nonmonetary effects of the financial crisis in propagation of the great depression this paper examines the effects of the financial crisis of the 1930s onthe path of aggregate output during that period our approach is complementary to that of friedman and schwartz who emphasized the monetary impact of the bank failures we focus on non monetary primarily credit related aspects of the financial sector output link and consider the problems of debtors as well as those of the banking system we argue that the financial disruptions of 1930 33 reduced the efficiency of the credit allocation process and that the resulting higher cost and reduced availability of credit acted to depress aggregate demand evidence suggests that effects of this type can help explain the unusual length and depth of the great depression this abstract was borrowed from another version of this item

equilibrium exchange rates and supply side performance this paper develops a two country optimising sticky price model of real exchange rate determination in the new open macroeconomics tradition which allows several different forms of deviation from purchasing power parity ppp both along the adjustment path and in the steady state the model has a rich structure and is designed to provide a flexible tool for policy analysis unlike most other papers in the literature both of the key components of the real exchange rate the relative price of non tradables and the terms of trade are made endogenous allowing a more complete analysis of the impact of structural shocks to illustrate one possible application the model is calibrated to match key elements of the uk and euro area economies and used to examine the extent to which possible improvements in the united kingdom s relative supply side performance might account for the sharp and persistent appreciation in sterling since 1996 the results are not supportive of this hypothesis in the model improvements in productivity goods market and labour market competitiveness are all associated with a depreciation in both the spot and the equilibrium real sterling exchange rates two potential supply side sources of an equilibrium appreciation a productivity improvement biased towards traded goods balassa samuelson effect and an anticipated future productivity rise are considered however each is insufficient to account for a long run equilibrium appreciation the latter may account for an initial appreciation of the real exchange rate we conclude by considering further mechanisms that could affect our results

capital taxation and accumulation in a life cycle growth model almost all of the serious economic work on savings decisions within the past decade has relied on some variant of the life cycle hypothesis in which savings arise out of individual choices of an optimum lifetime consumption path this paper reexamines the incidence and welfare consequences of capital income taxes within a realistic life cycle model the results suggest that the elimination of capital income taxation would have very substantial economic effects for example a complete shift to consumption taxation might raise steady state output by as much as 18 percent and consumption by 16 percent the long run welfare gain from such a shift would for plausible parameter values exceed 150 billion annually stated somewhat differently shifting to consumption taxation would raise the lifetime utility of the representative consumer by the equivalent of about six years income in the new steady state these estimates dwarf estimates of the static welfare cost of taxation and significantly exceed even extreme previous estimates of the dynamic loss this study departs from earlier analyses of the effects of taxes on capital income in several respects probably the most important difference between this treatment and most preceding ones lies in the assumptions about the interest elasticity of saving it is shown below that the common two period formulation of saving decisions yields quite misleading results a more realistic model of life cycle savings demonstrates that for a wide variety of plausible parameter values savings are very interest elastic this implies that shifting away from capital income taxation would significantly increase capital formation making possible long run increases in consumption many studies of the welfare effects of capital income taxation have ignored the general equilibrium effects of increased capital formation in an economy with life cycle savings there is no presumption that the undistorted growth path corresponds to any sort of social optimum as peter diamond has shown life cycle savings can lead to a steady state capital intensity either greater or less than the golden rule level more generally it is clear that there is no reason to believe that a life cycle economy will maximize any particular intertemporal social welfare function a fundamental tenet of welfare evaluation is that preexisting distortions must be considered in evaluating the consequences of tax changes the results presented in this paper take explicit account of the nonoptimal character of the no tax steady state this explains in large part why such a sizeable welfare effect of capital taxes is found in an economy far from the golden rule level of capital intensity there are substantial gains in steady state consumption achievable through increased capital formation section i of the paper examines the aggregate savings function in a continuous time life cycle framework the second section clarifies the differences between wage and consumption taxes an aggregate production function is added to complete the model in the third section the effects of changes in capital taxes on both steady state incidence and welfare are considered within a general equilibrium framework the final section of the paper discusses some implications of the results and suggests areas which appear to warrant further study assistant professor of economics massachusetts institute of technology and research analyst national bureau of economic research i am grateful to alan auerbach martin feldstein laurence kotlikoff to the participants in the nber workshop on business taxation and to the harvard public finance seminar for useful discussions james poterba and james buchal performed the numerical calculations

the debt payment to income ratio as an indicator of borrowing constraints evidence from two household surveys liquidity constraints have been proposed as an important explanation for deviations from the rational expectations permanent income hypothesis this paper introduces to the liquidity constraint literature the ratio of a household s debt payments to its disposable personal income the debt service ratio dsr we find that a household with a high dsr is significantly more likely to be turned down for credit than other households also the consumption growth of likely constrained households identified using the dsr along with the liquid asset to income ratio is significantly more sensitive to past income than that of other households confirming the dsr s value in identifying constrained households

