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711. Political Disagreement, Lack of Commitment and the Level of Debt

Author:
Davide Debortoli and Ricardo Nunes
Publication Date:
07-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We analyze how public debt evolves when successive policymakers have different policy goals and cannot make credible commitments about their future policies. We consider several cases to be able to disentangle and quantify the respective effects of imperfect commitment and political disagreement. Absent political turnover, imperfect commitment drives the long-run level of debt to zero. With political disagreement, debt is a sizeable fraction of GDP and increasing in the degree of polarization among parties, no matter the degree of commitment. The frequency of political turnover does not produce quantitatively relevant effects. These results are consistent with much of the existing empirical evidence. Finally, we find that in the presence of political disagreement the welfare gains of building commitment are lower.
Topic:
Economics, Markets, and Political Economy
Political Geography:
United States

712. Optimal Fiscal and Monetary Policy in Customer Markets

Author:
David M. Arseneau and Sanjay K. Chugh
Publication Date:
01-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
A growing body of evidence suggests that ongoing relationships between consumers and firms may be important for understanding price dynamics. We investigate whether the existence of such customer relationships has important consequences for the conduct of both long-run and short-run policy. Our central result is that when consumers and firms are engaged in long-term relationships, the optimal rate of price inflation volatility is very low even though all prices are completely flexible. This finding is in contrast to those obtained in first-generation Ramsey models of optimal fiscal and monetary policy, which are based on Walrasian markets. Echoing the basic intuition of models based on sticky prices, unanticipated inflation in our environment causes a type of relative price distortion across markets. Such distortions stem from fundamental trading frictions that give rise to long-lived customer relationships and makes pursuing inflation stability optimal.
Topic:
Economics and Markets
Political Geography:
United States

713. On the Application of Automatic Differentiation to the Likelihood Function for Dynamic General Equilibrium Models

Author:
Houtan Bastani and Luca Guerrieri
Publication Date:
02-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
A key application of automatic differentiation (AD) is to facilitate numerical optimization problems. Such problems are at the core of many estimation techniques, including maximum likelihood. As one of the first applications of AD in the field of economics, we used Tapenade to construct derivatives for the likelihood function of any linear or linearized general equilibrium model solved under the assumption of rational expectations. We view our main contribution as providing an important check on finite-difference (FD) numerical derivatives. We also construct Monte Carlo experiments to compare maximum-likelihood estimates obtained with and without the aid of automatic derivatives. We find that the convergence rate of our optimization algorithm can increase substantially when we use AD derivatives.
Topic:
Economics and Markets
Political Geography:
United States

714. Cross-border Bank Acquisitions: Is there a Performance Effect?

Author:
Ricardo Correa
Publication Date:
03-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper uses a unique database that includes deal and bank balance sheet information for 220 cross-border acquisitions between 1994 and 2003 to analyze the characteristics and performance effects of international takeovers on target banks. A discrete choice estimation shows that banks are more likely to get acquired in a cross-border deal if they are large, bad performers, in a small country, and when the banking sector is concentrated. Post-acquisition performance for target banks does not improve in the first two years relative to domestically-owned financial institutions. This result is explained by a decrease in the banks' net interest margin in developed countries and an increase in overhead costs in emerging economies.
Topic:
Economics, International Trade and Finance, and Markets

715. Do Differences in Financial Development Explain the Global Pattern of Current Account Imbalances?

Author:
Joseph W. Gruber and Steven B. Kamin
Publication Date:
03-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper addresses the popular view that differences in financial development explain the pattern of global current account imbalances. One strain of thinking explains the net flow of capital from developing to industrial economies on the basis of the industrial economies' more advanced financial systems and correspondingly more attractive assets. A related view addresses why the United States has attracted the lion's share of capital flows from developing to industrial economies; it stresses the exceptional depth, breadth, and safety of U.S. financial markets.
Topic:
Economics, International Trade and Finance, and Markets
Political Geography:
United States

