Discussion papers 2018

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Agénor, P-R., (2018). 'Health and Knowledge Externalities: Implications for Growth and Public Policy', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 245.

Interactions between knowledge and health are studied in a three-period overlapping generations model with health persistence. Reproductive agents face a non-zero probability of death in adulthood. In addition to working, adults allocate time to child-rearing.

Growth dynamics are shown to depend in critical ways on the externalities associated with knowledge and health. Depending on the strength of these externalities, the best policy to improve education outcomes may be to spend relatively more on children's health. Trade-offs between education and health spending can be internalised by setting the optimal composition of expenditure so as to maximize the growth rate. With an endogenous adult survival rate, multiple growth paths may emerge. A reallocation of public spending from education to health may shift the economy from a low-growth equilibrium to a high-growth path.

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Haque, M.E, Middleditch, P., Zhang, S., (2018). 'Financial development and innovation: A DSGE comparison of Chinese and US business cycles', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 244.

This paper investigates the contrasting business cycle characteristics of China and the US, specifically in terms of economic activity and total factor productivity. To help explain the differing profiles for these two variables for both countries, we build and estimate a DSGE model with extended financial markets and endogenous technology creation to identify key structural parameters, comparing the decomposition of the shock processes in our analysis. We reveal stark differences in the contributing factors of business cycle fluctuations for both countries and demonstrate the importance of the stock market for economic recovery after a sizable and persistent financial shock. Macroeconomic intervention in China works well but is unable to smooth total factor productivity (TFP) due to the presence of multiple shocks transmitted through the endogenous technology creation channel. Whilst the US achieves a similar prole for economic activity with less volatility in TFP, it also contends with additional risks, fed in by the existence of the stock market. The stock market allows firms to hedge finance during periods of financial instability, though this is not cost-free.

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Bratsiotis, G.J., (2018). 'Credit Risk, Excess Reserves and Monetary Policy: The Deposits Channel', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 243.

This paper examines the role of precautionary liquidity (reserves) and the interest on reserves as two potential determinants of the deposits channel that can help explain the role of monetary policy, particularly at the near zero-bound. Through the deposits channel and balance sheet channel, either of these determinants can explain a number of effects including, (i) zero-bound optimal policy rates, (ii) a negative deposit rate spread, but also (iii) determinacy at the lower-zero bound. Similarly, through its effect on the deposits channel and balance sheet channel the interest on reserves can act as the main tool of monetary policy, that is shown to provide higher welfare gains in relation to a simple Taylor rule. This result is shown to hold at the zero-bound and it is independent of precautionary liquidity, or the fiscal theory of the price level.

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Berardi, M., (2018). 'Discrete beliefs space and equilibrium: a cautionary note', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 242.

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Bounded rationality requires assumptions about ways in which rationality is constrained and agents form their expectations. Evolutionary schemes have been used to model beliefs dynamics, with agents choosing endogenously among a limited number of beliefs heuristics according to their relative performance. This work shows that arbitrarily constraining the beliefs space to a finite (small) set of possibilities can generate artificial equilibria that can be stable under evolutionary dynamics. Only when "enough" heuristics are available, beliefs in equilibrium are not artificially constrained. I discuss these findings in light of an alternative approach to modelling beliefs dynamics, namely adaptive learning.

Berardi, M., (2018). 'Information aggregation and learning in a dynamic asset pricing model', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 241.

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This paper analyses a dynamic framework where an unobservable fundamental can be learned over time through two signals: one exogenous and private and the other, prices, endogenous and public. As information cumulates over time through Bayesian learning, prices become fully revealing and agents disregard their private information, suggesting a possible route through which fundamental values and prices can become misaligned. The analysis is then extended to a setting where agents need to infer the statistical properties of the signals they receive, merging Bayesian with adaptive learning. By introducing uncertainty about the moments of the relevant distributions used for Bayesian learning, adaptive learning can improve the ability of prices to track changes in fundamentals and thus their efficiency.

