Cardiff Business School

Xue Dong, Patrick Minford, David Meenagh and Xiaoliang Yang (February 2023)
A heterogeneous-agent model of growth and inequality for the UK (706K, 40 pages)
Since the channel for agents’ expectations matters for the effectiveness of monetary policies, it is crucial for policy-makers to assess the degree to which economic agents are boundedly rational and understand how the bounded rationality affects the monetary rules in stabilising the economy. We investigate the empirical evidence for the bounded rationality in a small open economy model of the UK, and compare the results with those for the conventional rational expectations model. Overall, comparing the estimated models favours the bounded rationality framework. The results show that bounded rationality model helps to explain the hump-shaped dynamics of real exchange rate following monetary shocks, while the rational expectations model cannot. Also, we find that the exchange rate channel in the bounded rationality enlarges the effects of foreign mark-up shock, policymakers should send stronger signals over its target to the economics agents to combat the inflation. So the bounded rationality that can be found in the data still leaves scope for the forward guidance channel to work strongly enough to be exploited by policymakers.
Keywords: bounded rationality, monetary policy, small open economy, exchange rate channel
JEL Classification: E52, E70, F41, C51, F31

Patrick Minford, Zhirong Ou and Zheyi Zhu (February 2023)
Is there international risk-sharing between developed economies? New evidence from indirect inference (491K, 10 pages)
It has been an `empirical consensus' that data from developed economies generally do not support the hypothesis of international risk-sharing, either in the form of full risk-pooling via state-contingent assets or in the form of uncovered interest parity enforced by trading non-contingent assets. We reassess these hypotheses in the context of a full DSGE model, as opposed to testing them as single regressions in previous work. We prove that the two model versions behave identically, suggesting that consumers would receive the same scope of protection against risks whether bonds are state-contingent. We further find that the model, when tested appropriately as a whole embracing risk-pooling/UIP, fits the data well and universally through the lens of indirect inference; hence, we provide new evidence of the hypotheses' empirical validity spuriously rejected by single regressions.
Keywords:  consumer risk-pooling; UIP; two-country DSGE model; indirect inference test
JEL Classification:  C12, E12, F41

Patrick Minford, Zhirong Ou and Zheyi Zhu (February 2023)
On the determination of the real exchange rate in free markets: do consumer risk-pooling and uncovered interest parity differ and fit? (100K, 13 pages)
We revisit the ‘puzzle’ in open economy studies that evidence of international risk-sharing is hardly seen despite the completeness of the financial market. We reassess both risk-pooling via state-contingent bonds, and uncovered interest parity – both were believed to be different, and spuriously rejected, in previous work – in the context of a full DSGE model. We prove that the two models are identical, both analytically and numerically. When tested as part of the full DSGE model by indirect inference which circumvents the bias of single-equation tests, we find strong and wide evidence of international risk-sharing.
Keywords:  consumer risk-pooling; UIP; two-country DSGE model; indirect inference test
JEL Classification:  C12, E12, F41

Patrick Minford and Zheyi Zhu (January 2023)
How the short run effects of Brexit on trade, investment and GDP have been miscalculated in some recent work(670K, 12 pages)
We look for statistically significant effects of Brexit events in UK data relationships. We find evidence of trade disruption by Brexit departure from the single EU market, much as we would expect. However, with investment, we find no statistically significant effects of Brexit. With GDP, inflation and interest rates we find some positive effects due to the fall in the pound. Previous work using weighted averages of selected other countries to mimic UK behaviour is inconsistent with economic theory stressing the key role of idiosyncratic country structure and shocks; it is also vulnerable to selection bias and does not test for the statistical significance of Brexit events, which have occurred in the context of enormous turbulence in the past few years in all economies due to Covid and the Ukraine war, besides accompanying large fiscal and monetary policy fluctuations. 
Keywords:
JEL Classification:  

Kul B Luintel  and Panayiotis M. Pourpourides (December 2022)
New Results and a Model of Scale Effects on Growth(1.1M, 36 pages)
A consensus in the growth literature is that scale effects of R&D are non-existent across mature industrialized economies. However, the scrutiny across emerging economies is lacklustre at best. The empirical studies of scale effects also leave the issues of unbalanced regression (non-standard distribution) largely unaddressed. In this paper, we conduct separate but parallel empirical scrutiny of scale effects across the panels of industrialized and emerging countries, clearly addressing these econometric issues, and employing a more realistic measure of the scale of R&D activities than has been applied hitherto. We provide parallel but novel estimates of significant scale effects across emerging countries, and their absence across developed countries. We then propose an endogenous growth model and show that scale effects exist during growth transitions but not at the vicinity of the long-run equilibrium, which reconciles our results. Thus, we shed light on a long-debated and important issue. Estimates of our model’s predictions reveal that the long-run growth rates of per capita real GDP and TFP are driven by the growth rates of technological innovation and aggregate employment, except that only the former matters for the TFP growth across emerging countries.
Keywords: Endogenous Technical Change; Scale Effects; Panel Integration and Cointegration
JEL Classification:  O3; O4; O14; O33; O47

Armenak Antinyan Luca Corazzini, Miloš Fišar and Tommaso Reggiani (October 2022)
Mind the framing when studying social preferences in the domain of losses (1.2M, 29 pages)
There has been an increasing interest in altruistic behaviour in the domain of losses recently. Nevertheless, there is no consensus in whether the monetary losses make individuals more generous or more selfish. Although almost all relevant studies rely on a dictator game to study altruistic behaviour, the experimental designs of these studies differ in how the losses are framed, which may explain the diverging findings. Utilizing a dictator game, this paper studies the impact of loss framing on altruism. The main methodological result is that the dictators’ prosocial behaviour is sensitive to the loss frame they are embedded in. More specifically, in a dictator game in which the dictators have to share a loss between themselves and a recipient, the monetary allocations of the dictators are more benevolent than in a standard setting without a loss and in a dictator game in which the dictators have to share what remains of their endowments after a loss. These differences are explained by the different social norms that the respective loss frames invoke.
Keywords: loss; framing; altruism; dictator game; experiment; social norms.
JEL Classification: C91; D02; D64

Huw Dixon and Maoshan Tian (August 2022)
The Confidence Interval of Cross-Sectional Distribution of Durations (466K, 23 pages)
Tian and Dixon (2022) derived the variance of the estimator of Cross-Sectional Distribution of Durations (CSD). In this paper, we apply Fieller’s method and Delta method to derive confidence interval of CSD with Tian and Huw’s variance formulae. (CSD) is a new estimators derived by Dixon (2012). It can be applied in general Taylor model (GT E) by Dixon and Bihan (2012a) and hospital waiting times by Dixon and Siciliani (2009). We use Monte Carlo simulations to evaluate the empirical size of Fieller’s method and delta method among different sample sizes. The empirical results show that Fieller’s method is superior to delta method in terms of estimating the confidence interval of CSD even both methods are available. Finally, we use both methods to two data sets: the UK CPI micro-price data and waiting time data from UK hospitals. All the estimators are located in their confidence intervals.
Keywords: Fieller’s Method, Delta Method, Confidence Interval
JEL Classification:  C10, C15, E50

Sergey V. Popov (July 2022)
Tactical Refereeing and Signaling by Publishing  (466K, 19 pages)
A peer review is used ubiquitously in hiring, promotional, and evaluation decisions, within academia and beyond. It is usually conducted to allocate limited resources, such as the budget of a funder or the pages of a journal. With limited capacity, a peer review may lead to negatively biased evaluations precisely because approving a peer’s worthy project lowers the chance that a referee’s own project will be approved. I show that limited capacity is inconsistent with a hypothesis that the decision-maker’s policy is to stimulate efforts, and I discuss possible decision-maker motivations that could lead to a limited capacity policy.
Keywords: refereeing, peer review.
JEL Classification:  C78

Chunping Liu, Patrick Minford and Zhirong Ou (July 2022)
Modern Monetary Theory: the post-Crisis economy misunderstood?(442K,27 pages)
We set out Modern Monetary Theory (MMT) as a full DSGE model, and test it by indirect inference on post Financial Crisis US data, alongside a standard New Keynesian, NK, model. The MMT model is rejected, while the NK model has a high probability. We then evaluate replacing the fiscal and monetary policies within the NK model by MMT policies, and find that they imply a material loss of welfare
Keywords: Modern Monetary Theory; DSGE model; fiscal activism; Wald test; indirect inference
JEL Classification:

David Meenagh, Patrick Minford  and Yongdeng Xu (July 2022)
Targeting moments for calibration compared with indirect inference(208K, 6 pages)
A common practice in estimating parameters in DSGE models is to find a set that when simulated gets close to an average of certain data moments; the model's simulated performance for other moments is then compared to the data for these as an informal test of the model. We call this procedure informal Indirect Inference, III. By contrast what we call Formal Indirect Inference, FII, chooses a set of moments as the auxiliary model and computes the Wald statistic for the joint distribution of these moments according to the structural DSGE model; it tests the model according to the probability of obtaining the data moments. The FII estimator then chooses structural parameters that maximise this probability. We show in this note via Monte Carlo experiments that the FII estimator has low bias in small samples, whereas the III estimator has much higher bias. It follows that models estimated by III will typically also be rejected by formal indirect inference tests.
Keywords: Moments, Indirect Inference
JEL Classification: C12, C32, C52

Cemil Selcuk and Bilal Gokpinar (June 2022)
Incentivizing flexible workers in the gig economy: The case of ride-hailing (576K, 46 pages)
Creating the right incentives for a flexible workforce lies at the heart of the gig economy. For most companies, a key question is how to best connect a limited number of independent
workers in their platforms with service-seeking consumers through the right pricing and matching mechanisms. We focus on ride-hailing where drivers have significant discretion over where and when to work across different locations. Building a spatial model, we study how a platform can create incentives for independent drivers via prices and commissions, and how such policies affect driversísearch behavior across a network of locations.  Contrary to common perception, we find that the áexibility of the commissions, and not the flexibility of prices, plays a dominant role in resolving local demand and supply mismatch. This is because location based price hikes at the bottlenecks negatively distort the local demand and generally do a poor job in incentivizing drivers towards such locations. Adjusting the commissions, on the other hand, does not interfere with the local demand; creates better incentives for the drivers, and therefore is more suitable to mitigate the effects of bottlenecks. Simulations based on actual ride patterns from New York City and Los Angeles confirm our insights.
Keywords: Ride-sharing, Gig workersícompensation, Flexible commission, Sharing economy
JEL Classification:

David Meenagh, Patrick Minford  and Yongdeng Xu (May 2022)
Why does Indirect Inference estimation produce less small sample bias than maximum likelihood? A note (455K, 8 pages)
Maximum Likelihood (ML) shows both lower power and higher bias in small sample Monte Carlo experiments than Indirect Inference (II) and IIís higher power comes from its use of the model-restricted distribution of the auxiliary model coefficients (Le et al. 2016). We show here that IIís higher power causes it to have lower bias, because false parameter values are rejected more frequently under II; this greater rejection frequency is partly offset by a lower tendency for ML to choose unrejected false parameters as estimates, due again to its lower power allowing greater competition from rival unrejected parameter sets.
Keywords: Bias, Indirect Inference, Maximum Likelihood
JEL Classification: C12, C32, C52

David Meenagh and Patrick Minford (May 2022)
A structural model of coronavirus behaviour: what do four waves of Covid tell us? (518K, 12 pages)
This paper extends Meenagh and Minford (2021) to the four waves of infection in the UK by end-2021, using the unique newly available sample-based estimates of infections created by the ONS. These allow us to estimate the effects on the Covid hospitalisation and fatality rates of vaccination and population immunity due to past infection: the latter was the most significant factor driving both trends, while the vaccination rate also had a significant short run effect on the fatality rate. We also updated our policy comparison with Sweden for the most recent data, with similar conclusions.: lower Swedish lockdown intensity relative to personal response in waves 1 and 2 caused much lower economic costs with no discernible effect on infections.
Keywords:
JEL Classification:

Štěpán Mikula and Tommaso Reggiani (March 2022)
Residential-based discrimination in the labor market(2.1 M, 18 pages)
Through a correspondence study, this paper investigates whether employers discriminate job applicants based on their living conditions. Exploiting the natural setting provided by a Rapid Re-housing Program, we sent 1,347 job applications for low-qualified front-desk jobs in Brno, Czech Republic. The resumes exogenously differed in only one main aspect represented by the address of the applicants, signaling both the quality of the neighborhood and the quality of the housing conditions in which they were living. We found that while the higher quality of the district has a strong effect in increasing the hiring chances (+20%) the actual improvement of the living conditions standards, per se, does not generate any significant positive effect.
Keywords: correspondence study, labor discrimination, housing conditions, Rapid Re-housing.
JEL Classification:  C93, J08, J71

Joshy Easaw, Roberto Golinelli and Saeed Heravi (March 2022)
Professionals Forecasting Inflation: The Role of Inattentiveness and Uncertainty(761K, 41 pages)
The purpose of this paper is to investigate the nature of professionals’ inflation forecasts inattentiveness. We introduce and empirically investigate a new generalized model of inattentiveness due to informational rigidity. In doing so, we outline a novel model that considers the non-linear relationship between inattentiveness and aggregate uncertainty, which crucially distinguishes between macro-economic and data (measurement error) uncertainty. The empirical analysis uses the Survey of Professional Forecasters data and indicates that inattentiveness due to imperfect information explains professional forecasts’ dynamics.
Keywords:Inflation Forecasts, Information Rigidities, Inattentiveness, Uncertainty, Survey Forecasts
JEL Classification:  E3, E4, E5.

Iain W. Long, Kent Matthews and Vaseekaran Sivarajasingam (March 2022)
Overconfidence, Alcohol and the Environment: Evidence from a Lab-in-the-Field Experiment (486K, 32 pages)

Keywords:  Alcohol intoxication, overconfidence
JEL Classification: C93, D91, I18

Yongdeng Xu (March 2022)
Exponential High-Frequency-Based-Volatility (EHEAVY) Models  (491K, 32 pages)
This paper proposes an Exponential HEAVY (EHEAVY) model. The model specifies the dynamics of returns and realized measures of volatility in an exponential form, which guarantees the positivity of volatility without restrictions on parameters and naturally allows the asymmetric effects. It provides a more flexible modelling of the volatility than the HEAVY models. A joint quasi-maximum likelihood estimation and closed form multi-step ahead forecasting is derived. The model is applied to 31 assets extracted from the Oxford-Man Institute's realized library. The empirical results show that the dynamic of return volatility is driven by the realized measure, while the asymmetric effect is captured by the return shock (not by the realized return shock). Hence, both return and realized measure are included in the return volatility equation. Out-of-sample forecast and portfolio exercise further shows the superior forecasting performance of the EHEAVY model, in both statistical and economic sense.
Keywords: HEAVY model, High-frequency data, Asymmetric effects, Realized variance, Portfolio
JEL Classification: C32, C53, G11, G17

Sisi Ji and Zheyi Zhu (February 2022)
Does higher education matter for health? (725K, 41 pages)
Using 6 sweeps from 1958 British NCDS data we adopt a quasi-parametric approach of propensity score matching to estimate causal effects of higher education attainment on a wide range of cohorts’ health-related outcomes at ages 33, 42 and 50. The non-pecuniary benefits to HE attainments on health are substantial. Higher educated cohorts are more likely to report better health, maintain a healthy weight, be non-smokers and to have a higher sense of control on drinking alcohol and are less likely to be obese. We also highlight the importance of investigating incremental returns to HE within the lifetime of cohorts. Effects on self-reported health (SRH), BMI, drinking alcohol increase with age but continuously decrease with smoking frequency. When taking into account gender heterogeneity, HE has a larger effect on BMI and likelihood of being obese for males and a greater effect on SRH and drinking alcohol and smoking frequencies for females. Furthermore, we find no significant evidence that HE reduces the likelihood of depression, both for males and females.
Keywords: Casual effect; Health; Higher Education; Propensity Score matching
JEL Classification:   C21, I12, I23, I26

Jenyu Chou, Yifei Cao and Patrick Minford (January 2022)
Evaluation and Indirect Inference Estimation of Inattentive Features in a New Keynesian Framework (756K, 41 pages)
We test the standard New Keynesian (NK) Dynamic Stochastic General Equilibrium (DSGE) model under the condition with and without inattentive features, where inattentiveness is modelled in the form of sticky information and imperfect information data revision. All models are tested with the Indirect Inference method, and our test result based on real-time data suggests that the model with sticky information passes the test and consistently outperforms the baseline NK model with full information and rational expectation, while the model with imperfect information data revision fails to pass the test. Furthermore, we show that none of the modles passes the test when Survey of Professional Forecaster data are used for model evaluation. Overall, our findings provide important implications on the modelling of expectation formation in the DSGE framework.
Keywords:  Inattentive expectation, New Keynesian, DSGE, Indirect Inference
JEL Classification:  E12,E52,C52

Patrick W. Saart, Namhyun Kim, Yingcun Xia and Francesco Moscone (January 2022)
Varying Coefficient Model with Correlated Error Components and Application to Disparities Between Mental Health Service by Councils in England (62 pages)
In this paper, we discuss estimation procedure and various inferential methods for varying coefficient panel data models that include spatially correlated error components. Our estimation procedure is an extension of the quasi-maximum likelihood method for spatial panel data regression to the conditional local kernel-weighted likelihood. We allow both relevant and irrelevant regressors in our model and propose a variable selection procedure that we show to perform well for models that involve spatial error dependence. We also extend our procedure so that it allows empirical modelling and testing of the so-called semi-varying coefficient specification. To ensure the statistical validity of our methods, we derive a set of asymptotic properties based on a collection of primitive assumptions that appear regularly in the nonparametric literature. Finally, we use the proposed model and methods to analyse the municipal disparities in mental health service spending by local authorities in England in order to illustrate practicability and empirical relevance.
Keywords: Spatial models, Error components, Local maximum likelihood, Varying coefficient,  Variable selection, Mental health services and expenditures
JEL Classification: C14; C51; C52; G12; G17

Jenyu Chou，Joshy Easaw and Patrick Minford (December 2021)
Does Inattentiveness Matter for DSGE Modelling? An Empirical Investigation (1.6M, 60 pages)
The purpose of this paper is to investigate the empirical performance of the standard New Keynesian dynamic stochastic general equilibrium (DSGE) model in its usual form with full-information rational expectations and compare it with versions assuming inattentiveness- namely sticky information and imperfect information data revision. Using a Bayesian estimation approach on US quarterly data (both realtime and survey) from 1969 to 2015, we find that the model with sticky information fits best and is the only one that can generate the delayed responses observed in the data. The imperfect information data revision model is improved fits better when survey data is used in place of real-time data, suggesting that it contains extra
information.
Keywords: Expectation formation, Inattentive expectation, New Keynesian, DSGE, Bayesian estimation
JEL Classification:  C11, C32, C52, E10, E12, E17

Joshy Easaw, Yongmei Fang and Saeed Heravi (December 2021)
Using Polls to Forecast Popular Vote Share for US Presidential Elections 2016 and 2020: An Optimal Forecast Combination Based on Ensemble Empirical Model (2.8M, 23 pages)
This study introduces the Ensemble Empirical Mode Decomposition (EEMD) technique to forecasting popular vote share. The technique is useful when using polling data, which is pertinent when none of the main candidates is the incumbent. Our main interest in this study is the short- and long-term forecasting and, thus, we consider from the short forecast horizon of 1-day to three months ahead. The EEMD technique is used to decompose the election data for the two most recent US presidential elections; 2016 and 2020 US. Three models, Support Vector Machine (SVM), Neural Network (NN) and ARIMA models are then used to predict the decomposition components. The final hybrid model is then constructed by comparing the prediction performance of the decomposition components. The predicting performance of the combination model are compared with the benchmark individual models, SVM, NN, and ARIMA. In addition, this compared to the single prediction market IOWA Electronic Markets. The results indicated that the prediction performance of EEMD combined model is better than that of individual models.
Keywords: Forecasting Popular Votes Shares; Electoral Poll; Forecast combination, Hybrid model; Support Vector Machine
JEL Classification: 

Andrea Geraci, Mattia Nardotto, Tommaso Reggiani and Fabio Sabatini (December 2021)
Broadband Internet and Social Capital (1M, 50 pages)
We study the impact of broadband penetration on social capital in the UK. Our empirical strategy exploits a technological feature of the telecommunication infrastructure that generated substantial variation in the quality of Internet access across households. The speed of a domestic connection rapidly decays with the distance of a user's line from the network's node serving the area. Merging information on the topology of the network with geocoded longitudinal data about individual social capital from 1997 to 2017, we show that access to fast Internet caused a significant decline in civic and political engagement. Overall, our results suggest that broadband penetration crowded out several dimensions of social capital.
Keywords: Tax Competition; Proportional Taxes; Per-Unit Taxes; Capital Taxes.
JEL Classification: H21; H25; H77; F21; F23, F53, C72.

Helmuts Azacis and David R. Collie (December 2021)
A General Model of International Tax Competition with Applications (613K,49 pages)
A general version of the ZMW model of international tax competition is presented that confirms and extends the results of the existing literature about the choice of tax policy instruments in the symmetric case when the tax externality is positive for both countries. In the asymmetric case when the tax externality is positive for one country and negative for the other country, it is shown that the results are reversed. This demonstrates the importance of the sign of the tax externality in models of international tax competition. This general model is then used to analyse a couple of policy-relevant applications: depreciation allowances and interest payment deductibility.
Keywords: Tax Competition; Proportional Taxes; Per-Unit Taxes; Capital Taxes.
JEL Classification: H21; H25; H77; F21; F23, F53, C72.

Martin Iseringhausen, Ivan Petrella and Konstantinos Theodoridis (March 2022)
Aggregate Skewness and the Business Cycle (1.6M, 43 pages)
We develop a data-rich measure of expected macroeconomic skewness in the US economy. Expected macroeconomic skewness is strongly procyclical, mainly reflects the cyclicality in the skewness of real variables, is highly correlated with the cross-sectional skewness of firm-level employment growth, and is distinct from financial market skewness. Revisions in expected skewness deliver dynamics that are nearly indistinguishable from those produced by the main business cycle shock of Angeletos et al. (2020). This result is robust to controlling for macroeconomic volatility and uncertainty, and alternative macroeconomic shocks. Our findings highlight the importance of higher-order dynamics for business cycle theories.
Keywords: Asymmetry, principal component analysis, quantile regression, VAR
JEL Classification: C22, C38, E32

Abida Naurin and Panayiotis M. Pourpourides (November 2021, Updated October 2022)
On the Causality Between Household and Government Spending on Education: evidence from a panel of 40 countries (562K, 22 pages)

Keywords: Household Spending on Education, Government Spending on Education, Causality, Credit Market
JEL Classification: C91, D70, H26, H31.

Milos Fisar, Tommaso Reggiani, Fabio Sabatini and Jirí Spalek (October 2021)
Media negativity bias and tax compliance: Experimental evidence (3M, 69 pages)
We study the impact of the media negativity bias on tax compliance. Through a framed laboratory experiment, we assess how the exposure to biased news about government action affects compliance in a repeated taxation game. Subjects treated with positive news are signicantly more compliant than the control group. Instead, the exposure to negative news does not prompt any significant reaction compared to the neutral condition, suggesting that participants may perceive the media negativity bias in the selection and tonality of news as the norm rather than the exception. Overall, our results suggest that biased news provision is a constant source of psychological priming and plays a vital role in taxpayers' compliance decisions.
Keywords: tax compliance, media bias, taxation game, laboratory experiment.
JEL Classification: C91, D70, H26, H31.
Forthcoming in International Tax and Public Finance

Tianshu Zhao, Kent Matthews and Max Munday (October 2021)
Neither True-friend nor Fairweather friend: Relationship Banking and SME borrowing under Covid-19 (607K, 38 pages)
A growing literature addresses the costs and benefits associated with relationship banking, particularly for smaller firms, but with much of this work focused on normal trading conditions. Covid-19 provides an ideal testbed to explore the resilience of relationship banking. We examine whether the presence of closer pre-Covid ties between SMEs and their banks helps in accessing funds in the Covid-19 pandemic period. Then are ties between relationship bankers and SME borrowers a case of ‘true love’ or rather are the parties more akin to ‘fair-weather friends’? Data from the UK SME Finance Monitor from 2018Q2-2020Q3 is used to examine this question. Our analysis suggests that relationship banking was important for the acquisition of bank credit pre-Covid-19 but was of limited influence in post-Covid-19 lending behaviour. Banks treated SMEs that had a good relationship with them in the same way as those that did not and with public interventions to support lenders material in this.
Keywords: Covid-19, Relationship Banking, SMEs
JEL Classification: G21, G28, G40

Hans Degryse, Kent Matthews and Tianshu Zhao (October 2021)
Relationship lending, Trust, and SME bank financing in the UK (662K, 43 pages)
It is well recognized that relationship banking helps to relieve the credit constraints faced by SMEs to access bank finance. Trust is an important part of relationship banking. However, the term trust is nebulous, and relationship banking means different things to different banks and different borrowers. How trust enables the credit market for SMEs through relationship banking is largely unexplored. Using a unique primary dataset of SMEsin the UK, we construct a measure of trust-based relationship banking from the perspective of the borrower. We examine the drivers of trust-based relationship banking in terms of organizational trust in the relationship manager, defined as the delegation of operational autonomy, along with local market and social capital factors, and the style of the bank-borrower relationship. Along with bank, firm, and market factors, trust-based relationship banking helped to reduce the credit constraints faced by SMEs in the decade following the global financial crisis.
Keywords: Trust, Relationship Banking, SME Financing, Bank Organization
JEL Classification: G21, G290, L140

David Meenagh, Patrick Minford and Michael Wickens (September 2021)
Estimating macro models and the potentially misleading nature of Bayesian estimation (218K, 10 pages)
We ask whether Bayesian estimation creates a potential estimation bias as compared with standard estimation techniques based on the data, such as maximum likelihood or indirect estimation. We investigate this with a Monte Carlo experiment in which the true version of a New Keynesian model may either have high wage/price rigidity or be close to pure áexibility; we treat each in turn as the true model and create Bayesian estimates of it under priors from the true model and its false alternative. The Bayesian estimation of macro models may thus give very misleading results by placing too much weight on prior information compared to observed data; a better method may be Indirect estimation where the bias is found to be low.
Keywords: Bayesian; Maximum Likelihood; Indirect Inference; Estimation Bias
JEL Classification: C11; E12

Patrick Minford, Yongdeng Xu and Xue Dong (August 2021)
Testing competing world trade models against the facts of world trade (1.7M, 31 pages)
We carry out an indirect inference test of two versions of a computable general equilibrium (CGE) model of world trade. One of these, the ‘classical’ model, is well-known as the Heckscher-Ohlin-Samuelson model of world trade, in which countries trade homogeneous products in world markets and produce according to their comparative advantage as determined by their resource endowments. The other, the ‘gravity’ model, assumes products are differentiated by geographical origin, so that trade is determined largely by demand and relative prices differing according to distance; trade in turn affects productivity through technology transfer. These two CGE models of world trade behave in very different ways and predict quite different effects for trade policy, underlining the importance of discovering which best fits the facts of international trade. Our findings here are that the classical model fits these facts fairly well in general, while the gravity model is largely strongly rejected by them.
Keywords: Bootstrap, indirect inference, gravity model, classical trade model, trade
JEL Classification: F10-14, F16-17

Helmuts Azacis and Peter Vida (August 2021)
Fighting Collusion: An Implementation Theory Approach (688K,44 pages)
A competition authority has an objective, which specifies what output profile firms need to produce as a function of production costs. These costs change over time and are only known by the firms. The objective is implementable if in equilibrium, the firms cannot collude on their reports to the competition authority. Assuming that the firms can only report prices and quantities, we characterize what objectives are one-shot and repeatedly implementable. We use this characterization to identify conditions when the competitive output is implementable. We extend the analysis to the cases when a buyer also knows the private information of firms and when the firms can supply hard evidence about their costs.
Keywords: Collusion, Antitrust, (Repeated) Implementation, Monotonicity, Price-Quantity Mechanism, Hard Evidence
JEL Classification: C72; C73; D71; D82; L41

Patrick Minford (August 2021)
Free Trade under Brexit- why its benefits have been widely underestimated (1.7M, 24 pages)

Keywords:
JEL Classification:

Armenak Antinyan, Zareh Asatryan, Zhixin Dai, Kezhi Wang (July 2021)
Does the Frequency of Reminders Matter for their Effectiveness? A Randomized Controlled Trial (312K, 28 pages)
We assess the impact of reminder frequency on the probability of paying overdue property taxes in a randomized controlled trial in China. One reminder a week (sent as a text message) considerably increases the probability of tax compliance and results in tangible fiscal gains compared to a one-off reminder. However, increasing the frequency of reminders to two text messages a week diminishes their effectiveness. The takeaway of our study is that frequent reminders are an important trigger for human behavior, nonetheless, beyond a certain frequency the effectiveness of additional reminders seems to decline.
Keywords:Reminder Frequency; Randomized Controlled Trial; Tax Compliance
JEL Classification: C93; H24; H26

Wenna Lu, Laurence Copeland,and Yongdeng Xu (July 2021)
The Pricing of Unexpected Volatility in the Currency Market (724K, 31 pages)
Many recent papers have investigated the role played by volatility in determining the cross-section of currency returns. This paper employs two time-varying factor models: a threshold model and a Markov-switching model to price the excess returns from the currency carry trade. We show that the importance of volatility depends on whether the currency markets are unexpectedly volatile. Volatility innovations during relatively tranquil periods are largely unrewarded in the market, whereas during the volatile period, this risk, has a substantial impact on currency returns. The empirical results show that the two time-varying factor models fit the data better and generate a smaller pricing errors than the linear model, while the Markov-switching model outperforms the threshold factor models not only by generating lower pricing errors but also distinguishing two regimes endogenously and without any predetermined state variables.
Keywords: carry trade; asset pricing; trading strategies; currency portfolios; Markov switching model
JEL Classification: F3; G21; G15

Gang Chen, Xue Dong, Patrick Minford, Guanhua Qiu,Yongdeng Xu and Zequn Xu (June 2021)
Computable General Equilibrium Models of Trade in the Modern Trade Policy Debate (3.7M, 48 pages)
We set up two rival Computable General Equilibrium (CGE) models of world trade, one based on classical theories of comparative advantage, the other based on recent gravity theories. We have tested them by indirect inference on the time-series of trade facts for five major countries or country blocs: the UK, the US, China and the EU. The UK is a small enough economy for the rest of the world's behaviour to be treated as exogenous, so we test the UK model with this held constant; the other countries/blocs are large so we test their model by a `part of model' test in which the other world variables are simulated by a reduced form VAR of the unknown true world model.. We show by Monte Carlo experiments that these tests have high power. Our findings are that the Gravity version of the world model is rejected strongly for two of these country cases, but passes the test for the other two. By contrast the Classical model is comfortably accepted in all cases; our power experiment implies that this world model is very likely to be close to the truth and should therefore be used for policy analysis. The policy message of the classical model is that protection is damaging to welfare; this includes protection by customs union, where even though some members may gain, general welfare is reduced.
Keywords: Bootstrap, indirect inference, gravity model, classical trade model, UK trade
JEL Classification: F10-14, F16-17

David Meenagh, Patrick Minford and Zhiqi Zhao (June 2021)
Should Hong Kong switch to Taylor Rule?—Evidence from DSGE Model (1.5M, 30 pages)
This paper studies the economy of Hong Kong through the lens of a small open economy DSGE model with a currency board exchange rate commitment. It assumes flexible prices and a banking system that provides credit to entrepreneurial household-firms; the money supply is fully backed by reserves under the currency board. We estimate and evaluate the model by Indirect Inference over the sample period of 1994Q1-2018Q3; we find that it matches the data behaviour, as represented by a VAR. We examined the economy’s volatility using bootstrapping of the model innovations, under both the estimated currency board model and a standard alternative regime with floating exchange rate and a Taylor rule; we found that Hong Kong welfare is higher in the currency board, which substantially reduces output volatility.
Keywords: Currency Board, Monetary Policy, Hong Kong, Indirect Inference
JEL Classification: E52, F41, G5

James Foreman-Peck (June 2021)
Public Private Partnerships in Britain: Interpreting Recent Experience (531K, 33 pages)
Britain was in the forefront of utilising Public-Private Partnerships (PPP) and contracting out from the 1980s. The British experience of increasing disenchantment with private finance and outsourcing in recent years is therefore of considerable interest.  Private contractors have not proved invariably better at managing government services than direct government supply. Nearly complete measurement of the service is highly desirable if the supply is to be successfully contracted out or provided by a PPP. Though potentially beneficial for controlling project whole life costs, bundling different stages of supply boosts the size of the contract, which in turn reduces the number of potential competitors and the intensity of competition for the contract. Credible risk transfer continues to be challenging. H M Treasury project appraisal in some respects was biased in favour of private finance projects and yardstick competition between procurement routes remains underutilised. Private finance has been shown an expensive way of massaging the national debt-gdp ratio, although less than 10% of government investment is at stake. On the other hand, considerable experience has been obtained in controlling whole life project costs with other, simpler, procurement routes.
Keywords:
JEL Classification: 

Patrick Minford, Zhirong Ou, Michael Wickens and Zheyi Zhu (June 2021)
The eurozone: what is to be done? (670K, 27 pages)
We construct a macro DSGE model of the eurozone and its two main regions, the North and the South, with the aim of matching the macro facts of these economies by indirect inference and using the resulting empirically-based model to assess possible new policy regimes. The model we have found to fit the facts suggests that substantial gains in macro stability and consumer welfare are possible if the fiscal authority in each region is given the freedom to respond to its own economic situation. Further gains could come with the restoration of monetary independence to the two regions, in effect creating a second 'southern euro' bloc.
Keywords: eurozone; macro stability; fiscal policy; monetary independence
JEL Classification:   E32, E52, E62, F41

Huw Dixon, Jeremy Franklin and Stephen Millard (May 2021)
Sectoral shocks and monetary policy in the United Kingdom(794K, 60 pages)
In this paper, we examine the extent to which monetary policy should respond to movements in sectoral inflation rates.  To do this we construct a Generalised Taylor model that takes specific account of the sectoral make-up of the consumer price index (CPI).  We calibrate the model for each sector using the UK CPI microdata.  We find that a policy rule that allows for different responses to inflation in different sectors outperforms a rule which just targets aggregate CPI, as does a rule that responds only to non food and energy inflation.  However, we find that the optimal sectoral rule only leads to a small absolute improvement in terms of extra consumption.
Keywords: CPI inflation, Sectoral inflation rates, Generalised Taylor economy, Financial Intermediation.
JEL Classification: E17, E31, E52

Namhyun Kim and Patrick W. Saart (May 2021)
Estimation in partially linear semiparametric models with parametric and/or nonparametric endogeneity  (42 pages)
Partially linear semiparametric models are advantageous to use in empirical studies of various economic problems due to a special feature that allows the parametric and nonparametric components to exist simultaneously in the model. However, systematic estimation procedures and methods have not yet been satisfactorily developed to deal effectively with a well-known endogeneity problem that may be present in some empirical applications. In the current paper, we aim to address endogeneity comprehensively, which may take place in either a parametric or a nonparametric component or both, and to provide guidance to an appropriate estimation procedure and method in the presence of such a problem. A significant difficulty we must overcome before such goals can be achieved is a generated regressor problem which arises because a critical part, known in the literature as the "control variables", is not observable in practice and hence must be estimated. We show theoretically (i.e. through the derivation of a set of important asymptotic properties) and experimentally (i.e. through the use of simulation exercises) that our newly introduced method can help in overcoming the above-mentioned endogeneity problem. For the sake of completeness, we also discuss an adaptive data-driven method of bandwidth selection and show its asymptotic optimality.
Keywords:  Semiparametric Models with Endogeneity
JEL Classification: C12, C14, C22

Patrick W. Saart, Namhyun Kim, and Ian Bateman (May 2021)
Understanding spatial heterogeneity in GB agricultural land-use for improved policy targeting (38 pages)
Today, one of the biggest challenges facing the UK is the new target set when the nation became first major economy to pass net zero emissions law, which requires the country to bring all greenhouse gas emissions to net zero by 2050. On the one hand, there are already a few ideas about how we should farm and use land in order to deliver such a target. On the other hand, the government has a new strategy which is to pay farmers for providing public goods, especially for climate change mitigation through the reduction and storage of greenhouse gas emissions. The most critical task is to find a solution to such a question as \How should public spending on farm public goods be allocated?" In this paper, we argue that formulating an effective subsidy scheme cannot focus on the public need alone, but should also take into consideration what farmers must endure and the opportunities they must forgo. This requires a good understanding about the generating process behind the spatial heterogeneity of agricultural land-use at a _ne spatial scale. We aim to provide government and its agents with decision support for policy making post-Brexit in two directions. Firstly, we employ detailed spatial resolution data and establish a new statistical tool that can help: (i) to effectively capture the spatial heterogeneity of agricultural land-use, (ii) to disentangle the contributions of terrain formulations, environmental characteristics, climatic conditions, policies, and other legacy and agglomeration effects in the generating process of the land-use patterns, and (iii) accurately gauge their relative importance across different regions of GB for more targeted subsidies schemes. Secondly, we employ our new method and provide policy advice and evaluation.
Keywords:  Agro-environmental policy, land-use, multivariate Tobit, system of censored equation, spatial model, error component model.
JEL Classification: C13, C21, C23, C34, Q15, Q53

Patrick W. Saart, Namhyun Kim, and Ian Bateman (May 2021)
Modeling and predicting agricultural land use in England based on spatially high-resolution data (47 pages)
This paper addresses various statistical and empirical challenges associated with modelling farmers' decision-making processes concerning agricultural land-use. These include (i) use of spatially high-resolution data so that idiosyncratic effects of physical environment drivers, e.g. soil textures, can be explicitly modelled; (ii) modelling land-use shares as censored responses, which enables consistent estimation of the unknown parameters; (iii) incorporating spatial error dependence and heterogeneity, which leads to accurate formulation of the variances for the parameter estimates and more effective statistical inferences; and (iv) reducing the computational burden and improving estimation accuracy by introducing an alternative GMM/QML hybrid estimation procedure. We also provide extensive evidence, which suggests that our approach can construct more accurate land-use predictions than existing methods in the literature. We then apply our method to empirically investigate how the climatic, economic, policy and physical determinants influence the land-use patterns in England over time and spatial space. We are also interested in examining whether environmental schemes and grants have assisted in freeing up land used for arable, rough grazing, temporary and permanent grasslands and converting it to bio-energy crops to help to achieve deep emission reductions and prepare for climate change.
Keywords:  Agro-environmental policy, land-use, multivariate Tobit, system of censored equation, spatial model, error component model.
JEL Classification: C13, C21, C23, C34, Q15, Q53

Juyi Lyu, Vo Phuong Mai Le, David Meenagh and Patrick Minford (March 2021)
Macroprudential Regulation in the Post-Crisis Era: Has the Pendulum Swung Too Far? (39 pages)
This paper presents an institutional model to investigate the cooperation between a government and a central bank. The former selects the monetary policy and then delegates the organization of macroprudential policy to the latter. Their policy stances are the result of sequential constrained utility maximization. Using indirect inference, we find a set of coefficients that can capture the UK policy stances for 1993-2016. This suggests post-crisis regulation has been overly intrusive. Finally, we show that this regulatory dilemma can be avoided by committing to a highly stabilizing monetary regime that uses QE extensively.
Keywords: Bank regulation; Financial stability; Monetary policy; Public choice theory
JEL Classification: E52; E58; G28

