FINANCIAL CRISES,OUTPUT LOSSES,AND THE ROLE OF STRUCTURAL REFORMS

Financial crises take a heavy toll on output growth. We assess the role of structural reforms in reducing the output losses resulting from financial crises across advanced economies, emerging and developing economies, and low‐income developing economies. We also revisit the role of macroeconomic policies in this context. The impact of crises on output growth differs between types of crises and economies, thus warranting sample splits along these lines. Some but not all reforms and policies help to reduce the output losses of crises in the medium term, highlighting the need not to overgeneralize the effectiveness of reforms and policies. Further research is warranted to further explore the heterogeneity in the impact of financial crises on output growth and to better understand when and how specific structural reforms and macroeconomic policies can mitigate the output costs of financial crises. (JEL E32, E44, E63, G28, O47)     

STRUCTURAL ESTIMATION OF THE OUTPUT GAP: A BAYESIAN DSGE APPROACH

We estimate the output gap that is consistent with a standard New Keynesian dynamic stochastic general equilibrium (DSGE) model, where the output gap is defined as a deviation of output from its flexible‐price equilibrium, using Bayesian methods. Our output gap illustrates the U.S. business cycles well, compared with other estimates. We find that the main source of the output gap movements is the demand shocks, but that the productivity shocks contributed to the stable output gap in the late 1990s. The robustness analysis shows that the estimated output gap is sensitive to the specification for monetary policy rules. (JEL E30, E32, C11)     

DOES THE GREAT RECESSION IMPLY THE END OF THE GREAT MODERATION? INTERNATIONAL EVIDENCE

In this paper we examine whether or not the Great Recession had a temporary or permanent effect on output growth volatility after years of low macroeconomic volatility since the early eighties. Based on break detection methods applied to a set of advanced countries, our empirical results do not give evidence to the end of the Great Moderation period but rather that the Great Recession is characterized by a dramatic short‐lived effect on the output growth but not on its volatility. We show that neglecting the breaks both in mean and in variance can have large effects on output volatility modeling based on GARCH specifications. (JEL E32, C22, O40)     

A MONETARY BUSINESS CYCLE MODEL FOR INDIA

A New Keynesian monetary business cycle model is constructed to study why monetary transmission in India is weak. Our models feature banking and financial sector frictions as well as an informal sector. The predominant channel of monetary transmission is a credit channel. Our main finding is that base money shocks have a larger and more persistent effect on output than an interest rate shock, as in the data. The presence of an informal sector hinders monetary transmission. Contrary to the consensus view, financial repression in the form of a statutory liquidity ratio and administered interest rates, does not weaken monetary transmission. (JEL E31, E32, E44, E52, E63)     

HAS PRODUCTION MANAGEMENT IMPROVED SINCE 1984?

The growth rate of GDP stabilized around 1984, and improvements in production management have been cited as a possible cause. This article examines this rationale with two‐digit SIC manufacturing data. The empirical questions are whether there is evidence of structural change in industry output around 1984 and, if so, did output track demand more closely following the change? The results indicate that only two industries exhibited structural change in the 1982–86 period. There is evidence that output has tracked demand more closely in recent years, but this is because demand shocks have become less persistent. (JEL C15, D21, E22)     

GROWTH AND CONVERGENCE WHEN TECHNOLOGY AND HUMAN CAPITAL ARE COMPLEMENTS

This article presents a model of endogenous growth, in which a firm's technology and a country's human capital stock are complementary in the production of output. Production technologies are created by costly research and development (R&D) and are owned by firms that can freely choose where in the world to produce. Both production and R&D have a positive effect on a country's human capital stock. While all countries typically grow at the same rate in the long run, they differ in their levels of human capital, per capita output, and the quality of the technologies that are used in production. A country's relative position in terms of productivity is history dependent. Countries that start out with a lower human capital stock or industrialize later end up with a lower per capita GDP in long‐term equilibrium. (JEL O4, O33, O47)     

THE SHIFTS IN LEAD-LAG PROPERTIES OF THE U.S. BUSINESS CYCLE

We document shifts in the lead-lag properties of the U.S. business cycle since the mid-1980s. Specifically, (1) the well-known inverted leading indicator property of real interest rates has completely vanished; (2) labor productivity switched from positively leading to negatively lagging output and labor inputs over the cycle; and (3) the unemployment rate shifted from lagging productivity negatively to leading positively. Many contemporary business cycle models produce counterfactual cross-correlations revealing that popular frictions and shocks provide an incomplete account of business cycle comovement. Determining the underlying sources of these shifts in the lead-lag properties and their consequences for macroeconomic forecasts is therefore a promising direction for future research. (JEL E24, E32, E43)     

