Showing papers in "National Bureau of Economic Research in 2005"

Monetary policy and exchange rate volatility in a small open economy

Abstract: We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to a simple representation in domestic inflation and the output gap. We use the resulting framework to analyse the macroeconomic implications of three alternative rulebased policy regimes for the small open economy: domestic inflation and CPI-based Taylor rules, and an exchange rate peg. We show that a key difference among these regimes lies in the relative amount of exchange rate volatility that they entail. We also discuss a special case for which domestic inflation targeting constitutes the optimal policy, and where a simple second order approximation to the utility of the representative consumer can be derived and used to evaluate the welfare losses associated with the suboptimal rules.

Interpreting the Evidence on Life Cycle Skill Formation

Abstract: This paper presents economic models of child development that capture the essence of recent findings from the empirical literature on skill formation. The goal of this essay is to provide a theoretical framework for interpreting the evidence from a vast empirical literature, for guiding the next generation of empirical studies, and for formulating policy. Central to our analysis is the concept that childhood has more than one stage. We formalize the concepts of self-productivity and complementarity of human capital investments and use them to explain the evidence on skill formation. Together, they explain why skill begets skill through a multiplier process. Skill formation is a life cycle process. It starts in the womb and goes on throughout life. Families play a role in this process that is far more important than the role of schools. There are multiple skills and multiple abilities that are important for adult success. Abilities are both inherited and created, and the traditional debate about nature versus nurture is scientifically obsolete. Human capital investment exhibits both self-productivity and complementarity. Skill attainment at one stage of the life cycle raises skill attainment at later stages of the life cycle (self-productivity). Early investment facilitates the productivity of later investment (complementarity). Early investments are not productive if they are not followed up by later investments (another aspect of complementarity). This complementarity explains why there is no equity-efficiency trade-off. for early investment. The returns to investing early in the life cycle are high. Remediation of inadequate early investments is difficult and very costly as a consequence of both self-productivity and complementarity.

How Changes in Entry Requirements Alter the Teacher Workforce and Affect Student Achievement. NBER Working Paper No. 11844.

Abstract: We are in the midst of what amounts to a national experiment in how best to attract, prepare, and retain teachers, particularly for high-poverty urban schools. Using data on students and teachers in grades 38, this study assesses the effects of pathways into teaching in New York City on the teacher workforce and on student achievement. We ask whether teachers who enter through new routes, with reduced coursework prior to teaching, are more or less effective at improving student achievement. When compared to teachers who completed a university-based teacher education program, teachers with reduced coursework prior to entry often provide smaller initial gains in both mathematics and English language arts. Most differences disappear as the cohort matures, and many of the differences are not large in magnitude, typically 2 to 5 percent of a standard deviation. The variation in effectiveness within pathways is far greater than the average differences between pathways.

Earnings Functions, Rates of Return and Treatment Effects: The Mincer Equation and Beyond

Abstract: This paper considers the interpretation of "Mincer rates of return." We test and reject the Mincer model. It fails to track the time series of true returns. We show how repeated cross section and panel data improves the ability of analysts to estimate the ex ante and ex post marginal rate of returns. Accounting for sequential revelation of information calls into question the validity of the internal rate of return as a tool for policy analysis. The large estimated psychic costs of schooling found in recent work helps to explain why persons do not attend school even though the financial rewards for doing so are high. We present methods for computing distributions of ex post and ex ante returns.

The divergence of human capital levels across cities

Abstract: . Over the past 30 years, the share of adult populations with college degrees increased more in cities with higher initial schooling levels than in initially less educated places. This tendency appears to be driven by shifts in labor demand as there is an increasing wage premium for skilled people working in skilled cities. In this article, we present a model where the clustering of skilled people in metropolitan areas is driven by the tendency of skilled entrepreneurs to innovate in ways that employ other skilled people and by the elasticity of housing supply.

From "Hindu Growth" to Productivity Surge: The Mystery of the Indian Growth Transition

Abstract: This paper explores the causes of India's productivity surge around 1980, more than a decade before serious economic reforms were initiated. Trade liberalization, expansionary demand, a favorable external environment, and improved agricultural performance did not play a role. We find evidence that the trigger may have been an attitudinal shift by the government in the early 1980s that, unlike the reforms of the 1990s, was probusiness rather than promarket in character, favoring the interests of existing businesses rather than new entrants or consumers. A relatively small shift elicited a large productivity response, because India was far away from its incomepossibility frontier. Registered manufacturing, which had been built up in previous decades, played an important role in determining which states took advantage of the changed environment.

