Emerging economy business cycles: Interest rate shocks vs trend shocks

The recent literature studying the source of business cycles in emerging market economies (EMEs) has debated the relative importance of productivity trend shocks versus interest rate shocks coupled with financial frictions. The studies in which an important role is assigned to interest rate shocks do not force their models to match the historical paths of the world or country interest rate. We show that this leads to poorly identified interest rate shocks and inaccurate measures of contributions of shocks to EME business cycles. To address this issue, we estimate a small open economy model for Argentina and Mexico using Bayesian methods where the world and country interest rate series in the model are forced to match their data counterparts. This estimation strategy results in larger variations in interest rate shock and, therefore, shifts explanatory power away from trend shocks towards interest rate shocks, although both shocks remain important.     

INTERNATIONAL BUSINESS CYCLES IN EMERGING MARKETS

I document cyclical behavior of real exchange rates (RERs) in emerging and developed economies: stronger RER procyclicality coincides with larger relative volatility of consumption and more countercyclical trade balance. I then reevaluate the sources of fluctuations in emerging economies using an international business cycle model estimated to match the behavior of the RERs. Interest rate shocks, without any frictions, account for most of output fluctuations. This result is driven by imperfect substitution between domestic and foreign goods, which dampens the impact of trend shocks and accentuates the impact of interest rate shocks on output and consumption.     

Performance of interest rate rules under credit market imperfections

The stabilization effects of Taylor rules are analyzed in a limited participation framework with and without credit market imperfections in capital goods production. Financial frictions substantially amplify the impact of shocks, and also reinforce the stabilizing or destabilizing effects of interest rate rules on output. However, these effects are reversed relative to new Keynesian models: under limited participation, interest rate rules are stabilizing for productivity shocks, but imply an output-inflation tradeoff for demand shocks. Moreover, because financial frictions imply excessive fluctuation, stabilization via an interest rate rule can be a welfare-improving response to productivity shocks.     

The Role of Productivity and Financial Frictions in the Business Cycles of a Small Open Economy: Hong Kong 1984–2011

This paper analyzes the business cycle properties of the Hong Kong economy during the 1984–2011 period, which includes the financial crisis experienced in 1997/98 and the economic crisis of 2008–2010. We show that the volatility respectively, of output, of the growth rate of output and of real interest rates in Hong Kong are higher than the corresponding average volatility among developed economies. Furthermore, interest rates are countercyclical. We build a stochastic neoclassical small open‐economy model estimated with a Bayesian likelihood approach that seeks to replicate the main business cycle characteristics of Hong Kong, and through which we try to quantify the role played by exogenous total factor productivity (TFP) shocks (transitory and permanent), real interest rate shocks and financial frictions. The main finding is that financial frictions, jointly with the assumption that the country spread is endogenous, seem important in explaining the countercyclicality of the real interest rates.     

ON THE SOURCES OF AGGREGATE FLUCTUATIONS IN EMERGING ECONOMIES

Recent research on macroeconomic fluctuations in emerging economies has advocated introducing a stochastic productivity trend or allowing for interest rate shocks and financial frictions. We estimate a model that encompasses these two approaches, shedding light on their relative merits and on how financial frictions affect the transmission of shocks. The model accounts for aggregate fluctuations by assigning a dominant role to financial frictions in amplifying conventional (temporary) productivity shocks, whereas trend shocks play a minor role. A link between spreads and expected future productivity emerges as essential for a reasonable approximation to the data.     

Unemployment dynamics in emerging countries: Monetary policy and external shocks

This paper quantifies the impact of three key external shocks – external demand, interest rate, and uncertainty shocks – on emerging market economies (EMEs). We find that external shocks have a sizeable impact on macroeconomic fluctuations in EMEs and that a considerable fraction of this impact is through the domestic stock market. A decrease in external demand and an increase in external interest rate and uncertainty lead to a higher unemployment rate, lower stock market return, and a depreciation of the domestic currency. The EMEs' monetary policy actively responds to external shocks and dampens their impact on domestic activity.     

Land collateral and labor market dynamics in France

The value of land in the balance sheet of French firms correlates positively with their hiring and investment flows. To explore the relationship between these variables, we develop a macroeconomic model with firms that are subject to both credit and labor market frictions. The value of collateral is driven by the forward-looking dynamics of the land price, which reacts endogenously to fundamental and non-fundamental (sunspot) shocks. We calibrate the model to French data and find that land price shocks give rise to significant amplification and hump-shaped responses of investment, vacancies and unemployment that are in line with the data. We show that both the endogenous movements in the firms׳ discount factor and the sluggish response of the land price are key elements that drive the results.     

