Working Papers

Authors: Simon Wren-Lewis, Jonathan Portes

May 2014

Theory suggests that government should as far as possible smooth taxes and its recurrent consumption spending, which means that government debts should act as a shock absorber, and any planned adjustments in debt should be gradual.  This suggests that operational targets for governments (e.g. for 5 years ahead should involve deficits rather than debt, because such rules will be more robust to shocks.  Beyond that, fiscal rules need to reflect the constraints on  monetary policy, and the extent to which governments are subject to deficit bias.  Fiscal rules for countries in a monetary union or fixed exchange rate regime need to include a strong countercyclical element.  Fiscal rule should also contain a 'knock out' if interest rates hit the zero lower bound: in that case the fiscal and monetary authorities should cooperate to formulate a fiscal expansion package that allows interest rates to rise above this bound.  In more normal times, the design of fiscal policy rules is likely to depend on the extent to which governments are subject to deficit bias, and the effectiveness of any national fiscal council.  For example, governments that had not shown a history of deficit bias could aim to target deficits five years ahead (rolling targets), and these would not require cyclical adjustment.  In contrast, governments that were more prone to bias could target a cyclically adjusted deficit at the end of their expected period of office.  In both cases fiscal councils would have an important role to play, in ensuring plans were implemented in the first case and allowing for departures from target when exernal shocks occurrred in the second.

JEL Codes: E62

Keywords: fiscal policy, fiscal rules, fiscal councils

Reference: 704

Individual View

Authors: Vellore Arthi

Apr 2014

 I use variation in childhood exposure to the Dust Bowl, an environmental shock to health and income, as a natural experiment to explain variation in adult human capital.  I find that the Dust Bowl produced significant adverse impacts in later life, especially when exposure was in utero, increasing rates of poverty and disability, and decreasing rates of fertility and college completion.  Dependence on agriculture exacerbates these effects, suggesting that the Dust Bowl was most damaging via the destruction of farming livelihoods.  This collapse of farm incomes, however, had the positive effect of reducing demand for child farm labor and thus decreasing the opportunity costs of secondary schooling, as evidence by increases in high school completion amongst the exposed.

Keywords: Dust Bowl, environmental shock, human capital formation, early life health

Reference: Number 129

Individual View

Authors: Damoun Ashournia, Jakob MunchDaniel Nguyen

Apr 2014

The impact of imports from low-wage countries on domestic labor market outcomes has been a hotly debated issue for decades.  The recent surge in imports from China has reignited this debate.  Since the 1980s several developed economies have experienced contemporaneous increases in the volume of imports and in the wage gap between high- and low-skilled workers.  However, the literature has not been able to document a strong causal relationship between imports and the wage gap.  Instead, past studies have attributed the widening wage gap to skill biased technological change.  This paper finds evidence for the direct impact of low wage imports on the wage gap.  Using detailed Danish panel data for firms and workers, it measures the effects of Chinese import penetration at the firm level on wages within job-spells and over the longer term taking transitions in the labor market into account.  We find that greater exposure to Chinese imports corresponds to a negative firm-level demand shock, which is biased towards low-skill intensive products.  Consistent with this an increase in Chinese import penetration results in lower wages for low skilled employees.

JEL Codes: F16

Keywords: Chinese import penetration, wage inequality, firm heterogeneity

Reference: 703

Individual View

Authors: Francesco Zanetti

Apr 2014

This paper estimates a New Keynesian model to investigate to what extent labour market reforms undertaken by the Thatcher government in the late 1930s and the introduction of a constant inflation target in 1992 might have changed the UK economic outlook if they had been introduced in the early 1970s.  The results suggest that a stronger reaction to deviations of inflation from target have contributed to a more stable economic outlook, while labour market reforms and the introduction of a constant inflation target are unlikely to have produced a different outcome.

JEL Codes: E24, E32, E52, J64

Keywords: Labour market reforms, Search and matching, New Keynesian model

Reference: 702

Individual View

Authors: Tim Willems, Shaun Larcom, Mare Sarr

Apr 2014

History offers many examples of dictators who worsened their behavior significantly over time (like Zimbabwe's Robert Mugabe), while there are also cases of dictators who have displayed remarkable improvements (like Jerry Rawlings of Ghana).  We show that such mutations can result from rational behavior when the dictator's flow use of repression is complementary to his accumulated stock of wrongdoings.  This complementarity gives rise to two steady states (one where repression is low and one where repression is high) and implies that any individual rising to power in this setup has the potential to end up as either a moderate leader, or as a dreaded tyrant.  Our model shows that dictators are more likely to derail with higher levels of divertible funds available, for example stemming from fungible aid inflows or from the exploitation of natural resources.

