Uncertainty and disagreement in economic prediction: the Bank of England Survey of External Forecasters
Gianna Boero, Jeremy Smith and Kenneth F Wallis
This article introduces a new source of survey data, namely the Bank of England Survey of External Forecasters. The survey collects point and density forecasts of inflation and GDP growth, and hence offers the opportunity of constructing direct measures of uncertainty. We present a simple statistical framework in which to define and interrelate measures of uncertainty and disagreement. The resulting measures are compared with other direct measures of uncertainty, nationally and internationally. A significant, sustained reduction in inflation uncertainty followed the 1997 granting of operational independence to the Bank of England to pursue a monetary policy of inflation targeting.
Contracts with Endogenous Information
I study covert information acquisition and reporting in a principal agent problem allowing for general technologies of information acquisition. When posteriors satisfy local versions of the standard First Order Stochastic Dominance and Concavity/Convexity of the Distribution Function conditions, a first-order approach is justified. Under the same conditions, informativeness and riskiness of reports are equivalent. High powered contracts, that make the agents informational rents more risky, are used to increase incentives for information acquisition, insensitive contracts are used to reduce incentives for information gathering. The value of information to the agent is always positive. The value of information to the principal is ambiguous.
Taxes and Employment Subsidies in Optimal Redistribution Programs (Revised Version)
Paul Beaudry, Charles Blackorby and Dezso Szalay
This paper explores how to optimally set tax and transfers when taxation authorities : (1) are uninformed about individuals’ value of time in both market and non-market activities and (2) can observe both market-income and time allocated to market employment. We show that optimal redistribution in this environment involves distorting market employment upwards for low wage individuals through decreasing wage-contingent employment subsidies, and distorting employment downwards for high wage individuals through positive and increasing marginal income tax rates. In particular, we show that whether a person is taxed or subsidized depends primarily on his wage, that is, the optimal program involves a cut-off wage whereby workers above the cutoff are taxed as they increase their income, while workers earning a wage below the cutoff receive an income supplement (an earned income tax credit) as they increase their income. Finally, we show that the optimal program transfers zero income to individuals who choose not to work.
Trade Costs and the Open macroeconomy
Trade costs are known to be a major obstacle to international economic integration. Following the approach of New Open Economy Macroeconomics, this paper explores the effects of international trade costs in a micro-founded general equilibrium model that also allows for pricing to market. Trade costs are shown to create an endogenous home bias in consumption and reduce cross-country consumption correlations. In addition, trade costs magnify exchange rate volatility in response to monetary shocks and typically turn a monetary expansion into a beggar-thy-neighbor policy. It is striking that trade costs generally lead to these results both under producer and local currency pricing.
Quantile Forecasts of Daily Exchange Rate Returns from Forecasts of Realized Volatility
Michael P Clements, Ana Beatriz Galvao and Jae H Kim
Quantile forecasts are central to risk management decisions because of the widespread use of Value-at-Risk. A quantile forecast is the product of two factors : the model used to forecast volatility, and the method of computing quantiles from the volatility forecasts. In this paper we calculate and evaluate quantile forecasts of the daily exchange rate returns of five currencies. The forecasting models that have been used in recent analyses of the predictability of daily realized volatility permit a comparison of the predictive power of different measures of intraday variation and intraday returns in forecasting exchange rate variability. The methods of computing quantile forecasts include making distributional assumptions for future daily returns as well as using the empirical distribution of predicted standardized returns with both rolling and recursive samples. Our main findings are that the HAR model provides more accurate volatility and quantile forecasts for currencies which experience shifts in volatility, such as the Canadian dollar, and that the use of the empirical distribution to calculate quantiles can improve forecasts when there are shifts.
Regional Vulnerability: The Case of East Asia
Ashoka Mody and Mark P Taylor
In a case study of six East Asian economies, we use dynamic factor analysis to estimate a regional component of the exchange market pressure index (EMPI) as a measure of regional financial stress. The extent to which this indicator is explained by regional economic and financial factors is interpreted as regional vulnerability to crisis. We find that regional external liabilities and exuberance in domestic stock and credit markets, as well as the US high yield spread, were positively correlated with regional vulnerability. Individual country EMPIs are also explained by regional factors, with country-specific factors and trade linkages playing little role.