Ziyi Cao and Zhirong Ou (February 2021)
Can debt monetisation be helpful for China's post-Covid recovery? Some empirical evidence (383K, 15 pages)
A measure of the degree of debt monetisation is constructed for its impact on the business cycle to be studied in a standard VAR model. Debt monetisation is hardly expansionary, as it raises public demand that crowds out almost as much demand from the private sector. However, it generates ináation, presumably because of ináationary expectations. Nevertheless the impact of debt monetisation on the business cycle dynamics is trivial, due to the low e¢ ciency of the monetary transmission mechanism. Unless policy proposals are for extraordinarily aggressive moves, or they are accompanied by monetary reforms which facilitate monetary transmission, the recent debate on debt monetisation, we argue, possesses more theoretical meaning than practical meaning for Chinaís post-Covid recovery.
Keywords: Debt monetisation; business cycle; VAR; China
JEL Classification:  E31, E32, E63, H63

Chunping Liu and Zhirong Ou (February 2021)
Revisiting the determinants of house prices in China’s megacities: cross-sectional heterogeneity, interdependencies and spillovers
(455K,19 pages)
We revisit the determinants of house prices in Chinaís megacities. Previous work on similar topics fails to account for the widespread cross-sectional heterogeneity and interdependencies, despite the importance of them. Using a PVAR estimated by the Bayesian method allowing for these features, we Önd each city is rather unique, especially on the extent to which local house prices are disturbed by external house price shocks. The spillovers are mainly due to direct housing market interdependence, which seems related more to demand before 2010, but more to supply thereafter due to property purchase restrictions. The new evidence we establish therefore suggests that city-level stabilisation of house prices should fully respect local features, including how local markets respond to external disturbances.
Keywords: house price; Chinese megacities; PVAR; cross-sectional heterogeneity and interdependencies
JEL Classification: C11, R15, R31

Tiziana Medda, Vittorio Pelligra and Tommaso Reggiani (February 2021)
Lab-Sophistication: Does Repeated Participation in Laboratory Experiments Affect Pro-Social Behaviour?(737K, 19 pages)
Experimental social scientists working at research-intensive institutions deal inevitably with subjects who have most likely participated in previous experiments. It is an important methodological question to know whether participants that have acquired a high level of lab-sophistication show altered pro-social behavioral patterns. In this paper, we focus both on the potential effect of the subjects’ lab-sophistication, and on the role of the knowledge about the level of lab-sophistication of the other participants. Our main findings show that while lab-sophistication per se does not significantly affect pro-social behaviour, for sophisticated sub-jects the knowledge about the counterpart’s level of (un)sophistication may systematically alter their choices. This result should induce caution among experimenters about whether, in their settings, information about labsophistication can be inferred by the participants, due to the characteristics of the recruitment mechanisms, the management of the experimental sessions or to other contextual clues
Keywords: Lab-sophistication; Experimental Methodology; External Validity; Pro-social behaviour; Cooperation
JEL Classification:  D03, D83, C91, C9

Bo Zhou, Ying Zhang and  Peng Zhou (February 2021)
Multilateral Political Effects on Outbound Tourism (1M, 31 pages)
To capture the role of politics in tourism, we propose a novel measure to quantify political relations based on text analysis of published diplomatic statements. We explain how political relations affect outbound tourist flows from China to Japan and Korea. Estimated on monthly data (1997m1-2018m12), our model shows how China-Japan disputes affect tourist flows to Korea and how China-Korea clashes influence the number of Chinese tourists going to Japan. The political effects are estimated to peak after three months, but half of the effects vanish in six months. We also observe asymmetries in the political effects—the tourists respond more to negative political shocks than to positive ones, and more to territorial disputes than to war history disputes.
Keywords: political relation; outbound tourism; China; multilateral interdependence.
JEL Classification: 

See also: Supplementary Materials

Huw Dixon and Christian Grimme(January 2021)
State-Dependent or Time-Dependent Pricing? New Evidence from a Monthly Firm-Level Survey: 1980–2017(721K, 23 pages)
We examine the relative importance of time and state dependence in the price-setting decisions of firms using a monthly panel of German firms over the period 1980–2017.  We propose a refined version of time dependence by introducing different hazard functions for price increases and decreases. We find three sets of results. First, time dependence is much more important for price setting than what the previous literature has found. Second, price decreases can be well explained by time dependence alone. Price increases are best predicted by the interaction of time-dependent and firm-specific state factors. Third, time dependence for price increases and decreases look completely different from each other. Our empirical results suggest that theoretical models should integrate both time and state dependence rather than developing the approaches separately.
Keywords: SVAR; Sign and Zero Restrictions; DSGE; Precautionary Liquidity Shock; Excess Reserves; Deposit Rate; Risk, Financial Intermediation.
JEL Classification: C10, C32, E30, E43; E51, G21

George Bratsiotis and Konstantinos Theodoridis(December 2020)
Precautionary Liquidity Shocks, Excess Reserves and Business Cycles(721K, 23 pages)
This paper identifies a precautionary banking liquidity shock via a set of sign, zero and forecast variance restrictions imposed. The shock proxies the reluctance of the banking sector to "lend" to the real economy induced by an exogenous change in financial intermediaries' preference for "high" liquid assets. The identified shock has sizeable and state (volatility) dependent effects on the real economy. To understand the transmission of the shock, we develop a DSGE model of financial intermediation with credit and liquidity frictions. The precautionary liquidity shock is shown to work through two channels: it increases the level of reserves and the deposit rate. The former is a balance sheet effect, which reduces the loan-to-deposit ratio. The higher deposit rate affects the intertemporal decisions of households and the cost of borrowing to firms. The overall effect is a downward co-movement in output, consumption, investment and prices, which is amplified the higher are the long-run risks in the economy and the responsiveness of banks to potential risk.
Keywords: SVAR; Sign and Zero Restrictions; DSGE; Precautionary Liquidity Shock; Excess Reserves; Deposit Rate; Risk, Financial Intermediation.
JEL Classification: C10, C32, E30, E43; E51, G21

Patrick Minford, Yue Gai and David Meenagh (November 2020, Revised August 2021)
North and South: A Regional Model of the UK(827K, 48 pages)
We set up a two-region model to study the policy challenge of bringing the North’s income up to the level of the South in the UK. The model focuses on labour costs as the driver of output gains through the international competitiveness channel. The empirical results show that the regional model behaviour fits the regional UK data behaviour over the period of 1986Q1 and 2019Q4, using the demanding Indirect Inference method. We also carry out a Monte Carlo power test, which shows the empirical results we obtain are trustworthy and can provide us a reliable guide for policy reform.The results suggest that in response to tax cuts and labour market reforms GDP in the North increases almost twice as much as GDP in the South. Given that a broad programme of tax cuts and regulatory reform would more than pay for itself in the long run, it must be considered as a highly attractive political agenda.
Keywords: Regional study; DSGE model; Policy implication; Indirect Inference
JEL Classification: E32; E60; P48

James Foreman-Peck and Peng Zhou (November 2020)
Fertility versus Productivity: A Model of Growth with Evolutionary Equilibria (1.2M, 43 pages)
We develop a quantitative model that is consistent with three principal building blocks of Unified Growth Theory: the break-out from economic stagnation, the buildup to the Industrial Revolution, and the onset of the fertility transition. Our analysis suggests that (i) the escape from the Malthusian trap was triggered by the demographic catastrophes in the aftermath of the Black Death, (ii), household investment in children ultimately raised wages despite an increasing population, and (iii) rising human capital, combined with the increasing elasticity of substitution between child quantity and quality, reduced target family size and contributed to the fertility transition.
Keywords: Fertility Transition, Industrial Revolution, English Economy, Economic Development
JEL Classification: O11, J11, N13

See also: Supplementary Materials
               Codes
               Data

Patrick Minford, Zhirong Ou and Zheyi Zhu (October 2020)
Is there consumer risk-pooling in the open economy? The evidence reconsidered (427K, 12 pages)
We revisit the evidence on consumer risk-pooling and uncovered interest parity. Widely used singleequation tests are strongly biased against both. Using the full-model, Indirect Inference test, which is unbiased and has Goldilocks power by Monte Carlo experiments, we Önd that both the risk-pooling hypothesis and its weaker UIP version are generally accepted as part of a full world DSGE model.The fact that the risk-pooling hypothesis, with its implication of strong cross-border consumer linkage,has passed this test with generally the highest p-value, suggests that it deserves serious attention from policy-makers looking for a relevant model to discuss international monetary and other business cycle issues.
Keywords: Open economy; consumer risk-pooling; UIP; full-model test; Indirect Inference
JEL Classification:  C12,E12,F41

Helmuts Azacis and David R. Collie ( July 2020)
The Non-Equivalence of Import Tariffs and Export Taxes in Trade Wars: Ad Valorem vs Specific Trade Taxes (379K,41 pages)
Using perfectly competitive, general equilibrium models of international trade, specific import tariffs, specific export taxes, and ad valorem trade taxes are compared in a trade war. A trade war is modelled as a NE in trade policies, where each country can choose to use ad valorem trade taxes (import tariffs or export taxes, which are equivalent), or specific import tariffs, or specific export taxes. In the two-country case, where there is a negative terms of trade externality a specific export tax dominates a specific import tariff or ad valorem trade taxes. Hence, the Lerner Symmetry Theorem does not hold for specific trade taxes in a trade war. This result continues to hold when the model is extended to the case of many countries assuming that there is a negative terms of trade externality. In a trade policy game where two countries export the same good so there is a positive terms of trade externality in the trade policy game between these two countries, the results are reversed with a specific import tariff dominating a specific export tax or ad valorem trade taxes. Hence, again the Lerner Symmetry Theorem does not hold for specific trade taxes in a trade war.
Keywords: Ad Valorem Trade Tax; Specific Trade Tax; Perfect Competition; General Equilibrium; NE in Trade Taxes; Lerner Symmetry Theorem.
JEL Classification: F11; F13; C72; D51; H21

Alessandro Bucciol and Serena Trucchi ( July 2020)
Locus of Control, Savings and Propensity to Save (466K,28 pages)
We study the relationship between saving choices and a key psychological characteristic such as locus of control using data from a longitudinal survey representative of the Dutch population. Locus of control measures the extent to which individuals perceive their life outcomes to be determined by their own actions, as opposed to external factors. Our findings show that those who believe to be in control of future outcomes save more, both at the extensive (probability to save) and intensive margins (amount of savings). We also investigate the mechanisms behind the relationship. Locus of control may affect both the propensity to save for general purposes and savings to achieve a specific purchase goal (e.g. buying a house). We find that both channels are significant, the latter being more sizeable.
Keywords: Locus of Control; Saving decisions; Propensity to save; Mediation analysis.
JEL Classification: D14; D91.

Melanie Jones and Ezgi Kaya ( June 2020)
The Gender Pay Gap: What can we learn from Northern Ireland?(435K,30 pages)
Northern Ireland forms an important outlier to the established international pattern of a pronounced gender pay gap in favour of men. Using contemporary data from the Quarterly Labour Force Survey we provide a comprehensive analysis of the gender pay gap in Northern Ireland and make comparisons to the rest of the UK. Despite the relatively common institutional and policy context, the gender pay gap in Northern Ireland is found to be far smaller than in the rest of the UK. This can largely be attributed to the superior productivity-related characteristics of women relative to men in Northern Ireland, which partially offset the influence of gender differences in the returns to these characteristics. Our analysis highlights the importance of occupation – both in terms of occupational allocation and the returns to occupations – in explaining the cross-country differential. This is reinforced by the impact of lower earnings inequality in Northern Ireland.
Keywords: Gender pay gap, pay discrimination, decomposition analysis, Labour Force Survey, Northern Ireland.
JEL Classification: J16; J31; J24.

Manipushpak Mitra, Indrajit Ray and Souvik Roy ( May 2020)
A Characterisation of Trading Equilibria in Market Games(280K,17 pages)
We provide a full characterisation of the set of trading equilibria (in which all goods are traded at a positive price) in a strategic market game (as introduced by Shapley and Shubik), for both the “buy and sell” and the “buy or sell” versions of this model under standard assumptions on the utility functions. We also interpret and illustrate our main equilibrium-characterising condition, using simple examples.
Keywords: strategic market game, trading equilibrium, buy and sell, buy or sell.
JEL Classification: C72, D44.

Vittorio Pelligra, Tommaso Reggiani and Daniel John Zizzo (May 2020)
Responding to (Un)Reasonable Requests by an Authority(710K, 33 pages)
We consider the notions of static and dynamic reasonableness of requests by an authority in a trust game experiment. The authority, modelled as the experimenter, systematically varies the experimental norm of what is expected from trustees to return to trustors, both in terms of the level of each request and in terms of the sequence of the requests. Static reasonableness matters in a self-biased way, in the sense that low requests justify returning less, but high requests tend to be ignored. Dynamic reasonableness also matters, in the sense that, if requests keep increasing, trustees return less compared to the same requests presented in random or decreasing order. Requests never systematically increase trustworthiness but may decrease it.
Keywords: trust; trustworthiness; authority; reasonableness; moral wiggle room; moral licensing.
JEL Classification: C91; D01; D03; D63.

Patrick Minford, Yue Gai and Zhirong Ou (May 2020)
Is housing collateral important to the business cycle? Evidence from China(827K, 25 pages)
This paper investigates whether housing collateral is important to the business cycle in China. We develop two models, one without housing collateral as benchmark and one variant allowing for it. Indirect Inference procedure tests these two models’ compatibility with the data. We find that the benchmark model passes the test, while the collateral model is strongly rejected. According to the benchmark model, shocks from the housing market have limited impact on the Chinese business cycle. By contrast, the exogenous spending shock from gov- ernment and net exports, the monetary policy shock and the goods-sector cost/productivity shock, all in turn most likely connected to world business cycle shocks (especially the global financial crisis), are found to be the main drivers.
Keywords: Housing market; DSGE model; Housing collateral; Indirect Inference; China;
JEL Classification: E32; E44; E52; R31

Michael G. Arghyrou, Wenna Lu and Panayiotis M. Pourpourides (May 2020, Updated October 2022)
Exchange Rate Risk and Deviations from Purchasing Power Parity (1.8M, 34 pages)
Firstly, we show that domestic prices of net importer countries incorporate a risk premium, driven by higher moments of future nominal exchange rate returns and secondly, using US dollar exchange rates against three currencies of major net exporting countries to the US such as Canada, Japan and the European Union, we find that the skewness of the future nominal exchange rate is the major and statistically robust moment-based factor of the deviations from purchasing power parity (PPP). Our estimates further suggest that only low and moderate exchange rate risks induce risk premia that drive deviations from PPP.
Keywords: Purchasing Power Parity, risk-aversion, exchange rate, downside risk
JEL Classification: G15, F31, F41

David Meenagh and Patrick Minford (September 2020)
A structural model of corona virus behaviour for testing on data behaviour (449K, 27 pages)
We fit the logistic function, the reduced form of epidemic behaviour, to the data for deaths from Covid-19, for a wide variety of countries, with a view to estimating a causal model of the covid virus' progression. We then set out a structural model of the Covid virus behaviour based on evolutionary biology and social household behaviour; we estimated and tested this by indirect inference, matching its simulated logistic behaviour to that found in the data. In our model the virus' progression depends on the interaction of strategies by household agents, the government and the virus itself as programmed by evolution. Within these interactions, it turns out that there is substitution between government topdown direction (such as lockdown) and social reaction to available information on the virusíbehaviour. We also looked at experience of second waves, where we found that countries successfully limited second waves when they had had longer first waves and followed policies of localised reaction in the second.
Keywords: coronavirus, Covid-19, evolution, optimisation, indirect inference, lockdown
JEL Classification: C54, I12

See also: Online Appendix

Rangan Gupta, Jun Ma, Konstantinos Theodoridis and Mark E. Wohar (April 2020)
Is there a National Housing Market Bubble Brewing in the United States? (2.2M, 57 pages)
We use a time-varying parameter dynamic factor model with stochastic volatility (DFM-TV-SV) estimated using Bayesian methods to disentangle the relative importance of the common component in FHFA house price movements from state-specific shocks, over the quarterly period of 1975Q2 to 2017Q4. We find that the contribution of the national factor in explaining fluctuations in house prices is not only critical, but also has been increasing and has become more important than the local factors since around 1990. We then use a Bayesian change-point vector autoregressive (VAR) model, that allows for different regimes throughout the sample period, to study the impact of aggregate supply, aggregate demand, (conventional) monetary policy, and term-spread shocks, identified based on sign-restrictions, on the national component of house price movements. We detect three regimes corresponding to the periods of “Great Inflation”, “Great Moderation”, and the zero-lower bound (ZLB). While the conventional monetary policy is found to have played an important role in the historical evolution of the national factor in the first-regime, other shocks are found to be quite dominant as well especially during the second regime, with monetary policy shocks playing virtually no role during this period. In the third-regime, unconventional monetary policy shock is found to have led to a (delayed) recovery in the housing market. But more importantly, we find evidence that the national housing factor has been detached from the identified macroeconomic shocks (fundamentals) since 2014, thus suggesting that a “national bubble” might be brewing again in the US housing market. Understandably, our results have important policy implications.
Keywords: House Prices, Time-Varying Dynamic Factor Model, Change-Point Vector Autoregressive Model, Macroeconomic Shocks, Bayesian Analysis
JEL Classification:  C11, C32, E31, E32, E43, E52, R31

Carlo Pizzinelli, Konstantinos Theodoridis and Francesco Zanetti (March 2020)
State Dependence in Labor Market Fluctuations   (1.2M, 63 pages)
This paper documents state dependence in labor market fluctuations. Using a Threshold Vector Autoregression model (TVAR), we establish that the unemployment rate, the job separation rate, and the job finding rate exhibit a larger response to productivity shocks during periods with low aggregate productivity. A Diamond-Mortensen-Pissarides model with endogenous job separation and on-the-job search replicates these empirical regularities well. We calibrate the model to match the standard deviation of the job-transition rates explained by productivity shocks in the TVAR, and show that the model explains 88 percent of the state dependence in the unemployment rate, 76 percent for the separation rate and 36 percent for the job finding rate. The key channel underpinning state dependence in both job separation and job finding rates is the interaction of the firm’s reservation productivity level and the distribution of match-specific idiosyncratic productivity. Results are robust across several variations to the baseline model.
Keywords: Search and Matching Models, State Dependence in Business Cycles, Threshold Vector Autoregression
JEL Classification:  E24, E32, J64, C11.

Sergey V. Popov (March 2020)
Arithmetics of Research Specialization   (457K, 10 pages)
I model the use of research specialization in hiring as a signal of ability. I demonstrate that rewarding for specialization can make an average non-specializing candidate on average better than average specializing candidate, and vice versa. Specialization works as a good ability signal only when both good and bad candidates are very likely to churn out good projects. 

Keywords: specialization, research, job market.
JEL Classification:  A11, D4, I23, J4

Joshy Easaw and Samuli Leppälä (December 2019)
Democracy, State Capacity and Public Finance (370K, 29 pages)
The purpose of this paper is to consider the determinants of state capacity investments and public finance in societies with different intensities of democracy. Specifically, we consider the implications of political (dis)parity between the political parties as well as voter groups for state capacity investments, public goods provision, preferential tax policies between the elites and citizens, and the ability of the incumbent government to accrue political rents. The paper provides a unified framework to study the direct and indirect effects of democracy by combining state capacity investment and probabilistic voting. Paradoxically, while stronger electoral contestability leads to higher public good provision and lower political rents, it deteriorates the incumbent’s incentive to invest in state capacity. Similarly, when increased political inclusivity between the voters leads to higher public good provision and lower political rents, it will have a negative effect on state capacity. Conversely, if the effect of inclusivity on state capacity investment is positive, then public good provision will decline.
Keywords: democracy, state-capacity investment, electoral bias, political inclusivity, political rents, public goods provision.
JEL Classification:  D72, H10.

Chunping Liu and Zhirong Ou (November 2019)
Has fiscal expansion inflated house prices in China? Evidence from an estimated DSGE model (640K, 32 pages)
A canonical DSGE model for housing, extended to embrace government spending and government investment, is estimated on Chinese data to evaluate the impact of fiscal policy on house prices. Government spending substitutes for housing; a rise in government spending lowers house prices, but its impact is weak. Government investment generates a wealth effect, causing housing demand, and therefore prices, to rise; its variation had a substantial impact on the boom-bust cycles of house prices in the past decade. Both government spending and government investment are effective instruments for manipulating output. However, their different impacts on house prices would recommend policies to count more on spending if fiscal expansion is not to sacrifice the stability of house prices.
Keywords: Contests: fiscal policy; housing price; China; DSGE model
JEL Classification: E62; R31

Iain W. Long (August 2019)
Contests and Negotiation Between Hubristic Players (340K, 8 pages)
Why do contests exist in settings where negotiation provides a costless alternative? I assess a new explanation: parties may be overconfident about their ability or optimistic about their chances of winning. For both parties in a contest, this hubris: (i) reduces the incentive to exit the contest; (ii) reduces effort; and (iii) increases expected payoffs. Whilst hubris leads to the contest being preferred to costless negotiation, the welfare loss is nonmonotonic in either behavioural bias.
Keywords: Contests; Optimism bias; Overconfidence bias; Negotiation
JEL Classification: C71, D74, D91.

Effrosyni Adamopoulou and Ezgi Kaya (July 2019)
Not Just a Work Permit: EU Citizenship and the Consumption Behavior of Documented and Undocumented Immigrants (1M, 66 pages)
This paper explores the impact of the 2007 European Union enlargement on the consumption behavior of immigrant households. Using data from a unique Italian survey and a difference-in-differences approach, we find that the enlargement induced a significant consumption increase for the immigrant households from new member states both in the short- and in the medium-run. This enlargement effect cannot be attributed to the mere legalization as it concerns both undocumented and documented immigrants, albeit through different channels. Detailed information on immigrants’ legal status (undocumented/documented) and sector of employment (informal/formal) allows us to shed light on the exact mechanisms. Following the enlargement, previously undocumented immigrants experienced an increase in the labor income by moving from the informal towards the formal economy, whereas immigrants who were already working legally in Italy benefitted from the increased probability of getting a permanent contract. Enhanced employment stability in turn reduced the uncertainty about future labor income leading to an increase in documented immigrants’ consumption expenditure. 
Keywords: consumption; citizenship; informality; (un)documented immigrants; work permit 
JEL Classification:  D12, E21, F22

Vo Phuong Mai Le, David Meenagh and Patrick Minford (July 2020)
State-dependent pricing turns money into a two-edged sword (438K, 34 pages)
Strong evidence exists that price/wage durations are dependent on the state of the economy, especially inflation. We embed this dependence in a macro model of the US that otherwise does well in matching the economy's behaviour in the last three decades; it now also matches it over the whole post-war period. This finding implies a major new role for monetary policy: besides controlling inflation it now determines the economy's price stickiness. We find that, when backed by fiscal policy in preventing a ZLB, by targeting nominal GDP monetary policy can achieve high price stability and avoid large cyclical output fluctuations.
Keywords: state-dependence; New Keynesian; Rational Expectations crises; price stability; nominal GDP
JEL Classification: E2; E3

Jiayi Huang, Kent Matthews and Peng Zhou (May 2019)
What Causes Chinese Listed Firms To Switch Bank Loan Provider? Evidence From A Survival Analysis (713K, 37 pages)
This paper analyses the duration of firm-bank relationships and examines what drives firms in China to change from one bank loan provider to another. Matched data of firm-loan-duration to bank provides a unique panel data set of relationship between China’s listed firms and their lending banks consisting of 2,102 firms listed on both the Shanghai Stock Exchange and Shenzhen Stock Exchange in the period of 1996-2016. The Cox proportional hazard model is used to allow for a semiparametric hazard function after parametrically controlling for firm specific financial factors, industry factors, ownership characteristics, internal management changes, and external macroeconomic changes. In addition, we explore the impact of the 2008 financial crisis, bank-financial and ownership characteristics. The main finding of this study is that in an environment of growing commercialisation of relationships the firm-bank relationship between state-owned enterprises (SOEs) and state-owned banks (SOBs) in China remains super-stable. However, a change in the CEO of a firm even of a SOE increases the probability of the loan-provider being changed.
Keywords: Firm-Bank Switch, China, Survival analysis, Hazard Function.
JEL Classification: G21, D22, G41

Patrick Minford (April 2019)
Post-Brexit Realism and international law: renegotiating a bad Withdrawal Agreement (567K, 7 pages)
Some pro-Brexit MPs will not vote for the government’s proposed Withdrawal Agreement because of its fine print: they think it will be written in indelible tablets of law that we can never change. But they forget that sovereign states will not indefinitely stay in treaties that do not suit them, if no one can force them to, as in general no one can, unlike in national law where the state can force us. That is just the plain economics of national self-interest, as deployed in game theory studies of international treaties. Our Agreement with the EU if we sign it will not last for long if it stops us from pursuing our interests in trade and regulation: no one, certainly not the EU, can force us to stay with it. It has been negotiated like a hostile divorce because the EU wanted to prove it does not pay to leave. But once the divorce has happened, it will be a new situation where, as with ex-partners in a divorce, they will want to live harmoniously with us in the long term. There will be sensible diplomacy so that we can accommodate each other’s interests, in a process of adaptation. After leaving, we can push ahead with good policies on trade, regulation and migration that the government we vote for will pursue; the EU will cooperate as it will not wish us to move to default WTO rules.
Keywords:
JEL Classification:  

Li Dai and Peng Zhou (April 2019)
The Health Issues of the Homeless and the Homeless Issues of the Ill-Health (617K, 20 pages)
In public policy planning and budgeting, the health issues and homeless issues tend to be in-terrelated and reinforced by each other, but this mutual causality is usually ignored in the ex-isting literature. This paper provides an unbiased estimate of a structural equation model taking endogeneity into account. A questionnaire is designed based on the health-related quality of life (EQ-5D) framework and is given to 322 homeless individuals. Evidence shows that, with-out timely support, the homeless state and health state will fast deteriorate and reinforce each other. It is therefore arguable to broaden the definition of statutory homelessness, and the “pre-ventative approach” can save, rather than increase, the public resources spent on the homeless.
Keywords:
JEL Classification:  Socio-Economic Policy; Health Needs; Homeless; Structural Equation Model

James Foreman-Peck and Peng Zhou (April 2019)
Response to Edwards and Ogilvie (224K, 4 pages)

Keywords:
JEL Classification: 

Patrick Minford, Zhirong Ou and Zheyi Zhu (April 2019)
Can a small New Keynesian model of the world economy with risk-pooling match the facts? (567K, 34 pages)
We ask whether a model of the US and Europe trading with the rest of the world can match the facts of world behaviour in a powerful indirect inference test. One version has uncovered interest parity (UIP), the other risk-pooling. Both pass the test but the most probable is risk-pooling. This is consistent with risk-pooling failing a number of single equation tests, as has been found in past work; we show that these tests will typically reject risk-pooling when it in fact prevails. World economic behaviour under risk-pooling shows much stronger spillovers than under UIP with opposite monetary responses to the exchange rate. We argue that the risk-pooling model therefore demands more attention from policy-makers.
Keywords: Openeconomy, UIP, risk-pooling, test, Indirect Inference
JEL Classification:  C12,E12,F41

Iain W. Long, Kent Matthews and Vaseekaran Sivarajasingam (March 2019)
Behavioural Change and Alcohol-Fuelled Violence: A Field Experiment (862K, 38 pages)
We conduct a field experiment to assess whether alcohol-induced behavioural changes explain participants’ recent history of violence. We find that being in a drinking environment, rather than intoxication, reduces participants’ cognitive ability but increases their overconfidence. Those who experience small reductions in ability or become much more overconfident tended to have been involved in more violent incidents. Since these behavioural changes were largely unanticipated, our results suggest that individuals underestimate their true likelihood of becoming involved in violence when making alcohol consumption decisions. This presents additional challenges when formulating policy designed to deter alcohol-fuelled violence.
Keywords: Intoxication, over-optimism, violence
JEL Classification: C93, D91, I18

James Foreman-Peck and Peng Zhou (March 2019)
The Demographic Transition in a Unified Growth Model of the English Economy (1381K, 44 pages)
A dynamic stochastic unified growth model is estimated from English economy data for almost a millennium. At the core of the (seven) overlapping generations, rational expectations structure is household choice about target number and quality of children. The trends of births, deaths, population and, the real wage, are closely matched by the estimated model. In the 19th century English fertility transition, the model shows how the generalized child price relative to the child quality price rose. The rising opportunity cost of education was as decisive for the transition as the parental shift to child quality.
Keywords: Economic Development, Demography, Unified Growth, Overlapping Generations, English Economy
JEL Classification: O11, J11, N13

Ezgi Kaya (February 2019)
Gender wage gap across the quantiles:What is the role of firm segregation? (1M, 33 pages)
In this paper, we explore the role of firm segregation on the gender wage gap. Using linked employee-employer data for Turkey, we investigate whether female segregation into low-paying firms and into low-paying jobs within a firm influence the gender wage gap across the wage distribution. We find that there is a ‘glass ceiling’ effect in the Turkish labour market, but this effect is more apparent within a firm than between firms. We also find a ‘sticky floor’ effect, but only among workers employed at the same firm. Our results imply that the allocation of women into lowpaying jobs within each firm accounts for the existence of these effects more than the segregation of women into low-paying firms.
Keywords: gender wage gap, segregation, within- and between-firms, glass ceiling, sticky floor
JEL Classification:  C21, J31, J71

Michael G. Arghyrou, María Dolores Gadea (February 2019)
Private bank deposits and macro/fiscal risk in the euro-area  (4.1M, 92 pages)
We examine the relationship between private bank deposits and macro/fiscal risk in the euro area. We test three hypotheses: First, private bank deposits relative to Germany are determined by macro/fiscal risk factors. Second, this relationship is time-varying. Third, time-variation is driven by the level of macro/fiscal risk. Our findings validate all three tested hypotheses. They also reveal persistent fragmentation between EMU core and periphery banking systems caused by a deficit of trust in periphery banking systems, unmitigated by the introduction of OMT and European Banking Union. Our findings have implications for the introduction of the European Deposits Insurance Scheme (EDIS), for which they offer tentative support.
Keywords: Private bank deposits, macro/fiscal risk, eurozone, TVP panel, fragmentation
JEL Classification: F30; F36; F45; G11; G15 

Luc Bauwens and Yongdeng Xu (February 2019, Revised August 2021)
DCC and DECO-HEAVY: a multivariate GARCH model based on realized variances and correlations (1.1M, 55 pages)
This paper introduces the scalar DCC-HEAVY and DECO-HEAVY models for conditional variances and correlations of daily returns based on measures of realized variances and correlations built from intraday data. Formulas for multi-step forecasts of conditional variances and correlations are provided. Asymmetric versions of the models are developed. An empirical study shows that in terms of forecasts the new HEAVY models outperform the BEKKHEAVY model based on realized covariances, and the BEKK, DCC and DECO multivariate GARCH models based exclusively on daily data.
Keywords: correlation forecasting, dynamic conditional correlation, equicorrelation, high-frequency data, multivariate volatility.
JEL Classification:  C32, C58, G17

David R. Collie (January 2019)
Trade Wars under Oligopoly: Who Wins and is Free Trade Sustainable?   (682K, 58 pages)
The outcome of a trade war (with import tariffs and export subsidies) between two countries is analysed in a Cournot duopoly and in a Bertrand duopoly with differentiated products. The model allows for asymmetries between the countries in terms of competitiveness. When the two countries are similar, both countries will be worse off in a trade war than under free trade, but the country with the uncompetitive firm may win the trade war when the asymmetries are sufficiently great. Hence, in an infinitely -repeated game, cost asymmetries make it difficult to sustain free trade using infinite Nash reversion. However, it is shown that both countries minimaxing each other by setting prohibitive import tariffs and export taxes is also a Nash equilibrium in trade policies that results in each country obtaining autarky welfare. In an infinitely-repeated game, it is much easier to sustain free trade using infinite minimax reversion when there are cost asymmetries than with infinite Nash reversion. In fact, free trade can be sustained even if the punishment phase lasts for only a few rounds. Since there are two Nash equilibria of the trade policy game, free trade can also be sustained in a finitely-repeated game.
Keywords: Retaliation; Tariffs; Cournot Oligopoly; Bertrand Oligopoly
JEL Classification:  F11; F12; F13

Konstantinos Georgalos, Indrajit Ray and Sonali Sen Gupta (January 2019)
Nash vs. Coarse Correlation (409K, 40 pages)
We run a laboratory experiment with a two-person game with unique pure Nash equilibrium which is also the solution of the iterative elimination of strictly dominated strategies. The subjects are asked to commit to a device that randomly picks one of three symmetric outcomes in this game (including the Nash equilibrium) with higher ex-ante expected payoff than the pure Nash equilibrium payoff. We find that the subjects do not accept this lottery (which is a coarse correlated equilibrium as in Moulin and Vial, 1978), instead, they choose to play the game and then coordinate on the pure Nash equilibrium. However, given an individual choice between a lottery with equal probabilities of the same outcomes and the sure payoff as in the Nash equilibrium, the lottery is chosen by the individuals. The result is robust against variations like (i) a lottery choice for a pair of individuals, (ii) different payoffs in the game and (iii) the fixed-match between pairs.
Keywords: Correlation, Coordination, Lottery, Risk dominance
JEL Classification: C72, C91, C92, D63, D83

Alexey Parakhonyak, Sergey V. Popov (January 2019)
Same-Sex Marriage, The Great Equalizer   (419K, 27 pages)
When limited to heterosexual marriage, agents of different genders are not guaranteed to harvest the same payoff even conditional on having the same type, even if all other factors, such as search costs or the distribution of partner types, are same across genders. If same-sex marriage is legalized and there is a positive mass of agents who find marriage with both sexes acceptable, then only symmetric equilibria survive in symmetric environments.
Keywords: marriage markets, matching, gender equality, same-sex marriage
JEL Classification:  C78, D1

Patrick Minford (January 2019)
The effects of Brexit on the UK economy (747K, 16 pages)
Forthcoming in The World economy
Keywords:
JEL Classification: 

Maoshan Tian and Huw Dixon (December 2018)
The Cross-sectional Distribution of Completed Lifetimes: Some New Inferences from Survival Analysis  (422K, 27 pages)
The cross-sectional distribution of completed lifetimes (DCL) is a new estimator defined and derived by Dixon (2012) in the general Taylor price model (GTE). DCL can be known as the cross-sectional weighted estimator summing to 1. It is a new statistics applying to describe the data. This paper focuses on the cross-sectional distribution in the survival analysis. The delta method is applied to derive the variance of the of three cumulative distribution functions: the distribution of duration, cross-sectional distribution of age, distribution of duration across  rms. The Monte Carlo experiment is applied to do the simulation study. The empirical results show that the asymptotic variance formula of the DCL and distribution of duration performs well when the sample size above 25. With the increasing of the sample size, the bias of the variance is reduced.
Keywords: Delta Method, Survival Analysis, Kaplan-Meier Estimator
JEL Classification:  C19, C46

Michael Hatcher and Panayiotis M. Pourpourides (September 2022, First draft December 2018)
Does the impact of Private Education on Growth differ at different levels of Credit Market Development? (746K, 55 pages)
Using an overlapping generations model, we show that the impact of private financing of education on growth depends on credit market development, being positive when credit markets are adequately developed, but negative if sufficiently low levels of credit market development occur alongside relatively high private financing intensities. Employing cross-country data, we find that reduced-form growth relationships are statistically significant and robust under various controls and samples. We also lay out conditions under which economies with missing credit markets are dynamically efficient and outperform, in terms of growth, economies with complete credit markets. The latter may explain large cross-country differences in savings and growth, while facilitating the evaluation of policies on financing education.
Keywords: Private Education, Credit Market Development, Economic Growth.
JEL Classification: I25, O16, O41

Samuli Leppälä (December 2018)
PARTIAL EXCLUSIVITY CAN RESOLVE THE EMPIRICAL PUZZLES ASSOCIATED WITH RENT-SEEKING ACTIVITIES (425K, 36 pages)
This study presents a model in which interest groups compete for partially exclusive rents and the number of winners is stochastic. Partial exclusivity can explain the low empirical estimates of rent dissipation that create the Tullock paradox. However, partial exclusivity also increases aggregate effort and social waste. This study includes an empirical analysis of U.S. state-level lobbying expenditures, which reveals another puzzle regarding the constant relationship between aggregate expenditures and the number of spenders. In contrast to the existing rent-seeking contest models, this outcome is consistent with partially exclusive rents when the contest is designed by a rent-seeking maximising policymaker.
Keywords: rent seeking, interest groups, multiple-winner contests, rent dissipation, contest design, lobbying expenditures.
JEL Classification: C72, D72

Ching-Wai (Jeremy) Chiu, Simon Hayes, George Kapetanios and  Konstantinos Theodoridis (November 2018)
A New Approach for Detecting Shifts in Forecast Accuracy   (1.5M, 31 pages)
Forecasts play a critical role at inflation targeting central banks, such as the Bank of England. Breaks in the forecast performance of a model can potentially incur important policy costs. Commonly used statistical procedures, however, implicitly put a lot of weight on type I errors (or false positives), which result in a relatively low power of tests to identify forecast breakdowns in small samples. We develop a procedure which aims at capturing the policy cost of missing a break. We use data-based rules to find the test size that optimally trades of the costs associated with false positives with those that can result from a break going undetected for too long. In so doing, we also explicitly study forecast errors as a multivariate system. The covariance between forecast errors for different series, though often overlooked in the forecasting literature, not only enables us to consider testing in a multivariate setting but also increases the test power. As a result, we can tailor the choice of the critical values for each series not only to the in-sample properties of each series but also to how the series for forecast errors covary.
Keywords: Forecast Breaks, Statistical Decision Making, Central Banking
JEL Classification: C53, E47, E58

Antonio Cabrales, Michalis Drouvelis, Zeynep Gurguc and Indrajit Ray (November 2018)
Do we need to listen to all stakeholders?: communicating in a coordination game with private information (933K, 51 pages)
We consider an experiment with a version of the Battle of the Sexes game with two-sided private information, preceded by a round of either one-way or two-way cheap talk. We compare different treatments to study truthful revelation of information and subsequent payoffs from the game. We find that the players are overall truthful about their types in the cheap-talk phase in both one-way and two-way talk. Furthermore, the unique symmetric cheap-talk equilibrium in the two-way cheap talk game is played when the players fully reveal their information; however, they achieve higher payoffs in the game when the talk is one-way as the truthful reports facilitate desired coordination.
Keywords: Battle of the Sexes, Private Information, Cheap talk, Coordination.
JEL Classification: C72, C92, D83

Woon K. Wong (November 2018, updated September 2022)
Can we afford defined benefit pensions in low interest rates environment? (1M, 29 pages)
Since defined benefit (DB) pensions are guaranteed, they are often priced using risk-free interest rates. This paper shows how time diversification limits the cost of guarantying DB pensions to no more than the required cash contributions to pay for outgo, which can be significantly cheaper than the risk-free interest rate approach. The discrepancy can be explained by the incompleteness of financial markets for pensions and hence the breach of Ross’s (1976) arbitrage-free conditions to price DB benefits using interest rates. Given the current negative interest rates, it is optimal to hold more equity so that the increased risk can be mitigated by cash contributions, a higher funding ratio and long investment horizon. The above findings are applied to the Universities Superannuation Scheme, the largest privately funded DB scheme in the UK. Overlooking the role of cash contributions in mitigating risks is identified as the main reason for the scheme’s deficits.
Keywords: pension, defined benefit, low interest rate, cost of guarantee, prudence
JEL Classification: G1, G22, G23, G3

Haroon Mumtaz and Konstantinos Theodoridis (October 2018)
Dynamic Effects of Monetary Policy Shocks on Macroeconomic Volatility   (5.9M, 35 pages)
We develop a VAR that allows the estimation of the impact of monetary policy shocks on volatility. Estimates for the US suggest that an increase in the policy rate by 1% is associated with a rise in unemployment and inflation volatility of about 15%. Using a New Keynesian model, with search and matching labour frictions and Epstein-Zin preferences we show that these volatility effects are driven by the coexistence of agents’ fears of unemployment and concerns about the (in) ability of the monetary authority to reverse deviations from the policy rule with the impact magnified by the agents’ preferences.
Keywords: DSGE, Non-Linear SVAR, New Keynesian, Search and Matching Frictions, Epstein-Zin preferences, Stochastic Volatility
JEL Classification:  E30, E40, E52, C11, C13, C15, C50

