creator: Ghironi, Fabio
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Macroeconomic Tradeoffs in the United States and Europe: Fiscal Distortions and the International Monetary Regime
description- – This paper studies the impact of changes in the extent to which fiscal policy is distortionary on the short-run macroeconomic tradeoffs facing fiscal policymakers in an era of budget equilibrium. It does so in an open economy framework, that we use to interpret U.S.-European policy interactions. Our analysis features both fiscal and monetary policy to study how changes in the extent to which fiscal policy is distortionary affect the interaction between central banks and fiscal authorities, both intra- and internationally. In addition, strategic interactions among policymakers³and the tradeoffs they face³are affected by the exchange-rate regime. When government spending is funded through distortionary taxes alone³a scenario that we call anti-Keynesian, changing spending moves both inflation and employment in the desired direction following a worldwide supply shock. Smaller and more open economies face a more favorable tradeoff than large relatively closed ones. Under a managed exchange rate regime, European governments face a better tradeoff than under flexible rates, but the improvement is more significant for the country that controls the exchange rate. When both European countries in our model join in a monetary union, the country that had control of the exchange rate under the managed exchange rate regime faces a worse tradeoff, while the tradeoff improves for the country that controlled money supply. In the fully Keynesian case, in which taxes are non-distortionary, all countries face the same positively sloped tradeoff regardless of the exchange-rate regime. Increases in spending cause both output and inflation to rise. When fiscal policy is neither fully anti-Keynesian nor fully Keynesian, the governmentsê tradeoffs lie in between the extreme cases, and the exact position depends on the extent to which fiscal policy is Keynesian. Under all European exchange-rate regimes, small increases in the fraction of firms that are subject to distortionary taxation at home are beneficial when the equilibrium is characterized by unemployment, while a less Keynesian fiscal policy abroad is harmful. Governments in the U.S. and Europe will want the ECB and the Fed to coordinate their reactions to an unfavorable supply shock, while monetary policymakers will have little incentive to do so. Intra-European fiscal cooperation can be counterproductive, whereas cooperation between governments and central banks inside each continent can be beneficial. Our study suggests that, if governments are concerned mainly about the relation between fiscal policy and the business cycle, maintaining some fiscal distortions may be optimal.
- – WP467
- – 1999-11-22
- – application/pdf
Alternative Monetary Rules for a Small Open Economy: The Case of Canada
description- – I compare the performance of alternative monetary rules for Canada using an open economy model under incomplete markets. Different rules generate different paths for the markup and the terms of trade. A comparison of welfare levels suggests that flexible inflation targeting, the Bank of Canadaês current policy, dominates strict targeting rules³among which a fixed exchange rate with the U.S.³and the Taylor rule. In contrast to other studies, strict targeting rules generate a more stable real economy by stabilizing markup dynamics. Flexible inflation targeting dominates because it yields a positive covariance between consumption and the labor effort, which provides agents with a source of risk diversification.
- – WP466
- – 2000-10-30
- – application/pdf
Towards New Open Economy Macroeconometrics
description- – I estimate the structural parameters of a small open economy model using data from Canada and the United States. The model improves upon the recent literature in open economy macroeconomics from an empirical perspective. I estimate parameters by using non-linear least squares at the single-equation level. Estimates of most parameters are characterized by small standard errors and are in line with the findings of other studies. I also develop a plausible way of constructing measures for non-observable variables. To verify if multiple-equation regressions yield significantly different estimates, I run full information maximum likelihood, system-wide regressions. The results of the two procedures are similar. Finally, I illustrate a practical application of the model, showing how a shock to the U.S. economy is transmitted to Canada under an inflation targeting monetary regime.
- – WP469
- – 2000-02-23
- – application/pdf
U.S.-Europe Economic Interdependence and Policy Transmission
description- – This paper proposes a microfounded general equilibrium model of the U.S. and European economies suitable for analyzing the transmission of monetary and fiscal policy shocks between the U.S. and Europe. The focus is on understanding the determinants of transatlantic economic interdependence. A positive analysis of the consequences of policy changes in the U.S. and Europe is made and results about the transmission of such shocks are obtained. In the model, consumer preferences in the U.S. and Europe are biased in favor of goods produced in the continent where agents reside. Hence, PPP does not hold across the Atlantic, except in steady state. However, this is not sufficient to cause overshooting of the dollar exchange rate following policy shocks. U.S. current-account surplus can be achieved by means of a monetary expansion, a persistent increase in government spending, and/or higher long-run distortionary taxes relative to Europe.
- – WP470
- – 2000-01-10
- – application/pdf
Monetary Rules for Emerging Market Economies
description- – We compare the performance of a currency board arrangement, inflation targeting, and dollarization in a small open, developing economy with liberalized capital account. We focus explicitly on the transmission of shocks to currency and country risk premia in international financial markets and on the role of fluctuations in premia in the propagation of other shocks. We calibrate our model on Argentina. The framework fits the data relatively well in that it matches the second moments of several key macro variables. Welfare analysis suggests that dollarization is preferable to the alternative regimes we consider because it removes the volatility that originates from the currency premium. However, a currency board can match dollarization if the central bank holds a sufficiently large stock of foreign reserves on average.
