Testing the Unstable Middle and Two Corners Hypotheses About Exchange Rate Regimes

The recent rash of international currency crises has generated considerable interest in the role that exchange rate regimes have played in contributing to these crises. Many economists have argued that efforts to operate adjustably pegged exchange rate regimes have been a major contributor to “the unstable middle” hypothesis and some have argued that this unstable middle is so broad that only the two corners of hard fixes or floating rates will be stable in a world of high capital mobility—the two corners or bipolar hypothesis. Two recent empirical studies by researchers at the International Monetary Fund reach opposing conclusions on these issues. We examine the issue further and show that conclusions can be quite sensitive to how exchange rate regimes are grouped into categories and the measures of currency crises that are used. In general we find that the dead center of the adjustable peg is by far the most crisis prone broad type of exchange rate regimes, but that countries need not go all the way to freely floating rates or hard fixes to substantially reduce the risks of currency crises.

Can Agents Be Better Off with Pay Caps?

A popular way to discipline the managers of companies or banks that got into trouble during the recent financial crisis has been to impose caps on managers' pay. Using a small extension of the standard principal–agent model, we argue that pay caps might serve the opposite purpose, because the agent might be better off with a pay cap. Specifically, we show that, given a fixed effort level to be implemented, the agent's expected utility can be decreasing in an upper bound for the agent's reward. The effect of pay caps on the general structure of optimal incentive contracts is also characterized. While an improvement of contracting information always helps the principal, it might increase or decrease the marginal cost of imposing pay caps.     

EMPLOYMENT PROTECTION,TECHNOLOGY CHOICE,AND WORKER ALLOCATION

We show empirically that high‐risk sectors, which contribute strongly to aggregate productivity growth, are relatively small and have relatively low productivity growth in countries with strict employment protection legislation (EPL). To understand these findings, we develop a two‐sector matching model where firms endogenously choose between a safe technology and a risky technology. For firms that have chosen the risky technology, EPL raises the costs of shedding workers in case they receive a low productivity draw. According to our calibrated model, high‐EPL countries benefit less from the arrival of new risky technologies than low‐EPL countries. Parameters estimated through reduced‐form regressions of employment and productivity on exit costs, riskiness, and in particular their interaction are qualitatively similar for actual cross‐country data and simulated model data. Our model is consistent with the slowdown in productivity in the European Union relative to the United States since the mid‐1990s.     

Heterogeneous Mortgage Markets: Implications for Business Cycles and Welfare in the EMU

This paper evaluates business cycle effects of asymmetric cross‐country mortgage market developments in a monetary union. By employing a two‐country New Keynesian DSGE model with collateral constraints tied to housing values, we show that a change in institutional characteristics of mortgage markets, such as the loan‐to‐value (LTV) ratio, is an important driver of asymmetric developments in housing markets and economic activity. Our analysis suggests that the home country where credit standards are lax booms, while the rest of European Monetary Union faces a negative output gap. Overall welfare is lower if LTV ratios are higher.     

The economic growth impact of natural disasters in developing countries: Evidence from hurricane strikes in the Central American and Caribbean regions

In this paper we investigate the macroeconomic impact of natural disasters in developing countries by examining hurricane strikes in the Central American and Caribbean regions. Our innovation in this regard is to employ a wind field model on hurricane track data to arrive at a more scientifically based index of potential local destruction. This index allows us to identify damages at a detailed geographical level, compare hurricanes' destructiveness, as well as identify the countries that are most affected, without having to rely on potentially questionable monetary loss estimates. Combining our destruction index with macroeconomic data we show that the average hurricane strike caused output to fall by at least 0.83 percentage points in the region, although this depends on controlling for local economic characteristics of the country affected and what time of the year the storm strikes.     

Foetal Exposure to Air Pollution and Students' Cognitive Performance: Evidence from Agricultural Fires in Brazil*

This paper examines the impact of foetal exposure to air pollution from agricultural fires on Brazilian students' cognitive performance later in life. We rely on comparisons across children who were upwind and downwind of the fires while in utero to address concerns around sorting and temporary income shocks. Our findings show that agricultural fires increase $$, resulting in significant negative effects on pupils' scores in Portuguese and Maths in the $$ grade through prenatal exposure. Back-of-the-envelope calculations suggest that a 1% reduction in $$ from agricultural burning has the potential to increase later life wages by 2.6%.     

Multinationals and Training: Some Evidence from Irish Manufacturing Industries

This paper sets out to analyse the effect of plant and sectoral level characteristics on the provision of training to employees using plant level data for Irish manufacturing. There is no clear evidence that foreign owned plants are more likely to provide training. By contrast, we find that they spend less than domestic plants on training, ceteris paribus. There is also no evidence that plants that receive training grants are more likely to provide training. This may be likely to reflect the targeting of training grants on plants that are otherwise unlikely to provide much training. We do, however, find that training activity in the sector, either by other foreign or domestic plants, has a positive effect on plant level training activity, at least for domestic owned plants.     

Water accounting for the Orange River Basin: An economic perspective on managing a transboundary resource

The framework for water accounting is applied to an international river basin, the Orange River Basin, which is shared among Botswana, Namibia, Lesotho and South Africa. Each of the riparian states faces water constraints and relies increasingly on shared international water resources. The countries have adopted the principle of an economic approach to water management, once basin human needs are met, and all but Lesotho have constructed national water accounts to assist in water management. The water accounts for the Orange River Basin bring an economic perspective to water management at the regional level. The accounts include supply and use tables, which are used to compare the contribution to water supply from each riparian state to the amount used. The water accounts are then linked to economic data for each country to calculate water use and productivity by industry and country. There are considerable disparities in water productivity among the countries, which should be taken into account in future decisions about water allocation, pricing and infrastructure development.     

Estimating Key Economic Variables: The Policy Implications

The current monetary policy debate has focused on current estimates and the future path of the natural rate of unemployment and the equilibrium interest rate. Estimates of the natural rate of unemployment should vary over time with changes in demographics and improvements in human capital. However, these changes should be gradual. This paper shows that the estimates of the natural rate of unemployment by Federal Reserve officials and private-sector economists seem to move pro-cyclically, potentially showing too much weight given to short-term fluctuations in economic variables. As with the natural rate, there are good reasons to expect the equilibrium interest rate to change over time. In fact, the level may actually be more responsive to current economic data, reflecting changes in aggregate savings and investment. Yet, we see that equilibrium interest rate estimates by both Federal Reserve officials and private-sector economists have declined quite dramatically over the past five years. A potential concern raised in this paper is that estimates of these critical economic variables for policy determination appear to be overly sensitive to high frequency economic data.