The disturbing 'rise' of global income inequality

We use aggregate GDP data and within-country income shares for theperiod 1970-1998 to assign a level of income to each person in theworld. We then estimate the gaussian kernel density function for theworldwide distribution of income. We compute world poverty rates byintegrating the density function below the poverty lines. The $1/daypoverty rate has fallen from 20% to 5% over the last twenty five years.The $2/day rate has fallen from 44% to 18%. There are between 300 and500 million less poor people in 1998 than there were in the 70s.We estimate global income inequality using seven different popularindexes: the Gini coefficient, the variance of log-income, two ofAtkinson s indexes, the Mean Logarithmic Deviation, the Theil indexand the coefficient of variation. All indexes show a reduction in globalincome inequality between 1980 and 1998. We also find that most globaldisparities can be accounted for by across-country, not within-country,inequalities. Within-country disparities have increased slightly duringthe sample period, but not nearly enough to offset the substantialreduction in across-country disparities. The across-country reductionsin inequality are driven mainly, but not fully, by the large growth rateof the incomes of the 1.2 billion Chinese citizens. Unless Africa startsgrowing in the near future, we project that income inequalities willstart rising again. If Africa does not start growing, then China, India,the OECD and the rest of middle-income and rich countries diverge awayfrom it, and global inequality will rise. Thus, the aggregate GDP growthof the African continent should be the priority of anyone concerned withincreasing global income inequality.

Structural changes in the US economy: is there a role for monetary policy?

This paper investigates the contribution of monetary policy to the changes in outputgrowth and inflation dynamics in the US. We identify a policy shock and a policy rule ina time-varying coefficients VAR using robust sign restrictions. The transmission of policyshocks has been relatively stable. The variance of the policy shock has decreased over time,but policy shocks account for a small fraction of the level and of the variations in inflationand output growth volatility and persistence. We find little evidence of a significant increasein the long run response of the interest rate to inflation. A more aggressive inflation policyin the 1970s would have produced large output growth costs.

Is lumpy investment really irrelevant for the business cycle?

New-Keynesian (NK) models can only account for the dynamic effects of monetary policy shocks if it is assumed that aggregate capital accumulation is much smoother than it would be the case under frictionless firm-level investment, as discussed in Woodford (2003, Ch. 5). We find that lumpy investment, when combined with price stickiness and market power of firms,can rationalize this assumption. Our main result is in stark contrast with the conclusions obtained by Thomas (2002) in the context of a real business cycle (RBC) model. We use our model to explain the economic mechanism behind this difference in the predictions of RBC and NK theory.

Rethinking the effects of financial liberalization

During the last few decades, many emerging markets have lifted restrictions on cross-borderfinancial transactions. The conventional view was that this would allow these countries to: (i)receive capital inflows from advanced countries that would finance higher investment and growth;(ii) insure against aggregate shocks and reduce consumption volatility; and (iii) accelerate thedevelopment of domestic financial markets and achieve a more efficient domestic allocationof capital and better sharing of individual risks. However, the evidence suggests that thisconventional view was wrong.In this paper, we present a simple model that can account for the observed effects of financialliberalization. The model emphasizes the role of imperfect enforcement of domestic debts and theinteractions between domestic and international financial transactions. In the model, financialliberalization might lead to different outcomes: (i) domestic capital flight and ambiguous effectson net capital flows, investment, and growth; (ii) large capital inflows and higher investmentand growth; or (iii) volatile capital flows and unstable domestic financial markets. The modelshows how these outcomes depend on the level of development, the depth of domestic financialmarkets, and the quality of institutions.

General preferences for consumption goods in the random matching model of commodity money

This paper generalizes the original random matching model of money byKiyotaki and Wright (1989) (KW) in two aspects: first, the economy ischaracterized by an arbitrary distribution of agents who specialize in producing aparticular consumption good; and second, these agents have preferences suchthat they want to consume any good with some probability. The resultsdepend crucially on the size of the fraction of producers of each goodand the probability with which different agents want to consume eachgood. KW and other related models are shown to be parameterizations ofthis more general one.

On the sources of business cycles in the G-7

This paper examines sources of cyclical movements in output, inflation and the term structure of interest rates. It employs a novel identification approach which uses the sign of the cross correlation function in response to shocks to catalog orthogonal disturbances. We find that demand shocks are the dominant source output, inflation and term structure fluctuations in six of the G-7 countries. Within the class of demand disturbances, nominal shocks are dominant, but their importance declined after 1982. Furthermore, there are no significant differences in the proportion of term structure variability explained by different structural sources at different horizons.

