The dot-com bubble, the Bush deficits and the US current account

Over the past decade the US has experienced widening current account deficits and a steady deterioration of its net foreign asset position. During the second half of the 1990s, this deterioration was fueled by foreign investment in a booming US stock market. During the first half of the 2000s, this deterioration has been fuelled by foreign purchases of rapidly increasing US government debt. A somewhat surprising aspect of the current debate is thatstock market movements and fiscal policy choices have been largely treated as unrelated events. Stock market movements are usually interpreted as reflecting exogenous changes in perceived or real productivity, while budget deficits are usually understood as a mainly political decision. We challenge this view here and develop two alternative interpretations. Both are based on the notion that a bubble (the dot-com bubble) has been driving the stock market, but differ in their assumptions about the interactions between this bubble and fiscal policy (the Bush deficits). The benevolent view holds that a change in investorsentiment led to the collapse of the dot-com bubble and the Bush deficits were a welfare-improving policy response to this event. The cynical view holds instead that the Bush deficits led to the collapse of the dot-com bubble as the new administration tried to appropriate rents from foreign investors. We discuss the implications of each of these views for the future evolution of the US economy and, in particular, its net foreign asset position.

Asset pricing with idiosyncratic risk and overlapping generations

A number of existing studies have concluded that risk sharing allocations supported by competitive, incomplete markets equilibria are quantitatively close to first-best. Equilibrium asset prices in these models have been difficult to distinguish from those associated with a complete markets model, the counterfactual features of which have been widely documented. This paper asks if life cycle considerations, in conjunction with persistent idiosyncratic shocks which become more volatile during aggregate downturns, can reconcile the quantitative properties of the competitive asset pricing framework with those of observed asset returns. We begin by arguing that data from the Panel Study on Income Dynamics support the plausibility of such a shock process. Our estimates suggest a high degree of persistence as well as a substantial increase in idiosyncratic conditional volatility coincident with periods of low growth in U.S. GNP. When these factors are incorporated in a stationary overlapping generations framework, the implications for the returns on risky assets are substantial. Plausible parameterizations of our economy are able to generate Sharpe ratios which match those observed in U.S. data. Our economy cannot, however, account for the level of variability of stock returns, owing in large part to the specification of its production technology.

Technological change and the wealth of nations

We discuss a unified theory of directed technological change and technologyadoption that can shed light on the causes of persistent productivity differencesacross countries. In our model, new technologies are designed in advanced countries and diffuse endogenously to less developed countries. Our framework is richenough to highlight three broad reasons for productivity differences: inappropriatetechnologies, policy-induced barriers to technology adoption, and within-countrymisallocations across sectors due to policy distortions. We also discuss the effectsof two aspects of globalization, trade in goods and migration, on the wealth ofnations through their impact on the direction of technical progress. By doing so,we illustrate some of the equalizing and unequalizing forces of globalization.

Dynamic higher order expectations

In models where privately informed agents interact, agents may need to formhigher order expectations, i.e. expectations of other agents' expectations. This paper develops a tractable framework for solving and analyzing linear dynamic rational expectationsmodels in which privately informed agents form higher order expectations. The frameworkis used to demonstrate that the well-known problem of the infinite regress of expectationsidentified by Townsend (1983) can be approximated to an arbitrary accuracy with a finitedimensional representation under quite general conditions. The paper is constructive andpresents a fixed point algorithm for finding an accurate solution and provides weak conditions that ensure that a fixed point exists. To help intuition, Singleton's (1987) asset pricingmodel with disparately informed traders is used as a vehicle for the paper.

The structural dynamics of output growth and inflation: some international evidence

We examine the dynamics of output growth and inflation in the US, Euro area and UK using a structural time varying coefficient VAR. There are important similarities in structural inflation dynamics across countries; output growth dynamics differ. Swings in the magnitude of inflation and output growth volatilities and persistences are accounted for by a combination of three structural shocks. Changes over time in the structure of the economy are limited and permanent variations largely absent. Changes in the volatilities of structural shocks matter.

Should banking supervision and monetary policy tasks be given to different agencies?

This paper adds some new arguments to the thesis that the responsibility forbanking supervision should be assigned to an agency formally separated bythe Central bank. We also provide some additional evidence on the macroand microeconomic performance of OECD countries whose banking systems areclassified according to the regulatory regime in place. We find that theinflation rate is considerably higher and more volatile in countries wherethe Central bank acts as a monopolist in banking supervision. Besides,although banks seem to be more profitable when Central banks supervise them,they incur into higher costs and rely more on deposits with respect to moresophisticated liabilities as a funding source.The data are not definitively in favor of functional separation. However, we argue that the evolution of financial intermediaries, moral hazard problems and especially cost accountability seem to suggest that separation would be a better solution for industrialized countries.We also critically discuss the current arrangement of financial regulationand supervision in the EMU: our proposal is to establish an independentEuropean System of Financial Supervisors (ESFS) structured similarly to theESCB.