Haroon Mumtaz and Konstantinos Theodoridis (August 2018)
Fiscal Policy Shocks and Stock Prices in the United States   (2.7M, 68 pages)
This paper uses a range of structural VARs to show that the response of US stock prices to fiscal shocks changed in 1980. Over the period 1955-1979 an expansionary spending or revenue shock was associated with modestly higher stock prices. After 1980, along with a decline in the fiscal multiplier, the response of stock prices to the same shock became negative. We use an estimated DSGE model to show that this change is consistent with a switch from an economy characterised by a more active fiscal policy and passive monetary policy to one where fiscal policy was passive and the central bank acted aggressively in response to inflationary shocks.
Keywords: Fiscal policy shocks, Stock prices, VAR, DSGE.
JEL Classification:  C5, E1, E5, E6

Michael Chin, Ferre De Graeve, Thomai Filippeli and Konstantinos Theodoridis (July 2018)
Understanding International Long-Term Interest Rate Comovement  (2.6M, 88 pages)
Long-term interest rates of small open economies correlate strongly with the US long-term rate. Can central banks in those countries decouple from the US? An estimated DSGE model for the UK (vis-`a-vis the US) establishes three structural empirical results. (1) Comovement arises due to nominal fluctuations, not through real rates or term premia. (2) The cause of comovement is the central bank of the small open economy accommodating foreign inflation trends, rather than systematically curbing them. (3) Small open economies may find themselves much more affected by changes in US inflation trends than the US itself.
Keywords: DSGE Model, Small Open Economy, Yield Curve, Long-Term Interest Rates, Term Premia, Comovement
JEL Classification:  E43, E44, F30, F44, F65, G15

Peng Zhou and Huw Dixon (June 2018)
The Determinants of Price Rigidity in the UK: Analysis of the CPI and PPI Microdata and Application to Macrodata Modelling (1.3M, 27 pages)
This paper systematically integrates microdata and macrodata analysis of price rigidity in mon-etary economics. We explore the mechanism of price-setting using survival based approaches in order to see what factors drive the observed price rigidity. We find significant effects of macroeconomic variables such as inflation and output, which should be purged off before cal-ibrating any macroeconomic models. The microdata findings are then used to estimate and simulate a heterogeneous price-setting model with a generalised Calvo goods sector and a gen-eralised Taylor service sector, which improves the performance in matching macrodata persistence.
Keywords: Price Rigidity, Price Setting Behaviour, Microdata, Survival Analysis, Heterogeneous Agent Model, Persistence Puzzle
JEL Classification: C41, D21, E31, E32

David Meenagh, Patrick Minford and Xiaoliang Yang (June 2018)
A heterogeneous-agent model of growth and inequality for the UK (992K, 26 pages)
This paper analyses the effect of wealth inequality on UK economic growth in recent decades with a heterogeneous-agent growth model where agents can enhance individual productivity growth by undertaking entrepreneurship. The model assumes wealthy people are more able to afford the costs of entrepreneurship. Wealth concentration therefore stimulates entrepreneurship among the rich and so aggregate growth, whose fruits in turn are largely captured by the rich. This process creates a mechanism by which inequality and growth are correlated. The model is estimated and tested by indirect inference and is not rejected. Policy-makers face a trade-off between redistribution and growth.
Keywords: Heterogeneous-agent Model, Entrepreneurship, Aggregate Growth, Wealth Inequality, Redistribution, Indirect Inference
JEL Classification: E10; C63; O30; O40

Vo Phuong Mai Le, David Meenagh and Patrick Minford (June 2018)
Oil and Commodities Drive the World Business Cycle: A Long-Commodity-Cycle Model of the World Economy Over a Century and a Half (438K, 22 pages)
This paper explores the world business cycle using unfiltered data from 1870 and looks for a theory that could account for the long wave commodity cycle in the world economy. We build a simple DSGE model that includes a long time-to-build constraint in the commodity sector. We find that this model can produce long cycles in output and commodity prices as introduced by Kontradieff (1925) and Schumpeter (1935). Our findings show that these long business cycles are produced by the long gestation of commodity capacity which causes very large swings in commodity prices.
Keywords: Long waves; commodities; DSGE model; Indirect Inference
JEL Classification: E10; E32; E52

Giovanni Angelini, Mauro Costantini and Joshy Easaw (June 2018)
Uncertainty and spillover effects across the Euro area  (2.1M, 20 pages)
This paper investigates how macroeconomic uncertainty shocks spillover over four Eurozone countries. It also evaluates their impact on real economic activity. The paper proposes a simple two-country model with a core and a periphery economy, where uncertainty shocks spread from one country to another, with potential feedback fromthe periphery economy to the core one. An empirical analysis is conducted using a Structural Vector Autoregressive (SVAR) model with two regimes: pre-crisis period and crisis period. The findings point to uncertainty spillovers among the Eurozone countries, with some feedback from periphery economies to the core economies during the financial crisis period. Further, there is a need to account for spillovers when studying the impact of uncertainty on real economic activity.
Keywords: Uncertainty, EuroArea, Spillover effects, Real Economic Activity
JEL Classification: C32, C50, E32

David Meenagh, Patrick Minford, Michael Wickens and Yongdeng Xu (June 2018)
Testing DSGE Models by indirect inference: a survey of recent findings  (464K, 22 pages)
Forthcoming in Open Economies Review
We review recent findings in the application of Indirect Inference to DSGE models. We show that researchers should tailor the power of their test to the model under investigation in order to achieve a balance between high power and model tractability; this will involve choosing only a limited number of variables on whose behaviour they should focus. Also recent work reveals that it makes little difference which these variables are or how their behaviour is measured whether via A VAR, IRFs or Moments. We also review identification issues and whether alternative evaluation methods such as forecasting or Likelihood ratio tests are potentially helpful.
Keywords: Pseudo-true inference, DSGE models, Indirect Inference; Wald tests, Likelihood Ratio tests; robustness
JEL Classification: C12, C32, C52, E1

Nasir Aminu, David Meenagh, Patrick Minford (June 2018)
The Role of Energy Prices in the Great Recession — A Two-Sector Model with Unfiltered Data  (2M, 51 pages)
We investigate the role of energy shocks during the Great Recession. We study the behaviour of the UK energy and non-energy intensive sectors firms in a real business cycle (RBC) model using unfiltered data. The model is econometrically estimated and tested by indirect inference. Output contraction during the Great Recession was largely caused by energy price and sector-specific productivity shocks, all of which are non-stationary and hence tend to dominate the sample variance decomposition. We also found that the channel by which the energy price shock reduces output in the model is via the terms of trade: these fall permanently when world energy prices increase and as substitutes for energy inputs are strictly limited there are few reactions via production channels. Therefore, there is no other way to balance the deteriorating current account than through lower domestic absorption.
Keywords: 
JEL Classification: 

Woon K. Wong (May 2018, updated in December 2018)
The Discount Rate Debate and Its Implications for Defined Benefit Pensions (1M, 24 pages)
While the Universities Superannuation Scheme recently reported the biggest deficit of any British pension fund, the union’s actuary finds no funding crisis for the scheme. The huge contrast can be explained by the current debate on whether low gilt yields imply low future returns on other asset classes. This article argues that falling interest rates since 1980s are essentially the result of successful monetary policies to control inflation, thereby the economy benefited and firms made good profits, giving rise to healthy funding level for the scheme. Since index-linked gilt yields are found to explain up to 99% variation of its past liabilities, the scheme is likely to be in surplus if a correct discount rate is used in the valuation. The implications are that many past closures of defined benefit schemes were unwarranted, expensive disputes could have been avoided and firms’ spending on such schemes are unnecessarily high.
Keywords: pension, defined benefit, discount rate, risk-free rate, equity risk premium
JEL Classification: G1, G22, G23, G3

Xue Dong, Patrick Minford and David Meenagh  (May 2018)
How Important are International Financial Market Imperfections for Foreign Exchange Rate Dynamics: A Study of the Sterling Exchange Rate  (5.2M, 28 pages)
The UK has been a net debtor over the past two decades and the sterling exchange rates are sensitive to any chaos that might occur in the Financial market. This paper examines the importance of the inter-national financial imperfections in the sterling exchange rate dynamics. We build a small open economy DSGE model with the constrained international financial institutions that intermediate capital flows, and derive tractable analytical solutions. The constraint works to introduce a wedge between lending and borrowing rates, which compensates financiers for their currency risk-taking. The model has been estimated by using a simulation-based Indirect Inference approach, which provides a natural framework for testing the hypothesis implied by the model. We find that the model cannot be rejected by the UK data. Shocks to financial forces are the main driving forces behind the large and sudden depreciation of the Sterling exchange rates in the aftermath of the collapse of Lehman Brothers and the Brexit vote. Furthermore, the optimal policy rules have been proposed.
Keywords: Small open economy DSGE model, International financial imperfections, Sterling exchange rates, Indirect Inference, Crisis, Policy rules
JEL Classification: E63, F31, F34, F41, F47

Lucy Minford and David Meenagh (April 2018)
Supply-side policy and economic growth: A case study of the UK  (536K, 35 pages)
This paper investigates the potential for a causal relationship between certain supply-side policies and UK output and productivity growth between 1970 and 2009. We outline an open economy DSGE model of the UK in which productivity growth is determined by the tax and regulatory environment faced by firms. This model is estimated and tested using simulation-based econometric methods (indirect inference). Using Monte Carlo methods we investigate the power of the test as we apply it, allowing the construction of uncertainty bounds for the structural parameter estimates and hence for the quantitative implications of policy reform in the estimated model. We also test and confirm the modelís identification, thus ensuring that the direction of causality is unambiguously from policy to productivity. The results offer robust empirical evidence that temporary changes in policies underpinning the business environment can have sizeable effects on economic growth over the medium term.
Keywords: Taxation, Regulation, Labour Market Regulation, Economic Growth, DSGE
JEL Classification: E02, O4, O43, O5

Georgios Chortareas, Vassilis Logothetis and Andreas Papandreou (April 2018)
Public Opinion, Elections, and Environmental Fiscal Policy   (1.2M, 47 pages)
We investigate how public opinion along with the electoral process affect the strength of environmental fiscal policies in the European Union (EU). Our analysis accounts for a set of economic, institutional, and political factors that can affect environmental taxes and expenditures. We pursue a dynamic panel data analysis covering 27 EU countries using public opinion data. We produce evidence showing that public concern for the environment, as gauged by opinion surveys, positively affects environmental protection expenditures, while elections negatively affect environmental tax revenues and environmental protection expenditures shrink in the aftermath of elections. We do not find evidence of partisan effects. The effect of public opinion and elections on environment-related fiscal decisions depends on the degree of integration with the global economy as well as several institutional factors including the level of corruption and the soundness of the rule of law. We also document that the results are impervious to a wide set of robustness tests.
Keywords: Environmental Protection, Taxes and Expenditures, Public Opinion, European Union, Panel Data
JEL Classification: D72, Q58, C23

David R. Collie (March 2018)
Maximum-Revenue Tariffs versus Free Trade   (243K, 9 pages)
Welfare with the maximum-revenue tariff is compared to free-trade welfare under perfect competition in the case of a large country able to affect its terms of trade; under Cournot duopoly with differentiated products; and under Bertrand duopoly with differentiated products. Under perfect competition, assuming linear demand and supply, welfare with the maximum-revenue tariff will be higher than free-trade welfare if the country has sufficient market power. Under Cournot duopoly and Bertrand duopoly, assuming linear demands and constant marginal costs, welfare with the maximum-revenue tariff is always higher than free-trade welfare.
Keywords: Maximum-Revenue Tariff; Free Trade; Perfect Competition; Cournot Oligopoly; Bertrand Oligopoly
JEL Classification:  F11; F12; F13

David Meenagh, Patrick Minford, Michael Wickens and Yongdeng Xu (March 2018)
The small sample properties of Indirect Inference in testing and estimating DSGE models  (278K, 16 pages)
Indirect inference testing can be carried out with a variety of auxiliary models. Asymptotically these different models make no difference. However, the small sample properties can differ. We explore small sample power and estimation bias both with different variable combinations and descriptive models (Vector Auto Regressions, Impulse Response Functions or Moments) in the auxiliary model. We find that VAR and IRF descriptors perform slightly better than Moments but that alternative three variable combinations make little difference. More than three variables raises power and lowers bias but reduces the chances of finding a tractable model that passes the test. The paper sheds light on the small sample properties of II estimation and tests of DSGE models.
Keywords: Indirect Inference, DGSE model, Auxiliary Models, Simulated Moments Method, Impulse Response Functions, VAR, Moments, power, bias
JEL Classification: C12; C32; C52; E1

Yongdeng Xu, Nick Taylor and Wenna Lu(January 2018)
Illiquidity and Volatility Spillover effects in Equity Markets during and after the Global Financial Crisis: an MEM approach  (3M, 36 pages)
Even though volatility spillover effects in global equity markets have been documented extensively, the transmission of illiquidity across national borders has not. In this paper, we propose a multiplicative error model (MEM) for the dynamics of illiquidity. We empirically study the illiquidity and volatility spillover effects in eight developed equity markets during and after the recent financial crisis.  The results indicate that equity markets are interdependent, both in terms of volatility and illiquidity. Most markets show an increase in volatility and illiquidity spillover effects during the crisis. Furthermore, we find volatility and illiquidity transmission are highly relevant. Illiquidity is a more important channel than volatility in propagating the shocks in equity markets. Our results show an overall crucial role for illiquidity in the US market in influencing other equity markets’ illiquidity and volatility. These findings are of importance for policy makers as well as institutional and private investors. 
Keywords: Illiquidity Spillover, Volatility Spillover, Multiplicative Error Model
JEL Classification:  C32, C52, G14

Thomai Filippeli, Richard Harrison and Konstantinos Theodoridis (January 2018)
DSGE-based Priors for BVARs & Quasi-Bayesian DSGE Estimation  (1M, 38 pages)
We present a new method for estimating Bayesian vector autoregression (VAR) models using priors from a dynamic stochastic general equilibrium (DSGE) model. We use the DSGE model priors to determine the moments of an independent Normal-Wishart prior for the VAR parameters. Two hyper-parameters control the tightness of the DSGE-implied priors on the autoregressive coefficients and the residual covariance matrix respectively. Determining these hyper-parameters by selecting the values that maximize the marginal likelihood of the Bayesian VAR provides a method for isolating subsets of DSGE parameter priors that are at odds with the data. We illustrate the ability of our approach to correctly detect incorrect DSGE priors for the variance of structural shocks using a Monte Carlo experiment. We also demonstrate how posterior estimates of the DSGE parameter vector can be recovered from the BVAR posterior estimates: a new ‘quasi-Bayesian’ DSGE estimation. An empirical application on US data reveals economically meaningful differences in posterior parameter estimates when comparing our quasi-Bayesian estimator with Bayesian maximum likelihood. Our method also indicates that the DSGE prior implications for the residual covariance matrix are at odds with the data.
Keywords: BVAR, SVAR, DSGE, DSGE-VAR, Gibbs Sampling, Marginal Likelihood Evaluation, Predictive Likelihood Evalution, Quasi-Bayesian DSGE Estimation,
JEL Classification:  C11, C13, C32, C52

Vo Phuong Mai Le, David Meenagh and Patrick Minford (January 2018)
Financial stability: To Regulate or Not? A public choice inquiry (350K, 17 pages)
The paper takes the stand that the central banks as financial regulators have their own interest in imposing more regulations. It models the institutional behaviour for the central bank and government using the Indirect Inference testing and estimation method as it finds a set of coefficients of the model that can generate the actual observed behaviour for the US. The paper establishes that good monetary policy can reduce instability. Regulation at worse destabilises the economy and at best contributes little to stabilise the economy. After the financial crisis, financial regulations were too severe and thus actually increased instability.
Keywords: DSGE, Regulations, Financial Stability, Monetary Policy
JEL Classification: E10; E58; G28

Lucy Minford and David Meenagh (January 2018)
Testing a model of UK growth - a causal role for R&D subsidies   (405K, 36 pages)
We show that a DSGE model in which subsidies to private sector R&D stimulate economic growth, following the predictions of semi-endogenous growth theory, can account for the joint behaviour of UK output and total factor productivity for 1981-2010. R&D subsidies are measured as government- funded R&D performed by the private sector as a proportion of total private sector R&D. We estimate and test the performance of the model using Indirect Inference, and also investigate the robustness of the results using a Monte Carlo exercise. Our fïndings indicate that sharp cuts in R&D subsidies tend to have highly persistent growth e§ects in the UK.
Keywords: R&D, subsidies, economic growth, government policy.
JEL Classification:  E00, O00, O38, O50

Ali Sina Onder, Sergey V. Popov and Sascha Schweitzer (January 2018, updated in December 2018)
Leadership in Scholarship: Editors’ Influence on the Profession’s Narrative   (450K, 25 pages)
Academic journals disseminate new knowledge, and therefore can influence the direction and composition of ongoing research by choosing what to publish. We study the influence of editors and coeditors of the American Economic Review (AER) on the topic structure of papers published in the AER between 1976 and 2013 using a textual analysis of manuscripts. We compare AER’s topic structure to that of the other top general interest journals. The appointment of new AER editors, while accompanied by a minor comovement of AER topics towards topics of editor’s post-appointment publications, serves more to premediate trends in the other Top 5 journals.
Keywords: Text Search; Topical Analysis; Academia; Knowledge Dissemination; In- fluence; Journals; Editors.
JEL Classification:  A11, A14, O3

Haroon Mumtaz and Konstantinos Theodoridis (January 2018)
The Federal Reserve’s implicit inflation target and Macroeconomic dynamics. A SVAR analysis   (1.6M, 70 pages)
This paper identifies shocks to the Federal Reserve's inflation target as VAR innovations that make the largest contribution to future movements in long-horizon  inflation expectations. The effectiveness of this scheme is documented via Monte-Carlo experiments. The estimated impulse responses indicate that a positive shock to the target is associated with a large increase in inflation and long-term interest rates in the US and the industrialised world. Target shocks are estimated to be a vital factor behind the increase in inflation during the pre-1980 period and are an important driver of the decline in long-term interest rates over the last two decades.
Keywords: SVAR, DSGE model, inflation target, international transmission.
JEL Classification:  C5, E1, E5, E6

Haroon Mumtaz and Konstantinos Theodoridis (December 2017)
US financial shocks and the distribution of income and consumption in the UK   (2.2M, 59 pages)
We show that US financial shocks have an impact on the distribution of UK income and consumption. Households with higher income and higher levels of consumption are affected more by this shock than households located towards the lower end of these distributions. An estimated multiple agent DSGE model suggests that the heterogeneity in the household responses can be explained by the different levels of access to financial markets. We find that this heterogeneity magnifies the effect of this shock on aggregate output.
Keywords: FAVAR, DSGE model, Financial Shock
JEL Classification:  D31, E32, E44

David R. Collie (December 2017)
A Simple Model of Brexit under Oligopoly   (371K, 39 pages)
The welfare effects of Brexit on the UK, the EU27 and the rest of the world are analysed in a model of international trade under oligopoly. A hard Brexit where the UK trades according to WTO rules is shown to decrease total UK welfare, to have an ambiguous effect on total EU27 welfare, and to increase total welfare in the rest of the world. Unilateral free trade for the UK is shown to decrease total UK welfare, to increase total EU27 welfare, and to increase total welfare in the rest of the world. A free trade agreement with the rest of the world rather than the EU27 will be beneficial, ceteris paribus, if the rest of the world market is larger than the EU27 market; if the rest of the world tariff is larger than the EU27 tariff; and if firms in the rest of the world have higher costs than EU27 firms. It will not be beneficial if trade between the UK and the rest of the world is more costly than trade between the UK and the EU27 as is likely to be the case since the EU27 is close to the UK.
Keywords: Brexit; Oligopoly; International Trade; Tariffs; EU
JEL Classification:  F12; F13; L13

Helmuts Azacis (December 2017)
Repeated Implementation with Overlapping Generations of Agents   (275K, 29 pages)
We study repeated implementation in a model with overlapping generations of agents. A social choice function selects an alternative in each period as a function of preferences of the agents who are alive in that period. When the agents' preferences do not change during their lifetime, we show that any social choice function satisfying a mild unanimity condition is repeatedly implementable in subgame perfect equilibrium if there are at least three agents and they live sufficiently long. When the agents' preferences change every period, we show that only efficient social choice functions can be repeatedly implementable if the agents live sufficiently long.
Keywords: Repeated Implementation, Subgame Perfect Implementation, Overlapping Generations, Necessary and Sufficient Conditions, Efficiency in the Range
JEL Classification:  C72; C73; D71; D82

Georgios Magkonis and Andreas Tsopanakis (November 2017)
The Financial Connectedness between Eurozone Core and Periphery: A Disaggregated View   (1.9M, 48 pages)
This paper examines the financial stress interconnectedness among GIIPS economies and Germany. Based on market level financial stress indices, it examines the stress transmission process as well as the causal network relationships in banking sector, bond, money and stock markets. The period under investigation, 2001-2013, allows to test the effects of financial crisis of 2008 as well as the subsequent European sovereign crisis. Using two alternative techniques for connectedness analysis, our evidence suggests that the peripheral economies of Italy and Spain play a highly significant role in the stress transmission in all markets, especially in the cases of banks and equity markets. Moreover, we visualize our results using network analysis. Contrary to common wisdom, Portugal, Ireland, and mainly Greece, do not seem to have an important role in amplifying stress levels.
Keywords: Eurozone, stress transmission, connectedness analysis, spillovers, networks
JEL Classification:  C43, G15, F30

Menelaos Karanasos and Yongdeng Xu (November 2017)
Matrix Inequality Constraints for Vector (Asymmetric Power) GARCH/HEAVY Models and MEM with spillovers: some New (Mixture) Formulations   (452K, 29 pages)
In this paper we review and generalize results on the derivation of tractable non-negativity (necessary and sufficient) conditions for N-dimensional asymmetric power GARCH/HEAVY models and MEM. We show that these non-negativity constraints are translated into simple matrix inequalities, which are easily handled. One main concern is that the existence of such conditions is often ignored by researchers. We hope that our paper will create more awareness of the presence of these non-negativity conditions and increase their usage. In practice these constraints may not be fulfilled. To handle these cases we propose a new mixture formulation in order to eliminate some of these constraints. By using the exponential specification for some (but not all) of the conditional variables in the system we considerably reduce the dimensions of them. We also obtain new theoretical results about the second moment structure and the optimal forecasts of such multivariate processes. Four empirical examples are included to show the effectiveness of the proposed method.
Keywords: Asymmetries; Matrix Inequality Constraints; Mixture Formulation; Multivariate Modelling; Optimal Forecasts; Power Transformations; Second Moment Structure
JEL Classification: C32, C53, C58, G15

Patrick Minford, Yi Wang and Peng Zhou  (October 2017)
Resolving the Public Sector Wage Premium Puzzle by Indirect Inference   (1.4M, 25 pages)
This paper investigates the public-sector wage premium in the UK using a microfounded economic model and indirect inference. To answer the question whether there is public-sector wage premium, we ask an equivalent question—whether a model assuming perfect competition can explain the data. The neoclassical labour economic model is tested and estimated without introducing any ad hoc gap between the theoretical and empirical models. Popular econometric models are used as auxiliary models to summarise the data features, based on which we evaluate the distance between the observed data and the model-simulated data. We show that it is not the non-market factors, but the total costs and benefits of working in different sectors and so simple market forces, that create the public-sector wage premium. In other words, there is no inefficiency or unfairness in the labour market to justify government intervention. In addition, selection bias test can be incorporated into the indirect inference procedures in a straightforward way, and we find no evidence for it in the data.
Keywords: Public Sector Wage Premium, Selection Bias, Indirect Inference, Monte Carlo
JEL Classification: C21, C35, J31, J45

António Afonso, Michael G. Arghyrou, María Dolores Gadea and Alexandros Kontonikas (September 2017)
“Whatever it takes” to resolve the European sovereign debt crisis? Bond pricing regime switches and monetary policy effects   (1.2M, 39 pages)
This paper investigates the role of unconventional monetary policy as a source of time-variation in the relationship between sovereign bond yield spreads and their fundamental determinants. We use a two-step empirical approach. First, we apply a time-varying parameter panel modelling framework to determine shifts in the pricing regime characterising sovereign bond markets in the euro area over the period January 1999 to July 2016. Second, we estimate the impact of ECB policy interventions on the time-varying risk factor sensitivities of spreads. Our results provide evidence of a new bond-pricing regime following the announcement of the Outright Monetary Transactions (OMT) programme in August 2012. This regime is characterised by a weakened link between spreads and fundamentals, but with higher spreads relative to the pre-crisis period and residual redenomination risk. We also find that unconventional monetary policy measures affect the pricing of sovereign risk not only directly, but also indirectly through changes in banking risk. Overall, the actions of the ECB have operated as catalysts for reversing the dynamics of the European sovereign debt crisis.
Keywords: euro area, spreads, crisis, time-varying relationship, unconventional monetary policy
JEL Classification: E43, E44, F30, G01, G12

Sergey V. Popov (August 2017)
On Basu’s Proposal: Fines Affect Bribes   (306K, 9 pages)
I model the connection between the equilibrium bribe amount and the fines imposed on both bribe-taker and bribe-payer. I show that Basu’s (2011) proposal to lower the fines imposed on bribe-payers in order to induce more whistleblowing and increase the probability of penalizing corrupt government officials might instead increase bribe amounts. Higher expected fines on bribe-takers will make them charge larger bribes; at the same time, lowering fines for bribe-paying might increase bribe-payers’ willingness to pay bribes.
Keywords: corruption, bribery, extortion, decentralization, fines
JEL Classification: H8, K4.

Patrick Minford and Yongdeng Xu (August 2017)
Classical or Gravity? Which trade model best matches the UK facts?   (340K, 34 pages)
We examine the empirical evidence bearing on whether UK trade is governed by a Classical model or by a Gravity model, using annual data from 1965 to 2015 and the method of Indirect Inference which has very large power in this application. The Gravity model here differs from the Classical model in assuming imperfect competition and a positive effect of total trade on productivity. We found that the Classical model passed the test rather easily, and that the Gravity model did so too but at a rather lower level of probability. As the gravity elements are strengthened the model's probability falls and vice versa. The two models' policy implications are also similar.
Keywords: Bootstrap, indirect inference, gravity model, classical trade model, UK trade
JEL Classification:

Cemil Selcuk and Bilal Gokpinar (August 2017)
Fixed vs. Flexible Pricing in a Competitive Market. (850K, 63 pages)
We study the selection and dynamics of two popular pricing policies fixed price and flexible pricing in competitive markets. Our paper extends previous work in marketing, e.g. Desai and Purohit (2004) by focusing on decentralized markets with a dynamic and fully competitive framework while also considering possible non-economic aspects of bargaining. We construct and analyze a competitive search model which allows us to endogenize the expected demand depending on pricing rules and posted prices. Our analysis reveals that  fixed price and flexible pricing policies generally coexist in the same marketplace, and each policy comes with its own list price and customer demographics. More specifically, if customers dislike haggling, then fixed pricing emerges as the unique equilibrium, but if customers get some additional satisfaction from the bargaining process, then both policies are offered, and the unique equilibrium exhibits full segmentation: Haggler customers avoid fixed-price firms and exclusively shop at flexible firms whereas non-haggler customers do the opposite. We also find that prices increase in customer satisfaction, implying that sellers take advantage of the positive utility enjoyed by hagglers in the form of higher prices. Finally, considering the presence of seasonal cycles in most markets, we analyze a scenario where market demand goes through periodic ups and downs and find that equilibrium prices remain mostly stable despite significant áuctuations in demand. This finding suggests a plausible competition-based explanation for the stability of prices.  
Keywords : pricing policy, negotiation, competition, competitive search
JEL Classification: 

Anthony Savagar and Huw Dixon (July 2017)
Firm Entry, Excess Capacity and Aggregate Productivity. (867K, 51 pages)
Slow firm entry over the business cycle causes measured TFP to vary endogenously because incumbent firms bear shocks. Our main theorem states that imperfect competition and dynamic firm entry are necessary and sufficient conditions for these endogenous productivity fluctuations. The result focuses on the short-run absence of entry and incumbents' output response given this quasi-fixity. Quantitatively we show the endogenous productivity effect is as large as a traditional capital utilization effect. 
Keywords : dynamic entry, endogenous productivity, endogenous sunk costs, business stealing, business cycle, continuous time
JEL Classification: E32, D21, D43, L13, C62

Vo Phuong Mai Le, David Meenagh and Patrick Minford (July 2017)
How Should News Shocks Be Specified Under Rational Expectations? (178K, 6 pages)
A number of studies have found that news shocks account for a large part of the aggregate fluctuations of the main macroeconomic variables. We show that when taking rational expectations into consideration there is a limit on the size of the variance of the news shocks, which has not been considered in the literature. We offer an explanation to why this restriction should be imposed and show, with an empirical example from a recent paper, that if you do impose the rational expectations restriction the importance of the news is drastically reduced. 
Keywords : News shocks; DSGE; Rational Expectations
JEL Classification: E2; E3

Kul B Luintel and Mosahid Khan (July 2017)
Ideas Production and International Knowledge Spillovers: Digging Deeper into Emerging Countries (1197K, 50 pages)
Research and Development (R&D) activities of emerging countries (EMEs) have increased considerably in recent years. Recent micro studies and anecdotal evidence points to industrialized countries as the sources of knowledge in EMEs. In this context, we examine ideas production and international knowledge spillovers in a panel of 31 EMEs by accounting for six diffusion channels and two types (national versus USPTO) of patent filings. Knowledge spillovers to EMEs accruing from (i) the industrialized world, (ii) the emerging world, (iii) different country and regional groups, and (iv) selected bilateral cases are modeled. Spillovers from the industrialized world appear robust via geographical proximity and disembodied channels only. Other conduits, including trade flows, are either insignificant or not robust. Spillovers from emerging world are virtually non-existent. Analyses of regional clusters of EMEs do not support any role of language, culture or geographical characteristics in knowledge diffusion. Overall, the breadth and depth of knowledge spillovers appear extremely moderate across EMEs; however, we find pockets (specific countries and certain groups) generating positive spillovers. A carefully choreographed policy focusing on such pockets might be fruitful. We hope that this study (i) complements the micro literature, (ii) furthers the existing macro literature and (iii) provides some new policy insights. Our results are robust to a range of robustness checks, including the estimators – a cointegration approach versus a simple fixed effects OLS estimator.
Keywords:  Ideas Production; Diffusion; Fixed Effects; Panel Integration and Cointegration.
JEL Classification:   O3; O4; O47

See also: Online Appendix A  Online Appendix B

Ezgi Kaya (May 2017)
Quantile regression and the gender wage gap: Is there a glass ceiling in the Turkish labor market? (1565K, 34 pages)
Recent studies from different countries suggest that the gender gap is not constant across the wage distribution and the average wage gap provides limited information on women’s relative position in the labour market. Using micro level data from official statistics, this study explores the gender wage‐gap in Turkey across the wage distribution. The quantile regression and counterfactual decomposition analysis results reveal three striking features of the Turkish labour market. The first is that the gender wage gap is more pronounced at the upper tail of the wage distribution, implying the existence of a glass ceiling effect for women in the Turkish labour market. The second is that, the glass ceiling effect in Turkey is not observed in the raw gender wage gap and only revealed after controlling for workers’ labour market qualifications implying that women are better qualified and better educated than their male counterparts’ at the upper tail of the wage distribution. The third finding is that despite the narrowing effect of the women’s relative labour market qualifications, the glass ceiling effect in the Turkish labour market exists due to unequal treatment of men and women and the increasing labour market discrimination toward women as we move up the wage distribution.
Keywords: Gender wage gap, quantile regression, decomposition
JEL Classification:  C21, J31, J71  

Chunping Liu and Zhirong Ou (May 2017)
What determines China's housing price dynamics? New evidence from a DSGE-VAR (1003K, 48 pages)
We investigate what determines China's housing price dynamics using a DSGE-VAR estimated with priors allowing for the featured operating of normal and 'shadow' banks in China, with data observed between 2001 and 2014. We find that the housing demand shock, which is the essential factor for housing price 'bubbles' to happen, accounts for near 90% of the housing price áuctuation. We also find that a prosperous housing market could have led to future economic growth, though quantitatively its marginal impact is small. But this also means that, for policy-makers who wish to stabilise the housing market, the cost on output reduction would be rather limited.
Keywords: Housing price; Bubbles; Market spillovers; DSGE-VAR; China
JEL Classification:   C11, E32, E44, R31

Piotr Denderski and Wojciech Paczos (May 2017)
Foreign Banks and The Bank Lending Channel   (449K, 23 pages)
We provide new evidence on the bank lending channel of monetary policy using bank-level data of 440 banks from eleven CEE transition economies between 1998 and 2012. Our findings are: i) banks adjust their loans to changes in host country’s monetary policy, ii) foreign-owned banks are less responsive to monetary policy of a host country than domestic-owned banks in both normal and crisis times, iii) foreign parent bank characteristics are irrelevant for the bank lending channel. We propose market segmentation hypothesis that can account for those facts better than the alternative, the internal market hypothesis. Foreign banks have a competitive advantage so that their loan portfolio adjusts less to changes in monetary policy. As a consequence, an increase in foreign penetration of the banking sector does not render monetary policy less effective.
Keywords: banks, bank ownership, bank lending channel, monetary policy
JEL Classification:  E44, E50, G21

Helmuts Azacis (March 2017)
Information Disclosure by a Seller in Sequential First-Price Auctions  (783K, 60 pages)
I study sequential first-price auctions where two items are sold to two bidders with private binary valuations. A seller, prior to the second auction, can publicly disclose some information about the outcome of the first auction. I characterize equilibrium strategies for various disclosure rules when the valuations of bidders are either perfectly positively or perfectly negatively correlated across items. I establish outcome equivalence between different disclosure rules. I find that it is optimal for the seller to disclose some information when the valuations are negatively correlated, whereas it is optimal not to disclose any information when the valuations are positively correlated. For most of the parameter values, the seller's expected revenue is higher if the losing bid is disclosed. When only the winner's identity is disclosed, the equilibrium is efficient whether the valuations are positively or nega tively correlated.
Keywords: Efficiency; Information disclosure; Seller's revenue; Sequential first-price auctions
JEL Classification:  D44; D47; D82

Peng Zhou (March 2017)
Separating Yolk from White: A Filter based on Economic Properties of Trend and Cycle   (796K, 8 pages)
This paper proposes a new filter technique to separate trend and cycle based on stylised economic properties of trend and cycle, rather than relying on ad hoc statistical proper-ties such as frequency. Given the theoretical separation between economic growth and business cycle literature, it is necessary to make the measures of trend and cycle match what the respective theories intend to explain. The proposed filter is applied to the long macroeconomic data collected by the Bank of England (1700-2015).
Keywords: Filter, Trend, Cycle
JEL Classification:  C32

David Meenagh, Patrick Minford, Michael Wickens and Yongdeng Xu (December 2016)
What is the truth about DSGE models? Testing by indirect inference  (277K, 21 pages)
This paper addresses the growing gulf between traditional macroeconometrics and the increasingly dominant preference among macroeconomists to use DSGE models and to estimate them using Bayesian estimation with strong priors but not to test them as they are likely to fail conventional statistical tests. This is in conflict with the high scientific ideals with which DSGE models were first invested in their aim of finding true models of the macroeconomy. As macro models are in reality only approximate representations of the economy, we argue that a pseudo-true inferential framework should be used to provide a measure of the robustness of DSGE models.
Keywords: Pseudo-true inference, DSGE models, Indirect Inference; Wald tests, Likelihood Ratio tests; robustness
JEL Classification: C12; C32; C52; E1

Ricardo Gonçalves and Indrajit Ray (December 2016)
Equilibria in a Japanese-English Auction with Discrete Bid Levels for the Wallet Game (395K, 22 pages)
We consider the set-up of a Japanese-English auction with exogenously fixed discrete bid levels for the wallet game with two bidders. We prove that bidding twice the signal - the equilibrium strategy with continuous bid levels - is never an equilibrium in this set up. We show that partition equilibria exist that may be separating or pooling. We illustrate some separating and pooling equilibria with two and three discrete bid levels; we also compare the revenues of the seller from these equilibria and thereby find the optimal bid levels in these cases.
Keywords: Japanese-English auctions, wallet game, discrete bids, partitions, pooling equilibrium, separating equilibrium
JEL Classification: C72; D44

Patrick Minford, Michael Wickens and Yongdeng Xu (November 2016)
Testing part of a DSGE model by Indirect Inference (183K, 11 pages)
We propose a new type of test. Its aim is to test subsets of the structural equations of a DSGE model. The test draws on the statistical inference for limited information models and the use of indirect inference to test DSGE models. Using Monte Carlo experiments on two subsets of equations of the Smets-Wouters model we show that the model has accurate size and good power in small samples. In a test of the Smets-Wouters model on US Great Moderation data we reject the speci…cation of the wage-price but not the expenditure sector, pointing to the …first as the source of overall model rejection.
Keywords: sub sectors of models, limited information, indirect inference, testing DSGE models equations, Monte Carlo, power, test size
JEL Classification: C12; C32; C52; E1

Vo Phuong Mai Le, David Meenagh and Patrick Minford (October 2016)
A note on news about the future: the impact on DSGE models and their VAR representation  (330K, 25 pages)
In this paper we investigate the role of news shocks in aggregate fluctuations by comparing the empirical performance of models with and without the feature of the news shocks. We found a trivial difference between the two models. That is, the model with news shocks explains the variation as well as the alternative. The reason is that the news shocks can only advance the date at which agents know about the changes, but they do not change the stochastic structure of the model.
Keywords: News shocks; DSGE; VAR; Indirect Inference
JEL Classification: E2; E3

Garry DA Phillips and Yongdeng Xu (September 2016)
Almost Unbiased Variance Estimation in Simultaneous Equation Models (246K, 36 pages)
While a good deal of research in simultaneous equation models has been conducted to examine the small sample properties of coefficient estimators there has not been a corresponding interest in the properties of estimators for the associated variances. In this paper we build on Kiviet and Phillips (2000) and explore the biases in variance estimators. This is done for the 2SLS and the MLIML estimators.The approximations to the bias are then used to develop less biased estimators whose properties are examined and compared in a number of simulation experiments. In addition, a bootstrap estimator is included which is found to perform especially well. The experiments also consider coverage probabilities/test sizes  and test powers of the t-tests where it is shown that tests based on 2SLS are generally oversized while test sizes based on MLIML are closer to nominal levels. In both cases test statistics based on the corrected variance estimates generally have a higher power than standard procedures.
Keywords: Simultaneous equation models, 2SLS and Fuller's estimators, Bias corrected variance estimation, Inference and bias corrected variance
JEL Classification: C12; C13; C26; C30

Woon K. Wong, Iris Biefang-Frisancho Mariscal, Wanru Yao and Peter Howells (August 2016)
Liquidity and Credit Risks in the UK’s Financial Crisis: How ‘Quantitative Easing’ changed the relationship (1251K, 30 pages)
This paper investigates the relationship between credit and liquidity risk components in the UK interbank spread during the recent financial crisis and sheds light on the transmission mechanism of the quantitative easing (QE) carried out by the Bank of England on short term interest rates. Specifically, we find that prior to the Bank’s intervention counterparty risk was a major factor in the widening of the spread and also caused a rise in liquidity risk. However, this relationship was reversed during the period when QE was implemented. Using the accumulated value of asset purchases as a proxy for the central bank’s liquidity provisions, we provide evidence that the QE operations were successful in reducing liquidity premia and ultimately, and indirectly, credit risk. We also find evidence that suggests liquidity schemes provided by other central banks and international market sentiment contributed to the reduction of interbank spread.
Keywords: interbank spreads, liquidity premia, credit risk, quantitative easing, financial crisis.
JEL Classification: 

