Exchange rates dynamics with long-run risk and recursive preferences
Standard macro models cannot explain why real exchange rates are volatile and disconnected from macro aggregates. Recent research argues that models with persistent growth rate shocks and recursive preferences can solve that puzzle. I show that this result is highly sensitive to the structure of financial markets. When just a bond is traded internationally, then long-run risk generates insufficient exchange rate volatility. A long-run risk model with recursive-preferences can generate realistic exchange rate volatility, if all agents efficiently share their consumption risk by trading in complete financial markets; however, this entails massive international wealth transfers, and excessive swings in net foreign asset positions. By contrast, a long-run risk, recursive-preferences model in which only a fraction of households trades in complete markets, while the remaining households lead hand-to-mouth lives, can generate realistic exchange rate and external balance volatility.
AUTHORS: Kollmann, Robert
Oil, Volatility and Institutions: Cross-Country Evidence from Major Oil Producers
This paper examines the long-run effects of oil revenue and its volatility on economic growth as well as the role of institutions in this relationship. We collect annual and monthly data on a sample of 17 major oil producers over the period 1961-2013, and use the standard panel autoregressive distributed lag (ARDL) approach as well as its cross-sectionally augmented version (CS-ARDL) for estimation. Therefore, in contrast to the earlier literature on the resource curse, we take into account all three key features of the panel: dynamics, heterogeneity and cross-sectional dependence. Our results suggest that (i) there is a significant negative effect of oil revenue volatility on output growth, (ii) higher growth rate of oil revenue significantly raises economic growth, and (iii) better fiscal policy (institutions) can offset some of the negative effects of oil revenue volatility. We therefore argue that volatility in oil revenues combined with poor governmental responses to this volatility drives the resource curse paradox, not the abundance of oil revenues as such.
AUTHORS: El-Anshasy, Amany; Mohaddes, Kamiar; Nugent, Jeffrey B.
Do Sovereign Wealth Funds Dampen the Negative Effects of Commodity Price Volatility?
This paper studies the impact of commodity terms of trade (CToT) volatility on economic growth (and its sources) in a sample of 69 commodity-dependent countries, and assesses the role of Sovereign Wealth Funds (SWFs) and quality of institutions in their long-term growth performance. Using annual data over the period 1981-2014, we employ the Cross-Sectionally augmented Autoregressive Distributive Lag (CS-ARDL) methodology for estimation to account for cross-country heterogeneity, cross-sectional dependence, and feedback effects. We find that while CToT volatility exerts a negative impact on economic growth (operating through lower accumulation of physical capital and lower TFP), the average impact is dampened if a country has a SWF and better institutional quality (hence a more stable government expenditure).
AUTHORS: Mohaddes, Kamiar; Raissi, Mehdi
Risk sharing in a world economy with uncertainty shocks
This paper analyzes the effects of output volatility shocks and of risk appetite shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country world with recursive preferences and complete financial markets. When the risk aversion coefficient exceeds the inverse of the intertemporal substitution elasticity, then an exogenous rise in a country?s output volatility triggers a wealth transfer to that country, in equilibrium; this raises its consumption, lowers its trade balance and appreciates its real exchange rate. The effects of risk appetite shocks resemble those of volatility shocks. In a recursive preferences-complete markets framework, volatility and risk appetite shocks account for a noticeable share of the fluctuations of net exports, net foreign assets and the real exchange rate. These shocks help to explain the high empirical volatility of the real exchange rate and the disconnect between relative consumption growth and the real exchange rate.
AUTHORS: Kollmann, Robert
Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel
The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-traded good, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand-determined employment under rigid wages). Recursive intertemporal preferences magnify the terms of trade response to country-specific shocks. Hence, a productivity (and GDP) increase in a given country triggers a strong improvement of the foreign country?s terms of trade, which raises foreign labor demand. With a muted labor wealth effect, foreign labor and GDP rise, i.e. domestic and foreign real activity commove positively.
AUTHORS: Kollmann, Robert
The Propagation of Regional Shocks in Housing Markets: Evidence from Oil Price Shocks in Canada
Shocks to the demand for housing that originate in one region may seem important only for that regional housing market. We provide evidence that such shocks can also affect housing markets in other regions. Our analysis focuses on the response of Canadian housing markets to oil price shocks. Oil price shocks constitute an important source of exogenous regional variation in income in Canada because oil production is highly geographically concentrated. We document that, at the national level, real oil price shocks account for 11% of the variability in real house price growth over time. At the regional level, we find that unexpected increases in the real price of oil raise housing demand and real house prices not only in oil-producing regions, but also in other regions. We develop a theoretical model of the propagation of real oil price shocks across regions that helps understand this finding. The model differentiates between oil-producing and non-oil-producing regions and incorporates multiple sectors, trade between provinces, government redistribution, and consumer spending on fuel. We empirically confirm the model prediction that oil price shocks are propagated to housing markets in non-oil-producing regions by the government redistribution of oil revenue and by increased interprovincial trade.
