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Abstracts of Other Working Papers

WORKING PAPER NO 526
"Time, Self-Selection and User Charges for Public Goods"
Dan Anderberg, Fredrik Andersson and Alessandro Balestrino

'Many public goods generate utility only when combined with time-input. Important examples include road networks and publicly provided leisure facilities. If it is possible to charge for the time spent using the public good it is generally a second-best Pareto optimal policy to do so even in the absence of congestion. An optimal linear user charge is analysed within a standard optimum income-tax framework. Second-best public good provision in the presence of a user charge is also characterized and factors that influence the direction of optimal distortion of the public good supply are identified.'

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WORKING PAPER NO 524
"Modelling the Behaviour of the Spot Prices of Various Types of Coffee"
By Jesus G. Otero and Costas Milas

'This paper investigates long-run relationships among the spot prices of four coffee types. We find two cointegrating vectors: one between the prices of Other Milds and Colombian coffee, and the other one between Unwashed Arabicas and Robustas. Following Pesaran and Shin (1996), persistence profile analysis of the two cointegrating vectors shows a rapid adjustment towards their equilibrium value. This suggests that the four coffee markets are highly related, and that discrepancies in the equilibrium relationships are short-lived. Out of sample evaluation of the model is reasonably good, except for two occasions of sharp price increases following adverse weather conditions.'

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WORKING PAPER NO 523
"A Dynamic Macroeconometric Model For Short-Run Stabilisation in India"
By Sushanta K. Mallick

'This paper presents a small macroeconometric model examining the determinants of Indian trade and inflation to address the effects of a reform policy package similar to those implemented in 1991. This is different from previous studies along one important dimension that we explicitly incorporate the non-stationarity of the data into our model and estimation procedures, which suggest that the stationarity assumption may be a source of misspecification in previous work. So the model has been estimated using the data from 1950 to 1995 employing fully-modified Phillips-Hansen Method of estimation to obtain the cointegrating relations and short-run dynamic model. Policy simulations using dynamic simulations method compare the dynamic responses to devaluation with the responses to tight credit policy. It is shown that the trade balance effects of tight credit policy are more enduring than those of devaluation. The simulations demonstrate that the devaluation has actually worsened the trade balance and hence devaluation is not an option in response to a negative trade shock, whereas the reduction in domestic credit produces a desirable improvement in the trade balance.'

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WORKING PAPER NO 522
"Business Cycles Asymmetries: Characterisation and Testing based on Markov-Switching Autoregressions"
By Michael P. Clements and Hans-Martin Krolzig

'We propose testing for business cycle asymmetries in Markov-switching autoregressive (MS-AR) models. We derive the parametric restrictions on MS-AR models that rule out types of asymmetries such as deepness, steepness, and sharpness, and set out a testing procedure based on Wald statistics which have standard asymptotics. For a two-regime model, such as that popularised by Hamilton (1989), we show that deepness implies sharpness (and vice versa) while the process is always non-steep. We illustrate with two and three-state MS models of US GNP growth, and with models of US output and employment. Our findings are compared with those obtained from standard non-parametric tests.'

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WORKING PAPER NO 521
"Maximum Sustainable Government Debt in the Overlapping Generational Model"
By Neil Rankin and Barbara Roffia

'The theoretical determinants of maximum sustainable government debt are investigated using Diamond’s overlapping-generations model. A level of debt is defined to be ‘sustainable’ if a steady state with non-degenerate values of economic variables exists. We show that a maximum sustainable level of debt almost always exists. Most interestingly, it normally occurs at a ‘catastrophe’ rather than a ‘degeneracy’, i.e. where variables such as capital and consumption are in the interiors, rather than at the limits, of their economically meaningful ranges. This means that if debt is increased step by step, the economy may suddenly collapse without obvious warning.'

