jump diffusion processes and the term structure of interest rates the authors investigate the term structure of interest rates when the underlying state variables and production technologies follow the jump diffusion processes even in some cases where the traditional expectations theory about the term structure is consistent with general equilibrium under diffusion processes the traditional theory is not consistent under jump diffusion processes it is shown that bond prices are strictly higher under jump risks than otherwise and that consumers with logarithmic utility functions will develop hedge portfolios in the presence of jump diffusion a number of continuous time asset pricing models have been derived under stochastic diffusion processes with continuous sample paths see e g black and scholes 2 merton 21 breeden 3 and cox ingersoll and ross 8 however recent empirical studies see e g brown and dybvig 4 feinstone 10 and jarrow and rosenfeld 17 suggest that the underlying processes may follow

does one soros make a difference a theory of currency crises with large and small traders do large investors increase the vulnerability of a country to speculative attacks in the foreign exchange markets to address this issue we build a model of currency crises where a single large investor and a continuum of small investors independently decide whether to attack a currency based on their private information about fundamentals even abstracting from signaling the presence of the large investor does make all other traders more aggressive in their selling relative to the case in which there is no large investors small investors attach the currency when fundamentals are stronger yet the difference can be small or null depending on the relative precision of private information of the small and large investors adding signaling makes the influence of the large trader on small traders behaviour much stronger

detecting periodically collapsing bubbles a markov switching unit root test this paper addresses the problem of testing for the presence of a stochastic bubble in a time series in the case that the bubble is periodically collapsing so that the asset price keeps returning to the level implied by the market fundamentals as this is essentially a problem of identifying the collapsing periods from the expanding ones we propose using a generalization of the dickey fuller test procedure which makes use of the class of markov regime switching models the potential of the new methodology is illustrated via simulation and an empirical example is given copyright 1999 john wiley sons ltd

a note on nonstationarity structural breaks and the fisher effect abstract we find empirical evidence that inflation nominal and real interest rates in the us are trend stationary with a structural break in both the unconditional mean and the drift rate of a deterministic trend which occurs shortly after the change in operating procedures of the fed in september 1979 this finding casts some doubts on cointegration tests of the long run fisher effect conducted in recent studies since the results of these tests can be affected by the existence of common structural breaks in the series we propose an alternative test of the fisher effect based on a var representation in appropriately detrended variables we find strong support for the fisher effect both in the medium term and in the long term

real exchange rates and relative prices an empirical investigation abstract this paper uncovers a striking empirical regularity the consumer price of a good relative to a different good within a country tends to be much less variable than the price of that good relative to a similar good in another country this fact seems to hold for all goods except very simple homogeneous products models of real exchange rates are likely to have predictions regarding this relation so this fact may provide a useful gauge for discriminating among models

nonlinear mean reversion in the short term interest rate using a new bayesian method for the analysis of diffusion processes this article finds that the nonlinear drift in interest rates found in a number of previous studies can be confirmed only under prior distributions that are best described as informative the assumption of stationarity which is common in the literature represents a nontrivial prior belief about the shape of the drift function this belief and the use of flat priors contribute strongly to the finding of nonlinear mean reversion implementation of an approximate jeffreys prior results in virtually no evidence for mean reversion in interest rates unless stationarity is assumed finally the article documents that nonlinear drift is primarily a feature of daily rather than monthly data and that these data contain a transitory element that is not reflected in the volatility of longermaturity yields the drift of the short term interest rate is an important determinant of a wide variety of asset prices both inside and outside the boundaries of what is often called fixed income while volatilities may be estimated relatively accurately using high frequency observations of the short rate the short rate s extreme persistence makes identifying the true shape of the drift function a particularly elusive goal if our goal is merely to fit prices then the difficulty in estimating a drift function can be avoided by backing out implied drifts using a no arbitrage approach such as hull and white 1990 or heath jarrow and morton 1992 these methods bypass the true distribution entirely focusing on solving for the risk neutral drift function that is consistent with the cross section of bond prices if our goal however is to learn from prices and to be able to assess theories such as the expectations hypothesis that link short and long rates then estimating the drift function under the true measure is unavoidable in several recent articles a variety of sophisticated econometric techniques have been brought to bear on the problem in particular

crises and exchange rate regimes time to break down the bipolar view we revisit the link between crises and exchange rate regimes err using a panel of 90 developed and developing countries over the period 1980 2009 we find that corner err are not more prone to crises compared to intermediate err this finding holds for different types of crises banking currency and debt and is robust to a wide set of alternative specifications consequently we clearly break down the traditional bipolar view countries that aim at preventing crisis episodes should focus less on the choice of the err and instead implement sound structural macroeconomic policies

price and wage inflation persistence across countries and monetary regimes abstract we augmented a macro model with intrinsic inflation inertia assuming that prices farer in the past are more likely to be reset we estimated the model for seven industrialized economies to compare their price wage structures and to explore the potential nexus between changes the price wage structure and changes in policy stances we find evidence for duration dependent price adjustments in all the country of the sample although positively sloped after few periods price hazard functions often become flat as in calvo based models instead wage hazard shapes are in line with taylor contracts with the exceptions of france and the united kingdom country comparison shows that price and wage stickiness are correlated regarding monetary policy stances no systematic effect is found observed changes are explained by country specific factors e g market reforms