Has financial development made the world riskier

Abstract: Developments in the financial sector have led to an expansion in its ability to spread risks. The increase in the risk bearing capacity of economies, as well as in actual risk taking, has led to a range of financial transactions that hitherto were not possible, and has created much greater access to finance for firms and households. On net, this has made the world much better off. Concurrently, however, we have also seen the emergence of a whole range of intermediaries, whose size and appetite for risk may expand over the cycle. Not only can these intermediaries accentuate real fluctuations, they can also leave themselves exposed to certain small probability risks that their own collective behavior makes more likely. As a result, under some conditions, economies may be more exposed to financial-sector-induced turmoil than in the past. The paper discusses the implications for monetary policy and prudential supervision. In particular, it suggests market-friendly policies that would reduce the incentive of intermediary managers to take excessive risk.

Trade Liberalization, Poverty and Inequality: Evidence from Indian Districts

Abstract: Although it is commonly believed that trade liberalization results in higher GDP, little is known about its effects on poverty and inequality. This paper uses the sharp trade liberalization in India in 1991, spurred to a large extent by external factors, to measure the causal impact of trade liberalization on poverty and inequality in districts in India. Variation in pre-liberalization industrial composition across districts in India and the variation in the degree of liberalization across industries allow for a difference-in-difference approach, establishing whether certain areas benefited more from, or bore a disproportionate share of the burden of liberalization. In rural districts where industries more exposed to liberalization were concentrated, poverty incidence and depth decreased by less as a result of trade liberalization, a setback of about 15 percent of India's progress in poverty reduction over the 1990s. The results are robust to pre-reform trends, convergence and time-varying effects of initial district-specific characteristics. Inequality was unaffected in the sample of all Indian states in both urban and rural areas. The findings are related to the extremely limited mobility of factors across regions and industries in India. The findings, consistent with a specific factors model of trade, suggest that to minimize the social costs of inequality, additional policies may be needed to redistribute some of the gains of liberalization from winners to those who do not benefit as much.

Externalities and Growth

Abstract: Externalities play a central role in most theories of economic growth. We argue that international externalities, in particular, are essential for explaining a number of empirical regularities about growth and development. Foremost among these is that many countries appear to share a common long run growth rate despite persistently different rates of investment in physical capital, human capital, and research. With this motivation, we construct a hybrid of some prominent growth models that have international knowledge externalities. When calibrated, the hybrid model does a surprisingly good job of generating realistic dispersion of income levels with modest barriers to technology adoption. Human capital and physical capital contribute to income differences both directly (as usual), and indirectly by boosting resources devoted to technology adoption. The model implies that most of income above subsistence is made possible by international diffusion of knowledge.

The Formation of International Production and Distribution Networks in East Asia

Abstract: The international production and distribution networks consist of vertical production chains and distribution networks extended across a number of countries. This paper claims that the international production and distribution networks in East Asia present distinctive characters in their significance in the regional economy, their geographical extensiveness involving a large number of countries in the region, and their sophistication of both intra-firm and arm's-length relationships across different firm nationalities. The paper starts from reviewing crucial changes in policy framework observed in the developing East Asian countries a decade ago and sketching the theoretical thoughts explaining the mechanics of international production and distribution networks. Then, the empirical part of the paper examines the micro data of Japanese corporate firms to make a closer look at the nature of networks through the pattern of FDI after analyzing overall trade patterns of the major East Asian countries to confirm the importance of international trade of machinery parts and components. In addition, the paper quantifies the magnitude of economic activities of Japanese firms through different channels of transactions, using the firm nationality approach. The last part of the paper discusses policy implication of the networks.(This abstract was borrowed from another version of this item.)

Behavioral Public Economics: Welfare and Policy Analysis with Non-Standard Decision-Makers

Abstract: This paper has two goals. First, we discuss several emerging approaches to applied welfare analysis under non-standard ("behavioral") assumptions concerning consumer choice. This provides a foundation for Behavioral Public Economics. Second, we illustrate applications of these approaches by surveying behavioral studies of policy problems involving saving, addiction, and public goods. We argue that the literature on behavioral public economics, though in its infancy, has already fundamentally changed our understanding of public policy in each of these domains.