716. A Solution to the Default Risk-Business Cycle Disconnect

Author:
Enrique G. Mandoza and Vivian Z. Yue
Publication Date:
03-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Models of business cycles in emerging economies explain the negative correlation between country spreads and output by modeling default risk as an exogenous interest rate on working capital. Models of strategic default explain the cyclical properties of sovereign spreads by assuming an exogenous output cost of default with special features, and they underestimate debt-output ratios by a wide margin. This paper proposes a solution to this default risk-business cycle disconnect based on a model of sovereign default with endogenous output dynamics. The model replicates observed V-shaped output dynamics around default episodes, countercyclical sovereign spreads, and high debt ratios, and it also matches the variability of consumption and the countercyclical fluctuations of net exports. Three features of the model are key for these results: (1) working capital loans pay for imported inputs; (2) imported inputs support more efficient factor allocations than when these inputs are produced internally; and (3) default on the foreign obligations of firms and the government occurs simultaneously.
Topic:
Economics, International Trade and Finance, and Markets

717. Predicting Cycles in Economic Activity

Author:
Jane Haltmaier
Publication Date:
04-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Predicting cycles in economic activity is one of the more challenging but important aspects of economic forecasting. This paper reports the results from estimation of binary probit models that predict the probability of an economy being in a recession using a variety of financial and real activity indicators. The models are estimated for eight countries, both individually and using a panel regression. Although the success of the models varies, they are all able to identify a significant number of recessionary periods correctly.
Topic:
Economics and Markets

718. Emerging Market Business Cycles Revisited: Learning about the Trend

Author:
Emine Boz, Christian Daude, and Ceyhun Bora Durdu
Publication Date:
04-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The data reveal that emerging markets do not differ from developed countries with regards to the variance of permanent TFP shocks relative to transitory. They do differ, however, in the degree of uncertainty agents face when formulating expectations. Based on these observations, we build an equilibrium business cycle model in which the agents cannot perfectly distinguish between the permanent and transitory components of TFP shocks. When formulating expectations, they assign some probability to TFP shocks being permanent even when they are purely transitory. This is sufficient for the model to produce "permanent-like" effects in response to transitory shocks. The imperfect information model calibrated to Mexico predicts a higher variability of consumption relative to output and a strongly negative correlation between the trade balance and output, without the predominance of trend shocks. The same model assuming perfect information and calibrated to Canada accounts for developed country business cycle regularities. The estimated relative variance of trend shocks in these two models is similar.
Topic:
Economics, Emerging Markets, and Markets
Political Geography:
Canada and Mexico

719. Competitive Search Equilibrium in a DSGE Model

Author:
David M. Arseneau and Sanjay K. Chugh
Publication Date:
04-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We show how to implement a competitive search equilibrium in a fully-specified DSGE environment. Competitive search, an equilibrium concept well-understood in labor market theory, offers an alternative to the commonly-used Nash bargaining in search-based macro models. Our simulation-based results show that business cycle fluctuations under competitive search equilibrium are virtually identical to those under Nash bargaining for a broad range of calibrations of Nash bargaining power. We also prove that business cycle fluctuations under competitive search equilibrium are exactly identical to those under Nash bargaining restricted to the popularly-used Hosios condition for search efficiency. This latter result extends the efficiency properties of competitive search equilibrium to a DSGE environment. Our results thus provide a foundation for researchers interested in studying business cycle fluctuations using search-based environments to claim that the sometimes-awkward assumption of bargaining per se does not obscure interpretation of results.
Topic:
Economics and Markets

720. Why Do U.S. Cross-Listings Matter?

Author:
Francis E. Warnock, John Ammer, Sara B. Holland, and David C. Smith
Publication Date:
05-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper investigates the underlying determinants of home bias using a comprehensive sample of U.S. investor holdings of foreign stocks. We document that U.S. cross-listings are economically important, as U.S. ownership in a foreign firm roughly doubles upon cross-listing in the United States. We explore the cross-sectional variation in this "cross-listing effect" and show that increases in U.S. investment are largest in firms from weak accounting backgrounds and in firms that are otherwise informationally opaque, indicating that U.S. investors value the improvements in disclosure associated with cross-listing. We confirm that relative equity valuations rise for cross-listed stocks, and provide evidence suggesting that valuation increases are due in part to increases in U.S. shareholder demand and in part to the fact that the equities become more attractive to non-U.S. shareholders.
Topic:
Economics, International Trade and Finance, and Markets
Political Geography:
United States