Working Papers

Authors: Jennifer Castle,David Hendry, Michael P. Clements

Jan 2014

We investigate alternative robust approaches to forecasting, using a new class of robust devices, contrasted with equilibrium correction models.  Their forecasting properties are derived facing a range of likely empirical problems at the forecast origin, including measurement errors, implulses, omitted variables, unanticipated location shifts and incorrectly included variables that experience a shift.  We derive the resulting forecast biases and error variances, and indicate when the methods are likely to perform well.  The robust methods are applied to forecasting US GDP using autoregressive models, and also to autoregressive models with factors extracted from a large dataset of macroeconomic variables.  We consider forecasting performance over the Great Recession, and over an earlier more quiescent period.

JEL Codes: C51, C53

Keywords: Robust forecasts, Smoothed Forecasting devices, Factor models, GDP forecasts, Location shifts

Reference: 697

Individual View

Authors: Climent Quintana-Domeque, Pierre-Andre Chiappori, Sonia Oreffice

Jan 2014

We develop a bidimensional matching model under transferable utility, where individuals are characterized by a continuous trait (e.g., socioeconomic status) and a binary attribute (e.g., smoking status).  The model is "truly multidimensional", in the sense that the impact of the traits cannot be summarized by a one-dimensional index.  We present a general resolution strategy based on optimal control theory, and characterize the stable matching.  We derive testable predictions about equilibrium matching patterns.  Using US data, we find that the observed marital sorting of smokers and non-smokers by education is consistent with our model.

JEL Codes: D1, J1

Keywords: Marriage market, multidimensional matching, continuous and discrete characteristics, heterogeneous preferences

Reference: 696

Individual View

Authors: Alexander B. Lippert

Jan 2014

Do local populations bene t from resource booms? How strong are market linkages between the mining sector and the regional economy? This paper exploits exogenous variation in mine-level production volumes generated by the recent copper boom in Zambia to shed light on these questions.  Using a novel dataset, I nd robust evidence that an increase in local copper production improves living standards in the surroundings of the mines even for households not directly employed in the mining sector: a 10% increase in constituency-level copper output is associated with a 2% increase in real household expenditure; positive effects on housing conditions, consumer durable ownership and child health are of similar magnitude. The positive spill-overs extend to the rural hinterland of mining cities, neighboring constituencies, and constituencies on the copper transportation route. Additionally, I identify boom-induced changes in the demand for services and agricultural products as key channels through which the urban and rural populations benefit from the mine expansions. Since the boom failed to generate fiscal revenues, these effects can be interpreted as the result of the mines' backward linkages. Taken together, these findings highlight the welfare potential of local procurement policies in resource rich developing countries.

JEL Codes: I31, O12, O13, Q32, Q33

Keywords: Commodity Shocks, Local Development, Mining, Natural Resources

Reference: 131

Individual View

Authors: Rick Van der Ploeg, Gerard van der Meijden, Cees Withagen

Jan 2014

A rapidly rising carbon tax leads to faster extraction of fossil fuels and accelerates global warming. We analyze how general equilibrium effects operating through the international capital market affect this Green Paradox. In a two-region, two-period world with identical homothetic preferences and without investment, the global interest rate falls and the Green Paradox weakens. With investment or a relatively more impatient oil-importing region, the Green Paradox may be strengthened because the future oil demand function shifts downward or because the interest rate rises. If the oil-importing region is very much more patient than the oil-exporting region, the Green Paradox may be reversed but in our calibrated model the effects are tiny. With exploration and endogenous initial oil reserves, a future carbon tax lowers cumulative oil extraction in partial equilibrium. If the boost to current oil extraction is weakened, strengthened or reversed in general equilibrium, so is the fall in cumulative extraction. A partial and general equilibrium welfare analysis of a future carbon tax, both for full and partial exhaustion, is given. The effects of stock-dependent extraction costs are separately discussed in an appendix.

JEL Codes: D90, H20, Q31, Q38

Keywords: Global warming, Green Paradox, Hotelling rule, oil importers, oil producers, investment, capital markets, carbon tax, exploration investment, general equilibrium

Reference: 130

Individual View

Authors: Ian Jewitt,Clare Leaver, Heski Bar-Isaac

Jan 2014

This paper develops a framework for the analysis of how asymmetric information impacts on adverse selection and market efficiency.  We adopt Akerlof's (1970) unit-demand model extended to a setting with multidimensional public and private information.  Adverse selection and efficiency are defined quantitatively as real valued random variables.  We characterize how public information disclosure and private information acquisition affect the relationship between adverse selection and efficiency.  These results are applied to inform welfare and empirical analysis and, in an employer learning setting, to study the endogenous choice of information structures.  Equilibrium information structures impose adverse selection efficiently.  We show that this makes adverse selection hard to detect using standard positive correlation tests.

