The policy maker faces four sources of inefficiency: price stickiness, mo- nopolistic competition, the congestion externality following from labor market frictions and the composition externality which arises because of skill erosion during unemployment. Given that the policy maker has only one instrument, it will in general not be possible to eliminate all four dis- tortions. Thus the policy maker faces a trade-off between them. Below I discuss each of those frictions and their policy implications in more detail. Price stickiness distorts the economy in the following way. If all firms could reset their price in response to shocks they would all set their price such as to achieve their constant desired markup. As a result, the econ- omy’s average markup in the absence of price stickiness would be con- stant over time. However, when prices are sticky, and hence not all firms can reset their prices, the economy’s average markup will vary over time in response to shocks, making it deviate from the constant frictionless markup. Therefore, aggregate demand, and hence output and employ- ment will either by too high or too low. Moreover, price stickiness also leads to price dispersion, which in turn leads to dispersion in demand.
On the other hand, the literature on health comes to a conclusion that health is very important in determining later life outcomes. Currie and Gruber (1996a,b) study the ef- fects of the Medicaid expansion to pregnant women and low-income children and find big positive effect for children’s health and negative effect for child mortality. Prados (2013) quantifies the health-income feedback and states that it accounts for 17% of earnings in- equality. In seminal Grossman (1972)’s paper the notion of health capital is introduced and health is modeled as a result of investments into health and it’s depreciation over time. This gave rise to macroeconomic models that incorporate health risks in a life-cycle framework. Attanasio, Kitao and Violante (2010), for example, study tax implications due to projected rise in medical spending financed through Medicare – governmentally pro- vided partial insurance against negative health shocks for older people. Palumbo (1999) and De Nardi, French and Jones (2010a) study saving decisions of the elderly and the role of medical shocks in savings behaviour, Jung and Tran (2014) study medical expenditure behavior over the life cycle, separating pure age effects and cohort effects. Ozkan (2013) studies differences in the lifetime profile of health care usage between low- and high-income groups and finds that policies encouraging the use of health care (especially preventive) by the poor early in life have significant welfare gains, even when fully accounting for the increase in taxes required to pay for them. Kopecky and Koreshkova (2014) evaluate joint effect of social security and Medicaid onlabor supply, savings, economic inequality and welfare due to idiosyncratic risks in labor earnings, health expenses and survival. Brown et al. (2015) study long-term impact of expansion of Medicaid and State Children’s Health Insurance Program that occurred in 1980’s and 1990’s and find that the government will recoup 56 percent of spending on childhood Medicaid by the time these children reach 60. However, papers on health and health policies typically ignore human capital dimension. The current work builds a bridge between literature on health and health policies on the one hand and human capital and human capital policies literature on the other and provides a more structural model to look at the relationship of health and health policies, their interaction with educational policies and intergenerational mobility.
positive wealth effect that decreases labor force participation. At the same time, this shock triggers a stronger reallocation of both short- and long-term unemployed jobseekers towards the private sector than a public vacancy cut. The different reaction of the long-term unemployed comes from the fact that a public wage cut does not imply for them more adverse prospects of finding a job as is the case of a public vacancy cut. In other words, the cut in the public wage does not decrease the probability of long-term unemployed for finding a job and become more efficient in their matching and for that reason it does not reduce labor force participation by as much as a government vacancy cut. The increase in the relative supply of labor in the private sector leads to increases in private vacancies and employment for a lower wage and private output rises with a lag. This might not seem surprising when government output is assumed to be unproductive (dashed and dotted lines in Figure 9). However, the expansionary effects are limited when public output is productive (continued and dash-dotted lines in Figure 9). The reason behind this result is very simple. A public wage cut reduces the supply of labor in the public sector and, hence, public output. If public output is assumed to be productive, such a fall will imply a decrease in the productive capacity of the economy and, hence, private output will increase less than in the case in which the public good is a waste. Hence, the assumption on the productive nature of public goods is crucial in explaining our empirical findings. The insignificant output and unemployment multipliers can be perfectly rationalized if one is willing to accept that public goods enhance to some degree private productivity.