The Role of Collateralized Household Debt in Macroeconomic Stabilization

Abstract: Market innovations following the financial reforms of the early 1980s relaxed collateral constraints on household borrowing. The present paper examines the contribution of this development to the macroeconomic stabilization that occurred shortly thereafter. The model combines collateral constraints on households with heterogeneity of thrift in a calibrated general equilibrium setup. We use this tool to characterize the business cycle implications of lowering required down payments and rates of amortization for durable goods purchases as in the early 1980s. The model predicts that this relaxation of collateral constraints can explain a large fraction of the actual volatility decline in hours worked, output, household debt, and household durable goods purchases.

Bank Concentration and Fragility. Impact and Mechanics

Abstract: Public policy debates and theoretical disputes motivate this paper%u2019s examination of (i) the relationship between bank concentration and banking system fragility and (ii) the mechanisms underlying this relationship. We find no support for the view that concentration increases the fragility of banks. Rather, banking system concentration is associated with a lower probability that the country suffers a systemic banking crisis. In terms of policies, we find that (i) regulations and institutions that facilitate competition in banking are associated with less -- not more -- banking system fragility and (ii) including these policy indicators does not change the results on concentration. This suggests that concentration is a proxy for something else besides the competitive environment. Also, we do not find that official capital regulations, reserve requirements, or official prudential regulations lower crises probabilities. Finally, we present suggestive evidence that concentrated banking systems tend to have larger, better-diversified banks, which may help account for the positive link between concentration and stability.

Political Competition and Economic Performance: Theory and Evidence from the United States

Abstract: One of the most cherished propositions in economics is that market competition by and large raises consumer welfare. But whether political competition has similarly virtuous consequences is far less discussed. This paper formulates a model to explain why political competition may enhance economic performance and uses the United States as a testing ground for the model's implications. It finds statistically robust evidence that political competition has quantitatively important effects on state income growth, state policies, and the quality of Governors.

Crime, punishment, and myopia

Abstract: Economic theory predicts that increasing the severity of punishments will deter criminal behavior by raising the expected price of committing crime. This implicit price can be substantially raised by making prison sentences longer, but only if offenders' discount rates are relatively low. We use a large sample of felony arrests to measure the deterrence effect of criminal sanctions. We exploit the fact that young offenders are legally treated as adults--and face longer lengths of incarceration--the day they turn 18. Sufficiently patient individuals should therefore significantly lower their offending rates immediately upon turning 18. The small behavioral responses that we estimate suggest that potential offenders are extremely impatient, myopic, or both.

Is the u.s. current account deficit sustainable? and if not, how costly is adjustment likely to be?

Abstract: MANY ANALYSTS IN academia, the private sector, and applied research institutions express increasing concern about the growing U.S. current account deficit. There is a general sense that current global imbalances are unsustainable and that adjustment must come sooner rather than later. The unprecedented magnitude of the U.S. current account deficit and the United States' growing net foreign indebtedness have fueled these worries, with many analysts arguing that, unless something is done, the world will move toward a major financial crisis. (1) Some have gone as far as to suggest an imminent collapse of the dollar and a global financial meltdown. (2) Underlying this view is the fact that, if the deficit continues at its current level, U.S. net international liabilities will eventually reach 100 percent of GDP, a figure widely considered to be excessively large. (3) The source of financing of the U.S. current account deficit has also become a matter of concern. A number of authors have argued that, by relying on foreign and particularly Asian central banks' purchases of Treasury securities, the United States has become extremely vulnerable to sudden changes in expectations and economic sentiments. (4) Robert Skidelsky recently argued in the New York Times that the value of the dollar is one of the most important sources of political tension between the United States and Europe. Arguing that "[U]nilateralism is not more acceptable in currency matters than in foreign policy," Skidelsky points out that, The United States is the only major country proclaiming itself indifferent to its currency's value. In countries running persistent current account deficits, governments normally--indeed must--reduce domestic consumption. But so far, the United States has relied on other countries to adjust their economies to profligate American spending.... (5) There is, however, an alternative view. Some authors have argued that, in an era of increasing financial globalization and rapid U.S. productivity gains, it is possible--indeed, even logical and desirable--for the United States to run very large current account deficits for a very long period (say, a quarter of a century). In this view, growing international portfolio diversification implies that the rest of the world will be willing to accumulate large U.S. liabilities during the next few years, maybe even in excess of 100 percent of U.S. GDP. From this perspective, since the U.S. current account deficit poses no threat, there are no fundamental reasons to justify a significant fall in the value of the dollar. (6) This paper analyzes the relationship between the dollar and the U.S. current account, with particular attention to the issue of sustainability and the mechanics of current account adjustment. I develop a portfolio model of the current account and show that, even under a very positive scenario where foreigners' (net) demand for U.S. assets doubles from its current level, the U.S. current account will have to go through a significant adjustment in the not-too-distant future. Indeed, one cannot rule out a scenario where the U.S. current account deficit shrinks abruptly by 3 to 6 percent of GDP. To get an idea of the possible consequences of such an adjustment, I also analyze the international historical evidence on current account reversals. The results of this empirical investigation indicate that significant current account reversals have tended to result in large declines in GDP growth. The U.S. Dollar and the Current Account: A Thirty-Year Perspective This section analyzes the behavior of the U.S. real exchange rate (RER) and current account since the adoption of floating exchange rates in the early 1970s. (7) I begin by discussing the course of the U.S. RER and current account during that period and the changing nature of the U.S. trade-weighted RER index. I argue that the last thirty years of U. …

