Working Papers

Authors: John Knight, LI Shi, WAN Haiyuan

Dec 2016

The inequality of wealth in China has increased rapidly in recent years. Prior to 1978 all Chinese households possessed negligible wealth. China therefore presents a fascinating case study of how inequality of household wealth increases as economic reform takes place, marketisation occurs, and capital accumulates. Wealth inequality and its growth are measured and decomposed using data from two national sample surveys of the China Household Income Project (CHIP) relating to 2002 and 2013. Techniques are devised and applied to measure the sensitivity of wealth inequality to plausible assumptions about under-representation of and under-reporting by the wealthy. An attempt is made to explain the rising wealth inequality in terms of the relationships between income and wealth, house price inflation, differential saving, and income from wealth.

JEL Codes: C80; D31

Keywords: China; wealth inequality and its decomposition; top-tail income c

Reference: 816

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Authors: Guido Ascari, Louis Phaneuf, Eric Sims

Dec 2016

Recent empirical evidence identfi es investment shocks as key driving forces behind business cycle fluctuations. However, existing New Keynesian models emphasizing these shocks counterfactually imply a negative unconditional correlation between consumption growth and investment growth, a weak positive unconditional correlation between consumption growth and output growth and anomalous profi les of cross-correlations involving consumption growth. These anomalies arise because of a short-run contractionary eff ect a positive investment shock on consumption. Such counterfactual co-movements are typical of the "Barro-King curse" (Barro and King 1984), wherein models with a real business cycle core must rely on technology shocks to account for the observed co-movement among output, consumption, investment, and hours. We show that two realistic additions to an otherwise standard medium scale New Keynesian model - namely, roundabout production and real per capita output growth stemming from trend growth in neutral and investment-specifi c technologies - can break the Barro-King curse and provide a more accurate account of unconditional business cycle comovements more generally. These two features substantially magnify the eff ects of neutral technology and investment shocks on aggregate fluctuations and generate a rise of consumption on impact of a positive investment shock.

JEL Codes: E31, E32

Keywords: Investment shocks, Business cycle comovements, Standard household preferences, Monopolistic competition, Wage and price contracting, Intermediate inputs, Trend output growth, Trend inflation

Reference: 815

Individual View

Authors: James Forder

Dec 2016

Abstract

It is widely accepted that the importance of Friedman’s Presidential Address to the American Economic Association lies in its criticism of policy based on the Phillips curve. It is argued that a reading of the text does not support such a view, and this and other considerations suggest that any such aim was far from Friedman’s mind in 1968. His objective was the quite different one of making a case for policy ‘rules’ rather than discretion.

JEL Codes: B22, B31, E58

Keywords: Milton Friedman; rules and discretion; expectations; Phillips curve

Reference: 814

Authors: Fidel Perez-Sebastian, Ohad Raveh

Nov 2016

In economies with multi-level governments, why would a change in the …scal rule of a gov-ernment in one level lead to a …scal response by a government in a di¤erent level? Previous explanations focus on the standard common-pool problem. In this paper we study a new potential channel: complementarities between the public goods supplied by the two governments. First, we illustrate its potential key role in determining the sign of the vertical reaction through a standard model of horizontal tax competition with vertical …scal interactions. Second, we propose a novel strategy for identifying it, by considering an empirical design that con…nes the common-pool channel to speci…c locations. We implement this design through a quasi-natural experiment: the 1980 U.S. Crude Oil Windfall Act, which increased federal tax collections from sale of crude oil, thereby a¤ecting the tax base of oil rich states speci…cally. This latter feature enables attributing the vertical …scal reactions of the remaining states to the complementarity channel. Following this strategy, via a di¤erence-in-di¤erences approach, we decompose the sources of the vertical …scal reactions arising from this federal tax change and …nd that those attributed to the novel channel: (i) point at complementarity between state and federal public goods; (ii) account for approximately 40% of the overall vertical …scal response; (iii) are manifested primarily via corporate taxation.