An analysis of 26 individual manufacturing industries (Frenkel and González Rozada 1999) shows that none was an exception to the trends described above. Each one experienced an adjustment process qualitatively similar to the manufacturing sector as a whole. Almost all industries expelled labor force. Of course, the individual performances differ among them with respect to the rise in demand (domestic demand plus exports) and also with respect to the composition of the corresponding increase in supply (domestic output plus imports). A comparative analysis of the industries shows a negative correlation between the increase in output per worker and the change in the degree of economic openness (change in imports divided by change in demand). On the other hand, changes in the degree of openness are positively correlated with the degree of openness observed in 1990 at the beginning of the period. Domestic output and output per worker grew more in the industries showing lower import penetration before the new conditions of the nineties were established.
level of real economic activity in the long-run. The classical neutrality result is not challenged: a temporary shock to the policy instrument dies off in the long-run. A change in the policy rule, however, has a permanent real effect since it alters the steady state equilibrium level of employment. Two assumptions are key for the result: wage setters have positive mass and they internalize the consequences of their actions. Since wage setters are non-atomistic, they are able to influence the aggregate wage index. In addition, if unions understand that firms set the price at a mark-up over the marginal cost, they also realize that a variation in the aggregate wage index has an impact on inflation, triggering the reaction of the central bank. Then, wage inflationary pressures will induce the monetary authority to contract aggregate demand and, as a consequence, aggregate labor demand. The higher central bank’s inflation aversion, the stronger the response of the nominal interest rate and the more severe the contraction of aggregate labor demand. Therefore, tougher inflation stabilization policies raise the steady state level of employment by giving unions the incentive to restrain wages. Because of strategic interaction, the central bank can push output towards Pareto efficiency without creating inflation.
The idea that government debt enhances private liquidity provision when there is a lack of collateral is not new and has been already discussed by Woodford (1990) and Holm- strom and Tirole (1998). In particular, the latter show that the shortage of collateral creates an under-supply of private securities posing a limit on the saving capacity of firms. On the contrary, the government, thanks to its assumed ability to commit work- ers’ income through taxation, can expand the supply of financial assets above the value of private collateral. However, it must be remarked that Holmstrom and Tirole’s ar- gument depends crucially on the assumption that domestic firms cannot store liquidity by saving abroad. When there are no restrictions on international capital flows and no sovereign risk, the IFM provides the economy with sufficient liquidity (as entrepreneurs are indifferent between foreign and government supply and the supply of foreign bond is infinitely elastic) and there is no need for government intervention. The following section, however, shows that, by relaxing the government commitment assumption in the same setup as before, Holmstrom and Tirole’s argument can be restored in an open economy setting: as government repayment becomes contingent on the state of the economy, public debt then represents an imperfectly substitutable source of liquidity for the domestic private sector. Nonetheless, the optimal fiscal policy of the government has a downside, as it exposes the economy to costly liquidity crises.
