Working Papers

Global warming can be curbed by pricing carbon emissions and thus substituting fossil fuel with renewable energy consumption. Breakthrough technologies (e.g., fusion energy) can reduce the cost of such policies. However, the chance of such a technology coming to market depends on investment. We model breakthroughs as an irreversible tipping point in a multi-country world, with different degrees of international cooperation. We show that international spill-over effects of R&D in carbon-free technologies lead to double free-riding, strategic over-pollution and underinvestment in green R&D, thus making climate change mitigation more difficult. We also show how the demand structure determines whether carbon pricing and R&D policies are substitutes or complements.

JEL Codes: D2, D90, H23, Q35, Q38, Q54, Q58

Keywords: global warming, carbon pricing, renewable R&D, tipping point, international cooperation, non-cooperative policies, feedback Nash equilibrium

Reference: 190

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Authors: Pablo Astorga Junquera

Mar 2017

Abstract

This paper discusses and documents a new dataset of real wages for unskilled, semi-skilled, and relatively skilled labour in Argentina, Brazil, Chile, Colombia, Mexico, and Venezuela (LA-6) over the period 1900-2011. Three interrelated aspects are examined: the wage growth record associated with periods dominated by a particular development strategy; wage convergence across the LA-6; and changes in wage skill premiums and their links with fundamentals. The key findings are: i) the region’s unskilled wage rose by 147% in the period compared to rises of 243% in the average wage and 440% in income per worker (including both property and labour income); ii) there is a limited process of wage convergence across the LA-6; and weak persistence in the country hierarchy; iii) skill premiums tended to peak during the middle decades of the 20th century, coinciding with the acceleration of industrialisation and the timing of the demographic transition. Movements in the terms of trade are broadly associated with both fluctuations and trends in wage premiums, though the direction of the link is country and time specific.

JEL Codes: J31, O1, N36

Keywords: wage levels and differentials, economic development, Latin America

Reference: 153

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Authors: Nemera Mamo, Sambit Bhattacharyya, Alexander
Moradi, Rabah Arezki

Mar 2017

What are the economic consequences of mining in Sub-Saharan Africa? Using a panel of 3,635 districts from 42 Sub-Saharan African countries for the period 1992 to 2012 we investigate the effects of mining on living standards measured by night-lights. Night-lights increase in mining districts when mineral production expands (intensive margin), but large effects approximately equivalent to 16% increase in GDP are mainly associated with new discoveries and new production (extensive margin). We identify the effect by carefully choosing feasible but not yet mined districts as a control group. In addition, we exploit giant and major mineral discoveries as exogenous news shocks. In spite of the large within district effects, there is little evidence of significant spillovers to other districts reinforcing the enclave nature of mines in Africa. Furthermore, the local effects disappear after mining activities come to an end which is consistent with the ’resource curse’ view.

JEL Codes: O11, O13, Q32

Keywords: Mineral discovery, Mineral production, Night-time lights

Reference: 189

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Authors: Thorsten Beck, Steven Poelhekke

Mar 2017

The need to absorb windfalls gains and manage them appropriately has been discussed extensively by academics and policy makers alike. We explore the role of the financial sector in intermediating these windfalls. Controlling for the level of financial development, inflation, GDP growth and country fixed-effects, we find a relative decline in financial sector deposits in countries that experience an unexpected natural resource windfall as measured by shocks to exogenous world prices. Moreover, we find a similar relative decline in lending, which is mostly due to the decrease in deposits. The smaller role for the financial sector in intermediating resource booms is accompanied by a stronger role of governments in channeling resources into the economy, mostly through higher government consumption.