Employment Dynamics and Business Relocation: New Evidence from the National Establishment Time Series

Abstract: We analyze and assess new evidence on employment dynamics from a new data source %uF818 the National Establishment Time Series (NETS). The NETS offers advantages over existing data sources for studying employment dynamics, including tracking business establishment relocations that can contribute to job creation or destruction on a regional level. Our primary purpose in this paper is to assess the reliability of the NETS data along a number of dimensions, and we conclude that it is a reliable data source although not without limitations. We also illustrate the usefulness of the NETS data by reporting, for California, a full decomposition of employment change into its six constituent processes, including job creation and destruction stemming from business relocation, which has figured prominently in policy debates but on which there has been no systematic evidence.

Electoral Manipulation via Expenditure Composition: Theory and Evidence

Abstract: We present a model of the Political Budget Cycle in which voters and politicians have preferences for different types of government spending Incumbents try to influence voters by changing the composition of government spending, rather than overall spending or revenues Rational voters may support an incumbent who targets them with spending before the election even though such spending may be due to opportunistic manipulation, because it can also reflect sincere preference of the incumbent for types of spending voters favor Classifying expenditures into those which are targeted to voters and those that are not, we provide evidence supporting our model in data on local public finances for all Colombian municipalities Our findings indicate both a pre-electoral increase in targeted expenditures, combined with a contraction of other types of expenditure, and a voter response to targeting

The History and Politics of Corporate Ownership in Sweden

Abstract: Not despite but because of persistent Social Democratic political influence since the Great Reversal in 1932 have a few families and banks controlled the largest listed firms in Sweden. The Social Democrats have de facto been the guarantor rather than the terminator of private capitalism since the political and corporate incumbencies have been united by strong common interests. Incumbent owners need the political support to legitimize that their corporate power rests on extensive use of dual-class shares and pyramiding. While the Social Democrats only get the necessary resources and indirect support for their social and economic policies from the private sector if the largest firms remain under Swedish control so that capital does not migrate. The extensive use of mechanisms to separate votes from capital however drives a significant wedge between the costs of internal and external capital that causes an enhanced (political) pecking order of financing where new external equity is strongly avoided. By not encouraging outsiders to create new firms and fortunes, and by not fully activating the primary equity markets, the heavy politicized system has redistributed incomes but not property rights and wealth. The result is an ageing economy with an unusually large proportion of very old and very large firms with well-defined owners in control. 31 of the 50 largest listed firms in 2000 were founded before 1914, only 8 in the post-war period and none after 1970.

Crises in emerging market economies: a global perspective

Abstract: The paper argues that global financial factors played an important role in the capital-inflow episode in Emerging Market economies (EMs), during the early part of the 1990s, and clearly in the Sudden Stop (of capital inflows) crises that took place after the 1998 Russian crisis. Moreover, the paper shows that recovery after crises that exhibit large output loss (more than 5 percent of GDP from peak to trough) occurs in a Phoenix-like fashion: little credit or investment is required. These results strongly suggest that: (1) deep financial crises can be prevented or at least largely alleviated and (2) global institutions and arrangements should be high on the policy agenda. The paper then discusses an Emerging Market Fund (EMF) charged with the task of lowering the incidence of contagion in EM bond prices. In addition, the paper analyzes domestic policies and concludes that they are critical and important in making EMs less vulnerable to shocks but are unlikely to succeed in fully shielding these economies from global financial shocks if not supported by arrangements like the EMF. Finally, two sections of the paper are devoted to discussing some current issues regarding applicable theory and econometrics.(This abstract was borrowed from another version of this item.)