It is worth to relate these results to the historical literature. For the hyperinflation period, the literature has associated the economic contraction to the stabilization measures. The evidence posted here shows that the collapse started before the inflation came to be under controlled. Second, stock-investors were optimistic until mid 1923 in relation to the future dividend growth rate. The failure in issuing gold-backed bonds was the final coordination device that made the easy-credit/negative-real-interest-rate policy to disappear from agents’ expectations. Third, expected dividend growth rate was not higher in 1927 than in pre-collapse period, or the immediate post-war period. Therefore, there is no evidence of overpricing in the sense of un- usually high expected dividend growth rates. This piece of evidence reinforces Voth (2003) in the sense of showing that the monetary au- thorities did not have hard evidence pointing in the direction of a bub- ble existence by 1927. Finally, the Reichbank intervention in May 1927 undoubtedly affected the long-run expectations of the agents, but these were already decreasing before the intervention. Thus, is difficult from this evidence to conclude that the intervention actually was the inflection event that led the way to the 30’s crisis as in Voth (2003). Actually, March 1927 seems to be the true inflection point 25 . The negative correlation between inflation and expected dividend growth deserves particular attention. In Table 4.3, I present the results from regressing the long-term expected dividend growth on inflation. Expected dividend growth rate is negatively correlated with inflation. During normal times, an increase in inflation makes agents to expect lower future real dividend growth rates. For the hyperinflation period the overall effect of inflation is statistically not different from zero. However, the dummy variable is significant and negative, implying a
This chapter seeks to remedy these problems by applying a suitable recent methodol- ogy to identify government spending shocks, whenever data are available, in a sample of developing countries. Data are gathered from 9 countries and the methodology employed is the SVAR technique where identification is achieved via sign restrictions. Sign restrictions are preferable to those of the standard SVAR approach, in the context of this study, particu- larly because they are valid with data at any frequency. The identification scheme is based on Pappa (2009) and applies the restrictions that government spending shocks are the only shocks that raise government spending, output, deficit and tax revenue in the impact period. The identified shocks serve two purposes. First, they are used to examine the effects of gov- ernment spending on output, consumption, net exports and the nominal exchange rate. The knowledge of how these macroeconomic variables respond to government spending shocks helps to study the countercyclical and stabilization properties of fiscal policyand to what extent fiscal policy is able to stabilize the business cycle in developing countries. Second, the identified government spending shocks helped to learn about the output multipliers in each of these countries. The results can provide insight into the size of the multipliers and hence about the role of fiscal stimulus in the context of developing countries.
The empirical evidence on central banks’ reaction to financial instability is rather scant. Following the ongoing debate about whether central banks should respond to asset price volatility (e.g. Bernanke and Gertler, 1999, 2001; Cecchetti et al., 2000; Bordo and Jeanne, 2002), some studies tested the response of monetary policy to different asset prices, most commonly to stock prices (Rigobon and Sack, 2003; Siklos and Bohl, 2008; Fuhrer and Tootel, 2008). They find some evidence that asset prices either entered the policy information set (because they contain information about future inflation) or that some central banks were directly trying to offset its disequilibria. 3 All these papers estimate time-invariant policy rules, which means that they test a permanent response to these variables. However, it seems more plausible that if central banks respond to asset prices, they do it only when their misalignments are substantial, in other words their response is asymmetric. There are two additional controversies related to the effects of asset prices on monetary policy decisions: (i) The first concerns the measure, in particular whether the stock market index that is typically employed is sufficiently representative or whether some other assets, in particular the housing prices, should be considered as well, and (ii) the second issue is related to the (even ex-post) identification of the asset price misalignment. Finally, it is likely that the perception of misalignments is influenced by general economic conditions and that a possible response could evolve over time. Detken and Smets (2004) summarize some stylized facts onmacroeconomicand monetary policy developments during asset price booms. Overall they find that monetary policy was significantly looser during the high-cost booms that were marked by the investment and real estate prices crash in the post-boom periods.
In the presence of credit market imperfections, the initial response of output and investment to the same shock is not only ampli…ed but also more persistent than in the frictionless case. The ampli…cation of investment is especially strong: about 40% larger than the benchmark case without imperfections. This is because in the event of an innovation to productivity, higher out- put increases entrepreneurs’ net worth. Given the negative relationship between entrepreneurs’ net worth and monitoring costs, an increase in the proportion of internal funds provided by entrepreneurs will diminish the monitoring cost problem. This is re‡ected in a fall in the risk premium. The …nal e¤ect on the price of capital is in general ambiguous. In this model, given the high elasticity of net worth with respect to output, consistent with the data, the price of capital falls. These changes will reduce the marginal costs of …rms, increasing both laborand investment demands. That is, changes in the price of capital induced by variations in net worth will eventually a¤ect the allocation of labor in the opposite direction. These additional interac- tions will drive the dynamics of the model under credit market imperfections, whereas they are absent in the SI setting.