Altansukh, G., Becker, R., Bratsiotis, G.J., Osborn, D.R., (2018). 'Structural Breaks in International Inflation Linkages for OECD Countries', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 240.

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This paper studies the link between domestic inflation for 19 OECD countries and a corresponding country-specific global inflation series. This is achieved through an iterative methodology, which iterates between coefficient and variance tests while taking account of outliers. This procedure is applied to both univariate and bivariate inflation models that relate domestic and global inflation, with the latter is calculated as a trade-weighted average of inflation in a country's trading partners. The empirical analysis uses monthly consumer price inflation from 1970 to 2010 and the following key results emerge. First, the univariate analysis yields break in the conditional mean that is broadly consistent with the existing literature. Second, we document clusters of variance breaks occurring around the mid-1970s, early 1980s and early 1990s, casting doubt on the claim in the literature that changes of the in inflation has been mainly in the mean. Third, bivariate models show a positive and strengthening contemporaneous relationship between domestic and country-specific global inflation. Although the dates and extent of change vary over countries, our results imply increased co-movements of inflation, particularly during the 1980s and 1990s. Fourth, we demonstrate that the above results crucially depend on the appropriate treatment of outliers.

Motta, G., Rossi, R., (2018). 'Optimal Fiscal Policy with Consumption Taxation', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 239.

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We characterise optimal fiscal policies in a tractable Dynamic General Equilibrium model with monopolistic competition and endogenous public spending. The government has access to consumption taxation, as an alternative to labour income taxes. Consumption taxation acts as indirect taxation of profits (intertemporal gains of taxing consumption) and enables the policy-maker to manage the burden of public debt more efficiently (intertemporal gains of taxing consumption). We show analytically that these two gains imply that the optimal share of government spending is higher under consumption taxation than with labour income taxation. Then, we quantify numerically each of these gains on households’ welfare by calibrating the model on the US economy.

Neanidis, K.C., Savva, C.S., (2018). 'Regional Spillovers in Financial Dollarization', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 238.

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This paper examines the presence of cross-country or regional spillovers in financial dollarization. Using spatial econometric techniques and a unique monthly dataset of deposit and loan dollarization extending over two decades for 23 transition countries that belong in the same geographical region, we find strong evidence of regional spillovers in both types of dollarization. Spillovers are channelled by trade and banking linkages and pass through to all countries independently of their level of financial dollarization. Policy interventions that reduce dollarization in one country can, therefore, affect neighbouring countries.

Agénor, P-R., (2018). 'A Theory of Social Norms, Women's Time Allocation, and Gender Inequality in the Process of Development', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 237.

This paper studies how social norms influence gender bias in the workplace and in the family, how these two forms of discrimination interact among themselves and with intra-household bargaining, and how gender norms evolve in the course of development. The presence of women in the labour market is a key determinant of the degree of gender bias in the workplace. Household preferences towards girls' education depend on women's bargaining power which, through the male-female wage gap, depends itself on gender bias in the labour market. Experiments with a calibrated version of the model for a stylized low-income country show that interactions between social norms, women's time allocation, and gender gaps are a critical source of growth dynamics. Initial measures aimed at mitigating the influence of discriminatory norms regarding gender roles in the workplace and in the family can magnify over time the benefits of standard policy prescriptions (aimed for instance at fostering childhood education) in promoting development and gender equality.

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This paper examines the role of the precautionary demand for liquidity and the interest on reserves as two potential determinants of the deposits channel that can help explain the role of monetary policy, particularly at the near zero-bound. At high levels of precautionary liquidity hoarding, the optimal policy response of a Taylor rule is shown to indicate a zero weight on inflation. This result is explained by the effect that the demand for liquidity has on the deposit rate which determines the intertemporal choices of households. Similarly, through its effect on the deposits channel the interest on reserves can act as the main tool of monetary policy, that is shown to provide higher welfare gains in relation to a simple Taylor rule. This result is shown to hold at the zero-bound and it is independent of the precautionary demand for liquidity, or fiscal theory of the price level properties.

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