Working Papers

Authors: Martin Ellison, Andreas Tischbirek

Feb 2018

Abstract

A novel decomposition highlights the scope for information to in uence the term structure of interest rates. Based on the law of total covariance, we show that real term premia in macroeconomic models contain a component that depends on covariances of realised stochastic discount factors and a component that depends on covariances of expectations of those stochastic discount factors. The impact of different informational assumptions can then be identified by looking at their effect on the second, expectational, component. If agents have full information about technology in a simple macro-finance model then the conditional covariance of expectations is low, which contributes to the real term premia implied by the model being at least an order of magnitude too small, a result that is unchanged if some components of technology are unobservable or observed with noise. To generate realistic term premia, we draw on the beauty contest literature by differentiating between private and public information and introducing the possibility of strategic complementarities in the formation of expectations. A quantitative version of the model is found to explain a significant proportion of observed term premia when estimated using data on expectations of productivity growth from the Survey of Professional Forecasters.

JEL Codes: E40, E43, E70, G12

Keywords: Yield Curve, Term Premia, Information Friction, Beauty Contest, Asset Pricing

Reference: 846

Individual View

Authors: Judy Stephenson

Feb 2018

Abstract

This paper provides new information and data on how work and pay actually operated for skilled and semi-skilled men on large London construction projects in the early 1700s, and for the first time, offers detailed firm level evidence on the number of days per year worked by men. Construction workers’ working days were bounded by structural factors of both supply and demand, men worked a far lower number of days than has been assumed until now. This has implications for our understanding of the ‘industrious revolution’, and industrialisation.

JEL Codes: J3, J4, J6, N33, N63

Keywords: England; industrial revolution; industrious revolution; labour input; living standards; wages, building craftsmen

Reference: 162

Individual View

Authors: Ohad Raveh, Yacov Tsur

Feb 2018

We identify an adverse consequence of natural resource windfalls, which is partic-
ularly detrimental in advanced democracies. We construct a political economy model
with endogenous public debt under exogenous resource windfall shocks, in which po-
litical myopia results from reelection prospects. Reelection-seeking politicians, while
more accountable toward their electorate, are also more myopic. The latter e ect
gives rise to a budget de cit bias, with the ensuing debt buildup that is exacerbated
by resource windfalls. We nd that the positive e ect of resource windfalls on debt
increases as the restrictions on reelection get laxer. We test the model's predictions
using a panel of U.S. states over the period 1963-2007. Our identi cation strategy
rests on constitutionally-entrenched di erences in gubernatorial term limits that pro-
vide plausibly exogenous cross-sectional and time variation in political time horizon,
and geographically-based cross-state di erences in natural endowments interacted with
the international prices of oil and gas. The empirical ndings corroborate the model's
predictions. In particular, our baseline estimates indicate that a resource windfall of
$1 induces an increase of approximately g14:7 in the public debt of states with no
gubernatorial term limits.

JEL Codes: Q32, H63, H74

Keywords: Resource windfalls, public debt, political myopia reelection

Reference: 205

Individual View

Authors: Martin Ellison, Charles Brendon

Jan 2018

Abstract

This paper proposes and characterises a new normative solution concept for Kydland and Prescott problems, allowing for a commitment device. A policy choice is dominated if either (a) an alternative exists that is superior to it in a time-consistent subdomain of the constraint set, or (b) an alternative exists that Pareto-dominates it over time. Policies may be time-consistently undominated where time-consistent optimality is not possible. We derive necessary and sufficient conditions for this to be true, and show that these are equivalent to a straightforward but significant change to the first-order conditions that apply under Ramsey policy. Time-consistently undominated policies are an order of magnitude simpler than Ramsey choice, whilst retaining normative appeal. This is illustrated across a range of examples.

JEL Codes: D02, E61

Keywords: Time Consistency; Undominated Policy; Ramsey Policy

Reference: 844

Individual View

Authors: Rick Van der Ploeg, Ton S. Van den Bremer

Jan 2018

A popular model of economy and climate change has logarithmic preferences and damages proportional to the carbon stock in which case the certainty-equivalent carbon price is optimal. We allow for different aversions to risk and intertemporal fluctuations, convex damages, uncertainties in economic growth, atmospheric carbon, climate sensitivity and damages, correlated risks, and distributions that are skewed in the longer run to capture climate feedbacks. We derive a non-certainty-equivalent rule for the carbon price, which incorporates precautionary, risk-insurance and risk-exposure, and climate beta effects to deal with future economic and climatic risks. We interpret these effects with a calibrated DSGE model.