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

the effectiveness of fiscal and monetary policy responses to twin crises we study how effective fiscal and monetary policy responses are during a twin crisis using the dataset provided by laeven and valencia 2008 we identify 57 episodes of twin crises following the methods proposed in baldacci et al 2009 and hutchison et al 2010 we construct the variables measuring the duration and output cost of a twin crisis we find that fiscal policy does not seem to be associated with the shortening of a twin crisis regarding monetary policy we find that monetary tightening is associated with the lengthening of a twin crisis duration consistent with the result in hutchison et al 2010 dealing with a sudden stop crisis in addition our results show that while a mild monetary expansion is effective in reducing a twin crisis duration over expansionary monetary policy loses its effectiveness

a note on dynamic tax incidence under certain reasonable conditions for a growth model the path of adjustment between steady states generated by a change in an exogenous policy variable is solved for explicitly the overall welfare effect is then shown to be a weighted average of the short and long run effects for a large class of social welfare functions these results are applied to a simple neoclassical growth model for the purpose of investigating the dynamic incidence of a labor income tax contrary to the claims of previous investigators the long run effect is shown to be more important for a wide range of parameter values

debt deleveraging and the liquidity trap a fisher minsky koo approach in this paper we present a simple new keynesian style model of debt driven slumps that is situations in which an overhang of debt on the part of some agents who are forced into rapid deleveraging is depressing aggregate demand making some agents debt constrained is a surprisingly powerful assumption fisherian debt deflation the possibility of a liquidity trap the paradox of thrift a keynesiantype multiplier and a rationale for expansionary fiscal policy all emerge naturally from the model we argue that this approach sheds considerable light both on current economic difficulties and on historical episodes including japan s lost decade now in its 18th year and the great depression itself

chronicle of currency collapses re examining the effects on output abstract the impact of currency collapses i e large nominal depreciations or devaluations on real output remains unsettled in the empirical macroeconomic literature this paper provides new empirical evidence on this relationship using a dataset for 108 emerging and developing economies over the period 1960 2006 we provide estimates of how these episodes affect growth and output trend our main finding is that currency collapses are associated with a permanent output loss relative to trend which is estimated to range between 2 and 6 of gdp however we show that such losses tend to materialize before the drop in the value of the currency which suggests that the costs of a currency crash largely stem from the factors leading to it taken on its own i e ceteris paribus we find that currency collapses tend to have a positive effect on output more generally we also find that the likelihood of a positive growth rate in the year of the collapse is over two times more likely than a contraction and that positive growth rates in the years that follow such episodes are the norm finally we show that the persistence of the crash matters i e one time events induce exchange rate and output dynamics that differ from consecutive episodes

lending booms latin america and the world recent theories of crisis put lending booms at the root of financial collapses yet lending booms may be a natural consequence of economic development and fluctuations so are lending booms dangerous in this paper we investigate empirically this question using a broad sample of lending boom episodes over 40 years with a special eye for latin america our results indicate that 1 lending booms are often associated with i a domestic investment boom ii an increase in domestic interest rates iii a worsening of the current account iv a declines in reserves v a real appreciation vi a decline in output growth 2 typical lending booms do not increase substantially the vulnerability of the banking sector or the balance of payments comparing latin america and the rest of the world we find that latin america lending booms make the economy considerably more volatile and vulnerable to financial and balance of payment crisis

welfare analysis and intertemporal substitution abstract this paper explores the structure of welfare comparisons when direct utility is weakly separable over time the lifetime welfare effect of a reform is then the sum of atemporal hicksian variations and intertemporal variations reflecting intertemporal substitution these latter are shown to be of only second order importance in lifetime welfare comparisons approximations to the intertemporal variations when preferences are intertemporally additive are derived pointing to the welfare significance in this context of not only the intertemporal elasticity of substitution but also within period income effects numerical examples illustrate the analysis and suggest possible orders of magnitude

can appreciation be expansionary evidence from the euro area summarywe identify exogenous effects of shifts in effective exchange rates for euro area ea countries between 1999 and 2016 the identification strategy is based on an external instrument built on the assumption that movements in the euro nominal effective exchange rate are largely exogenous for individual ea countries once we control for ea aggregates we find that a real appreciation creates a trade off between expenditure switching contractionary and terms of trade expansionary effects with the latter prevailing in most countries we also find some heterogeneity in the way movements in the euro exchange rate are transmitted within the ea in particular between core and peripheral countries although differences are mostly not statistically significant

tax policy and consumer foresight a general equilibrium simulation study this paper presents a dynamic computational general equilibrium model in which expectations regarding future prices can be varied systematically the model is employed to evaluate how expectations influence the effect of long run tax policy changes under policies like a consumption tax that reduce rates of return over time individuals with perfect foresight save less than individuals with myopic beliefs this is because consumers with foresight are better able to anticipate the lower returns lower saving means that existing distortions due to capital taxes are not offset as much so that welfare gains are smaller under perfect foresight

when credit bites back using data on 14 advanced countries between 1870 and 2008 we document two key facts of the modern business cycle relative to typical recessions financial crisis recessions are costlier and more credit intensive expansions tend to be followed by deeper recessions in financial crises or otherwise and slower recoveries we use local projection methods to condition on a broad set of macro economic controls to study how past credit accumulation impacts key macro economic variables such as output investment lending interest rates and inflation the facts that we uncover lend support to the idea that financial factors play an important role in the modern business cycle