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WORKING PAPER NO 520
"A Note on the Estimated Coefficients in Random Effects Probit Models"
By Wiji Arulampalam

'This note points out to applied researchers what adjustments are needed to the coefficient estimates in a random effects probit model in order to make valid comparisons in terms of coefficient estimates and marginal effects across different specifications. These adjustments are necessary because of the normalisation that is used by standard software in order to facilitate easy estimation of the random effects probit model.'

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WORKING PAPER NO 518
"Too Cool for School? A Theory of Countersignaling"
By Nick Feltovich, Rick Harbaugh and Ted To

'In sender-receiver games high-quality types can distinguish themselves from low-quality types by sending a costly signal. Allowing for additional, noisy information on sender types can radically alter sender behavior in such games. We examine equilibria where meduim types seperate themselves from low types by signaling, but high types then differentiate themselves from medium types by not signaling or counter-signaling. High types not only save the cost of signaling by relying on the additional information to stochastically separate themselves from low types, but in doing so they separate themselves from the signaling medium types. Hence they may countersignal even when signaling is a productive activity. To evaluate this theory we report on a two-cell experiment in which the unique Nash-equilibrium of one cell involves countersignaling by high types. Experimental results confirm that subjects can learn to countersignal.'

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WORKING PAPER NO 516
"Forecasting with Difference-Stationary and Trend-Stationary Models'
By M. P. Clements and D. P. Hendry

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WORKING PAPER NO 515
"A Non-Normative Theory of Inflation and Central Bank Independence"
By Berthold Herrendorf and Manfred J. M. Neumann

We study monetary policy under different central bank constitutions when the labor-market insiders set the nominal wage so that outsiders are involuntarily unemployed. If the insiders are in the majority, the representative insider will be the median voter. We show that an independent central bank, if controlled by the median voter, does not produce a systematic inflation bias, albeit equilibrium employment is too low from a social welfare point of view. A dependent central bank, in contrast, is forced by the government to collect seigniorage and to take the government's re-election prospects into account. The predictions of our theory are consistent with the evidence that central bank independence decreases average inflation and inflation variability, but does not affect employment variability.'

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WORKING PAPER NO 513
"Distributive Politics and the Benefits of Decentralisation"
By Ben Lockwood

This paper integrates the distributive politics literature with the literature on decentralization by incorporating inter-regional project externalities into a standard model of distributive policy. A key finding is that the degree of uniformity (or "universalism") of the provision of regional projects is endogenous, and depends on the strength of the externality. The welfare benefits of decentralization, and the performance of "constitutional rules" (such as majority voting) which may be used to choose between decentralization and centralization, are then discussed in this framework.

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WORKING PAPER NO 512
"Tests of the Expectations Hypothesis and Policy Reaction to the Term Spread: Some Comparative Evidence"
By Gianna Boero and Costanza Torricelli

The aim of this paper is to evaluate the impact of monetary policy in tests of the Expectations Hypothesis of the term structure of interest rates. We apply the model developed by McCallum (1994b), in which the Expectations Hypothesis interacts with a policy reaction function and with a time-varying term premium, to eight countries with different monetary policy stances, within the period 1985 to 1995. The results suggest the importance of the treatment of monetary policy in explaining the empirical performance of the Expectations Hypothesis. Amongst other results, we also find that the model performs better for some countries than others depending upon the monetary policy stance adopted.

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WORKING PAPER NO 511
"The Assignment of Powers in Federal and Unitary States"
By Ben Lockwood

This paper studies a model where the power to set policy (a choice of project) may be assigned to central and regional government via either a federal or unitary constitutional rule (CR). The benefit of central provision is economies of scale, while the cost is political inefficiency. Using the analytical tool of the net dissenting vote, the relationship between federal and unitary CRs is characterized. Efficiency of CRs is also studied: the federal CR need not be more efficient than the unitary CR when regions are diverse in tastes.