Labour markets, liquidity, and monetary policy regimes

Abstract.  We develop an equilibrium model of the monetary policy transmission mechanism that highlights information frictions in the market for money and search frictions in the labour market. The information friction increases the persistence in the response of interest rates following monetary policy regime shifts. This occurs because agents have incomplete information about the nature of the shifts and optimally update their inflation forecasts using an 'adaptive' expectations rule. The search friction transmits the interest rate movements to the labour market by affecting job creation activities; together, the two frictions imply that unemployment reacts very gradually to monetary policy shocks. JEL Classification: E4, E5     

Exogenous shocks,dynamic correlations,and portfolio risk management for the Asian emerging and other global developed and emerging stock markets

ABSTRACT

This study examines the potential influence of exogenous shocks on time-varying correlations and portfolio strategies between the Asian emerging and other global stock markets including developed and other emerging markets. Using the ARMA-cDCC-FIEGARCH model with and without exogenous shocks, our results highlight the usefulness of including other global stock assets in the traditional portfolio for Asian emerging market investors. However, investors have limited opportunities to diversify their assets during the global financial crisis. Moreover, the shocks from the U.S. stock market have a greater influence on global stock markets compared to that from U.S. economic policy. Fortunately, the model with exogenous shocks improves its accuracy, which plays the same role of controlling structural breaks in the model. More importantly, incorporating exogenous shocks in our model also provides better value-at-risk performance results and hedging effectiveness. These results have several important implications for investors, researchers, and policymakers.     

The role of inventories and capacity utilization as shock absorbers

We examine the role of inventories and capacity utilization (of both capital and labor) for the propagation of business cycle fluctuations. We document a new set of facts regarding the U.S. cyclical regularities of inventories and capacity utilization. First, we find that capital utilization and the flows of services from both capital and labor are procyclical, and comove with the holdings of inventories. Second, we find that labor utilization is procyclical as well, but is weakly negatively correlated with inventories. We build a model that accounts for these facts, and also accounts for the stylized inventory facts, i.e., inventory holdings are procyclical, while the inventory-to-sales ratio is countercyclical. The analysis is centered on the effects of two possible shocks: preference (demand) shocks and technology shocks. Our model shows that inventories and the rate of capital utilization are mostly complements, while inventories and the rate of labor utilization are mostly substitutes. It further shows that temporary demand shocks emphasize the role of inventories as being a “shock absorber,” whereas high-persistence demand shocks, as well as technology shocks of any persistence, emphasize the role of inventories as being a complement to consumption.     

Ageing shocks and short-run regional labour market dynamics in a spatial panel VAR approach

Using a flexible spatial panel VAR model for a small-scale labour market system, we investigate the dynamic interdependences between changes in the demographic structure and the labour market performance of a regional economy. With a particular focus on ageing shocks, we describe an increase in the share of elderly in regional population due to exogenous changes in the institutional context, such as pension reforms. The regional labour market implications of an ageing shock are then tested with regard to the effects on employment growth, unemployment and labour participation rate. Our results based on a sample of 71 Scandinavian regions point to negative regional labour market effects of an ageing shock implying a reduction in employment growth and a temporarily declining labour participation rate, while the unemployment rate increases. Importantly, spatial spillovers amplify these negative impacts through a marginalization of macro-regional labour markets. As a robustness check, we reverse the causal ordering and analyze the responses to a positive macroeconomic shock which initially increases employment growth. We find direct and spatially indirect adjustment patterns characterized by a reduction of the unemployment rate, an increase in the labour participation rate and a decrease in the share of elderly in the population.     

Bank behavior, incomplete interest rate pass-through, and the cost channel of monetary policy transmission

This paper employs a New Keynesian DSGE model to explore the role of banks within the cost channel of monetary policy transmission for shaping the interest rate pass-through from money market rates to loan rates. Banks extend loans to firms in an environment of monopolistic competition by setting their loan rates in a staggered way, which means that the adjustment of the aggregate loan rate to a monetary policy shock is sticky. We estimate the model for the euro area by adopting a minimum distance approach. Our findings exhibit that (i) financial costs are an important factor for price changes, (ii) frictions in the loan market have an effect on the propagation of monetary policy shocks as the pass-through from a change in money market rates to loan rates is incomplete, and (iii) the strength of the cost channel is mitigated as banks shelter firms from monetary policy shocks by smoothing loan rates.     

Oil shocks,US economic uncertainty,and emerging stock markets

This paper investigates the impacts of oil price shocks and US economic uncertainty on emerging equity markets within a structural VAR model. I find that both precautionary oil demand and US economic uncertainty shocks have significant negative effects on emerging stock returns, whereas aggregate demand shocks cause a sustained rise of the returns. In particular, the direct effects of oil shocks on emerging stock returns are amplified by the endogenous response of US economic uncertainty. Variance decomposition analysis shows that oil market fundamentals and US economic uncertainty are an important determinant of emerging equity returns, accounting for 35% and 24% of their long-term variations, respectively. The heterogeneous impacts of structural shocks on individual emerging markets, however, suggest that a well-diversified portfolio can be obtainable.     