house prices home equity based borrowing and the u s household leverage crisis us household leverage sharply increased in the years preceding the 2007 eco nomic recession the top panel of figure 1 shows the steady rise in household debt since 1975 which accelerated beginning in 2002 in just five years the household sector doubled its debt balance in comparison the contemporaneous increase in corporate debt was modest the middle panel shows that the increase in household debt from 2002 to 2007 translated into a striking rise in household leverage as mea sured by the debt to income ratio during the same time period corporate leverage declined the dramatic absolute and relative rise in us household leverage from 2002 to 2007 is unprecedented compared to the last 25 years one reason for the rapid expansion in household leverage during this period is that mortgage credit became more easily available to new home buyers mian and sufi 2009 strong house price appreciation from 2002 to 2006 however which may have been fueled by the availability of mortgage credit to a riskier set of new home buyers could also have had an important feedback effect on household lever age through existing homeowners given that 65 percent of us households already owned their primary residence before the acceleration in house prices the feedback from house prices to borrowing may be an important source of the rapid rise in household leverage that preceded the economic downturn our central goals in this study are to estimate how homeowner borrowing responded to the increase in house prices and to identify which homeowners responded most aggressively we examine this home equity based borrowing channel using a dataset consisting of anonymous individual credit files of a national consumer credit bureau agency we follow a random sample of over 74 000 us homeowners who owned their homes as of 1997 at an annual frequency from the end of 1997 until the end of 2008 the bottom panel of figure 1 plots the growth in debt of 1997 homeowners over time and shows that existing homeowners borrow significantly more debt as their house prices appreciate from 2002 to 2006 while the aggregate trend is suggestive

household debt and fiscal multipliers we study the size of government spending multipliers in a general equilibrium model with search and matching frictions in which we allow for different levels of household indebtedness the main results are a the presence of impatient households and private debt helps to generate government spending multipliers greater than 1 b as financial conditions worsen the size of the government spending multiplier falls c conversely employment vacancies and unemployment multipliers are larger in a credit crunch d the model explains the observed pattern of responses of labour market variables housing prices and private debt to a fiscal shock reasonably well

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

bond markets initiation and tax revenue mobilization in developing countries we analyze the relationship between the introduction of a sovereign bond market bm and tax revenue mobilization behavior using a large sample of 119 developing countries propensity scores matching estimations reveal that bm participation significantly fosters domestic tax revenue mobilization moreover we find that this favorable effect is sensitive to bm countries characteristics namely the stance of monetary and fiscal policies the exchange rate regime the level of economic development and the degree of financial openness and financial development finally our results show that bm participation fosters internal taxes and reduces their instability compared to international trade taxes these findings highlight the strength of bm in promoting structural reforms in developing countries through encouraging them to increase their tax effort and even by contributing to some extent to the fiscal transition process

choosing and reneging on exchange rate regimes we use data on announced and actual exchange rate arrangements to ask which countries follow de facto regimes different from their de iure ones that is do not do what they say our results suggest that countries with poor institutional quality have difficulty in maintaining pegging and abandon it often in contrast many countries with relatively good institutions display fear of floating that is they manage more than announced perhaps to signal their differences from those countries incapable of maintaining promises of monetary stability jel f3 o1

measuring the impact of fiscal policy in the face of anticipation a structural var approach empirical estimates of the impact of government spending shocks disagree on central issues such as the size of output multipliers and the responses of consumption and the real wage one explanation for the disagreement is that fiscal shocks are often anticipated due to misspecification of the information set anticipation effects may invalidate svar estimates of impulse responses we use economic theory to derive a fiscal svar estimator that is applicable when fiscal shocks are anticipated we study its properties and apply it to us data we fail to find evidence that anticipation effects overturn the existing findings from the fiscal svar literature despite years of intensive research the empirical literature on fiscal policy has yet to reach consensus on the macroeconomic impact of fiscal policy shocks disagreements concern central issues such as the size of output multipliers and the impact of government spending shocks on consumption and the real wage clearly such level of disagreement constrains our ability to give simple guidelines for the operation of one of the most important stabilisation policies a key empirical obstacle is the measurement of innovations to fiscal policy one strand of the literature employs structural vector autoregressive svar methods and achieves identification based on the presence of decision lags or sign restrictions

insurance fraud and optimal claims settlement strategies abstract we examine the optimal claims settlement strategy for a liability insurer when claimants can permanently misrepresent their losses by engaging in costly claims falsification in this environment claims auditing is not a possible deterrent to fraud and the settlement strategy consists of an indemnification profile that relates the insurance payment to the claimed amount of loss the optimal indemnification profile is shown to involve systematic underpayment of claims at the margin as a means to deter loss exaggeration with the extent of underpayment limited by expected litigation costs and potential bad faith claims the key testable implication of the theory is that the extent of underpayment should be greater for classes of claims for which loss exaggeration is easier empirical analysis of insurance settlements for bodily injury liability in automobile accidents confirms this prediction this suggests that liability insurers optimally choose claims payment strategies to lessen a claimant s i