Funding Higher Education and Wage Uncertainty: Income Contingent Loan versus Mortgage Loan
In a world where graduate incomes are uncertain and higher education is financed through governmental loans, we build a theoretical model to show whether an income contingent loan (ICL) or a mortgage loan (ML) is preferred for higher levels of uncertainty. Assuming a single lifetime shock on graduate incomes, we compare the individual expected utilities under the two loan schemes, for both risk neutral and risk averse individuals. The theoretical model is calibrated using real data on wage uncertainty and considering the features of the UK Higher Education Reform to observe the implications of the switch from a ML to an ICL and the effect of the top-up fees. Different scenarios are simulated according to individual characteristics and family background. We finally extend the initial model to incorporate stochastic changes of income over time.
Forecasy Encompassing Tests and Probability Forecasts
Michael P Clements and David I Harvey
We consider tests of forecast encompassing for probability forecasts, for both quadratic and logarithmic scoring rules. We propose test statistics for the null of forecast encompassing, present the limiting distributions of the test statistics, and investigate the impact of estimating the forecasting models’ parameters on these distributions. The small-sample performance of the various statistics is investigated, both in terms of small numbers of forecasts and model estimation sample sizes. Two empirical applications show the usefulness of the tests for the evaluation of recession probability forecasts from logit models with different leading indicators as explanatory variables, and for evaluating survey-based probability forecasts.
Macroeconomic Forecasting with Mixed Frequency Data: Forecasting US output growth and inflation
Michael P Clements and Ana Beatriz Galvao
Although many macroeconomic series such as US real output growth are sampled quarterly, many potentially useful predictors are observed at a higher frequency. We look at whether a recently developed mixed data-frequency sampling (MIDAS) approach can improve forecasts of output growth and inflation. We carry out a number of related real-time forecast comparisons using various indicators as explanatory variables. We find that MIDAS model forecasts of output growth are more accurate at horizons less than one quarter using coincident indicators ; that MIDAS models are an effective way of combining information from multiple indicators ; and that the forecast accuracy of the unemployment-rate Phillips curve for inflation is enhanced using the MIDAS approach.
Internal consistency of survey respondents' forecasts: Evidence based on the Survey of Professional Forecasters
Michael P Clements
We ask whether the different types of forecasts made by individual survey respondents are mutually consistent, using the SPF survey data. We compare the point forecasts and central tendencies of probability distributions matched by individual respondent, and compare the forecast probabilities of declines in output with the probabilities implied by the probability distributions. When the expected associations between these different types of forecasts do not hold for some idividuals, we consider whether the discrepancies we observe are consistent with rational behaviour by agents with asymmetric loss functions.
Testing for unit roots in three-dimensional heterogeneous panels in the presence of cross-sectional dependence
Monica Giulietti, Jesus Otero and Jeremy Smith
This paper extends the cross-sectionally augmented IPS (CIPS) test of Pesaran (2006) to a three-dimensional (3D) panel. This 3D-CIPS test is correctly sized in the presence of cross-sectional dependency. Comparing its power performance to that of a bootstrapped IPS (BIPS) test, we find that the BIPS test invariably dominates, although for high levels of cross-sectional dependency the 3D-CIPS test can out-perform the BIPS test.
Cartels and Search
Norman Ireland and Michael Waterson
This paper unifies two significant but somewhat contradictory ideas. First, search costs potentially influence market price equilibria significantly; in many equilibria consumers do not search despite above-competitive prices. Second, cartels must guard against individual members offering lower prices, thereby creating incentives for consumers to search. We develop a simple framework, and then an example, in which whether search takes place depends upon the magnitude of search costs. Three potential equilibria result, dependent upon model parameters. These include a tacit cartel agreement exhibiting price variance and volatility. A policy conclusion is that such market characteristics do not always guarantee non-cartelisation.
The Obstinate Passion of Foreign Exchange Professionals : Technical Analysis
Lukas Menkhoff and Mark P. Taylor
Technical analysis involves the prediction of future exchange rate (or other assetprice) movements from an inductive analysis of past movements. A reading of the large literature on this topic allows us to establish a set of stylised facts, including the facts that technical analysis is an important and widely used method of analysis in the foreign exchange market and that applying certain technical trading rules over a sustained period may lead to significant positive excess returns. We then analyze four arguments that have been put forward to explain the continuing widespread use of technical analysis and its apparent profitability: that the foreign exchange market may be characterised by not-fully-rational behaviour; that technical analysis may exploit the influence of central bank interventions; that technical analysis may be an efficient form of information processing ; and finally that it may provide information on nonfundamental influences on foreign exchange movements. Although all of these positions may be relevant to some degree, neither non-rationality nor official interventions seem to be widespread and persistent enough to explain the obstinate passion of foreign exchange professionals for technical analysis.