JEL Codes: H77, H71, Q32

Keywords: Federalism, vertical fiscal reactions, common-pool problem, complimentarities, natural resources

Reference: 183

Individual View

Authors: Francesco Zanetti, Wei Li

Nov 2016

This paper uses VAR analysis to identify monetary policy shocks on U.K. data using surprise changes in the policy rate as external instruments and imposing block exogeneity restrictions on domestic variables to estimate parameters from the viewpoint of the domestic economy. The results show large and persistent effects of monetary policy shocks on the domestic economy and point to the critical role of exchange rates and term premia. The analysis resolves important empirical puzzles of traditional recursive identification methods.

JEL Codes: E44, E52, F41

Keywords: Monetary Policy Transmission, Structural VAR, Small Open Economy, External Instruments Identification

Reference: 812

Individual View

Authors: Ohad Raveh

Nov 2016

Can monetary policy shocks induce redistribution across natural resource rich and poor economies within a union? Resource-rich economies are more capital intensive. A two-region monetary union DSGE model with an equalizing fiscal rule and heterogeneity in capital intensity shows that positive monetary policy shocks induce redistribution from the capital-scarce region to its capital-rich counterpart because investment contracts more strongly in the latter. These patterns persist over the medium-term. We test the model's predictions using a panel of U.S. states over the period 1969-2007. Our identification strategy rests on narrative-based monetary policy shocks that are exogenous to individual states, and geographically-based cross-state differences in natural endowments interacted with the international price of oil. The empirical results corroborate the theoretical predictions. We find that a contractionary monetary policy shock induces a relative drop (increase) in investment (federal transfers) in resource-rich states, over the course of four years, due to differences in capital intensities. We estimate that approximately $2.4 billion is redistributed from the resource-poor to the resource-rich states, within the first year of the shock.

JEL Codes: E52, Q32, H77

Keywords: Monetarypolicy, naturalresources, redistribution

Reference: 181

Individual View

Authors: Francesco Zanetti, Christoph Görtz, John D. Tsoukalas

Nov 2016

We examine the dynamic effects and empirical role of TFP news shocks in the context of frictions in financial markets. We document two new facts using VAR methods. First, a (positive) shock to future TFP generates a signicant decline in various credit spread indicators considered in the macro-finance literature. The decline in the credit spread indicators is associated with a robust improvement in credit supply indicators, along with a broad based expansion in economic activity. Second, it is striking that VAR methods also establish a tight link between TFP news shocks and shocks that explain the majority of un-forecastable movements in credit spread indicators. These two facts provide robust evidence on the importance of movements in credit spreads for the propagation of news shocks. A DSGE model enriched with a financial sector of the Gertler-Kiyotaki-Karadi type generates very similar quantitative dynamics and shows that strong linkages between leveraged equity and excess premiums, which vary inversely with balance sheet conditions, are critical for the amplication of TFP news shocks. The consistent assessment from both methodologies provides support for the traditional 'news view' of aggregate fluctuations.

JEL Codes: E2, E3

Keywords: News shocks, Business cycles, DSGE, VAR, Bayesian estimation

Reference: 813

Individual View

Authors: Fidel Perez-Sebastian, Ohad Raveh

Nov 2016

What determines legislators' ’voting behavior over federal tax policies? Conventional wisdom points primarily at party affiliation. This paper presents a novel mechanism of voting patterns across state-levels of …scal advantage. We construct a political economy model of …scal federalism with state …scal asymmetries that originate in heterogeneity in natural resource abundance, representing a non-mobile source of income that provides a …scal advantage in the inter-state …scal competition. The model shows that representatives of natural resource rich states are more willing to vote in favor of federal tax increases, despite the lower net …scal bene…fits their states receive. This occurs because these states can reduce their tax rates as a response to an increase in the federal tax rate, and hence attract capital from the rest of the nation to the extent of increasing their pre-shock tax base. Data on roll-call votes in the U.S. Congress over major changes in federal tax bills in the post WW-II period support the predicted voting patterns. Speci…cally, we …nd that elected officials of resource rich states are more (less) supportive of capital-related federal tax increases (decreases), controlling for their party affiliation, ideology, federal transfers, and economic conditions. Our results indicate that the …scal advantage channel is as dominant as party affiliation in driving legislators' ’voting decisions over federal tax policies.