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

private debt overhang and the government spending multiplier evidence for the united states using state dependent local projections and historical us data we find that government spending multipliers are considerably larger in periods of private debt overhang in particular while multipliers are below or close to one in low private debt states we find significant crowding in of private spending in periods of debt overhang resulting in multipliers that are much larger than one in high private debt episodes more government purchases even reduce the ratio of government debt to gross domestic product these results are robust for the type of shocks and when we control for the business cycle financial crises deleveraging episodes government debt overhang and the zero lower bound

marginal cost of public funds for different tax instruments and government expenditures the marginal cost of public funds that is the size of the direct and indirect excess burden costs for marginal tax revenues is examined in this paper for an open economy with a savings response and using swedish 1979 data the marginal cost of public funds spent on transfer payments is estimated to vary from 1 47 for a distributionally neutral tax on labor and capital to 7 20 for a more progressive tax where average and marginal labor taxes increase by the same rates for changes in the most important tax instrument the marginal cost of public funds varies from 0 98 for expenditures on infrastructure to 2 27 for transfer payments

exploring different views of exchange rate regime choice the empirical distinction between de facto and de jure exchange rate regimes raises a number of interesting questions which factors may induce a de facto peg why do countries enforce a peg but do not announce it why do countries break their promises we show that a stable socio political environment and an efficient political decision making process are a necessary prerequisite for choosing a peg and sticking to it challenging the view that sees the exchange rate as a commitment device policymakers seem rather concerned with regime sustainability in the face of adverse economic and socio political fundamentals

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

an empirical test of the comparative and contributory negligence rules in accident law scholars in the field of law and economics have developed an extensive theoretical literature on the effects of liability rules in accident law but have done little testing of their theoretical models in this article i develop an empirically testable model of the incentives for injurers and victims to avoid accidents under both the older contributory negligence rule and the newer rule of comparative negligence the model takes account of the fact that in the automobile accident context drivers do not know in advance with whom they will be involved in an accident and whether they will be the injurer or the victim or both it also allows for uncertainty in legal decision making the model is tested using a data set of rear end automobile accidents litigated in court the results suggest first that incentives to take care to avoid accidents are stronger under the contributory negligence rule than under the newer rule of comparative negligence and second the incentives set up by the comparative negligence rule for drivers to avoid accidents are weaker than is economically efficient

the indexation of interest depreciation and capital gains and tax reform in the united states abstract the treasury s 1984 tax plan suggests features of a comprehensive income tax including the indexation of interest depreciation and capital gains the 1985 president s proposal retains some of these indexing provisions but the tax reform act of 1986 does not this paper looks at the incentives under these tax regimes to make marginal investments in the corporate sector noncorporate sector and owner occupied housing it finds that inflation in the old system caused effective tax rates to rise for some assets and fall for others under the treasury or president s proposals the interference of inflation is virtually eliminated also the effects of inflation are substantially reduced by the 1986 act because mismeasured depreciation and interest deductions are taken at much lower rates

macroeconomic effects from government purchases and taxes for u s annual data that include world war ii the estimated multiplier for temporary defense spending is 0 4 0 5 contemporaneously and 0 6 0 7 over 2 years if the change in defense spending is permanent gauged by ramey s defense news variable the multipliers are higher by 0 1 0 2 since all estimated multipliers are significantly less than 1 greater spending crowds out other components of gdp particularly investment the lack of good instruments prevents estimation of reliable multipliers for nondefense purchases multipliers in the literature of two or more likely reflect reverse causation from gdp to nondefense purchases increases in average marginal income tax rates measured by a newly constructed time series have significantly negative effects on gdp when interpreted as a tax multiplier the magnitude is around 1 1 the combination of the estimated spending and tax multipliers implies that the balanced budget multiplier for defense spending is negative we have some evidence that tax changes affect gdp mainly through substitution effects rather than wealth effects

the price of negligence under differing liability rules although economics journals have been filled with theoretical articles about the effects of various negligence rules on allocative efficiency there have been no econometric studies on whether juries act according to the standards implied by the various liability rules if juries do not act accordingly then the actual allocative effects of a particular liability rule can vary greatly from the theoretical predictions because those who are subject to liability for example automobile drivers will face expected losses different from the theoretically determined ones in this paper i first develop hypotheses concerning the interrelationship of liability rules jury decision making and litigant behavior and then test these hypotheses using data from 582 civil cases involving rear end automobile accidents in california during 1974 76 in a sense jury trials are the ultimate arbiters in all personal injury cases while some trials involve only a judge and many cases are negotiated out of court both sides always have the option of going to ajury trial the expected behavior of juries therefore sets the boundaries within which negotiated settlements take place for example if the jury is expected to award the plaintiff 100 000 the plaintiff will not accept a negotiated settlement of 2 000 if juries tend to award more than judges do then plaintiffs will tend to opt for juries if juries tend to award less than

