2015

1506

Non-Renewable Resources, Extraction Technology, and Endogenous Growth
Martin Stuermer and Gregor Schwerhoff
Abstract: We add an extractive sector to an endogenous growth model of expanding varieties and directed technological change. Firms increase their economically extractable stocks of non-renewable resources through R&D investment in extraction technology and reduce their stocks through extraction. We show how the geological distribution of the non-renewable resource interacts with technological change. Our model accommodates long-term trends in non-renewable resource markets—namely stable prices and exponentially increasing extraction—for which we present data going back to 1792. The model suggests that over the long term, development of new extraction technologies neutralizes the increasing demand for non-renewable resources in industrializing countries such as China.

DOI: https://doi.org/10.24149/wp1506

1505

Seasonal Adjustment of State and Metro CES Jobs Data
Keith R. Phillips and Jianguo Wang
Published as: Phillips, Keith R. and Jianguo Wang (2016), "Seasonal Adjustment of Hybrid Time Series: An Application to U.S. Regional Jobs Data," Journal of Economic and Social Measurement 41 (2): 191-202.
Abstract: Hybrid time series data often require special care in estimating seasonal factors. Series such as the state and metro area Current Employment Statistics produced by the Bureau of Labor Statistics (BLS) are composed of two different source series that often have two different seasonal patterns. In this paper we address the process to test for differing seasonal patterns within the hybrid series. We also discuss how to apply differing seasonal factors to the separate parts of the hybrid series. Currently the BLS simply juxtaposes the two different sets of seasonal factors at the transition point between the benchmark part of the data and the survey part. We argue that the seasonal factors should be extrapolated at the transition point or that an adjustment should be made to the level of the unadjusted data to correct for a bias in the survey part of the data caused by differing seasonal factors at the transition month.

DOI: https://doi.org/10.24149/wp1505

1504

The Other (Commercial) Real Estate Boom and Bust: The Effects of Risk Premia and Regulatory Capital Arbitrage
John V. Duca and David C. Ling
Abstract: The last decade’s boom and bust in U.S. commercial real estate (CRE) prices was at least as large as that in the housing market and also had a large effect on bank failures. Nevertheless, the role of CRE in the Great Recession has received little attention. This study estimates cohesive models of short-run and long-run movements in capitalization rates (rent-to-price-ratio) and risk premiums across the four major types of commercial properties. Results indicate that CRE price movements were mainly driven by sharp declines in required risk premia during the boom years, followed by sharp increases during the bust phase. Using decompositions of estimated long-run equilibrium factors, our results imply that much of the decline in CRE risk premiums during the boom was associated with weaker regulatory capital requirements. The return to normal risk premia levels in 2009 and 2010 was first driven by a steep rise in general risk premia that occurred after the onset of the Great Recession and later by a tightening of effective capital requirements on commercial mortgage-backed securities (CMBS) resulting from the Dodd-Frank Act. In contrast to the mid-2000s boom, the recovery in CRE prices since 2010 has been mainly driven by declines in real Treasury yields to unusually low levels. Our findings have important implications for the channels through which macro-prudential regulation may or may not be effective in limiting unsustainable increases in asset prices.

DOI: https://doi.org/10.24149/wp1504

1503

Money and Velocity During Financial Crisis: From the Great Depression to the Great Recession
Richard G. Anderson, Michael Bordo, and John V. Duca
Abstract: This study models the velocity (V2) of broad money (M2) since 1929, covering swings in money [liquidity] demand from changes in uncertainty and risk premia spanning the two major financial crises of the last century: the Great Depression and Great Recession. V2 is notably affected by risk premia, financial innovation, and major banking regulations. Findings suggest that M2 provides guidance during crises and their unwinding, and that the Fed faces the challenge of not only preventing excess reserves from fueling a surge in M2, but also countering a fall in the demand for money as risk premia return to normal amid velocity shifts stemming from financial reform.

DOI: https://doi.org/10.24149/wp1503

1502

Are Income Taxes Destined to Rise? The Fiscal Imbalance and Future Tax Policy
Jason L. Saving and Alan D. Viard
Published as: Saving, Jason L. and Alan Viard (2015), "Are Income Taxes Destined to Rise? Fiscal Imbalance and Future Tax Policy in the United States," National Tax Journal, 68 (2): 235-250.
Abstract: We present a model of optimizing government behavior in which a need for increased revenue leads to the introduction of a new revenue source, such as a VAT, accompanied by a reduction in income taxes. We argue that this is a plausible outcome for the United States, in view of international experience and recent fiscal reform proposals, and has important implications for individual investment decisions.