Real Exchange Rates Over the Past Two Centuries : How Important is the Harrod-Balassa-Samuelson Effect?
James R. Lothian and Mark P Taylor
Using data since 1820 for the US, the UK and France, we test for the presence of real effects on the equilibrium real exchange rate (the Harrod-Balassa-Samuelson, HBS effect) in an explicitly nonlinear framework and allowing for shifts in real exchange rate volatility across nominal regimes. A statistically signifcant HBS effect for sterling-dollar captures its longrun trend and explains a proportion of variation in changes in the real rate that is proportional to the time horizon of the change. There is signifcant evidence of nonlinear reversion towards long-run equilibrium and downwards shifts in volatility during fixed nominal exchange rate regimes.
Merger Simulations of Unilateral Effects: What Can We Learn from the UK Brewing Industry
I discuss the use of simulation techniques to evaluate unilateral effects of horizontal mergers and the pitfalls that one can encounter when using them. Simple econometric models are desirable because they can be implemented in a short period of time and can be understood by non experts. Unfortunately, their predictions are often misleading. Complex models are more reliable but they require more time to implement and are less transparent. The use of merger simulations and the sensitivity of predictions to modeling choices is illustrated with an application to mergers in the UK brewing industry. There have been a number of brewing mergers that have changed the structure of the UK market, as well as proposed but unconsummated mergers that would have had even more profound effects. I assess two of them: the successful merger between Scottish&Newcastle and Courage and the proposed merger between Bass and Carlsberg–Tetley.
Taxes and Employment Subsidies in Optimal Redistribution Programs
Paul Beaudry and Charles Blackorby
This paper explores how to optimally set tax and transfers when taxation authorities: (1) are uninformed about individuals’ value of time in both market and non-market activities and (2) can observe both market-income and time allocated to market employment. In contrast to much of the optimal income taxation literature, we show that optimal redistribution in this environment involves distorting market employment upwards for low net-income individuals through phased-out wage-contingent employment subsidies, and distorting employment downward for high net-income individuals through positive and increasing marginal income tax rate. We also show that workfare may also be used as part of an optimal redistribution program.
Hedge Your Costs: Exchange Rate Risk and Endogenous Currency Invoicing
The choice of invoicing currency for trade is crucial for the international transmission of macroeconomic policy. This paper develops a three-country model that endogenizes the choice of invoicing currency and that allows for a share of firms' costs to be denominated in foreign currency, consistent with the empirical evidence on the high degree of pass-through to import prices. Invoicing decisions are driven by firms' desire to hedge costs but also by exchange rate volatility and currency comovements. The model is tested empirically with a data set that spans ten currencies and 24 reporting countries, confirming the importance of currency comovements for the decision to invoice in vehicle currency. The findings also imply that if the U.S. share of world output continues to fall, other currencies will increasingly replace the U.S. dollar as an international vehicle currency.
Is the Iceberg Melting Less Quickly? International Trade Costs after World War II
International trade costs are of vital importance because they determine trade patterns and therefore economic performance. This paper develops a new micro-founded measure of international trade costs. It is based on a multi-country general equilibrium model of trade that incorporates bilateral "ice-berg" trade costs. The model results in a gravity equation from which the implied trade costs can be easily computed. The trade cost measure is intuitive, takes multilateral resistance into account and yields empirical results that are economically sensible. It is found that during the post-WorldWar II period trade costs have declined markedly. The dispersion of trade costs across countries can best be explained by geographical and historical factors like distance and colonial linkages but also by tariffs and free trade agreements
Correlated Equilibria, Incomplete Information and Coalitional Deviations
Francis Bloch and Bhaskar Dutta
This paper proposes new concepts of strong and coalition-proof correlated equilibria where agents form coalitions at the interim stage and share information about their recommendations in a credible way. When players deviate at the interim stage, coalition-proof correlated equilibria may fail to exist for two-player games. However, coalition- proof correlated equilibria always exist in dominance-solvable games and in games with positive externalities and binary actions.