Woon K. Wong (August 2016)
A GMM Skewness and Kurtosis Ratio Test for Higher Moment Dependence (827K, 29 pages)
This article extends the variance ratio test of Lo and MacKinlay (1988) to tests of skewness and kurtosis ratios using the generalized methods of moments. In particular, overlapping observations are used in which dependencies are explicitly modelled so that more information can be used to make the tests more powerful and have better size properties. The proposed tests can be useful in risk management where risk models are estimated using daily data but multiperiod forecasts of tail risks are required for the determination of risk capital. Application of the tests fïnds signifïcant higher moment dependence in the US stock markets.
Keywords: Skewness, kurtosis, overlapping observations, moments, cumulants
JEL Classification: C10, G11

James Foreman-Peck and Peng Zhou (July 2016)
Migration and Tax Yields in a Devolved Economy (1381K, 38 pages)
Households may migrate between jurisdictions to secure preferred mixes of collectively sup-plied services and taxation. But devolution of taxes to sub-national jurisdictions could reduce expected tax revenue if some move to lower tax regimes, constraining devolved government policy. This paper develops an indirect approach to establish lower bound tax revenue impacts of possible tax changes by devolved governments. We estimate and aggregate migration responses to existing tax differentials between smaller, component administrative areas of the devolved jurisdictions. Because such existing taxes may have different bases from proposed devolved taxes, appropriate corrections are made in a model of the devolved economy. This model also establishes how the tax base and therefore the tax yield of the devolved economy, as well as the output per capita, would be changed by implementing different tax rates, given the migration responses estimated. The model is used to assess the fiscal possibilities for Wales created by the UK Government of Wales Act 2014.
Keywords: Migration; Fiscal Decentralisation; Tax Revenue
JEL Classification: R23; J61; H11; H22; H71; H72; H77

Paulo Brito, Luís F. Costa and Huw David Dixon (June 2016)
From Sunspots to Black Holes: Singular dynamics in macroeconomic models (720K, 35 pages)
We present conditions for the emergence of singularities in DGE models. We distinguish between slow-fast and impasse singularity types, review geometrical methods to deal with both types of singularity and apply them to DGE dynamics. We find that impasse singularities can generate new types of DGE dynamics, in particular temporary determinacy/indeterminacy. We illustrate the different nature of the two types of singularities and apply our results to two simple models: the Benhabib and Farmer (1994) model and one with a cyclical fiscal policy rule.
Keywords: slow-fast singularities; impasse singularities; macroeconomic dynamics; temporary indeterminacy
JEL Classification: C62; D43; E32

Patrick Minford, Michael Wickens and Yongdeng Xu (May 2016)
Comparing different data descriptors in Indirect Inference tests on DSGE models (200K, 11 pages)
Indirect inference testing can be carried out with a variety of auxiliary models. Asymptotically these different models make no difference. However, in small samples power can differ. We explore small sample power with three different auxiliary models: a VAR, average Impulse Response Functions and Moments. The latter corresponds to the Simulated Moments Method. We find that in a small macro model there is no difference in power. But in a large complex macro model the power with Moments rises more slowly with increasing misspecification than with the other two which remain similar.
Keywords: : Indirect Inference; DGSE model; Auxiliary Models; Simulated Moments Method
JEL Classification: C12; C32; C52; E1

Kul B Luintel and Mosahid Khan (April 2016)
R&D, Scale Effects and Spillovers: New Insights from Emerging Countries (662K, 40 pages)
There has been a concomitant rise in R&D and the rate of economic growth in emerging countries. Analyzing a panel of 31 emerging countries, we find convincing evidence of scale effects which make government policies potent for long-run growth. This contrasts sharply with the well known findings of Jones (1995a). Innovations show increasing returns to knowledge stock, implying that the diminishing returns assumed by some semi-endogenous growth models might not be generalized. International R&D spillovers raise the innovation bar. The observed growth rates of emerging economies appear in transition therefore their growth rates may recede with the passage of time.
Keywords: Scale Effects; Ideas Production; Diffusion; Panel Integration and Cointegration
JEL Classification: O3; O4; O47

David R. Collie (April 2016)
Gains from Variety? Product Differentiation and the Possibility of Losses from Trade under Cournot Oligopoly with Free Entry (314K, 14 pages)
In a free-entry Cournot oligopoly model with a quadratic utility function that yields differentiated products, it is shown that there are losses from trade when the trade cost is close to the prohibitive level. Although the total number of varieties increases, there is a reduction in consumer surplus. This occurs because trade leads to an increase in imported varieties where consumer surplus is low due to the high trade cost and a decrease in domestically-produced varieties where consumer surplus is high. This result is in contrast with results from the free-entry Cournot oligopoly models with homogeneous products of Brander and Krugman (1983) and Venables (1985); the monopolistic competition models such as Krugman (1980) and Venables (1987), and heterogeneous firm models such as Melitz (2003) and Melitz and Ottaviano (2008).
Keywords: Gains from Trade; Trade Liberalisation; Free Entry; Cournot Oligopoly; Product Variety
JEL Classification: F12

Kul B Luintel, Mosahid Khan, Roberto Leon-Gonzalez and GuangJie Li (March 2016)
Financial Development, Structure and Growth: New Data, Method and Results (721K, 42 pages)
The existing weight of evidence suggests that financial structure (the classification of a financial system as bank-based versus market-based) is irrelevant for economic growth. This contradicts the common belief that the institutional structure of a financial system matters. We re-examine this issue using a novel dataset covering 69 countries over 1989-2011 in a Bayesian framework. Our results are conformable to the belief - a market-based system is relevant - with sizable economic effects for the high-income but not for the middle-and-low-income countries. Our findings provide a counterexample to the weight of evidence. We also identify a regime shift in 2008.
Keywords: Financial Structure; Economic Growth; Cointegration; Bayesian Model Averaging; Structural Breaks
JEL Classification: G0; O4; O16
See also: Online Appendix

Patrick Minford (March 2016)
Understanding UK trade agreements with the EU and other countries (533K, 17 pages)
Recent work has exposed the extent of EU protectionism within the single market Customs Union. If the UK leaves the EU customs union for unilateral free trade, as a small country within the world market, it will therefore make gains according to the standard trade model. Should it do so, trade agreements with other small countries would simply divert UK trade to these markets without affecting UK trade or output overall – hence while harmless they are also pointless. Trade agreements with large countries or country-blocs should be treated with care, since while they might give scope for UK industries to enjoy higher prices on all their output by diverting trade to these markets, they could come at a cost in higher prices for imports as in the case of the EU customs union. If having left the EU the UK finds a large country willing to offer a beneficial free trade agreement, it is likely to be easier to conclude with the UK outside the EU than with it as part of the EU, because of the complex and varied industrial interests of the EU as whole compared with the more limited interests of the UK. Already in services which are in general not governed by EU trade rules UK trade takes place under WTO rules and is also closely integrated with other countries’ markets such as the US and most Commonwealth countries.

David Meenagh, Patrick Minford and Olayinka Oyekola (November 2015)
Energy Business Cycles (671K, 38 pages)
We find that, when estimated, a two sector computable dynamic stochastic general equilibrium open economy model of the U.S. that formally admits energy into the production process can generate plausible parameter values that can be applied to deal with a broad range of economic issues. As a benchmark, we require that the model fits the data for output, real exchange rate, energy use, and consumption: output because it serves as a measure of a country’s total income,real exchange rate because it serves as a determinant of a country’s relative competitiveness,energy use because it serves as an indicator of special inputs into a country’s production process,and consumption because it serves as a yardstick for evaluating a country’s standard of living. Finally, we argue that this model, with appropriate extensions, some of which we also propose, can help future modelers to tackle other research questions.
Keywords: Two sector; US DSGE model; Oil price volatility; Open economy; Indirect inference
JEL Classification: E32; D58; F41; C52; Q43
See also: Supporting Annex

David Meenagh, Patrick Minford and Olayinka Oyekola (November 2015)
Oil Prices and the Dynamics of Output and Real Exchange Rate (881K, 32 pages)
We examine the role of oil price shocks in effecting changes both at the aggregate and sectoral levels using an estimated dynamic stochastic equilibrium open economy model. Our main finding is that energy price shocks are not able directly to generate the magnitude of the economic downturn observed in the data. These shocks, however, do possess a strong indirect transmission link that endogenously spreads their effect through the system such that they account for a considerable portion of the U.S. business cycle movements. This leads us to conclude that previous results that attribute a minimal importance to oil price shocks must be focusing more on the energy cost share of gross domestic product and less on how they affect the intertemporal decisions of economic agents. We also find that external shocks have been responsible for explaining volatility in U.S. economic activities for a long time. This leads us to conclude that modelling the U.S. as a closed economy discounts a sizeable set of very relevant factors.
Keywords: Two sector; non-stationary DSGE model; Oil price; Relative prices; Domestic shocks; Imported shocks
JEL Classification: E32; D58; F41; C52; Q43
See also: Supporting Annex

Patrick Minford (November 2015)
Evaluating European trading arrangements (541K, 21 pages)
The EU protects agriculture and manufacturing through its commercial policies, namely its tariffs, its non-tariff barriers and the Common Agricultural Policy. By leaving the EU the UK would be able to abandon the EU’s protectionist system in favour of free trade combined with transitional compensation for those hit by the changes. This would raise economic welfare by around 4% (i.e. UK households would be able to consume 4% more goods and services) and enhance the shift of the UK economy away from manufacturing into service industries where UK growth has been concentrated largely in the decades since 1979. As the UK is a small country with little if any monopoly power in world markets, bilateral trade agreements have trivial effects on it.

David R. Collie (October 2015)
Taxation under Oligopoly in a General Equilibrium Setting (505K, 45 pages)
Taxation under oligopoly is analysed in a general equilibrium setting where the firms are large relative to the size of the economy and maximise the utility of their shareholders. It turns out that the model is an aggregative game, which simplifies the comparative statics for the effects of taxation. This novel analysis of taxation leads to a number of counterintuitive results that challenge conventional wisdom in microeconomics. A lump-sum tax may increase the price of the oligopolistic good and decrease welfare whereas a profits tax may decrease the price of the oligopolistic good and increase welfare. An ad valorem tax may decrease the price of the oligopolistic good and increase welfare. Furthermore, in line with conventional wisdom, total tax revenue is always higher with an ad valorem tax than with a specific tax that leads to the same price for the oligopolistic good.
Keywords: Oligopoly; General Equilibrium; Aggregative Games; Ad Valorem Taxes; Specific Taxes; Profits Taxes; Lump-Sum Taxes
JEL Classification: C72; D21; D43; D51; H22; H25; L13; L21

Joshy Easaw (October 2015)
Household Forming Inflation Expectations: Why Do They ‘Overreact’? (377K, 17 pages)
The purpose of the present paper is to provide a simple model which explains how households (or non-experts) form their inflation forecasts. The paper contributes to the existing literature and the understanding of how inflation expectations are formed in two ways. Firstly, we present an integrated model of how non-experts form their inflation expectations. The paper initially outlines how professionals form inflation forecast. Subsequently, the model presents the non-expert’s expectations formation incorporating the dynamics of the professional’s forecast. Secondly, we explain the prevalent phenomena where non-experts tend to overreact, or overshoot, initially as they revise their inflation forecast.
Keywords: Inflation Expectations Formation; Information Rigidities; Over-reaction
JEL Classification: E3; E4; E5

Joshy Easaw, Saeed Heravi and Huw David Dixon (October 2015)
Professionals’ Forecast of the Inflation Gap and its Persistence (737K, 33 pages)
The purpose of the present paper is to investigate perceived inflation gap persistence using actual data of professional forecasts. We derive the unobserved perceived inflation gap persistence and using a state dependent model we estimate the non-linear persistence coefficient of inflation gap. Our main result is that for GDP deflator inflation, the estimates of persistence largely confirm the results obtained indirectly using a linear model. However, when we look at CPI inflation, we find that there is strong evidence for state-dependence and time variation.
Keywords: Perceived Inflation Gaps; Professional’s Survey-based Forecasts; State-Dependent Models
JEL Classification: E31; E52; E58

Effrosyni Adamopoulou and Ezgi Kaya (September 2015)
Young Adults Living with their Parents and the Influence of Peers (528K, 38 pages)
This paper focuses on young adults living with their parents in the U.S. and studies the role of peers. Using data from the National Longitudinal Study of Adolescent Health (Add Health) we analyze the influence of high school friends on the nest-leaving decision of young adults. We achieve identification by exploiting the differences in the timing of leaving the parental home among peers, the individual-specific nature of the peer groups that are based on friendship nominations, and by including school (net-work) and grade (cohort) fixed effects. Our results indicate that there are statistically significant peer effects on the decision of young adults to leave parental home. This is true even after we control for labor and housing market conditions and for a comprehensive list of individual and family-of-origin characteristics that are usually unobserved by the econometrician. We discuss various mechanisms and we confirm the robustness of our results through a placebo exercise. Our findings reconcile with the increasing trend of young adults living with their parents that has been observed in the US during the last 50 years.
Keywords: peer effects; friends; living arrangements; leaving parental home
JEL Classification: D10; J12; J60; Z13

Marina Kryukova and Laurence Copeland (August 2015)
The CDS-bond basis puzzle in the financial sector (2714K, 59 pages)

Hans Degryse, Kent Matthews and Tianshu Zhao (August 2015)
SMEs and access to bank credit: Evidence on the regional propagation of the financial crisis in the UK (935K, 56 pages)
We study the sensitivity of banks’ credit supply to small and medium size enterprises (SMEs) in the UK to banks’ financial condition before and during the financial crisis. Employing unique data on the geographical location of all bank branches in the UK, we connect firms’ access to bank credit to the financial condition (i.e., bank health and the use of core deposits) of all bank branches in the vicinity of the firm over the period 2004-2011. Before the crisis, banks’ local financial conditions did not influence credit availability irrespective of the functional distance (i.e., the distance between bank branch and bank headquarters). However, during the crisis, we find that SMEs with in their vicinity banks that have stronger financial condition face greater credit availability when the functional distance is low. Our results point to a “flight to headquarters” effect during the financial crisis.
Keywords: financial crisis; credit supply; flight to headquarters; flight to quality; bank organization
JEL Classification: G21; G290; L140

Vo Phuong Mai Le, David Meenagh, Patrick Minford, Michael Wickens and Yongdeng Xu (July 2015)
Testing macro models by indirect inference: a survey for users (2545K, 29 pages)
With Monte Carlo experiments on models in widespread use we examine the performance of indirect inference (II) tests of DSGE models in small samples. We compare these tests with ones based on direct inference (using the Likelihood Ratio, LR). We find that both tests have power so that a substantially false model will tend to be rejected by both,but that the power of the II test is substantially greater, both because the LR is applied after reestimation of the model error processes and because the II test uses the false model’s own restricted distribution for the auxiliary model’s coefficients. This greater power allows users to focus this test more narrowly on features of interest, trading off power against tractability.
Keywords: Bootstrap; DSGE; New Keynesian; New Classical; indirect inference; Wald statistic; likelihood ratio
JEL Classification: C12; C32; C52; E1

David Meenagh, Patrick Minford, Michael Wickens and Yongdeng Xu (July 2015)
Comparing Indirect Inference and Likelihood testing: asymptotic and small sample results (367K, 18 pages)
Indirect Inference has been found to have much greater power than the Likelihood Ratio in small samples for testing DSGE models. We look at asymptotic and large sample properties of these tests to understand why this might be the case. We find that the power of the LR test is undermined when reestimation of the error parameters is permitted,this offsets the effect of the falseness of structural parameters on the overall forecast error. Even when the two tests are done on a like-for-like basis Indirect Inference has more power because it uses the distribution restricted by the DSGE model being tested.
Keywords: Indirect Inference;Likelihood Ratio;DSGE model;structural parameters;error processes
JEL Classification: C12; C32; C52; E1

Chirantan Ganguly and Indrajit Ray (June 2015)
Information-Revelation and Coordination Using Cheap Talk in a Game with Two-Sided Private Information (359K, 19 pages)
We consider a Bayesian game, namely the Battle of the Sexes with private information, in which each player has two types, High and Low. We allow cheap talk regarding players’ types before the game and prove that the unique fully revealing symmetric cheap talk equilibrium exists for a low range of prior probability of the High-type. This equilibrium has a desirable type-coordination property: it fully coordinates on the ex-post efficient pure Nash equilibrium when the players’ types are different. Type-coordination is also obtained in a partially revealing equilibrium in which only the High-type is not truthful, for a medium range of prior probability of the High-type.
Keywords: Battle of the Sexes; Private Information; Cheap Talk; Coordination; Full Revelation
JEL Classification: C72

Nasir Aminu (June 2015)
An estimation of DSGE model of Energy in the United Kingdom using indirect inference testing
This paper has been removed for revision.

Hans Degryse, Kent Matthews and Tianshu Zhao (June 2015)
SMEs and access to bank credit: Evidence on the regional propagation of the financial crisis in the UK (927K, 56 pages)
We study the sensitivity of banks’ credit supply to small and medium size enterprises (SMEs) in the UK to banks’ financial condition before and during the financial crisis. Employing unique data on the geographical location of all bank branches in the UK, we connect firms’ access to bank credit to the financial condition (i.e., bank health and the use of core deposits) of all bank branches in the vicinity of the firm over the period 2004-2011. Before the crisis, banks’ local financial conditions did not influence credit availability irrespective of the functional distance (i.e., the distance between bank branch and bank headquarters). However, during the crisis, we find that SMEs with in their vicinity banks that have stronger financial condition face greater credit availability when the functional distance is low. Our results point to a “flight to headquarters” effect during the financial crisis.
Keywords: financial crisis; credit supply; flight to headquarters; flight to quality; bank organization
JEL Classification: G21; G290; L140;

Iain W. Long and Vito Polito (June 2015)
Cash-in-Hand, Benefit Fraud and Unemployment Insurance (444K, 18 pages)
Recent evidence questions the nature of the re-employment spike as unemployment insurance (UI) payments expire. Unemployed agents do not appear to devote more time to search and are observed leaving the UI scheme early without necessarily entering employment. We show that benefit fraud is consistent with both observations. Over time, UI recipients become increasingly willing to accept short-term cash-in-hand work. This takes them away from job search. Immediately before UI expiry, the risk of punishment for fraud exceeds the value of remaining payments. Recipients may voluntarily leave the scheme to accept cash-in-hand opportunities.
Keywords: Cash-in-hand; Benefit fraud; Unemployment insurance; Re-employment spike
JEL Classification: J46; J64; J65; K42

Samuli Leppälä (February 2015)
Innovation, R&D spillovers, and the variety and concentration of the local production structure (425K, 28 pages)
This paper presents a Cournot oligopoly model with R&D spillovers both within and across industries. The aim is to provide an appropriate theoretical foundation for three different hypotheses regarding the impact of the local production structure on innovation and output, as well as addressing mixed empirical results in this area. Both the effective R&D and total industry output are shown to increase with the variety of industries, which is aligned with Jacobs externalities. With respect to the concentration, the outcome is more ambiguous, where it depends on the variety, both spillover rates, and the R&D efficiency. If the variety is limited, then partial support is given to both Marshall-Arrow-Romer externalities in the case of effective R&D, and to Porter externalities in the case of the total industry output. The use of a relative rather than an absolute measure of variety is also shown to be important.
Keywords: concentration; innovation; knowledge spillover; regional economy; variety
JEL Classification: O33; R11; L13

Vo Phuong Mai Le, David Meenagh, Patrick Minford and Michael Wickens (January 2015)
Small sample performance of indirect inference on DSGE models (796K, 41 pages)
Using Monte Carlo experiments, we examine the performance of indirect inference tests of DSGE models in small samples, using various models in widespread use. We compare these with tests based on direct inference (using the Likelihood Ratio). We find that both tests have power so that a substantially false model will tend to be rejected by both,but that the power of the indirect inference test is by far the greater, necessitating re-estimation to ensure that the model is tested in its fullest sense. We also find that the small-sample bias with indirect estimation is around half of that with maximum likelihood estimation.
Keywords: Bootstrap; DSGE; Indirect Inference; Likelihood Ratio; New Classical; New Keynesian; Wald statistic
JEL Classification: C12; C32; C52; E1

Vo Phuong Mai Le, Kent Matthews, David Meenagh, Patrick Minford and Zhiguo Xiao (January 2015)
China’s financial crisis – the role of banks and monetary policy (654K, 64 pages)
This paper develops a model of the Chinese economy using a DSGE framework that accommodates a banking sector and money. The model is used to shed light on the period of the recent period of financial crisis. It differs from other applications in the use of indirect inference to estimate and test the fitted model. We find that the main shocks that hit China in the crisis were international and that domestic banking shocks were unimportant. Officially mandated bank lending and government spending were used to supplement monetary policy to aggressively offset shocks to demand. An analysis of the frequency of crises shows that crises occur on average about every half-century, with about a third accompanied by financial crises. We find that monetary policy can be used more vigorously to stabilise the economy, making direct banking controls and fiscal activism unnecessary.
Keywords: DSGE model; Financial Frictions; China; Crises; Indirect Inference; Money; Credit
JEL Classification: E3; E44; E52; C1

Herve Moulin, Indrajit Ray and Sonali Sen Gupta (December 2014)
Coarse Correlated Equilibria in an Abatement Game (398K, 18 pages)
We consider the well-analyzed abatement game (Barrett 1994) and prove that correlation among the players (nations) can strictly improve upon the Nash equilibrium payoffs. As these games are potential games, correlated equilibrium — CE — (Aumann 1974, 1987) cannot improve upon Nash,however we prove that coarse correlated equilibria — CCE — (Moulin and Vial 1978) may do so. We compute the largest feasible total utility and hence the efficiency gain in any CCE in those games: it is achieved by a lottery over only two pure strategy profiles.
Keywords: Abatement game; Coarse correlated equilibrium; Efficiency gain
JEL Classification: C72; Q52

Ezgi Kaya (November 2014)
Gender Wage Gap Trends in Europe: The Role of Occupational Allocation and Skill Prices (482K, 59 pages)
In this paper, we explore the recent gender wage gap trends in a sample of European countries with a new approach that uses the direct measures of skill requirements of jobs held by men and women. We find that, during the 1990s and 2000s, the gender wage gap declined in the majority of the European countries. Similar to the U.S. experience, a part of this decline is explained by changes in returns to brain and brawn skills in Austria and in the U.K. However, in contrast to the U.S. experience, the changes in returns to brain and brawn skills had a widening effect on the gender wage gap in Southern European countries and in Ireland?. Furthermore, we find that a substantial part of the changes in the gender wage gaps in European countries and in the U.S. cannot be explained by the changes in brain and brawn skill prices. The findings of this study suggest the importance of changes in labor market institutions in explaining the gender wage gap trends.
Keywords: Gender wage gap; brain skills; brawn skills; decomposition
JEL Classification: J16; J24; J31; J71

Vo Phuong Mai Le, David Meenagh and Patrick Minford (October 2014)
Monetarism rides again? US monetary policy in a world of Quantitative Easing (578K, 47 pages)
This paper gives money a role in providing cheap collateral in a model of banking,besides the Taylor Rule, monetary policy can affect the risk-premium on bank lending to firms by varying the supply of M0, so at the zero bound monetary policy is effective,fiscal policy crowds out investment via the risk-premium. A rule for making M0 respond to credit conditions can enhance the economy’s stability. Both price-level and nominal GDP targeting rules for interest rates combined with this stabilise the economy further. With these rules for monetary control, aggressive and distortionary regulation of banks’ balance sheets becomes redundant.
Keywords: DSGE model; Financial Frictions; Crises; Indirect Inference; money supply; QE; monetary policy; fiscal multiplier; zero bound
JEL Classification: E3; E44; E52; C1

Joshy Easaw and Roberto Golinelli (October 2014)
Inflation Expectations and the Two Forms of Inattentiveness (871K, 42 pages)
The purpose of the present paper is to investigate the structure and dynamics of professionals' forecast of inflation. Recent papers have focused on their forecast errors and how they may be affected by informational rigidities, or inattentiveness. In this paper we extend the existing literature by considering a second form of inattentiveness. While showing that both types of inattentiveness are closely related, we focus on the inattentiveness that forecasters face when undertaking multi-period forecast and, thereby, the expected momentum of inflation. Using number survey-based data for the US and UK, we establish a new structure for the professional's forecast error with direct implications for the persistence of real effects
Keywords: Expectations; Information Rigidity; Survey Forecasts
JEL Classification: E3; E4; E5

Jingwen Fan, Patrick Minford and Zhirong Ou (October 2014)
The role of Fiscal policy in Britain’s Great Inflation (558K, 34 pages)
We investigate whether the Fiscal Theory of the Price Level (FTPL) can explain UK inflation in the 1970s. We confront the identification problem involved by setting up the FTPL as a structural model for the episode and pitting it against an alternative Orthodox model,the models have a reduced form that is common in form but, because each model is over-identified, numerically distinct. We use indirect inference to test which model could be generating the VECM approximation to the reduced form that we estimate on the data for the episode. Neither model is rejected, though the Orthodox model outperforms the FTPL. But the best account of the period assumes that expectations were a probability-weighted combination of the two regimes. Fiscal policy has a substantial role in this weighted model. A similar model accounts for the 1980s though the role of fiscal policy gets smaller.
Keywords: UK Inflation; Fiscal Theory of the Price Level; Identification; Testing; Indirect inference
JEL Classification: E31; E37; E62; E65

Iain W. Long (October 2014)
Better Feared than Loved: Reputations and the Motives for Conflict (487K, 33 pages)
Throughout history, victory in conflict has created fearsome reputations. With it, the victor ensures greater allegiance of the wider population, increasing their rents at the expense of their enemy. Such reputational concerns generate two motives for conflict. When only victory or defeat is informative, the less scary party may attack to show that they are tougher than expected. If the occurrence of conflict also conveys information, the scarier party is more likely to attack. By failing to do so, the population would perceive them as weak and switch loyalties anyway. In this case, conflict arises to save face.
Keywords: Conflict;Reputations
JEL Classification: D74; C73; D83; F51; H56

Ezgi Kaya (October 2014)
Heterogeneous Couples, Household Interactions and Labor Supply Elasticities of Married Women (585K, 61 pages)
This paper estimates labor supply elasticities of married men and women allowing for heterogeneity among couples (in educational attainments of husbands and wives) and explicitly modeling how household members interact and make labor supply decisions. We find that the labor supply decisions of husbands and wives are interdependent unless both spouses are highly educated (college or above). Couples with high education, the labor supply decisions of husband and wife are jointly determined only if they have pre-school age children. We also find that labor supply elasticities differ greatly between households. The participation own-wage elasticity is largest (0.77) for women with low education married to men with low education, and smallest (0.03) for women with high education married to men with low education. The participation own-wage elasticities for women with low education married to highly educated men and for women with high education married to highly educated men are similar and fall between these two extremes (about 0.30 for each). For all types of couples, participation non-labor family income elasticity is small. We also find that participation cross-wage elasticities for married women are relatively small (less than -0.05) if they are married to men with low education and larger (-0.37) if they are married to highly educated men. Allowing for heterogeneity across couples yields an overall participation wage elasticity of 0.56, a cross wage elasticity of -0.13 and an income elasticity of -0.006 for married women. The analysis in this paper provides a natural framework to study how changes in educational attainments and household structure affect aggregate labor supply elasticities.
Keywords: Labor supply elasticity; household labor supply; household interactions; educational homogamy
JEL Classification: J22; D10; C30

Wei Yin and Kent Matthews (September 2014)
Why do firms switch banks? Evidence from China (543K, 25 pages)
This paper uses a sample of matched data of firms-banks in China over the period 1999-2012 to determine the drivers of firms switching behaviour from one bank relationship to another. The findings conform to the extant literature and therefore indicate that the switching behaviour of Chinese firms is no different to firms elsewhere. The results show that the principal driver of a switching action is the credit needs of the firm and a mixture of firm and bank characteristics. The findings support the extant literature that less opaque firms are able to switch more readily than opaque firms. The results also suggest that banks that develop there fee income services are more effective in locking-in their borrowers.
Keywords: Switching behaviour; Chinese firms; Chinese banks
JEL Classification: G21; L22

Michael G Arghyrou (September 2014)
Is Greece turning the corner? A theory-based assessment of recent Greek macro-policy (854K, 44 pages)
We use a macro-theory framework of analysis to assess Greek economic policy, with emphasis on the current period of the Greek debt crisis. We argue that this is mainly the result of misguided past internal policies deviating substantially from the policy lessons of modern macroeconomics. The current policy, however, is consistent with mainstream macro and provides a credible platform for achieving sustainable growth. We argue that Greece has entered the process of economic recovery, but this is still fragile and exposed to risks. Overall, we support the continued participation of Greece to the euro: Although a country’s currency is not per se a determinant of long-term economic prosperity, supply-side reforms and institutional performance are,and both these objectives are better served for Greece within the EMU rather than outside.
Keywords: Macroeconomics; Greece; euro
JEL Classification: B22; E00; F4;

Helmuts Azacis and David R. Collie (September 2014)
Taxation and the Sustainability of Collusion: Ad Valorem versus Specific Taxes (366K, 27 pages)
Assuming constant marginal cost, it is shown that a switch from specific to ad valorem taxation has no effect on the critical discount factor required to sustain collusion. This result is shown to hold for Cournot oligopoly as well as for Bertrand oligopoly when collusion is sustained with Nash-reversion strategies or optimal-punishment strategies. In a Cournot duopoly model with linear demand and quadratic costs, it is shown that the critical discount factor is lower with an ad valorem tax than with a specific tax. However, in contrast to Colombo and Labrecciosa (2013), it is shown that revenue is always higher with an ad valorem tax than with a specific tax.
Keywords: Taxes; Imperfect Competition; Oligopoly; Cartel; Supergame
JEL Classification: H21; H22; L13; L41; C72; C73

Kul B Luintel, Sheikh Selim and Pushkar Bajracharya (August 2014)
Reforms, Incentives and Banking Sector Productivity: A Case of Nepal (578K, 41 pages)
We model banks as profit-cum-utility maximizing firms and study, inter alia, bankers’ incentives (optimal effort) and incentive driven productivity following deregulations. Our model puts to test a panel of Nepalese commercial banks which went through deep financial reforms in the recent past. We find that (i) bankers’ efforts and productivity have notably improved in Nepal, (ii) bankers’ efforts significantly explain the banking sector’s productivity, (iii) the proportion of non-performing loans has considerably declined, and (iv) banking services have become costly, although the bank spread has moderately declined. Our approach is different from the widely used data envelopment analysis (DEA) of bank productivity, hence complements the literature. It also informs the current policy debate in Nepal where the Central Bank is seen to be geared towards regulating the financial system and micro-managing the banking institutions.
Keywords: Reforms; incentives; productivity; panel integration; cointegration; simulation
JEL Classification: G21; G28; O43; O53

Wei Yin and Kent Matthews (July 2014)
The determinants and profitability of switching costs in Chinese banking (672K, 33 pages)
Using a sample of 151 banks over the period 2003 to 2010, this paper estimates a model that examines the effect of switching costs in the Chinese loan market on banking profitability. In keeping with the extant empirical literature it reports a positive relationship between bank profitability and switching costs. Furthermore it reports the estimation of a systems model of switching costs and profitability. The main result is that bank size measured by total assets is has a complex relationship with switching costs. Competition between small banks creates the incentive for lock-in and increased switching costs whereas very large banks are less exercised by lock-in and switching costs. The study also finds that concentration has a negative relationship with switching costs and profitability, confirming the accepted view that the large state-owned banks are concerned with social as well as profit objectives.
Keywords: Chinese banking; switching costs; bank profitability
JEL Classification: G21; C51; L14

Yan Yang and Laurence Copeland (July 2014)
The Effects of Sentiment on Market Return and Volatility and The Cross-Sectional Risk Premium of Sentiment-affected Volatility (1096K, 33 pages)
We construct investor sentiment of UK stock market using the procedure of principal component analysis. Using sentiment-augmented EGARCH component model, we analyse the impacts of sentiment on market excess return, the permanent component of market volatility and the transitory component of market volatility. Bullish sentiment leads to higher market excess return while bearish sentiment leads to lower excess return. Sentiment-augmented EGARCH component model compares favourably to the original EGARCH component model which does not take investor sentiment into account. Furthermore, we test the cross-sectional risk premia of the permanent and transitory components of sentiment-affected volatility in the framework of ICAPM.
Keywords: investor sentiment; principal component analysis; EGARCH component model; ICAPM; cross-sectional risk premium
JEL Classification: G12; G15

Patrick Minford, Yongdeng Xu and Peng Zhou (July 2014)
How good are out of sample forecasting Tests on DSGE models? (374K, 24 pages)
Out-of-sample forecasting tests of DSGE models against time-series benchmarks such as an unrestricted VAR are increasingly used to check a) the specification b) the forecasting capacity of these models. We carry out a Monte Carlo experiment on a widely-used DSGE model to investigate the power of these tests. We find that in specification testing they have weak power relative to an in-sample indirect inference test,this implies that a DSGE model may be badly mis-specified and still improve forecasts from an unrestricted VAR. In testing forecasting capacity they also have quite weak power, particularly on the lefthand tail. By contrast a model that passes an indirect inference test of specification will almost definitely also improve on VAR forecasts.
Keywords: Out of sample forecasts; DSGE; VAR; specification tests; indirect inference; forecast performance
JEL Classification: E10; E17

Samuli Leppälä (July 2014)
Theoretical Perspectives on Localised Knowledge Spillovers and Agglomeration (402K, 17 pages)
There is substantial empirical evidence that innovation is geographically concentrated. Unlike what is generally assumed, however, it is not clear that localised knowledge spillovers provide a theoretically valid explanation for this. Studying spillovers of cost-reducing technology between Cournot oligopolists we show that 1) localised knowledge spillovers of any level do encourage agglomeration, but 2) whether this leads to higher levels of effective R&D depends on the type and level of knowledge spillovers, the number of firms, and the industry's R&D efficiency.
Keywords: knowledge spillovers; agglomeration economies; innovation; location
JEL Classification: O33; R32; L13

Iain W. Long and Vito Polito (July 2014)
Unemployment, Crime and Social Insurance (678K, 38 pages)
We study an individual's incentive to search for a job in the presence of random criminal opportunities. These opportunities extenuate moral hazard, as the individual sometimes commits crime rather than searching. Even when he searches, he applies less effort. We then revisit the design of optimal unemployment insurance in this environment. If the individual is more likely to remain unemployed and unpunished when he commits crime than when he searches for a job (as suggested by empirical studies), declining unemployment benefits reduce the payoff from crime relative to that from searching. Compared to the canonical models of optimal unemployment insurance, this provides a further incentive to reduce benefits over time.
Keywords: Unemployment insurance;Moral hazard;Crime;Recursive contracts
JEL Classification: C61; D82; H55; J65; K42

Iain W. Long (July 2014)
The Storm Before the Calm? Adverse Effects of Tackling Organised Crime (498K, 30 pages)
Policies targeted at high-crime neighbourhoods may have unintended consequences in the presence of organised crime. Whilst they reduce the incentive to commit crime at the margin, those who still choose to join the criminal organisation are hardened criminals. Large organisations take advantage of this, substituting away from membership size towards increased individual criminal activity. Aggregate crime may rise. However, as more would-be recruits move into the formal labour market, falling revenue causes a reversal of this effect. Thereafter, the policy reduces both size and individual activity simultaneously.
Keywords: Organised crime;crime policy;occupational choice
JEL Classification: D82; J24; J28; K42; L21

Huw David Dixon, Kul B Luintel and Kun Tian (June 2014)
The impact of the 2008 crisis on UK prices: what we can learn from the CPI microdata (968K, 76 pages)
This paper takes the locally collected price-quotes used to construct the CPI index in the UK for the period 1996-2013 to explore the impact of the crisis on the pricing behavior of firms. We develop a time-series framework which is able to capture the link between macro- economic variables (in?ation and output) and the behavior of prices in terms of the frequency of price change, the dispersion of price levels and the dispersion of price-growth. Whilst these effects are present, they are small and do not have significant effects for monetary policy.
Keywords: Price-spell; steady state; duration
JEL Classification: E50

James Foreman-Peck and Peng Zhou (June 2014)
Firm-Level Evidence for the Language Investment Effect on SME Exporters (790K, 38 pages)
Both analysis of international trade and the knowledge resource theory of the firm imply that language skills should play a vital role in exporting. This may be apparent to large multinationals with sites in many different linguistic locations, but we show it is less obvious to smaller companies. With data on the language used by each of a large sample of European small and medium sized enterprises in their export markets we test and estimate the effects of language assets on language performance in export markets and on export sales. Controlling for the possibility that language skills may be acquired by exporting, we find a very substantial export return to linguistic expertise, indicative of unexploited gains from investment in languages. There is also evidence of greater under-investment in language skills in English-speaking Europe, which we show can be a prediction of Konya’s (2006) trade model.
Keywords: Internationalisation; language skills; SMEs
JEL Classification: D22; F13; H52; R42

Jesus Lopez-Rodriguez and Diego Martinez (June 2014)
Looking beyond the R&D effects on innovation: The contribution of non-R&D activities to total factor productivity growth in the EU (274K, 29 pages)
Although non-R&D innovation activities account for a significant portion of innovation efforts carried out across very heterogeneous economies in Europe, how to incorporate them in to economic models is not always straightforward. For instance, the traditional macro approach to estimating the determinants of total factor productivity (TFP) does not handle them well. To counter these problems, this paper proposes applying an augmented macro-theoretical model to estimate the determinants of TFP by jointly considering the effects of R&D and the impact of non-R&D innovation activities on the productivity levels of firms. Estimations from a model of a sample of EU-26 countries covering the period 2004-2008 show that the distinction between R&D and non-R&D effects is significant for a number of different issues. First, the results show a sizeable impact on TFP growth, as the impact of R&D is twice that of non-R&D. Second, absorptive capacity is only linked to R&D endowments. And third, the two types of endowments cannot strictly been seen as complementary, at least for the case of countries with high R&D intensities or high non-R&D intensities.
Keywords: TFP; R&D; non-R&D expenditures; EU countries
JEL Classification: O0; O3; O4

Li Dai, Patrick Minford and Peng Zhou (May 2014)
A DSGE Model of China (743K, 32 pages)
We use available methods for testing macro models to evaluate a model of China over the period from Deng Xiaoping’s reforms up until the crisis period. Bayesian ranking methods are heavily influenced by controversial priors on the degree of price/wage rigidity. When the overall models are tested by Likelihood or Indirect Inference methods, the New Keynesian model is rejected in favour of one with a fair-sized competitive product market sector. This model behaves quite a lot more ‘flexibly’ than the New Keynesian.
Keywords: China; DSGE; Bayesian Inference; Indirect Inference
JEL Classification: C11; C15; C18; E27

James Foreman-Peck and Peng Zhou (April 2014)
The Rise of the English Economy 1300-1900: A Lasting Response to Demographic Shocks (2152K, 39 pages)
We construct a Dynamic Stochastic General Equilibrium model of the interaction between demography and the economy for six centuries of English history. At the core of the four overlapping generations, rational expectations model is household choice about target number and quality of children, as well as female age at first marriage. The parameters are formally estimated rather than calibrated. Data on births, deaths, population and the real wage, and data moments can be closely matched by the estimated model. We show that the marriage age rises to reach that typical of the Western European Marriage Pattern at the end of the high mortality epoch of the 14th century. Higher marriage age lowers costs of child quality so that human capital gradually accumulates over the generations. But it does so more slowly than that of population initially, so that there is a negative correlation between population and wage. Ultimately the growth of human capital catches up with that of population and triggers a break out from the Malthusian equilibrium at the end of the 18th century. Without the contribution of late female age to human capital, human capital would have been about 20% of what it actually was around 1800, and real wages would only have attained about half their actual value.
Keywords: Economic development; Demography; DGSE model; English economy
JEL Classification: O11; J11; N13

