25 Years IWH

Four Research Clusters

Research Cluster Macroeconomic Dynamics and Stability

The central research questions of the cluster on "Macroeconomic Dynamics and Stability" are: (i) What are the causes and consequences of macroeconomic fluctuations and instabilities, how can these be empirically identified, and what measures can be taken to ensure macroeconomic stability during convergence and integration processes? (ii) What are the distributional effects of macroeconomic policies, such as monetary policy? (iii) How can we integrate the financial sector into macroeconomic models and macroeconomic forecasting?

The cluster consists of the following Research Groups:

This cluster focuses on the empirical analyses of macroeconomic dynamics and stability in the European Union (EU). The focus is on the development, implementation and application of quantitative macroeconomic forecasting and simulation models. Furthermore, methods to identify important unobserved economic variables, such as production potential and the structural deficit are evaluated, developed and applied. Forecasting and simulation models are important tools for rational economic policy and effective macroeconomic monitoring, especially in relation to macroeconomic stability.

From a regional perspective, the cluster "Macroeconomic Dynamics and Stability" mainly analyses the aggregate economic activities in the EU by issuing, for example, regular economic reports for Europe, Germany and East Germany, and by analysing monetary and financial policies in the European Economic and Monetary Union and in other EU member states.

Macroeconomic policies do not affect all agents equally. The research in this cluster aims to take the distributional effects into account, for example between borrowers and lenders or across the income distribution. Ultimately we aim to integrate these refinements into the economic forecasting process.

Research Cluster Institutions and Social Norms

The central research questions of the cluster on "Institutions and Social Norms" are: How do different institutional settings and their changes influence resource (re)allocation, in particular of human and real capital? How do values and social norms influence economic outcomes and the choices of individuals? How can we link these individual choices to macroeconomic aggregates? What are the role of difference governance mechanisms in financial markets and the real economy?

The cluster consists of the following Research Groups:

More questions are being asked – not least as a result of the debt crisis – about how market processes and state regulation of these processes can best strike a balance. The institutional framework conditions for market activity are being redesigned in many different ways. Financial market regulation is in a state of upheaval, new institutional regulations are being established in Europe for better fiscal control, and there are plans to more strongly coordinate national policies in order to increase the competitiveness of countries.

The success of upcoming reforms in Germany and in other European countries will depend greatly on the way in which political decision-makers in different local authorities interact and cooperate with one another in their search for solutions for overcoming fiscal policy challenges. Therefore, a comprehensive analysis of institutional framework conditions is needed whereby frictional losses between various federal government units are avoided to the greatest extent possible and interregional competition that increases welfare is promoted.

Improving the quality of public finances in individual member states of the European Union will be an important focus in European stability and growth policy in the coming years. In addition to creating long-term sustainability of public budgets, appropriate financial market regulations and public expenditure programmes should ensure the competitiveness and stability of national economies. To this effect, many policy measures must be adjusted to meet the new challenges in the private and public sector.

Reforms can only be successfully implemented when underlying methods of resolution are optimally adjusted to circumstances specific to the task and region. Ideally, the political processes should leave room to evaluate the decisions that were taken based on new evidence and, if needed, revise these. The design of policy measures should be consistently based on evidence-based impact analysis in order to avoid costly wrong decisions or the influence of interest groups when developing reform processes. Thus, there is also a need to analyse control structures in the public sector that support evidence-based decision-making processes in the public sector.

Research Cluster Productivity and Innovation

The central research questions in the cluster "Productivity and Innovation" are: What are the determinants and consequences of resource misallocation at the firm level? What is the relationship between firm productivity and innovation? What are the adjustment costs of firm exit on workers? What is the relationship between innovation in the financial sector and the real economy? Are specific innovation policies needed and, if so, how can they be designed to be incentive-based?

The cluster consists of the following Research Groups:

The productivity and innovativeness of firms are key to economic growth and convergence. Productivity growth has been significantly lower in Europe than in the U.S. or in some Asian countries. Inhibitions to productivity growth directly translate into lower per capital income. Rigidities in capital and labour markets hinder economies to adjust to structural changes and prevent less developed economies from catching up. Ultimately, aggregate growth processes are rooted at the firm level. Therefore, the thematic focus is on innovative activity, resource allocation and firm dynamics at the microeconomic level as ingredients for long-term growth.

Productivity can be increased by resource reallocation from low productive to high productive firms through entry or growth at the one hand and exit or shrinkage at the other hand. Beyond efficiency aspects, it is crucial to better understand the distributional effects of structural change. The adjustment costs that arise due to human capital depreciations or the loss of firm-specific rents in the course of market exit are of prime importance to discuss policies facilitating structural change.

Government institutions establish a framework that may either be favourable to innovation or create rigidities that prevent innovation. While innovation policy programmes or specific public demand on the product market may stimulate innovation and growth, the design and effectiveness of such measures needs thorough evaluation and improvement.

The interplay between the financial and real economy plays an important role. Innovation in the financial sector can enable better resource allocation. However, such innovation can also have negative implications on the real economy if it causes increased instability in the financial sector.

The empirical work of this cluster is devoted to understanding the impact of firm dynamics and innovation on the productivity of firms and regions. The research on innovations is largely based on the use of firm, patent and publication data and on linking this. Firm dynamics and labour market adjustments are analysed using linked employer-employee data.

Research Cluster Financial Stability and Regulation

The central research questions in the cluster on "Financial Stability and Regulation" are: (i) What are the effects of financial crises on the real economy? (ii) How does the structure and regulation of the financial system affect the allocation of resources within economies and internationally? (iii) How do the international linkages of the financial system affect the ability to regulate the financial sector?

The cluster connects three Research Groups:

It is well known that financial instability and cries result in large output losses. However, the precise transmission mechanisms are much less clear. But understanding these is crucial for devising the appropriate regulatory response. Inappropriate regulation may itself hamper the ability of the financial sector to fulfill its role and may have significant adverse consequences for the real economy. At the same time, historically it has been exceedingly difficult to construct appropriate predictors of financial instability, which in turn makes it difficult to act in a forward-looking manner and attempt to prevent the emergence of financial stability ex ante.

Since the financial crisis of 2008/2009, there have been numerous initiatives to re-regulate the financial system (Basel III, liquidity regulation, separation of commercial and investment banking, management compensation etc). While well intended, these initiatives are faced with severe obstacles. For example, financial systems are internationally interlinked, financial institutions operate globally, the interaction between different regulatory changes is poorly understood and policy makers tend to disagree on the ultimate objective of the re-regulation, because they place themselves on different points on the trade-off between tighter financial regulation and growth.

Methodologically, empirical research on the causal effects of financial instability and of financial regulation on economic outcomes, such as investment, consumption, and productivity growth is difficult. The challenge is to empirically identify and isolate the effects of regulation and financial instability from other factors and disentangle supply from demand effects. For example, households may reduce consumption because due to uncertainty about future economic developments they demand less finance or they reduce consumption because they are cut off from credit. To distinguish the two is of utmost importance when trying to devise the appropriate policy response.

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