Markets with Bilateral Bargaining and Incomplete Information
Kalyan Chatterjee and Bhaskar Dutta
We study the relationship between bargaining and competition with incomplete information. We consider a model with two uninformed and identical buyers and two sellers. One of the sellers has a privately-known reservation price, which can either be Low or High. The other seller’s reservation price is commonly known to be in between the Low and High values of the privately-informed seller. Buyers move in sequence, and make offers with the second buyer observing the offer made by the first buyer. The sellers respond simultaneously. We show that there are two types of (perfect Bayes) equilibrium. In one equilibrium, the buyer who moves second does better. In the second equilibrium, buyers’ expected payoffs are equalised, and the price received by the seller with the known reservation value is determined entirely by the equuilibrium of the two-player game between a single buyer and an informed seller. We also discuss extensions of the model to multiple buyers and sellers, and to the case where both sellers are privately informed.
Unit Versus Ad Valorem Taxes: Monopoly In General Equilibrium
Charles Blackorby and Sushama Murty
We show that if a monopoly sector is imbedded in a general equilibrium framework and profits are taxed at one hundred percent, then unit (specific) taxation and ad valorem taxation are welfare-wise equivalent. This is contrary to all known claims.
Supply shocks and currency crises : the policy dilemma reconsidered
Javier Garcia-Fronti, Marcus Miller and Lei Zhang
The stylised facts of currency crises in emerging markets include output contraction coming hard on the heels of devaluation, with a prominent role for the adverse balance-sheet effects of liability dollarisation. In the light of the South East Asian experience, we propose an eclectic blend of the supply-side account of Aghion, Bacchetta and Banerjee (2000) with a demand recession triggered by balance sheet effects (Krugman, 1999). This sharpens the dilemma facing the monetary authorities - how to defend the currency without depressing the economy. But, with credible commitment or complementary policy actions, excessive output losses can, in principle, be avoided.
Games of Status and Discrininatory Contract
Amrita Dhillon and Alexander Herzog-Stein
Following recent empirical evidence which indicates the importance of rank for the determination of workers’ wellbeing, this paper introduces status seeking preferences in the form of rank-dependent utility functions into a moral hazard framework with one firm and multiple workers, but no correlation in production. Workers’ concern for the rank of their wage in the firm’s wage distribution may induce the firm to offer discriminatory wage contracts when its aim is to induce all workers to expend effort.
Testing for stationarity in heterogeneous panel data in the presence of cross section dependence
Monica Giullietti, Jesus Otero and Jeremy Smith
The panel variant of the KPSS tests developed by Hadri (2000) for the null of stationarity suffers from size distortions in the presence of cross section dependence. However, applying the bootstrap methodology we find that these tests are approximately correctly sized.
Sovereign debt restructuring: the Judge, the vultures and creditor rights
Marcus Miller and Dania Thomas
What role did the US courts play in the Argentine debt swap of 2005? What implications does this have for the future of creditor rights in sovereign bond markets? The judge in the Argentine case has, it appears, deftly exploited creditor heterogeneity – between holdouts seeking capital gains and institutional investors wanting a settlement – to promote a swap with a supermajority of creditors. Our analysis of Argentine debt litigation reveals a ‘judge-mediated’ sovereign debt restructuring, which resolves the key issues of Transition and Aggregation - two of the tasks envisaged for the IMF’s still-born Sovereign Debt Restructuring Mechanism. For the future, we discuss how judge-mediated sovereign debt restructuring (together with creditor committees) could complement the alternative promoted by the US Treasury, namely collective action clauses in sovereign bond contracts.
Externalities and Fundamental Nonconvexities: A Reconciliation of Approaches to General Equilibrium Externality Modelling and Implications for Decentralization
By distinguishing between producible and nonproducible public goods, we are able to propose a general equilibrium model with externalities that distinguishes between and encompasses both the Starrett  and Boyd and Conley  type external effects. We show that while nonconvexities remain fundamental whenever the Starrett type external effects are present, these are not caused by the type discussed in Boyd and Conley. Secondly, we find that the notion of a “public competitive equilibrium” for public goods found in Foley [1967, 1970] allows a decentralized mechanism, based on both price and quantity signals, for economies with externalities, which is able to restore the equivalence between equilibrium and efficiency even in the presence of nonconvexities. This is in contrast to equilibrium notions based purely on price signals such as the Pigouvian taxes.
