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152. The Inflation Persistence of Staggered Contracts
- Author:
- Luca Guerrieri
- Publication Date:
- 08-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- One of the criticisms routinely advanced against models of the business cycle with staggered contracts is their inability to generate inflation persistence. This paper finds that staggered contracts µa la Taylor are, in fact, capable of reproducing the inflation persistence implied by U.S. data. Following Fuhrer and Moore, I capture the moments that the contract specification needs to replicate by using the correlograms from a small vector autoregression (VAR) that includes inflation among the endogenous variables. A simple structural model substitutes the inflation equation from the VAR with the contract specification. I estimate the contract parameters in the structural model by maximum likelihood. The correlogram for the endogenous variables from the estimated structural model, including that for inflation, are very close to the correlograms from the VAR (and are contained within their 90% confidence intervals). By the same metric, where Taylor contracts do not fare well is in reproducing the cross-correlations between inflation and output.
- Topic:
- International Relations, Economics, and International Trade and Finance
- Political Geography:
- United States
153. Productivity Shocks, Habits, and the Current Account
- Author:
- Joseph W. Gruber
- Publication Date:
- 08-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- Empirical work regarding Intertemporal Current Account (ICA) models has centered around two distinct testing methodologies, present value tests and a productivity shock approach as formulated by Glick and Rogoff (1995). In previous work, Gruber (2001), I have tested and ICA model that allows for habits in aggregate consumption via the present value method. This paper applies the alternative Glick and Rogoff style approach to testing the model. The benefits of doing such are an ability to separate country-specific from worldwide output changes, a distinction of considerable importance, as well as to impose restrictions on the relationship between investment and output, neither of which are possible in the present value framework. The results of the test are supportive of the existence of habits and coincide with the results of Gruber (2001). The degree of habit persistence implied by the model is estimated for the G-7 countries. The paper also proposes habit formation as a possible solution to an empirical puzzle identified in the original Glick and Rogoff paper.
- Topic:
- International Relations, Economics, and International Trade and Finance
- Political Geography:
- United States
154. Testing the Null of Identification in GMM
- Author:
- Jonathan H. Wright
- Publication Date:
- 07-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- This paper proposes a new test of the null hypothesis that a generalized method of moments model is identified. The test can detect local or global underidentification, and underidentification in some or all directions. The idea of the test is to compare the volume of two confidence sets -- one that is robust to lack of identification and one that is not. Under the null hypothesis the relative volume of these two sets is Op(1), but under the alternative, the robust confidence set has high probability of being unbounded.
- Topic:
- Economics and International Trade and Finance
- Political Geography:
- United States
155. Factor Endowments and Industrial Structurev
- Author:
- Trevor A. Reeve
- Publication Date:
- 07-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- What determines industrial structure? Do sector-specific characteristics such as unionization, regulation, and trade policy dominate production patterns? One is inclined to believe so based on countless industry-level studies and the many political battles that are continually fought over trade and industrial policy. In contrast, standard neoclassical trade theory suggests that industrial structure is primarily driven by relative factor supplies. This paper demonstrates that aggregate factor endowments explain much of the structure of production—independent of industry idiosyncrasies—and quantifies the extent to which shifts in industrial structure in a cross section of countries are driven by the broad forces of factor accumulation. This result has important implications for policy. In particular, investment in physical capital and education may have as great an impact on the pattern of production as sector-specific trade and industrial policies. Thus, general equilibrium effects should not be ignored in efforts either to understand industrial structure or to form policies that attempt to alter it. These conclusions are reached through an empirical application of the factor proportions model of production.
- Topic:
- Economics, Industrial Policy, and International Trade and Finance
- Political Geography:
- United States
156. Recent U.S. Macroeconomic Stability: Good Policies, Good Practices, or Good Luck?
- Author:
- Beth Anne Wilson, Shaghil Ahmed, and Andrew Levin
- Publication Date:
- 07-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- The volatility of U.S. real GDP growth since 1984 has been markedly lower than that over the previous quarter-century. In this paper, we utilize frequency-domain and VAR methods to distinguish among several competing explanations for this phenomenon: improvements in monetary policy, better business practices, and a fortuitous reduction in exogenous disturbances. We find that reduced innovation variances account for much of the decline in aggregate output volatility. Our results support the “good-luck” hypothesis as the leading explanation for the decline in aggregate output volatility, although “good-practices” and “good-policy” are also contributing factors. Applying the same methods to consumer price inflation, we find that the post-1984 decline in inflation volatility can be attributed largely to improvements in monetary policy.