regime changes in international real interest rates are they a monetary phenomenon in this paper we use the bai and perron 1998 2001 2003 methodology to test for multiple structural breaks in the mean real interest rate for 13 industrialized countries we find extensive evidence of structural breaks in the mean real interest rate for all 13 countries in an attempt to explain the breaks in international real interest rates we also test for multiple structural breaks in the mean inflation rate for the 13 countries once again we find extensive evidence of structural breaks in the mean inflation rate for all of the countries interestingly the breaks in inflation rates and real interest rates often coincide with increases decreases in the mean inflation rate as we move from one regime to the next typically associated with decreases increases in the mean real interest rate

the instability of fixed exchange rate systems when raising the nominal interest rate is costly abstract this paper points to a vicious circle which may arise when a government tries to defend its currency by raising the nominal interest rate in a fixed exchange rate system we present a stylised model in which raising the nominal interest rate helps to maintain the parity but is costly for the government the speculators are aware that this cost gives incentives for the government to stop defending the parity which in turn reinforces the speculation against the currency we show that this mechanism can generate self fulfilling currency crises the outcome of which depends on the level of sacrifice that the government is ready to endure and the evolution of domestic economic conditions we provide some informal evidence showing that this model explains some features of the 1992 93 ems crisis

extracting inflation expectations and inflation risk premia from the term structure a joint model of the uk nominal and real yield curves abstract this paper analyses the uk interest rate term structure over the period since october 1992 when the united kingdom adopted an explicit inflation target using an affine term structure model estimated using both government bond yields and survey data the model imposes no arbitrage restrictions across nominal and real yields which enables interest rates to be decomposed into expected real policy rates expected inflation real term premia and inflation risk premia the model is used to shed light on major developments over the period including the impact of bank of england independence and the low real bond yield conundrum

on the fisher effect abstract we use post war quarterly data for belgium canada denmark france germany greece ireland japan the netherlands the united kingdom and the united states to examine the fisherian link between inflation and short term nominal interest rates in doing so we apply the king and watson 1997 methodology paying particular attention to the integration and cointegration properties of the variables since meaningful fisher effect tests critically depend on such properties we conclude that the data are generally rejecting the fisher effect

hedging and financial fragility in fixed exchange rate regimes currency crises that coincide with banking crises tend to share at least three elements first banks have a currency mismatch between their assets and liabilities second banks do not completely hedge the associated exchange rate risk third there are implicit government guarantees to banks and their foreign creditors this paper argues that the first two features arise from banks optimal response to government guarantees we show that guarantees completely eliminate banks incentives to hedge the risk of a devaluation our model also articulates one reason why governments might be tempted to provide guarantees to bank creditors guarantees lower the domestic interest rate and lead to a boom in economic activity but this boom comes at the cost of a more fragile banking system in the event of a devaluation banks renege on foreign debts and declare bankruptcy

nonparametric nonlinear cotrending analysis with an application to interest and inflation in the united states given the assumption that the components of a vector time series are stationary around nonlinear deterministic time trends nonlinear cotrending is the phenomenon that one or more linear combinations of the time series are stationary around a linear trend or a constant hence the series have common nonlinear deterministic time trends in this article i develop nonparametric tests for nonlinear cotrending and i derive nonparametric estimators of the cotrending vectors i apply this approach to the federal funds rate and the consumer price index inflation rate in the united states using monthly data to analyze the price puzzle

learning under fear of floating in recent years a large fraction of economies overcame the fear of floating we study a model that describes the policy of a central bank uncertain about whether currency depreciations cause output to expand textbook model or contract balance sheet model we conclude that the movement away from fear of floating may not be explained by bayesian or robust policies when the private sector anticipates the central bank s policy and endogenously determines the model central banks may fall in a learning trap an increase in financial volatility provides an escape to such trap that replicates patterns in the data

sudden stops and phoenix miracles in emerging markets a decade has passed since the salvos from mexico s tequila crisis of 1994 1995 echoed around the financial world since then many more crises have taken place in emerging market economies ems furthermore crises have tended to bunch together bringing to the forefront the systemic nature of these events true every new crisis has its own idiosyncratic features but useful policy lessons must be derived from robust empirical regularities this is the research strategy we have pursued in the last few years we will report on two types of regularities that strike us as highly robust across em crises a sudden stops of capital inflows and b phoenix miracles a sudden stop is a sharp fall in capital inflows relative to their past trajectory sudden stops are not a common feature in developed economies and display a large degree of temporal bunching suggesting that global capital market turmoil acts as a coordinating factor external to ems as shown in section i however balance sheet effects namely the interaction of large changes in the real exchange rate during sudden stops and liability dollarization i e foreign exchange denominated debts are key in influencing the likelihood of a sudden stop thus even though the initial shock is in principle exogenous to the economy whether or not it materializes into a sudden stop depends on domestic financial vulnerabilities on the other hand a phoenix miracle is defined as a case in which output recovers relatively quickly from a sharp collapse with virtually no recovery in credit or capital inflows and a very weak recovery in investment hence the reference to the mythical bird rising from the ashes the existence of phoenix like recoveries suggests that financial frictions play a key role in pushing economies to the abyss from which in some way or another they can crawl back to safe ground by means less than apparent to the conventional observer looking for standard fundamentals and thus may appear miraculous interestingly the great depression of the 1930s shares some of the key features of phoenix miracles in ems but shows salient differences as well that suggest nominal labor market rigidities are not crucial in explaining output collapse in ems understanding these regularities could and we believe does shed light on policies aimed at preventing crises and attenuating their effects