JEL Codes: D72, H77, Q32

Keywords: Federal tax changes, voting behaviour, federalism, natural resources

Reference: 182

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Authors: John Muellbauer

Nov 2016

The failure of the ubiquitous New Keynesian "Dynamic Stochastic General Equilibrium" (NK-DSGE) models to capture interactions of finance and the real economy is widely-recognized since the 2008-9 financial crisis. NK-DSGE models exclude money, debt and asset prices and, importantly, ignore changing credit markets. These problems stem from assuming unrealistic micro-foundations for household behaviour, and that aggregate behaviour mimics a fully-informed representative agent (both assumptions are embodied in the underlying rational expectations permanent income' hypothesis (REPIH). This survey critiques the NK-DSGE models and its integral REPIH model, and discusses alternative post-crisis general equilibrium models which do incorporate debt and allow crises to occur. But neither model type can be directly applied to policy-making. The survey reviews misspecifications in standard non-DSGE macro-models used by central banks (e.g. the Fed.'s FRB-US), and related co-integration literature linking consumption with household portfolios. These too omit most of the 'financial accelerator', ignoring credit shifts and crucially, aggregating liquid, illiquid assets, debt and housing into a single 'net worth' construct. The survey's second focus is to improve non-DSGE models for policy using the Latent Interactive Variable Equation System (LIVES) approach, in which aggregate consumption is jointly modelled with the main elements of household balance sheets, extracting credit conditions as a latent variable. Empirical work on aggregate data is surveyed revealing the important role of debt and financial assets and the time and context-dependent role of housing collateral. Rather than 'one-size-fits-all' monetary and macro-prudential policy, institutional differences between countries then imply major differences for monetary policy transmission and policy.

JEL Codes: E17, E21, E44, E51, E52, E58, G01

Keywords: DSGE, macroeconomic policy models, finance and the real economy, financial crisis, consumption, credit constraints, household portfolios, asset prices

Reference: Paper 811

Individual View

Authors: Qi Zhang, James Cust

Nov 2016

An increasing number of papers in the literature use satellite data on nighttime lights as a proxy for economic activities, such as GDP or GDP growth. They implicitly assume that the relationship between GDP and nighttime lights works through the demand side, and there is no constraint on the supply of electricity. This paper first points out a paradox in using this method: the countries for which the method is needed the most, i.e. the countries with poor statistical capacity, are just the countries, for which the assumption of the method is satisfied the least, i.e. the countries with a large power infrastructure deficit. Motivated by this, we collected the data on power infrastructure investment in Angola, a country with a large power infrastructure funding gap. Indeed, we find that in the case of Angola the stable relationship between GDP growth and lights growth assumed in the literature is broken. Instead,increase in lights strongly co-moved with increase in power infrastructure investment. The strong link between lights and investment enables us to develop a new method of quantitatively evaluating value-for-money for infrastructure investments, which directly estimates the cost-effectiveness of transforming investment to welfare, as measured by lights. We estimate the overall cost-effectiveness, and the cost-effectiveness of different financing methods in the case of Angola.

JEL Codes: Q4, O1, H4

Keywords: procurement, growth accounting, nighttime lights, investment, electricity, infrastructure, value-for-money

Reference: 185

Individual View

Open competitive bidding with the contract awarded to the bidder offering the lowest bid price is commonly the recommended method for public procurement. However, the benefits of this form of bidding are subject to certain conditions, such as a good number of available bidders and no post-contract adaptations. This paper quantitatively evaluates the implications of the extent to which these conditions are satisfied for contract performance. It combines the performance ratings of World Bank financed projects with the information on bidding for World Bank procurement contracts and uses natural resources as exogenous variations to show that in resource-rich countries, where the conditions are less likely to be satisfied, awarding the contract to the bidder with the lowest bid price may not be the best procurement method in terms of contract performance. This is consistent with the evidence that World Bank financed projects performed better in non-resource-rich countries than in resource-rich countries over the last 40 years. This may explain why since 2016 the World Bank has shifted the focus of bid evaluation from the lowest bid to bids that provide the best overall value for money, taking into account risk, quality, cost and other factors as needed.

