Should We Use Linearized Models To Calculate Fiscal Multipliers?
Jesper Lindé, Mathias Trabandt
Journal of Applied Econometrics,
No. 7,
2018
Abstract
We calculate the magnitude of the government consumption multiplier in linearized and nonlinear solutions of a New Keynesian model at the zero lower bound. Importantly, the model is amended with real rigidities to simultaneously account for the macroeconomic evidence of a low Phillips curve slope and the microeconomic evidence of frequent price changes. We show that the nonlinear solution is associated with a much smaller multiplier than the linearized solution in long-lived liquidity traps, and pin down the key features in the model which account for the di¤erence. Our results caution against the common practice of using linearized models to calculate scal multipliers in long-lived liquidity traps.
Read article
The Joint Dynamics of Sovereign Ratings and Government Bond Yields
Makram El-Shagi, Gregor von Schweinitz
Journal of Banking and Finance,
2018
Abstract
Can a negative shock to sovereign ratings invoke a vicious cycle of increasing government bond yields and further downgrades, ultimately pushing a country toward default? The narratives of public and political discussions, as well as of some widely cited papers, suggest this possibility. In this paper, we will investigate the possible existence of such a vicious cycle. We find no evidence of a bad long-run equilibrium and cannot confirm a feedback loop leading into default as a transitory state for all but the very worst ratings. We use a bivariate semiparametric dynamic panel model to reproduce the joint dynamics of sovereign ratings and government bond yields. The individual equations resemble Pesaran-type cointegration models, which allow for valid interference regardless of whether the employed variables display unit-root behavior. To incorporate most of the empirical features previously documented (separately) in the literature, we allow for different long-run relationships in both equations, nonlinearities in the level effects of ratings, and asymmetric effects in changes of ratings and yields. Our finding of a single good equilibrium implies the slow convergence of ratings and yields toward this equilibrium. However, the persistence of ratings is sufficiently high that a rating shock can have substantial costs if it occurs at a highly speculative rating or lower. Rating shocks that drive the rating below this threshold can increase the interest rate sharply, and for a long time. Yet, simulation studies based on our estimations show that it is highly improbable that rating agencies can be made responsible for the most dramatic spikes in interest rates.
Read article
Non-linearity in the Finance-Growth Nexus: Evidence from Indonesia
Nuruzzaman Arsyad, Iftekhar Hasan, Wahyoe Soedarmono
International Economics,
August
2017
Abstract
This paper investigates the finance-growth nexus where bank credit is decomposed into investment, consumption, and working capital credit. From a panel dataset of provinces in Indonesia, it documents that higher financial development measured by financial deepening and financial intermediation exhibits an inverted U-shaped relationship with economic growth. This non-linear effect of financial deepening is driven by both investment credit and consumption credit. These results suggest that too much investment credit and, to a lesser extent, consumption credit are detrimental to economic growth. Ultimately, only financial intermediation associated with working capital credit has a positive and monotonic impact on economic growth.
Read article
Inflation Dynamics During the Financial Crisis in Europe: Cross-sectional Identification of Long-run Inflation Expectations
Geraldine Dany-Knedlik, Oliver Holtemöller
IWH Discussion Papers,
No. 10,
2017
Abstract
We investigate drivers of Euro area inflation dynamics using a panel of regional Phillips curves and identify long-run inflation expectations by exploiting the crosssectional dimension of the data. Our approach simultaneously allows for the inclusion of country-specific inflation and unemployment-gaps, as well as time-varying parameters. Our preferred panel specification outperforms various aggregate, uni- and multivariate unobserved component models in terms of forecast accuracy. We find that declining long-run trend inflation expectations and rising inflation persistence indicate an altered risk of inflation expectations de-anchoring. Lower trend inflation, and persistently negative unemployment-gaps, a slightly increasing Phillips curve slope and the downward pressure of low oil prices mainly explain the low inflation rate during the recent years.
Read article
Decision-making Power in Foreign Subsidiaries and Its Effect on Financial Constraints: An Analysis for Selected European Transition Economies on the Basis of the IWH FDI Micro Database 2013
Andrea Gauselmann, Felix Noth
Eastern European Economics,
No. 6,
2016
Abstract
This article analyzes whether the distribution of decision-making power between the headquarters and foreign subsidiaries of multinational enterprises (MNEs) affects the foreign affiliates’ financial constraints. The findings show that not much decision-making power has as yet been moved from headquarters to foreign subsidiaries in European post-transition economies. The high concentration of decision-making power within the MNE’s subsidiary points toward higher financial constraints. However, a nonlinear effect is found, which suggests that financial constraints within the subsidiary only increase with more decision-making power when the power granted to the subsidiary is at a low level. For subsidiaries that already have autonomy in decision-making, granting more power in this regard has no effect on financial constraints.