Charlotte Pointon and Kent Matthews (April 2014, updated November 2014)
Dynamic Efficiency in the English and Welsh Water and Sewerage Industry (745K, 34 pages)
The English and Welsh water and sewerage industry is characterised by indivisible capital which has a long service life. Previous studies of efficiency for the English and Welsh water and sewerage industry take a static framework, assuming all inputs can be adjusted instantaneously. This paper measures dynamic efficiency by incorporating intertemporal links of capital within the production function for the English and Welsh water and sewerage industry for the period 1997–2011. Dynamic Data Envelopment Analysis (DEA) considers capital as a quasi-fixed input and is modelled as a contemporaneous output into current production and an input from past production. The results show that the inadequate intertemporal allocation of quasi-fixed inputs is the largest contributor of inefficiency.
Keywords: Dynamic efficiency; water and sewage industry; DEA; intertemporal allocation
JEL Classification: D24; L23; L31

James Foreman-Peck and Peng Zhou (January 2014)
Cultures of Female Entrepreneurship (996K, 30 pages)
The present research shows how entrepreneurial culture contributes to the widely noted difference in entrepreneurial propensities between men and women. The consequences of the assumed differential importance of household and family generate testable hypotheses about the gender effects of entrepreneurial culture. The principal hypothesis is that there is a greater chance of females in ‘unentrepreneurial’ cultures being relatively entrepreneurial compared to males. Also women from different entrepreneurial cultures show greater similarity of behaviour (lower variance) than men. But proportionate gender gaps within entrepreneurial cultures are less than those between males of different cultures. These hypotheses are tested on US immigrant data from the 2000 census and are not rejected.
Keywords: Entrepreneurship; Culture; Gender; Migrants
JEL Classification: D01; J15; J23; J61; J16

Michael C. Hatcher and Patrick Minford (December 2013)
Stabilization policy, rational expectations and price-level versus inflation targeting: a survey (450K, 37 pages)
We survey recent literature comparing inflation targeting (IT) and price-level targeting (PT) as macroeconomic stabilization policies. Our focus is on New Keynesian models and areas which have seen significant developments since Ambler’s (2009) survey: the zero lower bound on nominal interest rates,financial frictions,and optimal monetary policy. Ambler’s main conclusion that PT improves the inflation-output volatility trade-off in New Keynesian models is reasonably robust to these extensions, several of which are attempts to address issues raised by the recent financial crisis. The beneficial effects of PT therefore appear to hang on the joint assumption that agents are rational and the economy New Keynesian. Accordingly, we discuss recent experimental and survey evidence on whether expectations are rational, as well as the applied macro literature on the empirical performance of New Keynesian models. In addition, we discuss a more recent strand of applied literature that has formally tested New Keynesian models with rational expectations. Overall the evidence is not conclusive, but we note that New Keynesian models are able to match a number of dynamic features in the data and that behavioural models of the macroeconomy are outperformed by those with rational expectations in formal statistical tests. Accordingly, we argue that policymakers should continue to pay attention to PT.
JEL Classification: E52

Lorant Kaszab and Ales Marsal (November 2013)
Fiscal Policy and the Nominal Term Premium (299K, 14 pages)
Distortionary income taxation in a standard New Keynesian model substantially increases the nominal term-premium on long-term bonds relative to a model with lumpsum taxes. Also the empirical level of the nominal term premium can be matched with lower risk-aversion coefficient in case of a model with income taxes relative to a model with long-run inflation risks.
Keywords: zero-coupon bond; nominal term premium; third-order approximation; distortionary income taxation
JEL Classification: E13; E31; E43; E44; E62

Jingwen Fan, Patrick Minford and Zhirong Ou (November 2013)
The Fiscal Theory of the Price Level - identification and testing for the UK in the 1970s (575K, 33 pages)
We investigate whether the Fiscal Theory of the Price Level (FTPL) can explain UK inflation in the 1970s. We confront the identification problem involved by setting up the FTPL as a structural model for the episode and pitting it against an alternative Orthodox model,the models have a reduced form that is common in form but, because each model is over-identified, numerically distinct. We use indirect inference to test which model could be generating the VECM approximation to the reduced form that we estimate on the data for the episode. Neither model is rejected, though the Orthodox model outperforms the FTPL. But the best account of the period assumes that expectations were a probability-weighted combination of the two regimes.
Keywords: UK Inflation;Fiscal Theory of the Price Level;Identification;Testing;Indirect inference
JEL Classification: E31; E37; E62; E65

Laurence Copeland and Wenna Lu (November 2013, updated December 2013)
Dodging the Steamroller: Fundamentals versus the Carry Trade (675K, 41 pages)
Although, according to uncovered interest rate parity, exchange rates should move so as to prevent the carry trade being systematically profitable, there is a vast empirical literature demonstrating the opposite. High interest currencies more often tend to appreciate rather than depreciate, as noted by Fama (1983). In this paper, we treat volatility as the critical state variable and show that positive returns to the carry trade are overwhelmingly generated in the low-volatility "normal" state, whereas the high-volatility state is associated with lower returns or with losses as currencies revert to the long run level approximated by their mean real exchange rate – in other words, purchasing-power parity (PPP) tends to reassert itself, at least to some extent, during periods of turbulence. We confirm these results by comparing the returns from three possible monthly trading strategies: the carry trade, a strategy which is long the undervalued and short the overvalued currencies (the "fundamental" strategy) and a mixed strategy which involves switching from carry trade to fundamentals whenever volatility is in the top quartile. The mixed strategy generates positive returns greater than for either of the pure strategies.
Keywords: carry trade; trading strategies; currency portfolios
JEL Classification: F3; G21; G15

Iain W. Long (October 2013)
Recruitment to Organised Crime (697K, 41 pages)
Organised crime is unique within the underground economy. Unlike individual criminals, criminal organisations can substitute between a variety of inputs,chiefly labour and effort. This paper considers the effect of several popular anti-crime policies in such an environment. Using a profit maximisation framework, I find that certain policies may cause the organisation to reduce its membership in favour of more intensive activity. Others may lead to increases in membership. Consequently, policies designed to reduce the social loss suffered as a result of criminal activities may actually increase it. Results prove robust to differences in hiring practices on the part of the criminal organisation.
Keywords: Organised crime; Crime policy; Occupational choice
JEL Classification: J24; J28; K42

David R. Collie and George Norman (September 2013)
Partial Collusion and Foreign Direct Investment (950K, 25 pages)
We show that the static duopoly model in which firms choose between exporting and foreign direct investment is often a prisoners' dilemma game in which a switch from exporting to foreign direct investment reduces profits. By contrast, we show that when the game is repeated there is a range of parameters for which the firms can partially collude by choosing to export rather than invest. In this range, a reduction in export costs may undermine the partial collusion, causing a switch from export to investment.
Keywords: Foreign Direct Investment;Trade Liberalization;Partial Collusion
JEL Classification: F12; F13; F23

Vo Phuong Mai Le and David Meenagh (June 2013)
Testing and Estimating Models Using Indirect Inference (278K, 4 pages)
In this short article we explain how to test an economic model using Indirect Inference. We then go on to show how you can use this test to estimate the model.
JEL Classification: C01; C13; C52; E27

Yongdeng Xu (April 2013)
The dynamics of trading duration, volume and price volatility – a vector MEM model (4269K, 41 pages)
We propose a general form of vector Multiplicative Error Model (MEM) for the dynamics of duration, volume and price volatility. The vector MEM relaxes the two restrictions often imposed by previous empirical work in market microstructure research, by allowing interdependence among the variables and relaxing weak exogeneity restrictions. We further propose a multivariate lognormal distribution for the vector MEM. The model is applied to the trade and quote data from the New York Stock Exchange (NYSE). The empirical results show that the vector MEM captures the dynamics of the trivariate system successfully. We find that times of greater activity or trades with larger size coincide with a higher number of informed traders present in the market. But we highlight that it is unexpected component of trading duration or trading volume that carry the information content. Moreover, our empirical results also suggest a significant feedback effect from price process to trading intensity, while the persistent quote changes and transient quote changes affect trading intensity in different direction, confirming Hasbrouck (1988,1991).
Keywords: Vector MEM; ACD; GARCH; intraday trading process; duration; volume; volatility
JEL Classification: C15; C32; C52

Yongdeng Xu (April 2013)
Weak exogeneity in the financial point processes (535K, 33 pages)
This paper analyses issues related to weak exogeneity in a financial point process. We extend the Hausman test of weak exogeneity in a time series model and propose three cases in which weak exogeneity conditions will break down. The simulation study suggested that a failure of the exogeneity assumption implied biased estimators. The bias is very large in the third case non-weak exogeneity, which makes the econometric inferences on the parameters unreliable or even misleading. We then derive an LM test for weak exogeneity. The LM test is attractive because it only requires estimation of the restricted model. The empirical results indicate that the weak exogneity of duration is often rejected for frequently traded stocks, but is less likely to be rejected for infrequently traded stocks.
Keywords: Weak exogeneity; ACD model; LM test; point process; market microstructure

Vo Phuong Mai Le, Kent Matthews, David Meenagh, Patrick Minford and Zhigui Xiao (April 2013)
Banking and the Macroeconomy in China: A Banking Crisis Deferred? (656K, 34 pages)
The downturn in the world economy following the global banking crisis has left the Chinese economy relatively unscathed. This paper develops a model of the Chinese economy using a DSGE framework with a banking sector to shed light on this episode. It differs from other applications in the use of indirect inference procedure to test the ?tted model. The model finds that the main shocks hitting China in the crisis were international and that domestic banking shocks were unimportant. However, directed bank lending and direct government spending was used to supplement monetary policy to aggressively offset shocks to demand. The model finds that government expenditure feedback reduces the frequency of a business cycle crisis but that any feedback effect on investment creates excess capacity and instability in output.
Keywords: DSGE model;Financial Frictions;China;Crises;Indirect Inference
JEL Classification: E3; E44; E52; C1

Vo Phuong Mai Le, Patrick Minford and Michael Wickens (March 2013)
A Monte Carlo procedure for checking identification in DSGE models (413K, 20 pages)
We propose a numerical method, based on indirect inference, for checking the identification of a DSGE model. Monte Carlo samples are generated from the model's true structural parameters and a VAR approximation to the reduced form estimated for each sample. We then search for a different set of structural parameters that could potentially also generate these VAR parameters. If we can find such a set, the model is not identified.
Keywords: Identification;DSGE model;Monte Carlo;Indirect Inference
JEL Classification: C13; C51; C52; E32

Vo Phuong Mai Le, David Meenagh, Patrick Minford and Zhirong Ou (March 2013, updated May 2013)
What causes banking crises? An empirical investigation for the world economy (1312K, 35 pages)
We add the Bernanke-Gertler-Gilchrist model to a world model consisting of the US, the Eurozone and the Rest of the World in order to explore the causes of the banking crisis. We test the model against linear-detrended data and reestimate it by indirect inference,the resulting model passes the Wald test only on outputs in the two countries. We then extract the model's implied residuals on unfiltered data to replicate how the model predicts the crisis. Banking shocks worsen the crisis but 'traditional' shocks explain the bulk of the crisis,the non-stationarity of the productivity shocks plays a key role. Crises occur when there is a 'run' of bad shocks,based on this sample Great Recessions occur on average once every quarter century. Financial shocks on their own, even when extreme, do not cause crises - provided the government acts swiftly to counteract such a shock as happened in this sample.
Keywords: DSGE model; Financial Frictions;China; Crises; Indirect Inference
JEL Classification: E3; E44; E52; C1

Samuli Leppälä (February 2013)
Arrow's paradox and markets for nonproprietary information (1413K, 27 pages)
Arrow's information paradox asserts that demand for undisclosed information is undefined. Reassessing the paradox, I argue that the value of information for the buyer depends on its relevance, which can be known ex ante, and the uncertainty shifts to the capability of the seller to acquire the knowledge and her reliability in disclosing it. These three together form the buyer’s reservation price. Consequently, differences in capability and reliability between the sellers may revoke the appropriation problem of nonproprietary information, where the original source loses her monopoly after the first purchase.
Keywords: Arrow’s information paradox; markets for information; knowledge; reliability; appropriability
JEL Classification: D83; L15; O31; O34

Huw David Dixon and Kun Tian (January 2013)
What we can learn about the behavior of firms from the average monthly frequency of price-changes: an application to the UK CPI data. (814K, 46 pages)
The monthly frequency of price-changes is a prominent feature of many studies of the CPI micro-data. In this paper, we see how much this ties down the behavior of price-setters ("firms") in steady-state in terms of the average length of price-spells across firms. We are able to divide an upper and lower bound for the mean duration of price-spells averaged across firms. We use the UK CPI data at the aggregate and sectoral level and find that the actual mean is about twice the theoretical minimum consistent with the observed frequency. We estimate the distribution using the hazard function and find that although the estimated hazard differs significantly from the Calvo distribution, the means and medians are similar. However, despite the micro differences, we find that the artificial Calvo distributions generated using the sectoral frequencies result in very similar impulse responses to the estimated hazards when used in the Smets-Wouters (2003) model.
Keywords: Price-spell; steady state; duration
JEL Classification: E50

Paulo Brito, Bipasa Datta and Huw David Dixon (December 2012)
The evolution of mixed conjectures in the rent-extraction game (4603K, 54 pages)
This paper adopts an evolutionary perspective on the rent-extraction model with conjectural variations (CV). We analyze the global dynamics of the model with three CVs under the replicator equation. We find that the end points of the evolutionary dynamics include the pure-strategy consistent CVs. However, there are also mixed-strategy equilibria that occur. These are on the boundaries between the basins of attraction of the pure-strategy sinks. We develop a more general notion of consistency which applies to mixed-strategy equilibria. In a three conjecture example, we find that in contrast to the pure-strategy equilibria, the mixed-strategy equilibria are not ESS: under the replicator dynamics, there are three or four mixed equilibria that may either be totally unstable, or saddle-stable. There also exist heteroclinic orbits that link equilibria together.
Keywords: Rent-extraction; evolutionary dynamics; consistent conjectures; global dynamics; mixed-strategy
JEL Classification: D03; L15; H0

Chunping Liu and Patrick Minford (August 2012, updated December 2013)
How important is the credit channel? An empirical study of the US banking crisis (1169K, 32 pages)
We examine whether by adding a credit channel to the standard New Keynesian model we can account better for the behaviour of US macroeconomic data up to and including the banking crisis. We use the method of indirect inference which evaluates statistically how far a model's simulated behaviour mimics the behaviour of the data. We find that the model with credit dominates the standard model by a substantial margin. Credit shocks are the main contributor to the variation in the output gap during the crisis.
Keywords: financial frictions; credit channel; bank crisis; indirect inference
JEL Classification: C12; C52; E12; G01; G1

Chunping Liu and Patrick Minford (August 2012)
Comparing behavioural and rational expectations for the US post-war economy (1059K, 19 pages)
The banking crisis has caused a resurgence of interest in behavioural models of expectations in macroeconomics. Here we evaluate behavioural and rational expectations econometrically in a New Keynesian framework, using US post-war data and the method of indirect inference. We find that after full re-estimation the model with behavioural expectations is strongly rejected by the data, whereas the standard rational expectations version passes the tests by a substantial margin.
Keywords: behavioural expectation; rational expectation; bank crisis; indirect inference

Ceri Davies, Max Gillman and Michal Kejak (August 2012)
Deriving the Taylor Principle when the Central Bank Supplies Money (1176K, 36 pages)
The paper presents a human-capital-based endogenous growth, cash-in-advance economy with endogenous velocity where exchange credit is produced in a decentralized banking sector, and money is supplied stochastically by the central bank. From this it derives an exact functional form for a general equilibrium “Taylor rule”. The inflation coefficient is always greater than one when the velocity of money exceeds one,velocity growth enters the equilibrium condition as a separate variable. The paper then successfully estimates the magnitude of the coefficient on inflation from 1000 samples of Monte Carlo simulated data. This shows that it would be spurious to conclude that the central bank has a reaction function with a strong response to inflation in a ‘Taylor principle’ sense, since it is only meeting fiscal needs through the inflation tax. The paper also estimates several deliberately misspecified models to show how an inflation coefficient of less than one can result from model misspecification. An inflation coefficient greater than one holds theoretically along the balanced growth path equilibrium, making it a sharply robust principle based on the economy’s underlying structural parameters.
Keywords: Taylor rule; velocity; forward-looking; misspecification bias
JEL Classification: E13; E31; E43; E52

Panagiotis Tziogkidis (August 2012, updated November 2012)
The Simar and Wilson’s Bootstrap DEA approach: a critique
This paper has been removed for revision
JEL Classification: C14; C15; C61; C67

Panagiotis Tziogkidis (August 2012)
Bootstrap DEA and Hypothesis Testing
This paper has been removed for revision
Keywords: Data Envelopment Analysis; Efficiency; Bootstrap; Bootstrap DEA; Hypothesis Testing
JEL Classification: C12; C14; C15; C61; C67

David Meenagh, Patrick Minford and Michael Wickens (July 2012)
Testing macroeconomic models by indirect inference on unfiltered data (1249K, 22 pages)
We extend the method of indirect inference testing to data that is not filtered and so may be non-stationary. We apply the method to an open economy real business cycle model on UK data. We review the method using a Monte Carlo experiment and find that it performs accurately and has good power.
Keywords: Bootstrap; DSGE; VECM; indirect inference; Monte Carlo
JEL Classification: C12; C32; C52; E1

Patrick Minford and Naveen Srinivasan (July 2012)
Can the learnability criterion ensure determinacy in New Keynesian Models? (1066K, 16 pages)
Forward-looking RE models such as the popular New Keynesian (NK) model do not provide a unique prediction about how the model economy behaves. We need some mechanism that ensures determinacy. McCallum (2011) says it is not needed because models are learnable only with the determinate solution and so the NK model, once learnt in this way, will be determinate. We agree: the only learnable solution that has agents converge on the true NK model is the bubble-free one. But once they have converged they must then understand the model and its full solution therefore including the bubble. Hence the learnability criterion still fails to pick a unique RE solution in NK models.
Keywords: New-Keynesian; Taylor Rule; Determinacy; E-stability; Learnability
JEL Classification: C62; D84

Vo Phuong Mai Le, David Meenagh, Patrick Minford and Michael Wickens (June 2012)
Testing DSGE models by Indirect inference and other methods: some Monte Carlo experiments (4321K, 35 pages)
Using Monte Carlo experiments, we examine the performance of Indirect Inference tests of DSGE models, usually versions of the Smets-Wouters New Keynesian model of the US postwar period. We compare these with tests based on direct inference (using the Likelihood Ratio), and on the Del Negro–Schorfheide DSGE–VAR weight. We ?nd that the power of all three tests is substantial so that a false model will tend to be rejected by all three,but that the power of the indirect inference tests are by far the greatest, necessitating re-estimation by indirect inference to ensure that the model is tested in its fullest sense.
Keywords: Bootstrap; DSGE; New Keynesian; New Classical; indirect inference; Wald statistic; likelihood ratio; DSGE-VAR weight
JEL Classification: C12; C32; C52; E1

Vo Phuong Mai Le, David Meenagh and Patrick Minford (June 2012, updated April 2013)
What causes banking crises? An empirical investigation (623K, 31 pages)
We add the Bernanke-Gertler-Gilchrist model to a modified version of the Smets-Wouters model of the US in order to explore the causes of the banking crisis. We test the model against the data on HP-detrended data and reestimate it by indirect inference,the resulting model passes the Wald test on output, inflation and interest rates. We then extract the model’s implied residuals on US unfiltered data since 1984 to replicate how the model predicts the crisis. The main banking shock tracks the unfolding ‘sub-prime’ shock, which appears to have been authored mainly by US government intervention. This shock worsens the banking crisis but ‘traditional’ shocks explain the bulk of the crisis,the non-stationarity of the productivity shock plays a key role. Crises occur when there is a ‘run’ of bad shocks,based on this sample they occur on average once every 40 years and when they occur around half are accompanied by financial crisis. Financial shocks on their own, even when extreme, do not cause crises — provided the government acts swiftly to counteract such a shock as happened in this sample.
Keywords: DSGE; Banking; Crisis; Bootstrap
JEL Classification: C32; C52; E1

Lorant Kaszab (June 2012, updated April 2013)
Rule-of-Thumb Consumers and Labor Tax Cut Policy in the Zero Lower Bound (1290K, 29 pages)
This paper finds that labor tax cut can be an effective policy tool to mitigate the negative effects of a shock that made the zero lower bound on the nominal interest rate binding if the economy features rule-of-thumb households (besides Ricardian ones) and nominal rigidities in prices and wages. Our results are meant to contribute to the discussion initiated by Eggertsson (2010a) who found labor tax cut policy destabilising under zero nominal interest rate in a New Keynesian economy consisting only Ricardian consumers.
Keywords: Fiscal policy; zero lower bound; labor tax cut; New Keynesian
JEL Classification: E52; E62

Max Gillman (May 2012)
AS-AD in the Standard Dynamic Neoclassical Model: Business Cycles and Growth Trends (583K, 41 pages)
The paper shows how a dynamic neoclassical AS-AD can be derived and used to describe business cycles and growth trends to undergraduates. Derived within the Ramsey-Cass-Koopmans (RCK) model, the AS-AD is the stationary equilibrium of the deterministic dynamic general equilibrium framework. Allowing Solow exogenous growth, the AS-AD is derived along the balanced growth path equilibrium. The derivation first builds consumption demand, aggregate demand, and then aggregate supply through the equilibrium conditions and a closed form solution for the capital stock. Through a comparative static change in goods sector productivity, the paper shows the basic failing of the standard RBC model. Allowing a second comparative static change in the consumer's time endowment, this captures a change in the "external margin" of labor supply. These comparative statics enable explanation of the business cycle, and "Solow-plus" growth trends including education time and working time. In extension of RCK, the paper shows beyond the undergraduate level, how to derive AS-AD when including human capital and endogenous growth. This allows an endogenous change in the time endowment for work and leisure through a change in human capital productivity, with a similar but more fundamental AS-AD story of business cycles and growth trends.
Keywords: Ramsey-Cass-Koopmans; supply; demand; state variable
JEL Classification: A22; A23; E13

Helmuts Azacis and Péter Vida (May 2012)
Collusive Communication Schemes in a First-Price Auction (1231K, 50 pages)
We study optimal bidder collusion at first-price auctions when the collusive mechanism only relies on signals about bidders’ valuations. We build on Fang and Morris (2006) when two bidders have low or high private valuation of a single object and additionally each receives a private noisy signal from an incentiveless center about the opponent’s valuation. We derive the unique symmetric equilibrium of the first price auction for any symmetric, possibly correlated, distribution of signals, when these can only take two values. Next, we find the distribution of 2-valued signals, which maximizes the joint payoffs of bidders. We prove that allowing signals to take more than two values will not increase bidders’ payoffs if the signals are restricted to be public. We also investigate the case when the signals are chosen conditionally independently and identically out of n = 2 possible values. We demonstrate that bidders are strictly better off as signals can take on more and more possible values. Finally, we look at another special case of the correlated signals, namely, when these are independent of the bidders’ valuations. We show that in any symmetric 2-valued strategy correlated equilibrium, the bidders bid as if there were no signals at all and, hence, are not able to collude.
Keywords: Bidder-optimal signal structure;Collusion; (Bayes) correlated equilibrium; First price auction; Public and private signals
JEL Classification: D44; D82

Péter Vida and Helmuts Azacis (May 2012)
A Detail-Free Mediator (1312K, 28 pages)
We present an extension to any finite complete information game with two players. In the extension, players are allowed to communicate directly and, additionally, send private messages to a simple, detail-free mediator, which, in turn, makes public announcements as a deterministic function of the private messages. The extension captures situations in which people engage in face-to-face communication and can observe the opponent's face during the conversation before choosing actions in some underlying game. We prove that the set of Nash equilibrium payoffs of the extended game approximately coincides with the set of correlated equilibrium payoffs of any underlying game.
Keywords: Correlated equilibrium; detail-free mechanism; mediated pre-play communication
JEL Classification: C72

Patrick Minford, Zhirong Ou and Michael Wickens (May 2012, updated April 2014)
Revisiting the Great Moderation: policy or luck? (484K, 43 pages)
We investigate the relative roles of monetary policy and shocks in causing the Great Moderation, using indirect inference where a DSGE model is tested for its ability to mimic a VAR describing the data. A New Keynesian model with a Taylor Rule and one with the Optimal Timeless Rule are both tested. The latter easily dominates, whether calibrated or estimated, implying that the Fed’s policy in the 1970s was neither inadequate nor a cause of indeterminacy,it was both optimal and essentially unchanged during the 1980s. By implication it was largely the reduced shocks that caused the Great Moderation – among them monetary policy shocks the Fed injected into inflation.
Keywords: Great Moderation;Causes;Indirect inference;Test;Wald statistics
JEL Classification: E42; E52; E58
See also: Supporting Annex

Huw David Dixon and Engin Kara (April 2012)
Taking Multi-Sector Dynamic General Equilibrium Models to the Data (1131K, 43 pages)
We estimate and compare two models, the Generalized Taylor Economy (GTE) and the Multiple Calvo model (MC), that have been built to model the distributions of contract lengths observed in the data. We compare the performances of these models to those of the standard models such as the Calvo and its popular variant, using the ad hoc device of indexation. The estimations are made with Bayesian techniques for the US data. The results indicate that the data strongly favour the GTE.
Keywords: DSGE models; Calvo; Taylor; price-setting
JEL Classification: E32; E52; E58

Paulo Brito and Huw David Dixon (April 2012)
Fiscal policy, entry and capital accumulation: hump-shaped responses (1928K, 48 pages)
In this paper we consider the entry and exit of firms in a Ramsey model with capital and an endogenous labour supply. At the firm level, there is a fixed cost combined with increasing marginal cost, which gives a standard U-shaped cost curve with optimal firm size. The costs of entry (exit) are quadratic in the flow of new firms. The number of firms becomes a second state variable and the entry dynamics gives rise to a richer set of dynamics than in the standard case: in particular, there is likely to be a hump shaped response of output to a fiscal shock with maximum impact after impact and before steady-state is reached. Output and capital per firm are also likely to be hump shaped.
Keywords: Entry; Ramsey; fiscal policy; macroeconomic dynamics
JEL Classification: E22; D92; E32; D92

Kul B Luintel and Mosahid Kahn (March 2012)
Ideas Production in Emerging Economies (957K, 13 pages)
We model ‘new ideas’ production in a panel of 17 emerging countries. Our results reveal: (i) ideas production is duplicative, (ii) externality associated with domestic knowledge stocks is of above unit factor proportionality, (iii) OECD countries raise the innovation-bar for emerging countries, (iv) there is no significant knowledge diffusion across emerging countries, and (v) growth in emerging countries appear far from a balanced growth path.
Keywords: Ideas Production; Knowledge Diffusion; Panel Co-integration
JEL Classification: C2; O3; O4

James Foreman-Peck (January 2012)
Effectiveness and Efficiency of SME Innovation Policy (1833K, 44 pages)
Forthcoming in Small Business Economics
This paper assesses UK innovation policy impact on a large, population weighted, sample of both service and manufacturing SMEs. By focussing on self-reported innovation the study achieves a wider coverage of the effects of SME innovation policy than possible with more traditional indicators. Propensity score matching indicates that SMEs receiving UK state support for innovation were more likely to innovate than unsupported comparable enterprises. Innovating enterprises are shown to have grown significantly faster over the years 2002-4 when other growth influences are appropriately controlled. Combining these two results and comparing the outlays on SME innovation policy with the estimated effects suggests that policy was efficient as well as effective. There is evidence that SME tax credits were expensive compared with earlier support instruments. But the overall high returns estimated suggest that, even in times of public spending cuts, persisting with SME innovation policy would be prudent.
Keywords: Innovation; State Aid; SME; Policy Evaluation
JEL Classification: L25; R38

Huw David Dixon and Panayiotis M. Pourpourides (January 2012)
On Imperfect Competition with Occasionally Binding Cash-in-Advance Constraints (523K, 61 pages)
We depart from the assumption of perfect competition in the final goods sector, commonly used in cash-in-advance (CIA) models, providing extensive theoretical analysis of the general equilibrium of an economy with imperfect competition, endogenous production and fully flexible prices in the presence of occasionally binding CIA constraints, under general assumptions about the velocity of money. Homothetic preferences generate Marshallian demands which are linear in own price allowing for any combination of equilibrium number of firms and demand elasticity. Whether the CIA constraint binds or not depends, among others, on the degree of imperfect competition. As the market becomes more competitive it is certainly no less likely that the CIA constraint will bind. The degree of imperfect competition directly affects the distribution of consumption and indirectly the level of output and work effort via the CIA constraint. With perfect foresight, there is an optimal negative steady-state inflation rate. We also consider how the introduction of capital and bonds would fit into the framework.

Erhan Artuç and Panayiotis M. Pourpourides (January 2012)
R&D and Aggregate Fluctuations (1279K, 51 pages)
Using US data for the period 1959-2007, we identify sectoral productivity shocks and capital investment-specific shocks by employing a Vector Autoregression whose shock structure is disciplined by a general equilibrium model. Controlling for real and nominal factors, we find that capital investment-specific shocks explain 70 percent of fluctuations of R&D investment while R&D technology shocks explain 30 percent of the variation of aggregate output net of R&D investment (i.e. the output of the non-R&D sector). Technology shocks jointly explain almost all the variation of output in the R&D sector and 78 percent of the variation of output in the non-R&D sector.
Keywords: Productivity Shocks; Investment-specific Shocks; R&D; VAR
JEL Classification: C13; C32; C68; E32; O3

Cemil Selcuk (January 2012)
Seasonal Cycles in the Housing Market (1141K, 10 pages)
The housing market exhibits a puzzling yet repetitive seasonal boom and bust cycle where prices and trade volume rise in summers and fall in winters. This paper presents a search model that analytically generates the observed deterministic cycle.
Keywords: housing; search; thin and thick markets; seasonality
JEL Classification: D39; D49; D83

Tianshu Zhao, Kent Matthews and Victor Murinde (November 2011)
Cross-Selling, Switching Costs and Imperfect Competition in British Banks (1650K, 32 pages)
This paper attempts to evaluate the competitiveness of British banking in the presence of cross-selling and switching costs during 1993-2008. It presents estimates of a model of banking behaviour that encompasses switching costs as well as cross-selling of loans and off-balance sheet transactions. The evidence from panel estimation of the model lends support to our theoretical priors on the cross-selling behaviour of British banks, which helps explain the rapid growth of non-interest income during the last two decades. We also find that the consumer faced high switching costs in the loan market in the latter part of the sample period, as a result of lower competitiveness.
JEL Classification: G21; L13

Jenifer Daley and Kent Matthews (November 2011)
Competitive Conditions in the Jamaican Banking Market 1998-2009 (1370K, 18 pages)
This paper presents an empirical assessment of the degree of competition within the Jamaican banking sector during the period 1998 to 2009. We employ a dynamic version of the Panzar-Rosse Model to estimate market power among the sample of banks that constitute over 90 percent of the banking market. Using the conventional statistical tests, we are unable to reject monopoly/perfect collusion for the merchant banking sector in Jamaica but find competitive conditions in the commercial banking sector. This contrasts with earlier findings using alternative estimators that find monopolistic competition in the market as a whole.
Keywords: Competition; banking; Rosse-Panzar H statistic; dynamic panel estimation; Jamaica
JEL Classification: G21; G28

Jenifer Daley, Kent Matthews and Tiantian Zhang (November 2011)
Post-crisis cost efficiency of Jamaican banks (1454K, 26 pages)
Deregulation, re-regulation and continuing globalisation embody an imperative that banks increase efficiency in order to survive. We employ the Simar-Wilson (2007) two-step double bootstrap Data Envelopment Analysis method to measure whether cost efficiency among Jamaican banks has improved between 1999 and 2009 following a number of post-crisis responses aimed at strengthening and improving the sector. Efficiency is extracted from a meta-frontier construction for the full sample period. In addition we conduct tests for unconditional beta- and sigma-convergence and overall, the results suggest that there has been a tendency towards improvement in bank efficiency levels for the industry as a whole but there is also evidence that foreign banks show a higher trend improvement in efficiency.
Keywords: Bank efficiency; DEA; bootstrap; convergence; Jamaica
JEL Classification: G21; G28

David R. Collie and Vo Phuong Mai Le (November 2011)
Product Differentiation, the Volume of Trade and Profits under Cournot and Bertrand Duopoly (1147K, 24 pages)
This paper analyses how product differentiation affects the volume of trade under duopoly using Shubik-Levitan demand functions rather than the Bowley demand functions used by Bernhofen (2001). The Shubik-Levitan demand functions have the advantage that an increase in product differentiation does not increase the size of the market as happens with the Bowley demand functions. It is shown that the volume of trade in terms of quantities is decreasing in the degree of product differentiation when the trade cost is relatively low, but increasing in the degree of product differentiation when the trade cost is relatively high.
Keywords: Product Differentiation; Cournot Oligopoly; Bertrand Oligopoly
JEL Classification: F12; F13

Huw David Dixon and Hervé Le Bihan (October 2011)
Generalized Taylor and Generalized Calvo price and wage-setting: micro evidence with macro implications (1173K, 38 pages)
The Generalized Calvo and the Generalized Taylor models of price and wage-setting are, unlike the standard Calvo and Taylor counterparts, exactly consistent with the distribution of durations observed in the data. Using price and wage micro-data from a major euro-area economy (France), we develop calibrated versions of these models. We assess the consequences for monetary policy transmission by embedding these calibrated models in a standard DSGE model. The Generalized Taylor model is found to help rationalizing the humpshaped and persistent response of inflation, without resorting to the counterfactual assumption of systematic wage and price indexation.
Keywords: Contract length; steady state; hazard rate; Calvo; Taylor; wage-setting; price-setting
JEL Classification: E31; E32; E52; J30

Michael C. Hatcher (October 2011)
Inflation versus price-level targeting and the zero lower bound: Stochastic simulations from the Smets-Wouters US model (1235K, 28 pages)
Using a version of the Smets-Wouters model of the US economy augmented to include both New Keynesian and New Classical sectors, this paper investigates the performance of inflation targeting and price-level targeting when the zero lower bound on nominal interest rates is occasionally-binding. Several notable results emerge. First, the unconditional probability of hitting the lower bound is lower under price-level targeting than inflation targeting, with 'lower bound episodes' being less frequent and lasting for shorter periods of time. Second, the volatilities of key macroeconomic variables are lower under price-level targeting than inflation targeting. Third, the lower frequency and severity of lower bound episodes under price-level targeting appears to have a first-order impact on consumption, investment and output, raising their mean values. Intuitively, price-level targeting performs well because inflation expectations act as automatic stabilisers, reducing the chance of hitting or remaining at the lower bound whilst also providing stability when the economy is away from the lower bound.
Keywords: Zero lower bound; occasionally-binding constraint; price-level targeting; inflation targeting
JEL Classification: E52; E58

Vito Polito and Peter Spencer (September 2011)
UK Macroeconomic Volatility and the Welfare Costs of Inflation (1560K, 60 pages)
This paper explores the implications of time varying volatility for optimal monetary policy and the measurement of welfare costs. We show how macroeconomic models with linear and quadratic state dependence in their variance structure can be used for the analysis of optimal policy within the framework of an optimal linear regulator problem. We use this framework to study optimal monetary policy under inflation conditional volatility and Find that the quadratic component of the variance makes policy more responsive to inflation shocks in the same way that an increase in the welfare weight attached to inflation does, while the linear component reduces the steady state rate of inflation. Empirical results for the period 1979-2010 underline the statistical significance of inflation-dependent UK macroeconomic volatility. Analysis of the welfare losses associated with inflation and macroeconomic volatility shows that the conventional homoskedastic model seriously underestimates both the welfare costs of inflation and the potential gains from policy optimization.
Keywords: Monetary policy; Macroeconomic volatility; Optimal control; Welfare costs of inflation
JEL Classification: C32; C61; E52

Michael C. Hatcher (August 2011)
Comparing inflation and price-level targeting: A comprehensive review of the literature (1319K, 54 pages)
This paper provides a detailed survey of the economic literature comparing inflation and price-level targeting as macroeconomic stabilisation policies. Its contributions relative to past surveys are as follows. First, rather than focusing on any particular topic, the survey gives equal emphasis to all key areas of the literature. Second, the paper discusses 'new results' in several areas, including the zero lower bound on nominal interest rates,the long-term impact of price-level targeting,and financial market considerations. Finally, the survey is written in such a way that it can be understood by economists with little or no prior knowledge of price-level targeting and the related academic literature. The survey concludes that whilst price-level targeting has a number of potential advantages, further research is needed to accurately quantify its costs and benefits and to test robustness. Potential obstacles to the introduction of price-level targeting in practice include: concerns about its credibility,lack of public understanding,and lack of prior experience with price-level targeting regimes.
Keywords: Price-level targeting; inflation targeting; macroeconomic stabilisation
JEL Classification: E52; E58

James Foreman-Peck and Leslie Hannah (August 2011)
Extreme Divorce: the Managerial Revolution in UK Companies before 1914 (1100K, 54 pages)
We present the first broadly representative study for any early twentieth century economy of the extent to which quoted company ownership was already divorced from managerial control. In the 337 largest, independent, UK companies in the Investor's Year Book (those with \pounds 1m or more share capital in 1911) the two million outside shareholders were fewer than today's shareholding population, but they held 97.5% of the shares in the median company and their directors only 2.5%. This indicates a lower level of personal ownership by boards, and of director voting control, in the largest securities market of the early twentieth century than in any of the world.s major securities markets toward the end of that century. Berle, Means, Gordon and others later quantified the USA's delayed (and on this dimension less advanced) managerial "revolution." Their evidence has been widely misinterpreted: some erroneously concluded that America pioneered this aspect of "modernity" and that the "divorce" of ownership from control, globally, was a new and continuing trend.

Garry D.A. Phillips and Gareth Liu-Evans (August 2011)
The Robustness of the Higher-Order 2SLS and General k-Class Bias Approximations to Non-Normal Disturbances (1109K, 28 pages)
In a seminal paper Nagar (1959) obtained first and second moment approximations for the k-class of estimators in a general static simultaneous equation model under the assumption that the structural disturbances were i.i.d and normally distributed. Later Mikhail (1972) obtained a higher-order bias approximation for 2SLS under the same assumptions as Nagar while Iglesias and Phillips (2010) obtained the higher order approximation for the general k-class of estimators. These approximations show that the higher order biases can be important especially in highly overidentified cases. In this paper we show that Mikhail.s higher order bias approximation for 2SLS continues to be valid under symmetric, but not necessarily normal, disturbances with an arbitrary degree of kurtosis but not when the disturbances are asymmetric. A modified approximation for the 2SLS bias is then obtained which includes the case of asymmetric disturbances. The results are then extended to the general k-class of estimators.