From World Banker to World Venture Capitalist: US External Adjustment and The Exorbitant Privilege ∗

Abstract: Does the center country of the International Monetary System enjoy an “exorbitant privilege” that significantly weakens its external constraint as has been asserted in some European quarters? Using a newly constructed dataset, we perform a detailed analysis of the historical evolution of US external assets and liabilities at market value since 1952. We find strong evidence of a sizeable excess return of gross assets over gross liabilities. Interestingly, this excess return increased after the collapse of the Bretton Woods fixed exchange rate system. It is mainly due to a “return discount”: within each class of assets, the total return (yields and capital gains) that the US has to pay to foreigners is smaller than the total return the US gets on its foreign assets. We also find evidence of a “composition effect”: the US tends to borrow short and lend long. As financial globalization accelerated its pace, the US transformed itself from a World Banker into a World Venture Capitalist, investing greater amounts in high yield assets such as equity and FDI. We use these findings to cast some light on the sustainability of the current global imbalances.

Emigration, Labor Supply, and Earnings in Mexico

Abstract: In this paper, I examine changes in labor supply and earnings across regions of Mexico during the 1990s. I focus the analysis on individuals born in states with either high-exposure or low-exposure to emigration, as measured by historical data on state migration to the United States. During the 1990s, rates of external migration and interval migration were higher among individuals born in high-migration states. Consistent with positive selection of emigrants in terms of observable skill, emigration rates appear to be highest among individuals with earnings in the top half of the wage distribution. Controlling for regional differences in observable characteristics and for initial regional differences in earnings, the distribution of male earnings in high-migration states shifted to the right relative to low-migration states. Over the decade, average hourly earnings in high-migration states rose relative to low-migration states by 6-9%.

How Much Do Banks Use Credit Derivatives to Reduce Risk

Abstract: This paper examines the use of credit derivatives by US bank holding companies from 1999 to 2003 with assets in excess of one billion dollars. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2003 only 19 large banks out of 345 use credit derivatives. Though few banks use credit derivatives, the assets of these banks represent on average two thirds of the assets of bank holding companies with assets in excess of $1 billion. Few banks are net buyers of credit protection and disclose using credit derivatives to hedge loans. Banks are more likely to be net protection buyers if they engage in asset securitization, originate foreign loans, and have lower capital ratios. The likelihood of a bank being a net protection buyer is positively related to the percentage of commercial and industrial loans in a bank's loan portfolio and negatively or not related to other types of bank loans. The use of credit derivatives by banks is limited because adverse selection and moral hazard problems make the market for credit derivatives illiquid for the typical credit exposures of banks.

Consequences and Predictors of New Health Events

Abstract: Smith uses the HRS and AHEAD panels to examine the consequences of new health on a series of SES related outcomes- out-of-pocket labor supply, labor force activity, household income and wealth. For each of these outcomes, new severe health events have a significant effect although most of the impact on income and wealth takes place through labor supply and not not medical expenses. The paper also examines the ability of different measures of SES to predict the future onset of disease. The author finds no predictive effect of income or wealth but education does predict future onset even after controlling for current health status. The reasons for this continuing predictive effect of education are explored in the paper.

Capital Account Liberalization, Institutional Quality and Economic Growth: Theory and Evidence

Abstract: This paper shows that the effect of capital account liberalization on growth depends upon the environment in which that policy occurs. A theoretical model demonstrates the possibility of an inverted-U shaped relationship between the responsiveness of growth to capital account liberalization and institutional quality. Three empirical specifications based on the model are estimated using a panel of 71 countries. Estimates of all three specifications support the hypothesis of a non-monotonic interaction between the responsiveness of growth to capital account liberalization and institutional quality, with about one-quarter of the countries, those with better (but not the best) institutions exhibiting a statistically significant and economically meaningful effect of capital account openness on economic growth.