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The Centre for Growth and Business Cycle Research

Discussion papers 2015

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Ahsan, H., Haque, M.E, (2015). 'Threshold Effects of Human Capital: Schooling and Economic Growth', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 217.

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Many recent studies have found average years of schooling to be unrelated with economic growth. In this note, we show that the significant positive effect of schooling can only be realised after an economy crosses a threshold level of development.

Agénor, P-R., Pereira da Silva, L.,(2015). 'Cyclically Adjusted Provisions and Financial Stability', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 216.

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This paper studies the extent to which alternative loan loss provisioning regimes affect the procyclicality of the financial system and financial stability. It uses a DSGE model with financial frictions (namely, balance sheet and collateral effects, as well as economies of scope in banking) and a generic formulation of provisioning regimes. Numerical experiments with a parameterized version of the model show that cyclically adjusted (or, more commonly called, dynamic) provisioning can be highly effective in terms of mitigating procyclicality and financial instability, measured in terms of the volatility of the credit-output ratio and real house prices, in response to financial shocks. The optimal combination of simple cyclically adjusted provisioning and countercyclical reserve requirements rules is also studied. The simultaneous use of these instruments does not improve the ability of either one of them to mitigate financial instability, making them partial substitutes rather than complements.

Neanidis, K.C. (2015). 'Volatile Capital Flows and Economic Growth: The Role of Macro-prudential Regulation', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 215.

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In this paper, we examine the links among macro-prudential regulation, the volatility of financial flows, and economic growth. In particular, we explore whether macroprudential regulation mitigates the adverse effects of capital flows volatility on economic growth. Using cross-country data for the period 1973-2013, we find that macroprudential regulation promotes economic growth by reducing the negative impact of volatile capital flows. The findings hold for both aggregate capital flows and their various components, while they are also robust for various indicators of macro-prudential policies. The results support the argument that macro-prudential policy rules designed to ensure financial stability are beneficial to long-run economic growth.

Berardi, M., (2015). 'Prices, fundamental values and learning', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 214.

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In this paper we show how uncertainty and learning about fundamental values can lead to excess volatility in prices and to volatility clustering in returns, as observed on real markets. The key assumption is that agents use prices, besides an exogenous signal on long run dividends, to infer fundamental values: as the relative weight on the two signals changes endogenously through learning, price dynamics are affected. In particular, periods of high volatility are periods where agents rely more heavily on prices in predicting fundamentals.

Lim, K.Y., (2015). 'Industrial Transformation with Heterogeneous FDI and Human Capital', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 213.

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This paper examines industrial transformation using an imitation-innovation growth model with a stylised internalisation framework developed to determine the composition of heterogeneous foreign multinationals in a developing host economy. A key feature of the model is the introduction of a dichotomous relationship between domestic and foreign firms, where the latter, each of which consisting of an expert bringing either standardisation or sophisticated know-how, perceives heterogeneity among the productivity of domestic workers. Productivity is a transformation of ability, hence linking the skills acquisition decision and foreign subsidiaries' operational mode choice along the same ability distribution. Calibrated for Malaysia, the simulations uncover complementarities between labour market and FDI-promoting policies. These complementarities are stronger in an environment with endogenous technological change.

Agénor, P-R., Jia, P., (2015). 'Capital Controls and Welfare with Cross-Border Bank Capital Flows', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 212.

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This paper studies the performance of time-varying capital controls on cross-border bank borrowing in an open-economy, dynamic stochastic general equilibrium model with credit market frictions and imperfect capital mobility. The model is calibrated for a middle-income country and is shown to replicate the main stylized facts associated with a fall in world interest rates (capital inflows, real appreciation, credit boom, asset price pressures, and output expansion). A capital controls rule, which is fundamentally macroprudential in nature, is defined in terms of either changes in bank foreign borrowing or cyclical output. An optimal, welfare-maximizing rule is established numerically. The analysis is then extended to solve jointly for optimal countercyclical reserve requirements and capital controls rules. These instruments are complements in the sense that both are needed to maximize welfare. However, a more aggressive reserve requirement rule (which responds to the credit-output ratio) also induces less reliance on capital controls. Thus, at the margin, countercyclical reserve requirements and capital controls are partial substitutes in maximizing welfare.

Bratsiotis, G. J., Madsen, J., Martin, C., (2015). 'Inflation Targeting and Inflation Persistence', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 211.

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This paper argues that the adoption of an inflation target reduces the persistence of inflation. We develop the theoretical literature on inflation persistence by introducing a Taylor Rule for monetary policy into a model of persistence and showing that inflation targets reduce inflation persistence. We investigate changes in the time series properties of inflation in seven countries that introduced inflation targets in the late 1980s or early 1990s. We find that the persistence of inflation is greatly reduced or eliminated following the introduction of inflation targets.