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

saving pension contributions and the real interest rate a test of the hypothesis that estimates of the interest elasticity of personal and private saving may be biased downward by a failure to control for behavior related to defined benefit pension programs fails to reject existence of a positive interest elasticity of private saving correcting for pension funding bias the estimated interest elasticity of private saving is 0 04 well below michael j boskin s 1978 estimate of 0 4 obtained with a different data set and different estimation procedures the estimated interest elasticity of personal saving is 0 28 copyright 1989 by mit press

do real exchange rate appreciations matter for growth the impact of exchange rate changes on growth a long standing key issue in international macroeconomics has received renewed attention in recent years owing to weaker growth rates and the debate on currency wars the connection between real exchange rates and growth remains however an unsettled question in the academic literature we fill this gap by providing an empirical assessment based on a broad sample of emerging and advanced economies we assess the impact of appreciations productivity booms and capital inflows surges using a propensity score matching approach to address causality issues appreciations associated with higher productivity have a larger impact on growth than those associated with capital inflows furthermore appreciations per se tend to have a negative impact on growth we provide a simple theoretical model that delivers a contrasted growth appreciation pattern depending on the underlying shock the model also implies adverse effects of shocks to international capital flows so concerns about an appreciation are not inconsistent with concerns about a depreciation while the presence of an externality through firms destruction leads to inefficient allocations addressing the inefficiency does not dampen exchange rate movements

from the static to the dynamic some problems in the theory of taxation abstract this paper considers problems and issues that arise when we attempt to extend the static theory of taxation and production planning to a dynamic context and to combine that theory with theories of growth the reasons dynamic theory is less developed include problems with the analytical tractability of even those dynamic models which attempt to retain the basic structure of the static model furthermore difficult and interesting issues arise in a dynamic context which are either not present or are much less severe in the static theory special attention is paid to these new issues and the difficulties they pose

the financial cycle and macroeconomics what have we learnt abstract it is high time we rediscovered the role of the financial cycle in macroeconomics in the environment that has prevailed for at least three decades now it is not possible to understand business fluctuations and the corresponding analytical and policy challenges without understanding the financial cycle this calls for a rethink of modelling strategies and for significant adjustments to macroeconomic policies this essay highlights the stylised empirical features of the financial cycle conjectures as to what it may take to model it satisfactorily and considers its policy implications in the discussion of policy the essay pays special attention to the bust phase which is less well explored and raises much more controversial issues

household heterogeneity and the transmission of foreign shocks abstract we study the role of heterogeneity in the transmission of foreign shocks we build a heterogeneous agent new keynesian small open model economy hanksome that experiences a current account reversal households portfolio composition and the extent of foreign currency borrowing are key determinants of the magnitude of the contraction in consumption associated with a sudden stop in capital inflows the contraction is more severe when households are leveraged and owe debt in foreign currency in this setting the revaluation of foreign debt causes a larger contraction in aggregate consumption when debt and leverage are concentrated among poorer households closing the output gap via an exchange rate devaluation may therefore be detrimental to household welfare due to the heterogeneous impact of the foreign debt revaluation our hanksome framework can rationalize the observed fear of floating in emerging market economies even in the absence of contractionary devaluations

asset prices and twin crises abstract emerging market crises have been characterized by two key features i banking crises generally precede currency crises and ii asset prices decline in advance of currency crises this paper argues that asset prices provide a key link between banking and currency crises it is shown that a prospective currency crisis due to an unanticipated increase in the public debt triggers an asset price decline banks exposure to asset prices in turn deteriorates their balance sheets and precipitates a banking crisis under the assumption of government bailout of banks it is shown that the twin crises are self fulfilling and their time line follows i and ii described above the timing of currency crisis is decreasing in the ratio of government s bailout to banks loss of capital

currency crises capital account liberalization and selection bias are countries with unregulated capital flows more vulnerable to currency crises efforts to answer this question properly must control for self selection bias since countries with liberalized capital accounts may also have more sound economic policies and institutions that make them less likely to experience crises we employ a matching and propensity score methodology to address this issue in a panel analysis of developing countries our results suggest that after controlling for sample selection bias countries with liberalized capital accounts experience a lower likelihood of currency crises that is when two countries have the same likelihood of allowing free movement of capital based on historical evidence and a very similar set of economic and political characteristics and one country imposes controls and the other does not the country without controls has a lower likelihood of experiencing a currency crisis this result is at odds with the conventional wisdom and suggests that the benefits of capital market liberalization for external stability are substantial

corporate debt firm size and financial fragility in emerging markets abstract the post global financial crisis period shows a surge in corporate leverage in emerging markets and a number of countries with deteriorated corporate financial fragility indicators altman s z score firm size plays a critical role in the relationship between leverage firm fragility and exchange rate movements in emerging markets while the relationship between firm leverage and distress scores varies over time the relationship between firm size and corporate vulnerability is relatively time invariant all else equal large firms in emerging markets are more financially vulnerable and also systemically important consistent with the granular origins of aggregate fluctuations in gabaix 2011 idiosyncratic shocks to the sales growth of large firms are positively and significantly correlated with gdp growth in our emerging markets sample relatedly the negative impact of exchange rate shocks has a more acute impact on the sales growth of the more highly levered large firms