JEL Codes: D82, J30

Keywords: asymmetric information, adverse selection, information structures, information acquisition, information disclosure, employer learning

Reference: 695

Individual View

Authors: Peter Neary, Monika Mrazova

Jan 2014

We show that relaxing the assumption of CES preferences in monopolistic competition has surprising implications when trade is restricted.  Integrated and segmented markets behave differently, the latter typically exhibiting reciprocal dumping.  Globalization and lower trade costs have different effects: the former reduces spending on all existing varieties, the latter switches spending from home to imported varieties; when demands are less convex than CES, globalization raises whereas lower trade costs reduce firm output.  Finally,calibrating gains from trade is harder.  Many more parameters are needed, while import demand elasticities typically overestimate the true elasticities, and so underestimate the gains from trade.

JEL Codes: F12, F15, F17

Keywords: Additively Separable Preference, CES Preference, Iceberg Trade Costs, Quantifying Gains from Trade, Super- and Subconvexity of Demand, Super- and Subconcavity of Utility

Reference: 694

Individual View

Authors: Kevin Hjortshøj O'Rourke, Alan Fernihough

Jan 2014

We examine the importance of geographical proximity to coal as a factor underpinning comparative European economic development during the Industrial Revolution.  Our analysis exploits geographical variation in city and coalfield locations, alongside temporal variation in the availability of coal-powered technologies, to quantify the effect of coal availability on historic city population sizes.  Since we suspect that our coal measure could be endogenous, we use a geologically derived measure as an instrumental variable: proximity to rock strata from the Carboniferous era.  Consistent with traditional historical accounts of the Industrial Revolution, we find that coal exhibits a strong influence on city population size from 1800 onward.  Counterfactual estimates of city population sizes indicate that our estimated coal effect explains at least 60% of the growth in European city populations from 1750 to 1900.  This result is robust to a number of alternative modelling assumptions regarding missing historical population data, spatially lagged effects, and the exclusion of the United Kingdom from the estimation sample.

Keywords: Coal, Historical Population, Geography

Reference: 124

Individual View

Authors: Francesco Zanetti

Jan 2014

This paper derives closed-form and numerical solutions for relative risk aversion in a standard consumption-based model enriched with housing.  The presence of housing enables the household to hedge against unexpected shocks and may decrease relative risk aversion.  In addition, housing may generate state-dependent, time-varying risk aversion.

JEL Codes: D81, E21, R21

Keywords: Relative risk aversion, housing

Reference: 693

Individual View

Authors: Sujoy Mukerji, Robin Cubitt, Gijs van de Kuilen

Jan 2014

The exchange between Epstein (2010) and Klibanoff et al. (2012) identified a behavioral issue that sharply distinguishes between two classes of models of ambiguity sensitivity, exemplified by the α-MEU model and the smooth ambiguity model, respectively. The issue in question is whether a subject

JEL Codes: C91, D01, D03, D81, G02

Keywords: Ambiguity sensitivity; ambiguity attitude; testing models of ambiguity sensitive preference

Reference: 692

Individual View

Authors: Rick Van der Ploeg, Ton van den Bremer

Dec 2013

One of the most important developments in international finance and resource economics in the past twenty years is the rapid and widespread emergence of the $6 trillion sovereign wealth fund industry. Oil exporters typically ignore below-ground assets when allocating these funds, and ignore above-ground assets when extracting oil. We present a unified stylized framework for considering both. Subsoil oil should alter a fund’s portfolio through additional leverage and hedging. First-best spending should be a share of total wealth, and any unhedgeable volatility must be managed by precautionary savings. If oil prices are pro-cyclical, oil should be extracted faster than the Hotelling rule to generate a risk premium on oil wealth. Finally, we discuss how our analysis could improve the management of Norway’s fund in practice.

