Inequality, Happiness and Relative Concerns: What Actually is their Relationship?

This paper briefly and informally surveys different theoretical models of relative concerns and their relation to inequality. Models of inequity aversion in common use in experimental economics imply a negative relation between inequality and happiness. In contrast, empirical studies on happiness typically employ models of relative concerns that assume that increases in others’ income always have a negative effect on own happiness. However, in these latter models, the relation between inequality and happiness can be positive. One possible solution is a rivalry model where a distinction is made between endowment and reward inequality which have respectively a negative and positive effect on happiness. These different models and their contrasting results may clarify why the empirical relationship between inequality and happiness has been difficult to establish.

Dynamic Option Adjusted Spread and the Value of Mortgage Backed Securities (Draft 1)

We extend a reduced form model for pricing pass-through mortgage backed securities (MBS) and provide a novel hedging tool for investors in this market. To calculate the price of an MBS, traders use what is known as option-adjusted spread (OAS). The resulting OAS value represents the required basis points adjustment to reference curve discounting rates needed to match an observed market price. The OAS suffers from some drawbacks. For example, it remains constant until the maturity of the bond (thirty years in mortgage-backed securities), and does not incorporate interest rate volatility. We suggest instead what we call dynamic option adjusted spread (DOAS). The latter allows investors in the mortgage market to account for both prepayment risk and changes of the yield curve.

Expectations, Learning and Monetary Policy: An Overview of Recent Research

Expectations about the future are central for determination of current macroeconomic outcomes and the formulation of monetary policy. Recent literature has explored ways for supplementing the benchmark of rational expectations with explicit models of expectations formation that rely on econometric learning. Some apparently natural policy rules turn out to imply expectational instability of private agents’ learning. We use the standard New Keynesian model to illustrate this problem and survey the key results about interest-rate rules that deliver both uniqueness and stability of equilibrium under econometric learning. We then consider some practical concerns such as measurement errors in private expectations, observability of variables and learning of structural parameters required for policy. We also discuss some recent applications including policy design under perpetual learning, estimated models with learning, recurrent hyperinflations, and macroeconomic policy to combat liquidity traps and deflation.

Can Migrants save Greece from Ageing? A Computable General Equilibrium Approach using G-AMOS.

The population of Greece is projected to age in the course of the next three decades. This paper combines demographic projections with a multi-period economic Computable General Equilibrium (CGE) modelling framework to assess the macroeconomic impact of these future demographic trends. The simulation strategy adopted in Lisenkova et. al. (2008) is also employed here. The size and age composition of the population in the future depends on current and future values of demographic parameters such as the fertility, mortality rates and the level of annual net migration. We use FIV-FIV software in order to project population changes for 30 years. Total population and working age population changes are introduced to the GAMOS modelling framework calibrated for the Greek economy for the year 2004. Positive net migration is able to cancel the negative impacts of an ageing population that would otherwise occur as a result of the shrinking of the labour force. The policy implication is that a viable, long-lasting migration policy should be implemented, while the importance of policies that could increase fertility should also be considered.

Threshold Effects of Dismissal Protection Regulation and the Emergence of Temporary Work Agencies

Labour market regulations aimed at enhancing job-security are dominant in several OECD countries. These regulations seek to reduce dismissals of workers and fluctuations in employment. The main theoretical contribution is to gauge the effects of such regulations on labour demand across establishment sizes. In order to achieve this, we investigate an optimising model of labour demand under uncertainty through the application of real option theory. We also consider other forms of employment which increase the flexibility of the labour market. In particular, we are modelling the contribution of temporary employment agencies (Zeitarbeit) allowing for quick personnel adjustments in client firms. The calibration results indicate that labour market rigidities may be crucial for understanding sluggishness in firms´ labour demand and the emergence and growth of temporary work.

Political Risk, Economic Integration, and the Foreign Direct Investment Decision

In this paper we analyse the impact of policy uncertainty on foreign direct investment strategies. We also consider the impact of economic integration upon FDI decisions. The paper follows the real options approach, which allows investigating the value to a firm of waiting to invest and/or disinvest, when payoffs are stochastic due to political uncertainty and investments are partially reversible. Across the board we find that political uncertainty can be very detrimental to FDI decisions while economic integration leads to an increasing benefit of investing abroad.

Can a Lucas model with habit generate realistic conditional volatility in exchange rate returns?

In this paper, we attempt to give a theoretical underpinning to the well established empirical stylized fact that asset returns in general and the spot FOREX returns in particular display predictable volatility characteristics. Adopting Moore and Roche s habit persistence version of Lucas model we nd that both the innovation in the spot FOREX return and the FOREX return itself follow "ARCH" style processes. Using the impulse response functions (IRFs) we show that the baseline simulated FOREX series has "ARCH" properties in the quarterly frequency that match well the "ARCH" properties of the empirical monthly estimations in that when we scale the x-axis to synchronize the monthly and quarterly responses we find similar impulse responses to one unit shock in variance. The IRFs for the ARCH processes we estimate "look the same" with an approximately monotonic decreasing fashion. The Lucas two-country monetary model with habit can generate realistic conditional volatility in spot FOREX return.