can government purchases stimulate the economy this essay briefly reviews the state of knowledge about the government spending multiplier drawing on theoretical work aggregate empirical estimates from the united states as well as cross locality estimates i assess the likely range of multiplier values for the experiment most relevant to the stimulus package debate a temporary deficit financed increase in government purchases i conclude that the multiplier for this type of spending is probably between 0 8 and 1 5 jel e23 e62 h50

uncertainty and currency crises evidence from survey data this paper studies empirically how uncertainty aects speculation in the foreign ex change markets we use the dispersion of survey forecasts of key macroeconomic variables to measure uncertainty about fundamentals we nd that uncertainty has a non monotone eect on exchange rate pressures namely uncertainty heightens speculative pressures when expected fundamentals are good and eases them when they are bad we prove that this prediction arises from a broad class of currency crisis theories ranging from rst generation to global game models we also show that the proposed empirical strategy remains valid in the presence of forecasters with strategic objectives and use a novel set of instrumental variables to address potential endogeneity bias

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

a general equilibrium model of housing taxes and portfolio choice we describe a model in which rental and owner housing are risky assets tenure choice is endogenous and each household is constrained to consume the same amount of owner housing that it has in its investment portfolio at each iteration in the search for an equilibrium we determine the new taxable income for each of 3 578 households from the survey of consumer finances and we use statutory schedules to find the marginal rate and tax paid equilibrium net rates of return are major determinants of the amount of owner housing but a logit model indicates that demographic factors are the main determinants of ownership rates in our simulation taxes on owner housing would raise welfare not only by reallocating capital but also by the government s taking part of the risk from individual properties and diversifying it away measures to disallow property tax or mortgage interest deductions do not help share this risk simulations of the 1986 tax reform indicate a small shift from rental to owner housing and

state dependent monetary policy transmission and financial market tensions is monetary policy more powerful when strains in the financial system are high applying local projections to us time series i approach this question by allowing monetary policy shocks and its propagation to the broader economy to smoothly vary according to a measure of financial market tensions the so called excess bond premium ebp i find that monetary policy impacts macroeconomic housing and financial variables stronger and more persistently when financial frictions are high

how does capital control spur economic growth this paper provides a conceptual and empirical framework for evaluating the effect of capital controls on long term economic growth in a small open economy which relies on successful investment projects to provide capital goods taking out short term loans has two contradictory impacts i it reduces the interest costs of financing investment projects and ii it also leads to larger asset losses in the scenario of short term debt run in this work we hypothesise that private financing decisions made by domestic investors are distorted towards excessive risk taking leading to ineffective capital formation thus capital control policies particularly regulations on short term loans can be socially beneficial as they alter the debt composition promote capital formation and achieve a higher output level using a panel data set covering 77 countries from 1995 to 2009 we employ a system generalised method of moments gmm estimator to sequentially test three hypotheses and find strong empirical evidence that supports our theory

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

fault settlement and negligence law state tort laws that govern the apportionment of damages from accidents often bar potential plaintiffs who played even a minor causal role in the accident from recovering damages from other culpable parties however anecdotal evidence suggests that judges and juries fail to enforce the letter of the law which leads to a weaker relationship between fault in an accident and recovery for injuries than the laws would predict data from insurance settlements arising out of auto accidents are consistent with the anecdotal evidence this indicates that the letter of the law may be less important in shaping individuals behavior than scholars have supposed

a simple model of endogenous tax reform abstract this paper presents a model of optimal taxation that is useful for understanding governments incentives to switch from wage to consumption taxation the key ingredient is the fact that governments cannot precommit policy although under precommitment governments would tax only wages there is an ex post incentive to switch to the consumption tax as savings grow numerical examples for a nested ces utility function find that for reasonable parameter values equilibrium features a switch to consumption taxation in particular the model produces this tax reform when parameterized as in auerbach and kotlikoff s 1987 study

international and domestic collateral constraints in a model of emerging market crises abstract we build a model of emerging markets crises which features two types of collateral constraints firms in a domestic economy have limited borrowing capacity from international investors they also have limited borrowing capacity with respect to each other we study how the presence and changes in these collateral constraints affect financial and real variables a binding international constraint in the aggregate leads to a sharp rise in interest rates and fire sales of domestic assets while limited domestic collateral can lead to wasted international collateral these two collateral constraints can interact in important ways the first is disintermediation a fire sale of domestic assets causes banks to fail in their function of reallocating resources across the economy leading to wasted international collateral the second is a dynamic effect we show that firms in an economy with limited domestic collateral and a binding international collateral constraint will not adequately precaution against adverse shocks increasing the severity of these shocks

are government spending multipliers greater during periods of slack evidence from 20th century historical data a key question that has arisen during recent debates is whether government spending multipliers are larger during periods of slack some researchers and policymakers have argued that while government spending multipliers are estimated to be modest on average they might become greater during times when resources are underutilized auerbach and gorodnichenko 2012 forthcoming henceforth ag test this hypothesis and find larger multipliers dur

austerity and private debt this study provides empirical evidence that the costs of austerity crucially depend on the level of private indebtedness in particular fiscal consolidations lead to severe contractions when implemented in high private debt states contrary fiscal consolidations have no significant effect on economic activity when private debt is low these results are robust to alternative definitions of private debt overhang the composition of fiscal consolidations and controlling for the state of the business cycle and government debt overhang i show that deterioration in household balance sheets is important to understand private debt dependent effects of austerity