Emma M. Iglesias and Garry D.A. Phillips (August 2011)
Almost Unbiased Estimation in Simultaneous Equations Models with Strong and / or Weak Instruments (1180K, 38 pages)
We propose two simple bias reduction procedures that apply to estimators in a general static simultaneous equation model and which are valid under reatively weak distributional assumptions for the errors. Standard jackknife estimators, as applied to 2SLS, may not reduce the bias of the exogenous variable coefficient estimators since the estimator biases are not monotonically non-increasing with sample size (a necessary condition for successful bias reduction) and they have moments only up to the order of overidentification. Our proposed approaches do not have either of these drawbacks. (1) In the first procedure, both endogenous and exogenous variable parameter estimators are unbiased to order T^-2 and when implemented for k-class estimators for which k < 1, the higher order moments will exist. (2) An alternative second approach is based on taking linear combinations of k-class estimators for k < 1. In general, this yields estimators which are unbiased to order T^-1 and which possess higher moments. We also prove theoretically how the combined k-class estimator produces a smaller mean squared error than 2SLS when the degree of overidentification of the system is larger than 8. Moreover, the combined k-class estimators remain unbiased to order T^-1 even if there are redundant variables (including weak instruments) in any part of the simultaneous equation system, and we can allow for any number of endogenous variables. The performance of the two procedures is compared with 2SLS in a number of Monte Carlo experiments using a simple two equation model. Finally, an application shows the usefulness of our new estimator in practice versus competitor estimators.
Keywords: Combined k-class estimators;Bias correction;Weak instruments;Endogenous and exogenous parameter estimators;Permanent Income Hypothesis
JEL Classification: C12; C13; C30; C51; D12; D31; D91; E21; E40

Hao Hong (July 2011)
Money, interest rates and the real activity (1119K, 25 pages)
This paper examines the effectiveness of monetary aggregates through various nominal interest rates by integrating the financial sector into the Cash-in-Advance (CIA) economy. The model assumes that there are two types of representative agents in the financial sector, which are: productive banks and financial intermediates. The productive banks supply a financial service, which is an exchange technology service to households and financial intermediates receive savings fund from savers and offer loans to borrowers. The monetary expansions are increased banking costs through the rate of inflation. It leads households to use more exchange credit relative to cash at the goods market. Since the number of savings funds is equal to the number of exchange credits used at the goods market, money injections are lower the nominal interest rate on saving as the saving fund increases with exchange credit. By assuming that firms are the only borrowers at the capital market from Fuerst (1992), a lower nominal interest rate on the saving fund reduces the marginal cost of labour and increases labour demand. Meanwhile, the increasing marginal cost of money through the expected inflation effect has a negative effect on labour supply. With labour demand dominating labour supply effects, both output and employment increase with monetary expansion. The paper is able to generate a decreasing nominal interest rate with an increasing money supply with an absence of limited participation monetary shocks from Lucas (1990),and by allowing firms to borrow wage bills payment from financial intermediates, it examines the positive response of aggregate output subject to monetary expansion under flexible price framework.
Keywords: monetary transmission; business cycles; banking sector; interest rates
JEL Classification: E10; E44; E51

Kateryna Onishchenko (June 2011)
Can a pure real business cycle model explain the real exchange rate: the case of Ukraine (1640K, 30 pages)
Real exchange rate (RER) is an important instrument for restoring sustainable economic growth in the small open economy with large export share. RER of Ukrainian currency can be explained within the real business cycle (RBC) framework without any forms of nominal rigidities. Fitting Ukrainian quarterly data for the period of 1996:Q1-2009:Q3 into the small open economy real business cycle model and testing it by method of indirect inference shows that RER can be reproduced by RBC framework. The generated pseudo-samples for RER by method of bootstrapping allow to obtain the distribution of the best fit ARIMA(2,1,4) parameters and to show with the Wald statistics that those parameters lie within 95% confidence intervals of those estimated for bootstrapped pseudo Q parameters.
Keywords: sustainable economic growth; business cycle; real exchange rates; small open economy; indirect inference; ARIMA
JEL Classification: E31; E32; E37; F31; F37

Hao Hong (June 2011)
Monetary aggregates, financial intermediate and the business cycle (1056K, 17 pages)
This paper explains and evaluates the transmissions and effectiveness of monetary policy shock in a simple Cash-in-Advance (CIA) economy with financial intermediates. Lucas-Fuerst's (1992) limited participation CIA models are able to explain decreasing nominal interest rates and increasing real economic activity with monetary expansion through limited participation monetary shock and the cost channel of monetary policy. Calvo's (1983) sticky price monetary model examines the real effects of money injections through firms price setting behaviour, but it fails to generate a negative correlation between nominal interest rates and money growth rate, which has been observed in the data. This paper employs McCandless (2008) financial intermediates CIA model to explain the transmissions and impacts of monetary shocks. The model does not request limited participation monetary shock or Keynesian type of sticky price/wage, to examine the lower nominal interest rate and increasing real economic activity with monetary expansion. By extending the model with Stockman's (1981) CIA constraint, it is able to account for both positive response of consumption subject to monetary innovations, which has been found in Leeper et al. (1996) and the positive correlation between output and consumption which has been observed in the data.
Keywords: Monetary business cycle; financial intermediate; cash-in-advance model
JEL Classification: E44; E52

Ernesto Longobardi and Vito Polito (June 2011)
Capital income taxation incentives during economic downturns: re-thinking theory and evidence (1288K, 39 pages)
This paper studies the effectiveness of corporate tax incentives in reducing the effective tax rate (ETR) on income from capital to stimulate business investment during economic downturns. We focus on tax rate incentives (TRIs), such as corporate tax rate cuts, and tax base incentives (TBIs), such as increased capital allowances. The standard economic theory states that TRIs reduce the ETR by decreasing tax payments on corporate profits. TBIs instead reduce the ETR as they defer firms tax payments, in turn increasing the present value of dividend distribution. However, this theory does not consider that, in reality, firms face accounting constraints preventing any distribution of cash flows arising from TBIs. For this reason, the standard economic analysis overstates the benefit of any TBI relative to that of TRIs. The paper incorporates accounting constraints on dividend policy into the model for the computation of the ETR and employs the new model to recalculate ETRs in the US and in the UK during 1980-2010. The empirical results confirm that the benefit of TBIs is significantly overstated by the standard theory, and tax rate cuts are more effective in reducing the ETR. We show that this result holds regardless of the form of investment finance (retained earning, new equity and debt), the type capital asset (building and plant and machinery), the level of capital income taxation (corporate and shareholders), and the value of accounting depreciation relative to economic depreciation.
Keywords: Capital income taxation; dividend policy; effective marginal tax rates; financial constraints
JEL Classification: H3

Vito Polito (June 2011)
Deferred Taxation and Effective Tax Rates on Income from Capital in the United States, 2000-2010 (1161K, 43 pages)
The accounting and economic literature have long highlighted the potential implications of deferred taxation for tax policy analysis. This paper incorporates deferred taxation into the neoclassical investment model for the computation of the Effective Tax Rate (ETR) on business investment and revisits the empirical evidence on the evolution of ETRs in the United States over the last decade. The numerical results show that after including deferred taxation there is little differential in the ETRs across assets,ETRs in the 2000s have been essentially in line with statutory rates,and partial expensing had little effect on ETRs. These results hold whether investment is financed by equity or debt,profits are distributed to individual shareholders through dividends, interests or capital gains,and regardless of the differential between book and economic depreciation.
Keywords: Deferred taxation; effective marginal tax rates; taxation of income from capital
JEL Classification: H3

Vito Polito (June 2011)
Up or down? Capital income taxation in the United States and the United Kingdom (1126K, 29 pages)
Empirical evidence suggests that the Effective Marginal Tax Rate (EMTR) on income from capital has increased considerably in both the United States and the United Kingdom over the period 1982-2005. This evidence contradicts the corporate tax literature which predicts that the EMTR should instead fall over time as a result of increasing international capital mobility and higher tax competition between governments. This paper argues that this inconsistency is entirely due to the fact that EMTRs on income from capital are currently computed from versions of the neoclassical investment model which do not take into account financial constraints on dividend policy faced by firms investing in both the United States and the United Kingdom. The paper incorporates financial constraints on dividend policy into the analytical framework for the computation of the EMTR and employs the new model to re-calculate time series of the EMTRs in both countries. The new empirical results show that, in contrast to the existing evidence, the EMTR on investment financed by either retained earnings or new equity has indeed declined over time in both countries, while the EMTR on debt-financed investment has remained relatively stable.
Keywords: Capital income taxation; dividend policy; effective marginal tax rates; financial constraints
JEL Classification: H3

Tiantian Zhang and Kent Matthews (April 2011)
Efficiency Convergence Properties of Indonesian Banks 1992-2007 (1445K, 28 pages)
This paper examines the convergence properties of cost efficiency for Indonesian banks for the period 1992-2007. It employs the Simar and Wilson's (2007) two stage semi-parametric double bootstrap DEA procedure to estimate cost efficiency. Using panel data estimation, the paper examines ß-convergence and σ,-convergence, to test the speed at which Indonesian banks are converging, towards the best practice and country average. We find evidence that in general the post-crisis structural reform process improved the average level of efficiency and improved the distribution of efficiency across banks significantly. The Asian financial crisis and the structural reform had the effect of slowing the adjustment speed of bank efficiency.
Keywords: Banks; Efficiency; Indonesia; Convergence
JEL Classification: G21; G28

Lorant Kaszab (April 2011)
Fiscal Policy Multipliers in a New Keynesian Model under Positive and Zero Nominal Interest Rate (1290K, 42 pages)
This paper uses a simple new-Keynesian model (with and without capital) and calculates multipliers of four types. That is, we assume either an increase in government spending or a cut in sales/labor/capital tax that is financed by lump-sum taxes (Ricardian evidence holds). We argue that multipliers of a temporary fiscal stimulus for separable preferences and zero nominal interest rate results in lower values than what is obtained by Eggertsson (2010). Using Christiano et al. (2009) non-separable utility framework which they used to calculate spending multipliers we study tax cuts as well and find that sales tax cut multiplier can be well above one (joint with government spending) when zero lower bound on nominal interest binds. In case of a permanent stimulus we show in the model without capital and assuming non-separable preferences that it is the spending and wage tax cut which produce the highest multipliers with values lower than one. In the model with capital and assuming that the nominal rate is fixed for a one-year (or two-year) duration we present an impact multiplier of government spending that is very close to the one in Bernstein and Romer (2009) but later declines with horizon in contrast to their finding and in line with the one of Cogan et al. (2010). We also demonstrate that the long-run spending multiplier calculated similarly to Campolmi et al. (2010) implies roughly the same value for both types of preferences for particular calibrations. For comparison, we also provide long-run multipliers using the method proposed by Uhlig (2010).
Keywords: New-Keynesian model; fiscal multipliers; zero lower bound; monetary policy; government spending; tax cut; permanent; transitory
JEL Classification: E52; E62

Lucun Yang (April 2011)
An Empirical Analysis of Current Account Determinants in Emerging Asian Economies (1392K, 49 pages)
Limited empirical work has been done to the diverging current account balances of the individual emerging Asian economies. Based on the intertemporal approach to current account, this paper empirically examines both the long-run and short-run impacts of initial stock of net foreign assets, degree of openness to international trade, real exchange rate and relative income on current account balances for eight selected emerging Asian economies over the period 1980-2009, making use of the cointegrated VAR (Vector Autoregression) methodology. This paper finds that current account behaviours in emerging Asian economies are heterogeneous. Initial stock of net foreign assets and degree of openness to international trade are important factors in explaining the long-run behaviour of current accounts. Moreover, the current accounts of all sample economies have a self-adjusting mechanism except China. Short-run current account adjustment towards long-run equilibrium path is gradual, with the disequilibrium term being the main determinant of the short-run current account variations.
Keywords: Current account;Emerging Asia;Structural and macroeconomic determinants;Saving-investment balance;Cointegration
JEL Classification: E21; F10; F32; F41

Jingwen Fan and Michael G Arghyrou (March 2011)
UK Fiscal Policy Sustainability, 1955-2006 (1124K, 26 pages)
We test for fiscal policy sustainability in the UK for the period 1955-2006. We find evidence of sustainability with three structural breaks, respectively occurring in the early 1970s, early 1980s and late 1990s. UK fiscal policy has been sustainable throughout the sample period except from 1973-1981 when a non-Ricardian regime applied. For the remaining periods correction of fiscal disequilibrium occurs through adjustments in public revenue rather than expenditure. Finally, we find evidence of non-linear fiscal adjustment, with UK authorities not reacting to relatively small deficits,but correcting exceedingly large deficits and any temporary surpluses relatively fast.
Keywords: Fiscal policy; Sustainability; UK; Structural breaks; Non-linear adjustment
JEL Classification: E62; H60

Jing Dang, Max Gillman and Michal Kejak (March 2011)
Real Business Cycles with a Human Capital Investment Sector and Endogenous Growth: Persistence, Volatility and Labor Puzzles (1209K, 43 pages)
A positive joint two-sector productivity shock causes Rybczynski (1955) and Stolper and Samuelson (1941) effects that release leisure time and initially raises the relative price of human capital investment so as to favor it over goods production. This enables a basic RBC model, modified by having the household sector produce human capital investment sector, to succeed along related major dimensions of output, consumption, investment and labor, similar to the international approach of Maodifying the dynamics relative to the important work of Jones et al. (2005), two key US facts stressed by Cogley and Nason (1995) are captured: persistent movements in the growth rates of output and hump-shaped impulse responses of output. Further, physical capital investment has data consistent persistence within a hump-shaped impulse response. And Gali's (1999) challenging empirical finding that labour supply decreases upon impact of a positive productivity shock is reproduced, while volatility in working hours is also data-consistent because of the substitution between market and nonmarket sectors.
Keywords: Real business cycle; human capital; persistence; volatility; labor
JEL Classification: E24; E32; O41

Hongru Zhang (March 2011)
Financial Sector Shocks, External Finance Premium and Business Cycle . (1304K, 45 pages)
This paper extends Nolan and Thoenissen (2009), hence NT, model with an explicit financial intermediary that transfer funds from households to entrepreneurs subject to a well defined loan production function. The loan productivity shock is treated as the supply side financial disturbance. Together with NT.s net worth shock that resembles the credit demand perturbation, both of the two-sided shocks are robustly extracted by combining the model with US quarterly data. The two shocks are found to be tightly linked with the post-war recessions. Each recession happens when both of the two shocks become contractionary. A few potential economic downturns seem to have been avoided because of the expansion of credit which offset the simultaneous contraction of entrepreneurial net wealth. This new introduced shock has significant explanatory power for the variance of EFP and the model simulated EFP holds high correlation with various spreads as proxies for empirical EFP.
Keywords: DSGE modeling; corporate net wealth shock; loan productivity shock; external financing; shock construction; historical decomposition; variance decomposition
JEL Classification: E32; E44; G21

Sheikh Selim (March 2011)
Optimal Taxation and Redistribution in a Two Sector Two Class Agents' Economy (1049K, 19 pages)
We examine the optimal taxation problem in a two sector neoclassical economy with workers and capitalists. We show that in a steady state of this economy the optimal policy may involve a capital income tax or subsidy, differential taxation of labour income and redistribution. The level and the direction of the redistribution associated with such an optimal policy depends on the pre tax allocation of capital but not on the social weights attached to the different groups of taxpayers. Excess production of consumption goods creates a difference between the social marginal values of consumption and investment which in turns violates the production efficiency condition. Such a difference can be undone by taxing capital income from the consumption sector, and with this optimal policy the government can implement a redistribution scheme where both workers and capitalists bear the burden of distorting taxes. On the contrary, an optimal policy that involves a capital income subsidy in the production of consumption can implement allocations that minimize the relative price difference between consumption and investment that resulted from the excess production of investment goods.
Keywords: Optimal taxation; Ramsey problem; Two Sector Economy; Redistribution
JEL Classification: C61; E13; E62; H21

Michael C. Hatcher (March 2011)
Price-level targeting versus inflation targeting over the long-term (1368K, 50 pages)
This paper investigates the long-term impact of price-level targeting on social welfare in an overlapping generations model in which the young save for old age by investing in productive capital and indexed and nominal government bonds. A key feature of the model is that the extent of bond indexation is determined endogenously in response to monetary policy as part of an optimal commitment Ramsey policy. Due to the absence of base-level drift under price-level targeting, long-term inflation risk is reduced by an order of magnitude compared to inflation targeting. Consequently, real bond returns are stabilised somewhat, and consumption volatility for old generations is reduced by around 15 per cent. The baseline welfare gain from price- level targeting is equivalent to a permanent increase in aggregate consumption of only 0.01 per cent, but this estimate is strongly sensitive on the upside.
Keywords: inflation targeting; price-level targeting; optimal indexation; government bonds
JEL Classification: E52; E58

Max Gillman (February 2011, updated May 2011)
A Simple Theory of Structural Transformation (1164K, 40 pages)
The paper presents a theory of the industrial transformation amongst sectors using endogenous growth theory. Allowing only a slight upward trend in the productivity of the human capital sector, combined with ascending degrees of human capital shares of sectoral output, in say, agriculture, manufacturing and services, output gradually shifts relatively over time from agriculture to manufacturing and to services. Abstracting from international trade theory, sectors intensive in the factor that is becoming relatively more plentiful find their relative outputs expanding. Adding more sectors of greater human capital intensity causes labor time to decrease within each sector, as shown for agriculture, and in general for any number of sectors.
Keywords: Human Capital Intensity; Sectoral Allocation; Labor Shares; Secular Endogenous Growth
JEL Classification: E25; F11; J24; O14

Michael C. Hatcher (January 2011, updated March 2011)
Optimal indexation of government bonds and monetary policy (1350K, 46 pages)
Using an overlapping generations model in which the young save for old age using indexed and nominal government bonds, this paper investigates how optimal indexation is influenced by monetary policy. In order to do so, two monetary policies with markedly different long run implications are examined: inflation targeting and price-level targeting. Optimal indexation differs significantly under the two regimes. Under inflation targeting, long-term inflation uncertainty is substantial due to base-level drift in the price level. Nominal bonds are thus a poor store of value and optimal indexation is relatively high (76 per cent). With price-level targeting, by contrast, long-term inflation uncertainty is minimal because the price level is trend-stationary. This makes nominal bonds a better store of value compared to indexed bonds, reducing optimal indexation somewhat (26 per cent). Importantly for these results, the model captures two imperfections of indexation (indexation bias and lagged indexation) that are calibrated to the UK case.
Keywords: optimal indexation; government bonds; inflation targeting; price-level targeting
JEL Classification: E52; E58

Sheikh Selim (January 2011)
The Impact of Price Regulations on Regional Welfare and Agricultural Productivity in China (1077K, 9 pages)
The nineties' agricultural reform in China that was aimed at deregulating the agricultural market eventually resulted in a huge drop in agricultural production and a high rate of inflation in agricultural prices,this apparently motivated the government to take over the control of agricultural prices in 1998. We examine how and to what extent this reform affected the productivity and welfare of grain farmers in China at the regional level. We find that the price regulation that destroyed the incentive to exert more effort adversely affected the growth in agricultural productivity but contributed to the growth in farmers. welfare. Although the price regulations resulted in short term improvement in welfare across all the regions, for the long run such regulations can result in larger drop in agricultural production because of its negative impact on incentives to produce more.
Keywords: China; Welfare; TFP; Agriculture; Grain Production
JEL Classification: N55; O13; O53; Q12

Kul B Luintel and Mosahid Kahn (January 2011)
Basic, Applied and Experimental Knowledge and Productivity: Further Evidence (960K, 11 pages)
Analyzing a novel dataset we find significantly positive effects of basic, and applied and experimental knowledge stocks on domestic output and productivity for a panel of 10 OECD countries. This letter updates the work of, among others, Mansfield (1980), Griliches (1986) and Adams (1990), at an international setting.
Keywords: Basic and Applied Research;TFP;Panel Co-integration
JEL Classification: F12; F2; O3

Sheikh Selim, Naima Parvin and Vasita Patel (December 2010)
Interaction and Non-neutral Effects of Factors in Chinese Wheat Production (1152K, 26 pages)
In this paper we examine the role of the interaction between labour productivity and the use of factors in explaining the recent (1998-2007) 11% decline in wheat production in China. We employ a non-neutral stochastic production frontier approach that enables us to identify the interaction and non-neutral effects of factors that are used in wheat production. For regional level wheat production in China we find that identifying the technical inefficiency effects and the non-neutral effects of factors assist big time in explaining the recent decline in wheat production. A higher level of labour productivity can stimulate efficiency gains in production, but adding more labour to the workforce or adding to the stock of machinery power can depress this potential marginal efficiency gain. We also find significant marginal efficiency gain of land reforms that add to the stock of cultivable land. Our results indicate that future agricultural reforms in China should address the incentive scheme for labour.
Keywords: China; Stochastic Frontier; Factor Interaction; Non neutrality; Agriculture; Wheat Production
JEL Classification: N55; O13; O53; Q12

Vasita Patel and Sheikh Selim (December 2010, updated January 2011)
Reforms, Incentives, Welfare and Productivity Growth in Chinese Wheat Production (1202K, 32 pages)
Following the rural reform in 1978 a series of agricultural reforms were introduced in China with an aim to create incentives for the farmers to produce more. The nineties. price reform that was aimed at deregulating the agricultural market eventually resulted in a huge drop in agricultural production,this apparently motivated the government to take over the control of agricultural prices in 1998. For a dataset that covers all the major rural reforms undertaken in China, we examine how and to what extent these reforms affected the productivity and welfare of wheat farmers in China. We find that the nineties. price reforms resulted in a high magnitude of effort-response from wheat farmers which led to a faster growth of the incentive component of productivity. Due to random weather shocks this response did not result in the expected level of profit and as a result the farmers suffered a decline in welfare. The regulations introduced in 1998 destroyed the incentive-induced growth in TFP. In general wheat farmers in China responded highly when markets were made more competitive, and their effort-response for flat subsidies (e.g. the ones introduced in the eighties) was very marginal.
Keywords: China; Incentives; TFP; Agriculture; Wheat Production
JEL Classification: N55; O13; O53; Q12

Sheikh Selim (November 2010)
Optimal Tax Policy and Wage Subsidy in an Imperfectly Competitive Economy (1009K, 9 pages)
In an imperfectly competitive economy with direct and indirect taxes, the first best wage subsidy overcompensates workers and provides the incentive to misreport working hours. We show that in the second best optimum where the government cannot use a wage subsidy, the optimal policy is to tax labour income at a zero rate. This policy is optimal because it minimizes the incentive to misreport working hours.
Keywords: Optimal Taxation; Ramsey Problem; Wage Subsidy
JEL Classification: D42; E62; H21; H30

Michael G Arghyrou and John D. Tsoukalas (November 2010)
The Option Of Last Resort: A Two-Currency Emu (1003K, 5 pages)
This article, originally published at www.roubini.com on 7 February 2010, spells out our two-currency EMU proposal as a plan of last resort for resolving the present EMU sovereign-debt crisis. The key ingredients of our proposal involve a temporary split of the euro into two currencies, both run by the European Central Bank. The hard euro will be maintained by the core-EMU members whereas periphery EMU countries will adopt for a suitable period of time the weak euro. All existing debts will continue to be denominated in strong-euro terms. The plan involves a one-off devaluation of the weak euro versus the strong one, simultaneously with the introduction of far-reaching reforms and rapid fiscal consolidation in the periphery EMU countries. We argue that due to enhanced market credibility, our two-tier euro plan has a realistic chance of success in resolving the EMU crisis, if all other approaches fail.
Keywords: euro; two-currency EMU
JEL Classification: E44; F30; G01

James Davidson, David Meenagh, Patrick Minford and Michael Wickens (November 2010)
Why crises happen - nonstationary macroeconomics (1573K, 27 pages)
A Real Business Cycle model of the UK is developed to account for the behaviour of UK nonstationary macro data. The model is tested by the method of indirect inference, bootstrapping the errors to generate 95% confidence limits for a VECM representation of the data,we find the model can explain the behaviour of main variables (GDP, real exchange rate, real interest rate) but not that of detailed GDP components. We use the model to explain how `crisis' and `euphoria' are endemic in capitalist behaviour due to nonstationarity,and we draw some policy lessons.
Keywords: Nonstationarity; Productivity; Real Business Cycle; Bootstrap; Indirect Inference; Banking Crisis; Banking Regulation
JEL Classification: E32; F32; F41

Kent Matthews (November 2010)
Banking Efficiency in Emerging Market Economies (1168K, 19 pages)
This paper reviews the different ways to measure bank efficiency and highlight the results of research on bank efficiency in Asian emerging economies. In particular it will outline the extent of research thus far conducted on the efficiency of banks in Pakistan and comment on how to build and improve upon them.
Keywords: bank efficiency; bootstrap; Pakistan
JEL Classification: G20; G21

Peng Zhou (October 2010, updated November 2010)
An Empirical Study on Price Rigidity (1953K, 32 pages)
This paper uses unpublished retailer-level microdata underlying UK consumer price indices to investigate price rigidity. Based on the conventional method, little rigidity is found in frequency of price change, since the implied price duration is only 5.5 months. However, it significantly underestimates the true duration (9.3 months) as suggested by cross-sectional method. Results also exhibit conspicuous heterogeneities in rigidity across sectors and shop types but weak difference across regions and time. The overall distribution of duration can be decomposed by sector into a decreasing component and a cyclical component with 4-month cycles. Both time and state dependent features exist in pricing. These findings support New Keynesian theories and enable a better calibration to improve the performances of macroeconomic models.
Keywords: Price Rigidity; Price Duration; Microdata; Cross-Sectional
JEL Classification: C41; D22; E31; L11

Patrick Minford and Zhirong Ou (October 2010)
US post-war monetary policy: what caused the Great Moderation? (1557K, 34 pages)
Using indirect inference based on a VAR we confront US data from 1972 to 2007 with a standard New Keynesian model in which an optimal timeless policy is substituted for a Taylor rule. We find the model explains the data both for the Great Acceleration and the Great Moderation. The implication is that changing variances of shocks caused the reduction of volatility. Smaller Fed policy errors accounted for the fall in inflation volatility. Smaller supply shocks accounted for the fall in output volatility and smaller demand shocks for lower interest rate volatility. The same model with differing Taylor rules of the standard sorts cannot explain the data of either episode. But the model with timeless optimal policy could have generated data in which Taylor rule regressions could have been found, creating an illusion that monetary policy was following such rules.
Keywords: Great Moderation; Shocks; Monetary policy; New Keynesian model; Bootstrap; VAR; Indirect inference; Wald statistic
JEL Classification: E32; E42; E52; E58

Michael G Arghyrou and Alexandros Kontonikas (September 2010)
The EMU sovereign-debt crisis: Fundamentals, expectations and contagion (1630K, 48 pages)
We offer a detailed empirical investigation of the European sovereign debt crisis based on the theoretical model by Arghyrou and Tsoukalas (2010). We find evidence of a marked shift in market pricing behaviour from a 'convergence-trade' model before August 2007 to one driven by macro-fundamentals and international risk thereafter. The majority of EMU countries have experienced contagion from Greece. There is no evidence of significant speculation effects originating from CDS markets. Finally, the escalation of the Greek debt crisis since November 2009 is confirmed as the result of an unfavourable shift in country specific market expectations. Our findings highlight the necessity of structural, competitiveness-inducing reforms in periphery EMU countries and institutional reforms at the EMU level enhancing intra-EMU economic monitoring and policy co-ordination.
Keywords: euro-area; crisis; spreads; fundamentals; expectations; contagion; speculation
JEL Classification: E43; E44; F30; G01; G12

Michael G Arghyrou (September 2010)
Corruption as a form of extreme individualism: An economic explanation based on geography and climate conditions (1324K, 42 pages)
We present a simple model explaining corruption on geography and climate conditions. We test the model's validity in a cross-section of 115 countries. Controlling for all other corruption's determinants we find evidence supporting the model's predictions. Corruption increases with temperature and declines with precipitation and non-cultivatable land. Corruption also declines with per capita GDP, democracy, median age and British colonial heritage,and increases with natural resources, bureaucracy and communist past. Finally, corruption declines with the ratio of internet users to total population. This new finding is interpreted as capturing the beneficial interaction of economic development, human capital/education and independent news.
Keywords: individualism; fairness; corruption; geography and climate conditions
JEL Classification: D73; H11

Kul B Luintel, Mosahid Khan and Konstantinos Theodoridis (September 2010)
How Robust is the R&D-Productivity relationship? Evidence from OECD Countries (1096K, 44 pages)
We examine the robustness of R&D and productivity relationship in a panel of 16 OECD countries. We control for fifteen productivity determinants predicted by different theoretical models. Following the advances in non-stationary panel data econometrics, we estimate four variants of thirteen specifications. All models appear co-integrated. Results are rigorously scrutinized through extensive bootstrap simulations and sensitivity checks. R&D and human capital emerge robust in all specifications making them universal drivers of productivity across nations. Most other determinants are also significant. Productivity relationships are heterogonous across countries depending on their accumulated stocks of knowledge and human capital.
Keywords: R&D Capital Stocks; Multifactor Productivity; Heterogeneity; Panel Cointegration; Bootstrap Simulations
JEL Classification: F12; F2:; O3; O4; C15

Huw David Dixon and Panayiotis M. Pourpourides (July 2010)
General Equilibrium with Monopolistic Firms and Occasionally Binding Cash-in-Advance Constraints (1107K, 28 pages)
We show a simple way to introduce monopolistic competition in a general equilibrium model where prices are fully flexible, the velocity of money is variable and cash-in-advance (CIA) constraints occasionally bind. We establish the conditions under which money has real effects and demonstrate that an equilibrium that occurs at a binding CIA constraint is welfare inferior to any equilibrium that occurs at a non-binding CIA constraint with the same level of technology. We argue that even though the probability of a binding CIA constraint can be increasing with money supply, under certain conditions, expansionary money supply is welfare improving.
Keywords: general equilibrium; monopolistic competition
JEL Classification: D43; E31; E41; E51

Stefano Battilossi, Regina Escario and James Foreman-Peck (July 2010)
Economic Policy and Output Volatility in Spain, 1950-1998: Was Fiscal Policy Destabilizing? (1288K, 39 pages)
Was Spanish fiscal policy destabilizing? We estimate policy reaction functions and test the impact of fiscal shocks on growth volatility over the period 1950-1998. We find that a transition from pro-cyclical to countercyclical fiscal policy occurred in the late years of the Franco regime, contributing to the stabilization of the growth pattern. The timing of the shift, between the late 1960s and early 1970s, was not determined by a single policy change, but rather by gradual pressure from economic liberalization, the external constraint imposed by a fixed exchange rate regime and the modernization of fiscal policy instruments. The aggressiveness of fiscal shocks also decreased over time, thus contributing to the progressive stabilization of output growth. There appears to be little necessity to appeal to a 'Great Moderation' of monetary policy to understand the greater stability of the Spanish economy from the 1980s
Keywords: fiscal reaction function; fiscal shocks; SVAR; growth volatility
JEL Classification: E32; E62; N14

David R. Collie (June 2010)
Multilateral Trade Liberalisation, Foreign Direct Investment and the Volume of World Trade (1088K, 11 pages)
Forthcoming in Economics Letters
A paradox in international trade is that multilateral trade liberalisation has resulted in increases in both the volume of world trade and the amount of foreign direct investment (FDI). This note presents a Cournot duopoly model with two regions, each consisting of two countries, and with an inter-regional transport cost. It is shown that multilateral trade liberalisation may lead firms to switch from exporting to undertaking export-platform FDI when the interregional transport cost is high. Also, when the inter-regional transport cost is high, the switch to FDI leads to an increase in the volume of world trade in this industry.
Keywords: Trade Liberalisation; Foreign Direct Investment; Cournot oligopoly
JEL Classification: F12; F13; F23

Michael G Arghyrou and John D. Tsoukalas (April 2010)
The Greek Debt Crisis: Likely Causes, Mechanics and Outcomes (1188K, 32 pages)
Forthcoming in The World economy
We use insights from the literature on currency crises to offer an analytical treatment of the crisis in the market for Greek government bonds. We argue that the crisis itself and its escalating nature are very likely to be the result of: (a) steady deterioration of Greek macroeconomic fundamentals over 2001-2009 to levels inconsistent with longterm EMU participation,and (b) a double shift in markets. expectations, from a regime of credible commitment to future EMU participation under an implicit EMU/German guarantee of Greek fiscal liabilities, to a regime of non-credible EMU commitment without fiscal guarantees, respectively occurring in November 2009 and February/March 2010. We argue that the risk of contagion to other periphery EMU countries is significant,and that without extensive structural reforms the sustainability of the EMU is in question.
Keywords: Currency crises; bonds market; expectations; fiscal guarantees; contagion
JEL Classification: F31; F33; F34; F41; F42; F50

Cemil Selcuk (March 2010)
Motivated Sellers in the Housing Market (1141K, 29 pages)
We present a search-and-matching model of the housing market where potential buyers' willingness to pay is private information and sellers may become desperate as they are unable to sell. A unique steady state equilibrium exists where desperate sellers offer sizeable price cuts and sell faster. If the number of distressed sales rises then even relaxed sellers are forced to lower their prices. Buyers, on the other hand, become more selective and search longer for better deals. The model yields a theoretical density function of the time-to-sale, which is positively skewed and may be hump-shaped. These results are consistent with recent empirical findings.
Keywords: housing; private information; random search; motivated sellers
JEL Classification: D39; D49; D83;

Kent Matthews (February 2010, updated April 2010)
Risk Management and Managerial Efficiency in Chinese Banks: A Network DEA Framework (1161K, 38 pages)
Risk Management in Chinese banks has traditionally been the Cinderella of its internal functions. Political stricture and developmental imperative have often overridden standard practice of risk management resulting in large non-performing loan (NPL) ratios. One of the stated aims of opening up the Chinese banks to foreign strategic investment is the development of risk management functions. In recent years NPL ratios have declined through a mixture of recovery, asset management operation and expanded balance sheets. However, the training and practice of risk managers remain second class compared with foreign banks operating in China. This paper evaluates bank performance using a Network DEA approach where an index of risk management practice and an index of risk management organisation are used as intermediate inputs in the production process. The two indices are constructed from a survey of risk managers in domestic banks and foreign banks operating in China. The use of network DEA can aid the manager in identifying the stages of production that need attention.
Keywords: Risk management; risk organisation; managerial efficiency; Network DEA
JEL Classification: D23; G21; G28;

James Foreman-Peck and Peng Zhou (December 2009, updated August 2010)
The Strength and Persistence of Entrepreneurial Cultures (1213K, 34 pages)
The twentieth century United States provides a natural experiment to measure the strength and persistence of entrepreneurial cultures. Assuming immigrants bear the cultures of their birth place, comparison of revealed entrepreneurial propensities of US immigrant groups in 1910 and 2000 reflected these backgrounds. According to this test North-western Europe, where modern economic growth is widely held to have originated, did not host unusually strong entrepreneurial cultures. Instead such cultures were carried by persons originating from Greece, Turkey and Italy, together with Jews. The rise of widespread female entrepreneurship provides additional evidence by showing that this trait systematically responded less strongly, but in the same way, to cultural background as did male entrepreneurship.
Keywords: Entrepreneurship; Culture; Migration
JEL Classification: D01; J15; J23; J61

Vo Phuong Mai Le, Patrick Minford and Michael Wickens (December 2009)
Some problems in the testing of DSGE models (983K, 6 pages)
We review the methods used in many papers to evaluate DSGE models by comparing their simulated moments and other features with data equivalents. We note that they select, scale and characterise the shocks without reference to the data,crucially they fail to use the joint distribution of the features under comparison. We illustrate this point by recomputing an assessment of a two-country model in a recent paper,we find that the paper's conclusions are essentially reversed.
Keywords: Boostrap; US-EU model; DSGE; VAR; indirect inference; Wald statistic; anomaly; puzzle
JEL Classification: C12; C32; C52; E1

Jenifer Daley and Kent Matthews (December 2009)
Efficiency and Convergence in the Jamaican banking sector 1998-2007 (1140K, 24 pages)
Deregulation, re-regulation and continuing globalisation embody an imperative that banks increase efficiency to survive. We employ non-parametric bootstrap DEA to measure technical efficiency among Jamaican banks between 1998 and 2007. In addition, we test for conditional convergence to identify pointing variables for technical efficiency. Overall, the results suggest that there has been a tendency towards improvement in bank efficiency levels for the largest banks. The findings show strong evidence of conditional convergence, which means that each bank is converging to its own steady-state and that GDP growth, ownership and size are the major influences on levels of technical efficiency.
Keywords: Bank efficiency; DEA; bootstrap; convergence; Jamaica
JEL Classification: G21; G28

Jenifer Daley and Kent Matthews (December 2009)
Measuring post-crisis productivity for Jamaican banks (1323K, 22 pages)
The study examines the changes to total factor productivity of Jamaican banks between 1998 and 2007. Using Data Envelopment Analysis with bootstrap to construct a Malmquist index, bank productivity is measured and decomposed into technical progress and efficiency. The results suggest an inconsistent growth pattern for banks between 1998 and 2007 driven mainly by efficiency gains in the immediate post-crisis period to 2002, and by technological progress towards the end of the sample period. The second largest banks along with merchant and locally-owned banks showed significant productivity growth in some models, with modest growth for commercial and foreign-owned banks.
Keywords: Bank productivity; Malmquist Productivity index; DEA; bootstrapping; Jamaica
JEL Classification: G21; G28

Jenifer Daley and Kent Matthews (December 2009)
Out of many, dominance by a few? Market power in the Jamaican banking sector. (1124K, 23 pages)
This paper presents an empirical assessment of the degree of competition within the Jamaican banking sector during the period 1998 to 2007. The popular H-statistic by Panzar and Rosse is utilised to estimate market power among the sample of banks. Using usual statistical tests, we are unable to reject monopoly/perfect collusion for the banking market in Jamaica. This contrasts with earlier findings using alternative estimators. Therefore, the use of a dynamic reformulation of the model with a dynamic estimator highlights some collusive behaviour among banks.
Keywords: Competition; banking; Rosse-Panzar H-statistic; Dynamic panel estimation; Jamaica
JEL Classification: G21; G28

Kent Matthews and Owen Matthews (December 2009)
Controlling Banker's Bonuses: Efficient Regulation or Politics of Envy? (1003K, 21 pages)
Published in Economic Affairs, 30, 1, March, 2010, 71-76
The positive relationship between bank CEO compensation and risk taking is a well established empirical fact. The global banking crisis has resulted in a chorus of demands to control banker's bonuses and thereby curtail their risk taking activities in the hope that the world can avoid a repeat in the future. However, the positive relationship is not a causative one. In this paper we argue that the cushioning of banks downside risks provide the incentive for banks to take excessive risk and design compensation packages to deliver high returns. Macro-prudential regulation will have a better chance of curbing excess risk taking than controlling banker's compensation.
Keywords: Banker's bonus;risk taking;Too-big-to-Fail;macro-prudential regulation
JEL Classification: G21; G28

Jingwen Fan and Patrick Minford (November 2009, updated March 2011)
Can the Fiscal Theory of the price level explain UK inflation in the 1970s? (1207K, 28 pages)
We investigate whether the Fiscal Theory of the Price Level can explain UK inflation in the 1970s. We find that fiscal policy was non-Ricardian and money growth entirely endogenous in this period. The implied model of inflation is tested in two ways: for its trend using cointegration analysis and for its dynamics using the method of indirect inference. We find that it is not rejected. We also find that the model's errors indicate omitted dynamics which merit further research.
Keywords: UK Inflation; Fiscal Theory of the Price Level; Bootstrap simulation; Indirect inference; Wald statistic
JEL Classification: E31; E37; E62; E65

Szilárd Benk, Max Gillman and Michal Kejak (November 2009)
A Banking Explanation of the US Velocity of Money: 1919-2004 (1231K, 33 pages)
The paper shows that US GDP velocity of M1 money has exhibited long cycles around a 1.25% per year upward trend, during the 1919-2004 period. It explains the velocity cycles through shocks constructed from a DSGE model and annual time series data (Ingram et al., 1994). Model velocity is stable along the balanced growth path, which features endogenous growth and decentralized banking that produces exchange credit. Positive shocks to credit productivity and money supply increase velocity, as money demand falls, while a positive goods productivity shock raises temporary output and velocity. The paper explains such velocity volatility at both business cycle and long run frequencies. With filtered velocity turning negative, starting during the 1930s and the 1987 crashes, and again around 2003, results suggest that the money and credit shocks appear to be more important for velocity during less stable times and the goods productivity shock more important during stable times.
Keywords: Volatility; business cycle; credit shocks; velocity
JEL Classification: E13; E32; E44

Jenifer Daley and Kent Matthews (November 2009)
Measuring bank efficiency: tradition or sophistication? - A note (1105K, 11 pages)
The recent literature on measuring bank performance indicates a preference for sophisticated techniques over simple accounting ratios. We explore the results and relationships between bank efficiency estimates using accounting ratios and Data Envelope Analysis (DEA) with bootstrap among Jamaican banks between 1998 and 2007. The results indicate different outcomes for the traditional accounting ratios and the sophisticated DEA methodology in the measurement of bank efficiency. GLS random effects two-variable regression tests for superiority using a risk index for insolvency suggest an advantage in favour of the DEA.
Keywords: Bank efficiency; Jamaica; Accounting Ratios
JEL Classification: G21; G28; G29

Michael G Arghyrou, Andros Gregoriou and Panayiotis M. Pourpourides (November 2009)
Exchange rate uncertainty and deviations from Purchasing Power Parity: Evidence from the G7 area (1124K, 14 pages)
Arghyrou, Gregoriou and Pourpourides (2009) argue that exchange rate uncertainty causes deviations from the law of one price. We test this hypothesis on aggregate data from the G7-area. We find that exchange rate uncertainty explains to a significant degree deviations from Purchasing Power Parity.
Keywords: Purchasing power parity; exchange rate uncertainty
JEL Classification: F31; F41

Vo Phuong Mai Le, Patrick Minford and Michael Wickens (November 2009)
The 'Puzzles' methodology: en route to Indirect Inference? (1305K, 24 pages)
We review the methods used in many papers to evaluate DSGE models by comparing their simulated moments with data moments. We compare these with the method of Indirect Inference to which they are closely related. We illustrate the comparison with contrasting assessments of a two-country model in two recent papers. We conclude that Indirect Inference is the proper end point of the puzzles methodology.
Keywords: Bootstrap; US-EU model; DSGE; VAR; indirect inference; Wald statistic; anomaly; puzzle
JEL Classification: C12; C32; C52; E1

Patrick Minford and Naveen Srinivasan (October 2009, updated April 2011)
Determinacy in New Keynesian models: a role for money after all? (1073K, 25 pages)
The New-Keynesian Taylor-Rule model of inflation determination with no role for money is incomplete. As Cochrane (2007a) argues, it has no credible mechanism for ruling out bubbles and as a results fails to provide a reason for private agents to pick a unique stable path. We propose a way forward. Our proposal is in effect that the New-Keynesian model should be formulated with a money demand and money supply function. It should also embody a terminal condition for money supply behaviour. If an unstable path occurred the central bank would switch to a money supply Rule explicitly designed to stop it via the terminal condition. This would be therefore a 'threat/trigger strategy' complementing the Taylor Rule - only to be invoked if inflation misbehaved. Thus we answer the criticisms levelled at the Taylor Rule that it has no credible mechanism for ruling out bubbles. However it does imply that money cannot be avoided int he New Keynesian set-up, contrary to Woodford (2008).
Keywords: New-Keynesian; Taylor Rule; Determinacy
JEL Classification: E31; E52; E58

Huw David Dixon (October 2009)
A unified framework for understanding and comparing dynamic wage and price setting models (1205K, 45 pages)
This paper argues that the cross-sectional approach to durations is essential to understand nominal rigidity because this captures the fact that price-spells are generated by firms' price-setting behavior. Since the distribution of durations is dominated by a proliferation of short contracts, the cross-sectional measure corrects for this by length-biased sampling. Modelling the price-spell durations in this way enables us to see how Taylor, Calvo and their generalizations relate to each other, and enable us to compare price-setting behavior for a given distribution of durations. We also show how the micro-data can be directly related to the macroeconomic pricing models in this setting.
Keywords: Price-spell; steady state; hazard rate; Calvo; Taylor
JEL Classification: E50

Patrick Minford and Zhirong Ou (September 2009, updated May 2010)
Taylor Rule or Optimal Timeless Policy? Reconsidering the Fed's behaviour since 1982 (1530K, 37 pages)
We calibrate a standard New Keynesian model with three alternative representations of monetary policy - an optimal timeless rule, a Taylor rule and another with interest rate smoothing - with the aim of testing which if any can match the data according to the method of indirect inference. We find that the only model version that fails to be strongly rejected is the optimal timeless rule. Furthermore this version can also account for the widespread finding of apparent 'Taylor rules' and 'interest rate smoothing' in the data, even though neither represents the true monetary policy
Keywords: Monetary policy; Kew Keynesian model; the 'target rule'; Taylor-type rules; Bootstrap simulation; VAR; Indirect inference; Wald statistic
JEL Classification: E12; E17; E42; E52; E58
See also: Supporting Annex

Rhys ap Gwilym (September 2009)
The Monetary Policy Implications of Behavioral Asset Bubbles (1391K, 39 pages)
I introduce behavioral asset pricing rules into a wider dynamic stochastic general equilibrium framework. Asset price bubbles emerge endogenously within the model. I find that in this model the only monetary policy that would be likely to enhance welfare is a counter-intuitive 'running with the wind' policy. I conclude that the optimal policy is highly dependent on the nature of the behavioral rules that are stipulated. Given that monetary authorities have limited information about the ways in which agents actually behave, a systematic monetary policy response to asset price misalignments is unlikely to enhance welfare.

