This paper shows that standard international business cycle models can be reconciled with the empirical evidence on the lack of consumption risk sharing. First, we show analytically that with incomplete asset markets productivity disturbances can have large uninsurable effects on wealth, depending on the value of the trade elasticity and shock persistence. Second, we investigate these findings quantitatively in a model calibrated to the U.S. economy. With the low trade elasticity estimated via a method of moments procedure, the consumption risk of productivity shocks is magnified by high terms of trade and real exchange rate (RER) volatility. Strong wealth effects in response to shocks raise the demand for domestic goods above supply, crowding out external demand and appreciating the terms of trade and the RER. Building upon the literature on incomplete markets, we then show that similar results are obtained when productivity shocks are nearly permanent, provided the trade elasticity is set equal to the high values consistent with micro-estimates. Under both approaches the model accounts for the low and negative correlation between the RER and relative (domestic to foreign) consumption in the data—the “Backus–Smith puzzle”.

/pdf/international-risk-sharing-and-the-transmission-of-2x6pk9zf7w.pdf

International Risk Sharing and the Transmission of Productivity Shocks

This paper investigates the average impact of government debt on per-capita GDP growth in twelve euro area countries over a period of about 40 years starting in 1970. It finds a non-linear impact of debt on growth with a turning point — beyond which the government debt-to-GDP ratio has a deleterious impact on long-term growth — at about 90-100% of GDP. Confidence intervals for the debt turning point suggest that the negative growth effect of high debt may start already from levels of around 70-80% of GDP, which calls for even more prudent indebtedness policies. At the same time, there is evidence that the annual change of the public debt ratio and the budget deficit-to-GDP ratio are negatively and linearly associated with per-capita GDP growth. The channels through which government debt (level or change) is found to have an impact on the economic growth rate are: (i) private saving; (ii) public investment; (iii) total factor productivity (TFP) and (iv) sovereign long-term nominal and real interest rates. From a policy perspective, the results provide additional arguments for debt reduction to support longer-term economic growth prospects.

https://www.econstor.eu/bitstream/10419/153671/1/ecbwp1237.pdf

The impact of high and growing government debt on economic growth: an empirical investigation for the euro area

The authors evaluate the Friedman-Schwartz hypothesis--that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, they first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and towards currency. The slowness of the recovery from the Depression was due to a shock that increased the market power of workers. The authors identify a monetary base rule that responds only to the money demand shocks in the model.

The Great Depression and the Friedman-Schwartz hypothesis

In order to explain the joint fluctuations of output, inflation and the labor market, this paper first develops a general equilibrium model that integrates a theory of equilibrium unemployment into a monetary model with nominal price rigidities. Then, it estimates a set of structural parameters characterizing the dynamics of the labor market. The estimated model can explain the cyclical behavior of employment, hours per worker, job creation and job destruction conditional on a shock to monetary policy. Moreover, allowing for variation of the labor input at the extensive margin leads to a significantly lower elasticity of marginal costs with respect to output. This helps to explain the sluggishness of inflation and the persistence of output after a monetary policy shock. The ability of the model to account for the joint dynamics of output and inflation relies on its ability to explain the dynamics of the labor market.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID515066_code356495.pdf?abstractid=515066&mirid=1

Equilibrium Unemployment, Job Flows and Inflation Dynamics

This study has been developed in the context of the "Eurosystem Inflation Persistence Network". We thank participants in this network, the Workshop "Microeconomic Pricing and the Macroeconomy" organised at the Central European University in Budapest and an internal seminar at the NBB, in particular Jordi Gali, Andy Levin, Attila Ratfai, Christoph Weiss and Alan Kackmeister for very useful comments on earlier drafts of this paper. We thank Jerzy Konieczny, Raf Wouters and David Cornille for very insightful and stimulating discussions and Jacques Dreze for his valuable comments. We are also grateful to an anonymous referee. Finally, we thank the Federal Public Service "Economy, SMEs, Selfemployed and Energy" (former Ministry of Economic Affairs) for providing us with the very rich database underlying the Belgian CPI and for carefully explaining us how the data are collected and stored, in particular Gerard Lalau, Paul Vanosselaer and Patrick Vranken. The views expressed in this paper are those of the authors and do not necessarily reflect the views of the National Bank of Belgium. All remaining errors are the authors'.

/pdf/how-frequently-do-prices-change-evidence-based-on-the-micro-188tjcvtq9.pdf

How frequently do prices change? evidence based on the micro data underlying the belgian cpi

In Lisbon the European Council proclaimed a European growth strategy. It considers an average economic "growth rate of around 3 percent as a realistic prospect for the coming years" and assigns public finances an important role in the process of achieving this goal. This paper addresses the question whether we can find empirical evidence for European countries that public finance reform affects trend growth. Focusing on time series patterns, we investigate whether there have been persistent shifts or trends in economic growth and fiscal variables over the last 40 years. In addition, we estimate a distributed lag model, which 1) indicates that government consumption and transfers negatively affect growth rates of GDP per capita over the business cycle, while public investment has a positive impact, and 2) provides robust evidence that distortionary taxation affects growth in the medium-term through its impact on the accumulation of private physical capital.

Public Finances and Long-Term Growth in Europe - Evidence from a Panel Data Analysis

This paper analyses the link between finance and growth by studying the effect that the process of financial deregulation and harmonisation of banking laws at the EU level has brought about on growth over the last 40 years. Our main findings point to the existence of a positive long-run growth impact from the liberalisation of capital controls and the harmonisation of banking legislation. Both policy changes affect growth even after controlling for other pro-growth policies implemented around the same time and they are robust to business cycle effects that could spuriously drive the relation. The analysis of the main channels through which our policy changes may have affected growth indicates that the harmonisation process has impacted growth through the increase in the level and efficiency of financial intermediation and the liberalisation of capital controls has mainly affected growth through improvements in the degree of efficiency in financial intermediation.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID457534_code356495.pdf?abstractid=457534&mirid=2

Finance and Growth in the EU: New Evidence from the Liberalisation and Harmonisation of the Banking Industry

The methodological issues and econometric problems in the empirical assessment of the determinants of growth are systematically reviewed in the first part of the paper by Hiebert, Lamo, de Avila and Vidal. In the second part, the authors assess empirically the long-run effects of fiscal policy on growth in the EU countries. As in the previous paper, the authors rely on panel data. They make use of a generalized method of moments estimator to control for the endogeneity of explanatory variables and correlated individual effects. In order to control for the cycle, trend growth is used as dependent variable in the estimation, innovating with respect to the standard practice of taking 5-years averages. The results tend to support the hypothesis that a negative relationship between the level of government revenue and trend growth exists for EU countries. Moreover, they show that improvements in the budget balance tend to enhance long-term growth. Finally, the results suggest that changes in government expenditure, controlling for their financing, have a limited impact on the trend growth rate.

Diego Romero de Avila Torrijos

Papers

Public Finances and Long-Term Growth in Europe - Evidence from a Panel Data Analysis

Finance and Growth in the EU: New Evidence from the Liberalisation and Harmonisation of the Banking Industry

Fiscal Policies and Economic Growth in Europe: An Empirical Analysis