the real exchange rate and economic growth revisiting the case using external instruments abstract we investigate the impact of movements in the real exchange rate on economic growth based on five year average data for a panel of over 150 countries in the post bretton woods period unlike previous literature we use external instruments to deal with possible reverse causality from growth to the real exchange rate our country specific instruments are i global capital flows interacted with individual countries financial openness and ii the growth rate of official reserves we find that a real appreciation depreciation reduces raises significantly annual real gdp growth more than in previous estimates in the literature however our results confirm this effect only for developing countries and for pegs

tax treatment of housing in a dynamic sequenced general equilibrium model this paper evaluates the efliciency effects of possible changes in the tax treatment of housing using a dynamic sequenced general equilibrium model based on canadian data for 1972 our model is similar in structure to that used by fullerton shoven and whalley fsw 1983 to analyze the impacts of a switch to a consumption tax in the united states except that we include two assets rather than one the motivation for the paper arises from existing literature on the treatment of housing under the income tax most of this literature emphasizes the non taxation of imputed income from owner occupied housing as a deviation from the haig simons concept of income and approaches taxation of housing as a static resource allocation issue this implicitly argues for the inclusion of imputed income in the income tax base and suggests that a welfare gain would result when viewed from a dynamic perspective one s perception of the appropriate tax treatment for housing correspondingly changes evaluated relative to a pure consumption tax rather than a pure income tax housing is appropriately treated if imputed income goes untaxed since the income stream to the asset is not further taxed once the asset has been purchased the intertemporal misallocation problem arises not with housing but from taxation of non housing capital income this issue is however more complex than this discussion indicates because of inter asset distortions arising from the differential tax treatment of housing

replacing the u s income tax with a progressive consumption tax a sequenced general equilibrium approach abstract this paper examines the welfare consequences of changing the current u s income tax system to a progressive consumption tax we compute a sequence of single period equilibria in which savings decisions depend on the expected future return to capital in the presence of existing income taxes the u s economy is assumed to lie on a balanced growth path with the change to a consumption tax individuals save more and initially consume less as the capital stock grows consumption eventually overtakes that of the original path and the economy approaches the new balanced growth path with higher consumption and a greater capital stock both the transition and the balanced growth paths enter our welfare evaluations we find the discounted present value of the stream of net gains is approximately 650 billion in 1973 dollars just over 1 percent of the discounted present value of national income larger gains occur if further reform of capital income taxation accompanies the change we examine the sensitivity of the results both to the design of the consumption tax and to the values of elasticity and other parameters the paper also contains estimates of the time required to adjust from one growth path to the other

fiscal policy in general equilibrium this paper studies four classic fiscal policy experiments within a quantitatively restricted neoclassical model the authors main findings are as follows 1 permanent changes in government purchases can lead to short run and long run output multipliers that exceed one 2 permanent changes in government purchases induce larger effects than temporary changes 3 the financing decision is quantitatively more important than the resource cost of changes in government purchases and 4 public investment has dramatic effects on private output and investment these findings stem from important dynamic interactions of capital and labor absent in earlier equilibrium analyses of fiscal policy copyright 1993 by american economic association

fiscal policy in good times and bad in the 1980s several countries with large government debt or deficit implemented substantial and in some cases drastic deficit cuts contrary to widespread expectations in many cases private consumption boomed rather than contracted this paper shows that in times of fiscal stress shocks to government revenues and especially expenditure have very different effects on private consumption than in normal times

does exchange rate stability increase trade and welfare we develop a simple general equilibrium framework to study the effect of the exchange rate system on trade and welfare an important feature of the model is deviations from purchasing power parity caused by rigid price setting in buyers currency we find the following first exchange rate stability is not necessarily associated with more trade in a simple benchmark model with separable preferences and only monetary shocks trade is unaffected by the exchange rate system consistent with most evidence second both trade and welfare can be higher under either exchange rate system depending on preferences and on the monetary policy rules followed under each system finally in general there is no one to one relationship between the levels of trade and welfare across exchange rate systems

tax policy and economic growth lessons from the 1980s the past seven years of u s economic policy and performance constitute a truly remarkable if confusing experiment few would have guessed in 1980 that inflation would fall rapidly to 4 percent and hold pretty steady during a lengthy recovery that productivity growth would partially rebound the national debt more than double capital imports reach 150 billion in a single year or that employment would continue to expand at rates envied by other advanced economies perhaps fewer still would have predicted two major and two minor tax reforms would be passed in six years a flip flop in depreciation schedules and a top personal tax rate below 30 percent while it is always easier to draw inferences concerning economic growth its determinants and policies affecting the determinants with long historical hindsight this paper will attempt to provide information evaluation and conjecture to draw some tentative lessons about the effects of tax policies in the 1980s on long run economic growth the good news from the 1980s is the remarkable achievement of substantially lower marginal tax rates making the government a much smaller silent partner in many economic decisions for example the tax advantage of debt finance is reduced substantially with the much lower marginal tax rates the bad news is that the nation could not afford all of the good news the very large budget deficits add to the instability in the tax code in addition to whatever other problems they cause moreover in a country with the lowest saving and investment rates in the advanced world the consequence of which may be to decrease our long run growth potential and short run trade competitiveness the remaining anti saving and investment features of our tax law while probably less important in the long run than the u s