Why are there Serial Defaulters? Evidence from Constitutions
Presidential democracies were 4.9 times more likely to default on external debts between 1976 and 2000 than parliamentary democracies. This paper argues that the explanation to the pattern of serial defaults among a number of sovereign borrowers lies in their constitutions. Ceteris paribus, parliamentary democracies are less likely to default on their liabilities as the confidence requirement creates a credible link between economic policies and the political survival of the executive. This link tends to strengthen the repayment commitment when politicians are opportunistic. I show that this effect is large and statistically significant in the contemporary world even when comparison is restricted to countries that are twins in terms of colonial origin, geography and economic variables. Moreover, the result persists if OECD or Latin American democracies are excluded from the sample. Since the form of government of a country is typically chosen at the time of independence and highly persistent over time, constitutions can explain why debt policies in developing countries are related to individual histories.
Money and Mental Wellbeing: A Longitudinal Studyof Medium-Sized Lottery Wins
Jonathan Gardner and Andrew J. Oswald
One of the famous questions in social science is whether money makes people happy. We offer new evidence by using longitudinal data on a random sample of Britons who receive medium-sized lottery wins of between £1000 and £120,000 (that is, up to approximately U.S. $200,000). When compared to two control groups -- one with no wins and the other with small wins -- these individuals go on eventually to exhibit significantly better psychological health. Two years after a lottery win, the average measured improvement in mental wellbeing is 1.4 GHQ points
Unions, Wages and Labour Productivity: Evidence from Indian Cotton Mills
This paper uses firm level data from all the textile producing regions in India to examine the relation between wages, unionization and labour productivity. We find that fewer workers were employed per machine in the unionized mills in Bombay and Ahmedabad, as compared to non-unionized regions implying that low labour productivity was not due to union resistance to increased work intensity. Our findings suggest that while low wages in India encouraged overmanning, higher wages, prompted by unionization, had productivity enhancing effects. We explore alternative explanations for low labour productivity, arising from the managerial and institutional structure of Indian cotton mills.
International Liquidity Swaps: Is the Chiang Mai Initiative Pooling Reserves Efficiently ?
Emanuel Kohlscheen and Mark P. Taylor
We analyze the network of bilateral liquidity swaps (BSAs) among the ASEAN+3 countries. We find that the network has taken the correlation of capital flows in the region into account, in the sense that countries with lower correlation of reserve growth have engaged in larger BSAs. All else equal, a decimal point increase in the correlation of international reserve growth decreases the size of a bilateral swap agreement between 18 and 27%. Moreover, we find that the approximatedly $ 60bn of BSAs have had a limited impact, if any, on government bond spreads so far. Finally, we identify potential gains from inter-regional BSAs.
Protests and Reputation
Lucia Buenrostro, Amrita Dhillon and Myrna Wooders
Protests take place for a variety of reasons. In this paper we focus on protests that have a well defined objective, that is in conflict with the objectives of the government. Hence the success or failure of a protest movement depends crucially on how the government responds. We assume that government types are private information so that governments have an interest in building a reputation to deter protestors. We extend the standard reputation framework to one where potential protesters in the domestic jurisdiction are competing in a common market with protestors of a foreign jurisdiction, resulting in a situation where domestic governments care about the decisions of foreign governments. We derive conditions under which an equilibrium with "contagion" in protests might exist: protests that start in one jurisdiction spread to others. Finally we use our results to interpret the Fuel tax protests in France and England that took place in 2000 as well as the three successive pro-democracy revolutions in Georgia, Ukraine and Kyrgyzstan in 2003-05.
Enfranchisement, Intra-Elite Conflict and Bargaining
Sayantan Ghosal and Eugenio Proto
Does power sharing between competing elites result in franchise extension to non-elites? In this paper, we argue that competing, risk-averse elites will enfranchise non-elites as in-surance against future, uncertain imbalances in relative bargaining power. We show that negligibly small changes in the bargaining power of non-elites, conditional on enfranchisment, via coalition formation, constrains the bargaining power of the stronger elite and result in discontinuous changes in equilibrium surplus division. Our results are robust to public good provision following enfranchisement when there is reference heterogeneity over the location of the public good across the di¤erent elites. We conclude with a comparative analysis of Indian democracy and show that our model is able to account for some of the distinctive features of Indian democracy.
Who benefits from Child Benefit?