DOI: https://doi.org/10.24149/wp1502

1501

Declining Female Labor Supply Elasticities in the U.S. and Implications for Tax Policy: Evidence from Panel Data
Anil Kumar and Che-Yuan Liang
Published as: Kumar, Anil and Che-Yuan Liang (2016), "Declining Female Labor Supply Elasticities in the U.S. and Implications for Tax Policy: Evidence from Panel Data," National Tax Journal 69 (3): 481-516.
Abstract: Recent work has provided compelling evidence of a long-term decline in US female labor supply elasticities with respect to wages and to income. While previous work used cross-sectional data from the Current Population Survey (CPS), we reexamine the trend for married women using panel data from the Panel Study of Income Dynamics (PSID) from 1980 to 2006. We find evidence in support of a long-term decline in married females’ labor supply elasticities on the participation margin, but less so on the hours margin. We also extend the analysis to investigating the implications of these results on welfare effects of tax reforms. Policy simulations indicate that shrinking elasticities, mostly concentrated on the participation margin, have contributed to a dramatic decline in welfare gains from actual and potential tax reforms since the 1980’s.

DOI: https://doi.org/10.24149/wp1501

Globalization Institute Working Papers

Globalization Institute No. 259

Lottery-Related Anomalies: The Role of Reference-Dependent Preferences 
Li An, Huijun Wang, Jian Wang and Jianfeng Yu
Abstract: Previous empirical studies find that lottery-like stocks significantly underperform their non-lottery-like counterparts. Using five different measures of the lottery features in the literature, we document that the anomalies associated with these measures are state-dependent: the evidence supporting these anomalies is strong and robust among stocks where investors have lost money, while among stocks where investors have gained profits, the evidence is either weak or even reversed. Several potential explanations for such empirical findings are examined and we document support for the explanation based on reference-dependent preferences. Our results provide a united framework to understand the lottery-related anomalies in the literature.

DOI: https://doi.org/10.24149/gwp318

Globalization Institute No. 247

The Cyclicality of (Bilateral) Capital Inflows and Outflows 
J. Scott Davis
Abstract: Recent research has shown that gross capital inflows and outflows are positively correlated and highly procyclical. This poses a puzzle since most theory predicts that capital inflows and outflows should be negatively correlated, and while capital inflows should be procyclical, capital outflows should be countercyclical. This previous work has examined the behavior of aggregate capital inflows and outflows (capital flows between a country and the rest of the world). This paper shows that bilateral capital inflows and outflows (flows between a pair of countries) are also positively correlated and strongly procyclical. This empirical finding poses a new puzzle. The data suggests that any model that can explain capital flows at the bilateral level needs to rely on market incompleteness and non-diversification. In addition, the data suggests that this positive correlation and procyclicality is largely the feature of crisis episodes. After controlling for crisis episodes, we find that bilateral capital flows move positively with GDP in the country receiving the capital and co-move negatively in the country sending the capital.

DOI: https://doi.org/10.24149/gwp247

Globalization Institute No. 245

Is There a Debt-threshold Effect on Output Growth? 
Alexander Chudik, Kamiar Mohaddes, M. Hashem Pesaran and Mehdi Raissi
Abstract: This paper studies the long-run impact of public debt expansion on economic growth and investigates whether the debt-growth relation varies with the level of indebtedness. Our contribution is both theoretical and empirical. On the theoretical side, we develop tests for threshold effects in the context of dynamic heterogeneous panel data models with crosssectionally dependent errors and illustrate, by means of Monte Carlo experiments, that they perform well in small samples. On the empirical side, using data on a sample of 40 countries (grouped into advanced and developing) over the 1965-2010 period, we find no evidence for a universally applicable threshold effect in the relationship between public debt and economic growth, once we account for the impact of global factors and their spillover effects. Regardless of the threshold, however, we find significant negative long-run effects of public debt build-up on output growth. Provided that public debt is on a downward trajectory, a country with a high level of debt can grow just as fast as its peers.