dualism and macroeconomic volatility this paper develops a simple macroeconomic model that shows that combining capital market imperfections together with unequal access to investment opportunities across individuals can generate endogenous and permanent euctuations in aggregate gdp investment and interest rates reducing inequality of access may be a necessary condition for macroeconomic stabilization moreover countercyclical escal policies have a role to play in our model savings are underutilized in slumps because of the limited debt capacity of potential investors therefore the government should issue public debt during recessions in order to absorb those idle savings and enance investment subsidies or tax cuts for investors the most important single fact about saving and investment activities is that in our industrial society they are generally done by different people and for different reasons for years there might tend to be too little investment leading to deeation losses excess capacity and unemployment for other years there might tend to be too much investment leading to periods of chronic ineation unless prudent and proper public policies in the escal and monetary eelds are followed paul a samuelson economics 8th edition 1970 pp 196 198

mean reversion in interest rates new evidence from a panel of oecd countries previous studies show that the standard univariate unit root tests cannot reject the hypothesis that interest rates follow integrated processes in this paper the authors pool interest rate data of twelve oecd countries and implement a multivariate test it is found that the unit root hypothesis can be decisively rejected copyright 1996 by ohio state university press

an intertemporal general equilibrium model of asset prices this paper develops a continuous time general equilibrium model of a simple but complete economy and uses it to examine the behavior of asset prices in this model asset prices and their stochastic properties are determined endogenously one principal result is a partial differential equation which asset prices must satisfy the solution of this equation gives the equilibrium price of any asset in terms of the underlying real variables in the economy in this paper we develop a general equilibrium asset pricing model for use in applied research an important feature of the model is its integration of real and financial markets among other things the model endogenously determines the stochastic process followed by the equilibrium price of any financial asset and shows how this process depends on the underlying real variables the model is fully consistent with rational expectations and maximizing behavior on the part of all agents our framework is general enough to include many of the fundamental forces affecting asset markets yet it is tractable enough to be specialized easily to produce specific testable results furthermore the model can be extended in a number of straightforward ways consequently it is well suited to a wide variety of applications for example in a companion paper cox ingersoll and ross 7 we use the model to develop a theory of the term structure of interest rates many studies have been concerned with various aspects of asset pricing under uncertainty the most relevant to our work are the important papers on intertemporal asset pricing by merton 19 and lucas 16 working in a continuous time framework merton derives a relationship among the equilibrium expected rates of return on assets he shows that when investment opportunities are changing randomly over time this relationship will include effects which have no analogue in a static one period model lucas considers an economy with homogeneous individuals and a single consumption good which is produced by a number of processes the random output of these processes is exogenously determined and perishable assets are defined as claims to all or a part of the output of a process and the equilibrium determines the asset prices our theory draws on some elements of both of these papers like merton we formulate our model in continuous time and make full use of the analytical tractability that this affords the economic structure of our model is somewhat similar to that of lucas however we include both endogenous production and

global financial instability framework events issues two of the key questions facing policymakers today are how to reduce the risk of global financial instability and how to cope with it when it occurs this paper starts by defining financial instability and then showing how it harms economic activity it then uses this framework to describe what happened during the recent financial crises in mexico and east asia the paper ends by raising several key policy issues not coincidentally these issues are addressed in the remaining papers in the symposium

informational contagion of bank runs in a third generation crisis model abstract this paper highlights the international spread of bank runs in a third generation model of financial crises through an informational channel banks short term liabilities include loans granted by foreign creditors who have imperfect information about the liquidation costs of banks assets a bank panic in a country induces lenders to downgrade early liquidation yields in other countries and thus to require higher interest rates to enable their banks to roll over their maturing debt those banks become therefore more prone to self fulfilling depositors runs the paper then studies the effect on contagion of increased transparency and bailouts

financial crisis and the great depression a regime switching approach i explore the timing of and effects of the u s financial crisis of the 1930s in a regime switching framework estimated conditional probabilities over the state of the financial sector suggest that a prolonged period of crisis begins not with the 1929 stock market crash but with the first banking panic of october 1930 these probabilities also suggest that the crisis persists until the introduction of federal deposit insurance in early 1934 consistent with the view that this financial crisis had real effects these conditional probabilities contain additional explanatory power for output fluctuations this is in addition to that provided by the money stock

time varying equilibrium real rates and monetary policy analysis abstract we show how a positive correlation between the equilibrium real interest rate err and trend growth matters for two widely debated issues in monetary policy first a simple taylor rule is more robust to uncertainty about the trend growth rate than suggested by some analyses of the increase in u s inflation during the 1970s because the policy mistake made when measuring the change in trend growth gets offset by the accompanying mistake in measuring the change in the err second ignoring this correlation when estimating policy rules results in coefficients that exaggerate both the degree of interest rate smoothing and the strength of the monetary authority s response to inflation