JEL Codes: D4, Q3, H4, H5

Keywords: procurement, auction, World Bank, project evaluation

Reference: 184

Individual View

Authors: Max Roser

Nov 2016

The large span of long-run projected temperature changes in climate projections does not predominately originate from uncertainty across climate models; instead it is the wide range of different global socio-economic scenarios and the implied energy production that results in high uncertainty about climate change. It is therefore important to assess the observational tracking of these scenarios. For the first time observations over two decades are available against which the initial sets of socio-economic scenarios used in IPCC reports can be assessed. Here we compare these socio-economic scenarios created in both 1992 and 2000 against the recent observational record to investigate the coupling of economic growth and fossil-fuel CO2 emissions. We find that the growth rate in fossil fuel CO2 emission intensity – fossil fuel CO2 emissions per GDP – over the 2000s exceeds the projections of all main emission scenarios. Proposing a method to disaggregate differences in global growth rates to country-by-country contributions, we find that the relative discrepancy is driven by high growth rates in Asia and Eastern Europe, in particular in Russia and China. The growth of emission intensity over the 2000s highlights the relevance of unforeseen local shifts in projections on a global scale.

JEL Codes: Q40, Q47, Q54

Keywords: Climate, Energy, Scenarios, Emission Intensity

Reference: 810

Individual View

Economic policy agencies accompany forecasts with narratives, a combination we call foredictions, often basing policy changes on developments envisaged. Forecast failure need not impugn a forecasting model, although it may, but almost inevitably entails forediction failure and invalidity of the associated policy. Most policy regime changes involve location shifts, which can induce forediction failure unless the policy variable is super exogenous in the policy model. We propose a step-indicator saturation test to check in advance for invariance to policy changes. Systematic forecast failure, or a lack of invariance, previously justified by narratives reveals such stories to be economic fiction.

JEL Codes: C51, C22

Keywords: Forediction; Invariance; Super exogeneity; Indicator saturation; Co-breaking; Autometrics

Reference: 809

Individual View

Authors: Alexei Parakhonyak, Nick Vikander

Oct 2016

This paper shows that a rm may benefit from restricting capacity so as to trigger herding behavior from consumers, in situations where such behavior is otherwise unlikely. We consider a setting with social learning, where consumers observe sales from previous cohorts and update beliefs about product quality before making their purchase. A capacity constraint directly limits sales but also results in coarser information: upon observing a sellout, consumers attach positive probability to all levels of demand that exceed the constraint. The resulting discrete jump in beliefs following a sellout benefits the firm, and can make it optimal to restrict capacity.

JEL Codes: D82, D83, L15

Keywords: Capacity Constraints, Herding, Informational Cascades

Reference: 808

Individual View

Authors: Alexei Parakhonyak, Maria Titova

Oct 2016

Abstract:

We consider a general model of a market for differentiated goods, in which firms are located in marketplaces: shopping malls or platforms. There are search frictions between the marketplaces, but not within them. Marketplaces differ in their size. We show that consumers prefer to start their search from the largest marketplace and continue in the descending order of their size. We show that the descending search order is the only search order which can be a part of an equilibrium for any market cofiguration. Despite charging lower prices, firms at larger marketplaces earn higher profits, and under free entry all firms cluster at one place. If a marketplace determines the price of entry, the equilibrium marketplace size depends negatively on search costs.

JEL Codes: D43, D83, L13

Keywords: Shopping Malls, Consumer Search, Platforms

Reference: 807

Individual View

Authors: Brian A'Hearn, Alexia Delfino, Alessandro Nuvolari

Oct 2016

A swelling stream of literature employs age-heaping as an indicator of human capital, more specifically of numeracy. We re-examine this connection in light of evidence drawn from nineteenth century Italy: census data, death records, and direct, qualitative evidence on age-awareness and numeracy. Though it can stand in as an acceptable proxy for literacy, our findings suggest that age-heaping is most plausibly interpreted as a broad indicator of cultural and institutional modernisation rather than a measure of cognitive skills.