Laura Blow, Ian Walker and Yu Zhu
Over much of the developed world governments make significant financial transfers to parents with dependent children. For example, in the US the recently introduced Child Tax Credit (CTC), which goes to almost all children, costs almost $1billion each week, or about 0.4% of GNP. The UK has even more generous transfers and spends about $25 a week on each of about 8 million children – about 1% of GNP. The typical rationale given for these transfers is that they are good for our children and here we investigate the effect on household spending patterns. The UK is an excellent laboratory to address this issue because such transfers, known as Child Benefit (CB), were simple lump sum universal payments for a period of more than 20 years. We do indeed find that CB is spent differently from other income – paradoxically, it appears to be spent disproportionately on adult-assignable goods. In fact we estimate that more than half of a marginal pound of CB is spent on alcohol. We resolve the puzzle by showing that the effect is confined to unanticipated variation in CB so we infer that parents are sufficiently altruistic towards their children that they completely insure them against shocks.
Development and the Interaction of Enforcement Institutions
Amrita Dhillon and Jamele Rigolini
We examine how institutions that enforce contracts between two parties, producers and consumers, interact in a competitive market with one-sided symmetric information and productivity shocks. We compare an informal enforcement mechanism, reputation, the efficacy of which is enhanced by consumers investing in “connectedness,” with a formal mechanism, legal enforcement, the effectiveness of which can be reduced by producers by means of bribes. When legal enforcement is poor, consumers connect more with one another to improve informal enforcement; in contrast, a well-connected network of consumers reduces producers’ incentives to bribe. In equilibrium, the model predicts a positive relationship between the the frequency of productivity shocks, bribing, and the use of informal enforcement, providing a physical explanation of why developing countries often fail to have efficient legal systems. Firm-level estimations confirm the partial equilibrium implications of the model.
Who really wants to be a miollionaire? Estimates of risk aversion from gameshow data (Updated version)
Roger Hartley, Gauthier Lanot and Ian Walker
This paper analyses the behaviour of contestants in one of the most popular TV gameshows ever to estimate risk aversion. This gameshow has a number of features that makes it well suited for our analysis: the format is extremely straightforward, it involves no strategic decision-making, we have a large number of observations, and the prizes are cash and paid immediately, and cover a large range – from £100 up to £1 million. Our data sources have the virtue that we are able to check the representativeness of the gameshow participants. Even though the CRRA model is extremely restrictive we find that a coefficient or relative risk aversion which is close to unity fits the data across a wide range of wealth remarkably well.
The other margin: do minimum wages cause working hours adjustments for low-wage workers?
Mark B. Stewart and Joanna K. Swaffield
This paper estimates the impact of the introduction of the UK minimum wage on the working hours of low-wage employees using difference-in-differences estimators. The estimates using the employer-based New Earnings Surveys indicate that the introduction of the minimum wage reduced the basic hours of low-wage workers by between 1 and 2 hours per week. The effects on total paid hours are similar (indicating negligible effects on paid overtime) and lagged effects dominate the smaller and less significant initial effects within this. Estimates using the employee-based Labour Force Surveys are typically less significant.
Liam Graham and Andrew J. Oswald
This paper proposes a new way to think about happiness. It distinguishes between stocks and flows. Central to the analysis is a concept we call ‘hedonic capital’. The paper sets out a model of the dynamics of wellbeing in which bad life-shocks are smoothed by the drawing down of hedonic capital. The model fits the patterns found in the empirical literature: the existence of a stable level of wellbeing and a tendency to return gradually towards that level. It offers a theory of hedonic adaptation.
An Examination of the Reliability of Prestigious Scholarly Journals: Evidence and Implications for Decision-makers
Andrew J. Oswald
In universities all over the world, hiring and promotion committees regularly hear the argument: “this is important work because it is about to appear in prestigious journal X”. Moreover, those who allocate levels of research funding, such as in the multi-billion pound Research Assessment Exercise in UKuniversities, often come under pressure to assess research quality in a mechanical way by using journal prestige ratings. This paper’s results suggest that such tendencies are dangerous. It uses total citations over a quarter of a century as the criterion. The paper finds that it is far better to publish the best article in an issue of a medium-quality journal like the Oxford Bulletin of Economics and Statistics than to publish the worst article (or often the worst 4 articles) in an issue of a top journal like the American Economic Review. Implications are discussed.
