestic relative price of food. We use the filtration exercise to recover the sequence of domestic and foreign macroeconomic shocks that account for business cycle dynamics in Kenya over the last few years, with a special emphasis on the various factors (international food prices, monetary policy) driving inflation. We find that while imported food price shocks have been an important source of inflation, both in 2008 and more recently, accommodating monetary policy has also played a role, most notably through its effect on the nominal exchange rate. We also discuss the implications of this exercise for the use of model‐based monetary policy analysis in sub‐Saharan African countries.     

Postwar business cycles in Japan: A quest for the right explanation

This paper explores the nature of postwar business cycles in Japan. Our basic strategy is to study different production behaviors of various manufacturing industries over business cycles. We are particularly interested in the problems of whether only monetary shocks are important and, if not, what kind of real shocks are important. We conclude that purely monetary theory is inadequate, and that construction activities were major causes of aggregate fluctuations in the pre-first oil shock period of rapid growth. We also present some evidence suggesting that real business cycle theory is implausible.     

The driving forces of China's business cycles: Evidence from an estimated DSGE model with housing and banking

We study the approximate sources of China's business cycles in an estimated dynamic stochastic general equilibrium (DSGE) model with housing and banking. The model replicates well the volatility and cyclicality of key macroeconomic variables observed in the past two decades in China. A host of shock decomposition exercises demonstrate that, among the shocks being considered, both financial and housing shocks are driving China's business cycles, accounting for a particularly large fraction of the variance in most macroeconomic and financial variables at the business cycle frequencies. In particular, the capital quality, housing demand, and loan-to-value shocks display prominent contributions to the business cycle fluctuations. Moreover, there exists substantial interactions between the banking and housing sectors in China, where the collateral constraint and the financial constraint amplify with each other. The results shed new light in the understanding of China's business cycles, and may serve as a useful benchmark for future quantitative analyses of China's macroeconomic fluctuations using DSGE frameworks.     

The labour market over the business cycle: can theory fit the facts?

We examine the ability of six labour market models to accountfor the business cycle behaviour of UK labour markets when embeddedin a stochastic growth model. We assess the models in termsof : (i) their ability to mimic general business cycle correlationsand volatility (ii) their success at explaining the persistenceof labour market fluctuations and (iii) whether they can explainwhy the growth and speed of adjustment of labour market variableschanges between periods of expansions and contractions. Themain success of the models is their ability broadly to accountfor business cycle correlations and comovements and the variationsin employment/unemployment growth rates between expansions andcontractions. However, there are three main failures: (i) themodels tend to produce insufficiently volatile employment andunemployment fluctuations (ii) they tend to produce too stronga correlation between wages and employment and (iii) most ofthem generate only brief temporary deviations in unemploymentin response to shocks rather than the protracted dynamics ofthe data.     

Have the Eurozone economies converged on a common European cycle?

The dating of a possible European business cycle has been inconclusive. At this stage, there is no consensus on the existence of such a cycle, or of its periodicity and amplitude, or of the relationship of individual member countries to that cycle. Yet convergence to a common cycle is the key consideration for a successful economic performance in any currency union. The confusion over whether and to what degree the Eurozone countries are converging on a common cycle is one example of this lack of consensus. In general, countries may vary in the components and characteristics that make up their output cycles; and also in their position around the output cycle at each point of time. In this paper we show how to decompose a business cycle into a time–frequency framework. This then allows us to decompose movements in output, at the European level and in member countries, into the component cycles and permits us to see how those component cycles (and the coherence between them) have varied in importance and cyclical characteristics over time. That in turn allows us to determine if the inconclusive convergence results obtained in the past have appeared because member countries have some cycles in common—but diverge at other cycles as a result of the asymmetric transmission of shocks, or external factors, or country specific shocks.     

Tsunami: Market Tightness and Asset Price Volatility

Abstract

This paper considers an asset market subject to search frictions, where there are adjustment costs to the entry rate of buyers. An implication is that even in asset markets where the search frictions are very small, asset prices respond to changes in liquidity. Another implication is that asset liquidity is a state variable, the dynamics of which are analysed. I demonstrate that transition paths of liquidity to its (stable) steady state can exhibit dramatic divergence before convergence following small positive deviations in the measure of buyers in the market. Thus, adjustment costs of entry are a potential source of volatility by generating large waves of liquidity, or “tsunami”, in asset markets. I quantitatively assess the ability of the mechanism to generate asset market booms and busts via the implied price movements.     