heterogeneous government spending multipliers in the era surrounding the great recession abstract we use novel quarterly data of u s states to examine the dynamics of relative spending multipliers in the decade surrounding the great recession while multipliers were around 1 in expans

corporate tax integration in the united states a general equilibrium approach this paper presents estimates of static and dynamic general equilibrium resource allocation effects for four alternative plans for corporate and personal income tax integration in the united states a medium scale numerical general equilibrium model is used which integrates the u s tax system with consumer demand behavior by household and producer behavior by industry results indicate that total integration of personal and corporate taxes would yield an annual static efficiency gain of around 6 billion 1973 dollars partial integration plans yield less dynamic effects are larger and our analysis indicates that full integration may yield gains whose present value is as large as 500 billion or about 1 0 percent of the discounted present value of the gnp stream to the u s economy after correction for population growth plans differ in their distributional impacts although these findings depend on the nature of replacement taxes used to preserve government revenues the size of dynamic resource allocation effects is sensitive to the choice of the replacement tax while static gains are reasonably robust

fiscal imbalances and the dynamics of currency crises abstract this paper analyzes links between the fiscal theory of the price level ftpl and the first generation models after krugman journal of money credit and banking 11 1979 311 325 exploring the idea that a synthesis between the two can become a new framework to analyze the fiscal dimension of currency crises working in a simple synthetic framework we show how external nominal shocks can cause a fiscal imbalance and undermine currency stability resolve two well known paradoxes of the first generation model discuss the role of seigniorage revenues and illustrate how fiscal and interest rate policies interact to determine the magnitude and the timing of speculative attacks and devaluations

uncertain parameter values and the choice among policy options abstract we use a tax policy example to show how debate on the value of an elasticity parameter translates into a debate about policy choices to construct this example suppose that the choice among four particular tax reform options is based on a single measure of efficiency gain for each reform we show how the size of this gain depends upon the elasticity of saving with respect to the net rate of return moreover within quite narrow and reasonable bounds for the elasticity parameter we find regions in which each of three different tax reforms turns out to dominate the others

output spillovers from fiscal policy in this paper we estimate the cross country spillover effects of government purchases on output for a large number of oecd countries following the methodology in auerbach and gorodnichenko 2012a b we allow these multipliers to vary smoothly according to the state of the economy and use real time forecast data to purge policy innovations of their predictable components we also consider the responses of other key macroeconomic variables our findings suggest that cross country spillovers have an important impact and also confirm those of our earlier papers that fiscal shocks have a larger impact when the affected country is in recession

fiscal stimulus and consumer debt in the aftermath of the consumer debt induced recession policymakers have questioned whether fiscal stimulus is effective during periods of high consumer indebtedness this study empirically inves

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

estimating fiscal multipliers news from a non linear world we estimate non linear vars to assess to what extent fiscal spending multipliers are countercyclical in the us we deal with the issue of non fundamentalness due to fiscal foresight by appealing to sums of revisions of expectations of fiscal expenditures this measure of anticipated fiscal shocks is shown to carry valuable information about future dynamics of public spending results based on generalised impulse responses suggest that fiscal spending multipliers in recessions are greater than one but not statistically larger than those in expansions however non linearities arise when focusing on extreme events that is deep recessions versus strong expansionary periods

credit booms and macrofinancial stability this paper explores several questions about credit booms and busts when do credit booms occur when do they end up in busts and when do they not what are the implications for different policies if curbing credit growth and or mitigating the associated risks is an objective we find that credit booms are often associated with financial reform and economic growth they also tend to be more frequent in fixed exchange rate regimes only one in three credit boom episodes are followed by a financial crisis these booms tend to be larger and last longer macroprudential tools have at times proven effective in containing booms and more often in limiting the consequences of busts due to the buffers they helped to build

household debt overhang and transmission of monetary policy we investigate how the level of household indebtedness affects the monetary transmission mechanism in the u s economy using state dependent local projection methods we find that the effects of monetary policy are less powerful during periods of high household debt in particular the impact of monetary policy shocks is smaller on gdp consumption residential investment house prices and household debt during a high debt state we then build a partial equilibrium model of borrower households with financial constraints to rationalize these facts the model points to the weakening of the home equity loan channel as a possible reason for the decline in monetary policy effectiveness when initial debt levels are high

tax reform and external balance abstract this paper examines the effect of a transformation from capital taxation to consumption in an open economy with the residential capital tax rate being endogenous an increase in the domestic consumption tax rate decreases the interest rate increases capital accumulation and increases the domestic country s net foreign asset holdings and trade surplus with the territorial capital tax rate being endogenous an increase in the domestic consumption tax rate may either increase or decrease the domestic country s interest rate net foreign asset holdings and trade surplus depending on the interest elasticity of capital demand

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