JEL Codes: E21, F65, G11, G15, O13, Q32, Q33

Keywords: oil revenue, portfolio allocation, sovereign wealth fund, leverage, hedging, optimal extraction, prudence, risk aversion

Reference: 129

Individual View

Authors: Peter Neary, Monika Mrazova

Dec 2013

We introduce two new tools for relating preferences and demand to firm behavior and economic performance.  The "Demand Manifold" links the elasticity and convexity of an arbitrary demand function; the "Utility Manifold" links the elasticity and concavity of an arbitrary utility function.  Along the way we present some new families of demand functions; show how the structure of demand and preferences determine the responses of monopoly firms and monopolistically competitive industries to exogenous shocks; characterize the efficiency of a monopolistically competitive equilibrium; and present a quantitative framework for predicting the welfare effects of exogenous shocks.

JEL Codes: F23, F15, F12

Keywords: Heterogeneous Firms, Quantifying Gains from Trade, Super- and Sub-Convexity, Supermodularity

Reference: 691

Individual View

The principles of how best to manage the various components of national wealth are outlined, where the permanent income hypothesis, the Hotelling rule and the Hartwick rule play a prominent role. As far as managing natural resource wealth is concerned, a case is made to use an intergenerational sovereign wealth fund to smooth consumption across generations, a liquidity fund for the precautionary buffers to deal with commodity price volatility, and an investment fund to park part of the windfall until the country is ready to absorb extra spending on domestic investment. Capital scarcity implies that a positive part of the windfall should be spent on domestic investment. The conclusions highlight the political economy problems that will have to be tackled with these normative proposals for managing wealth.

JEL Codes: E21, E22, D91, Q32

Keywords: permanent income, Hotelling rule, Hartwick rule, precaution, capital scarcity, absorption constraints, Dutch disease, investing to invest, political economy

Reference: 128

Individual View

Authors: Francesco Zanetti, Haroon Mumtaz

Dec 2013

This paper embeds labor market search frictions into a New Keynesian model with financial frictions as in Bernanke, Gertler and Gilchrist (1999).  The econometric estimation establishes that labor market frictions substantially improve the empirical fit of the model.  The effect of the interaction between labor and financial frictions on aggregate fluctuations depends on the nature of the shock.  For monetary policy, technology and entrepreneurial wealth shocks, labor market frictions amplify the effect of financial frictions since robust changes in hiring lead to persistent movements in employment and the return on capital that reinforce the original effect of financial frictions.  For cost-push, labor supply, marginal efficiency of investment and preference shocks, labor market frictions dampen the effect of financial frictions by reducing the real cost of repaying existing debt that lowers the exernal finance premium.

JEL Codes: E24, E32, E52

Keywords: Financial frictions, search and matching frictions, New Keynesian model

Reference: 690

Individual View

Authors: Robert Allen

Dec 2013

The causes of the USA's exceptional economic performance are investigated by comparing American wages and prices with wages and prices in Great Britain, Egypt, and India.  Habakkuk's views on the causes of American industrial pre-eminence are reassessed.  While the USA had abundant natural resources, they did not promote manufacturing since international trade equalized prices in Britain and the USA or American tariffs made resources dearer in the USA.  Wages were higher in the USA than in Britain since labor markets were tightly integrated and labor was drawn to the USA as the continent was settled.  Capital services were also more expensive in USA.  American industrialization required tariffs since virtually all input prices were higher than in Britain and industrial productivity was comparable.  America's comparative advantage shifted from agriculture to manufacturing after 1895 was industrial productivity soured.  This was due to a fall in energy prices in the USA, the American policy of mass schooling which increased the supply of skilled adults and induced firms to invent technology to raise their productivity since the supply of child labor was restricted in comparison to Britain, and the great growth of manufacturing investment induced by the tariff which provide a large market for inventions and generated technical knowledge through learning by doing.  Egypt and India could not have industrialized by following American policies since their wages were so low and their energy costs so high that the modern technology that was cost effective in Britain and the USA would not have paid in their circumstances.  The development of Egypt and India required more draconian state intervention than a protective tariff, mass education, and infrastructure investment - the American model.