Comparative advantage and the cross-section of business cycles

Business cycles are both less volatile and more synchronized with the world cycle in rich countries than in poor ones. We develop two alternative explanations based on the idea that comparative advantage causes rich countries to specialize in industries that use new technologies operated by skilled workers, while poor countries specialize in industries that use traditional technologies operated by unskilled workers. Since new technologies are difficult to imitate, the industries of rich countries enjoy more market power and face more inelastic product demands than those of poor countries. Since skilled workers are less likely to exit employment as a result of changes in economic conditions, industries in rich countries face more inelastic labour supplies than those of poor countries. We show that either asymmetry in industry characteristics can generate cross-country differences in business cycles that resemble those we observe in the data.

Bubbles and capital flows

This paper presents a stylized model of international trade and asset price bubbles. Its central insight is that bubbles tend to appear and expand in countries where productivity is low relative to the rest of the world. These bubbles absorb local savings, eliminating inefficient investments and liberating resources that are in part used to invest in high productivity countries. Through this channel, bubbles act as a substitute for international capital flows, improving the international allocation of investment and reducing rate-of-return differentials across countries. This view of asset price bubbles could eventually provide a simple account of some real world phenomenae that have been difficult to model before, such as the recurrence and depth of financial crises or their puzzling tendency to propagate across countries.

Effects of uncertain lifetime and annuity insurance on capital accumulation and growth

This paper studies the effects of uncertain lifetime on capitalaccumulation and growth and also the sensitivity of thoseeffects to the existence of a perfect annuities market. Themodel is an overlapping generations model with uncertainlifetimes. The technology is convex and such that the marginalproduct of capital is bounded away from zero. A contribution ofthis paper is to show that the existence of accidental bequestsmay lead the economy to an equilibrium that exhibits asymptoticgrowth, which is impossible in an economy with a perfect annuitiesmarket or with certain lifetimes. This paper also shows that ifindividuals face a positive probability of surviving in everyperiod, they may be willing to save at any age. This effect ofuncertain lifetime on savings may also lead the economy to anequilibrium exhibiting asymptotic growth even if there exists aperfect annuities market.

Externalities and interdependent growth: Theory and evidence

I formulate and estimate a model of externalities within countriesand technological interdependence across countries. I find that externalreturns to scale to physical capital within countries are 8 percent; thata 10 percent increase of total factor productivity of a country's neighborsraises its total factor productivity by 6 percent; and that a 2 percentannual growth rate of labor productivity can be explained as an endogenousresponse to an exogenous 0.2 percent annual growth rate of total factorproductivity in the steady--state.

Organizational capital and employment fluctuations

In this paper I present a model in which production requires two types of labor inputs: regular productive tasks and organizational capital, which is accumulated by workers performing organizational tasks. By allocating more workers from organizational to productive tasks, firms can temporarily increase production without hiring. The availability of this intensive margin of labor adjustment, in combination with adjustment costs along the extensive margin (search frictions, firing costs, training costs), makes it optimal to delay employment adjustments. Simulations indicate that this mechanism is quantitatively important even if only a small fraction of workers perform organizational tasks, and explains why the hiring rate is persistent and why employment is slow to recover after the end of a recession.

Trade and productivity

We estimate the effect of international trade on average laborproductivity at the country level. Our empirical approach relies onsummary measures of trade that, we argue, are preferable on boththeoretical and empirical grounds to the one conventionally used. Incontrast to the marginally significant and non-robust effects of tradeon productivity found previously, our estimates are highly significantand robust even when we include institutional quality and geographicfactors in the empirical analysis. We also examine the channels throughwhich trade and institutional quality affect average labor productivity.Our finding is that trade works through labor efficiency, whileinstitutional quality works through physical and human capitalaccumulation. We conclude with an exploratory analysis of the role oftrade policies for average labor productivity.

Multiple filtering devices for the estimation of cyclical DSGE models

We propose a method to estimate time invariant cyclical DSGE models using the informationprovided by a variety of filters. We treat data filtered with alternative procedures as contaminated proxies of the relevant model-based quantities and estimate structural and non-structuralparameters jointly using a signal extraction approach. We employ simulated data to illustratethe properties of the procedure and compare our conclusions with those obtained when just onefilter is used. We revisit the role of money in the transmission of monetary business cycles.

On the sources of the Great Moderation

The remarkable decline in macroeconomic volatility experienced by the U.S. economy since the mid-80s (the so-called Great Moderation) has been accompanied by large changes in the patterns of comovements among output, hours and labor productivity. Those changes are reflected in both conditional and unconditional second moments as well as in the impulse responses to identified shocks. That evidencepoints to structural change, as opposed to just good luck, as an explanation for the Great Moderation. We use a simple macro model to suggest some of the immediate sources which are likely to be behindthe observed changes.

On the timing of balance of payments crises: Disaggregated information and interest rate policy

This paper proposes a dynamic framework to study the timing of balance of paymentscrises. The model incorporates two main ingredients: (i) investors have private information; (ii)investors interact in a dynamic setting, weighing the high returns on domestic assets against the incentives to pull out before the devaluation. The model shows that the presence of disaggregated information delays the onset of BOP crises, giving rise to discrete devaluations. It also shows that high interest rates can be eective in delaying and possibly avoiding the abandonment of the peg. The optimal policy is to raise interest rates sharply as fundamentals become very weak. However, this policy is time inconsistent, suggesting a role for commitment devices such as currency boards or IMF pressure.