AUTHORS: Kilian, Lutz; Zhou, Xiaoqing
Argentina’s “Missing Capital” Puzzle and Limited Commitment Constraints
Capital accumulation in Argentina was slow in the 1990s, despite high total factor productivity (TFP) growth and low international interest rates. A possible explanation for the ?missing capital? is that foreign investors were reluctant to take advantage of the high returns to investment seemingly offered by that small open economy under such favorable conditions, on the grounds that previous historical developments had led them to perceive Argentina as a country prone to external debt ?opportunistic defaults.? The paper examines this conjecture from the perspective of an optimal contract between foreign lenders and a small open economy subject to limited commitment constraints. Numerical experiments for a deterministic version of that analytical framework show that limited commitment constraints introduce an asymmetry to the capital accumulation process of small open economies: the responses of investment to positive TFP shocks are muted and shortlived, while those to negative TFP shocks are large and persistent. Furthermore, under some circumstances, a lower international interest rate environment can magnify the asymmetry. A quantitative implementation of the model economy to data from Argentina accounts, in line with asymmetry just described, for the rapid decline that that country?s capital stock experienced, along with a falling TFP during the 1980s, as well as for the lack of any visible recovery of that stock during the significant surges of TFP observed between 1992-1998 and 2002-2008. In the absence of the limited commitment constraint, Argentina?s capital stock in 2008 would have been 50% higher than it actually was.
AUTHORS: Kapicka, Marek; Kydland, Finn E.; Zarazaga, Carlos E.
Markups and misallocation with trade and heterogeneous firms
With non-homothetic preferences, a monopolistic competition equilibrium is inefficient in the way inputs are allocated towards production. This paper quantifies a gains from trade component that is present only when reallocation is properly measured in a setting with heterogeneous firms that charge variable markups. Due to variable markups, reallocations initiated by aggregate shocks impact allocative efficiency depending on the adjustment of the market power distribution. My measurement compares real income growth with the hypothetical case of no misallocation in quantities. Using firm and industry-level data from Chile during a period with large terms of trade gains, I find that cost reductions are associated with losses in allocative efficiency because firms pass-through measured productivity gains into markups. From industry-year variation, there is also evidence that industries that import a larger share of their inputs become more misallocated as a result of exchange rate appreciations compared to open sectors whose output competition becomes fiercer.
AUTHORS: Weinberger, Ariel
The quantitative role of capital-goods imports in U.S. growth
Over the last 40 years, an increasing share of U.S. aggregate E&S investment expenditure has been allocated to capital-goods imports. While capital-goods imports were only 3.5 percent of E&S investment in 1967, by 2008 their share had risen tenfold to 36 percent. The goal of this paper is to measure the contribution of capital-goods imports to growth in U.S. output per hour using a simple growth accounting exercise. We find that capital-goods imports have contributed 20 to 30 percent to growth in U.S. output per hour between 1967 and 2008. More importantly, we find that capital-goods imports have been an increasing source of growth for the US economy: the average contribution of capital-goods imports to growth in U.S .output per hour has increased noticeably since 1967.
AUTHORS: Cavallo, Michele; Landry, Anthony E.
Innovation and Trade Policy in a Globalized World
How do import tariffs and R&D subsidies help domestic firms compete globally? How do these policies affect aggregate growth and economic welfare? To answer these questions, we build a dynamic general equilibrium growth model where firm innovation endogenously determines the dynamics of technology, market leadership, and trade flows, in a world with two large open economies at different stages of development. Firms? R&D decisions are driven by (i) the defensive innovation motive, (ii) the expansionary innovation motive, and (iii) technology spillovers. The theoretical investigation illustrates that, statically, globalization (defined as reduced trade barriers) has ambiguous effects on welfare, while, dynamically, intensified globalization boosts domestic innovation through induced international competition. Accounting for transitional dynamics, we use our model for policy evaluation and compute optimal policies over different time horizons. The model suggests that the introduction of the Research and Experimentation Tax Credit in 1981 proves to be an effective policy response to foreign competition, generating substantial welfare gains in the long run. A counterfactual exercise shows that increasing tariffs as an alternative policy response improves domestic welfare only when the policymaker cares about the very short run, and only when introduced unilaterally. Tariffs generate large welfare losses in the medium and long run, or when there is retaliation by the foreign economy. Protectionist measures generate large dynamic losses by distorting the impact of openness on innovation incentives and productivity growth. Finally, our model predicts that a more globalized world entails less government intervention, thanks to innovation-stimulating effects of intensified international competition.
AUTHORS: Akcigit, Ufuk; Ates, Sina T.; Impullitti, Giammario