high and volatile real interest rates where does the fed fit in the federal reserve s new procedures for the conduct of monetary policy introduced on october 6 1979 have been the subject not only of considerable academic and political interest but also of intense debate b friedman 1982 roley 1982 walsh 1982 1984 mascaro and meltzer 1983 among others the fed s new operating procedures generally are perceived to have resulted in abnormally high and volatile real interest rates and thus to have contributed to if not been totally responsible for the deepest recession in postwar history in this paper we address the following question was the advent of the increased volatility and level of the real rate of interest concurrent with the fed s october 1979 change in operating procedures that is was the real rate of interest high and more volatile immediately after the october 1979 change in policy procedures in which case we might infer a connection between the fed s change in policy procedures and the increased volatility and level of the real rate or did the real rate become high and more volatile some time following the policy change which might lead us to conclude that the increased volatility and the increased level of the real rate was connected to some other event s occurring after the october 1979 policy change

on real interest rate dynamics and regime switching abstract we find evidence of regime switching dynamics in the usa and the uk real interest rates over the period 1881 2003 for the uk there is a regime in which the real interest rate displays a relatively stronger mean reversion and a regime in which it displays a relatively weaker mean reversion the former regime is characterized by a relatively larger error in the estimation of the reversion parameter and higher volatility for the usa the two regimes differ in volatility the probability of transition from one regime to another is found to be significantly related to the inflation rate regime and to the political regime the results highlight the importance of regime switching in the dynamics of the real interest rate as well as the role of inflation and political regimes in explaining this switching

volatility regimes asymmetric basis effects and forecasting performance an empirical investigation of the wti crude oil futures market abstract this study employs a flexible regime switching egarch model with student t distributed error terms to investigate whether volatility regimes and basis affect the behavior of crude oil futures returns including the conditional mean variance skewness kurtosis as well as the extent of heavy tailedness the study also examines whether volatility regimes and asymmetric basis effects can improve the forecasting accuracy the main merit of the empirical model is that the basis effect is allowed to be asymmetric and to vary across volatility regimes empirical results suggest that the conditional mean and variance respond to the basis asymmetrically and nonlinearly and that the responses of transition probabilities to the basis are symmetric furthermore the conditional higher moments are sensitive to the absolute value of basis and the heavy tailed characteristic can be greatly alleviated by taking into account the asymmetric basis effects and regime switches finally the regime switches and asymmetric basis effects play decisive roles in forecasting return volatility and tail distribution

financial instability under a flexible exchange rate many governments in developing countries contemplate the possibility of increasing the flexibility of their exchange rates despite having accumulated substantial dollar denominated debt using a model of corporate dollar debt in which the future exchange rate is uncertain this paper studies the financial risks that might arise as a consequence of increased exchange rate flexibility since a firm may default on its debt either because its dollar income is too low or because investors refuse to roll over its debt the measure of the overall risk of default should take into account both factors as well as their interaction solving the model for the no default rational expectations equilibrium we find that a small risk of insolvency may bring about a substantial risk of illiquidity

monetary policy in emerging markets can liability dollarization explain contractionary devaluations abstract in emerging markets external debt is denominated almost entirely in large developed country currencies such as the u s dollar this liability dollarization offers a channel through which exchange rate variation can lead to business cycle instability when firms assets are denominated in domestic currency and liabilities are denominated in foreign currency an exchange rate depreciation worsens firms balance sheets which leads to higher capital costs and contractions in capital spending to illustrate this i construct a quantitative sticky price small open economy model in which a monetary policy induced devaluation leads to a persistent contraction in output in this model fixed exchange rates offer greater stability than an interest rule that targets inflation

quantitative implications of a debt deflation theory of sudden stops and asset prices abstract this paper shows that the quantitative predictions of an equilibrium asset pricing model with financial frictions are consistent with key features of the sudden stop phenomenon foreign traders incur costs in trading assets with domestic agents and a collateral constraint limits external debt to a fraction of the market value of domestic equity holdings when this constraint does not bind standard productivity shocks cause typical real business cycle effects when it binds the same shocks cause strikingly different effects depending on the leverage ratio and asset market liquidity with high leverage and a liquid market the shocks force fire sales of assets and fisher s debt deflation mechanism amplifies the responses of asset prices consumption and the current account precautionary saving makes these sudden stops infrequent in the long run

real interest rates and macroeconomic activity while standard discussions of the transmission mechanism of monetary policy tend to assume a strong and negative link between real interest rates and real macroeconomic activity and this appears to some extent to be borne out by simulation of large scale macroeconometric models the empirical evidence suggests that the link between real interest rates and macroeconomic aggregates such as consumption and investment is in fact somewhat tenuous the weak link between interest rates and aggregate consumption may be explained at a theoretical level while the apparently weak link between interest rates and investment is more puzzling although it may be related to neglect of issues such as uncertainty and the irreversibility of investment in empirical studies similarly evidence on the link between real interest rates and economic growth is mixed and this may be related to non linearities in the relationship the survey highlights the need for further research in this area