- Topic:
- Economics, Industrial Policy, and International Trade and Finance
- Political Geography:
- United States
157. Optimal Monetary Policy with Durable and Non-Durable Goods
- Author:
- Christopher J. Erceg and Andrew T. Levin
- Publication Date:
- 07-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- The durable goods sector is much more interest sensitive than the non-durables sector, and these sectoral differences have important implications for monetary policy. In this paper, we perform VAR analysis of quarterly US data and find that a monetary policy innovation has a peak impact on durable expenditures that is roughly five times as large as its impact on non-durable expenditures. We then proceed to formulate and calibrate a two-sector dynamic general equilibrium model that roughly matches the impluse response functions of the data. While the social welfare function involves sector-specific output gaps and inflation rates, we find that performance of the optimal policy rule can be closely approximated by a very simple rule that targets a weighted average of aggregate wage and price inflation rates. In contrast, some commonly-prescribed policy rules (such as strict price inflation targeting and Taylor's rule) perform very poorly in terms of social welfare.
- Topic:
- Economics, Human Welfare, and International Trade and Finance
- Political Geography:
- United States
158. A Theory of the Currency Denomination of International Trade
- Author:
- Philippe Bacchetta and Eric van Wincoop
- Publication Date:
- 07-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- Nominal rigidities due to menu costs have become a standard element in closed economy macroeconomic modeling. The "New Open Economy Macroeconomics" literature has investigated the implications of nominal rigidities in an open economy context and found that the currency in which prices are set has significant macroeconomic and policy implications. In this paper we solve for the optimal invoicing choice by integrating this microeconomic decision at the firm level into a general equilibrium open economy model. Strategic interactions between firms play a critical role in the analysis. We find that the less competition firms face in foreign markets, as reflected in market share and product differentiation, the more likely they will price in their own currency. We also show that when a set of countries forms a monetary union, the new currency is likely to be used more extensively in trade than the sum of the currencies it replaces.
- Topic:
- Economics, Emerging Markets, and International Trade and Finance
- Political Geography:
- United States
159. Regional Inflation in a Currency Union: Fiscal Policy vs. Fundamentals
- Author:
- Margarida Duarte and Alexandar L. Wolman
- Publication Date:
- 07-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- We develop a general equilibrium model of a two-region currency union. There are two types of goods: non-trade goods, and traded goods for which markets are segmented. Monetary policy is set by a central monetary authority and is non-neutral due to nominal price rigidities. Fiscal policy is determined at the regional level by each region's government. We find that productivity shocks alone generate significant variation in inflation across the two countries. Government spending shocks, in contrast, do not account for a significant portion of inflation variation. Varying relative country size, we find that smaller countries experience higher variability of their inflation differential in response to shocks to productivity growth. Moreover, we show that regional governments can suppress incipient inflation differentials associated with shocks to productivity growth by letting the income tax rate respond negatively to inflation differentials.
- Topic:
- Development, Economics, and International Trade and Finance
- Political Geography:
- United States
160. Inflation Dynamics and International Linkages: A Model of the United States, the Euro Area, and Japan
- Author:
- Gunter Coenen and Volker Wieland
- Publication Date:
- 07-2002
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- In this paper we estimate a small macroeconometric model of the United States, the euro area and Japan with rational expectations and nominal rigidities due to staggered contracts. Comparing three popular contracting specifications we find that euro area and Japanese inflation dynamics are best explained by Taylor-style contracts, while Buiter-Jewitt/Fuhrer- Moore contracts perform somewhat better in fitting U.S. inflation dynamics. We are unable to fit Calvo-style contracts to inflation dynamics in any of the three economies without allowing either for ad-hoc persistence in unobservables or a significant backward-looking element. The completed model matches inflation and output dynamics in the United States, the euro area and Japan quite well. We then use it to evaluate the role of the exchange rate for monetary policy. Preliminary results, which are similar across the three economies, indicate little gain from a direct policy response to the exchange rate.
- Topic:
- Economics and International Trade and Finance
- Political Geography:
- United States, Japan, and Israel