Government policy and the probability of coordination failures

This paper introduces an approach to the study of optimal government policy in economies characterized by a coordination problem and multiple equilibria. Such models are often criticized as not being useful for policy analysis because they fail to assign a unique prediction to each possible policy choice. We employ a selection mechanism that assigns, ex ante, a probability to each equilibrium indicating how likely it is to obtain. We show how such a mechanism can be derived as the natural result of an adaptive learning process. This approach leads to a well-defined optimal policy problem, and has important implications for the conduct of government policy. We illustrate these implications using a simple model of technology adoption under network externalities.     

Interest rates,exchange rates,and aggregate supply

The paper discusses fiscal policy incorporating interest-rate and exchange-rate effects on aggregate supply. It is shown how the familiar aggregate supply-aggregate demand framework can be used in the presence of endogenously determined interest rates and exchange rates.     

Interest expectations and exchange rates news

Using a new survey data set ofmatched exchange rate and interest rate expectations for eight currencies relative to the German mark, we examine empirically the relationship between exchange rate returns, news and risk premia. News on interest differentials enters significantly in equations for the difference between the spot rate and the lagged forward rate for the British pound, Japanese yen, Spanish peseta and the US dollar. An unexpected rise in the interest rate differential tends to strengthen the domestic exchange rate. For each of these currencies, we also find significant effects of our ex-ante measure of the risk premium. In addition, we investigate the effect of lagged interest rate differentials as proxy for the risk premium and find that they do not capture time-varying risk premia as is widely suggested in the literature, but probably capture a peso-problem, learning about a policy change, a market-inefficiency or a combination of these factors.     

Imitation and the role of information in overcoming coordination failures

We consider minimum-effort games played in an arbitrary network. For a family of imitation behavioral rules, including Imitate the Best and the Proportional Imitation Rule, we show that inefficient conventions arise independently of the interaction structure, if information is limited to the interaction neighborhoods. In the presence of information spillovers, we provide a condition on the network structure that guarantees the emergence of efficient conventions. In contrast, if this condition is violated we will observe inefficient conventions, even in the presence of information spillovers.     

Monetary and fiscal coordination in preventing bank failures and financial contagion

This paper uses a theoretical model to analyze the optimal combination of monetary response (lowering of interest rates) and fiscal bailouts in preventing bank failures and financial contagion. I show that the optimal way of rescuing failing banks is to combine the two. This is because lower interest rates reduce the size of the bailout required to rescue failing banks as they reduce the cost for banks to raise and retain deposits. The main result of the paper is that banks are willing to monitor their investments more closely when they anticipate a monetary response in addition to bailouts in case of a banking crisis. Additionally, capital requirements such as the Basel Accords do not always incentivize banks to monitor their investments if there is a potential contagion from unhealthy to healthy banks.     

Bank runs as coordination failures: An experimental study

We use experimental methods to investigate what factors contribute to breakdowns in coordination among a bank’s depositors. Subjects in our experiment decide whether to leave their money deposited in a bank or withdraw it early; a bank run occurs when there are too many early withdrawals. We explore the effects of adding uncertainty about fundamental withdrawal demand and of changing the number of opportunities subjects have to withdraw. Our results show that (i) bank runs are rare when fundamental withdrawal demand is known but occur frequently when it is stochastic, and (ii) subjects are more likely to withdraw when given multiple opportunities to do so than when presented with a single decision. For the multiple-opportunity case, we evaluate individual withdrawal decisions according to a set of simple cutoff rules. We find that the cutoff rule corresponding to the payoff-dominant equilibrium of the game, which involves Bayesian updating of probabilities, explains subject behavior better than other rules.     

Discount rates and shadow prices for public investment

This paper extends the Harberger–Sandmo–Drèze model for public discount rates to a many-good economy. It derives a formula for discount rates which are specific to each public enterprise or agency and used by them to discount future outputs and inputs evaluated at market prices. Such an approach is shown to be more efficient than that of simply using a single rate for all public projects. It is also more practical than asking each public firm to use second-best shadow prices in their analyses of investment projects.The general results are first provided; then, simple cases are considered and numerical examples presented to help interpret our formula and analyse its main determinants.     