JEL Codes: H21, Q51, Q54

Keywords: precaution, insurance, economic, climatic and damage uncertainties, skewness, mean reversion, climate betas, risk aversion, prudence, intergenerational inequality aversion, convex damages, DSGE

Reference: 203

Individual View

Authors: Elizabeth Baldwin, Yongyang Cai, Karlygash Kuralbayeva

Jan 2018

We investigate how irreversibility in “dirty” and “clean” capital stocks affects optimal climate policy, from both theoretical and numerical perspectives. An increasing carbon tax will reduce investments in assets that pollute, and so reduce emissions in the short term: our “irreversibility effect”. As such the “Green Paradox” has a converse if we focus on demand side capital stock effects. We also show that the optimal subsidy increases with the deployment rate: our “acceleration effect”. Considering second-best settings, we show that, although carbon taxes achieve stringent targets more efficiently, in fact renewable subsidies deliver higher welfare when policy is more mild.

JEL Codes: O44, Q54, Q58

Keywords: Infrastructure, Clean and Dirty Energy Inputs, Renewable Energy, Stranded Assets, Carbon Budget, Climate Change Policies, Green Paradox

Reference: 204

Individual View

Authors: Alexander A. J. Wulfers

Jan 2018

Abstract

The Age of Mass Migration came to an end in the interwar period with new American immigration restrictions, but did this end affect some potential migrants more than others? I use previously unanalysed data from passenger lists of ships leaving Bremen, one of the major European ports of emigration, between 1920 and 1933, to identify occupations and skill levels of individual migrants. The main focus of the paper is on the role that policy played in influencing the selection of migrants. I study the American quota laws of 1921, 1924, and 1929, and find that increasingly strict quotas led to an increase in the skill level of migrants as well as a shift from agricultural to manufacturing workers first, and from manufacturing to professional workers later.

JEL Codes: J15, K37, N32, N34

Keywords: immigration policy, skill selection, quotas, United States, Bremen, interwar period

Reference: 161

Individual View

Authors: Kevin Hjortshøj O'Rourke, Alan de Bromhead, Alan Fernihough, Markus Lampe

Jan 2018

Abstract

A recent literature explores the nature and causes of the collapse in international trade during 2008 and 2009. The decline was particularly great for automobiles and industrial supplies; it occurred largely along the intensive margin; quantities fell by more than prices; and prices fell less for differentiated products. Do these stylised facts apply to trade collapses more generally? This paper uses detailed, commodity specific information on UK imports between 1929 and 1933, to see to what extent the trade collapses of the Great Depression and Great Recession resembled each other. It also compares the free trading trade collapse of 1929-31 with the protectionist collapse of 1931-3, to see to what extent protection, and gradual recovery from the Great Depression, mattered for UK trade patterns.

JEL Codes: F14, N74

Keywords: Great Depression; Great Recession; trade; protectionism

Reference: 160

Individual View

Authors: David Ronayne, Greg Taylor

Jan 2018

Abstract

We study strategic interactions in markets where firms sell to consumers both directly and via a competitive channel (CC), such as a price comparison website or marketplace, where multiple sellers’ offers are visible at once. We ask how a CC’s relative size influences market outcomes. A bigger CC means more consumers compare prices, increasing within-channel competition. However, such seemingly procompetitive developments can raise prices and reduce consumer surplus by weakening between-channel competition. We also use the model to study relevant active policy issues including price clauses, integrated ownership structures, and access to consumers’ purchase data.

Revised June 2018

JEL Codes: JEL D43, D83, L11, M3

Reference: 843

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Authors: Ian Crawford, Laura Blow

Jan 2018

Abstract

We investigate necessary and sufficient nonparametric conditions for mental accounting.

Reference: 842

Individual View

Authors: Ohad Raveh, Yacov Tsur

Dec 2017

JEL Codes: H63, C61, H74

Keywords: Economic growth, public debt, political myopia, term limits

Reference: 200

Individual View

Abstract

A new class of marked and weighted empirical processes of residuals is introduced. The framework is general enough to accommodate both stationary and non-stationary regressions as well as a wide class of estimation procedures with applications in misspecification testing and robust statistics. Two applications are presented.

First, we analyze the relationship between truncated moments and linear statistical functionals of residuals. In particular, we show that the asymptotic behaviour of these functionals, expressed as integrals with respect to their empirical distribution functions, can be easily analyzed given the main theorems of the paper. In our context the integrands can be unbounded provided that the underlying distribution meets certain moment conditions. A general first order asymptotic approximation of the statistical functionals is derived and then applied to some cases of interest.

