The price of size and financial market allocations

A positive equilibrium price of size exists when size is a scarce productive resource. This paper articulates a costly-state-verification model of financial contracting with heterogeneous lender sizes. We find that in a non-rationing direct lending equilibrium, (1) Financial contract is nonlinear in that expected rates of return on loans increase with loan sizes; (2) Endogenous asset indivisibility arises; (3) The total social surplus under a nonlinear contract is less than that under a linear structure; (4) Average debt size affects the market value of a firm. We also extend analysis to the case of credit rationing and financial intermediation.I thank James A. Mirrlees, Yi Jin, Charles Ka Yui Leung, and seminar participants in the 2004 Royal Economic Society Conference and the Chinese University of Hong Kong for helpful comments. Suggestions from Stephen D. Williamson (the co-eidtor) and an anonymous referee are especially acknowledged.     

Labour market implications of EU product market integration

European labour markets are in a state of flux due to the changing market situation induced by international integration. This process affects wage formation through more fierce product market competition and increased mobility of jobs. This development is by some observers taken to enforce labour market flexibility, while for others it signals an erosion of social standards and in turn possibly the welfare society. Since labour is not very mobile in Europe, the effects of international integration on labour markets are mostly indirect via product market integration. We review the channels through which product market integration affects labour markets and perform an empirical analysis of the convergence and interdependencies in wage formation among EU countries. We find that integration is changing labour market structures and inducing wage convergences as well as stronger wage interdependencies, but it is a gradual process. Moreover, the present study does not support the view that international integration will lead to a 'race to the bottom' and rapidly erode domestic labour markets standards, nor that it will relieve politicians of the need to consider labour market reforms to improve labour market performance.     

EMU fiscal indicators: a misleading compass?

The effectiveness of any device for fiscal discipline crucially depends on the indicators it refers to. This paper assesses the indicators adopted for fiscal rules in the European Economic and Monetary Union (EMU) with respect to their relevance for EMU’s objective of fiscal soundness and to the adequacy of the underlying statistical framework in providing conditions for enforcement. The paper argues that EMU’s deficit and debt indicators present several shortcomings with respect to both sustainability analysis and monitoring requirements. The debt indicator allows the achievement of targets via operations that do not improve fiscal sustainability and tends to underestimate overall outstanding liabilities. The deficit indicator cannot be monitored in a timely manner, allows too much room for discretion, and is subject to significant revisions. While acknowledging that any single indicator can be distorted when used as a policy target, the paper argues that the weaknesses of EMU’s indicators would be much reduced if consistency cross-checks played a larger role than they currently do.The authors wish to thank Claudia Braz, Carlo Cottarelli, Jorge Cunha, Mark De Broek, Albert␣Jaeger, Mohan Kumar, Joao Nogueira, Ethan Wiseman and the anonymous referees for helpful comments.     

Price transmission and market integration: vertical and horizontal price linkages for salmon

Relationships between prices are of interest when testing for market integration as well as analyses of supply chains. A feature that has received little attention is that if two supply chains are linked by market integration at some stage, then the whole supply chain will be linked. Furthermore, the leading price in such a system can be in one supply chain and will not be revealed in market integration studies or analysis of a single supply chain. An empirical analysis is provided for the supply chains for salmon which originates in Norway and the United Kingdom and is then sold at retail level in France as smoked salmon. We find a high degree of price transmission in both supply chains, as well as integrated markets.     

Economic integration and fiscal devolution

In this paper we investigate how economic integration influences the political decision of integration and separation of jurisdictions. In a model with (imperfect) capital mobility, we consider that, not only the redistributive policy itself, but also the level of policy centralization is decided by a majority vote. We find that the net benefit from integration is not monotonic with the level of world capital market integration and present a case where integration of two regions occurs only for intermediate levels of mobility. This conclusion relies on the comparison of the regional majorities’ utility under the various regimes. The benefits from integration arise from the elimination of tax competition across jurisdictions, which allows for more income redistribution, whereas the costs are linked to the diversity of preferences across regions, namely that of the decisive voters. We also show that a federal regime is better than complete centralization in keeping a nation united.     

Partisan influence on social spending under market integration,fiscal pressure and institutional change

In this paper we examine whether partisan influence on social expenditure in the OECD has decreased over the past three decades. We analyze whether a reduced partisan influence is due to more trade openness, larger budget deficits or the creation of new supranational institutions. Our empirical approach distinguishes between the effects on the long-run growth of social expenditures and its short-run adjustment to violations of the long-run equilibrium linking social spending with macroeconomic and demographic trends. We find that partisan motives, indeed, play an important role in the explanation of short-run dynamics in social spending. Left-wing parties are found to spend significantly more than their right-wing counterparts and parties spend more before elections. However, the partisan influence has changed over time. While ideology has lost some of its influence, the electoral cycle has become more important to explain changes in social expenditure. This result should be addressed to a general institutional change that took place in the early 1990s and continued over that decade. While changes in trade openness, indebtedness and budget deficits have not changed the partisan influence on social spending, they are particularly important to explain the short-run dynamics of social spending.     

Measuring fiscal spillovers in EMU and beyond: A Global VAR approach

This paper identifies and measures fiscal spillovers in the EU countries empirically using a global vector autoregression (GVAR) model. Our aim was to look at the sign and the absolute values of fiscal spillovers in a countrywise perspective and at the time profile (impulse response) of the impacts of fiscal shocks. We find moderate spillover effects of fiscal policy shocks originating in Germany and France. However, there is significant variation regarding the magnitude of the spillovers on individual destination countries and country clusters. Furthermore, we find some evidence that German or French fiscal spillovers are stronger on EMU than on non‐EMU countries.     