Read article
The Joint Dynamics of Sovereign Ratings and Government Bond Yields
Makram El-Shagi, Gregor von Schweinitz
Abstract
Can a negative shock to sovereign ratings invoke a vicious cycle of increasing government bond yields and further downgrades, ultimately pushing a country toward default? The narratives of public and political discussions, as well as of some widely cited papers, suggest this possibility. In this paper, we will investigate the possible existence of such a vicious cycle. We find no evidence of a bad long-run equilibrium and cannot confirm a negative feedback loop leading into default as a transitory state for all but the very worst ratings.
Read article
Time-varying Volatility, Financial Intermediation and Monetary Policy
S. Eickmeier, N. Metiu, Esteban Prieto
IWH Discussion Papers,
No. 19,
2016
Abstract
We document that expansionary monetary policy shocks are less effective at stimulating output and investment in periods of high volatility compared to periods of low volatility, using a regime-switching vector autoregression. Exogenous policy changes are identified by adapting an external instruments approach to the non-linear model. The lower effectiveness of monetary policy can be linked to weaker responses of credit costs, suggesting a financial accelerator mechanism that is weaker in high volatility periods.
Read article
The Joint Dynamics of Sovereign Ratings and Government Bond Yields
Makram El-Shagi, Gregor von Schweinitz
Abstract
In the present paper, we build a bivariate semiparametric dynamic panel model to repro-duce the joint dynamics of sovereign ratings and government bond yields. While the individual equations resemble Pesaran-type cointegration models, we allow for different long-run relationships in both equations, nonlinearities in the level effect of ratings, and asymmetric effects in changes of ratings and yields. We find that the interest rate equation and the rating equation imply significantly different long-run relationships. While the high persistence in both interest rates and ratings might lead to the misconception that they follow a unit root process, the joint analysis reveals that they converge slowly to a joint equilibrium. While this indicates that there is no vicious cycle driving countries into default, the persistence of ratings is high enough that a rating shock can have substantial costs. Generally, the interest rate adjusts rather quickly to the risk premium that is in line with the rating. For most ratings, this risk premium is only marginal. However, it becomes substantial when ratings are downgraded to highly speculative (a rating of B) or lower. Rating shocks that drive the rating below this threshold can increase the interest rate sharply, and for a long time. Yet, simulation studies based on our estimations show that it is highly improbable that rating agencies can be made responsible for the most dramatic spikes in interest rates.
Read article
Risk and Return - Is there an Unholy Cycle of Ratings and Yields?
Makram El-Shagi, Gregor von Schweinitz
Economics Letters,
2015
Abstract
After every major financial crisis, the question about the responsibility of the rating agencies resurfaces. Regarding government bonds, the most frequently voiced concern targeted “unreasonably” bad ratings that might trigger capital flights and increasing risk premia which sanction further rating downgrades. In this paper we develop a multivariate, nonparametric version of the Pesaran type cointegration model that allows for nonlinearities, to show that a unique equilibrium between ratings and sovereign yields exists. Therefore, we have to reject the concern that there is an unholy cycle leading to certain default in the long run.
Read article
Estimating Monetary Policy Rules when the Zero Lower Bound on Nominal Interest Rates is Approached
Konstantin Kiesel, M. H. Wolters
Kiel Working Papers, No. 1898,
2014
Abstract
Monetary policy rule parameters estimated with conventional estimation techniques can be severely biased if the estimation sample includes periods of low interest rates. Nominal interest rates cannot be negative, so that censored regression methods like Tobit estimation have to be used to achieve unbiased estimates. We use IV-Tobit regression to estimate monetary policy responses for Japan, the US and the Euro area. The estimation results show that the bias of conventional estimation methods is sizeable for the inflation response parameter, while it is very small for the output gap response and the interest rate smoothing parameter. We demonstrate how IV-Tobit estimation can be used to study how policy responses change when the zero lower bound is approached. Further, we show how one can use the IV-Tobit approach to distinguish between desired policy responses, that the central bank would implement if there was no zero lower bound, and the actual ones and provide estimates of both.
Read article