Rhys ap Gwilym (September 2009)
Can behavioral finance models account for historical asset prices? (1129K, 10 pages)
I construct a behavioral model of asset pricing in which agents choose whether to base their expectations on chartist or fundamental forecasts. I simulate the model in order to test its efficacy in explaining the moments and time series properties of the FTSE All-Share index, and find that the model cannot be rejected as the data generating process.
Keywords: Behavioral finance; Asset pricing
JEL Classification: G12; D03

Parantap Basu, Max Gillman and Joseph Pearlman (September 2009)
Inflation, Human Capital and Tobin's q (1130K, 36 pages)
A pervasive empirical finding for the US economy is that inflation is negatively correlated with the normalized market price of capital (Tobin's q) and growth. A dynamic stochastic general equilibrium model of endogenous growth is developed to explain these stylized facts. In this model, human capital is the principal driver of self-sustained growth. Long run comparative statics analysis suggests that inflation diverts scarce time resource to leisure which lowers human capital utilization. This impacts growth adversely and modulates capital adjustment cost downward resulting in a decline in Tobin's q. For the short run, a Tobin effect of inflation on growth weakens the negative association between inflation and q.

James Foreman-Peck (September 2009)
The Western European Marriage Pattern and Economic Development (1139K, 32 pages)
For several centuries, women's age at first marriage in Western Europe was higher than in the east (and in the rest of the world). Over the same period Western Europe began slow but sustained economic development relative to elsewhere. A model based on the economics of the household explains this association in two related ways. Both connect mortality, and the exercise of fertility restraint through higher marriage age, with greater human capital accumulation. The first explanation is simply an association but the second proposes a causal link where higher age of motherhood reduced the cost of investment in children. Evidence is provided that the causal process was operative in later nineteenth century Europe
Keywords: Human Capital; Household Production; Economic Development; 19th Century Europe
JEL Classification: N13; N33; O15; J12; J24

Kent Matthews and Nina Zhang (September 2009)
Bank Productivity in China 1997-2007: An Exercise in Measurement (1281K, 41 pages)
This study examines the productivity growth of the nationwide banks of China and a sample of city commercial, banks for the eleven years to 2007. Estimates of total factor productivity growth are constructed with appropriate confidence intervals, using a bootstrap method for the Malmquist index. The study adjusts for the quality of the output by accounting for the non-performing loans on the balance sheets of the banks and tests for the robustness of the results by examining alternative sets of outputs. The productivity growth of the state-owned commercial banks (SOCBs) is compared with the joint-stock banks (JSCBs) and city commercial banks (CCBs). The results show that average total factor productivity for the joint-stock banks was better than that of the state-owned banks for some models of measurement but not others. But the average city commercial banks improved its productivity growth both in terms of frontier shift and efficiency gain throughout the whole period. The study also shows that individual state-owned and joint-stock banks did improve their productivity growth and defined an improving production frontier. Most other banks lagged behind so that the gap between the inefficient banks and the most efficient banks widened. While individual banks improved their productivity growth there is no evidence that the average productivity growth of Chinese banks as a whole improved in the run-up to WTO.
Keywords: Bank Efficiency; Productivity; Malmquist index; Bootstrap
JEL Classification: D24; G21;

Kent Matthews, Zhiguo Xiao and Xu Zhang (September 2009)
Rational Cost Inefficiency in Chinese Banks (1262K, 34 pages)
According to a frequently cited finding by Berger et al (1993), X-inefficiency contributes 20% to cost-inefficiency in western banks. Empirical studies of Chinese banks tend to place cost-inefficiency in the region of 50%. Such estimates would suggest that Chinese banks suffer from gross cost inefficiency. Using a non-parametric bootstrapping method, this study decomposes cost-inefficiency in Chinese banks into X-inefficiency and allocative-inefficiency. It argues that allocative inefficiency is the optimal outcome of input resource allocation subject to enforced employment constraints. The resulting analysis suggests that allowing for rational allocative inefficiency,Chinese banks are no better or worse than their western counterparts.
Keywords: Bank Efficiency; China; X-inefficiency; DEA; Bootstrapping
JEL Classification: D23; G21; G28

James Foreman-Peck and Simon Moore (August 2009)
Gratuitous Violence and the Rational Offender Model (1214K, 32 pages)
Rational offender models assume that individuals choose whether to offend by weighing the rewards against the chances of apprehension and the penalty if caught. While evidence indicates that rational theory is applicable to acquisitive crimes, the explanatory power for gratuitous non-fatal violent offending has not been evaluated. Lottery-type questions elicited risk attitudes and time preferences from respondents in a street survey. Admitted violent behaviour was predictable on the basis of some of these responses. Consistent with the rational model, less risk averse and more impatient individuals were more liable to violence. Such people were also more likely to be victims of violence. In line with a 'subjective' version of the rational model, respondents with lower estimates of average violence conviction chances and of fines were more prone to be violent.
Keywords: Violence; alcohol; risk; intertemporal choice; rational offending
JEL Classification: D81; D9; K14

David R. Collie (July 2009)
Immiserizing Growth and the Metzler Paradox in the Ricardian Model (1150K, 25 pages)
Forthcoming in International Economic Journal
Conditions for the occurrence of immiserizing growth and the Metzler paradox are analysed in the Ricardian model when consumers in the foreign country have Leontief preferences while consumers in the home country have Cobb-Douglas preferences. By using specific functional forms, the conditions for the occurrence of the two paradoxes are defined in terms of the exogenous parameters of the model rather than endogenous variables such as the elasticity of demand for exports in the conditions of Bhagwati (1958) and Metzler (1949a and b). It is shown that the simultaneous occurrence of both paradoxical results is possible for some parameter values.
Keywords: Immiserizing Growth; Metzler Paradox; Import Tariffs; Ricardian Model
JEL Classification: F11; F13

Patrick Minford (July 2009)
The Banking Crisis - A Rational Interpretation (1010K, 9 pages)
Published in Political Studies Review, vol. 8(1) (2010), 40-54
Modern macroeconomic models have been widely criticised as relying too much on rationality and market efficiency. However, basically their predictions about this crisis are being borne out by events. 'Crashes' are an integral part of an 'efficient market' capitalism and are brought on by swings in the news about productivity growth,this time nearly two decades of strong computer-based productivity growth were brought to a crashing halt by raw material shortages. This presages a slow recovery until innovation in material use frees growth up again as it did in the 1990s after the shortages of the 1970s.
Keywords: Macroeconomic models; Banking Crisis
JEL Classification: E0

Mark A Clatworthy, Christopher K.M. Pong and Woon K. Wong (August 2009, updated October 2011)
Auditor Quality and the Role of Accounting Information in Explaining UK Stock Returns (1380K, 34 pages)
In this paper, we examine the relative importance of the cash flow and accruals components of earnings in explaining the variation in UK company equity returns, together with the extent to which these relationships vary by auditor quality. We use a multivariate time-series approach that can be reconciled to a log-linear theoretical valuation model and, unlike the standard linear regression of returns on earnings components, accommodates time varying discount rates. Based on a decomposition of the variance of equity returns, cash flows and accruals, our results indicate that both cash flow news and accruals news are important drivers of equity returns, though cash flows are more influential than accruals. We also find that auditor quality moderates these relationships, since variation in both earnings components has a more significant effect for clients of large auditors. Finally, our results indicate that the impact of auditor quality is highest for the accruals component of earnings.

David R. Collie (June 2009)
Tacit Collusion over Foreign Direct Investment under Oligopoly (1308K, 36 pages)
A two-country model of the FDI versus export decisions of firms is analysed. The analysis considers both the Cournot duopoly and the Bertrand duopoly models with differentiated products. It is shown that the static game is often a prisoners' dilemma where both firms are worse off when they both undertake FDI. To avoid the prisoners' dilemma, in an infinitely-repeated game, the firms can collude over their FDI versus export decisions. Then, a reduction in trade costs may lead firms to switch from exporting to undertaking FDI when trade costs are relatively high. Also, collusion over FDI may increase welfare.
Keywords: Collusion; Trade Liberalisation; Foreign Direct Investment; Cournot Oligopoly; Bertrand Oligopoly; Infinitely-Repeated Game
JEL Classification: F12; F23; L13; L41; M16

Saeed Al-Muharrami and Kent Matthews (June 2009)
Market Power versus Efficient-Structure in Arab GCC Banking (978K, 21 pages)
Copyright NoticeAuthor Posting. (c) 'Copyright Holder', 2009.
This is the author's version of the work. It is posted here by permission of 'Copyright Holder' for personal use, not for redistribution.
The definitive version was published in Applied Financial Economics, Volume 19 Issue 18, September 2009. doi:10.1080/09603100902845478
Published in Applied Financial Economics, Volume 19 Issue 18, September 2009, pp. 1487-1496.
This paper evaluates the performance of the Arab GCC banking industry in the context of the Structure-Conduct-Performance hypothesis in the period 1993-2002. The paper uses panel estimation differentiating between bank fixed effects and country fixed effects. It examines the Relative-Market-Power and the Efficient-Structure hypotheses differentiating between the two by employing a non-parametric measure of technical efficiency, and finds that the banking industry in the Arab GCC countries is best explained by the mainstream SCP hypothesis. The empirical results do not find any support for the Hicks (1935) "Quiet Life" version of the market power hypothesis.
Keywords: GCC Banking; Structure Conduct Performance
JEL Classification: G2; L1

GuangJie Li and Roberto Leon-Gonzalez (March 2009)
A Correction Function Approach to Solve the Incidental Parameter Problem (1411K, 44 pages)
Following Lancaster (2002), we propose a strategy to solve the incidental parameter problem. The method is demonstrated under a simple panel Poisson count model. We also extend the strategy to accomodate cases when information orthogonality is unavailable, such as the linear AR(p) panel model. For the AR(p) model, there exists a correction function to fix the incidental parameter problem when the model is stationary with strictly exogenous regressors. MCMC algorithms are developed for parameter estimation and model comparison. The results based on the simulated data sets suggest that our method could achieve consistency in both parameter estimation and model selection.
Keywords: dynamic panel data model with fixed effect; incidental parameter problem; consistency in estimation; model selection; Bayesian model averaging; Markov chain Monte Carlo (MCMC)
JEL Classification: C52; C11; C12; C13; C15

GuangJie Li (March 2009)
Consistent Estimation, Model Selection and Averaging of Dynamic Panel Data Models with Fixed Effect (1322K, 44 pages)
In the context of an autoregressive panel data model with fixed effect, we examine the relationship between consistent parameter estimation and consistent model selection. Consistency in parameter estimation is achieved by using the transformation of the fixed effect proposed by Lancaster (2002). We find that such transformation does not necessarily lead to consistent estimation of the autoregressive coefficient when the wrong set of exogenous regressors are included. To estimate our model consistently and to measure its goodness of fit, we argue for comparing different model specifications using the Bayes factor rather than the Bayesian information criterion based on the biased maximum likelihood estimates. When the model uncertainty is substantial, we recommend the use of Bayesian Model Averaging. Finally, we apply our method to study the relationship between financial development and economic growth. Our findings reveal that stock market development is positively related to economic growth, while the effect of bank development is not as significant as the classical literature suggests.
Keywords: dynamic panel data model with fixed effect; incidental parameter problem; consistency in estimation; model selection; Bayesian Model Averaging; finance and growth
JEL Classification: C52; C11; C13; C15

GuangJie Li (March 2009, updated August 2009)
The Horizon Effect of Stock Return Predictability and Model Uncertainty on Portfolio Choice: UK Evidence (1391K, 44 pages)
We study how stock return's predictability and model uncertainty affect a rational buy-and-hold investor.s decision to allocate her wealth for different lengths of investment horizons in the UK market. We consider the FTSE All-Share Index as the risky asset, and the UK Treasury bill as the risk free asset in forming the investor's portfolio. We identify the most powerful predictors of the stock return by accounting for model uncertainty. We find that though stock return predictability is weak, it can still affect the investor's optimal portfolio decision over different investment horizons.
Keywords: stock return predictability; portfolio choice; Bayesian Model Averaging; SUR model
JEL Classification: C11; G11; G15

Vo Phuong Mai Le, David Meenagh, Patrick Minford and Michael Wickens (March 2009, updated December 2009)
Two Orthogonal Continents: Testing a Two-country DSGE Model of the US and EU Using Indirect Inference (1768K, 51 pages)
Published in Open Economies Review 21(1) pp. 23-44 February 2010.
We examine a two country model of the EU and the US. Each has a small sector of the labour and product markets in which there is wage/price ridigity, but otherwise enjoys flexible wages and prices with a one quarter information lag. Using a VAR to represent the data, we find the model as a whole rejected. Howerver it is accepted for particular features of the data, such as output and (marginally) inflation behaviour. The model highlights a lack of spillovers between the US and the EU.
Keywords: Bootstrap; Open economy model; DGSE; VAR; New Keynesian; New Classical; indirect inference; Wald statistic
JEL Classification: C12; C32; C52; E1

Michael G Arghyrou, Andros Gregoriou and Panayiotis M. Pourpourides (January 2009, updated July 2009)
A new solution to the purchasing power parity puzzles? Risk-aversion, exchange rate uncertainty and the law of one price: Insights from the market of online air-travel tickets (1188K, 27 pages)
Forthcoming in Canadian Journal of Economics
We argue that even in perfectly frictionless markets risk aversion driven by exchange rate uncertainty may cause a wedge between the domestic and foreign price of a totally homogeneous good. We test our hypothesis using a natural experiment based on a unique micro-data set from a market with minimum imperfections. The empirical findings validate our hypothesis, as accounting for exchange rate uncertainty we are able to explain a substantial proportion of deviations from the law of one price. Overall, our analysis suggests the possibility of a new solution to the purchasing power parity puzzles.
Keywords: Law of one price; purchasing power parity; risk aversion; exchange rate uncertainty
JEL Classification: F31; F41

Vo Phuong Mai Le, Patrick Minford and Eric Nowell (January 2009)
Economic Policy: protectionism as an elite strategy (1128K, 22 pages)
Published in The European Union and World Politics (eds. Andrew Gamble and David Lane), Palgrave Macmillan, ISBN 9780230221499, 2009
The EU has pursued protectionist policies not merely in food but also in manufacturing at the customs union level. In services it has not dismantled much of the existing national protectionism. The economic costs are calculated here at some 3% of GDP for the UK and some 4% for the rest of the EU - or much larger under liberal planning assumptions. Added to its social interventionism, these costs suggest that the EU has put political integration before economic efficiency. This policymaking pattern suggests that European elites believe their position would be threatened by the domestic effects of world competition.
Keywords: protectionism; manufactures; anti-dumping; tariff equivalent; customs union; competition
JEL Classification: F13; F14

Vo Phuong Mai Le, David Meenagh, Patrick Minford and Michael Wickens (December 2008, updated July 2011)
How much nominal rigidity is there in the US economy? Testing a New Keynesian DSGE Model using indirect inference (1327K, 37 pages)
Forthcoming in Journal of Economic Dynamics and Control
We evaluate the Smets-Wouters New Keynesian model of the US postwar period, using indirect inference, the bootstrap and a VAR representation of the data. We find that the model is strongly rejected. While an alternative (New Classical) version of the model fares no better, adding limited nominal rigidity to it produces a `weighted' model version closest to the data. But on data from 1984 onwards - the `great moderation' - the best model version is one with a high degree of nominal rigidity, close to New Keynesian. Our results are robust to a variety of methodological and numerical issues.
Keywords: Bootstrap; US model; DGSE; VAR; New Keynesian; New Classical; indirect inference; Wald statistic; regime change; structural break; great moderation
JEL Classification: C12; C32; C52; E1
See also: Supporting Annex

Eric Scheffel (December 2008)
Consumption Velocity in a Cash Costly-Credit Model (1447K, 34 pages)
In a seminal study Hodrick et al. (1991) evaluate the ability of a simple cash-credit model to produce realistic variability in consumption velocity while at the same time successfully explaining other key statistics. Sufficient variability in the latter is found to be associated with far too volatile interest rate behaviour. Introducing habit-formation in consumption into a production-based cash costly-credit model (see Gillman and Benk, 2007) makes the evolution of deposits more rigid relative to credit. The same deposit rigidity leads to a more volatile price of credit, causing credit production overshooting relative to deposits. But only by introducing adjustment costs to investment in addition to habit persistence does credit production overshoot sufficiently to produce realistic variability in consumption velocity. The model succeeds in capturing sufficient variability in consumption velocity without obtaining too volatile interest rates. Also, this model of endogenous velocity does not suffer from indeterminacy problems discussed in Auray et al. (2005). In contrast to Gillmand and Benk (2007), the present study examies the role of the price-channel of credit production at business cycle frequency, ignoring or holding fixed the marginal cost channel stemming from credit productivity shocks.
Keywords: Velocity; Consumption; Interest Rates
JEL Classification: E0; E2; E3; E4

Eric Scheffel (December 2008)
A Credit-Banking Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles (1725K, 67 pages)
Micro-founded de-centralized financial intermediation in a cash and costly-credit model (see Gillmand and Kejak, 2008) results in a cost-distortion of returns implying a lower average nominal and real risk-free rate when compared to standard cah-in-advance RBC models. Failure of both short-run and long-run Fisher equation relationships based on observable real and nominal rates and inflation are obtained. The cost-distortion also leads to an unconditionally upward-sloping average yield curve of interest rates which is also convex in shape. The model is capable of producing a positive correlation between the nominal rate and velocity, and a negative correlation between the ex-post real rate and inflation. More importantly, the model also predicts a negative correlation between the ex-ante real rate and the ex-ante expected rate of inflation. Finally, the condition spread between the usual CCAPM rate as defined by Canzoneri and Diba (2005) and the model-implied money market rate is positively correlated with the stance of monetary policy, offering a new perspective on this systematic link recently studied empirically by Canzoneri et al. (2007a) and theoretically by Canzoneri and Diba (2005).
Keywords: Business cycles;Money;Term structure of interest rates
JEL Classification: E4; E44

Kul B Luintel and Mosahid Khan (December 2008)
Heterogeneous Ideas Production and Endogenous Growth: An Empirical Investigation (1103K, 47 pages)
Published in Canadian Journal of Economics, vol. 42 (2009), 1176-1205
We examine the dynamics of ideas production and knowledge-productivity relationship in a panel of 19 OECD countries. A new data set of triadic patents is used. We rigorously address the issues of cross-country heterogeneity and endogeneity. Domestic and foreign ideas stocks exert positive but heterogeneous effects on ideas production. We find evidence of duplicate R&D but little support for endogenous growth. Countries with low domestic ideas bases could considerably improve productivity through ideas accumulation,however, this effect is modest for countries with sizeable ideas bases. An implication is that country-specific R&D policy appears potentially more effective than the one-size-fits-all approach.
Keywords: Knowledge Stocks;Dynamic Heterogeneity;TFP;Methods of Moments
JEL Classification: F12; F2; O3; O4; C15

Szilárd Benk, Max Gillman and Michal Kejak (November 2008)
US Volatility Cycles of Output and Inflation, 1919-2004: A Money and Banking Approach to a Puzzle (1525K, 43 pages)
The post-1983 moderation coincided with an ahistorical divergence in the money aggregate growth and velocity volatilities away from the downward trending GDP and inflation volatilities. Using an endogenous growth monetary DSGE model, with micro-based banking production, enables a contrasting characterization of the two great volatility cycles over the historical period of 1919-2004, and enables this puzzle to be addressed more easily. The volatility divergence is explained by the upswing in the credit volatility that kept money supply variability from translating into inflation and GDP volatility.
Keywords: Volatility; money and credit shocks; growth; inflation
JEL Classification: E13; E32; E44

David R. Collie and Vo Phuong Mai Le (November 2008)
Anti-Dumping Regulations: Anti-Competitive and Anti-Export (996K, 20 pages)
Published in Review of International Economics, Vol. 18, No. 5, 2010, pp. 796-806.
In a Bertrand duopoly model, it is shown that an anti-dumping regulation can be strategically exploited by the domestic firm to reduce the degree of competition in the domestic market. The domestic firm commits not to export to the foreign market which gives the foreign firm a monopoly in its own market. As a result the foreign firm will increase its price allowing the domestic firm to increase its price and its profits. If the products are sufficiently close substitutes then the higher profits in the domestic market are large enough to compensate for the loss of profits on exports.
Keywords: anti-dumping regulations; Bertrand oligopoly; strategic behaviour
JEL Classification: F13; L13

Kent Matthews, Jianguang Guo and Xu Zhang (November 2008)
X-efficiency versus Rent Seeking in Chinese banks: 1997-2006 (1195K, 34 pages)
This study demarcates cost-inefficiency in Chinese banks into X-inefficiency and rent-seeking-inefficiency. A protected banking market not only encourages weak management and X-inefficiency but also public ownership and state directed lending encourages moral hazard and bureaucratic rent seeking. This paper uses bootstrap non-parametric techniques to estimate measures of X-inefficiency and rent-seeking inefficiency for the 4 state owned banks and 10 joint-stock banks over the period 1997-2006. The paper adjusts for the quality of loans by treating NPLs as a negative output. The paper shows that Chinese banks have reduced cost inefficiency and reduced X-inefficiency at a faster rate than rent-seeking inefficiency.
Keywords: Bank Efficiency;China;X-inefficiency;DEA;Bootstrapping
JEL Classification: D23; G21; G28;

Max Gillman and Mark N. Harris (October 2008)
The Effect of Inflation on Growth: Evidence from a Panel of Transition Countries (1065K, 20 pages)
Published in Economics of Transition, Volume 18, Issue 4 (October), pages 697-714.
The paper examines the effect of inflation on growth in transition countries. It presents panel data evidence for 13 transition countries over the 1990-2003 period,it uses a fixed effects, full-information maximum likelihood, panel approach to account for possible bias from correlations among the unobserved effects and the observed country heterogeniety. The results find a strong, robust, negative effect of inflation on growth, and one that declines in magnitude as the inflation rate increases. These results include a role for a normalized money demand, by itself and as part of a nonlinearity in the inflation-growth effect. And these results derive from both a baseline single equation model and one that is then expanded into a three equation simultaneous system. This allows for possible simultaneity bias in the baseline model.
Keywords: Growth; transition; panel data; inflation; money demand; endogeneity
JEL Classification: C23; E44; O16; O42

Soubarna Pal (October 2008)
Does Public Investment Boost Economic Growth? Evidence from An Open-Economy Macro Model for India (1109K, 30 pages)
Using annual data for India for the period 1984-2003 and employing parametric technique (GMM), the present paper jointly determines GDP growth, real exchange rate and net foreign assets in Indian economy. There is evidence that public investment exerts a significant influence on real exchange rate and the growth rate and does so non-linearly. A comparison of the Indian estimates with those available for the UK and the USA economies is also revealing and highlights the role of governance on the effects of public investment.
Keywords: Public investment;Economic growth;Real exchange rate;Simultaneous model;Generalised method of moments

Michael G Arghyrou and Maria Dolores Gadea (October 2008)
The single monetary policy and domestic macro-fundamentals: Evidence from Spain (1202K, 33 pages)
We model pre-euro Spanish monetary policy and use our findings to assess the compatibility of the interest rates set by the ECB since 1999 with Spanish macrofundamentals. We find that in the 1990s Spain implemented successfully a monetary strategy tailored to its own domestic fundamentals,and by abolishing it to join the euro she has paid a cost in the form of a sub-optimal monetary policy. Spain.s experience suggests a cautious approach with regards to the timing of further EMU enlargement.
Keywords: Spain;ECB;monetary policy;domestic fundamentals;compatibility
JEL Classification: C51; C52; E43; E58; F37

Huw David Dixon and Engin Kara (September 2008)
Can we explain inflation persistence in a way that is consistent with the micro-evidence on nominal rigidity? (1109K, 27 pages)
Published in Journal of Money, Credit and Banking, Volume 42, Number 1, February 2010 , pp. 151-170.
This paper adopts the Impulse-Response methodology to understand inflation persistence. It has often been argued that existing models of pricing fail to explain the persistence that we observe. We adopt a common general framework which allows for an explicit modelling of the distribution of contract lengths and for different types of price setting. We also evaluate how far the theories are consistent with recent evidence on price and wage rigidity. We find that allowing for a distribution of durations can take us a long way to solving the puzzle of inflation persistence, but not all the way yet.
Keywords: DSGE models; inflation; persistence; price-setting
JEL Classification: E17; E3

Paulo Brito, Luís F. Costa and Huw David Dixon (September 2008, updated July 2010)
Non-smooth Dynamics and Multiple Equilibria in a Cournot-Ramsey Model with Endogenous Markups (1330K, 47 pages)
We consider a Ramsey model with a continuum of Cournotian industries where free entry generates an endogenous markup. The model produces two different regimes: monopoly and oligopoly. We study the non-smooth dynamics and analyze the global dynamics of the model, demonstrating the model exhibits robust heteroclinic orbits, either of the smooth or the non-smooth type. Similar economies may be in any of these regimes and they may change regime along its convergence path. Productivity, fixed costs and elasticities of demand, play a crucial role and changing their values may induce a discontinuous transition or hysteresis.
Keywords: endogenous mark-ups; non-smooth dynamics; discontinuous induced bifurcations; heteroclinic orbits
JEL Classification: C62; D43; E32

Michael C. Hatcher (September 2008)
Speed Limit Policies versus Inflation Targeting: A Free Lunch? (982K, 13 pages)
Inflation targeting is currently popular with central banks. Is this popularity justified? I investigate this question by comparing a speed limit policy and inflation targeting with a Lucas-type Phillips curve capturing output gap persistence. If the output gap is at least moderately persistent, a speed limit policy can: (1) partly eliminate the state-contingent inflation bias, and (2) reduce inflation variability at no output gap variability cost.
Keywords: inflation targeting;speed limit policy;inflation bias;discretion;stabilisation
JEL Classification: E50; E52; E58

Christopher Otrok and Panayiotis M. Pourpourides (August 2008, updated March 2009)
On The Cyclicality of Real Wages and Wage Differentials (1191K, 34 pages)
We show that two models of the labor market, a Walrasian model and a labor contracting model, both have an approximate dynamic factor structure. We use this result to motivate our empirical approach to estimating the cyclical properties of real wages, which does not impose any structure between real wages and observed cyclical indicators. In particular, we employ a Bayesian dynamic factor model and longitudinal microdata to estimate common latent factors driving real wages. We find that the comovement of real wages is related to a common factor that exhibits a mild correlation with the national unemployment rate. Our findings indicate that overall, roughly half of the wages move procyclically while half move countercyclically. In addition, we find that the estimated common factor can explain only a small portion of wage variability. We conclude that these facts are inconsistent with the prediction of a Walrasian labor market model, but consistent with the prediction of a labor contracting model. Finally, our findings suggest that although skilled and unskilled wages are driven by different common skill factors, these factors cannot explain a significant portion of wage variability.
Keywords: Wages; Wage Differentials; Business Cycles; Bayesian Analysis
JEL Classification: C11; C13; C22; C23; C81; C82; J31

Max Gillman and Michal Kejak (August 2008, updated October 2008)
Inflation, Investment and Growth: a Banking Approach (1191K, 35 pages)
Published in Economica, 78 (310, April 2011): 260-282.
Output growth, investment and the real interest rate are all found empirically to be negatively affected by inflation. But a seeming puzzle arises of opposite Tobin-like inflation effects because theory indicates a negative Tobin effect when investment falls and a positive Tobin effect when the real interest rate rises. We define inflation's Tobin effect more specifically in terms of the effect on the capital to effective labor ratio and resolve the puzzle by showing the simultaneous occurrence of all three negative inflation effects, on growth, investment and real interest rates, in a model calibrated to postwar US data. Here, investment along with consumption are exchanged for within a monetary endogenous growth economy with human capital and a decentralized credit-producing sector.
Keywords: Inflation; investment; growth; Tobin
JEL Classification: C23; E44; O16; O42

Kent Matthews, Jianguang Guo and Nina Zhang (November 2007, updated August 2008)
Non-Performing Loans and Productivity in Chinese Banks: 1997-2006 (1188K, 43 pages)
Published in The Chinese Economy, 42, 2, pp. 30-47
This study examines the productivity growth of the nationwide banks of China over the ten years to 2006. Using a bootstrap method for the Malmquist index estimates of productivity growth are constructed with appropriate confidence intervals. The paper adjusts for the quality of the output by accounting for the non-performing loans on the balance sheets and test for the robustness of the results by examining alternative sets of outputs. The productivity growth of the state-owned banks is compared with the Joint-stock banks and it determinants evaluated. The paper finds that average productivity of the Chinese banks improved modestly over this period. Adjusting for the quality of loans, by treating NPLs as an undesirable output, the average productivity growth of the state-owned banks was zero or negative while productivity of the Joint-Stock banks was markedly higher.
Keywords: Bank Efficiency; Productivity; Malmquist index; Bootstrapping
JEL Classification: D24; G21;

Patrick Minford (July 2008)
Commentary on Economic Projections and Rules of Thumb for Monetary Policy (by Athanasios Orphanides and Volker Wieland)
The Taylor rule is widely seen as a good summary of what the Federal Reserve does. Though the rule cannot easily be fitted to actual data as subsequently revised, at least for a full postwar sample, it can be fitted to real-time data (i.e., data as seen at the time), as shown by earlier work by Orphanides (2003). But in practice the Fed.s Federal Open Market Committee (FOMC), if it is using a Taylor rule, will look at its own forecasts or projections. Orphanides and Wieland (2008) examine whether a Taylor rule can be fitted to the FOMC.s own projections since 1988. They find that it can with appropriate parameters that satisfy the Taylor principle.that is, that give a unique stable solution under rational expectations. Furthermore, they find that the rule works better with these projections and resolves various puzzles regarding the data on outcomes.