JEL Codes: E20, F41,G20, O10, Q32, Q33

Keywords: natural resources, financial development, banking

Reference: 188

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Authors: Francesco Zanetti, Masashige Hamano

Feb 2017

 

Abstract

How do product variety and quality affect the aggregate price bias? We develop a general equilibrium model that accounts for the joint interaction of product quality and variety. Our findings show that the aggregate price bias is pro-cyclical and the contribution of product variety is persistent whereas the contribution of product quality becomes counter-cyclical in the medium to long run. We show that accounting for product quality and variety has critical implications on the measure of cyclical fluctuations. Measurements of cyclical fluctuations derived using the consumption deflator, which abstracts from changes in product quality and variety, underestimate the variables' true volatility.

JEL Codes: D24, E23, E32, L11, L60

Keywords: Firm's entry and exit, product quality, product variety

Reference: 823

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

Feb 2017

Abstract

International trade became much less multilateral during the 1930s. Previous studies, looking at aggregate trade flows, have argued that discriminatory trade policies had comparatively little to do with this. Using highly disaggregated information on the UK’s imports and trade policies, we find that policy can explain the majority of Britain’s shift towards Imperial imports in the 1930s. Trade policy mattered, a lot.

JEL Codes: F13, F14, N74

Keywords: trade policy, interwar period

Reference: 152

Individual View

Temperature responses and optimal climate policies depend crucially on the choice of a particular climate model. To illustrate, the temperature responses to given emission reduction paths implied by the climate modules of the well-known integrated assessments models DICE, FUND and PAGE are described and compared. A dummy temperature module based on President Trump’s climate sceptic view is added. Using a simple growth model of the global economy, the sensitivity of the optimal carbon price, renewable energy subsidy and energy transition to each of these climate models is discussed. The paper then derives max-min, max-max and min-max regret policies to deal with this particular form of climate uncertainty and with climate scepticism. The max-min or min-max regret climate policies rely on a non-sceptic view of global warming and lead to a substantial and moderate amount of caution, respectively. The max-max leads to no climate policies in line with the view of climate sceptics.

JEL Codes: H21, Q51, Q54

Keywords: carbon price, renewable energy subsidy, temperature models, climate model uncertainty, climate sceptics, max-min, max-max, min-max regret

Reference: 187

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The current debate about the optimal management of foreign exchange windfalls is highly relevant to low income countries such as Uganda, having recently discovered vast hydrocarbon reserves. Using a Computable General Equilibrium (CGE) model for Uganda this paper analyses three broad policy options for the use of oil revenues, increasing i) private consumption, ii) private investment, and iii) public infrastructure investment. The model allows for learning-by-doing in tradables, increasing returns to public infrastructure and the use of an Oil Fund held abroad. The fund allows government to smooth expenditure programs over the medium-term. When public infrastructure is biased towards tradables, a smooth expenditure profile yields higher economic growth than high expenditure skewed to the present. The government’s discount rate plays a key role in determining the optimal use and management of oil revenues. More impatient governments will be inclined to increase current expenditure at the cost of future generations’ welfare and negative distributional implications for poor households. Lower discount rates align the political incentives with respect to inter-temporal welfare and the long-run growth path of the economy.

JEL Codes: E62, O11, O13, O23, Q32

Keywords: Fiscal Policy, natural resources, economic development, Dutch-disease, CGE model, Uganda

Reference: 186

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Authors: Michalis Rousakis, Romanos Priftis

Jan 2017

Abstract

This paper presents an analytical narration of the later stages of the Greek crisis, focusing on two key events that unfolded during 2014-2015 and set Greece apart from other episodes of sovereign debt crises: the risk of Grexit and the imposition of capital controls on the banking sector. To account for them both, we extend the standard small open economy environment along three dimensions. First, we allow for an informal sector. Second, we allow for a richer menu of assets that include cash, which is needed for informal consumption and is costly to hold. Third, we introduce a banking sector that turns households' deposits into capital. We show that a risk of Grexit leads households to run down their deposits to the detriment of bank balance sheets, increase their demand for cash, and increase their consumption whilst reallocating it towards formal goods. As evidenced by the data capital controls mitigate the deposit ight and reinforce the switch of consumption to formality.

