Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0801 Title: Testing a DSGE model of the EU using indirect inference Author-Name: David Meenagh Author-Name: Patrick Minford Author-Name: Michael Wickens Abstract: We use the method of indirect inference, using the bootstrap, to test the Smets and Wouters model of the EU against a VAR auxiliary equation describing their data; the test is based on the Wald statistic. We find that their model generates excessive variance compared with the data. But their model passes the Wald test easily if the errors have the properties assumed by SW but scaled down. We compare a New Classical version of the model which also passes the test easily if error properties are chosen using New Classical priors (notably excluding shocks to preferences). Both versions have (different) difficulties fitting the data if the actual error properties are used. Creation-Date: 2008-09 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0801.pdf File-Format: Application/pdf Classification-JEL: C12, C32. Keywords: Bootstrap, DSGE Model, VAR model, Model of EU, indirect inference, Wald statistic. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0802 Title: Who pays for job training? Author-Name: Anurag Banerjee Author-Email: a.n.banerjee@durham.ac.uk Author-Name: Parantap Basu Author-Email: parantap.basu@durham.ac.uk Abstract: This paper addresses a puzzle in the UK labour market. Why is not there enough investment in job training when there is a high skill premium? We model this as a coordination game between firms and workers. Using a social planning model as a baseline, the paper demonstrates that while it is socially beneficial to invest in job training, the private sector may fail to internalize these benefits in a wide range of economies. The chance of this coordination failure is greater in economies with a higher inequality in the skill distribution and a higher rate of time preference.Creation-Date: 2008-11 Creation-Date: 2008-09 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0802.pdf Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0803 Title: Electoral Uncertainty and the Deficit Bias in a New Keynesian Economy Author-Name: Cambell Leith Author-Email: c.b.leith@lbss.gla.ac.uk Author-Name: Simon Wren-Lewis Abstract: Recent attempts to incorporate optimal fiscal policy into New Keynesian models subject to nominal inertia, have tended to assume that policy makers are benevolent and have access to a commitment technology. A separate literature, on the New Political Economy, has focused on real economies where there is strategic use of policy instruments in a world of political conflict. In this paper we combine these literatures and assume that policy is set in a New Keynesian economy by one of two policy makers facing electoral uncertainty (in terms of infrequent elections and an endogenous voting mechanism). The policy makers generally share the social welfare function, but differ in their preferences over fiscal expenditure (in its size and/or composition). Given the environment, policy shall be realistically constrained to be time-consistent. In a sticky-price economy, such heterogeneity gives rise to the possibility of one policy maker utilising (nominal) debt strategically to tie the hands of the other party, and influence the outcome of any future elections. This can give rise to a deficit bias, implying a sub-optimally high level of steady-state debt, and can also imply a suboptimal response to shocks. The steady-state distortions and inflation bias this generates, combined with the volatility induced by the electoral cycle in a stickyprice environment, can significantly raise the costs of having a less than fully benevolent policy maker. Creation-Date: 2008-09 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0803.pdf Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0804 Title: The Optimum Quantity of Money with Gold Reserves Author-Name: Max Gillman Author-Email: GillmanM@cardiff.ac.uk Author-Name: Charles Nolan Author-Email: Charles.Nolan@st-andrews.ac.uk Abstract: Monetary policymakers target positive inflation. This divergence from the long accepted Friedman optimum of deflation is troubling: Why does theory seem so at odds with what policymakers view as optimal policy? Without ad hoc assumptions e.g., about price stickiness, the fundamental Friedman view that money’s marginal social cost of zero ought to equal the marginal social benefit (the nominal interest rate), remains unassailed and the optimum still is deflation. Presenting an economy where the central bank must hold gold reserves, the optimum is shown to be instead one of zero inflation, consistent with the Fisher price stability prescription. Creation-Date: 2008-09 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0804.pdf File-Format: Application/pdf Classification-JEL: E42; E58; E61. Keywords: Optimal monetary policy; The Friedman Rule. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0805 Title: Bonuses, Credit Rating Agencies and the Credit Crunch Author-Name: Peter Sinclair Author-Email: p.j.n.sinclair@bham.ac.uk Author-Name: Guy Spier Author-Name: Tom Skinner Abstract: The payment of bonuses can bring big benefits. But harm, too, can result. In the financial sector, this is especially true, above all when they are related to noisy indicators of performance over brief periods. This paper starts by exploring these ideas, then proceeds to examine credit rating agencies and their role in the 2007 credit crunch. It emphasizes the paucity of long term high frequency financial data to quantify tail event risks, the failure to apply analysis of fundamentals in financial and housing markets, and rewards structures to individual players that reinforced myopia as three key components of the crisis. Creation-Date: 2008-09 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0805.pdf File-Format: Application/pdf Classification-JEL: D53, D86, G32. Keywords: bonuses; credit crunch; credit rating agencies. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0806 Title: Sacrifice Ratio or Welfare Gain Ratio? Disinflation in a DGSE monetary model Author-Name: Guido Ascari Author-Email: guido.ascari@unipv.it Author-Name: Tiziano Ropele Abstract: PRELIMINARY AND INCOMPLETE - PLEASE DO NOT CIRCULATE Creation-Date: 2008-05 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0806.pdf File-Format: Application/pdf Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0807 Title: Macroeconomic Implications of a Key Currency Author-Name: Matthew Canzoneri Author-Email: canzonem@georgetown.edu Author-Name: Robert Cumby Author-Email: cumbyr@georgetown.edu Abstract: What are the macroeconomic consequences of the dominant role of the dollar in the international monetary system? Here, we present a calibrated two country model in which exports are invoiced in the key currency, and government bonds denominated in the key currency are held internationally to facilitate trade. Domestic government bonds and money are held in each country to facilitate domestic transactions. Our model generates deviations from uncovered interest parity that are as volatile as some empirical estimates, but much too small by others. Our model also speaks to some other empirical anomalies, such as the Backus - Smith puzzle. Shocks affecting asset supplies – such as bond financed tax cuts, and open market operations – have large effects in our model because they generate non-Ricardian changes in household wealth. Generally, shocks emanating from the key currency country do more to destabilize the world economy than equal sized shocks coming from the other country. Similarly, monetary and fiscal policy innovations in the key currency country are more potent than those in the other country. On the other hand, the key currency country is more vulnerable to financial market turbulence, such as a sell off of key currency bonds, which can lower consumption dramatically. Creation-Date: 2008-08 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0807.pdf File-Format: Application/pdf Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0808 Title: Robust Learning Stability with Operational Monetary Policy Rules Author-Name: George W. Evans Author-Name: Seppo Honkapohja Abstract: We consider “robust stability” of a rational expectations equilibrium, which we define as stability under discounted (constant gain) least-squares learning, for a range of gain parameters. We find that for operational forms of policy rules, i.e. rules that do not depend on contemporaneous values of endogenous aggregate variables, many interest-rate rules do not exhibit robust stability. We consider a variety of interest-rate rules, including instrument rules, optimal reaction functions under discretion or commitment, and rules that approximate optimal policy under commitment. For some reaction functions we allow for an interest-rate stabilization motive in the policy objective. The expectations-based rules proposed in Evans and Honkapohja (2003, 2006) deliver robust learning stability. In contrast, many proposed alternatives become unstable under learning even at small values of the gain parameter. Creation-Date: 2008-01 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0808.pdf File-Format: Application/pdf Classification-JEL: E52, E31, D84. Keywords: Commitment, interest-rate setting, adaptive learning, stability, determinacy. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0809 Title: Factor demand linkages and the business cycle: interpreting aggregate fluctuations as sectoral fluctuations Author-Name: Sean Holly Author-Name: Ivan Petrella Abstract: This paper investigates the drivers of industry and aggregate fluctuations. We model the dynamics of a panel of highly disaggregated manufacturing sectors. This allows us to consider directly the linkages between sectors typical of any production system, in a framework where the sectors are fully heterogeneous. We establish that these features are fundamental for the propagation of the shocks in the aggregate economy. Aggregate fluctuations can be accounted for by small industry specific shocks. Moreover, a contemporaneous technology shock to all sectors in the economy, i.e. an aggregate technology shock, implies a positive response in both output and hours at the aggregate level. When this intersectoral channel is neglected we find a negative correlation as with much of the literature. This suggests that the standard technology driven Real Business Cycle paradigm is a reasonable approximation of a more complicated model featuring heterogeneously interconnected sectors. Creation-Date: 2008-06 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0809.pdf File-Format: Application/pdf Classification-JEL: E20, E32, C31, C51. Keywords: Sectors, Technology shocks, Business cycles, Long-run restrictions, Cross Sectional Dependence. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0810 Title: Monetary and Fiscal Rules in an Emerging Small Open Economy Author-Name: Nicoletta Batini Author-Name: Paul Levine Abstract: We build a two-bloc DSGE emerging small open economy - rest of the world model to examine the implications of financial frictions for the relative contributions of fiscal and monetary stabilization policy. The model is calibrated using Chile data. Alongside the optimal Ramsey policy benchmark, we study a variety of simple monetary and fiscal rules including a fixed exchange rate regime and both domestic and CPI inflation targeting interest rate rules alongside a ‘Structural Surplus Fiscal Rule’ as followed recently in Chile. We find that domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilizing the exchange rate. Financial frictions require fiscal policy to play a bigger role and lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy. Creation-Date: 2008-08 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0810.pdf File-Format: Application/pdf Classification-JEL: E52, E37, E58. Keywords: Monetary policy, emerging economies, fiscal and monetary rules, financial accelerator, liability dollarization. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0811 Title: Sticky Information versus Efficient Indexation Microfoundations for Monetary Policy Models Author-Name: Richard Mash Author-Email: richard.mash@economics.ox.ac.uk Abstract: We present an “efficient indexation” approach to price setting when full optimisation is infrequent due to decision making costs but firms observe relevant information between optimisations. Prices are updated in line with the structural characteristics of the economy and hence make efficient use of available information. Under plausible conditions this mechanism is superior to the predetermined prices of Mankiw and Reis (2002) [Sticky information versus sticky prices: A proposal to replace the New Keynesian Phillips Curve, Quarterly Journal of Economics, 117(4)]. If infrequent optimisation is caused by lack of information, indexing is infeasible and the Mankiw-Reis approach is optimal. Creation-Date: 2008-08 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0811.pdf File-Format: Application/pdf Classification-JEL: E52, E58, E22. Keywords: Sticky Information, Rational Inattention, Indexing, Monetary Policy, Microfoundations. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0812 Title: Managing Disinflation under Uncertainty Author-Name: Mewael F. Tesfaselassie Author-Name: Eric Schaling Abstract: In this paper we analyze disinflation policy when a central bank has imperfect information about private sector inflation expectations but learns about them from economic outcomes, which are in part the result of the disinflation policy. The form of uncertainty is manifested as uncertainty about the effect of past disinflation policy on current output gap. Thus current as well as past policy actions matter for output gap determination. We derive the optimal policy under learning (DOP) and compare it two limiting cases -- certainty equivalence policy (CEP) and cautionary policy (CP). It turns out that under the DOP inflation stay between the levels implied by the CEP and the CP. A novel result is that this holds irrespective of the initial level of inflation. Moreover, while at high levels of inherited inflation the DOP moves closer to the CEP, at low levels of inherited inflation the DOP resembles the CP. Creation-Date: 2008-08 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0812.pdf File-Format: Application/pdf Classification-JEL: C53, E43, E52, F33. Keywords: Learning, Inflation Expectations, Disinflation Policy, Separation Principle, Kalman Filter, Optimal Control. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0813 Title: Estimating insurance and incentive effects of labour market reforms Author-Name: Andrey Launov Author-Name: Irene Schumm Author-Name: Klaus Walde Abstract: We formulate a general equilibrium matching model with spell-dependent unemployment benefits and endogenous search effort. The model gives rise to an endogenous distribution of unemployment duration characterized by a time-varying hazard function. Using methods from the literature on Semi-Markov processes, we obtain an expression for the aggregate unemployment rate under heterogeneous search effort. We perform structural estimation of the model using a German micro-data set (SOEP) and discuss the effects of the recent unemployment benefit reform (Hartz IV). Our results show that although the reform and economic growth have contributed to the reduction of the aggregate unemployment rate, aggregate welfare has gone down. Creation-Date: 2008-06 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0813.pdf File-Format: Application/pdf Classification-JEL: J65, J64, C13. Keywords: Search and Matching Model, Structural Estimation, Unemployment Insurance. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0814 Title: Using time-varying VARs to diagnose the source of ‘Great Moderations’: a Monte Carlo analysis Author-Name: Richard Harrison Author-Name: Haroon Mumtaz Author-Name: Tony Yates Abstract: In this paper, we assess the ability of time-varying VAR models to correctly diagnose the source of ‘Great Moderations’ generated in simulations of a learning model. We find that, in general, they can. For example, in data sets with Great Moderations generated by good policy, the VAR correctly identifies a downward shift in the policy disturbance. And it shows that if the policy behaviour associated with the latter part of the sample (during which policy is conducted well) are applied to the earlier part of the sample, the implied variances of output, inflation and interest rates would have been much lower. An important caveat to our results is that they appear to be sensitive to the method used to identification of monetary policy shocks. When we identify monetary policy shocks using a Cholesky decomposition, the VAR provides quite clear evidence in favour of the correct explanation for our simulated Great Moderations When sign restrictions are used to identify the monetary policy shocks, conclusions from the counterfactual experiments are less precise. The contrast between our results and previous work based on Monte Carlo evidence using RE models suggests that the ability of VARs to correctly diagnose the source of the Great Moderation may be dependent on the nature of the expectations-formation process in the private sector. Creation-Date: 2008-09 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0814.pdf File-Format: Application/pdf