Second, the consequences of using the standard cumulant based normality test for robust regressions are analyzed. We show that the rescaling of the moment based statistic is case dependent, i.e., it depends on the truncation and the estimation method being used. Hence, using the standard least squares normalizing constants in robust regressions will lead to incorrect inferences. However, if appropriate normalizations, which we derive, are used then the test statistic is asymptotically chi-square.

Reference: 841

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Authors: Jonas Harnau

Dec 2017

Abstract

Despite the widespread use of chain-ladder models, so far no theory was available to test for model specification. The popular over-dispersed Poisson model assumes that the over-dispersion is common across the data. A further assumption is that accident year effects do not vary across development years and vice versa. The log-normal chain-ladder model makes similar assumptions. We show that these assumptions can easily be tested and that similar tests can be used in both models. The tests can be implemented in a spreadsheet. We show the implementation in several empirical applications. While the results for the log-normal model are valid in finite samples, those for the over-dispersed Poisson model are asymptotic. We show in a simulation study that the finite sample performance is close to the asymptotic performance.

Keywords: Bartlett test; F-test; over-dispersed Poisson; log-normal

Individual View

Authors: Rick Van der Ploeg, Armon Rezai

Nov 2017

With the election of President Trump, climate deniers moved from the fringes to the centre of global policy making and need to be addressed in policy-making. An agnostic approach to policy, based on Pascal’s wager, gives a key role to subjective prior probability beliefs about whether climate deniers are right. Policy makers that assign a 10% chance of climate deniers being correct set the global price on carbon to $19.1 per ton of emitted CO2 in 2020. Given that a non-denialist scientist making use of the DICE integrated assessment model sets the price at $21.1/tCO2, agnostics’ reflection of remaining scientific uncertainty leaves climate policy essentially unchanged. The robustness of an ambitious climate policy also follows from using the max-min or the min-max regret principle. Letting the coefficient of relative ambiguity aversion vary from zero corresponding to expected utility analysis to infinity corresponding to the max-min principle, it is possible to show how policy makers deal with fundamental climate model uncertainty when they are prepared to assign prior probabilities to different views of the world being correct. Allowing for a wide range of sensitivity exercises including damage uncertainty, it turns out that pricing carbon is the robust response under rising climate scepticism.

JEL Codes: H21, Q51, Q54

Keywords: climate model uncertainty, climate scepticism, robust climate policies, max-min, min-max regret, ambiguity aversion, DICE integrated assessment model

Reference: 202

Individual View

A cap on global warming implies a tighter carbon budget which can be enforced with a credible second-best renewable energy subsidy designed to lock up fossil fuel and curb cumulative emissions. Such a subsidy brings forward the end of the fossil fuel era, but accelerates fossil fuel extraction and global warming in the short run. A weaker fossil fuel oligopoly implies that anticipation of a given global carbon budget induces fossil producers to deplete reserves more voraciously and accelerate global warming. This race to burn the last ton of carbon is more intensive for the feedback than open-loop Nash equilibrium, so that the Green Paradox effect of a renewable energy subsidy is stronger. There is an intermediate phase of limit pricing to keep renewable energy producers at bay, which becomes much more relevant when a cap on global warming is enforced. A stronger fossil fuel oligopoly lengthens the period of limit pricing and typically brings forward the carbon-free era. Finally, the mere risk of a cap on global warming being enforced at some unknown, future date makes fossil fuel extraction more voracious and accelerates global warming

JEL Codes: H21, Q51, Q54

Keywords: Second-best climate policy, Green Paradox, carbon budget, stranded assets, oligopolistic resource markets, limit pricing, voracious extraction, regime shift.

Reference: 201

Individual View

Authors: H Peyton Young, Mark Paddrik, Sriram Rajan

Nov 2017

Abstract

A major credit shock can induce large intra-day variation margin payments between counterparties in derivatives markets, which may force some participants to default on their payments. These payment shortfalls become amplified as they cascade through the network of exposures. Using detailed DTCC data we model the full network of exposures, the shock-induced payments, the initial margin collected, and liquidity buffers for about 900 firms operating in the U.S. credit default swaps market. We estimate the total amount of contagion, the marginal contribution of each firm to contagion, and the number of defaulting firms for credit shocks of different magnitudes. A novel feature of the model is that it allows for a range of possible responses to balance sheet stress, including delayed or partial payments. These `soft default' options distinguish our approach from conventional network models, which typically assume that full default is triggered whenever the default boundary is breached.