THE CYCLICAL BEHAVIOR OF PRICES AND RELATIVE PRICES

Price and output shock correlations provide information concerning macroeconomic shocks. Previous research generally finds small or negative correlations between real gross domestic product (GDP) and GDP deflator shocks but positive correlations between industrial production (IP) and consumer price index (CPI) shocks at short forecast horizons. We show that mismatched price and output correlations may have different magnitudes or signs than matched pairs. Matched and mismatched correlations between disaggregated prices and output from the GDP accounts indicate the procyclical price of nondurables to durables makes correlations between mismatches misleading. Thus, there is reason to be skeptical of results based on IP and the CPI. (JEL E31, E32)     

THE U.S. LABOR INCOME SHARE AND AUTOMATION SHOCKS

The causes and consequences of the 1964–2016 swings in the U.S. labor income share/labor share (LS) are parsed through the lens of a structural model estimated on aggregate and LS series jointly. Where conventional models fall short, the present model yields a counter-cyclical LS unconditionally and in response to demand and monetary policy shocks, as well as a small wage pro-cyclicality, via moderate wage indexation. Shifts in automation, workers' market power, investment efficiency, and the relative price of investment account for 54%, 24%, 6%, and 4% of LS fluctuations, respectively. Automation shocks explain the lion's share of the post-2007 cyclical LS tumble and 11% of output cycles, and generate a distinctive counter-cyclical labor response. (JEL E32, E25, E52)     

DIMENSIONS OF MACROECONOMIC UNCERTAINTY: A COMMON FACTOR ANALYSIS

Uncertainty about the future course of the economy is a potential driver of aggregate fluctuations. To identify the distinct dimensions of uncertainty in the macroeconomy, we construct a large dataset covering all types of economic uncertainty. We then identify two fundamental factors that account for the common dynamics in this dataset. These factors are interpreted as macroeconomic uncertainty. The first factor captures business cycle uncertainty, while the second factor represents oil and commodity price uncertainty. While both types of uncertainty generate a decline in output, time‐varying oil and commodity price uncertainty is more important for fluctuations in real activity. However, nonlinearities seem to amplify the effect of business cycle uncertainty during the global financial crisis. (JEL C32, C38, E32)     

SECTORAL COMPOSITION OF GOVERNMENT SPENDING AND MACROECONOMIC (IN)STABILITY

This article examines the quantitative interrelations between sectoral composition of public spending and equilibrium (in)determinacy in a two‐sector real business cycle model with positive productive externalities in investment. When government purchases of consumption and investment goods are set as constant fractions of their respective sectoral output, we show that the public‐consumption share plays no role in the model's local dynamics, and that a sufficiently high public‐investment share can stabilize the economy against endogenous belief‐driven cyclical fluctuations. When each type of government spending is postulated as a constant proportion of the economy's total output, we find that there exists a trade‐off between public consumption versus investment expenditures to yield saddle‐path stability and equilibrium uniqueness. (JEL E32, E62, O41)     

ACCOUNTING FOR THE CYCLICAL DYNAMICS OF INCOME SHARES

Over the business cycle, labor's share of output is negatively but weakly correlated with output, and it lags output by about four quarters. Profits' share is strongly pro‐cyclical. It neither leads nor lags output, and its volatility is about five times that of output. Those assumptions relate to the structure of aggregate technology and the degree of competition in factor markets. Despite much evidence in favor of time‐varying income shares, macroeconomics still lacks models that can account for their time series facts. This article constructs a model that can replicate those facts. We introduce costly entry of firms in a model with frictional labor markets and find a link between the ability of the model to replicate income shares' dynamics and the ability of the model to amplify and propagate shocks. That link is a weak correlation between the real interest rate and output, a fact in U.S. data but a feature that models of aggregate fluctuations have had difficulty achieving. (JEL E3, E25, J3, E24)     

INSTITUTIONS,HOUSEHOLD CREDIT COMPOSITION,AND THE BUSINESS CYCLE

We show that the negative effect of household credit growth on subsequent economic growth documented in the recent literature is not the same across countries. The effect is stronger in countries with weak institutions where the fraction of consumer credit in total household credit is greater. That is an important nuance as consumer credit is a sizable part of household credit in many emerging markets and its rapid buildup should be observed with the same caution as a rapid buildup in housing credit. (JEL G21, E32, E44)     

HEALTH CARE INFLATION AND ITS IMPLICATIONS FOR MONETARY POLICY

Motivated by recent findings on the cyclical movement of both health and health spending, we construct a general equilibrium model that distinguishes health care demand from the demand for other goods. Using this model, we are able to generate inflation dynamics and cyclicality of health that match the US data. When the model is subjected to an expansionary monetary policy shock, it yields different output and inflation responses compared with a two‐sector model with homogeneous demand. We show that the trade‐off between leisure and health spending plays an important role in model dynamics. The model further predicts different degrees of inflation stabilization across sectors when a shift in the monetary policy occurs. (JEL E52, E31, E32, I10)     

