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The Centre for Growth and Business Cycle Research

Discussion papers 2009

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Blackburn, K.,Wang, Y., (2009). 'Uncertainty, Entrepreneurship and the Organisation of Corruption', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 133.

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We develop a model of occupational choice in which private agents have the option of either working in some costless, but low-yielding, activity (subsistence production), or undertaking a costly, but potentially more rewarding, venture (entrepreneurship). In the case of the latter, loans must be acquired from financial intermediaries and licenses must be obtained from public officials. Associated with these tasks are two potential sources of imperfection - an imperfection in financial markets due to asymmetric information and an imperfection in governance due to rent-seeking. Rent-seeking is risky because of a random probability that it will be detected and punished. Against this background, we show how corruption has different effects depending on the way that it is practised: in the case of disorganised corruption, bribe payments are uncertain and capital market imperfections are allowed to surface; in the case of organised corruption both of these features are removed. The implication is that, in terms of deterring entrepreneurial activity, organised corruption is likely to be the lesser of the two evils, even if bribe demands are higher in this case. This result may be used to explain the puzzle of why corruption appears to be much less damaging in some countries than in others.

Bataa, E., Osborn, D., Sensier, M., van Dijk, D., (2009). 'Changes in International Business Cycle Affiliations', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 132.

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We investigate changes in international business cycle affiliations using an iterative procedure for detecting system-wide structural breaks. We analyze GDP growth rates in two systems, one with the US, Euro-area, UK and Canada and the other for the Euro-area countries of France, Germany and Italy. We discover that international dynamic interactions change in both the mid-1980s and early 1990s, with such changes being particularly important for studying influences on the aggregate Euro-area. However, contemporaneous (conditional) correlations between these Euro-area countries increase in 1984 and 1998, with a large increase in correlations also evident across the international system during the 1990s.

Chouliarakis, G., Correa-López, M.,(2009). Catching-up, then Falling Behind: Comparative Productivity Growth between Spain and the United Kingdom, 1950-2004', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 131.

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The pattern of Spanish comparative labour productivity performance in the period 1950-2004 is underpinned by distinctive sectoral trends. From 1950 until the mid-1970s, Spain narrowed the aggregate labour productivity gap with Britain by shifting resources out of agriculture and by improving its comparative labour productivity position across most sectors, out of which manufacturing plays a central role. Significant improvements in comparative efficiency and the dynamic pace of comparative capital intensity characterize the catch-up phase. In the period 1975-1990 convergence stagnates. In spite of the continual shift of resources out of agriculture and the good comparative performance of small sectors, such as utilities, transport and communication, and agriculture itself, comparative labour productivity was adversely affected by the catching-up exhaustion of manufacturing and construction and by the deterioration of comparative labour productivity in services. A dramatic slowdown in efficiency gains characterizes the plateau phase. Lastly, Spain has widened the aggregate labour productivity gap since the early 1990s. The deterioration of Spain's relative productivity position with Britain has affected all sectors except agriculture. Efficiency stagnation characterizes the divergence phase.

Chouliarakis, G., Correa-López, M.,(2009). 'A Fair Wage Model of Unemployment with Inertia in Fairness Perceptions', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 130.

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Theories of psychology and empirical evidence suggest that the reference transactions against which workers judge fairness exhibit inertia. This paper shows that a fair-wage model with inertia in fairness perceptions provides a plausible explanation for the observed negative correlation between changes in productivity growth and equilibrium unemployment over the medium run, a stylized fact that remains elusive to most other classes of models. It also shows that skillbiased productivity shocks and shocks to workers’ taste for equal pay have permanent effects on unemployment and the skill premium. Our quantitative results suggest that the effect of these shocks can be sizeable.

Chouliarakis, G.,(2009). 'Coping with Uncertainty: Historical and Real-Time Estimates of the Natural Unemployment Rate and the UK Monetary Policy',Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 129.

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The paper derives and compares historical and real-time estimates of the UK natural unemployment rate and shows that real-time estimates are fraught with noise and should be treated with scepticism. A counterfactual exercise shows that, for most of the 1990s, the Bank of England tracked changes in the natural rate relatively successfully, albeit with some recognition lag which, at times, might have led to excessively cautious policy. A careful scrutiny of the minutes of the monetary policy committee meetings reveals that such ‘cautiousness’ should be taken as evidence of awareness of the real-time informational limitations that monetary policy is facing.