JEL Codes: F13, F14, N1, N3, N4, N5, N6, N7, O31

Keywords: economic growth, technical change, natural resources, international migration, American exceptionalism

Reference: 689

Individual View

Authors: Peter Neary, James E. Anderson

Dec 2013

What kind of tariff reform is likely to raise welfare in situations where tariff revenue is important?  Uncertainty about specification and risk from imprecise parameter estimates of any particular specification reduce the credibility of simulation estimates.  A promising alternative is to develop rules which are robust with respect to such uncertainty.  We present sufficient conditions for a class of linear rule that guarantee welfare-improving tariff reform.  The rules span cones of welfare-improving tariff reforms consisting of convex combinations of (i) trade-weighted-average-tariff-preserving dispersion cuts; and (ii) uniform tariff cuts that preserve domestic relative prices among tariff-ridden goods.

JEL Codes: F13, H21

Keywords: Trade policy reform, Generalized mean and variance of tariffs, Tariff revenue, Piecemeal policy reform

Reference: 688

Individual View

Authors: Tim Willems

Dec 2013

This paper presents a model of a rational seller who is actively learning the slope of his demand curve via his pricing strategy.  Consequently, this seller optimally experiments with his price.  Resulting price patterns show a lot of discreteness (as observed in the data), which has proved to be a major challenge to most price setting models.  This model's learning dynamics are able to reconcile individual price flexibility with aggregate price sluggishness, while the experimentation motive can explain the presence of many idiosyncratic price changes in the data as well as the observation that prices are more volatile than costs.

JEL Codes: D21, D83, E31

Keywords: Active learning, Price experimentation, Nominal rigidities, Sales, Discrete pricing

Reference: 687

Individual View

Authors: John Quah, Hiroki Nishimura, Efe A. Ok

Dec 2013

The theoretical literature on (non-random) choice largely follows the route of Richter (1966) by working in abstract environments and by stipulating that we see all choices of an agent from a given feasible set.  On the other hand, empirical work on consumption choice using revealed preference analysis is done following the approach of Afriat (1967), which assumes that we observe only one (and not necessarily all) of the potential choices of an agent.  These two approaches are structurally different and they are treated in the literature in isolation from each other.  This paper introduces a framework in which both approaches can be formulated in tandem.  We prove a rationalizability theorem in this framework that simultaneously generalizes the fundamental results of Afriat and Richter, along with many of their variants.



JEL Codes: D11, D81

Keywords: Revealed Preference, Rational Choice, Afriat's Theorem, Richter's Theorem

Reference: 686

Individual View

Authors: Robert Allen

Dec 2013

This paper compares historical poverty baskets to modern food security and poverty lines.  Changes in the historical baskets and indexing methods are proposed to bring historical studies into better alignment with modern measures as well as with historically based estimates of energy requirements.  In addition, it is argued that modern poverty measures could be improved by emulating the historical methods.

JEL Codes: I32, N30, O15

Keywords: poverty measurement, poverty line, subsistence ratio, nutritional standards, food security

Reference: 685

Individual View

Authors: James Cust, Torfinn Harding

Nov 2013

We provide evidence that institutions strongly influence where oil and gas exploration takes place. To identify the effect of institutions, we utilise a global dataset on the location of exploration wells and national borders. This allows for a regression discontinuity design, with the key assumption that the position of borders was determined independently of geology. To break potential simultaneity between borders, institutions and activities in the oil sector, we exploit the historical sequence of drilling occurring after the formation of borders and institutions. At borders, exploration companies choose to drill on the side with better institutional quality 58% of the time. The results are consistent with the view that institutions shape exploration companies’ incentives to invest in drilling as well as host countries’ supply of drilling opportunities. It follows that the observed distribution of natural capital across countries is endogenous with respect to institutions.

JEL Codes: F21, O13, O43, Q32

Keywords: institutions, investment, oil and gas exploration, regression discontinuity design

Reference: 127

Individual View

Authors: Ferdinand Rauch, Guy Michaels

Nov 2013

Do locational fundamentals such as coastlines and rivers determine town locations, or can historical events trap towns in unfavorable locations for centuries?  We examine the effects on town locations of the collapse of the Western Roman Empire, which temporarily ended urbanization in Britain, but not in France.  As urbanization recovered, medieval towns were more often found in Roman-era town locations in France than in Britain, and this difference still persists today.  The resetting of Britain's urban network gave it better access to naturally navigable waterways when this was important, while many French towns remained without such access.

