Discussion papers 2002
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Bratsiotis, G. J.and Martin, C. (2002). ‘Monetary Policy Rules, Real Rigidity and Endogenous Persistence’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 24.
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The bulk of literature on real rigidity attempts to identify sources of real rigidity in market imperfections while assuming that the money supply is exogenously set. This paper shows that monetary policy preferences affect the responsiveness of marginal cost to output and through this channel they are shown to determine (i) the degree of real rigidity and (ii) the degree of endogenous persistence. We find that substantial levels of real rigidity and persistence can be generated using plausible monetary parameter values and without relying on additional sources of real rigidity.
Bratsiotis, G. J.and Robinson, W. (2002). ‘Economic Fundamentals and Self-Fulfilling Crises: Some Evidence from Mexico’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 23. Published in Journal of International Money and Finance, vol. 23(4), pp. 595-613.
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This paper considers a model of debt stabilitisation under a fixed exchange rate in which a currency crisis can develop as the result of self-fulfilling speculation, following a bifurcation in the behaviour of economic fundamentals. Based on this theoretical framework and by exploiting the test developed by Jeanne (1997), this paper provides evidence that self-fulfilling speculation was at work in the 1994 Mexican crisis. In terms of fundamentals, we show that the critical variables in generating the Mexican crisis were the fast rise in the US$-denominated public debt (tesebonos), the appreciated real exchange rate and the small rises in unemployment and primary deficit.
Blackburn, K., Bose, N. and Haque, M. E. (2002). ‘Endogenous Corruption in Economic Development’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 22.
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This paper presents an analysis of the joint determination of bureaucratic corruption and economic development. The analysis is based on a simple neo-classical growth model in which bureaucrats are employed as agents of the government to collect taxes from households. Corruption is reflected in bribery and tax evasion as bureaucrats conspire with households to provide false information to the government. Costly concealment of this activity leads to a loss of resources available for productive investments. The incentive for an individual bureaucrat to accept a bribe depends on the number of other bureaucrats who are expected to accept bribes. This strategic interaction in bureaucratic decision making produces multiple (frequency-dependent) equilibria associated with different incidences of corruption. The predictions of the model accord strongly with recent empirical evidence.
Kaas, L. and Madden, P. (2002). ‘Equilibrium Involuntary Unemployment Under Oligempory’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 21.
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We show that equilibrium involuntary unemployment emerges in a multi–stage game model where all market power resides with firms, on both the labour and the output market. Firms decide wages, employment, output and prices, and under constant returns there exists a continuum of subgame perfect Nash equilibria involving unemployment and positive profits. A firm does not undercut the equilibrium wage since then high wage firms would attract its workers, thus forcing the undercutting firm out of both markets. Full employment equilibria are payoff dominated by unemployment equilibria, and the arguments are robust to decreasing returns.
Kaas, L. and Madden, P. (2002). ‘Imperfectly Competitive Cycles with Keynesian and Walrasian Features’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 20.
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We consider a multi–sector overlapping generations model with oligopolistic firms in the output markets and wage–setting trade unions in the labour markets. A coordination problem between firms creates multiple temporary equilibria which are either Walrasian or of the Keynesian unemployment type. There exist many deterministic and stochastic equilibrium cycles fluctuating between Keynesian recession and Walrasian boom periods with arbitrarily long phases in each regime. The cycles are in accordance with certain empirical regularities. Money is neutral and superneutral, but appropriate countercyclical fiscal policies stabilize the cycles in a textbook Keynesian way.
Kaas, L. and Madden, P. (2002). ‘Competitive Wage Cycles with Imperfect Output Market Competition’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 19.
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We consider a model of a sector in which the same set of oligopolistic firms faces a common labour supply constraint. The wage is given in the short run, adjusting competitively in the longer run. When the costs of job creation are low relative to the degree of output market power, there exists no wage that clears the labour market in the short run, and at some wages there are two equilibria, one with involuntary unemployment and one with unfilled vacancies. The competitive wage dynamics produces a cycle with persistent labour market disequilibrium and recurrent periods of involuntary unemployment.
