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Growth and Business Cycle Research Group

Discussion papers 2013

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Herranz, N., Krasa, S., Villamil, A.P.,(2013). 'Entrepreneurs, Risk Aversion and Dynamic Firms', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 189.

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This paper conducts a theoretical and quantitative analysis of how entrepreneurs choose firm size, capital structure, default, and owner consumption to manage firm risk, including how these choices change with risk aversion. We decompose an entrepreneur’s default decision into three elements: the fraction of firm debt; the potential reduction in personal consumption from losing the firm; and the ratio of personal wealth to firm scale, which determines an entrepreneur’s ability to inject personal funds to continue operation. Data from the Survey of Small Business Finances is used to calibrate the model and estimate entrepreneur risk aversion. We determine the evolution of entrepreneur net worth, consumption, and firm assets over time. We find that many entrepreneurs have lower net worth and consumption than non-entrepreneurs with the same preferences, but the densities of the distributions of consumption and net-worth have wide upper tails. Thus, entrepreneurship can be a path toward great wealth and high consumption for the top quantiles of entrepreneurs.


Bhatti, A.A., Haque, M.E, Osborn, D.R.,(2013). 'Is the Growth Effect of Financial Development Conditional on Technological Innovation?', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 188.

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This paper argues that excessive financial development in combination with high levels of technological innovation or R&D activities may lead to the former being ineffective in generating economic growth. This hypothesis is examined through a dynamic panel analysis using two measures of financial development, in conjunction with R&D expenditure, for 36 OECD and non-OECD countries. Using a range of panel data estimators, our results show that the relationship between financial development and economic growth is not straightforward; rather, it is conditional upon the level of R&D. Further, we find that a high level of R&D is associated with a weak or negative effect of financial development on economic growth.


Neanidis, K.C., Savva, C.S., (2013). 'Institutions and Financial Dollarization: Indirect Effects based on a Policy Experiment', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 187.

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We provide evidence that institutional improvements lead to lower levels of financial dollarization through previously unidentified channels. These indirect channels operate in addition to the direct impact identified in the literature and further illustrate the importance of institutions for the extent of banking dollarization. The analysis is based on a unique policy experiment: the admission process of countries to the European Union (EU).


Berardi, M., (2013). On the fragility of sunspot equilibria under learning and evolutionary dynamics', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 186.

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In this paper we investigate the possibility of sunspot equilibria to emerge from a process of learning and adaptation on agents' beliefs. To such end, we consider both infinite state Markov sunspots and sunspots in autoregressive form and derive conditions for the existence of an heterogeneous equilibrium where only a fraction of agents condition their forecasts on the sunspot: such conditions impose restrictions across primitive parameters, which are the equivalent, in a heterogeneous setting, of the resonant conditions found in the literature for homogeneous equilibria. We then show that evolutionary dynamics on predictor selection imply that such restrictions need to evolve endogenously with population shares, and argue that such requirement questions the possibility of sunspot equilibria to emerge through a process of evolution and adaptation on agents' beliefs. It follows that, in order for a sunspot equilibrium to obtain, all agents must simultaneously coordinate on using the same sunspot variable at the same time.


Agénor, P-R., Pereira da Silva, L., (2013). 'Macroprudential Regulation and the Monetary Transmission Mechanism, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 185.

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The paper presents a simple dynamic macroeconomic model of a bank-dominated financial system that captures some of the key credit market imperfections commonly found in middle-income countries. The model is used to analyse the interactions between monetary and macroprudential policies, involving, in the latter case, changes in reserve requirements. In addition to a qualitative analysis, a calibrated version is used to study numerically the transitional dynamics and steady-state effects of an increase in the reserve requirement ratio, under alternative parameter values. The analysis shows that understanding how these tools operate is essential because they may alter, possibly in substantial ways, the monetary transmission mechanism.


Agénor, P-R., Zilberman, R., (2013). 'Loan Loss Provisioning Rules, Procyclicality, and Financial Volatility', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 184.

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Interactions between loan loss provisioning rules and business cycle fluctuations are studied in a dynamic stochastic general equilibrium model with credit market imperfections. With a backward-looking provisioning system, provisions are triggered by past due payments, which, in turn, depend on current economic conditions and the loan loss reserves-loan ratio. With a forward-looking system, both past due payments and expected losses over the whole business cycle are accounted for, and provisions are smoothed over the cycle. Experiments show that holding more provisions can reduce the procyclicality of the financial system. However, a forward-looking provisioning regime can increase or lower procyclicality, depending on whether holding more loan loss reserves translates into a higher or lower fraction of nonperforming loans. A credit gap-augmented Taylor rule, coupled with a backward-looking provisioning system may be quite effective at mitigating real and financial volatility.