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WORKING PAPER NO 487
"Forecasting Seasonal UK Consumption"
By Michael P. Clements and Jeremy Smith

Periodic models for seasonal data allow the parameters of the model to vary across the different seasons. This paper uses the components of UK consumption to see whether the periodic autoregressive (PAR) model yields more accurate forecasts than non-periodic models, such as the airline model of Box and Jenkins, and autoregressive models that pre-test for (seasonal) unit roots. We analyse possible explanations for the relatively poor forecast performance of the periodic models that we find, notwithstanding the apparent support such models receive from the data in-sample.

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WORKING PAPER NO 477
"Crime and Drugs"
By Chris Doyle and Jennifer Smith

We present a model which ties together rational drug consumption, taxation, crime and other drug-related externalities. Drug control policy is addressed using an optimal tax framework. Consumption, possession and production of a drug may be prohibited, legalized or decriminalized. In all regimes illicit production of a drug may take place and drug-related crime occurs. We show that illicit drug production, the price elasticity of demand for a drug, the addictive nature of a drug, the effectiveness of drug enforcement strategies, and income distribution all influence optimal (second best) policy. Prohibition is contrasted with decriminalization and legalization, and where legalization yields a higher welfare than prohibition we show that this can be associated with greater drug-related crime and more drug addiction. The model is discussed in the context of US National Drug Control Strategy.

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WORKING PAPER NO 467
"Performance of Alternative Forecasting Methods for SETAR Models"
By Michael P. Clements and Jeremy Smith

We compare a number of methods that have been proposed in the literature for obtaining h-step ahead minimum mean square error forecasts for SETAR models. These forecasts are compared to those from an AR model. The comparison of forecasting methods is made using Monte Carlo simulation. The Monte Carlo method of calculating SETAR forecasts is generally at least as good as that of the other methods we consider. An exception is when the disturbances in the SETAR model come from a highly asymmetric distribution, when a Bootstrap method is to be preferred.

An empirical application calculates multi-period forecasts from a SETAR model of US GNP using a number of the forecasting methods. We find that whether there are improvements in forecast performance relative to a linear AR model depends on the historical epoch we select, and whether forecasts are evaluated conditional on the regime the process was in at the time the forecast was made.

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WORKING PAPER NO 464
"A Monte Carlo Study of the Forecasting Performance of Empirical SETAR Models"
By Michael P. Clements and Jeremy Smith

In this paper we investigate the multi-period forecast performance of a number of empirical self-exciting threshold autoregressive (SETAR) models that have been proposed in the literature for modelling exchange rates and GNP, amongst other variables. We take each of the empirical SETAR models in turn as the DGP to ensure that the 'non-linearity' characterises the future, and compare the forecast performance of SETAR and linear autoregressive models on a number of quantitative and qualitative criteria. Our results indicate that non-linear models have an edge in certain states of nature but not in others, and that this can be highlighted by evaluating forecasts conditional upon the regime.

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WORKING PAPER NO 455
"Bargaining Power and Local Labour Market Influences on Wage Determination"
By Jennifer Smith

This paper uses a unique panel of data at the level of the bargaining group to examine aspects of 'right-to-manage' models of wage determination. Empirical measures of firms' and unions' bargaining power are identified and found to be important influences on wage setting. The role of union characteristics in wage determination is examined; results confirm their importance and illuminate previous survey findings. Features of the local labour market are shown to affect bargained wages over and above the influence of aggregate factors.

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WORKING PAPER NO 454
"Saving, Investment and Real Interest Rates"
By Jennifer Smith

This paper investigates the determinants of real interest rates at world and country level. The starting point is the idea that real interest rates reflect the interaction of desired saving and planned investment, using the framework developed by Barro and Sala-i-Martin (1990) and Barro (1992). The paper updates previous results and extends the analysis to study long real interest rates. We analyse which factors have been responsible for real rate 'regime shifts' during 1959 to 1992. We examine the determinants of interest rate differentials across ten major industrialised countries and provide estimates of the extent of capital market integration.

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