Working Papers

Authors: Kevin Hjortshøj O'Rourke

Jan 2017

 

Abstract

This paper surveys independent Ireland’s economic policies and performance. It has three main messages. First, the economic history of post-independence Ireland was not particularly unusual. Very often, things that were happening in Ireland were happening elsewhere as well. Second, for a long time we were hampered by an excessive dependence on a poorly performing UK economy. And third, EC membership in 1973, and the Single Market programme of the late 1980s and early 1990s, were absolutely crucial for us. Irish independence and EU membership have complemented each other, rather than being in conflict: each was required to give full effect to the other. Irish independence would not have worked as well for us as it did without the EU; and the EU would not have worked as well for us as it did without political independence.

JEL Codes: N14, N74

Keywords: Ireland, economic history, trade policies, growth, Brexit

Reference: 150

Individual View

Authors: Fedrico Torrachi

Jan 2017

I examine the impact of credit supply conditions on the labor market via a bank credit channel. Using a Bayesian likelihood approach with US data, I build and estimate a New-Keynesian dynamic stochastic general equilibrium model that incorporates a labor market with search frictions and a banking sector subject to moral hazard. Including a banking sector improves the empirical fit with the data. Financial frictions amplify the response of TFP shocks and add persistence to exogenous disturbances. Financial intermediaries’ net worth plays a crucial role in the transmission of aggregate shocks. The banking sector is also a crucial source of business cycle fluctuations. Shocks to the net worth of the banking sector drive the volatility of labor market tightness, the unemployment rate, and the vacancy stock.

JEL Codes: E24, E32, E37, E43, E44, J20

Keywords: Financial Intermediation, Banking Sector, Labor Market Frictions, DSGE, Bayesian Estimation

Reference: 817

Individual View

Authors: Avner Offer

Jan 2017

Social democracy and market liberalism offered different solutions to the same problem: how to provide for life-cycle dependency. Social democracy makes lateral transfers from producers to dependents by means of progressive taxation. Market liberalism uses financial markets to transfer financial entitlement over time. Social democracy came up against the limits of public expenditure in the 1970s. The ‘market turn’ from social democracy to market liberalism was enabled by easy credit in the 1980s. Much of this was absorbed into homeownership, which attracted majorities of households (and voters) in the developed world. Early movers did well, but easy credit eventually drove house prices beyond the reach of younger cohorts. Debt service diminished effective demand, which instigated financial instability. Both social democracy and market liberalism are in crisis.

JEL Codes: H55, E51, R21, R31

Keywords: Welfare state, housing, credit and debt

Reference: 149

Individual View

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

Individual View

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: 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: 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: 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

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, 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: 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: 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: 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

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: 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 Malcomson, Timothy Besley

Aug 2016

In spite of a range of policy initiatives in sectors such as education, health care

and legal services, whether choice and competition is valuable remains contested

territory. This paper studies the impact of choice and competition on different dimensions

of quality, examining the role of not-for-profit providers. We explore two

main factors which determine whether an alternative provider enters the market:

cost efficiency and the preferences of an incumbent not-for-profit provider (paternalism).

The framework developed can incorporate standard concerns about

the downside of choice and competition when consumer choice is defective (an

internality) or choice imposes costs on those who do not switch (an externality).

The paper considers optimal funding levels for incumbents and entrants showing

when the “voucher” provided for consumers to move to the incumbent should be

more or less generous than the funding for consumers who remain with the incumbent.

Finally, the model also offers an insight into why initiatives are frequently

opposed by incumbent providers even if the latter have not-for-profit objectives.

Keywords: Choice, Competition, Public Service, Not-for-profit

Reference: Number 801

Individual View

Authors: Ferdinand Rauch, Jan David Bakker, Christopher Parsons

Jul 2016

Under apartheid, black South Africans were severely restricted in their choice of location and many were forced to live in homelands. Following the abolition of apartheid they were free to migrate. Given gravity, a town nearer to the homelands can be expected to receive a larger inflow of people than a more distant town following the removal of mobility restrictions. Exploting this exogenous variation, we study the effect of migration on urbanisation and the distribution of population. In particular, we test if migration inflows led to displacement, path dependence, or agglomeration in destination areas. We find evidence for path dependence in the aggregate, but substantial heterogeneity across town densities. An exogenous population shock leads to an increase of the urban relative to the rural population, which suggests that exogenous migration shocks can foster urbanisation in the medium run.