Trade balance and income in historical perspective

This paper develops a dynamic analysis of the trade balance to investigate the roles of supply and demand shocks. It also introduces global shocks in the analysis to take into account the comovement of income across countries. The results, based on the long-run historical data and a structural VAR analysis, show that, in the U.K., Australia, Canada, and Sweden, domestic and global supply shocks, while dominant causes in long-term and cyclical changes in output, are unimportant for the trade balance. The trade balance is explained mostly by shocks that cause transitory changes in income. Transitory income shocks cause income and the trade balance to move in opposite directions in all countries except Sweden. The countercyclical behavior of the trade balance seems to be a robust feature in the U.K. and Canada but not in the smaller economies of Australia and Sweden.This research was supported by a summer research grant from the Carol Martin Gatton College of Business and Economics at the University of Kentucky. The grant was made possible by a donation of funds to the College by Ashland Inc. I appreciate the Editor, two anonymous referees, Dick Gift and Mark Toma for their helpful suggestions. All remaining errors are mine.     

MONEY,CAPITAL, AND EXCHANGE RATE FLUCTUATIONS*

We explore how the informational frictions underlying monetary exchange affect international exchange rate dynamics. Our perfectly flexible price model is capable of producing endogenously rigid international relative prices in response to technology and monetary shocks. The model is capable of accounting for the empirical regularities that the real and nominal exchange rates are more volatile than U.S. output, and that the two are positively and perfectly correlated. The model is also consistent with other standard real business cycle facts for the United States.     

The transmission of financial shocks in an estimated DSGE model with housing and banking

We develop a dynamic stochastic general equilibrium (DSGE) model with housing and banking to study the transmission of financial shocks between the financial and real sectors. A deterioration in the bank's balance sheet induced by financial shocks could have amplified and persistent impacts on real activities. The amplification of the shocks are originated from financial frictions tied to households and banks. We find that a disruption in bank net worth initiated by capital quality shocks generates a decline in household loans, house prices and output. Bank liquidity shocks also have negative effects on these variables. Housing preference shocks could generate a positive comovement between house prices and output. All these findings are qualitatively consistent with empirical evidence, suggesting that these financial shocks are critical to the dynamics of house prices and other macroeconomic variables.     

EMU-related news and financial markets in the Czech Republic,Hungary and Poland

We analyse the impact of news on five financial markets in the Czech Republic, Hungary and Poland using a newly constructed data set in a Generalized Autoregressive Conditional Heteroscedastic (GARCH) framework. Macroeconomic shocks (on Gross Domestic Product (GDP), inflation rate, current account and trade balance) are constructed as deviations from expected values. Economic and Monetary Union (EMU)-related political and fiscal news is captured as news dummies. Macroeconomic shocks significantly affect short-term interest rates and, to a lesser extent, other financial variables. Political and fiscal news has an impact on long-term bond yields and exchange rates. News displayed prominently in our media sources has a greater impact on financial markets than other news and, in addition, the sources of news themselves matter. We also discover asymmetric effects of news within markets. Finally, using a pooled GARCH model we find that macroeconomic shocks have the strongest impact on financial markets in Hungary, while political news has the largest influence in both Hungary and Poland.     

Optimal Monetary Policy

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions—costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods—we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates.     

News shocks and labour market dynamics in matching models

We enrich a baseline real business cycle (RBC) model with search and matching frictions on the labour market and real frictions that are helpful in accounting for the response of macroeconomic aggregates to shocks. The analysis allows shocks to have an unanticipated and a news (i.e., anticipated) component. The Bayesian estimation of the model reveals that the model that includes news shocks on macroeconomic aggregates produces a remarkable fit of the data. News shocks in stationary and non‐stationary TFP, investment‐specific productivity and preference shocks significantly affect labour market variables and explain a sizeable fraction of macroeconomic fluctuations at medium‐ and long‐run horizons. Historically, news shocks have played a relevant role for output, but they have had a limited influence on unemployment.     

The Exchange Rate: A Shock Absorber or Source of Shocks in Turkey?

This study investigates the role of the exchange rate as shock-absorber as opposed to a source of its own shocks in Turkey during the period from 1990 to 2009 by employing a structural VAR framework with long-run and short-run restrictions. We find that the economic shocks have predominantly been asymmetric relative to one of the largest trading partner, the US. Our results provide evidence of the fact that while the major source of variability in exchange rates in the pre-2001 crisis period is mainly nominal shocks, a large proportion of the exchange rate variability can be attributed to supply and demand shocks in the post-2001 crisis period. This suggets that, rather than reacting to shocks to the foreign exchange market, such as shifts in risk premia, the exchange rate moves mainly in response to the real shocks during the post-2001 crisis period. Hence, there is a sizeable role for exchange rate stabilization during this period, absorbing those shocks and therefore requiring opposed monetary policy responses.