Revised January 2018

JEL Codes: D85, G23, L1

Keywords: Financial networks, contagion, stress testing, credit default swaps

Reference: 839

Individual View

Authors: Gerhard Toews, Pierre-Louis Vezina

Nov 2017

This paper examines the effect of giant oil and gas discoveries on foreign direct investment in developing economies. Across countries, we document a 58% increase in non-resource extraction FDI in the 2 years following a giant discovery, an event which is unpredictable due to the uncertainty of exploration. This effect is driven by a 30% increase in the number of projects and a 16% increase in targeted sectors. Mozambique's recent FDI boom provides a telling confirmation of this mechanism. Using project-level FDI data combined with multiple waves of household surveys and rm censuses we estimate that each FDI job results in 6.2 additional local jobs, linking the gas-driven FDI bonanza in Mozambique to widespread job creation.

JEL Codes: F21, F23, Q32, Q33

Keywords: Natural resources, investment, local multiplier

Reference: 199

Individual View

Authors: Masashige Hamano, Vessel N Vermeulen

Oct 2017

How is a firm's ability to export affected by changes in domestic trade costs? In particular we focus on the interation between firms and ports to answer how strongly exports from one ports are affected by changes in the cost of exporting at neighbouring ports?  To answer these questions we extend the standard trade model with heterogeneous firms to have a multiple port structure where exporting is subject to port specific local transportation costs and port specific fixed export costs as well as international bilateral trade costs.  We derive a gravity equation with multiple ports and show that gravity distortion due to firms heterogeneity is conditional on port comparitive advantage and resulting substitution of export across differentiated ports.  We present evident of the substitution effect using the 2011 Great East Japan Earthquake and following tsunami, which suggest that about 50% of the exports was substituted to other ports following the disaster.

JEL Codes: F14, O18, R1

Keywords: firm heterogeneity, entensive margins, transportation costs, fixed costs, natural disasters

Reference: 198

Individual View

Authors: Francesco Zanetti, Luca Gambetti, Dimitris Korobilis, John D. Tsoukalas

Sep 2017

Abstract

A VAR model estimated on U.S. data before and after 1980 documents systematic differences in the response of short- and long-term interest rates, corporate bond spreads and durable spending to news TFP shocks. Interest rates across the maturity spectrum broadly increase in the pre-1980s and broadly decline in the post-1980s. Corporate bond spreads decline signi ficantly, and durable spending rises signi ficantly in the post-1980 period while the opposite short-run response is observed in the pre-1980 period. Measuring expectations of future monetary policy rates conditional on a news shock suggests that the Federal Reserve has adopted a restrictive stance before the 1980s with the goal of retaining control over inflation while adopting a neutral/accommodative stance in the post-1980 period.

JEL Codes: E20, E32, E43, E52

Keywords: News shocks, Business cycles, VAR models, DSGE models

Reference: 838

Individual View

Authors: Inés Moreno de Barreda, Gilat Levy, Ronny Razin

Sep 2017

Abstract

We model the power of media owners to bias readers’ opinions. In particular we consider readers that have “correlation neglect”, i.e., fail to understand that content across news outlets might be correlated. We study how a media owner who controls several outlets can take advantage of the readers’ neglect. Specifically, we show that the owner can manipulate readers’ beliefs even when readers understand the informativeness of news outlet by outlet. The optimal strategy of the owner is to negatively correlate good news and positively correlate bad news. The owner’s power is increasing in the number of outlets she owns but is constrained by the limited attention of readers. Importantly, our analysis suggests several new insights about welfare in media markets. First, measures of media bias have to take into account the correlation between news outlets. Second, media-market competition curbs the ability of owners to bias readers’ beliefs. In particular, we show that readers always benefit from breaking conglomerates, even when all the new media owners share the same bias. Finally, we highlight a potential cost of media diversity. When readers have correlation neglect, diversity in the interests of owners might lower the informativeness of news content.

Reference: 836

Individual View

Authors: , Elisabetta De Cao

Sep 2017

Abstract

In this paper, we show that unemployment increases child neglect in the United States during the period from 2004 to 2012. A one percentage point increase in the unemployment rate leads to a 20 percent increase in neglect. We identify this effect by instrumenting for the county-level unemployment rate with a Bartik instrument, which we create as the weighted average of the national-level unemployment rates across each of twenty industries, where the weights are the county-level fraction of the employed working-age population in each industry at the start of the sample period. An important mechanism behind this effect is that parents lack social and private safety nets. The effect on neglect is smaller in states that introduce longer extensions to unemployment benefits, and is greater in counties where an initially larger fraction of children are not covered by health insurance. We find no evidence that the effect is driven by alcohol consumption or divorce.