JEL Codes: E2, E4, F41, G11, G28

Keywords: Capital controls, small open economy, exit from a currency union, cash, informal economy, financial intermediaries, Greece

Reference: 822

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Authors: Gregori Galofré-Vilà, Andrew Hinde, Aravinda Guntupalli

Jan 2017

Abstract

This paper uses a dataset of heights calculated from the femurs of skeletal remains to explore the development of stature in England across the last two millennia. We find that heights increased during the Roman period and then steadily fell during the ‘Dark Ages’ in the early medieval period. At the turn of the first millennium heights grew rapidly, but after 1200 they started to decline coinciding with the agricultural depression, the Great Famine and the Black Death. Then they recovered to reach a plateau which they maintained for almost 300 years, before falling on the eve of industrialisation. The data show that average heights in England in the early nineteenth century were shorter than those in Roman times, and that average heights reported between 1400 and 1700 were similar to those of the twentieth century. The paper also discusses the ssociation of heights across time with some potential determinants and correlates (real wages, inequality, food supply, climate change and expectation of life), showing that in the long run heights change with these variables, and that in certain periods, notably the thirteenth and fourteenth centuries, the associations are observable over the shorter run as well. We also examine potential biases surrounding the use of skeletal remains.

Keywords: Health, Height, England, Skeletal remains

Reference: 151

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Authors: Orazio Attanasio, Krisztina Molnar

Jan 2017

Abstract

In this paper, we make three substantive contributions: first, we use elicited subjective income expectations to identify the levels of permanent and transitory income shocks in a life-cycle framework; second, we use these shocks to assess whether households' consumption is insulated from them; third, we use the shock data to estimate an Euler equation for consumption. We find that households are able to smooth transitory shocks, but adjust their consumption in response to permanent shocks, albeit not fully. The estimates of the Euler equation parameters with and without expectational errors are similar, which is consistent with rational expectations. We break new ground by combining data on subjective expectations about future income from the Michigan Survey with micro data on actual income from the Consumer Expenditure Survey.

JEL Codes: C13; D12; D84; D91; E21

Keywords: life cycle models, estimating Euler Equations, survey expectations

Reference: 820

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Authors: H Peyton Young, Mark Paddrik, Sriram Rajan

Jan 2017

Abstract

This paper analyzes counterparty exposures in the credit default swaps market and examines the impact of severe credit shocks on the demand for variation margin, which are the payments that counterparties make to offset price changes. We employ the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) shocks and estimate their impact on the value of CDS contracts and the variation margin owed. Large and sudden demands for variation margin may exceed a firm's ability to pay, leading some firms to delay or forego payments. These shortfalls can become amplified through the network of exposures. Of particular importance in cleared markets is the potential impact on the central counterparty clearing house. Although a central node according to conventional measures of network centrality, the CCP contributes less to contagion than do several peripheral firms that are large net sellers of CDS protection. During a credit shock these firms can suffer large shortfalls that lead to further shortfalls for their counterparties, amplifying the initial shock.

JEL Codes: D85, G01, G17, L14

Keywords: Credit default swaps, stress testing, systemic risk, financial networks

Reference: 821

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Authors: James Duffy, David Hendry

Jan 2017

 

Abstract

Data spanning long time periods, such as that over 1860–2012 for the UK, seem likely to have substantial errors of measurement that may even be integrated of order one, but which are probably cointegrated for cognate variables. We analyze and simulate the impacts of such measurement errors on parameter estimates and tests in a bivariate cointegrated system with trends and location shifts which reflect the many major turbulent events that have occurred historically. When trends or shifts therein are large, cointegration analysis is not much affected by such measurement errors, leading to conventional stationary attenuation biases dependent on the measurement-error variance, unlike the outcome when there are no offsetting shifts or trends.

JEL Codes: C51, C22

Keywords: Integrated Measurement Errors; Location Shifts; Long-run Data; Cointegration

Reference: 818

Individual View

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

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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

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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

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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

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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

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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

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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

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