Blackburn, K., Neanidis, K.C., Rana, M.P., (2015). 'Organized Crime, Corruption and Growth: Theory and Evidence', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 210.

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We develop a framework for studying the interactions between organized crime and corruption, together with the individual and combined effects of these phenomena on economic growth. Criminal organizations co-exist with law-abiding productive agents and potentially corrupt law enforcers. The crime syndicate obstructs the economic activities of agents through extortion, and may pay bribes to law enforcers in return for their compliance in this. We show how organized crime has a negative effect on growth, and how this effect may be either enhanced or mitigated in the presence of corruption. The latter of these possibilities is evidenced strongly in an exhaustive empirical investigation using a panel of Italian regions for the period 1983-2009

Blackburn, K., Downing, G., (2015). 'Deconcentration, Corruption and Economic Growth', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 209.

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This paper highlights a channel through which decentralisation may curb the level of corruption and, in doing so, foster economic development. The analysis is based on a dynamic general equilibrium model in which corruption affects growth through entry regulation and the costs of doing business: for certain types of business to be undertaken, licenses are required from public officials who demand bribes in exchange for them. When entry regulation is centralised, each official issues his own designated type of license to all regions. When entry regulation is decentralised, each official issues all types of license to his own designated region. We show that the latter structure of government is associated with lower bribes, higher capital and higher growth.

Ahsan, H., Blackburn, K., (2015). 'Human capital and income distribution in a model of corruption', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 208.

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This paper studies the role of corruption in determining the distribution of income and, with this, the degree of poverty and inequality. The analysis is based on an overlapping generations model in which individuals may seek to improve their productive efficiency by supplementing or substituting publicly-provided services (education and health care) with their own expenditures on human capital formation. Financial market imperfections mean that their ability to do this depends on their initial wealth status, implying the possibility of persistent inequality in multiple long-run equilibria. We show how corruption may exacerbate this by compromising public service provision. This occurs through the double whammy of both reducing the earnings and increasing the population of those who rely most on such services. Higher levels of corruption are associated with higher levels of poverty and may result in a complete polarisation between the rich and poor through the elimination of any middle class.

Alpaslan, B., (2015). 'Are human and social capital linked? Evidence from India', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 207.

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This paper develops a two-period Overlapping Generations (OLG) model of endogenous growth in which a two-way relationship between social capital and human capital is studied. In order to illustrate the impact of public policies, the model is calibrated using the data for a low-income country, India and a sensitivity analysis is reported under different parameter configurations. Based on the numerical analysis, this paper focuses on possible trade-offs in the allocation of government spending between two productive components, that is, social capital-related activities and education. The results of this paper show that a higher share of spending on education promotes growth despite an offsetting cut in social capital-related activities; however, the reverse entails trade-offs. In other words, an increase in the share of spending on social capital-related activities through a concomitant cut in education is detrimental to long-run growth.

Berardi, M., (2015). 'Expectations formation under adaptive learning and evolutionary dynamics', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 206.

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Bounded rationality requires assumptions about ways in which rationality is constrained, and different assumptions are likely to lead to different economic predictions. In a simple forward-looking model we compare adaptive learning and evolutionary dynamics as means to model the process of beliefs' adaptation in response to observed outcomes. We show that the two methods deliver different conclusions about equilibrium and transition dynamics, and we try to shed some light on the reasons for such discrepancies.

Bhatti, A.A., Haque, M.E, Osborn, D.R.,(2015). 'Threshold Effects of Inequality on the Process of Economic Growth', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 205.

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This paper explores the relationship between inequality and growth in the context of a unified empirical approach suggested by the theoretical model of Galor and Moav (2004). Based on the model’s prediction, we construct a measure of human capital-to-physical capital ratio in order to investigate the threshold effects of inequality on economic growth. Using data of 82 countries for the period 1965–2003, our results are twofold: first, there exist significant thresholds of human-to-physical capital ratio below which the effect of inequality on growth is positive, whereas it is negative above it; second, human capital drives growth only when the human-to-physical capital ratio is above its threshold level. Our results are generally robust to using different measures of human capital and different data on inequality. These results are consistent with the predictions of Galor and Moav (2004).

Amann, K., Middleditch, P., (2015). 'Growth in a Time of Austerity: Evidence From the UK', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 204.

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A recent recovery in the United Kingdom comes after a program of austerity measures announced by the incoming coalition government in 2010. Can the recent pick up in economic activity be attributed to this controversial fiscal policy? This paper uses an empirical approach to test the causal relationship between debt and growth for the case of the UK using monthly time series data between 1995 and 2013. This time series perspective makes use of Granger-causality and co-integration tests that allow for non-stationarity in macroeconomic time series data. We find that controlling for structural breaks in this way leads us to the finding of no empirical support for the hypothesis that fiscal discipline can restore economic activity after a recession.