Herranz, N., Krasa, S., Villamil, A.P.,(2009). 'Entrepreneurs, Legal Institutions and Firm Dynamics', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 128.

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This paper assesses quantitatively the impact of legal institutions on entrepreneurial firm dynamics. Owners choose firm size, financial structure and default to manage risk. We find: (i) Less risk averse entrepreneurs run bigger firms and it is optimal for them to incorporate, while more risk averse entrepreneurs run smaller firms and generally are better off remaining unincorporated. (ii) More risk-averse owners tend to default more often than the less risk averse, though they carry less debt. (iii) The model estimates a credit constraint, which binds for many but not all entrepreneurs and matches bank lending criteria. The model also finds modest differences in owner risk aversion, consistent with micro studies.

Hall, A.R., Inoue, A., Nason, J.M., Rossi, B.,(2009).' Information Criteria for Impulse Response Function Matching Estimation of DSGE Models', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 127.

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We are grateful to Mehmet Caner, Manfred Deistler, John Einmahl, Atsushi Inoue and Denise Osborn for their comments, as well as for the comments of participants at the presentation of this paper at the Conference on Breaks and Persistence in Econometrics, London, UK, December 2006, Inference and Tests in Econometrics, Marseille, France, April 2008, European Meetings of the Econometric Society, Milan, Italy, August 2008, NBER-NSF Time Series Conference, Aarhus, Denmark, September 2008, Fed St. Louis Applied Econometrics and Forecasting in Macroeconomics Workshop, St. Louis, October 2008, and at the seminars in Tilburg University, University of Manchester, University of Exeter, University of Cambridge, University of Southampton, Tinbergen Institute, UC Davis and Institute for Advanced Studies, Vienna. The second author acknowledges the support of ESRC grant RES-062-23-1351.

Boldea, O., Hall, A.R.,(2009). 'Estimation and Inference in Unstable Nonlinear Least Squares Models ', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 126.

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We are grateful to Mehmet Caner, Manfred Deistler, John Einmahl, Atsushi Inoue and Denise Osborn for their comments, as well as for the comments of participants at the presentation of this paper at the Conference on Breaks and Persistence in Econometrics, London, UK, December 2006, Inference and Tests in Econometrics, Marseille, France, April 2008, European Meetings of the Econometric Society, Milan, Italy, August 2008, NBER-NSF Time Series Conference, Aarhus, Denmark, September 2008, Fed St. Louis Applied Econometrics and Forecasting in Macroeconomics Workshop, St. Louis, October 2008, and at the seminars in Tilburg University, University of Manchester, University of Exeter, University of Cambridge, University of Southampton, Tinbergen Institute, UC Davis and Institute for Advanced Studies, Vienna. The second author acknowledges the support of ESRC grant RES-062-23-1351.

Hall, A.R., Han, S., Boldea, O.,(2009). 'Inference Regarding Multiple Structural Changes in Linear Models with Endogenous Regressors ', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 125.

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We are grateful to Denise Osborn and Eric Renault for valuable comments and to Nikolaos Sakkas for assistance with the computations. The paper has also benefited from the comments of a co-editor and three anonymous referees. An earlier version of this paper was circulated under the title “Inference regarding multiple structural changes in linear models estimated via 2SLS” which was presented at the World Congress of the Econometric Society, London, August 19-24, 2005, the Triangle Econometrics Conference, RTP, NC, December 2, 2005, CIREQ Conference on Generalized Method of Moments, Montreal, November 16-17, 2007, the ESRC Econometrics group seminar at the Institute of Fiscal Studies, London, the London-Oxbridge Time Series Workshop and at seminars at Erasmus University and the Universities of Birmingham and Warwick. We are also very grateful to Chengsi Zhang and Denise Osborn for providing us with the data used in the empirical example. The first author acknowledges the support of the ESRC grant RES-062-23-1351.

Agénor, P-R., Alper, K., Pereira da Silva, L., (2009). 'Capital Requirements and Business Cycles with Credit Market Imperfections', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 124.

