Volume 22, Issue 2

What has been the effect of uncertainty shocks in the U.S. economy over the last century? What are the roles of the financial channel and monetary policy channel in propagating uncertainty shocks? Our empirical strategies enable us to distinguish between the effects of uncertainty shocks on key macroeconomic and financial variables transmitted through each channel. A hundred years of data further allow us to answer these questions from a novel historical perspective. This paper finds robust evidence that financial conditions captured by both borrowing costs and the availability of credit have played a crucial role in propagating uncertainty shocks over the last century. However, heightened uncertainty does not necessarily amplify the adverse effect of financial shocks, suggesting an asymmetric interaction between uncertainty and financial shocks. Interestingly, the monetary policy stance seems to play only a minor role in propagating uncertainty shocks, which is in sharp contrast to the recent claim that binding zero-lower-bound amplifies the negative effect of uncertainty shocks. We argue that the contribution of constrained monetary policy to amplifying uncertainty shocks is largely masked by the joint concurrence of binding zero-lower-bound and tightened financial conditions.

The Great Recession has drawn attention to the importance of macro-financial linkages. In this paper I explore the joint role of imperfections in labor and financial markets for the cyclical adjustment of the labor market. I show that jobless recoveries emerge when, upon exiting a recession, firms are faced with deteriorating credit conditions. On the financial side, collateral requirements affect the cost of borrowing for firms. On the employment side, hiring frictions and wage rigidity increase the need for credit, making the binding collateral constraint more relevant. In a general equilibrium business cycle model with search and matching frictions, I illustrate that tightening credit conditions calibrated from data negatively affect employment adjustments during recovery periods. Wage rigidity substantially amplifies this mechanism, generating empirically plausible fluctuations in employment and output.

This paper revisits the link between house prices and monetary policy using a data set on house prices provided by the Bank for International Settlements. It is found that a loose monetary policy unambiguously results in a rise in real house prices, and such an increase is statistically significant for 19 of the 20 countries studied here. Empirical results also show that for some countries (Belgium, Canada, Switzerland, Denmark, the Netherlands, Sweden, and South Africa), the interest rate shock can explain a large percentage of real house price movements. The response of house prices to monetary policy shocks varies between countries, and the strength of the relationship between house prices and monetary policy can be associated with financial liberalization. On the other hand, evidence shows that interest rate shock plays an important role in explaining recent house price hikes for Australia, Spain, Ireland, the Netherlands, the US, and South Africa. In particular, during 2002–2006, on average 24% of the house price hikes in the US can be attributed to monetary policy shocks. Finally, we also find evidence that central banks react to the housing market, particularly in those countries adopting a policy of inflation targeting.

Reforms to agricultural policy have been stalling in OECD economies. In this paper, we quantify the potential for public savings from switching to an optimal transfer system in small open economies. Following the insights from the literature on repeated moral hazard, optimal subsidies are front-loaded, which provides stronger incentives for farmers to transition out of agriculture, compared to the existing policies. In our counterfactual experiments, we find government savings of 6% for Chile, 45% for Japan, 24% for Switzerland, and 51% for Turkey. In addition, optimal subsidies more than double the speed of the transition of employment out of agriculture.

The standard models with incomplete markets (e.g. Aiyagari) have difficulty justifying the current income tax rates as an optimal or political equilibrium outcome. Given the highly skewed income distribution, the majority of the population would be in favor of raising taxes to a much higher level. We show that incorporating (i) the ex-ante heterogeneity of earnings and (ii) income-dependent voting behavior helps us to reconcile the large gap between the model and data.

We study how financial reforms affect the extent of consumption smoothing in a dynamic stochastic general equilibrium model of an emerging economy. Consistent with the empirical literature and reform efforts in South Korea and South Africa, we emphasize the relation between consumer credit and durable purchases, and model reforms as the relaxation of the collateral constraint on lower income households. We find that the relaxation of the collateral constraint accounts for a substantial share of the decline in consumption smoothing experienced in South Korea and South Africa.