JEL Codes: N33, J24

Keywords: Age-Heaping, Numeracy, Human capital, Italy

Reference: 148

Individual View

Authors: Amos Nadler, Veronika Alexander, Cameron J. Johnson, Paul J. Zak

Oct 2016

Abstract:

Financial markets deviate from efficiency due to behavioral causes and there is growing evidence that biological factors affect individual financial decisions that could be reflected in markets. Many behavioral influences on asset prices have underlying biological mechanisms associated with fluctuations in the levels of the male sex hormone testosterone. Testosterone, a chemical messenger especially influential in male physiology, varies cyclically and in response to challenge, fluctuates according to victory and defeat, and is taken as a performance-enhancer among some financial professionals, yet no study has tested how it causally affects trading decisions. We exogenously elevated testosterone in traders in an experimental asset market and found that it causes significantly higher and longer-lasting asset overpricing compared to placebo. Using both aggregated and individual trading data we demonstrate that testosterone administration generates bubbles by causing persistently high bids and slow incorporation of asset fundamental value among traders.

JEL Codes: G11, G12, C23, C91, C92, D87

Keywords: Asset price bubbles, Experiment, Testosterone

Reference: 806

Individual View

Authors: Andre Veiga,Ansgar Walther

Oct 2016

Abstract:

We contrast the impact of traditional news media and social media coverage on stock market volatility and trading volume. We develop a theoretical model of asset pricing and information processing, which allows for both rational traders and a variety of commonly studied behavioral biases. The model yields several novel and testable predictions about the impact of news and social media on asset prices. We then test the model’s theoretical predictions using a unique dataset which measures coverage of individual stocks in social and news media using a broad spectrum of print and online sources. Stocks with high social media coverage in one month experience high idiosyncratic volatility of returns and trading volume in the following month. Conversely, stocks with high news media coverage experience low volatility and low trading volume in the following month. These effects are statistically and economically significant and robust to controlling for stock and time fixed effects, as well as time-varying stock characteristics. The empirical evidence on news media is consistent with a market in which some traders are overconfident when interpreting new information. The evidence on social media is consistent with Tetlock (2011)’s “stale news” hypothesis (investors treat repeated information on social networks as though it were new) and with a model where investors’ perceptions are subject to random sentiment shocks.

JEL Codes: G02, G12, G14

Keywords: Social media, news media, behavioral finance, volatility, trading volume

Reference: Paper 805

Individual View

Authors: Rick Van der Ploeg, Ton van den Bremer

Sep 2016

We use a welfare-based intertemporal stochastic optimization model and historical data to estimate the size of the optimal intergenerational and liquidity funds and the corresponding resource dividend available to the government of the Canadian province Alberta. To first-order of approximation, this dividend should be a constant fraction of total above- and below-ground wealth, complemented by additional precautionary savings at initial times to build up a small liquidity fund to cope with oil price volatility. The ongoing dividend equals approximately 30 per cent of government revenue and requires building assets of approximately 40 per cent of GDP in 2030, 100 per cent of GDP in 2050 and 165 per cent in 2100. Finally, the effect of the recent plunge in oil prices on our estimates is examined. Our recommendations are in stark contrast with historical and current government policy.

JEL Codes: E21, E22, D91, Q32

Keywords: oil price volatility, precautionary saving, resource wealth, fiscal policy

Reference: 179

Individual View

Authors: Jane Humphries, Jacob Weisdorf

Sep 2016

Abstract:

Existing measures of historical real wages suffer from the fundamental problem that workers’ annual incomes are estimated on the basis of day wages without knowing the length of the working year. We circumvent this problem by presenting a novel wage series of male workers employed on annual contracts. We use evidence of labour market arbitrage to argue that existing real wage estimates are badly off target, because they overestimate the medieval working year but underestimate the industrial one. Our data suggests that modern economic growth began two centuries earlier than hitherto thought and was driven by an ‘Industrious Revolution’.

JEL Codes: J3, J4, J5, J6, J7, J8, N33

Keywords: England, industrial revolution, industrious revolution, labour input, living standards, wages, Malthusian model.