investment dynamics with fixed capital adjustment cost and capital market imperfections this paper examines the implications of financing frictions on capital stocks and on capital accumulation in the presence of non convex costs of adjusting the capital stock in this setup finance has an influence on both the level of capital and the timing of investment finance and productivity are complements and finance influences investment the strongest when firms wish to significantly adjust capital for fundamental reasons these theoretical considerations are confronted with uk data while finance is mostly irrelevant for long term capital decision the short run investment function shows a significant impact of finance which is also strongest for strong fundamental investment incentives

currency crises and monetary policy in an economy with credit constraints this paper presents a simple model of currency crises which is driven by the interplay between the credit constraints of private domestic firms and the existence of nominal price rigidities the possibility of multiple equilibria including a currency crisis equilibrium with low output and a depreciated domestic currency results from the following mechanism if nominal prices are sticky a currency depreciation leads to an increase in the foreign currency debt repayment obligations of firms and thus to a fall in their profits this reduces firms borrowing capacity and therefore investment and output in a credit constrained economy which in turn reduces the demand for the domestic currency and leads to a depreciation we examine the impact of various shocks including productivity fiscal or expectational shocks we then analyze the optimal monetary policy to prevent or solve currency crises we also argue that currency crises can occur both under fixed and flexible exchange rate regimes as the primary source of crises is the deteriorating balance sheet of private firms

economic fluctuations in the u s and euro area quantifying the contribution of technical change this article aims at quantifying the contribution of technical change to cyclical fluctuations in the u s and euro area we distinguish technical progress in labor augmenting and capital augmenting change to this end we derive and estimate a new keynesian dsge model embodying a constant elasticity of substitution ces production function for both areas our main findings are i capital augmenting progress is the main source of technical change volatility ii labor augmenting shocks give a negligible contribution to the variance of output iii technical change of both types explains more economic fluctuations in the u s than in the euro area and iv historical decomposition of gdp growth over our sample period 1980 2008 shows that capital augmenting progress is one of the key drivers of the business cycle

learning large deviations and recurrent currency crises this article studies a version of obstfeld s journal of international economics 43 1997 61 77 escape clause model the model is calibrated to produce three rational expectations equilibria two of these equilibria are e stable and one is unstable dynamics are introduced by assuming that agents must learn about the government s decision rule it is assumed they do this using a stochastic approximation algorithm it turns out that as a certain parameter describing the sensitivity of beliefs to new information gets small the algorithm converges to a small noise diffusion process the dynamics of exchange rate changes are then characterized using large deviation techniques from freidlin and wentzell random perturbations of dynamical systems second edition berlin springer verlag 1998 these methods describe the sense in which the limiting distribution of exchange rate changes is approximated by a two state markov switching process where the two states correspond to the two e stable equilibria the model is calibrated to the exchange rate histories of argentina brazil and mexico currency crises in these countries resemble the predicted escape routes of the model a key feature of these escape routes is that expectations of a devaluation erupt suddenly without large contemporaneous shocks this is consistent with evidence showing that crises are often poorly anticipated by financial markets

political regime change and the real interest rate the effect of changes in policy regimes on real interest rates has important implications for financial and economic theory there is little current evidence that policy regime changes have any impact on the level of real interest rates we use large political changes as our measure of policy regime changes changes in presidential administration are more significantly correlated with real rate changes than are changes in the federal reserve chair or the mean shift points identified by garcia and perron 1996 using time series methods we also show that change of party control of congress is a significant factor explaining real rates we argue that theoretical models built on the assumptions of constant or policy invariant real interest rates are at variance with the empirical evidence

volatile capital flows and financial integration the role of moral hazard abstract we study a model in which income and capital flows between countries are jointly determined in a world economy with integrated financial markets in a setting that combines risky entrepreneurial activity with moral hazard we find that a shift from autarky to financial integration leads to boom bust cycles in capital flows output and consumption moral hazard causes cycles because financial intermediaries incentivize effort by insisting entrepreneurs take an equity share in their own projects the size of this stake rises with wealth discouraging entrepreneurship and inhibiting capital formation the reverse is true when wealth falls generating cycles

chaotic dynamics in credit constrained emerging economies abstract this paper analyzes the role of financial development as a source of endogenous instability in small open economies by assuming that firms face credit constraints our model displays a complex dynamic behavior with high period cycles or even chaotic dynamic patterns for intermediate values of the parameter representing the level of financial development of the economy we derive sufficient conditions for global stability and we prove that chaos appears via a border collision bifurcation the basic implication of our model is that economies experiencing a process of financial development are more unstable than both very underdeveloped and very developed economies

exchange rates and monetary policy in emerging market economies this paper investigates the effects of exchange rate regimes and alternative monetary policy rules for an emerging market economy that is subject to a volatile external environment in the form of shocks to world interest rates and the terms of trade in particular we highlight the impact of financial frictions and the degree of exchange rate pass through in determining the relative performance of alternative regimes in stabilizing the economy in the face of external shocks our results are quite sharp when exchange rate pass through is high a policy of non traded goods inflation targeting does best in stabilizing the economy and is better in welfare terms when exchange rate pass through is low however a policy of strict cpi inflation targeting is better in all cases a fixed exchange rate is undesirable in addition financial frictions have no implications for the ranking of alternative policy rules