JEL Codes: R11, N93, O18

Keywords: Economic Geography, Economic History, Path Dependence, Transportation

Reference: 684

Individual View

Authors: Francesco Zanetti, Federico S. Mandelman

Nov 2013

Recent empirical evidence establishes that a positive technology shock leads to a

decline in labor inputs. Can a flexible price model enriched with labor market frictions

replicate this stylized fact? We develop and estimate a standard flexible price model using

Bayesian methods that allows, but does not require, labor market frictions to generate

a negative response of employment to a technology shock. We find that labor market

frictions account for the fall in labor inputs.

JEL Codes: E32

Keywords: Technology shocks, employment, labor market frictions

Reference: 683

Individual View

Authors: David Gill, John Thanassoulis

Oct 2013

We study price competition between firms over public list or posted prices when a fraction of consumers (termed 'bargainers') can subsequently receive discounts with some probability.  Such stochastic discounts are a feature of markets in which some consumers bargain explicitly; of markets in which sellers use the marketing practice of couponing; and of markets in which sellers offer both simple-to-understand tariffs (the posted prices) alongside complex or opaque tariffs that might offer a discount.  Even though bargainers receive reductions off the posted prices, the potential to discount dampens competitive pressure in the market by reducing the incentive to undercut a rival's posted price, thus raising all prices and increasing profits.  Welfare falls because of the stochastic nature of the discounts, which generates some misallocation of products to consumers.  We also find that stochastic discounts facilitate collusion by reducing the market share that can be gained from a deviation.

JEL Codes: C78, D43, L13

Keywords: Posted prices, list prices, collusion, bargaining, negotiation, haggling, discounting, coupons, obfuscation, flat rate bias, price takers

Reference: 682

Individual View

Authors: Karlygash Kuralbayeva

Oct 2013

I build an equilibrium search and matching model of an economy with an informal sector and rural urban migration to analyze the effects of budget-neutral green tax policy (raising pollution taxes, while cutting payroll taxes) on the labor market. The key results of the paper suggest that when general public spending varies endogenously in response to tax reform and higher energy taxes can reduce the income from self-employed work in the informal sector, green tax policy can produce a triple dividend: a cleaner environment, lower unemployment rate and higher after-tax income of the private sector. This is due to the ability of the government, by employing public spending as an additional policy instrument, to reduce the overall tax burden when an increase in energy tax rates does not exceed some threshold level. Thus governments should employ several instruments if they are concerned with labor market implications of green tax policies.

JEL Codes: H20, H23, H30

Keywords: informal sector, matching frictions, pollution taxes, double dividend

Reference: 125

Individual View

Authors: Alexander James

Oct 2013

An analytical framework predicts that, in response to an exogenous increase in resource based government revenue, a benevolent government will partially substitute away from taxing income, increase spending and save. Forty-two years of U.S. state-level data are consistent with this theory. Specifically, a baseline fixed effects model predicts that a 1% point increase in resource revenue results in a .20% point decrease in non-resource revenue, a .50% point increase in spending and a .30% point increase in savings. These results are generally robust to alternative model specifications and the instrumentation of resource-based government revenue. Interaction effects reveal some asymmetry in the fiscal response to revenue shocks according to state political leanings.

JEL Codes: Q38; H20

Keywords: Severance Tax; Fiscal Policy; Natural Resources

Reference: 126

Individual View

Authors: John Muellbauer

Oct 2013

This paper proposes that all new euro area sovereign borrowing be in the form of jointly guaranteed Eurobonds.  To avoid classic moral hazard problems and to insure the guarantors against default, each country would pay a risk premium conditional on economic fundamentals to a joint debt management agency.  This suggests that these bonds be called 'Euro-insurance-bonds'.  While the sovereign debt markets have taken increasing account of the economic fundamentals, the signal to noise ratio has been weakened by huge market volatility, so undercutting incentives for appropriate reforms and obscuring economic realities for voters.  This paper uses an econometric model to show that competitiveness, public and private debt to GDP, and the fall-out from housing market crises are the most relevant economic fundamentals.  Formula-based risk spreads based on these fundamentals would provide clear incentives for governments to be more oriented towards economic reforms to promote long-run growth than mere fiscal contraction.  Putting more weight on incentives that come from risk spreads, than on fiscal centralisation and the associated heavy bureaucratic procedures, would promote the principle of subsidiarity to which member states subscribe.  The paper compares Euro-insurance-bonds incorporating these risk spreads with other policy proprosals.

JEL Codes: E43, E44, G01, G10, G12

Keywords: Sovereign spreads, eurobonds, eurozone sovereign debt crisis, subsidiarity

Reference: 681

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