Evolutionary stability of bargaining and price posting: implications for formal and informal activities

In this paper we study the co-existence of two well known trading protocols, bargaining and price-posting. To do so we consider a frictional environment where buyers and sellers play price-posting and bargaining games infinitely many times. Sellers switch from one market to the other at a rate that is proportional to their payoff differentials. Given the different informational requirements associated with these two trading mechanisms, we examine their possible co-existence in the context of informal and formal markets. Other than having different trading protocols, we also consider other distinguishing features. We find a unique stable equilibrium where price-posting (formal markets) and bargaining (informal markets) co-exist. In a richer environment where both sellers and buyers can move across markets, we show that there exists a unique stable dynamic equilibrium where formal and informal activities also co-exist whenever sellers’ and buyers’ net costs of trading in the formal market have opposite signs.     

The eurozone financial crisis: debt,credit ratings and monetary and fiscal policy

This paper discusses the eurozone financial crisis. It argues that it was largely the result of a common monetary policy not being suitable for individual countries which led to excessive private and public borrowing and a debt crisis. Neither borrowing rates nor credit ratings anticipated the crisis. Fundamental changes to eurozone governance are being proposed. The paper examines whether instead there might be a market solution if financial markets priced risk better. Accordingly, a more timely way of obtaining credit ratings is shown.     

Dollarization and financial integration

How does a country's exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government responds to shocks by adjusting monetary policy and foreign borrowing. Sovereign borrowing is subject to endogenous limits, which ensure repayment when the default punishment corresponds to financial autarky. Dollarizing implies renouncing monetary policy, but can make access to international debt markets more valuable, thereby loosening borrowing constraints. This mechanism linking dollarization to financial integration is consistent with observed declines in spreads on foreign-currency debt in countries adopting the dollar or the euro.     

Market stability switches in a continuous-time financial market with heterogeneous beliefs

By considering a financial market of fundamentalists and trend followers in which the price trend of trend followers is formed as a weighted average of historical prices, we establish a continuous-time financial market model with time delay and examine the impact of time delay on market price dynamics. Conditions for the stability of the fundamental price in terms of agents' behavior parameters and time delay are obtained. In particular, it is found that an increase in time delay can not only destabilize the market price but also stabilize an otherwise unstable market price, leading to stability switching as delay increases. These interesting phenomena shed new light in understanding of mechanism on the market stability. When the fundamental price becomes unstable through Hopf bifurcations, sufficient conditions on the stability and global existence of the periodic solution are obtained.     

The effects of economic and political integration on fiscal decentralization: evidence from OECD countries

Abstract .  This paper examines the impact of economic and political integration on the vertical government structure. It argues that, by increasing the market size and the benefits of decentralized provision of public goods, integration triggered the recent process of decentralization in OECD countries. A panel analysis relates the degree of fiscal decentralization to economic and European integration, controlling for interregional heterogeneity, economies of scale, and institutions. The results mostly support a decentralizing effect of economic integration in general and of European integration in particular for heterogeneous EU countries, whereas participation of subnational governments in national decision-making is associated with more centralization.     

Government risk premiums in the bond market: EMU and Canada

This paper focuses on risk premiums paid by central governments in Europe and sub-national governments in Germany, Spain, and Canada, using data for bond yield spreads for the period 1991–2005. We find that risk premiums by central governments respond positively to debt and deficits; German states enjoyed a favourable position in financial markets before EMU but not thereafter; Spanish and Canadian provinces risk premiums over the whole period; German and Spanish sub-central governments pay liquidity-related interest rate premiums; Canadian and German provinces/states that benefit from fiscal equalization lower spreads. This is evidence of market discipline at work and of credibility of the EU no-bailout clause.     

The evolution of market integration in Russia

We use a statistical model of commodity trade to measure the extent of integration between regional commodity markets within Russia. Monthly time-series data on regional commodity prices spanning 1994 through 1999 indicate substantial fluctuations in integration over this period: an initial period of widespread integration gradually gave way to a period of disconnectedness in 1995 through 1997, which seems to have subsided by mid-1998. These fluctuations exhibit strong statistical relationships with a host of aggregate variables; most notably, internal integration exhibits a strong negative relationship with international trade.     

Monetary and fiscal policy interactions in the EMU when cyclical conditions are uncertain

This paper examines economic policy interactions in the Economic and Monetary Union when the assessment of cyclical conditions in real time is surrounded by uncertainty. On the basis of a simple stylised model it shows that with a Nash-type of interaction different views about the output gap on the side of the policy players—the Council of the European Union, the European Commission and the European Central Bank—can give rise to excessive activism with policy players pushing economic variables into opposite directions. It argues that the costs of such policy conflicts can be reduced by agreeing on a common assessment of the cycle, by constraining policy variables, and/or by increasing the weight of fiscally conservative institutions. An alternative option to sidestep policy conflicts ensuing from diverging views of the cycle is to take policy decisions sequentially, as is the case in a Stackelberg-type of interaction. The paper shows that for a given misperception of the cycle, the impact on the policy instruments and on output and inflation are generally smaller in the Stackelberg equilibrium as compared to a Nash outcome. Alternative allocations of roles—that is leader versus follower—are discussed and assessed.