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The business cycle effects of bank capital regulatory regimes are examined in a New Keynesian model with credit market imperfections and a cost channel of monetary policy. A key feature of the model is that bank capital increases incentives for banks to monitor borrowers, thereby reducing the probability of default. Basel I- and Basel II-type regulatory regimes are defined, and the model is calibrated for a middle-income country. Numerical simulations show that, depending on the elasticities that relate the repayment probability to its micro and macro determinants, and the elasticity of the risk weight (under Basel II) with respect to the repayment probability, Basel I may be more procyclical than Basel II in response to adverse supply and demand shocks.

Amarasekara, C., and Bratsiotis, G.J., (2009). 'Monetary Policy and Real Wage Cyclicality', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 122.

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Several recent studies highlight the potential bias that may arise in measuring real wage cyclicality. This paper points to the important role of monetary policy in determining the latter. Using a simple model that diverts its focus from relative nominal price and wage rigidities, we show that other things kept equal, the degree and direction of real wage cyclicality is determined by the interaction of (i) the returns to scale in production, (ii) the nature of aggregate shocks, and (iii) monetary policy. Given that production technology is fairly constant in the short run, we suggest that variations in the real wage-output covariance depend largely on the latter two. Empirical evidence from eight major OECD countries appears to be consistent with this claim.

Dungey, M., Osborn, D.R., (2009). 'Modelling International Linkages for Large Open Economies: US and Euro Area', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 121.

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Empirical modelling of the international linkages between the Euro Area and the US requires an open economy specification. This paper proposes and implements a structural VECM framework which imposes long run and short run cross-economy restrictions based on theoretically motivated restrictions and empirically supported dominance assumptions. The SVECM distinguishes between permanent and temporary shocks in a system where one cross-economy cointegrating relationship links output levels. In addition, the short run dynamics incorporate both contemporaneous interactions and feedbacks between the two economies. Importantly, greater empirical coherence is obtained by allowing for more direct inflationary effects between the two economies than considered in other recent analyses. Estimated using data from 1983Q1 to 2007Q4, the results demonstrate the cross-country impact of shocks. Although US shocks generally produce stronger effects, nevertheless some shocks originating in the Euro Area have significant effects on the US, particularly for inflation and interest rates.

Agénor, P-R., Alper, K., (2009). 'Monetary Shocks and Central Bank Liquidity with Credit Market Imperfections', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 120.

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This paper analyzes the transmission process of monetary policy in a closed-economy New Keynesian model with monopolistic banking, credit market imperfections, and a cost channel. Lending rates incorporate a risk premium, which depends on firms' net worth and cyclical output. The supply of bank loans is perfectly elastic at the prevailing bank rate and so is the provision of central bank liquidity at the official policy rate. The model is calibrated for a middle-income country. Numerical simulations show that credit market imperfections and sluggish adjustment of bank deposit rates (rather than lending rates) may impart a substantial degree of persistence in the response of output and inflation to monetary shocks.

Bataa, E., Osborn, D., Sensier, M., van Dijk, D., (2009). 'Structural Breaks in the International Transmission of Inflation', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 119.

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To shed light on changes in international inflation, this paper proposes an iterative procedure to discriminate between structural breaks in the coefficients and the disturbance covariance matrix of a system of equations, allowing these components to change at different dates. Conditional on these, recursive procedures are proposed to analyze the nature of change, including tests to identify individual coefficient shifts and to discriminate between volatility and correlation breaks. Using these procedures, structural breaks in monthly cross-country inflation relationships are examined for major G-7 countries (US, Euro area, UK and Canada) and within the Euro area (France, Germany and Italy). Overall, we find few dynamic spillovers between countries, although the Euro area leads inflation in North America, while Germany leads France. Contemporaneous inflation correlations are generally low in the 1970s and early 1980s, but inter-continental correlations increase from the end of the 1990s, while Euro area countries move from essentially idiosyncratic inflation to co-movement in the mid-1980s.

Artis, M., Dreger, C., Kholodilin, K., (2009). 'Common and spatial drivers in regional business cycles', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 118.

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We examine real business cycle convergence for 41 euro area regions and 48 US states. Results obtained by a panel model with spatial correlation indicate that the relevance of common business cycle factors is rather stable over the past two decades in the euro area and the US. Ongoing business cycle convergence often detected in cross-country data is not confirmed at the regional level. The degree of synchronization across the euro area is similar to that to be found for the US states. Thus, the lack of convergence does not seem to be an impediment to a common monetary policy.