Primus, K., (2013). 'Excess Reserves, Monetary Policy and Financial Volatility', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 183.

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This paper examines the financial and real effects of excess reserves in a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with monopoly banking, credit market imperfections and a cost channel. The model explicitly accounts for the fact that banks hold excess reserves and they incur costs in holding these assets. Simulations of a shock to required reserves show that although raising reserve requirements is successful in sterilizing excess reserves, it creates a procyclical effect for real economic activity. This result implies that financial stability may come at a cost of macroeconomic stability. The findings also indicate that using an augmented Taylor rule in which the policy interest rate is adjusted in response to changes in excess reserves reduces volatility in output and inflation but increases fluctuations in financial variables. To the contrary, using a countercyclical reserve requirement rule helps to mitigate fluctuations in excess reserves, but increases volatility in real variables.


Blackburn, K., Chivers, D., (2013). 'Fearing the Worst: The Importance of Uncertainty for Inequality', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 182.

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We present an overlapping generations model in which aspirational agents face uncertainty about the returns to human capital. Investment in human capital requires external funding, implying a probability of bankruptcy that is greater the lower the human capital endowment of an agent. We show that agents with sufficiently low human capital endowments may experience such a strong influence of loss aversion that they abstain from human capital investment. We further show how this behaviour may be transmitted through successive generations to cause initial inequalities to persist. These results do not rely on any capital market imperfections.


Agénor, P-R., Alpaslan, B., (2013). 'Child Labor, Intra-Household Bargaining and Economic Growth', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 181.

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This paper develops a three-period, gender-based overlapping generations model of endogenous growth with endogenous intra-household bargaining and child labour in home production by girls. Improved access to infrastructure reduces the amount of time parents find optimal for their daughters to spend on household chores, thereby allowing them to allocate more time to studying at home. The model is calibrated for a low-income country and various quantitative experiments are conducted, including an increase in the share of public spending on infrastructure, an increase in time allocated by mothers to their daughters, and a decrease in fathers' preference for girls' education. Our analysis shows that poor access by families to infrastructure may provide an endogenous explanation for the persistence in child labour at home and gender inequality in low-income countries.


Saltoglu, B., Yilmaz, S.D.,(2013). ''Why is it so Difficult and Complex to Solve the Euro Problem?', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 180.

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This paper discusses the complexities and challenges in finding a stable long-run solution for the Eurozone crisis. We first discuss the macroeconomic and structural differences among North and South European countries. Focusing on trade, labour productivity and balance of payments data, we show that periphery’s current account deficits are endemic and closely follow economic growth. Our analysis suggests that while German stagnant wage policy might have contributed to the building up of imbalances within the Eurozone to an extent, monetary policy by ECB, deficit-dependence of growth in Southern Europe and the cheap-credit environment of pre-crisis period also played major roles. In addition, we analyse the feasibility of policy proposals for saving the Eurozone, evaluating potential costs/benefits and reviewing the pros and cons of the newly established European Banking Union. We conclude that since the problems in Southern Europe are structural, an active industrialization policy in these countries and a partial fiscal union are essential for a sustainable long-run solution. Furthermore, the Banking Union as it is, is far too immature to have a quick impact on the problem. The costs of the necessary long-lasting reforms and regulations in the Eurozone can exceed short-run benefits. Therefore, a strong political will power with less attention to the short run benefits is necessary for a successful recovery.


Haque, M.E., Hussain, B.,(2013). ''Where does Education go? – The Role of Corruption', Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 179.

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This paper provides an explanation for recent empirical evidence on the heterogeneous effects of human capital on economic growth in developing countries. In a two-period overlapping generations economy with physical and capital accumulation, state-appointed bureaucrats are responsible for procuring productive public goods. Corruption arises because of an opportunity for bureaucrats to misappropriate public funds. The decision of the corruptible bureaucrat affects public finances and hence the capital accumulation in the economy. Alongside the positive productivity enhancing effect, human capital is assumed to increase the efficiency of corrupt bureaucrats in embezzlement. If the latter dominates the former, the incentive for bureaucrats to acquire education rises. The net effect may result in an insignificant (or even negative) effect of human capital on growth. Our main results are as follows: (1) corruption is always bad for economic development, but its effect is worse in the economy with (more) human capital; (2) the incidence of corruption may, itself, be affected by both the development and human capital level of the economy; (3) education is good for development when accompanied by good governance, but may be bad for development when governance is bad; and (4) corruption and poverty may co-exist as permanent, rather than just transitory, fixtures of an economy.