A Sovereign Debt Model with Trade Credit and Reserves
Emanuel Kohlscheen and Stephen A. O'Connell
This paper analyzes sovereign debt in an economy in which the availability of short-term trade credit reduces international trade transaction costs. The model highlights the distinction between gross and net international reserve positions. Borrowed reserves provide net wealth and liquidity services during a negotiation, as long as they are not fully attachable by creditors. Moreover, reserves strengthen the bargaining position of a country by shielding it from a cut-off from short-term trade credits thereby diminishing its degree of impatience to conclude a negotiation. We show that competitive banks do lend for the accumulation of borrowed reserves, which provide partial insurance
Political Budget Cycles and Fiscal Decentralization
Paula Gonzales, Jean Hindriks, Ben Lockwood and Nicolas Porteiro
In this paper, we study a model à la Rogoff (1990) where politicians distort fiscal policy to signal their competency, but where fiscal policy can be centralized or decentralized. Our main focus is on how the equilibrium probability that fiscal policy is distorted in any region (the political budget cycle, PBC) differs across fiscal regimes. With centralization, there are generally two effects that change the incentive for pooling behavior and thus the probability of a PBC. One is the possibility of selective distortion: the incumbent can be re-elected with the support of just a majority of regions. The other is a cost distribution effect, which is present unless the random cost of producing the public goods is perfectly correlated across regions. Both these effects work in the same direction, with the general result that overall, the PBC probability is larger under centralization (decentralization) when the rents to office are low (high). Voter welfare under the two regimes is also compared: voters tend to be better off when the PBC probability is lower, so voters may either gain or lose from centralization. Our results are robust to a number of changes in the specification of the model.
The Inter-related Dynamics of Unemployment and Low-Wage Employment
Funding Higher Education and Wage Uncertainty: Income Contingent Loan Versus Mortgate Loan
In a world where graduate incomes are uncertain (observation of the UK graduate wages from 1993 to 2003) and the higher education is financed through governmental loan (UK Higher Education Reform 2004), we build a theoretical model to show which scheme between an income contingent loan and a mortgage loan is preferred for higher level of uncertainty. Assuming a single lifetime shock on graduate incomes, we compare the individual expected utilities under the two loan schemes, for both risk neutral and risk averse individuals. We extend the analysis for graduate people working in the public sector and private sector, to stress on the extreme difference on the level of uncertainty. To make the model more realistic, we allow for the effects of the uncertainty each year for all the individual working life, assuming that the graduate income grows following a geometric Brownian motion. In general, we find that an income contingent loan is preferred for low level of the starting wage and high uncertainty.
The Real Exchange Rate Misalignment in the Five Central European Countries
Jan Frait, Luboš Komárek & Martin Melecký
The paper focuses on the developments of real exchange rates and their fundamental determinants in the five new EU Member States (Czech Republic, Hungary, Poland, Slovakia, and Slovenia). First, the approaches that can be used for estimation of equilibrium real exchange rates are briefly discussed. Then, we use well-established determinants of real exchange rates associated with the behavioral equilibrium exchange rate (BEER) approach to assess misalignments of the real exchange rates for the five new EU Member States. The estimates of the equilibrium exchange rates are obtained by means of both purely statistical approaches (HP filter, band-pass filter) and applying several multivariate estimation methods to our reduced-form BEER model. The results obtained indicate that the tendency towards appreciation of real exchange rates in the economies under consideration have been driven primarily by fundamental determinants.
Monetary Policy and Asset Prices: What Role for Central Banks in New EU Member States?
Jan Frait and Luboš Komárek
The paper deals with the relationship between monetary policy and asset prices. Besides surveying the general discussion, it attempts to extend it to recent developments in the new Member States of the EU (NMS), namely the Czech Republic, Hungary, Poland and Slovakia (the EU4). After a brief description of the current macroeconomic situation in the NMS, the appropriate reaction of monetary policy to asset price bubbles is dealt with and the main pros and cons associated with this reaction are summarised. Afterwards, the risks of asset market bubbles in the EU4 countries are evaluated. Since the capital markets are still underdeveloped and the real estate price boom seems to be a natural reaction to the initial undervaluation, the risks are viewed as rather small. The conclusion is thus that it is crucial for central banks in mature economies as well as in the NMS to conduct their monetary policies as well as their supervisory and regulatory roles in a way that does not promote the build-up of asset market bubbles. In exceptional times, central banks of small open economies must be ready to use monetary policy steps as a kind of insurance against the adverse effects of potential asset market bubbles.