JEL Codes: D72, D74, N47, O10

Keywords: Dictatorship, Repression, Political violence, Resource curse, Learning, Multiple steady states

Reference: 701

Individual View

Authors: Gregg Huff, Gillian Huff

Apr 2014

This working paper analyzes demographic change in Southeast Asia's main cities during and soon after the World War II Japanese occupation.  We argue that two main patterns of population movements are evident.  In food-deficient areas, a search for food security typically led to large net inflows to main urban centres.  By contrast, an urban exodus dominated in food surplus regions because the chief risk was to personal safety, especially from Japanese and Allied bombing.  Black markets were ubiquitous, and essential to sustaining livelihoods in cities with food-deficit hinterlands.  In Rangoon and Manila, wartime population fluctuations were enormous.  Famines in Java and northern Indochina severely impacted Jakarta and Hanoi through inflows of people from rural areas.  In most countries, the war's aftermath of refugees, revolution and political disruption generated major rural-urban population relocations.  Turmoil in the 1940s had the permanent consequences of augmenting the primacy of Southeast Asia's main cities and promoting squatter settlement.

JEL Codes: N15, N90, N95, R11

Keywords: urbanization, Southeast Asia, famine, World War II, entitlements, Japan

Reference: Number 128

Individual View

Authors: Kevin Hjortshøj O'Rourke, Gregory ClarkAlan M. Taylor

Mar 2014

Many previous studies of the role of trade during the British Industrial Revolution have found little or no role for trade in explaining British living standards or growth rates.  We construct a three-region model of the world in which Britain trades with North America and the rest of the world, and calibrate the model to data from the 1760s and 1850s.  We find that while trade had only a small impact on British welfare in the 1760s, it had a very large impact in the 1850s.  This contrast is robust to a large range of parameter perturbations.  Biased technological change and population growth were key in explaining Britain's growing dependent on trade during the Industrial Revolution.

JEL Codes: F11, F14, F43, N10, N70, O40

Keywords: British Industrial Revolution, Great Divergence, trade, colonies, growth, specialization

Reference: Number 126

Individual View

Authors: Jane Humphries, Jacob Weisdorf

Mar 2014

This paper presents a wage series for unskilled English women workers from 1260 to 1850 and compares it with existing evidence for men.  Our series cast light on long run trends in women's agency and wellbeing, revealing an intractable, indeed widening gap between women and men's remuneration in the centuries following the Black Death.  This informs several debates: first whether or not "the golden age of the English peasantry" included women; and second whether or not industrialization provided women with greater opportunities.  Our contributions to both debates have implications for analyses of growth and trends in wellbeing.  If the rise in wages that followed the Black Death enticed female servants to delay marriage, it contributed to the formation of the European Marriage Pattern, a demographic regime which positioned England on a path to modern economic growth.  If the industrial revolution provided women with improved economic options, their gains should be included in any overall assessment of trends in the standard of living distorts the overall evaluation of the gains from industrialization.

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

Keywords: Black Death, England, gender wage gap, industrial revolution, gender segregation, wages, women

Reference: Number 127

Individual View

Authors: Bary S.R. Pradelski

Mar 2014

We study decentralized learning dynamics for the classic assignment game with transferable utility.  At random points in time firms and workers match, break up, and re-match in the sesarch for better opportunities.  We propose a simple learning process in which players have no knowledge about other players' payoffs or actions and they update their behavior in a myopic fashion.  Behavior fluctuates according to a random variable that reflects current market conditions: sometimes the firms exhibit greater price stickiness than the workers, and at other times the reverse holds.  We show that this stochastic learning process converges in polynomial time to the core.  While convergence to the core is known for some types of decentralized dynamics this paper is the first to prove fast convergence, a crucial feature from a practical standpoint.  The proof relies on novel results for random walks on graphs, and more generally suggests a fruitful connection between the theory of random walks and matching theory.

JEL Codes: C71, C73, C78, D83

Keywords: assignment games, core, evolutionary game theory, matching markets, convergence time, random walks

Reference: 700

Individual View

Authors: James Fenske, Achyuta Adhvaryu, Anant Nyshadham

Feb 2014

We show that psychological well-being in adulthood varies substantially with circumstance in early life.  Combining a time series of real producer prices of cocoa with a nationally representative household survey in Ghana, we find that a one standard deviation rise in the cocoa price in early life decreases the likelihood of severe mental distress in adulthood by 3 percentage points (or half the mean prevalence) for cohorts born in cocoa-producing regions relative to those born in other regions.  Impacts on related personality traits are consistent with this result.  Maternal nutrition, reinforcing childhood investments, and adult circumstances are operative channels of impact.

JEL Codes: I12, I15, I31, Q02, O12

Keywords: mental health, subjective well-being, early life, fetal origins, endowments, commodity prices

Reference: 698

Individual View

Authors: Francesco Zanetti, Konstantinos Theodoridis

Feb 2014

This paper uses a VAR model estimated with Bayesian methods to identify the effect of productivity news shocks on labor market variables by imposing that they are orthogonal to current technology but they explain future observed technology.  In the aftermath of a positive news shock, unemployment falls, whereas wages and the job finding rate increase.  The analysis establishes that news shocks are important in explaining the historical developments in labor market variables, whereas they play a minor role for movements in real activity.  We show that the empirical responses to news shocks are in line with those of a baseline search and matching model of the labor market and that the job destruction rate and real wage rigidities are critical for the variables' responses to the news shock.

JEL Codes: E32, C32. C52

Keywords: Anticipated productivity shocks, Bayesian SVAR methods, labor market search frictions

Reference: 699

Individual View

Authors: Jennifer AstonPaolo Di Martino

Feb 2014

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: 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: Number 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: 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

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

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