The objective of the first chapter (titled Economic (In)Stability under Monetary Targeting ) is to check out whether the monetary policy conduct of targeting a mon- etary aggregate may or may not favor the stability properties of an economy. The literature has identified a number of reasons why monetary growth targeting can be an effective way of supporting macroeconomic stability. One reason is related to its ability to avoid sunspot instability associated with self-fulfilling multiple equi- libria, whose risk has been detected under interest-rate-feedback policy rules. In the chapter we scrutinize this property of monetary targeting by checking whether multiplicity of equilibria, in the form of local indeterminacy (LI), can or cannot be both a possible and a plausible outcome of a basic model with an exogenous money growth policy rule. We address the question in different versions of the Sidrauski- Brock-Calvo framework, which, abstracting from real and nominal rigidities and from market imperfections, isolates the contribution of monetary non-neutralities and monetary targeting. In line with previous literature, real effects of money are found to be a necessary condition for LI: we identify a single pattern for their mag- nitude if they are to be sufficient too. While the most elementary setups are unable to plausibly generate large enough real effects, LI becomes significantly more likely as one realistically considers additional channels of transmission of monetary expan- sions onto the real economy. In particular, we show that models factoring in a slight amplification of monetary non-neutrality, like a model that we lay down in which holding money is valuable to both households and firms, may yield a LI outcome for empirically relevant parameterizations. This hints to greater chances of sunspot equilibria - under monetary targeting - in models including a larger set of economi- cally relevant sources of monetary non-neutrality (like nominal rigidities or financial frictions). Therefore, making monetary targeting a part of a monetary policy strat-
Differently from the aforementioned papers, Corsetti and Pesenti (2005) and De- Paoli (2004) find that domestic inflation is not always the optimal target. But, the focus in those papers is not on which inflation to target but more on the general ques- tion of whether the policy should be inward-looking or outward-looking. Corsetti and Pesenti (2005) use a two-country model with firms’ prices set one period in advance and incomplete pass-through to show that ”inward-looking policy of domestic price stabilization is not optimal when firms’ markups are exposed to currency fluctua- tions”. DePaoli (2004) extends the welfare analysis for the small open economy of Gal´ı and Monacelli (2005) allowing for a more general specification of the utility func- tion and of the elasticity of substitution among domestically produced and foreign goods and finds that the monetary authority should target also the exchange rate, therefore supporting an outward-looking monetary policy. A paper dealing directly with the question of whether the monetary authority should target domestic or CPI inflation is the one by Svensson (2000). He uses a small open economy framework to analyse inflation targeting monetary policies and he underlines that ”all inflation- targeting countries have chosen to target CPI...None of them has chosen to target domestic inflation”. He assumes an ad-hoc loss function that includes both CPI in- flation and domestic inflation in addition to other variables. The result of the model (that is not fully microfounded) is that flexible CPI inflation targeting is better than flexible domestic inflation targeting. Also in Monacelli (2005), the monetary author- ity is assumed to target CPI inflation instead of domestic inflation, in order to behave like many central banks do in practice, but the welfare function is not derived from first principles.
The full resolution to these questions is beyond the scope of this paper. However, we are able to provide some insights by exhausting the explanatory power of labor market shocks in a standard incomplete markets heterogeneous agent model, in the spirit of Chang and Kim (2007) and Krusell et al. (2011): we introduce agents who diﬀer by gender and marital status. In our model, agents face both uninsurable income and employment risk (job-oﬀer and job-losing shocks), and chose how much to consume, save and whether to work or not, thus making labor supply discrete and endogenous. For married individuals the problem is compounded: they face more risk (both spouses are subject to shocks) but can self-insure by pooling income and enjoying public consumption inside the household. This setup has the advantage of providing a clean way of distinguishing the unemployed from all the not working, by way of computing for whom the expected value of working versus not-working is higher, conditional on currently not working (and the household’s current asset status). Given that the participation decision is important to account jointly for the lower unemployment rates of both married male and female agents, we prefer this over the classical Diamond- Mortensen-Pissarides framework, where there are only 2 labor market states (employment and unemployment) andlabor supply decisions are trivial.