Beyond market failures: the market creating and shaping roles of state investment banks

The paper develops a typological framework of the roles of state investment banks (SIBs) in the economy. The typology identifies four different roles: countercyclical; developmental; venture capitalist; and challenge-led. The paper conceptually elaborates the typology by first providing a historical overview of SIBs, and then discussing how the mainstream “market failure theory” justifies them. It then advances a different conceptualization based on insights from heterodox economics, showing that all roles of SIBs are more about market creating/shaping rather than market-failure fixing. The paper concludes with a proposal of a new agenda for research on SIBs based on our typological framework.     

The effects of regional tax and subsidy coordination on foreign direct investment

This paper analyses the effects of a regionally coordinated profit tax or location subsidy in a model with three active countries, one of which is not part of the union, and a globally mobile firm. We show that regional coordination can lead to two types of welfare gain. First, for investments that would take place in the union in the absence of coordination, a coordinated tax increase can transfer location rents from the firm to the union. Second, by internalising all of the union's benefits from foreign direct investment, a coordinated tax reduction can attract more welfare-enhancing investment than when member states act in isolation. Depending on which motive dominates, tax levels may thus rise or fall under regional coordination.     

Value maximizing hurdle rates for R&D investment

We show that the value maximizing hurdle rate for research and development (R&D) investments among private firms operating in a market setting is less than for conventional investments despite the fact that R&D has development risk. Because development risk arises only during R&D, entrepreneurs control this risk by deferring or pursuing R&D depending upon profitability. This risk management moderates downside loss and encourages upside gain which increases the value attraction of R&D and decreases the value maximizing hurdle rate below that of conventional investment.     

World real interest rates: a global savings and investment perspective

Over the past 15 years, long-term interest rates have declined to levels not seen since the 1970s. This article explores possible shifts in global savings and investment that have led to this fall in the world real interest rate. There are several key findings. First, the authors identify the relative weakness in investment demand as more important than the relative increase in desired global savings to explain the decline in global interest rates. Second, the results indicate that the key factors explaining movements in savings and investment are variables that evolve relatively slowly over time, such as labour force growth and age structure. The conclusions suggest that over the coming years, world real interest rates are likely to continue to adjust slowly, reflecting long-term trends.     

Corporate tax rates and foreign direct investment in the United States

A significant research effort has been directed at establishing the determinants of foreign direct investment (FDI), with taxation policy identified as an important factor. However, the empirical literature has been limited in several respects, with most work focused exclusively on host country tax regimes. This paper seeks to extend the boundaries of FDI empirical inquiry by using a panel of nine investing tax exemption and tax credit countries over the period 1982–2000, constituting more than 85% of total US FDI inflows, and incorporating home country tax rates to analyse two as yet unanswered questions. First, are corporate income tax rates an important determinant of FDI in the US? Secondly, do investors from tax credit countries differ significantly in their tax response relative to those from tax exemption countries?     

Interest rates,inflation, and taxes: The foreign connection

In this note it is shown that the existence of taxes on nominal interest receipts in an international setting introduces a non-neutrality in that a change in expected inflation in one country must change at least one expected real interest rate or the path of the real exchange rate.     

Interest rates and the fisher effect in India: An empirical study

This study throws light on the importance of adjustment lags, variability of inflation, changes in real income, etc. in the empirical estimation of Fisher hypothesis. Variability of inflation has a significant negative impact on both short- and long-term interest rates in a developing economy like India. The ‘Philips Curve Effect’ has not been operative in a developing country.     

Interest rates,expectations and the credibility of the Bank of Spain

The purpose of the paper is to pinpoint the date of the change of monetary policy regime which occurred in Spain during the year 1984, when it moved away from controlling monetary aggregates towards interest rate targeting. The most likely date for the change is estimated and, surprisingly, there is evidence that agents learned about the new intermediate target quite rapidly.A week after the change, the term structure of interest rates showed how market agents attributed much more informational content to interest rate changes than they had previously. Two types of transitions are tried: a one-step and a gradual logistic swithing function.     

Interest rates,government purchases and the Taylor rule in recessions and expansions

In this paper we study asymmetries in the Taylor rule for the United States during the 1970–2012 period. We show that monetary authorities have been constantly concerned with excess demand in overheated periods – when the output gap is positive or the unemployment rate falls below 7% or 7.5% – raising the interest rate aggressively in that case. However, the Fed seems more reluctant to decrease the fund’s rate during recessions. On the contrary, monetary authorities react symmetrically and forcefully to inflation in booms and busts. Finally, we provide evidence that an expansionary fiscal policy does not lead to an increase in interest rates, and thus there is not necessary a “crowding-out” effect in recessions.