MONEY,OUTPUT, AND INFLATION IN THE LONGER TERM: MAJOR INDUSTRIAL COUNTRIES, 1880–2001

We study how fluctuations in money growth correlate with fluctuations in real output growth and inflation. Using band‐pass filters, we extract cycles from each time series that last 2–8 (business cycles) and 8–40 (longer‐term cycles) years. We employ annual data, 1880–2001 without gaps, for 11 industrial countries. Fluctuations in money growth do not play a systematic role at business cycle frequencies. However, money growth leads or affects contemporaneously inflation, but not real output growth, in the longer run. Also, formal break tests indicate no structural changes for the longer‐term money growth and inflation relationship, despite changes in policy regimes.(JEL E3)     

LIMITED ASSET MARKET PARTICIPATION AND THE EURO AREA CRISIS: AN EMPIRICAL DSGE MODEL

We estimate a medium‐scale dynamic stochastic general equilibrium model for the Euro area with limited asset market participation (LAMP). Our results suggest that in the recent European Monetary Union years LAMP is particularly sizable (39% during 1993–2012) and important to understand business cycle features. The Bayes factor and the forecasting performance show that the LAMP model is preferred to its representative household counterpart. In the representative agent model the risk premium shock is the main driver of output volatility in order to match consumption correlation with output. In the LAMP model this role is played by the investment‐specific shock, because non‐Ricardian households introduce a Keynesian multiplier effect and raise the correlation between consumption and investments. We also detect the contractionary role of monetary policy shocks during the post‐2007 years. In this period consumption of non‐Ricardian households fell dramatically, but this outcome might have been avoided by a more aggressive policy stance. (JEL C11, C13, C32, E21, E32, E37)     

RISING R&D INTENSITY AND ECONOMIC GROWTH

Over the past decades, private R&D spending in the United States and other developed countries has been growing faster than gross domestic product. At the same time, the growth rates of per-capita and aggregate output have been rather stable, possibly declining slightly. This article proposes a growth model that can account for the observed phenomenon by explicitly describing competition among technological leaders and followers in individual markets in a way that is consistent with existing studies on firms' motivation to invest in R&D. The model shows the possibility that the unsustainable trend of rising R&D intensity persists for a very long time. (JEL O3, O4, L1)     

HYSTERESIS IN A NEW KEYNESIAN MODEL

This paper provides a simple, tractable way of incorporating “hysteresis,” in which persistent unemployment takes on structural characteristics, into a macroeconomic model. Hysteresis is modeled as deterioration in labor market matching efficiency as the average duration of unemployment increases. This is embedded in a basic New Keynesian macro model. A decline in labor market matching efficiency would be consistent with the observed rightward shift of the Beveridge curve since the 2007–2009 recession. Hysteresis is shown to lead to larger and more persistent responses of the unemployment rate and unemployment duration to productivity, intertemporal preference, and monetary shocks. Hysteresis also generates an increase in the natural rate of unemployment. (JEL E24, J64, E32)     

A MACROECONOMIC ANALYSIS OF ENERGY SUBSIDIES IN A SMALL OPEN ECONOMY

We construct a dynamic model of a small open economy to analyze the effects of large energy subsidies. The model includes domestic energy production and consumption, trade in energy at world market prices, as well as private and public sector production. The model is calibrated to Egypt and used to study reforms such as reductions in energy subsidies with corresponding reductions in various tax instruments or increases in infrastructure investment. We calculate the new steady states, transition paths to the new steady state, and the size of the associated welfare losses or gains. Our main results for a 15% cut in energy subsidies are: (1) Steady state gross domestic product drops in most of our experiments as less energy is used in production. (2) Steady state consumption rises in most of our experiments. (3) Welfare can rise by as much as 0.6% in consumption equivalent terms. (4) The largest gains in terms of output and of welfare can be obtained when savings from energy subsidy cuts are used to fund additional infrastructure investment. (JEL E21, E63, H55, J26, J45)     

DO CAPITAL ADEQUACY REQUIREMENTS MATTER FOR MONETARY POLICY?

Central bankers and financial supervisors can have conflicting goals. While monetary policymakers work to ensure sufficient lending activities as a foundation for high and stable economic growth, supervisors may limit banks’ lending capacities in order to prevent excessive risk taking. We show that, in theory, central bankers can avoid this potential conflict by adopting an interest rate strategy that takes accounts of capital adequacy requirements. Empirical evidence suggests that while policymakers at the Federal Reserve have adjusted their interest rate to neutralizing the procyclical impact of bank capital requirements, those in Germany and Japan have not. (JEL E52, E58, G21)