Kim, D.H., Osborn, D. R. and Sensier, M. (2002). ‘Nonlinearity in the Fed's Monetary Policy Rule’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 18. Forthcoming in Journal of Applied Econometrics.
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This paper investigates the nature of nonlinearities in the monetary policy rule of the US Fed using the flexible approach of Hamilton (2001). We find that while there is significant evidence of nonlinearity for the period to 1979, there is little such evidence for the subsequent period. Possible asymmetry in the Fed's reactions to inflation deviations from target and the output gap in the 1960s and 70s may tell part of the story, but do not capture the entire nature of the nonlinearity. The inclusion of the interaction between inflation deviations and the output gap, as recently proposed, appears to characterize the nonlinear policy rule more adequately.
Artis, M. (2002). ‘Dating the Business Cycle in Britain’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 17. Published in National Institute Economic Review, October 2002, no. 182, pp. 90-95.
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van Dijk, D., Osborn, D. R. and Sensier, M. (2002). ‘Changes in Variability of the Business Cycle in the G7 Countries’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 16.
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Volatility breaks are tested and documented for 19 important monthly macroeconomic time series across the G7 countries. Across all conditional mean specifications considered, including both linear and nonlinear models with and without a structural break, volatility breaks are found to be widespread. This continues to hold when business cycle nonlinearities are allowed in the variance. Multiple volatility breaks are also examined, and these are found to be especially prevalent for short-term interest rates. Volatility breaks in industrial production and consumer prices are largely synchronous across the G7. The facts established are discussed in the context of some explanations put forward in the literature to explain volatility breaks previously found for US series.
Osborn, D. R. and Sensier, M. (2002). ‘The Prediction of Business Cycle Phases: Financial Variables and International Linkages’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 15. Published in National Institute Economic Review, October 2002, no. 182, pp. 96-105.
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This paper discusses recent research at the Centre for Growth and Business Cycle Research on the prediction of the expansion and recession phases of the business cycle for the UK, US, Germany, France and Italy. Financial variables are important predictors in these models, with the stock market playing a key role in the US but not the European countries, including the UK. In contrast, international linkages are important for the European countries. Our models suggest that the US and German economy have now emerged from the recession of 2001, and that all five countries will be in expansion during the third quarter of this year.
Blackburn, K. and Cipriani, G.P. (2002). ‘Intergenerational Transfers and Demographic Transition’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 14. Forthcoming in Journal of Development Economics.
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This paper presents an analysis of demographic transition based on the endogenous evolution of intergenerational transfers along an economy's endogenous path of development. Two-period-lived agents belonging to overlapping generations choose optimally their desired levels of consumption and fertility, together with their desired sizes of transfers to both parents and children. Parents are more efficient than children in producing output, but some parental time must be devoted to child-rearing. At low levels of development, fertility is high and the flow of net intergenerational transfers is from the young to the old. At high levels of development, fertility is low and the flow of net transfers is from the old to the young. These results accord strongly with empirical observations and the analysis may be seen as formalising, for the first time, a long-standing and well-respected hypothesis in the demographic transition literature.
Blackburn, K. and Issa, H. (2002) ‘Endogenous Life Expectancy in a Simple Model of Growth’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 13.
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In an overlapping generations economy reproductive agents mature safely through two periods of life and face an endogenous probability of surviving for a third period. Given this probability, which depends on aggregate outcomes, each agent maximises her expected lifetime utility by choosing consumption and savings. The dynamic general equilibrium of the economy is characterised by multiple development regimes associated with different levels of economic activity and different rates of life expectancy. Transition between these regimes may or may not occur depending on parameter values and initial conditions.
Blackburn, K. and Pelloni, A. (2002). ‘Growth, Cycles and Stabilisation Policy’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 12. Oxford Economic Papers.