JEL Codes: I10, J12, J13, J65, K42

Keywords: child abuse and neglect, unemployment rate, recession, safety net, unemployment insurance

Reference: 837

Individual View

Authors: Martin Browning, Ian Crawford, Laura Blow

Sep 2017

Abstract

This paper provides a revealed preference characterisation of quasi-hyperbolic discounting which is designed to be applied to readily-available expenditure surveys. We describe necessary and sufficient conditions for the leading forms of the model and also explore the consequences the restrictions on preferences popularly used in empirical lifecycle consumption models. Using data from a household consumption panel dataset we explore the prevalence of time-inconsistent behaviour. The sophisticated quasi-hyperbolic model provides a signi ficantly more successful account of behaviour than the alternatives considered. We estimate the joint distribution of time preferences and the distribution of discount functions at various time horizons.

JEL Codes: D11, D12, D90

Keywords: Quasi-hyperbolic discounting, revealed preference

Reference: 835

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Authors: Kevin Hjortshøj O'Rourke

Sep 2017

Preliminary version of a paper prepared for IMF-BNM-IMFER Conference on Globalization in the Aftermath of the Crisis and the IMF Economic Review. The research on which this paper is based was in part funded by the European Research Council under the European Union's Seventh Framework Programme (FP7/2007-2013) / ERC grant agreement no. 249546. The paper draws on many collaborations, and I am extremely grateful to my co-authors: Miguel Almunia, Agustin Bénétrix, Roberto Bonfatti, Alan de Bromhead, Barry Eichengreen, Alan Fernihough, Ronald Findlay, William Hynes, David Jacks, Markus Lampe, Gisela Rua, and Jeffrey Williamson. The usual disclaimer applies.

Reference: 159

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Authors: Ferdinand Rauch, Guy Michaels, Dzhamilya Nigmatulina, Tanner Regan, Neeraj Baruah, Amanda Dahlstrand-Rudin

Sep 2017

Abstract

What are the long run consequences of planning and providing basic infrastructure in neighborhoods, where people build their own homes? We study "Sites and Services" projects implemented in seven Tanzanian cities during the 1970s and 1980s, half of which provided infrastructure in previously unpopulated areas (de novo neighborhoods), while the other half upgraded squatter settlements. Using satellite images and surveys from the 2010s, we find that de novo neighborhoods developed better housing than adjacent residential areas (control areas) that were also initially unpopulated. Specifically, de novo neighborhood are more orderly and their buildings have larger footprint areas and are more likely to have multiple stories, as well as connections to electricity and water, basic sanitation and access to roads. And though de novo neighborhoods generally attracted better educated residents than control areas, the educational difference is too small to account for the large difference in residential quality that we find. While we have no natural counterfactual for the upgrading areas, descriptive evidence suggests that they are if anything worse than the control areas.

JEL Codes: R31, O18, R14

Keywords: Urban Economics, Economic Development, Slums, Africa.

Reference: 834

Individual View

Authors: Martin Ellison, Andrew Scott

Sep 2017

Abstract

We construct a new monthly dataset for UK government debt over the period 1694 to 2017 based on price and quantity data for each individual bond issued. This enables us to examine long run fiscal sustainability using the theoretically  relevant variable of the market value of debt, and investigate the historical importance of debt management. We find the general implications of the tax smoothing literature are replicated in our data, especially around financing wars, although we find major shifts over time in how fiscal sustainability is achieved. Before the 20th century, governments continued to pay bond holders a high rate of return and achieved sustainability through running fiscal surpluses but since then governments have relied on low growth adjusted real interest rates. The optimal debt management literature tends to favour the use of long bonds but we find the government would have been better off over the 20th century issuing short bonds. The contrast with the literature occurs because of an upward sloping yield curve and long bonds rarely providing fiscal insurance. This is particularly true during periods of financial crises when falling interest rates lead to sharp rises in the price of long bonds, making them an expensive form of finance. We examine the robustness of our conclusions to liquidity e¤ects, rollover risks, buyback operations and leverage. In general, these do suggest a greater role for long bonds but do not overturn an issuance strategy based mainly on short term bonds.

JEL Codes: E43, E62, H63

Keywords: Debt Management, Fiscal Deficits, Fiscal Policy, Government Debt, Inflation, Maturity, Yield Curve

Reference: 833

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