the time varying behaviour of real interest rates a re evaluation of the recent evidence a time varying parameter model with markov switching conditional heteroscedasticity is employed to investigate two sources of shifts in real interest rates 1 shifts in the coefficients relating the ex ante real rate to the nominal rate the inflation rate and a supply shock variable and 2 unconditional shifts in the variance of the stochastic process the results underscore the importance of modelling continual change in the ex ante real rate in terms of other economic variables rather than relying on a statistical characterization that permits only a limited number of discrete jumps in the mean of the process copyright 1999 john wiley sons ltd

evaluation of currency regimes the unique role of sudden stops this paper tackles two established puzzles in international macroeconomics literature the first is the lack of systematic differences in the macroeconomic performance across exchange rate regimes the second is the absence of a clear empirical relationship between macroeconomic performance and capital account liberalization we suggest that these negative findings may be due to empirical methods that fail to account for a latent economic crisis state influenced by exchange rate and capital account regimes and to allow that latent variable to influence the growth effects of policy regimes in practice we model and estimate the latent state of the economy as a crisis probability our proposed framework of analysis allows exchange rate and capital market liberalization regimes to have both a direct effect on short term growth and an indirect effect on growth that is channelled through their effects on the crisis probability the empirical decomposition of the total effect into two conflicting effects helps resolve the puzzles assaf razin and yona rubinstein

financial development and the instability of open economies this paper introduces a framework for analyzing the role of financial factors as a source of instability in small open economies our basic model is a dynamic open economy model with a tradeable good produced with capital and a country specific factor we also assume that firms face credit constraints with the constraint being tighter at a lower level of financial development a basic implication of this model is that economies at an intermediate level of financial development are more unstable than either very developed or very underdeveloped economies this is true both in the sense that temporary shocks have large and persistent effects and also in the sense that these economies can exhibit cycles thus countries that are going through a phase of financial development may become more unstable in the short run similarly full capital account liberalization may destabilize the economy in economies at an intermediate level of financial development phases of growth with capital inflows are followed by collapse with capital outflows on the other hand foreign direct investment does not destabilize

testing for real effects of monetary policy regime shifts the rational expectations revolution in macroeconomics has forced economists to think about macroeconomic policy in terms of alternative policy rules or regimes huizinga and mishkin 1986 for example have argued recently that monetary policy has important effects on the ex ante real rate of interest and as evidence they cite apparent changes in the stochastic properties of the real rate coinciding with major shifts in monetary policy regimes more specifically they claim that in the post war period the real rate process in the united states shifted in october 1979 the month the fed changed operating procedures and in october 1982 when the fed deemphasized monetary aggregates mishkin 1986 has argued that these results suggest monetary policy not fiscal deficits bears responsibility for high u s real interest rates in the early 1980s because an understanding of the impact of monetary policy shifts on real interest rates is important for many issues in macroeconomics suggested methods for detecting real rate shifts deserve careful scrutiny the method employed by huizinga and mishkin 1986 tests for shifts in a projection equation of the expost real rate on a set of information variables such as the nominal interest rate and past inflation this projection equation approach is straightforward to apply and therefore potentially of use in testing a variety of macroeconomic hypotheses such as the neutrality of money for the projection equation approach to be valid it is desirable that it exhibit shifts if and only if the true real rate generating process has shifted the purpose of this paper is to show that changes in the real rate process while sufficient to

a corporate balance sheet approach to currency crises this paper presents a general equilibrium currency crisis model of the third generation in which the possibility of currency crises is driven by the interplay between private firms credit constraints and nominal price rigidities despite our emphasis on microfoundations the model remains sufficiently simple that the policy analysis can be conducted graphically the analysis hinges on four main features i ex post deviations from purchasing power parity ii credit constraints a la bernanke gertler iii foreign currency borrowing by domestic firms iv a competitive banking sector lending to firms and holding reserves and a monetary policy conducted either through open market operations or short term lending facilities we derive sufficient conditions for the existence of a sunspot equilibrium with currency crises we show that an interest rate increase intended to support the currency in a crisis may not be effective but that a relaxation of short term lending facilities can make this policy effective by attenuating the rise in interest rates relevant to firms

spatial competition with price taking firms we consider a price taking equilibrium in the spatial setting a unique pricing equilibrium is shown to exist for any set of firm locations this equilibrium is then used to examine locational incentives in the two stage process in whiclh firms first choose locations anticipating the subsequent price taking outcome the result is spatial agglomeration if demand is inelastic and there are only two firms agglomeration does not occur if demand is too elastic or if there are more than two firms this paper presents a two stage model of spatial competition in which the prices in the second stage constitute a competitive equilibrium rather than being chosen by firms the analysis applies to an industry in which firms prices are regulated by an authority whose concern is to maximize social surplus as we show the prices the regulator would choose are those that would arise in the price taking equilibrium of course the full social optimum could be attained if the authority were also to regulate locations however apart from coarse restrictions such as zoning location regulation does not seem common in practice thus we model firms as deciding on the locations non cooperatively and anticipating correctly the subsequent price regulation for example when airlines were regulated they could choose the quality of their service such as departure times but price was controlled 2 the price taking equilibrium is also relevant even in the absence of regula tion when there are several suppliers at each location then the marginal cost curve associated with each point occupied by firms is simply interpreted as the supply curve the points occupied by suppliers can be thought of as market places or as shopping malls and the rents earned owing to increasing marginal costs can be extracted by the developer of the market place or mall the developer s location decision aims to maximize rents earned in choosing a location each developer takes into account how the ensuing price competition among suppliers both in the mall and across different malls affects the rents that can be extracted in this way locations are determined as a non cooperative equilibrium whereas prices are subsequently determined by walrasian competition we first assume that demand is completely inelastic and we prove the existence of a unique price equilibrium and that an allocation is optimal if and only if it can be supported by a price equilibrium the proofs do not require fixed point theorems and are a direct application of an intuitively appealing result of dubins and spanier 1961 we then extend our existence uniqueness and optimality results to allow for price sensitive demands different demand