- – WP476
- – 2001-08-13
- – application/pdf
EMU and Enlargement
description- – We speculate about how Europe's monetary union will evolve in the next five to ten years. We concentrate on what is likely to be the most important change in that period, namely, the increased number and heterogeneity of the participating states. New members will be sharply different from the incumbents in terms of their per capita incomes and economic structures. We concentrate on the implications of this development for the structure, organization and operation of the monetary union. We focus on the implications for the conduct of monetary policy of voting and representation rules on the ECB Board on the grounds that these will have to change with the accession of additional members. We focus on prudential supervision and lending in the last resort on the grounds that the inclusion of countries with recently-created and still-developing financial systems will be among the most prominent consequences of EMU enlargement. We focus on the coordination of fiscal policies on the grounds that the fiscal positions and problems of the accession economies will differ from those of the incumbents. And we focus on labor market flexibility on the grounds that labor-market effects will be among the leading consequences of the admission of new members.
- – WP481
- – 2001-05-01
- – application/pdf
Endogenously persistent output dynamics: A puzzle for the sticky-price model?
description- – I show that endogenously persistent output dynamics are not a puzzle for the standard sticky-price model once openness of the economy is taken into account. I make this point using a two-country, monetary model of macroeconomic interdependence under internationally incomplete asset markets with stationary net foreign asset dynamics. If asset markets are incomplete, price stickiness generates endogenous persistence in the cross-country GDP differential by introducing persistence in the dynamics of the relative price differential between the two economies. This results in the dependence of the current real GDP differential on its past value, as well as on the stock of net foreign assets accumulated in the previous period. The elasticity of the current GDP differential to its past value is sizable for standard parameter values, implying a quantitatively significant persistence effect through this channel. Endogenous persistence yields hump-shaped responses of GDP to productivity and monetary policy shocks.
- – WP527
- – 2002-03-14
- – application/pdf
Net Foreign Assets and the Exchange Rate: Redux Revived
description- – We revisit Obstfeld and Rogoff's (1995) results on exchange rate dynamics in a two-country, monetary model with incomplete asset markets, stationary net foreign assets, and endogenous nominal interest rate setting a la Taylor (1993). Under flexible prices, the nominal exchange rate exhibits a unit root. However, today's exchange rate also depends on the stock of real net foreign assets accumulated in the previous period. The predictive power of net assets for the exchange rate is stronger the closer assets to non-stationary and the higher the degree of substitutability between domestic and foreign goods in consumption. When prices are sticky, the exchange rate still exhibits a unit root. The current level of the exchange rate depends on the past GDP differential, along with net foreign assets. Endogenous monetary policy and asset dynamics have consequences for exchange rate overshooting under both flexible and sticky prices.
- – WP505
- – 2002-02-01
- – application/pdf
Productivity Shocks and Consumption Smoothing in the International Economy
description- – We develop a two-country, dynamic general equilibrium model that links cross-country differences in net foreign asset and consumption dynamics to differences in discount factors and steady-state levels of productivity. We compare the results of the model to those of VARs for the G3 economies. We identify country-specific productivity shocks by assuming that productivity does not respond contemporaneously to other variables in these VARs. We identify global productivity shocks by estimating the VARs in common trend representation after testing for and imposing model-based, long-run cointegration restrictions. We then compare the model's predictions for net foreign asset and consumption dynamics in response to productivity shocks with the estimated VAR impulse responses. We find that the two sources of heterogeneity we consider go some way toward reconciling the consumption smoothing hypothesis with the data and explaining variations in net foreign asset and consumption dynamics across countries.
- – WP565
- – 2003-06-01
- – application/pdf
Macroeconomic Interdependence under Incomplete Markets
description- – I develop a tractable, two-country, real model of macroeconomic interdependence with a role for net foreign asset dynamics. Absence of Ricardian equivalence in an overlapping generations structure ensures existence of a well-defined, endogenously determined, steady-state, international distribution of asset holdings, to which the world economy returns following temporary shocks. The model offers a plausible explanation for the failure of statistical tests to reject the hypothesis of a unit root in series of net foreign assets. Model dynamics after productivity shocks are significantly different from those of a setup in which net foreign assets do not move after shocks, such as Corsetti and Pesenti's (2001a) model. The difference relative to a complete markets economy in which net foreign asset movements play no role in shock transmission is smaller. It is amplified if the substitutability across goods rises, if shocks are permanent, and if steady-state net foreign assets are not zero.
- – WP471
- – 2003-02-06
- – application/pdf
International Trade and Macroeconomic Dynamics with Heterogeneous Firms
description- – We develop a stochastic, general equilibrium, two-country model of trade and macroeconomic dynamics. Productivity differs across individual, monopolistically competitive firms in each country. Firms face a sunk entry cost in the domestic market and both fixed and per-unit export costs. Only relatively more productive firms export. Exogenous shocks to aggregate productivity and entry or trade costs induce firms to enter and exit both their domestic and export markets, thus altering the composition of consumption baskets across countries over time. In a world of flexible prices, our model generates endogenously persistent deviations from PPP that would not exist absent our microeconomic structure with heterogeneous firms. It provides an endogenous, microfounded explanation for a Harrod-Balassa-Samuelson effect in response to aggregate productivity differentials and deregulation. Finally, the model successfully matches several moments of U.S. and international business cycles.
- – 2004-05-23
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