The government size in developed economies expanded remarkably after the Second World War. This growth shaped the role of the government as a key player in the economic activity and the aggregate dynamics of a country. However, the way in which the government is represented in DSGE models is often reductive, containing homogeneous public spending and a few distortionary taxes without clear counterparts in fiscal data. This paper shows how dynamic general equilibrium models can incorporate a detailed government sector as defined in the System of National Accounts (SNA). This government features six types of public expenditures (i.e. the government’s intermediate consumption, public wage bill, debt service, public investment, and transfers to households both in-kind and other-than-in-kind), and five distortionary taxes (i.e. consumption tax, capital and labor income taxes, corporate tax and social contributions).

In this paper, we analyze the International Great Depression (IGD) in the U.S. and Western Europe by applying the business cycle accounting method to a dynamic stochastic general equilibrium model with time-varying production efficiency and factor market distortions. We measure the size of labor and capital market distortions with endogenous factor utilization and their relative importance in accounting for output fluctuation during the interwar period. Our main findings are that labor market distortions accounted for two-thirds of the output drops in both the U.S. and Western Europe, endogenous factor utilization amplified the negative effects of labor market distortions, and government spending played an important role in the recovery from the Great Depression in European countries who left the Gold Standard in the early 1930s.

This paper studies the dynamic effects of the fiscal policy shock on private activity using an array of vector autoregressive models for the post-war U.S. data . We are particularly interested in the role of consumer sentiment in the transmission of fiscal stimulus. Our major findings are as follows. Private spending fails to rise persistently in response to government spending shocks, while they exhibit persistent and significant increases when the sentiment shock occurs. Employing not only linear but also nonlinear state-dependent VAR model estimations, we show that the government spending shock generates consumer pessimism in all phases of business cycle resulting in subsequent decreases in private activity, which ultimately weakens the effectiveness of the fiscal policy. Our counterfactual simulation exercises confirm the important role of sentiment in propagating fiscal stimulus to private spending.

A fundamental aspect of China’s transition to a market economy is the change in fiscal decentralization marked by the tax reform in 1993. This paper examines the effect of revenue and expenditure decentralization and their divergences on fiscal spending multipliers in China using nationally aggregate and provincial-level data from 1978 to 2017. Our investigations show that expenditure decentralization weakens the efficacy of spending policies, while revenue decentralization enhances the efficacy. Moreover, the divergence of revenue and expenditure decentralization has significantly decreased the provincial spending multiplier, while its effect on the aggregate spending multiplier is insignificant. The provincial results are robust to the inclusion of off-budgetary expenditure and revenue, using different estimates of multipliers and different measures of fiscal decentralization, considering from a long-run perspective, and addressing the endogeneity issue.

In this study, we examine how a feed-in tariff (FIT) accompanied with deregulation in the energy sector affects the direction of technical change along the balanced growth path. A final good is composed of resource-saving (such as renewable) energy and traditional resource-intensive energy. The government introduces a FIT scheme for promoting resource-saving energy, while it deregulates the traditional energy sector for efficiency improvement. The implementation of the scheme positively affects directed technical change toward the resource-saving energy technology and economic growth. Meanwhile, the biased technical change leads to an upsurge in the surcharge. Associated deregulation not only accelerates the biased technical change but also drives the surge in the surcharge rate, unless the initial market structure of the traditional energy sector is highly concentrated.

This study analytically investigates the effects of pay-as-you-go social security and educational subsidies on the fertility rate, retirement age, and GDP per capita growth rate in an overlapping generations model, where parents invest resources toward their children’s human capital. We find that an old agent retires fully when his or her labor productivity is low and retires later when the labor productivity is high. Under the unique balanced-growth-path (BGP) equilibrium, when an old agent is still engaged in work, tax rates are neutral to the fertility rate, higher tax rates encourage him or her to retire earlier, a higher social security tax rate depresses the GDP per capita growth rate, and a higher tax rate for educational subsidies can accelerate growth. However, when an old agent fully retires, higher tax rates increase the fertility rate, a higher social security tax rate lowers the GDP per capita growth rate, and a higher tax rate for educational subsidies boosts growth. Additionally, if an old agent’s labor productivity increases, the fertility rate also increases. We also conduct numerical simulations and analyze how an old agent’s labor productivity affects the retirement age, fertility rate, and GDP per capita growth rate under the BGP equilibrium.