comparing shocks and frictions in us and euro area business cycles a bayesian dsge approach this paper estimates a dsge model with many types of shocks and frictions for both the us and the euro area economy over a common sample period 1974 2002 the structural estimation methodology allows us to investigate whether differences in business cycle behaviour are due to differences in the type of shocks that affect the two economies differences in the propagation mechanism of those shocks or differences in the way the central bank responds to those economic developments our main conclusion is that each of these characteristics is remarkably similar across both currency areas copyright 2005 john wiley sons ltd

modeling the dynamics of chinese spot interest rates using the daily data of chinese 7 day repo rates from january 1 1997 to december 31 2008 this paper tests a variety of popular spot rate models including single factor diffusion garch markov regime switching and jump diffusion models we document that chinese spot rates are subject to both market forces and administrative forces garch regime switching and jump diffusion models capture some important features of the dynamics of chinese spot rates but all models under study are overwhelmingly rejected we further explore possible sources of model misspecification using diagnostic tests

regime non stationarity in the us uk real exchange rate abstract using a markov switching extension of the adf regression we find evidence that the us uk real exchange rate is stationary in periods when it is in a low volatility regime and nonstationary when it is in a high volatility regime

the impact of monetary policy on the exchange rate a high frequency exchange rate puzzle in emerging economies abstract this study investigates the impact of monetary policy shocks on the exchange rates of brazil mexico and chile we find that even a focus on 1 day exchange rate changes following policy events which reduces the potential for reverse causality considerably fails to lend support for the view that associates unexpected interest rate hikes with immediate appreciations this lack of empirical backing for the predictions of standard open economy models persists irrespective of whether we use the us dollar or effective exchange rates whether changes in the policy rate that were followed by exchange rate interventions are excluded whether contaminated events are dropped from the analysis or whether we allow for non linearities we argue that it is difficult to attribute this stronger version of the exchange rate puzzle to fiscal dominance as unexpected rate increases are not associated with increases in risk premia and similar results are obtained in the case of chile a country that has had the highest possible short term credit rating since 1995 and a debt gdp ratio below 10

credible commitment to optimal escape from a liquidity trap the role of the balance sheet of an independent central bank we start from two empirical facts 1 central banks target cpi inflation 2 independent central banks are concerned about their balance sheet and the level of their capital the first fact makes it difficult for a central bank to implement the optimal escape from a liquidity trap because it makes a commitment to overshoot the inflation target not credible we show that the second fact helps to solve this credibility problem the optimal policy can take the form of a currency depreciation combined with a crawling peg a policy advocated by svensson as the foolproof way to escape from a liquidity trap jel e52 f31 f41 this paper starts from two empirical facts 1 central banks target infl ation measured by the consumer price index cpi 2 independent central banks are concerned about their balance sheet and the level of their capital we provide evidence for these facts below the first fact adds to the well known credibility problem of the optimal escape from a liquidity trap the second fact provides a mechanism through which the credibility problem can be solved and the optimal escape

economic development under alternative trade regimes how does openness affect economic development this question is answered in the context of a dynamic general equilibrium model of the world economy where countries have technological differences that are both sector neutral and specific to the investment goods sector relative to a benchmark case of trade in credit markets only consider i a complete restriction of trade and ii a full liberalization of trade the first change decreases the cross sectional dispersion of incomes only slightly and produces a relatively small welfare loss the second change instead decreases dispersion by a significant amount and produces a very large welfare gain

do expected shifts in inflation affect estimates of the long run fisher relation recent empirical studies suggest that nominal interest rates and expected inflation do not move together one for one in the long run a finding at odds with many theoretical models this article shows that these results can be deceptive when the process followed by inflation shifts infrequently we characterize the shifts in inflation by a markov switching model based upon this model s forecasts we reexamine the long run relationship between nominal interest rates and inflation interestingly we are unable to reject the hypothesis that in the long run nominal interest rates reflect expected inflation one for one

globalization and the politics of international finance the stiglitz verdict there are many outsiders who have written critiques of the global financial system insiders typically do not they have too much to lose what makes stiglitz s book globalization and its discontents unusual is that it is an insider s critique this book sketches the unfairness of the global system and how institutions like the imf perpetuate the asymmetries of power and wealth though the book provides a morally compelling account of recent global crises and its plea that we must think about radical change is hard to dismiss it does not break new analytical ground nor offer concrete suggestions of alternatives