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This paper presents an analysis of the joint determination of growth and business cycles with the view to studying the long-run implications of short-term monetary stabilisation policy. The analysis is based on a simple stochastic growth model in which both real and nominal shocks have permanent effects on output due to nominal rigidities (wage contracts) and an endogenous technology (learning-by-doing). It is shown that there is a negative correlation between the mean and variance of output growth irrespective of the source of fluctuations. It is also shown that, in spite of this, there may exist a conflict between short-term stabilisation and long-term growth depending on the type of disturbance. Finally, it is shown that, from a welfare perspective, the optimal monetary policy is that policy which maximises long-run growth to the exclusion of stabilisation considerations.
Sensier, M., Artis, M., Birchenhall, C. R., and Osborn, D. R. (2002). ‘Domestic and International Influences on Business Cycle Regimes in Europe’,Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 11. Published in International Journal of Forecasting, 2004, vol. 20, pp. 343-357.
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This paper examines the roles of domestic and international variables in predicting classical business cycle regimes in Germany, France, Italy and the UK over the period 1970 to 2001. A range of real and financial variables are used as leading indicators in domestic models, with these variables predicting regimes in Germany relatively well during the in-sample period to 1996, followed (in order) by the UK, Italy and France. Consideration of foreign variables leads to important roles for the composite leading indicators and interest rates of the US and Germany. The relative importance of these variables differs over countries, but overall they confirm the importance of international influences in the business cycles of these European countries. Three-months ahead post-sample forecasts are examined, with the international model for Germany correctly indicating recession during 2001.
Sensier, M., Osborn, D. R. and Öcal, N. (2002). ‘Asymmetric Interest Rate Effects for the UK Real Economy’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 10. Published in Oxford Bulletin of Economics and Statistics, September 2002, vol. 64, no. 4, pp. 315-339.
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Recent literature has uncovered asymmetries in the response of real output to monetary policy variables. Nevertheless, it remains unclear whether such asymmetries relate to different responses to monetary policy or to the business cycle. This paper uses nonlinear models to examine the issues in the context of interest rate effects on quarterly UK GDP growth. Strong evidence of nonlinearity is found, with asymmetry relating to the business cycle through lagged GDP regimes and interest rate changes. The results suggest that interest rate effects on GDP are larger when either lagged growth has been high or when interest rates have substantially increased in the past. However, the inclusion of interest rate regimes without taking account of GDP regimes yields an unsatisfactory model.
Kim, D. H. (2002).‘Another look at yield spreads: The role of liquidity’, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 4.
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Liquidity plays an important role in explaining how banks determine their allocation of funds. This paper examines whether this fact can explain yield spreads and the term structure of interest rates. The paper models banks’ demand for liquidity in a manner similar to that used to study household need for liquidity, namely, by using a cash-in-advance type model. The paper finds that the shadow price of the cash-in-advance constraint plays an important role in determining yield spreads. The empirical part of the paper shows that the expectations hypothesis might be salvaged under the maintained hypothesis concerning the liquidity premium and risk premium.
Barrios, S., Brülhart, M., Elliott, R.J.R. and Sensier, M. (2002). ‘A Tale of Two Cycles: Co-fluctuations Between UK Regions and the Euro Zone’,Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 3. Published in The Manchester School, 2003, vol. 71 (3), pp. 265-292.
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We examine the patterns and determinants of business-cycle correlations among eleven UK regions and six euro-zone countries over the 1966-1997 period, using GMM to allow for sampling error in comparing estimated correlations. The British business cycle is found to be persistently out of phase with that of the main euro-zone economies, and the trend is towards lower correlations. We detect only minor cyclical heterogeneity among UK regions. Differences in sectoral specialisation drive some of the asymmetry in GDP fluctuations, but they do not appear significant in explaining the observed reduction in UK-EU business-cycle correlations over time.