Berardi, M., (2009). 'Escape Dynamics and Policy Specification', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 117.

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In his monograph The conquest of American inflation (1999) Sargent suggests that the sharp reduction in US inflation that took place under Volker may vindicate the type of econometric policy evaluation famously criticized by Lucas (1976). At the core of this vindication story are the escape dynamics, recurrent sliding away from the path leading to the time-consistent sub-optimal equilibrium level of inflation. We try to understand here under which conditions this phenomenon arises. In particular, we note that economists, and consequently policymakers, knew long before the Lucas critique that in order to do policy analysis structural models were required. We thus endow our policymaker with a correctly specified model, one that takes explicitly into account the role of expectations. Using such a model, together with a policy that takes expectations as given, the escape dynamics do not appear. But they reappear when long run considerations of policy effects enter into the picture. We thus conclude that what really matters is the way in which the policymaker designs its policy, rather than the econometric specification of the model he uses.

Agénor, P-R., Agénor, M., (2009). 'Infrastructure, Women’s Time Allocation, and Economic Development', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 116.

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This paper develops a gender-based OLG model of endogenous growth to analyze the impact of infrastructure on women’s time allocation between market work, raising children, own health care, home production, and leisure. Gender bias occurs as a result of firms discriminating between men and women, and of mothers devoting relatively more time to rearing their sons. Women’s health status in adulthood, which affects productivity and wages, depends on their health status in childhood. A stagnation equilibrium and multiple development regimes are derived. An increase in productive government spending may shift the economy to a high-growth equilibrium, in a process involving changes in life expectancy, fertility, and a reallocation of women’s time.

Agénor, P-R., (2009). 'Public Capital, Health Persistence and Poverty Traps', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 115.

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Growth dynamics and health outcomes are studied in a three period overlapping generations model with public capital. Reproductive agents face a non-zero probability of death in both childhood and adulthood. In addition to working, adults allocate time to their own health and child rearing. Health status in adulthood depends on health in childhood. With partial persistence in health, pure stagnation may occur. With full persistence, a stagnating equilibrium with low growth and high fertility may result from poor access to public capital. With threshold effects in health status, multiple growth regimes may emerge. A reallocation of public spending toward health or infrastructure may shift the economy from a low-growth equilibrium to a high-growth, low-fertility steady state.

Haque M.E., Neanidis K.C., (2009). 'Fiscal Transparency and Corruption', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 114.

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This paper tests the proposition that fiscal transparency, measured by a newly constructed data on budget openness, can be a powerful control on corruption. This result is robust to the choice of index of corruption, conditioning variables, country sample, exclusion of outliers, and the use of different instrumentation and estimation techniques.

Neanidis K.C., Savva C.S., (2009). 'Financial Dollarization: Short-Run Determinants in Transition Economies', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 113.

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This paper examines the determinants of financial dollarization in transition economies from a short-run perspective. Using monthly data of deposit and loan dollarization we study the drivers of short-term fluctuations in dollarization and test their importance at different levels of dollarization. The results provide evidence that (a) the positive short-run effects of depreciation on deposit dollarization are exacerbated in high-dollarization countries; (b) short-run loan dollarization is mainly driven by banks matching of domestic loans and deposits, international financial integration, and institutional quality; and (c) both types of dollarization are affected by interest rate differentials and deviations from desired dollarization.

Berardi, M., (2009). 'Expectations, learning and policy rule', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 112.

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The optimal discretionary policy rule in the New Keynesian forwardlooking model under the hypothesis of rational expectations responds only to fundamental shocks. This leads to indeterminacy of equilibria and E-unstability of the MSV REE. The outcome can be improved by responding to private expectations. This requires the Central Bank to be able to observe those expectations, or to precisely estimate them. It has also been shown in the literature that when the private sector doesn’t have RE and instead is trying to learn the structure of the economy from data, the policymaker should implement a more aggressive policy. In light of these considerations, we ask how a policymaker that responds only to fundamental shocks should change its response when private expectations depart from rationality. In addition, we show that a policy rule that adequately takes into account the learning process of agents while responding only to fundamentals can obtain the same results as an expectations based policy rule.