Multinational Firms’ Heterogeneity in Tax Responsiveness: the Role of Transfer Pricing

In this paper we show that the ability of multinational firms to manipulate transfer prices affects the tax sensitivity of foreign direct investment (FDI). We offer a model of international capital allocation where firms are heterogeneous in their ability to manipulate transfer prices. Perhaps paradoxically, we show that the ability to shift profits can make parent companies' investment more sensitive to host-country tax rates, as long as investors expect fisscal authorities to use price and profit detection methods. We then offer a comprehensive empirical study to test our predictions in the case of Japanese FDI. We exploit the finding that the unobservable ability to manipulate transfer prices is correlated with whole ownership of a±liates and R&D expenditure. Based on country, parent firm and sector characteristics, we estimate an investment equation on a sample of 3614 Japanese affiliates in 49 emerging countries. We obtain a greater semi-elasticity of investment to the statutory tax rate in a±liates that are wholly-owned and that have R&D intensive parents. We interpret these results as indirect evidence that abusive transfer pricing is one of the determinants of FDI activity.

Assisted Reproductive Technologies (ART) in a Model of Fertility Choice

This paper provides a simple theoretical framework to discuss the relationship between assisted reproductive technologies and the microeconomics of fertility choice. Individuals make choices of education and work along with decisions about whether and when to have children. Decisions regarding fertility are influenced by policy and labor market factors that affect the earnings opportunities of mothers and the costs of raising children. We show how observed differences in these economic factors across countries explain observed different fertility and childbearing age patterns. We then use the model to predict behavioral responses to biomedical improvements in assisted reproductive technologies, and hence the impact of these technologies on fertility.

Political economics and normative analysis

The approaches and opinions of economists often dominate public policy discussion. Economists have gained this privileged position partly (or perhaps mainly) because of the obvious relevance of their subject matter, but also because of the unified methodology (neo-classical economics) that the vast majority of modern economists bring to their analysis of policy problems and proposed solutions. The idea of Pareto efficiency and its potential trade-off with equity is a central idea that is understood by all economists and this common language provides the economics profession with a powerful voice in public affairs. The purpose of this paper is to review and reflect upon the way in which economists find themselves analysing and providing suggestions for social improvements and how this role has changed over roughly the last 60 years. We focus on the fundamental split in the public economics tradition between those that adhere to public finance and those that adhere to public choice. A pure public finance perspective views failures in society as failures of the market. The solutions are technical, as might be enacted by a benevolent dictator. The pure public choice view accepts (sometimes grudgingly) that markets may fail, but so, it insists, does politics. This signals institutional reforms to constrain the potential for political failure. Certain policy recommendations may be viewed as compatible with both traditions, but other policy proposals will be the opposite of that proposed within the other tradition. In recent years a political economics synthesis emerged. This accepts that institutions are very important and governments require constraints, but that some degree of benevolence on the part of policy makers should not be assumed non-existent. The implications for public policy from this approach are, however, much less clear and perhaps more piecemeal. We also discuss analyses of systematic failure, not so much on the part of markets or politicians, but by voters. Most clearly this could lead to populism and relaxing the idea that voters necessarily choose their interests. The implications for public policy are addressed. Throughout the paper we will relate the discussion to the experience of UK government policy-making.

Flying High and Laying Low in the Public and Private Sectors: A Comparison of Pay Differentials for Full-Time Male Employees in Britain

Using new linked employee-employer data for Britain in 2004, this paper shows that, on average, full-time male public sector employees earn 11.7 log wage points more than their private sector counterparts. Decomposition analysis reveals that the majority of this pay premium is associated with public sector employees having individual characteristics associated with higher pay and to their working in higher paid occupations. Further focussing analysis on the highly skilled and unskilled occupations in both sectors, reveals evidence of workplace segregation positively impacting on earnings in the private sector for the highly skilled, and in the public sector for the unskilled. Substantial earnings gaps between the highly skilled and unskilled are found, and the unexplained components in these gaps are very similar regardless of sector.

Education and Economic Development in India

This brief survey examines the returns to education in India , and then examines the role of education on both economic growth and economic development with particular reference to India. Throughout, the objective is to draw out the implications of the empirical results for education policy. The results suggest that female education is of particular importance in India. They also suggest that perhaps because of the externalities it generates, primary education is more important than might be deduced from its relatively low private rate of return.

Which Inequality? The Inequality of Endowments Versus the Inequality of Rewards

Society often allocates valuable resources - such as prestigious positions, salaries, or marriage partners - via tournament-like institutions. In such situations, inequality affects incentives to compete and hence has a direct effect on equilibrium choices and hence material outcomes. We introduce a new distinction between inequality in initial endowments (e.g. ability, inherited wealth) and inequality of what one can obtain as rewards (e.g. prestigious positions, money). We show that these two types of inequality have opposing effects on equilibrium behavior and wellbeing. Greater inequality of rewards tends to hurt most people — both the middle class and the poor, — who are forced into greater effort. In contrast, greater inequality of endowments tends to benefit the middle class. Thus, which type of inequality is considered hugely affects the correctness of our intuitions about the implications of inequality.

The Global Dimension to Fiscal Sustainability

This paper examines the issue of fiscal sustainability in emerging market countries and industrial countries. We highlight the importance of the time series properties of the primary surplus and debt, and find evidence of a positive long run relationship. Consequently we emphasise, that especially for emerging markets, it is important to recognise the implications of global capital market shocks for fiscal sustainability, a relationship which has hitherto been ignored in the empirical literature. Using a factor model we demonstrate that the relationship between deficit and debt is conditional upon a global factor and we suggest that this global factor is related to world-wide liquidity. We also demonstrate that this acts as a constraint on emerging market economies’ fiscal policy.

Chebyshev polynomial approximation to approximate partial differential equations

This paper suggests a simple method based on Chebyshev approximation at Chebyshev nodes to approximate partial differential equations. The methodology simply consists in determining the value function by using a set of nodes and basis functions. We provide two examples. Pricing an European option and determining the best policy for chatting down a machinery. The suggested method is flexible, easy to program and efficient. It is also applicable in other fields, providing efficient solutions to complex systems of partial differential equations.