DOI: https://doi.org/10.24149/gwp245

Globalization Institute No. 243

On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments 
Enrique Martínez-García
Published as: Martínez-García, Enrique (2015), "On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments," Economics Letters 134: 86-89. 
Abstract: I show that parity realignments alone do not suffice to ensure the long-run sustainability of an exchange rate target zone with imperfect credibility due to the gambler’s ruin problem. However, low credibility and frequent realignments can destabilize the exchange rate.

DOI: https://doi.org/10.24149/gwp243

Globalization Institute No. 240

Monetary Policy Expectations and Economic Fluctuations at the Zero Lower Bound 
Rachel Doehr and Enrique Martínez-García
Abstract: Using a panel of survey-based measures of future interest rates from the Survey of Professional Forecasters, we study the dynamic relationship between shocks to monetary policy expectations and fluctuations in economic activity and inflation. We propose a smallscale structured recursive vector autoregression (VAR) model to identify the macroeconomic effects of changes in expectations about monetary policy. Our results show that when interest rates are away from the zero-lower bound, a perception of higher future interest rates leads to a significant rise in current measures of inflation and a rise in economic activity. However, when interest rates approach zero, the effect on economic activity is the opposite, with significant but lagged decreases in economic activity following an upward revision to expected future interest rates. The impact of changes in expectations about monetary policy is robust when we control for other features of the transmission mechanism (e.g., long-term interest rates, quantitative easing, exchange rate movements and even oil price shocks). Our findings also show that monetary policy expectations contribute up to 34 percent to the variability of economic activity (and 24 percent on inflation) while policy rates are fixed at the zero-lower bound. This evidence points to the importance of managing monetary policy expectations (forward guidance) as a crucial policy tool for stimulating economic activity at the zero-lower bound.

DOI: https://doi.org/10.24149/gwp240

Globalization Institute No. 235

Forecasting Local Inflation with Global Inflation: When Economic Theory Meets the Facts 
Roberto Duncan and Enrique Martínez-García
Abstract: This paper provides both theoretical insight as well as empirical evidence in support of the view that inflation is largely a global phenomenon. First, we show that inflation across countries incorporates a significant common factor captured by global inflation. Second, we show that in theory a role for global inflation in local inflation dynamics emerges over the business cycle even without common shocks, and under flexible exchange rates and complete international asset markets. Third, we identify a strong "error correction mechanism" that brings local inflation rates back in line with global inflation which explains the relative success of inflation forecasting models based on global inflation (e.g., Ciccarelli and Mojon (2010). Fourth, we argue that the workhorse New Open Economy Macro (NOEM) model of Martínez-García and Wynne (2010) can be approximated by a finite order VAR and estimated using Bayesian techniques to forecast domestic inflation incorporating all relevant linkages with the rest of the world. This NOEM-BVAR provides a tractable model of inflation determination that can be tested empirically in forecasting. Finally, we use pseudo-out-of-sample forecasts to assess the NOEM-BVAR at different horizons (1 to 8 quarters ahead) across 17 OECD countries using quarterly data over the period 1980Q1–2014Q4. In general, we find that the NOEM-BVAR model produces a lower root mean squared prediction error (RMSPE) than its competitors—which include most conventional forecasting models based on domestic factors and also the recent models based on global inflation. In a number of cases, the gains in smaller RMSPEs are statistically significant. The NOEM-BVAR model is also accurate in predicting the direction of change for inflation, and often better than its competitors along this dimension too.

DOI: https://doi.org/10.24149/gwp235

Globalization Institute No. 231

Evolving Comparative Advantage, Sectoral Linkages, and Structural Change 
Michael Sposi
Abstract: I quantitatively examine the effects of location-and sector-specific productivity growth on structural change across countries from 1970–2011. The results shed new light on the “hump shape" in industry's share in GDP across levels of development. There are two key features. First, otherwise identical changes in the composition of final demand translate differently into changes in the composition of value added because of systematic differences in sectoral linkages. Second, the mapping between sector-specific productivity and the composition of final demand systematically differs because of the relative importance of two components within final demand: final domestic expenditures and net exports.