JEL Codes: R12, R23, N97, O18

Keywords: Economic geography, migration, urbanisation, natural experiment

Reference: 800

Individual View

Authors: Sudhir Anand, Paul Segal

Jul 2016

The rise of the ‘emerging economies’ is leading to historically-unprecedented shifts in the global economy. While its implications for global poverty and the rise of a global ‘middle class’ have been documented, we present the first in-depth analysis of the changing composition of the global rich and the rising representation of developing countries at the top of the global distribution. We do so by constructing global distributions of income between 1988 and 2012 based on both household surveys and the new top incomes data derived from tax records, in order to capture the rich who are typically excluded from household surveys. We find that the representation of developing countries in the global top 1% declined until about 2002, but since 2005 it has risen significantly. This coincides with a salient decline in global inequality since 2005, according to a range of measures. We compare our estimates of the country-composition and income levels of the global rich with a number of other sources – including Credit Suisse’s estimates of global wealth, the Forbes World Billionaires List, attendees of the World Economic Forum, and estimates of top executives’ salaries. To varying degrees, all show a rise in the representation of the developing world in the ranks of the global élite. 

JEL Codes: D31, D63, O57

Keywords: top incomes, global top 1 percent, global inequality, extreme wealth

Reference: 799

Authors: Pawel Dziewulski

Jul 2016

Abstract

The evidence from psychophysics suggest that people are unable to discriminate between alternatives unless the options are significantly different. Since this assumption implies non-transitive indifferences, it can not be reconciled with utility maximisation. We provide a method of eliciting consumer preference from observable choices when the agent is incapable of discerning between similar bundles. It is well-known that the issue of noticeable differences can be modelled with semiorder maximisation. We introduce a necessary and sufficient condition under which a finite dataset of consumption bundles and corresponding budget sets can be rationalised with such a relation. The result can be thought of as an extension of Afriat's (1967) theorem to semiorders, rather than utility optimisation. Our approach is constructive and allows us to infer the just-noticeable difference that is sufficient for the agent to differentiate between bundles as well as the "true" preferences of the consumer (i.e., as if perfect discrimination were possible). Furthermore, we argue that the former constitutes a natural measure of how well the preference revealed in the data could be approximated by a weak order. We conclude by applying our test to household-level scanner panel data of food expenditures.

Revised June 2017.

 

JEL Codes: C14, C60, C61, D11, D12

Keywords: Revealed preference, testable restrictions, semiorder, just-noticeable difference, GARP, Afriat's efficiency index, money-pump index

Reference: 798

Individual View

Authors: Dominik Karos

Jul 2016

The members of a society are faced with the decision whether or not to participate in an anti-government protest. Their utilities depend on their own decision but also on those of their neighbors in an underlying social network. They randomly observe other people's decisions, gather information on who is already active, and base their decision on their information. The model uses a Markov process (that depends on the underlying social network) to analyze who will become active over time. Two new features are essential: first, only very mild assumptions about the underlying social network are made, in particular agents can be entirely heterogeneous. Second, individuals are allowed to coordinate their decision if they mutually observe each other. The government can use political violence in order to change people's utility from being active. The probability of a revolution can thereby be reduced in the short run, but not in the long run. Under political repression protests do not increase gradually, but suddenly; and the conditional probability of a quick revolution given a protest increases if the regime turns violently against the protesters. Since large jumps in the number of activists depend on their capability to coordinate, the repression of political activism is more effective in countries where social media are not easily accessible. The findings are illustrated by data on the number of protests and revolutions world-wide depending on a country's number on the Political Terror Scale.

JEL Codes: C72, D85, O33

Keywords: Social Networks, Coordination, Strong Nash Equilibrium, Innovation Diffusion, Unanticipated Revolutions, Political Repression

Reference: 797

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