Country portfolios

Capital flows to developing countries are small and are mostly take the form of loans rather than direct foreign investment. We build a simple model of North-South capital flows that highlights the interplay between diminishing returns, production risk and sovereign risk. This model generates a set of country portfolios and a world distribution of capital stocks that resemble those in the data.

Inequality over the business cycle: Estimating income risk using micro-data on consumption

We use CEX repeated cross-section data on consumption and income, to evaluate the nature of increased income inequality in the 1980s and 90s. We decompose unexpected changes in family income into transitory and permanent, and idiosyncratic and aggregate components, and estimate the contribution of each component to total inequality. The model we use is a linearized incomplete markets model, enriched to incorporate risk-sharing while maintaining tractability. Our estimates suggest that taking risk sharing into account is important for the model fit; that the increase in inequality in the 1980s was mainly permanent; and that inequality is driven almost entirely by idiosyncratic income risk. In addition we find no evidence for cyclical behavior of consumption risk, casting doubt on Constantinides and Duffie s (1995) explanation for the equity premium puzzle.

Modern perspectives on stabilization policies

The present paper describes recent research on two central themes of Keynes General Theory: (i) the social waste associated with recessions, and (ii) the effectiveness of fiscal policy as a stabilization tool. The paper also discusses some evidence on the extent to which fiscal policy has been used as a stabilizing tool in industrial economies over the past two decades.

It's still 2%: evidence on convergence from 116 years of the US States panel data

A new debate over the speed of convergence in per capita income across economies is going on. Cross sectional estimates support the idea of slow convergence of about two percent per year. Panel data estimates support the idea of fast convergence of five, ten or even twenty percent per year. This paper shows that, if you ``do it right'', even the panel data estimation method yields the result of slow convergence of about two percent per year.

The 'new political economy': Two recent books

This paper reviews two recent books on Political Economy by Allan Drazen and Torsten Persson and Guido Tabellini. It discusses some problems of the recent Political Economy literature.

Combining multivariate density forecasts using predictive criteria

This paper combines multivariate density forecasts of output growth, inflationand interest rates from a suite of models. An out-of-sample weighting scheme based onthe predictive likelihood as proposed by Eklund and Karlsson (2005) and Andersson andKarlsson (2007) is used to combine the models. Three classes of models are considered: aBayesian vector autoregression (BVAR), a factor-augmented vector autoregression (FAVAR)and a medium-scale dynamic stochastic general equilibrium (DSGE) model. Using Australiandata, we find that, at short forecast horizons, the Bayesian VAR model is assignedthe most weight, while at intermediate and longer horizons the factor model is preferred.The DSGE model is assigned little weight at all horizons, a result that can be attributedto the DSGE model producing density forecasts that are very wide when compared withthe actual distribution of observations. While a density forecast evaluation exercise revealslittle formal evidence that the optimally combined densities are superior to those from thebest-performing individual model, or a simple equal-weighting scheme, this may be a resultof the short sample available.

Does foreign direct investment crowd out domestic entrepreneurship?

In analyzing firm entry and exit across Belgian manufacturing industries,this paper presents evidence that import competition and foreign directinvestment discourage entry and stimulate exit of domestic entrepreneurs.These results are in line with theoretical occupational choice modelsthat predict foreign direct investment would crowd out domesticentrepreneurs through their selections in product and labor markets.However, the empirical results also suggest that this crowding out effectmay be moderated or even reversed in the long-run due to the long termpositive effects of FDI on domestic entrpreneurship as a result oflearning, demonstration, networking and linkage effects between foreignand domestic firms.

How much structure in empirical models?

This chapter highlights the problems that structural methods and SVAR approaches have when estimating DSGE models and examining their ability to capture important features of the data. We show that structural methods are subject to severe identification problems due, in large part, to the nature of DSGE models. The problems can be patched up in a number of ways but solved only if DSGEs are completely reparametrized or respecified. The potential misspecification of the structural relationships give Bayesian methods an hedge over classical ones in structural estimation. SVAR approaches may face invertibility problems but simple diagnostics can help to detect and remedy these problems. A pragmatic empirical approach ought to use the flexibility of SVARs against potential misspecificationof the structural relationships but must firmly tie SVARs to the class of DSGE models which could have have generated the data.

Strategic delegation in monetary unions

In monetary unions, monetary policy is typically made by delegates of the member countries. This procedure raises the possibility of strategic delegation - that countries may choose the types of delegates to influence outcomes in their favor. We show that without commitment in monetary policy, strategic delegation arises if and only if three conditions are met: shocks affecting individual countries are not perfectly correlated, risk-sharing across countries is imperfect, and the Phillips Curve is nonlinear. Moreover, inflation rates are inefficiently high. We argue that ways of solving the commitment problem, including the emphasis on price stability in the agreements constituting the European Union are especially valuable when strategic delegation is a problem.