The Role of the Exchange Rate as a Shock Absorber in a Small Open Economy

This paper analyses interactions between the real exchange rate and business cycles in a small open economy like Norway. Using a structural vector autoregression model, the role of different shocks are analysed, to investigate to what extent the real exchange rate is absorbing shocks, or a source of shocks itself. The results are ambiguous. Output and the real exchange rate are mainly explained by separate shocks, so that relinquishing exchange rate independence should come at little cost. However, the importance of nominal shocks in the business cycle emphasises that stabilisation is possible. Hence, remaining monetary independence may be attractive.     

Hot Money and Business Cycle Volatility： Evidence from China

This paper investigates the link between hot money and business cycle volatility in China from January 1997 to December 2009. Using the structural vector error correction model we find a considerable degree of long-run cointegration and bidirectional causality effects between hot money and business cycle volatility. The speculative shocks are found to temporarily promote China＇s economic growth, but also to exacerbate business cycle volatility. The liquidity shock stemming from hot money is shown to be the primary factor responsible for the significantly enhanced fluctuation in business cycles during the most recent global financial crisis period This could be detrimental to the smooth operation of financial markets. Therefore, informing future policies, it is critical for policy-makers to take precautions against the speculative factors.     

Examining Stock Volatility in the Segmented Chinese Stock Markets: A SWARCH Approach

Abstract

This study adopts the SWARCH model to examine the volatile behavior and volatility linkages among the four major segmented Chinese stock indices. We find strong evidence of a regime shift in the volatility of the four markets, and the SWARCH model appears to outperform standard generalized autoregressive conditional heteroskedasticity (GARCH) family models. The evidence suggests that, compared with the A-share markets, B-share markets stay in a high-volatility state longer and are more volatile and shift more frequently between high- and low-volatility states. In addition, the relative magnitude of the high-volatility compared with that of the low-volatility state in the B-share markets is much greater than the case in the two A-share markets. B-share markets are found to be more sensitive to international shocks, while A-share markets seem immune to international spillovers of volatility. Finally, analyses of the volatility spillover effect among the four stock markets indicate that the A-share markets play a dominant role in volatility in Chinese stock markets.     

Permanent and transitory shocks on real and nominal exchange rates in Turkey during the post-1980 period

With the adoption of export-led growth and a liberal exchange rate regime in a post-1980, high-inflation country like Turkey, it becomes important to measure the relative importance of permanent and temporary shocks on real and nominal exchange rates (RER and NER, respectively) and the decomposition of the RER into these two components. This task was undertaken by using a structural vector autoregressive approach which entailed restricting the long-run response of the RER only to real shocks. Both the bilateral and the effective rates were considered. For the post-1980 period, several discoveries were made. First, except for Italy, real shocks were dominant in explaining the fluctuation in the RER. Second, the changes in the price ratio determined the permanent component in the RER, again, with the exception of Italy. Third, it takes three to four years for both the RER and the NER responses to reach their permanent levels.     

Optimal Contracting,Accounting Standards,and Market Structures*

In this study I use a principal-agent framework to analyze optimal contracting under two accounting standards, referred to as historical cost (HC) and market value (MV), and under differing asset market assumptions. I distinguish HC from MV by the way revenue is recognized and in the reporting discretion allowed. The MV standard recognizes both realized and unrealized holding gains; HC recognizes only realized holding gains. MV allows the manager reporting discretion; the HC standard does not. Also, distinguishing an asset's value-in-use (VIU) from its net realizable value (NRV), I consider markets where the asset's VIU and NRV are always equal as well as markets where VIU and NRV differ. I show the following. If an asset's NRV and VIU are equal and if the manager's available reporting discretion is known, the principal prefers the MV standard because it provides better information about the manager's effort. However, the principal may prefer the HC standard if sufficiently uncertain about the manager's reporting discretion or if the asset's NRV exceeds its VIU, so that expected revenue is sufficiently enhanced by selling the asset earlier. Using an example (normal distribution and mean/variance preferences with linear contracts), I provide a case where the principal prefers the HC standard. Also, I compare the optimal effort and contract under each standard, and provide comparative static results that show how expected revenue, cost, and net income change due to changes in certain model parameters.     

Mozambique Metical Exchange Rate Dynamics: Evidence of Fractional Co‐Integration in the USA and South African Rates

This paper studies the exchange rate dynamics of the Mozambique metical with respect to the US dollar and the South African rand. However, instead of using standard I(0)/I(1) techniques, we use long memory and fractionally integrated and co‐integrated models. Our results indicate that the two exchange rates are highly persistent, with orders of integration equal to or above 1. They also seem to be co‐integrated, with an order of integration close to albeit above 0 but with an AR coefficient very close to 1. Thus, although the two series seem to be fractionally co‐integrated, shocks in the long‐run relationship between the two variables are persistent and take a long time to disappear.