fiscal and monetary policies and the cost of sudden stops abstract this article investigates the effects of monetary and fiscal policies on output growth during sudden stop balance of payments crisis in emerging markets and developing countries sudden stops in capital flows and subsequent deep recessions are a frequent occurrence in these countries but there is no professional consensus and little systematic empirical evidence shedding light on the macroeconomic policy mix most likely to limit output losses during these episodes to address this issue we investigate 83 sudden stop crisis in 66 countries using a baseline empirical model to control for the various determinants of output losses during sudden stops we measure the marginal effects of policy on output losses and find strong evidence that monetary tightening rise in the discount rate or unsterilized rise in international reserves and discretionary fiscal contraction are significantly correlated with larger output losses following a sudden stop fiscal expansion is associated with smaller output losses following a sudden stop but monetary expansion has no discernable effect the macroeconomic policy mix associated with the least output loss during a sudden stop financial crisis is a discretionary fiscal expansion combined with a neutral monetary policy

inflation presidents fed chairs and regime shifts in the u s real interest rate several recent papers agree on the existence of significant regime shifts in the u s real interest rate but disagree on the proximate causes of the shifts caporale and grier 2000 point to large political changes as correlates while rapach and wohar 2004 show that real rate breaks are correlated with inflation regime shifts and argue that the inflation regime changes cause the real rate shifts in this paper we show that controlling for the timing of changes in the inflation regime dummy variables representing either party change in the presidency or change in the identity of the fed chair are still strongly significant for explaining real interest rate fluctuations when we control for a fixed coefficient linear relationship between inflation and the real rate we find two real rate regime shifts that line up almost exactly with the accessions of paul volcker and alan greenspan even if we first let inflation regime switches explain the real rate and then look for regime shifts in the residuals we find almost exactly the same two breaks these results imply that fed chairs sometimes differ with respect to their preferred equilibrium real interest rate

monetary regime changes and the behavior of ex ante real interest rates a multi country study abstract previous research has found that u s monetary regime changes are related to changes in the behavior of ex ante real interest rates this paper examines monetary regime changes in other countries to test whether changes in expected real interest rates are related to monetary regime changes in a systematic manner the results show that while real rates have not been constant across monetary regimes the characteristics of the real rate process shifts differ across countries this evidence is consistent with theories that predict the neutrality of monetary regime changes with respect to real variables

the economic crisis of the 1990s in finland finland s depression a tale of bad luck and bad policies in the 1990s finland underwent a deep depression as its gdp dropped about 14 and unemployment rose from 3 to almost 20 this is a story of bad luck and bad policies bad luck took the form of external shocks the collapse of trade with the former soviet union in 1991 but also sharp cycles in the oecd area however bad luck is far from being the whole story in the absence of bad policies finland would have experienced a recession not a depression bad policies included a poorly designed financial regulation and mistaken reactions to the onset of the crisis of particular interest is the role of financial factors in triggering the crisis and aggravating the effects of bad policies not only were consumption and investment spending hurt by the credit crunch but there is evidence that the private sector s indebtedness has increased structural unemployment which explains why the recovery is proceeding with few job creations a number of general lessons emerge they concern the deregulation of financial markets the policy reaction to massive capital inflows and the role of employment policies seppo honkapohja and erkki koskela

monetary policy in a financial crisis what are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis under what conditions will a cut stimulate output and employment and raise welfare under what conditions will a cut have the opposite effects we answer these questions in a general class of open economy models where a financial crisis is modeled as a time when collateral constraints are suddenly binding we find that when there are frictions in adjusting the level of output in the traded good sector and in adjusting the rate at which that output can be used in other parts of the economy then a cut in the interest rate is most likely to result in a welfare reducing fall in output and employment when these frictions are absent a cut in the interest rate improves asset positions and promotes a welfare increasing economic expansion

foreign currency debt and the global financial architecture abstract this paper discusses some problems posed by foreign currency debt for emerging economies in the context of the ongoing debate on the reform of the global financial architecture we present a model in which the currency composition of corporate debt is endogenous and discuss the optimality of measures aimed at coping with the risks posed by foreign currency debt while removing these risks is not necessarily efficient in the presence of moral hazard some forms of public intervention such as a tax on foreign currency debt or international bailouts may be optimal

a positive theory of foreign currency debt abstract this paper makes a case for foreign currency debt as a hedging device in an open economy subject to stochastic shocks to output a government can reduce uncertainty in wealth and in consumption by issuing foreign or domestic currency debt if unexpected domestic and foreign inflation are negatively correlated with domestic output foreign currency debt is desirable in comparison to domestic currency debt if growth rates of output of both countries are closely related and if domestic inflation is relatively uncertain it has an additional advantage if domestic debt creates time consistency problems

financial innovation macroeconomic stability and systemic crises we present a general equilibrium model of intermediation designed to capture some of the key features of the modernnancial system the model incorporatesnan cial constraints and state contingent contracts and contains a clearly dened pe cuniary externality associated with assetre sales during periods of stress if a sufciently severe shock occurs during a credit expansion this externality is capa ble of generating a systemicnancial crisis that may be self fullling our model suggests thatnancial innovation and greater macroeconomic stability may have madenancial crises in developed countries less likely than in the past but poten tially more severe