In this paper, I provide ample evidence that countries who enjoyed greater macroeconomic stability during the years before the crisis, suffered from sig- nificantly larger downturns during the Great Recession of 2008-09, and ex- perienced a slower recovery in the following years. This result is remarkably robust across different measures of pre-crisis volatility and of performance during the crisis. The literature so far has struggled to determine robust predictors of economic performance during the Great Recession. Several recent papers start from a large set of potential explanatory variables and attempt to identify measures with predictive power, but results are inconclu- sive and depend on the exact measure of economic performance and whether the sample contains only advanced economies or also includes development countries (Rose and Spiegel, 2010). Berkmen et al. (2012) find that countries with flexible exchange rates suffer less, while Acosta-Gonz´ alez et al. (2012) conclude that the percentage of bank claims in the privae sector over deposits in the year 2006 is the only variable that has predictive power on the severity of the downturn. The role of initial level of development and openness to trade is highlighted in Lane and Milesi-Ferretti (2011) as well as in Blanchard et al. (2010) who focus on developing countries, yet in neither analysis does a clear picture emerge. Possible channels of contagion remain unclear. Neither Rose and Spiegel (2010) nor Kamin and Demarco (2010) find a significant in- fluence of financial linkage with the US, leading Bacchetta and van Wincoop (2013) to suspect that a self-fulfilling global panic was triggered by the initial problems in the US financial sector. Due to the lack of any clear predictors, Rose and Spiegel (2011) conclude that “While countries with higher income and looser credit market regulation seemed to suffer worse crises, we find few clear reliable indicators in the pre-crisis data of the incidence of the Great
The main result is that the combination of a high degree of price stickiness with a large share of rule-of-thumb agents generates indeterminacy. The intu- ition of this results can be illustrated with the following example. Let’s consider a transitory but persistent increase in the region H’s production due to a non fundamental shock. Sluggish price adjustment induces a decline in the markups which allows real wages to go up - even if labor productivity declines given the higher employment. Higher real wages generate a boom in rule-of-thumb con- sumption. Hence when the share of those agents is high enough their increase in consumption more then offset the decrease in Ricardian consumption and invest- ment (the latter is generated by a monetary rule that reacts with a coefficient bigger than one on inflation). On the other hand, exports to the foreign country are very sensitive to changes in the relative prices. Under the baseline calibration the increase in region H output generates a positive spillover on the neighbor country stimulating its output, employment and so foreign rule-of-thumb con- sumption. When the terms of trade does not appreciate enough foreign imports (home exports) barely decreases at impact and then increases. A higher share of foreign rule-of-thumb agents further mitigates this effect. This means that aggregate demand for output produced in region H increases, making possible to sustain the persistent boom in output the was originally anticipated by agents. This result is similar to that found by Gali et al. (2005) for a closed economy.
The recent financial crisis has hit countries and shaken financial systems all over the world. This has led to the implementation of large scale fiscal expansionary interventions. The massive bailouts of the banking system have further burdened fiscal balances and rise considerable concern about fiscal solvency of some countries. Many governments want to keep deficits under control by cutting spending and raising taxes. As a result, it could lead to an enormous wealth transfer from tax payers to the financial system. Expansionary fiscal policies might also bring a huge shift in resources among groups which causes worries about growing income inequality within countries (Piketty, 2014). Consequently, this can undermine political stability since people perceive such measures as an unfair redistribution of resources. Moreover, calls for redistribution could arise, and they might lead to fiscal policies that undermine economic progress and deteriorate fiscal performance. Redistributive mechanisms are usually described through political economy arguments that specify some transmission channels between income inequality and economic growth (Acemoglu and Robinson, 2008; Benabou, 2000; Neves and Silva, 2014). In the political economy arguments, the redistribution of income is implied to be implemented through fiscal policy by taxation and government spending. However, income is redistributed also via monetary policy. Economic activities are regulated by macroeconomic policies, which include both fiscal and monetary policies. They are used for comparatively different macroeconomic objectives. Fiscal policy is usually used to foster aggregate demand while monetary policy is generally used to control inflation. However, fiscal and monetary policies also affect the same economic activities, such as redistribution of income.