Reference: 147

Individual View

Authors: Mark Armstrong

Sep 2016

The paper discusses situations in which consumers search through their options

in a deliberate order, in contrast to more familiar models with random search. Topics

include: the existence of ordered search equilibria with symmetric sellers (all con-

sumers first inspect the seller they anticipate sets the lowest price, and a seller which

is inspected first by consumers will set the lowest price); the use of price and non-

price advertising to direct search; the impact of consumers starting a new search at

their previous supplier; and the incentive a seller can have to raise its own search

cost. I also show how ordered search can be reformulated as a simpler discrete choice

problem without search frictions or dynamic decision making.

JEL Codes: D21, D43, D83, L11, L15, M37

Keywords: Consumer search, sequential search, ordered search, directed search, discrete choice, oligopoly, advertising, obfuscation.

Reference: 804

Individual View

Authors: James Forder

Sep 2016

Using a range of sources, it is argued that, contrary to common belief, Milton Friedman had no special influence on British policy in the 1970s and 1980s. The opposing impression appears to be derived in part from the work of Friedman’s admirers, but principally from the allegations of Margaret Thatcher’s opponents who believed they could taint her with his name.

Keywords: Friedman,monetarism,Thatcherism

Reference: Paper 802

Individual View

Authors: James Forder

Sep 2016

It is noted that Harry G. Johnson was widely admired for his broad knowledge of economics, and particularly for the excellence and synthesizing quality of much of his writing. His discussions of the “Phillips curve” and related matters are considered. It is found that they are brief, inaccurate, and inconsistent. It is clear that, despite his reputation, they should not be treated as authoritative. It is further suggested that rather than supposing that Johnson’s knowledge and capabilities have been grossly exaggerated, it may be better to conclude that the Phillips curve was not nearly so important in the literature of the 1960s and 1970s as has been supposed.

JEL Codes: B22, B29, E61

Keywords: Phillips curve,Harry Johnson,expectations,Phillips curve,Phillips curve myth

Reference: paper 803

Individual View

Authors: Rick Van der Ploeg, Rabah Arezki, Ferderik Toscani

Sep 2016

This paper explores the effect of market orientation on (known) natural wealth using a novel dataset of world-wide major hydrocarbon and mineral discoveries. Consistent with the predictions of a two-region model, our empirical estimates based on a large panel of countries show that increased market orientation causes a significant increase in discoveries. In a thought experiment whereby economies in Latin America and sub-Saharan Africa remained closed, they would have only achieved one quarter of the actual increase in discoveries they have experienced since the early 1990s. Our results call into question the commonly held view that resource endowment is exogenous.

JEL Codes: E00, F3, F4.

Keywords: natural resources, discoveries, market orientation, liberalization, institutions, endogenous reserves

Reference: 180

Individual View

Policy prescriptions for managing natural resource windfalls are based on the permanent income hypothesis: none of the windfall is invested at home and saving in an intergenerational SWF is dictated by smoothing consumption across different generations. Furthermore, with Dutch disease effects the optimal response is to intertemporally smooth the real exchange rate, smooth public and private consumption, and limit sharp fluctuations in the intersectoral allocation of production factors. We show that these prescriptions need to be modified for the following reasons. First, to cope with volatile commodity prices precautionary buffers should be put in a stabilisation fund. Second, with imperfect access to capital markets the windfall must be used to curb capital scarcity, invest domestically and bring consumption forward. Third, with real wage rigidity consumption must also be brought forward to mitigate transient unemployment. Fourth, the real exchange rate has to temporarily appreciate to signal the need to invest in the domestic economy to gradually improve the ability to absorb the extra spending from the windfall. Fifth, with finite lives the timing of handing back the windfall to the private sector matters and consumption and the real exchange rate will be volatile. Finally, with nominal wage rigidity we show that a Taylor rule is a better short-run response to a crash in commodity prices than a nominal exchange rate peg.

JEL Codes: E60, F34, F35, F43, H21, H63, O11, Q33

Keywords: Dutch disease, permanent income, volatility, capital scarcity, domestic investment, Dutch disease, absorption constraints, overlapping generations, nominal wage rigidity

Reference: 178

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