DOI: https://doi.org/10.24149/gwp231

Globalization Institute No. 226

The Asymmetric Effects of Deflation on Consumption Spending: Evidence from the Great Depression 
J. Scott Davis
Published as: Davis, J. Scott (2015), "The Asymmetric Effects of Deflation On Consumption Spending: Evidence from the Great Depression," Economic Letters 130: 105-108. 
Abstract: Does expected deflation lead to a fall in consumption spending? Using data for U.S. grocery store sales and department store sales from 1919 to 1939, this paper shows that expected price changes have asymmetric effects on consumption spending. Department store sales (durable consumption) react negatively to the expectation of falling prices, but grocery store sales (non-durable consumption) do not react to expected price changes.

DOI: https://doi.org/10.24149/gwp226

Globalization Institute No. 225

The Global Component of Local Inflation: Revisiting the Empirical Content of the Global Slack Hypothesis with Bayesian Methods 
Enrique Martínez-García
Published as: Martínez-García, Enrique (2015), "The Global Component of Local Inflation: Revisiting the Empirical Content of the Global Slack Hypothesis with Bayesian Methods," in Monetary Policy in the Context of the Financial Crisis: New Challenges and Lessons, ed. William A. Barnett and Fredj Jawadi (Bingley, UK: Emerald Group Publishing Limited), 51-112. 
Abstract: The global slack hypothesis is central to the discussion of the trade-offs that monetary policy faces in an increasingly more integrated world. The workhorse New Open Economy Macro (NOEM) model of Martínez-García and Wynne (2010), which fleshes out this hypothesis, shows how expected future local inflation and global slack affect current local inflation. In this paper, I propose the use of the orthogonalization method of Aoki (1981) and Fukuda (1993) on the workhorse NOEM model to further decompose local inflation into a global component and an inflation differential component. I find that the log-linearized rational expectations model of Martínez-García and Wynne (2010) can be solved with two separate subsystems to describe each of these two components of inflation. I estimate the full NOEM model with Bayesian techniques using data for the U.S. and an aggregate of its 38 largest trading partners from 1980Q1 until 2011Q4. The Bayesian estimation recognizes the parameter uncertainty surrounding the model and calls on the data (inflation and output) to discipline the parameterization. My findings show that the strength of the international spillovers through trade—even in the absence of common shocks—is reflected in the response of global inflation and is incorporated into local inflation dynamics. Furthermore, I find that key features of the economy can have different impacts on global and local inflation—in particular, I show that the parameters that determine the import share and the price-elasticity of trade matter in explaining the inflation differential component but not the global component of inflation.

DOI: https://doi.org/10.24149/gwp225

Globalization Institute No. 224

Pegging the Exchange Rate to Gain Monetary Policy Credibility 
J. Scott Davis and Ippei Fujiwara
Abstract: Central banks that lack credibility often tie their exchange rate to that of a more credible partner in order to “import” credibility. We show in a small open economy model that a central bank that displays “limited credibility” can deliver significant improvements to a social welfare function that contains no role for exchange rate stabilization by maximizing an objective function that places weight on exchange rate stabilization, and thus the central bank with limited credibility will peg their currency to that of a more credible partner. As the central bank’s credibility improves it will place less weight on exchange rate stabilization in its objective function and thus loosen the peg. When the central bank is perfectly credible its objective function and the social welfare function are identical; it places no weight on exchange rate stabilization and allows the currency to freely float. Empirical results using a panel of both developed and developing countries show that as central banks become more independent they tend to allow more currency flexibility.

DOI: https://doi.org/10.24149/gwp224

Globalization Institute No. 223

Long-Run Effects in Large Heterogenous Panel Data Models with Cross-Sectionally Correlated Errors 
Alexander Chudik, Kamiar Mohaddes, M. Hashem Pesaran and Mehdi Raissi
Abstract: This paper develops a cross-sectionally augmented distributed lag (CS-DL) approach to the estimation of long-run effects in large dynamic heterogeneous panel data models with crosssectionally dependent errors. The asymptotic distribution of the CS-DL estimator is derived under coefficient heterogeneity in the case where the time dimension (T) and the crosssection dimension (N) are both large. The CS-DL approach is compared with more standard panel data estimators that are based on autoregressive distributed lag (ARDL) specifications. It is shown that unlike the ARDL type estimator, the CS-DL estimator is robust to misspecification of dynamics and error serial correlation. The theoretical results are illustrated with small sample evidence obtained by means of Monte Carlo simulations, which suggest that the performance of the CS-DL approach is often superior to the alternative panel ARDL estimates particularly when T is not too large and lies in the range of 30≤T<100.

DOI: https://doi.org/10.24149/gwp223