The main finding of this chapter is that the model is able to generate income differ- ences consistent with the observed international patterns for differences in the produc- tivity of the investment sector that produce reasonable differences in the relative price of investment. To generate a relative price of investment of a factor of 4 with respect to the benchmark economy the model only requires a reduction in the productivity of the investment sector of a factor of 3.11, which is smaller than the distortions required by most models in the literature. I also perform a “De Soto experiment” to analyze how much of the differences in the size of the informal sector and in per capita income can be accounted by policies that increases the entry cost in the formal sector. The quantitative exercises suggest that higher entry costs are associated with both a higher size of the informal sector and a lower per capita income level. The results supports De Soto’s (1989) argument that the size of the informal sector is mainly determined by entry barriers, and they are consistent with Djankov et al.’s (2002) findings that countries with heavier regulation of entry have higher corruption and larger unofficial economies. The magnitude of this effect on income, however, is modest.
It was argued already by Hall (2005) that the employment rents due to searching frictions determine a wage bargaining set and any wage within this set implies private efficiency in the worker-firm match. The worker and the firm thus must agree on a specific wage from the bargaining set. Hall (2005) assumes a con- stant wage rule, which can be interpreted as a wage norm, and shows that such a rule might address the unemployment volatility puzzle. In addition to arbitrari- ness, there are two particular problems associated with a constant wage contract. First, it is assumed that the wage always remains within the bargaining set, even though the wage never adjusts. As pointed out by Mortensen and Nagyp´al (2007), to maintain that the rigid wage is jointly rational, only small shocks can affect the employment relationship of workers and firms in the economy, as otherwise the wage will leave the bargaining set. In particular, this in practice rules out the possibility of idiosyncratic productivity shocks in the spirit of Mortensen and Pissarides (1994), at least of the size that is typically calibrated. Second, perfect wage rigidity lacks empirical support. In this respect, Gertler and Trigari (2009) provide a model with staggered multiperiod wage contracting of the Calvo (1983) type, which allows wages to be changed occasionally. Still, their model is incon- sistent with some empirical evidence that wages in new matches are completely flexible. 11
In the theoretical section I show that, provided the interest rates are low enough, an increase in the level of household credit can shift the composition of economic activity in an economy towards the non-tradable sector. In my simple model, firms are Cobb- Douglas aggregators of capital and labour. There has been a recent push towards modeling economic activity as an aggregation of capital, labour and intermediates to better capture the complex, inter-connected nature of production in modern economies through input-output linkages. A systematic study of the effect of household credit on production through a model of input-output linkages will give us a more microscopic view of the channels through which greater household spending affects investment and production in specific sectors of the economy. I propose two reasons why such a study presents an interesting and potentially very insightful line of investigation. Firstly, any sectoral changes that are the result of movements in household spending can account for more frequent, longer and deeper recessions (as highlighted by Jorda et al. (2014, 2015)) resulting from sharp increases in household credit. Secondly, compositional changes in production might also raise concerns of lower productivity growth or secular stagnation through channels emphasized in Duarte and Restuccia (2010) and Perla et al. (2015). Eventually, I envisage models which theorize an optimal level of household credit to guide Government policy. The optimal level is likely to result from the trade-off between welfare gains from higher spending and welfare losses from shifts in sectoral composition as has been identified in my paper.
First, the sample period is from 1996 to 2008, because the type of contract is not reliable for the previous period. We focus on men born between 1948 and 1971, that is between 25 and 48 years old in 1996. This is because is better to avoid the behavior of wages when starting the job career, that could be different from older ages workers. Second, we only use job spells posterior to 1996, since prior to that year, information on type of contract is not reliable. Third, we consider workers who are in the “Regimen General” which includes 90 per cent of all workers; i.e. we exclude the self-employed, workers in Agriculture, Fishing and other minor special cases. Forth, the data is transformed to show as unit of observation a quarter. Because of this, more restrictions are added. Simultaneous employment spells are disregarded and, instead, use the information cor- responding to the full time job or longer-lasting of these. We unify any two registers that present overlapping contracts, i.e., when one of the contracts begins before the previ- ous one has ended. Incomplete or incorrect registers are dropped (for example, negative spells durations). The sample is also restricted to full-employment workers at the time of displacement. This, the wage in a given quarter will be mean daily wage observed in that quarter.