Agénor, P-R., Alper, K., Pereira da Silva, L.,(2015). 'External Shocks, Financial Volatility and Reserve Requirements in an Open Economy', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 203.

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The performance of a countercyclical reserve requirement rule is studied in a dynamic stochastic model of a small open economy with financial frictions, imperfect capital mobility, a managed float regime, and sterilized foreign exchange market intervention. Bank funding sources, domestic and foreign, are imperfect substitutes. The model is calibrated and used to study the effects of a temporary drop in the world risk-free interest rate. Consistent with stylized facts, the shock triggers an expansion in domestic credit and activity, asset price pressures, and a real appreciation. A credit-based reserve requirement rule helps to mitigate both macroeconomic and financial volatility, with the latter defined both in terms of a narrow measure based on the credit-to-output ratio, the ratio of capital flows to output, and interest rate spreads, and a broader measure that includes real asset prices as well. An optimal rule, based on minimizing a composite loss function, is also derived. Sensitivity tests, related to the intensity of sterilization, the degree of exchange rate smoothing, and the rule used by the central bank to set the cost of bank borrowing, are also performed, both in terms of the transmission process and the optimal rule.

Middleditch, P., (2015). 'The Long Run and Real Effects of the Working Hours Restriction: Evidence From France', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 202.

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This paper uses a theoretical and empirical approach to examine the long run effects of working hours restrictions on the natural rate of unemployment. We estimate a French NAIRU using the Kalman filter applied to a Phillips curve model with French quarterly data between 1987 and 2009. The resulting profile of the NAIRU is then analysed around the introduction of these restrictions and suggests a fall in the NAIRU greater than that reflected in the actual unemployment series alone. The Bai-Perron multiple break point test, adds further evidence of real effects from this policy by predicting regime change around the announcement and implementation of this policy.

Haque, M.E., Atiq, Z., (2015). 'Financial Development and Economic Growth: The Role of Financial Liberalization', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 201.

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This paper argues that excessive liberalisation causes financial development to lose its effectiveness in generating economic growth. We investigate the hypothesis through a dynamic panel analysis for 88 countries for the period of 1973 - 2005 using a comprehensive financial development indicator constructed through principal component analysis of five different indicators used in the literature. For financial liberalisation, we use an aggregate index and its seven disaggregated components. The results indicate that the positive effect of financial development on long-run growth continues to decline as the financial sector becomes more liberalised. Our results are robust to changes in the financial development indicators and the disaggregation of the financial liberalisation index.

Neanidis, K.C., Savva, C.S., (2015). 'Is Loan Dollarization Contagious across Countries? Evidence from Transition Economies', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 200.

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We examine whether loan dollarization is contagious across countries and, if so, what factors contribute to such spillover effects. We analyse a unique monthly data set of loan dollarization for 23 transition economies. Using a flexible regime-switching model, we simultaneously test for shift contagion and bi-directional pure contagion between high dollarized and low-dollarized countries. Our findings document widespread evidence of both shift and pure contagion in loan dollarization, the latter moving in both directions. Our results also show that the factors promoting contagion are associated with (i) times of adverse economic conditions and (ii) greater financial connectivity with the rest of the world.

Alpaslan, B., (2015). 'Public Spending and Transitional Dynamics of an Innovation-Based Growth Model', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 199.

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This paper extends a three-period Overlapping Generations (OLG) model of endogenous growth where the interactions between public infrastructure, human capital with R&D activities, and growth are studied. The model accounts for the externality of technical knowledge associated with human capital which promotes the innovation capacity in adopting imported technologies and developing new technologies. In order to study the transitional dynamics of the model and to illustrate the impact of public policy, the model is calibrated using average data for low-income countries and sensitivity analysis is reported under different parameter configurations. Based on the numerical analysis for a low-income country, we show that trade-offs in the allocation of public spending may inevitably emerge. However, investment in infrastructure at the expense of spending on R&D is less likely to succeed in promoting growth, whereas it may be more effective to foster economic growth through an offsetting cut in education.

Amann, J., Middleditch, P., (2015). 'Revisiting Reinhart & Rogoff after the Crisis: A Time Series Perspective', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 198.

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This paper offers a straightforward and descriptive contribution to the recent and busy debate on fiscal discipline made popular by a seminal paper by Reinhart and Rogoff (2010) after policymakers have sought foundation and justification of a policy known as austerity measures following the recent sovereign debt crisis. We revisit the debate on whether or not higher debt levels impede growth rates and contribute by offering a time series perspective of a corrected data set and also a more recent and higher frequency source. We find that with further hindsight and from a time series perspective there is no support for the view that higher levels of debt cause reductions in economic activity.