Max Gillman and Anton Nakov (July 2008, updated November 2009)
Monetary Effects on Nominal Oil Prices (1151K, 30 pages)
Published in North American Journal of Economics and Finance, December 2009, Vol 20, Issue 3, pp. 239-254
The paper presents a theory of nominal asset prices for competitively owned oil. Focusing on monetary effects, with flexible oil prices the US dollar oil price should follow the aggregate US price level. But with rigid nominal oil prices, the nominal oil price jumps proportionally to nominal interest rate increases. We find evidence for structural breaks in the nominal oil price that are used to illustrate the theory of oil price jumps. The evidence also indicates strong Granger causality of the oil price by US inflation as is consistent with the theory.
Keywords: oil prices; inflation; cash-in-advance; multiple structural breaks; Granger causality
JEL Classification: E31; E4;

Woon K Wong and Laurence Copeland (July 2008)
Risk Measurement and Management in a Crisis-Prone World (1071K, 27 pages)
The current subprime crisis has prompted us to look again into the nature of risk at the tail of the distribution. In particular, we investigate the risk contribution of an asset, which has infrequent but huge losses, to a portfolio using two risk measures, namely Value-at-Risk (VaR) and Expected Shortfall (ES). While ES is found to measure the tail risk contribution effectively, VaR is consistent with intuition only if the underlying return distribution is well behaved. To facilitate the use of ES, we present a power function formula that can calculate accurately the critical values of the ES test statistic. This in turn enables us to derive a size-based multiplication factor for risk capital requirement.
Keywords: Value-at-Risk; expected shortfall; tail risk contribution; saddle point technique; risk capital
JEL Classification: G11; G32

Yanhui Zhu and Laurence Copeland (July 2008, updated October 2008)
The Credit Risk Premium in a Disaster-Prone World (1265K, 22 pages)
The seminal Barro (2006) closed-economy model of the equity risk premium in the presence of extreme events ("disasters") allowed for leverage in the form of risky corporate debt which defaulted only in states when the Government defaulted on its debt. The probability of default was therefore exogenous and independent of the degree of leverage. In this paper, we take the model a step closer to reality by assuming that, on the one hand, the Government never defaults, and on the other hand, that the .corporate sector. in the form of the Lucas tree owner pays its debts in full if and only if its asset value is sufficient, which is always the case in non-crisis states. Otherwise, in exceptionally severe crises, it defaults and hands over the whole .firm. to its creditors. The probability of default by the tree owner is thus endogenous, dependent both on the volume of debt issued (taken as exogenous) and on the uncertain value of output. We show, using data from both Barro (2006) and Barro and Ursua (2008), that the model can generate values of the riskless rate, equity risk premium and credit risk spread broadly consistent with those typically observed in the data.
Keywords: equity risk premium; default risk; credit spread; leverage; corporate debt
JEL Classification: F3; G1

Woon K Wong, Laurence Copeland and Ralph Lu (July 2008)
The Other Side of the Trading Story: Evidence from NYSE (995K, 24 pages)
We analyse the well-known TORQ dataset of trades on the NYSE over a 3-month period, breaking down transactions depending on whether the active or passive side was institutional or private. This allows us to compare the returns on the different trade categories. We find that, however we analyse the results, institutions are best informed, and earn highest returns when trading with individuals as counter party. We also confirm the conclusions found elsewhere in the literature that informed traders often place limit orders, especially towards the end of the day (as predicted on the basis of laboratory experiments in Bloomfield, O.Hara, and Saar (2005)). Finally, we find that trading between institutions accounts for the bulk of trading volume, but carries little information and seems to be largely liquidity-driven.
Keywords: liquidity trade; informed trades
JEL Classification: G14; G12

David Meenagh, Patrick Minford and Michael Wickens (May 2008, updated December 2008)
Testing a DSGE model of the EU using indirect inference (1454K, 41 pages)
Published in Open Economies Review, vol. 20(4) (2009), 435-471
We use the method of indirect inference, using the bootstrap, to test the Smets and Wouters model of the EU against a VAR auxiliary equation describing their data,the test is based on the Wald statistic. We find that their model generates excessive variance compared with the data. But their model passes the Wald test easily if the errors have the properties assumed by SW but scaled down. We compare a New Classical version of the model which also passes the test easily if error properties are chosen using New Classical priors (notably excluding shocks to preferences). Both versions have (different) difficulties fitting the data if the actual error properties are used. However, a version embedding a small sector with Calvo contracts in an otherwise New Classical economy fits the data well without any scaling.
Keywords: Bootstrap; DSGE Model; VAR model; Model of EU; indirect inference; Wald statistic
JEL Classification: C12; C32
See also: Supporting Annex

Woon K Wong (April 2008)
A Unique Orthogonal Variance Decomposition (1033K, 19 pages)
Let e and Σ,be respectively the vector of shocks and its variance covariance matrix in a linear system of equations in reduced form. This article shows that a unique orthogonal variance decomposition can be obtained if we impose a restriction that maximizes the trace of A, a positive definite matrix such that Az = e where z is vector of uncorrelated shocks with unit variance. Such a restriction is meaningful in that it associates the largest possible weight for each element in e with its corresponding element in z. It turns out that A = Σ,^1/2, the square root of Σ,.
Keywords: Variance decomposition; Cholesky decomposition; unique orthogonal decomposition and square root matrix
JEL Classification: C01

James Foreman-Peck and Tom Nicholls (April 2008, updated July 2012)
Peripherality and the Impact of SME Takeovers (1845K, 42 pages)
New Economic Geography models typically predict centripetal economic development. One process by which this might be brought about is if large companies based in the core of the economy buy up and remove small dynamic enterprises from peripheral regions, thereby suppressing development outside the core. This hypothesis is investigated by analysing the very large UK administrative firm-level Business Structure Database. Contrary to the experience of big firms, more productive small businesses are more subject to takeover - although this effect is weaker if they are located in peripheral regions than in the core. Takeovers also increase the chances of a small and medium size enterprise (SME) closing, but the exit consequence is greater for the core region. Takeovers raise productivity after acquisition in all regions but by less for the most productive SMEs. Ignoring any productivity gains to acquiring firms, the positive impact in the core region during the years considered is slightly larger than in the periphery, principally because takeovers are more common in the core. As this impact is a contributor to regional divergence, policy should aim to improve the operation of the market for SMEs in the periphery.
Keywords: SMEs; takeovers; regional development; exits
JEL Classification: L23; D21; R11

Woon K Wong, Dijun Tan and Yixiang Tian (April 2008)
Nonlinear ACD Model and Informed Trading: Evidence from Shanghai Stock Exchange (1077K, 31 pages)
Dufour and Engle (J. Finance (2000) 2467) find evidence of an increased presence of informed traders when the NYSE markets are most active. No such evidence, however, can be found by Manganelli (J. Financial Markets (2005) 377) for the infrequently traded stocks. In this paper, we fit a nonlinear log-ACD model to stocks listed on Shanghai Stock Exchange. When trading volume is high, empirical findings suggest presence of informed trading in both liquid and illiquid stocks. When volume is low, market activity is likely due to liquidity trading. Finally, for the actively traded stocks, our results support the price formation model of Foster and Viswanathan (Rev. Financial Studies (1990) 593).
Keywords: Informed trading; Liquidity trading; Duration; Volume; Volatility
JEL Classification: G11; G14; G15

David Meenagh, Patrick Minford, Eric Nowell, Prakriti Sofat and Naveen Srinivasan (April 2008, updated April 2010)
Can the Facts of UK Inflation Persistence be Explained by Nominal Rigidity? (1284K, 21 pages)
Published in Economic Modelling, vol. 26(5) (2009), 978-992
It has been widely argued that inflation persistence since WWII has been widespread and durable and that it can only be accounted for by models with a high degree of nominal rigidity. We examine UK post-war data where after confirming previous studies, findings of varying persistence due to changing monetary regimes, we find that models with little nominal rigidity are best equipped to explain it.
Keywords: inflation persistence; New Keynesian; New Classical; nominal rigidity; monetary regime shifts
JEL Classification: E31; E37
See also: Supporting Annex

Helmuts Azacis and Max Gillman (February 2008, updated October 2008)
Baltic Tax Reform (1264K, 52 pages)
Forthcoming in Journal of Macroeconomics
The paper presents an endogenous growth economy with a representation of the tax rate system in the Baltic countries. Assuming that government spending is a given fraction of output, the paper shows how a flat tax system balanced between labor and corporate tax rates can be second best optimal. It then computes how actual Baltic tax reforms from 2000 to 2007 affect the growth rate and welfare, including transition dynamics. Comparing the actual reform effects to hypothetical tax experiments, it results that equal flat tax rates on personal and corporate income would have increased welfare in all three Baltic countries by 24% more on average than the actual reforms. This shows how equal, balanced, flat rate taxes can be optimal in both theory and practice. Further, movement towards a more equal balance between labor and capital tax rates, through changing just one tax rate, achieved almost as high or higher utility gains as in actual law for all three countries under both open and closed economy cases. This shows benefits of moving towards the optimum.
Keywords: tax reforms; endogenous growth; transitional dynamics; flat taxes
JEL Classification: E13; H20; O11; O14

Patrick Minford and Naveen Srinivasan (February 2008)
Are Central Bank Preferences Asymmetric? A Comment (1048K, 13 pages)
Published in Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 37(1) (2008), 119-126
A recent paper by Ruge-Murcia [European Economic Review 48 (2004), 91-107] on asymmetric central bank objectives provides a new perspective on the policy roots of inflation in developed economies. More precisely, the paper demonstrates that if the distribution of the supply shocks is normal, then the reduced form solution for inflation implies a positive (or negative) relation between average inflation and the variance of shocks. We argue that the evidence offered in support of this hypothesis suffers from lack of identification because Phillips curve nonlinearity combined with quadratic central bank preferences yield the same reduced form solution for inflation. If so, estimating reduced form for inflation will not be able to discriminate between these models. Yet they have quite different implications for policy. Other, structural, evidence is needed.
Keywords: Preference asymmetry;Phillips curve nonlinearity;Identification
JEL Classification: E52; E58; E61

Kyriacos Kyriacou, Kul B Luintel and Bryan Mase (February 2008)
Private Information in Executives' Option Trades: Evidence from the UK (1112K, 45 pages)
Published in Economica, vol. 77 (2010), 751-774
This paper investigates whether UK executives use private information in the trading decisions associated with the exercise of their executive stock options. We find that UK executives' exercise and sell decisions are motivated by their private information but not by their anticipation of future return volatility. These findings appear robust when we control for additional motivating factors that include option moneyness, the previous stock return and the value of the exercise. We argue that the disparity in the informativeness of US and UK executives' trades at exercise is related to important differences in executive remuneration, and in the regulation and taxation of executive stock options.
Keywords: Executive remuneration; executive stock options; trade informativeness
JEL Classification: G14; G18

Kul B Luintel, Mosahid Khan, Philip Arestis and Konstantinos Theodoridis (January 2008)
Financial Structure and Economic Growth (1132K, 43 pages)
Published in Journal of Development Economics, 86 (2008) 181-200
Recent empirical work on financial structure and economic growth analyzes multicountry dataset in panel and/or cross-section frameworks and conclude that financial structure is irrelevant. We highlight their shortcomings and re-examine this issue utilizing a time series and a dynamic heterogeneous panel methods. Our sample consists of fourteen countries. Tests reveal that cross-country data cannot be pooled. Financial structure significantly explains output levels in most countries. The results are rigorously scrutinized through bootstrap exercises and they are robust to extensive sensitivity tests. We also test for several hypotheses about the prospective role of financial structure and financial development on economic growth.
Keywords: Financial Structure; Economic Growth; Co-integration; Bootstrap; Dynamic Heterogeneous Panels
JEL Classification: O16; G18; G28

Laurence Copeland, Woon K Wong and Y Zeng (January 2008)
Information-Based Trade in the Shanghai StockMarket (1036K, 20 pages)
We show that the probability of information-based trade (PIN) played a significant role in explaining monthly returns on Shanghai A shares over the period 2001 to 2006. In particular, PIN, as approximated by order imbalance as a proportion of total transactions, appears to explain returns even after controlling for risk in the much-cited Fama and French (1992) three-factor model. However, we also find that some of the PIN effect appears to be indistinguishable from a turnover effect.

Patrick Minford and Soubarna Pal (January 2008)
Real Exchange Rate Overshooting in Real Business Cycle Model - An Empirical Evidence From India (1352K, 63 pages)
The objective of this paper is to establish the ability of a Real Business Cycle (RBC) model to account for the behaviour of the real exchange rate, using Indian data (1966-1997). We calibrate the dynamic general equilibrium open economy model (Minford, Sofat 2004) based on optimising decisions of rational agents, using annual data for India. The first order conditions from the households' and firms' optimisation problem are used to derive the behavioural equations of the model. The interaction with the rest of the world comes in the form of uncovered real interest rate parity and current account both of which are explicitly micro-founded. The paper discusses the simulation results of 1 percent per annum productivity growth shock, which shows that the real exchange rate appreciates and then goes back to a new equilibrium (lower than the previous one), producing a business cycle. Thus the behaviour of the real exchange rate may be explicable within the RBC context. Finally we test our model and evaluate statistically whether our calibrated model is seriously consistent with the real exchange rate data, using bootstrapping procedure. We bootstrap our model to generate pseudo real exchange rate series and find that the ARIMA parameters estimated for the actual real exchange rate data lie within the 95% confidence limits constructed by bootstrapping. We find the same result for the nominal rigidity version of the RBC model. So we conclude that the behaviour of the Indian real exchange rate (US $ / Indian Rupees) can be explained by RBC.

Kent Matthews, Jianguang Guo and Nina Zhang (November 2007)
Non-Performing Loans and Productivity in Chinese Banks: 1997-2006 (1212K, 29 pages)
This study examines the productivity growth of the nationwide banks of China over the ten years to 2006. Using a bootstrap method for the Malmquist index estimates of productivity growth are constructed with appropriate confidence intervals. The paper adjusts for the quality of the output by accounting for the non-performing loans on the balance sheets and test for the robustness of the results by examining alternative sets of outputs. The productivity growth of the state-owned banks is compared with the Joint-stock banks and it determinants evaluated. The paper finds that average productivity of the Chinese banks improved modestly over this period. Adjusting for the quality of loans, by treating NPLs as an undesirable output, the average productivity growth of the state-owned banks was zero or negative while productivity of the Joint-Stock banks was markedly higher.
Keywords: Bank Efficiency; Productivity; Malmquist index; Bootstrapping
JEL Classification: D24; G21;

Vo Phuong Mai Le, Max Gillman and Patrick Minford (November 2007)
An Endogenous Taylor Condition in an Endogenous Growth Monetary Policy Model (1131K, 20 pages)
The paper derives a Taylor condition as part of the agent's equilibrium behavior in an endogenous growth monetary economy. It shows the assumptions necessary to make it almost identical to the original Taylor rule, and that it can interchangably take a money supply growth rate form. From the money supply form, simple policy experiments are conducted. A full central bank policy model is derived that includes the Taylor condition along with equations comparable to the standard aggregate-demand/aggregate-supply model.
Keywords: Taylor Rule; endogenous growth; money supply; policy model
JEL Classification: E51; E52; O0

Luís F. Costa and Huw David Dixon (October 2007)
A Simple Business-Cycle Model with Shumpeterian Features (1138K, 45 pages)
We develop a dynamic general equilibrium model of imperfect competition where a sunk cost of creating a new product regulates the type of entry that dominates in the economy: new products or more competition in existing industries. Considering the process of product innovation is irreversible, introduces hysteresis in the business cycle. Expansionary shocks may lead the economy to a new 'prosperity plateau,' but contractionary shocks only affect the market power of mature industries.
Keywords: Entry; Hysteresis; Mark-up
JEL Classification: E62; L13; L16

Helmuts Azacis and David R. Collie (October 2007)
The optimality of optimal punishments in Cournot supergames (1092K, 10 pages)
Published in Economics Letters, Vol. 105, 2009, pp. 56-57.
The result of Colombo and Labrecciosa (2006) that optimal punishments are inferior to Nash-reversion trigger strategies with decreasing marginal costs is due to the output when a firm deviates from the punishment path being allowed to become negative.
Keywords: Optimal punishments; trigger strategies; collusion; cartels
JEL Classification: C73; D43; L13

Michael G Arghyrou, Andros Gregoriou and Alexandros Kontonikas (September 2007)
Do real interest rates converge? Evidence from the European Union (1425K, 35 pages)
Published in Journal of International Financial Markets, Institutions & Money, vol. 19, July 2009, 447-460
We test for real interest parity (RIP) in the EU25 area. Our contribution is two-fold: First, we account for the previously overlooked effects of structural breaks on real interest rate differentials. Second, we test for RIP against the EMU average. For the majority of our sample countries we obtain evidence of real interest rate convergence towards the latter. Convergence, however, is a gradual process subject to structural breaks, typically falling close to the launch of the euro. Our findings have important implications relating to the single monetary policy and the progress new EU members have achieved towards joining the euro.
Keywords: real interest rate parity; convergence; structural breaks; EU; EMU
JEL Classification: F21; F32; C15; C22

David R. Collie (August 2007)
Auctioning Immigration Visas (965K, 15 pages)
Published in Review of Development Economics, Vol. 13, 2009, pp. 687-694.
Freeman (2006) suggested that auctioning immigration visas and redistributing the revenue to native residents in the host country would increase migration from low-income to high-income countries. The effect of the auctioning of immigration visas, in the Ricardian model from Findlay (1982), on the optimal level of immigration for the host country is considered. It is shown that auctioning immigration visas will lead to a positive level of immigration only if the initial wage difference between the host country and the source country is substantial. The cost of the immigration visa is more than half the earnings of the immigrant worker.
Keywords: Immigration; migration; international trade
JEL Classification: F22; F12; J61

Qaisar Abbas and James Foreman-Peck (August 2007)
The Mincer Human Capital Model in Pakistan: Implications for Education Policy (1040K, 32 pages)
Published in South Asian Economic Journal (2008), Vol 9, 2, 435-462
This paper estimates and interprets returns to education for three sub-sectors of labour market by gender in Pakistan, using the most recent data set of Pakistan Social and Living Standards Measurement (PSLM) Survey 2004-05. The results show two distinctive features of Pakistani education, the high apparent returns to female education outside agriculture, and the remarkable increase of returns with successive levels of education, are to be explained primarily by two departures from the basic Mincer model,generally poor quality primary schooling and family unwillingness to invest in female education because of lack of earning opportunities. There is some signaling in Pakistani education investment but mainly the education is productivity-enhancing investment in human capital, according to a comparison of self-employed and paid employed earnings equations. Returns to public spending of education are extremely high, suggesting very considerable state underinvestment. The policy challenge is in the low wages and high education in the female paid employment sector, and the low participation rate.
Keywords: Rates of return; gender; occupation; Pakistan
JEL Classification: J16; J18; J24

David R. Collie (August 2007)
Migration and trade with external economies of scale (1055K, 34 pages)
The analysis of migration in Findlay (1982) is extended by adding external economies of scale to the Ricardian model as in Ethier (1982). With external economies, the larger country always gains from trade but the smaller country may lose from trade unless the external economies of scale are sufficiently strong. The smaller country will always gain from emigration but the larger country may lose from immigration unless the external economies of scale are sufficiently strong. Both countries gain from complete economic integration (free labour migration with free trade). Finally, the optimal migration policies of the two countries are derived.
Keywords: Immigration; emigration; international trade; factor mobility
JEL Classification: F22; F12; J61

Qaisar Abbas and James Foreman-Peck (July 2007, updated December 2007)
Human Capital and Economic Growth: Pakistan, 1960-2003 (1129K, 22 pages)
Published in The Lahore Journal of Economics, (2008), Vol. 13, No.1, 1-27.
This paper investigates the relationship between human capital and economic growth in Pakistan with time series data. Estimated with the Johansen (1991) approach, the aggregate production function rejects one version of the endogenous growth formulation. But the fitted model indicates that the output elasticity of human capital may be expected to increase with foreign technical progress. Higher productivity of secondary schooling than in OECD economies is consistent with the low levels so far attained in Pakistan. High returns to health spending compare very favourably with industrial investment. Human capital is estimated to have accounted for just under one fifth of the increase in GDP per head, a figure that is probably biased downwards because of the unmeasured dimensions of human capital.
Keywords: Human Capital; Economic Growth; Cointegration; Pakistan
JEL Classification: C13; C22; C51; O15; O53

Panayiotis M. Pourpourides (June 2007, updated April 2010)
Implicit Contracts and the Cyclicality of the Skill-Premium (1272K, 47 pages)
Published in Journal of Economic Dynamics and Control, Volume 35, 2011, 963-979
To examine the cyclical behavior of the skill-premium, this paper introduces implicit labor contracts in a DSGE model where production is characterized by capital-skill complementarity and the utilization of capital is endogenous. It is shown that this model can reproduce the observed cyclical patterns of wages and the skill-premium. The feature of capital-skill complementarity coupled with variable capital utilization rates does not come at odds with the acyclical behavior of the skill-premium. The paper argues that the skill-complementarity of capital is not a quantitatively significant factor at high frequencies. The key aspects are the contracts and the capital utilization margin.
Keywords: Implicit Contracts;Wages;Skill-Premium;Business Cycles;Capital-Skill Complementarity
JEL Classification: E13; E24; E32

Sheikh Selim (June 2007)
Optimal Taxation in a Two Sector Economy with Heterogeneous Agents (995K, 23 pages)
In this paper we show that in a two sector economy with heterogeneous agents and competitive markets, in a steady state the optimal capital income tax rate is in general different from zero. The optimal tax policy in this setting depends on the relative price difference. In a two sector economy capital and labour margins are interdependent, which is why a difference between investment good's price and consumption good's price allows the government to tax capital income in one sector and undo the tax distortion by differential labour income taxation. This policy serves efficiency purpose as it restores production efficiency. For instance, if investment goods are more expensive than consumption goods, it is optimal to tax capital income in consumption sector, and set zero capital income tax and lower labour income tax in investment sector. This policy discourages work and investment in consumption sector, and encourages agents to shift capital and working time to investment sector. This increases production in investment sector and restores production efficiency. In a model with two classes of agents, we show that this policy can also serve redistributive purpose.
Keywords: Optimal taxation; Ramsey problem; Two Sector model
JEL Classification: C61; E13; E62; H21

Juan Páez-Farrell (June 2007)
Optimal Monetary Policy Under Inflation Targeting: Is Zero the Optimal Perception of Inflation Inertia? (1067K, 13 pages)
Recent research has suggested that in deriving optimal policy under discretion, policymakers should react as if there were no structural inflation persistence in order to improve welfare. This paper considers whether such a strong result extends to an inflation targeting central bank with a more general Phillips curve formulation. The findings indicate that if anything, a central banker that assumes a high degree of inflation inertia is often preferable.
Keywords: optimal monetary policy; discretion; uncertainty; inflation persistence
JEL Classification: E31; E52; E61; E63

Paulo Brito and Huw David Dixon (June 2007, updated October 2007)
Entry and the accumulation of capital: a two state-variable extension to the Ramsey model (1626K, 60 pages)
Published in International Journal of Economic Theory,, 5, 333-357
In this paper we consider the entry and exit of firms in a dynamic general equilibrium model with capital. At the firm level, there is a fixed cost combined with increasing marginal cost, which gives a standard U-shaped cost curve with optimal firm size. Entry is determined by a free entry condition such that the costs of entry are equal to the present value of incumbent firms, the cost of entry (exit) depends on the flow of entry (exit). Then equilibrium is saddle-point stable and the stable manifold is two-dimensional. Transitional dynamics can, under certain circumstances, be non-monotonic.
Keywords: Entry; dynamics; Ramsey
JEL Classification: D92; C62; E32; O41

Konstantinos Theodoridis (June 2007)
Dynamic Stochastic General Equilibrium (DSGE) Priors for Bayesian Vector Autoregressive (BVAR) Models: DSGE Model Comparison (1076K, 8 pages)
This Paper describes a procedure for constructing theory restricted prior distributions for BVAR models. The Bayes Factor, which is obtained without any additional computational effort, can be used to assess the plausibility of the restrictions imposed on the VAR parameter vector by competing DSGE models. In other words, it is possible to rank the amount of abstraction implied by each DSGE model from the historical data.
Keywords: BVAR; DSGE Model Evaluation; Gibbs Sampling; Bayes Factor
JEL Classification: C11; C13; C32; C52

Szilárd Benk, Max Gillman and Michal Kejak (May 2007)
Money Velocity in an Endogenous Growth Business Cycle with Credit Shocks (1119K, 18 pages)
Published in Journal of Money Credit and Banking Vol. 40, No. 6 (September 2008): 1281-1293.
The explanation of velocity in neoclassical monetary business cycle models relies on a goods productivity shocks to mimic the data's procyclic velocity feature,money shocks are not important,and the financial sector plays no role. This paper sets the model within endogenous growth, adds exchange credit shocks, and finds that money and credit shocks explain much of the velocity variation. The role of the shocks varies across sub-periods in an intuitive fashion. Endogenous growth is key to the construction of the money and credit shocks since these have similar effects on velocity, but opposite effects upon growth. The model matches the data's average velocity and simulates most of the velocity volatility that is found in the data. Its underlying money demand is Cagan-like in its interest elasticity, so that money and credit shocks cause greater velocity variation the higher is the nominal interest rate.
Keywords: Velocity; business cycle; credit shocks; endogenous growth
JEL Classification: E13; E32; E44

Juan Páez-Farrell (May 2007)
Monetary Policy Rules in Theory and in Practice: Evidence from the UK and the US (1083K, 30 pages)
Given the large amount of interaction between research on monetary policy and its practice, this paper examines whether some simple monetary policy rules that have been proposed in the academic literature, part of which has originated from within central banks, provide a reasonable characterisation of actual policy in the UK and the US. The paper finds that the simple rule that describes best actual US monetary policy is a speed limit rule with dynamics, whilst for the UK it is a forward-looking rule. The simpler dynamics in the UK's monetary policy rule are reflective of the lower persistence of inflation as a result of its policy of inflation targeting.

Patrick Minford, David Meenagh and Jiang Wang (April 2007)
Growth and relative living standards - testing Barriers to Riches on post-war panel data (1165K, 40 pages)
The effect of business tax and regulation on growth, together with potential effects of government spending on education and R&D, is embodied in a model of a small open economy with growth choices. The structural model is estimated on post-war panel data for 76 countries and the bootstrap is used to produce the model's sampling variation for the analysis of panel regressions of growth. Statistical rejection can occur at either the structural or the growth regression stage. The models featuring government spending on education and R&D are rejected while that with business taxation is accepted.
Keywords: growth; living standards; business regulation; business taxation; public education; government R&D; structural model; bootstrap testing
JEL Classification: O41; O57; C52

Sheikh Selim and Naima Parvin (April 2007)
Policy Reforms and Incentives in Rice Production in Bangladesh (962K, 12 pages)
We estimate an institutional production function to capture incentive induced growth in total factor productivity (TFP) of rice production in Bangladesh. The incentive component of TFP assists in explaining farmers' response to incentives due to major policy reforms during 1980s and 1990s.
Keywords: Bangladesh; Incentives; TFP
JEL Classification: C33; C51; O13; Q12

Sheikh Selim (April 2007, updated February 2010)
Labour Productivity and Rice Production in Bangladesh: A Stochastic Frontier Approach (1072K, 22 pages)
In this paper we examine the significance of labour productivity and use of inputs in explaining technical efficiency of rice production in Bangladesh. We find that higher labour productivity can stimulate high efficiency gains, but increased use of inputs (except land) induces negative marginal effect on technical efficiency. While more use of land, improved seeds and fertilizers contributes to the rate of labour-productivity induced marginal efficiency gain, any additional labour depresses this rate. Given the agricultural policy reform history in Bangladesh, our findings imply that rather than providing input subsidy or output price support, future reforms should put more emphasis on providing incentives to enhance labour productivity and encourage formalization of the agricultural labour market.
Keywords: Stochastic frontier; non-neutral frontier; technical efficiency
JEL Classification: C33; C51; O13; Q12

Sheikh Selim (April 2007)
Optimal Capital Income Taxation in a Two Sector Economy (1025K, 26 pages)
We extend the celebrated Chamley-Judd result of zero capital income tax and show that the steady state optimal capital income tax is nonzero, in general. In particular, we find that the optimal plan involves zero capital income tax in investment sector and a nonzero capital income tax in consumption sector. In a two sector neoclassical economy, interdependence of labour and capital margins allows the government to choose an optimal policy that involves nonzero tax on capital income. The distortion created by capital income tax in consumption sector can be undone by setting different rates of labour income taxes. The optimal plan thus involves zero capital income tax in both sectors only if optimal labour income taxes are equal. This may not be the optimal policy if marginal disutility of work is different across sectors and/or the social marginal value of capital is different across sectors. The difference in social marginal value of capital can be undone by setting different labour income taxes across sectors. We also show that if the government faces a constraint of keeping same capital and labour income tax rates across sectors, optimal capital income tax is nonzero.
Keywords: Optimal taxation; Ramsey problem; Primal approach; Two-sector model
JEL Classification: C61; E13; E62; H21

Vo Phuong Mai Le and Patrick Minford (March 2007, updated October 2008)
Calvo Contracts - Optimal Indexation in General Equilibrium (1155K, 38 pages)
Calvo contracts, which are the basis of the current generation of New Keynesian models, widely include indexation to general inflation. We argue that the indexing formula should be expected inflation rather than lagged inflation. This is likely to optimise the welfare of the representative agent in a general equilibrium model of the New Keynesian type. The economy's behaviour under rational indexation is similar to that of a New Classical model, with shocks producing an immediate fluctuation in both prices and output followed by a fairly rapid return to steady state. A monetary policy that targets the price level increases economic stability.
Keywords: Calvo contracts; general equilibrium; rational indexation
JEL Classification: F41; F42; E42

Vo Phuong Mai Le and Patrick Minford (March 2007)
Optimising indexation arrangements under Calvo contracts and their implications for monetary policy (1150K, 21 pages)
This paper investigates optimal indexation in the New Keynesian model, when the indexation choice includes the possibility of partial indexation and of varying weights on rational and lagged indexation. It finds that the Calvo contract adjusted for rationally expected indexation under both inflation and price level targeting regimes delivers the highest expected welfare under both restricted and full current information. Rational indexation eliminates the effectiveness of monetary policy on welfare when there is only price-level targeting under the current micro information. If including both wage setting and full current information, monetary policy is effective,and a price-level targeting rule delivers the highest benefits because it minimises the size of shocks to prices and thus dispersion. However, even less than full rational indexation ensures that there is very little nominal rigidity in the adapted world of Calvo contracts.
Keywords: optimal indexation; price-level target; inflation target; Calvo contracts; rational expectation; New Keynesian model
JEL Classification: E50; E52

Laurence Copeland and Yanhui Zhu (March 2007)
Rare Disasters and the Equity Premium in a Two-Country World (1130K, 22 pages)
We extend the Barro (2006) closed-economy model of the equity risk premium in the presence of extreme events ("disasters") to a two-country world. In this more general setting, both the output risk of rare disasters and the associated risk of a default on Government debt, can be diversified. The extent to which agents in one country can diversify away the risk of extreme events depends on the relative size of the two countries, and critically on the probability of a disaster in one country conditional on a disaster in the other. We show that, using Barro's own calibration in combination with a broad range of plausible values for the additional parameters, the model implies levels of the equity risk premium far lower than those typically observed in the data. We conclude that the model is unlikely to explain the equity risk premium
Keywords: equity risk premium; default risk; international diversification
JEL Classification: F3; G1

Kent Matthews, Jianguang Guo and Nina Zhang (February 2007)
Rational Inefficiency and non-performing loans in Chinese Banking: A non-parametric Bootstrapping Approach. (1009K, 29 pages)
Published in China Finance Review, 2007, 3, 1 , 55-75
The existing Chinese banking system was born out of a state-planning framework focussed on the funding of state-owned enterprises. Despite the development of a modern banking system, numerous studies of Chinese banking point to its high level of average inefficiency. Much of this inefficiency relates to the high level of non-performing loans held on the banks books. This study argues that a significant component of inefficiency relates to a defunct bureaucratic incentive structure. Using bootstrap non-parametric techniques the paper decomposes cost-inefficiency into X-inefficiency and rational inefficiency caused by bureaucratic rent seeking. In contrast to other studies of the Chinese banking sector, the paper argues that a change in the incentive structure and the competitive threat of the opening up of the banking market in 2007 has produced reduced inefficiency and improved performance.
Keywords: Bank Efficiency; China; X-inefficiency; DEA
JEL Classification: D23; G21; G28;

Kent Matthews, Jianguang Guo, Nina Zhang and Lina Wang (February 2007, updated March 2007)
Bank Efficiency in China, Rent Seeking versus X-inefficiency: A non-parametric Bootstrapping Approach. (1033K, 39 pages)
This study demarcates cost-inefficiency in Chinese banks into X-inefficiency and rent-seeking-inefficiency. A protected banking market not only encourages weak management and X-inefficiency but also public ownership and state directed lending encourages moral hazard and bureaucratic rent seeking. This paper uses bootstrap non-parametric techniques to estimate measures of X-inefficiency and rent-seeking inefficiency for the 4 state owned banks and 11 joint-stock banks over the period 1997-2004. In contrast to other studies of the Chinese banking sector, the paper argues that reduced inefficiency is an indicator that the competitive threat of the opening up of the banking market in 2007 has produced tangible benefits in improved performance. This paper finds evidence of declining trend in both types of inefficiency.
Keywords: Bank Efficiency; China; X-inefficiency; DEA; Bootstrapping
JEL Classification: D23; G21; G28;

Huw David Dixon (February 2007)
New Keynesian macroeconomics: Entry For New Palgrave Dictionary of Economics, 2nd Edition (1044K, 11 pages)
Forthcoming in New Palgrave Dictionary of Economics and Law, 2nd Edition
This dictionary entry defines the development of new Keynesian macroeconomics (NKM) since the 1980s. I argue that the key defining feature NKM is the introduction of imperfect competition, making price and/or wage setting endogenous and hence allowing for a rigorous understanding of nominal rigidity. This has led to a shift away from perfect competition in macroeconomics. The combination of NKM with dynamic macroeconomic modelling has led to the current orthodoxy: the new-neoclassical synthesis. Dynamic wage and price models lead to monetary neutrality in steady-state, non-neutrality out of steady-state. Other themes in NKM include efficiency wage theory and coordination failure.
Keywords: Keynesian; nominal; rigidity; new
JEL Classification: E1; E3; E4; B22

Patrick Minford, Konstantinos Theodoridis and David Meenagh (January 2007, updated April 2008)
Testing a model of the UK by the method of indirect inference (1334K, 31 pages)
Published in Open Economies Review, vol. 20(2) (2009), 265-291
We use the method of indirect inference to test a full open economy model of the UK that has been in forecasting use for three decades. The test establishes, using a Wald statistic, whether the parameters of a time-series representation estimated on the actual data lie within some confidence interval of the model-implied distribution. Various forms of time-series representations that could deal with the UK's various changes of monetary regime are tried,two are retained as adequate. The model is rejected under one but marginally accepted under the other, suggesting that with some modifications it could achieve general acceptability and that the testing method is worth investigating further.
Keywords: Bootstrap; Model Evaluation; Non-Linear Time Series Models; Indirect inference; open economy models; UK models
JEL Classification: C12; C32

Huw David Dixon and Engin Kara (January 2007)
Persistence and Nominal Inertia in a Generalized Taylor Economy: How Longer Contracts Dominate Shorter Contracts (1201K, 41 pages)
Forthcoming in European Economic Review
We develop the Generalized Taylor Economy (GTE) in which there are many sectors with overlapping contracts of different lengths. In economies with the same average contract length, monetary shocks will be more persistent when longer contracts are present. Using the Bils-Klenow distribution of contract lengths, we find that the corresponding GTE tracks the US data well. When we choose a GTE with the same distribution of completed contract lengths as the Calvo, the economies behave in a similar manner.
Keywords: Persistence; Taylor contract; Calvo
JEL Classification: E50; E24; E32; E52

Michael G Arghyrou (November 2006)
Monetary policy before and after the euro: Evidence from Greece (1053K, 38 pages)
Published in Empirical Economics, vol. 36, June 2009, 621-643.
We model Greek monetary policy in the 1990s and use our findings to address two interrelated questions. First, how was monetary policy conducted in the 1990s so that the hitherto highest-inflation EU country managed to join the euro by 2001? Second, how compatible is the current ECB monetary policy with Greek economic conditions? We find that Greek monetary policy in the 1990s was: (i) primarily determined by foreign (German/ECB) interest rates though still influenced, to some degree, by domestic fundamentals,(ii) involving non-linear output gap effects,(iii) subject to a deficit of credibility culminating in the 1998 devaluation. On the question of compatibility our findings depend on the value assumed for the equilibrium post-euro real interest rate and overall indicate both a reduction in the pre-euro risk premium and some degree of monetary policy incompatibility. Our analysis has policy implications for the new EU members and motivates further research on fast-growing EMU economies.
Keywords: monetary policy; reaction function; non-linear; compatibility; Greece; EMU
JEL Classification: C51; C52; E43; E58; F37

Kent Matthews, Patrick Minford and Ruthira Naraidoo (January 2006, updated November 2006)
Vicious and Virtuous Circles - The Political Economy of Unemployment in Interwar UK and USA (1260K, 33 pages)
Published in European Journal of Political Economy Volume 24, Issue 3, September 2008, Pages 605-614
This paper develops a political economy model of multiple unemployment equilibria to provide a theory of an endogenous natural rate of unemployment. This model is applied to the UK and the US interwar period which is remembered as the decade of mass unemployment. The theory here sees the natural rate and the associated path of unemployment as a reaction to shocks (mainly demand in nature) and the institutional structure of the economy. The channel through which these two forces feed on each other is a political economy process whereby voters with limited information on the natural rate react to shocks by demanding more or less social protection. The reduced form results obtained confirm a pattern of unemployment behaviour in which unemployment moves between high and low equilibria in response to shocks.
Keywords: Equilibrium unemployment; political economy; 'vicious' and 'virtuous' circles; bootstrapping
JEL Classification: E24; E27; P16

Max Gillman and Glen Otto (September 2006, updated October 2006)
Money Demand in General Equilibrium Endogenous Growth: Estimating the Role of a Variable Interest Elasticity (1119K, 32 pages)
Published in Quantitative and Qualitative Analysis in Social Sciences (QASS). Vol. 1 (1), Spring, 2007, 1-25, http://www.qass.org.uk/2007/vol1_1/p1-gillman_07_apr2.pdf
The paper presents and tests a theory of the demand for money that is derived from a general equilibrium, endogenous growth economy, which in effect combines a special case of the shopping time exchange economy with the cash-in-advance framework. The model predicts that both higher inflation and financial innovation - that reduces the cost of credit - induce agents to substitute away from money towards exchange credit. The implied interest elasticity of money demand rises with the inflation rate and financial innovation rather than being constant as is typical in shopping time specifications. Using quarterly data for the US and Australia, we find evidence of cointegration for the money demand model. This money demand stability results because of the extra series that capture financial innovation,included are robustness checks and comparison to a standard money demand specification.
JEL Classification: C23; E41; O42

Michael G Arghyrou and Georgios Chortareas (September 2006)
Current Account Imbalances and Real Exchange Rates in the Euro Area (1035K, 29 pages)
Global current account imbalances have been one of the focal points of interest for policymakers during the last few years. Less attention has been paid, however, to the diverging current account balances of the individual euro area countries. In this paper we consider the dynamics of current account adjustment and the role of real exchange rates in current account determination in the EMU. After controlling for the effects of income growth, we find the relationship between real exchange rates and the current account to be substantial in size and subject to non-linear effects. Overall, we argue that real exchange rates can offer further insights, beyond the effects of the income catch-up process, relevant to current account determination in the EMU.
Keywords: current account; real exchange rate; EMU; nonlinearities
JEL Classification: C51; C52; F31; F32; F41

Roger Clarke and David R. Collie (August 2006)
Maximum-Revenue versus Optimum-Welfare Export Taxes (1173K, 31 pages)
Published in Review of International Economics, Vol. 16, No. 5, pp. 919-929.
In a game between two exporting countries, both countries may be better off if they both delegate to policymakers who maximise tax revenue rather than welfare. However, both countries delegating to policymakers who maximise revenue is not necessarily a Nash equilibrium. The game may be a prisoner's dilemma where both countries are better off delegating to policymakers who maximise revenue, but both will delegate to policymakers who maximise welfare in the Nash equilibrium. This result is obtained in the Bertrand duopoly model of Eaton and Grossman (1986) and the perfectly competitive model of Panagariya and Schiff (1995).
Keywords: Trade Policy; Export Taxes; Game Theory; Delegation
JEL Classification: C72; F11; F12; F13

Laurence Copeland and Saeed Heravi (July 2006)
Structural Breaks in the Real Exchange Rate Adjustment Mechanism (1523K, 35 pages)
Published in Applied Financial Economics,19:2,121-134. DOI: 10.1080/09603100701765216
We show that the behaviour of the real exchange rates of the UK, Germany, France and Japan has been characterised by structural breaks which changed the adjustment mechanism. In the context of a Time-Varying Smooth Transition AutoRegressive of the kind introduced by Lundbergh et al (2003), we show that the real exchange rate process shifted in the aftermath of Black Wednesday in the case of the Pound, in 1984-5 in the case of the Franc and, more tentatively, during the Asian crisis of 1997-8 in the case of the Yen.

Sheikh Selim (April 2006, updated February 2010)
Revisiting the Capital Tax Ambiguity Result (1177K, 16 pages)
We provide a welfare based interpretation of the capital tax ambiguity result (due to Guo & Lansing, 1999). We show that the sign ambiguity of optimal capital tax rate in an imperfectly competitive economy is mainly due to the welfare cost of investment. The substitution and income effects of profit seeking investment reinforce each other which create a deadweight loss in welfare. Investors cannot perceive this effect and never invest at the right level. This loss is perceived only by the government which motivates capital taxation.
Keywords: Optimal taxation; Monopoly power; Ramsey policy
JEL Classification: D42; E62; H21; H30

Sheikh Selim (March 2006, updated July 2006)
On Policy Relevance of Ramsey Tax Rules (1032K, 34 pages)
Published in economics-ejournal economics discussion Papers, No 2007-31. http://www.economics-ejournal.org/economics/discussionpapers/2007-31
The Ramsey approach to optimal taxation and Ramsey tax rules have amassed substance in economic theory. However, they are often criticized on grounds of practicality, fairness, feasibility and some other aspects of designing actual tax policy. This paper contests these criticisms,it discusses how closely or remotely Ramsey rules are followed in designing tax policy. It argues that the most of these common criticisms, be it realistic, such as administrative and compliance costs, or be it rather abstract, such as fairness, are either unimportant or irrelevant for Ramsey taxation. The more important inadequacy of the traditional Ramsey tax models is the selective modelling of incentive effects of tax reforms and their limited applicability for designing tax policy in developing countries.
Keywords: Optimal taxation; Ramsey tax rules; Policy relevance
JEL Classification: E61; E62; H21; H30

Juan Páez-Farrell (March 2006)
Output and Inflation in Models of the Business Cycle with Nominal Rigidities: Some Counterfactual Evidence (1050K, 28 pages)
Published in Scottish Journal of Political Economy, September 2007 pp. 479-495, Vol. 54, No. 4
This paper examines the relationship between cyclical output and inflation in models commonly used for monetary policy analysis. This includes models that incorporate the New Keynesian, Fuhrer-Moore and backward-looking Phillips curves. The main finding is that these models imply a strong negative relationship between inflation and output, a result that is at odds with the data. The fact that New Keynesian models yield counterfactual implications is not new,the novelty of the paper lies in the fact that the finding extends to the other variants, such as the backward-looking Phillips Curve, which has been put forward as displaying superior dynamics.
Keywords: nominal rigidities; monetary policy; Phillips Curve; Output; Inflation; Correlation
JEL Classification: E20; E31; E32; E52; E61

Juan Páez-Farrell (March 2006)
Assessing Sticky Price Models Using the Burns and Mitchell Approach (979K, 27 pages)
Forthcoming in Applied Economics
This paper evaluates sticky-price models using the methods proposed by Burns and Mitchell, focusing on the monetary aspects of the business cycle. Recent research has emphasised the responses of models to shocks at the expense its systematic component. Whereas sticky-price models have been successful at replicating impulse response functions from VARs, this paper highlights that they are unable to mimic the data for nominal variables. Moreover, the results are robust to the specification of the Phillips curve, including its backward-looking variant,calibrated values and the inclusion of fiscal policy shocks. Since being able to mimic the data is the lowest hurdle a model must pass, these results pose a challenge for New Keynesian-type models.
Keywords: New Keynesian Models; Business Cycles; Correlations; Burns and Mitchell
JEL Classification: E32; E52; E58

Roger Clarke and David R. Collie (February 2006)
Welfare in the Nash Equilibrium in Export Taxes under Bertrand Duopoly (1071K, 9 pages)
Published in Bulletin of Economic Research, Vol. 60, Issue 2, pp. 183-189.
In the Eaton and Grossman (1986) model of export taxes under Bertrand duopoly, it is shown that welfare in the Nash equilibrium in export taxes is always higher than welfare under free trade for both countries.
Keywords: Trade Policy; Imperfect Competition; Oligopoly
JEL Classification: F12; F13; L13

Roger Clarke and David R. Collie (February 2006)
Export Taxes under Bertrand Duopoly (1105K, 17 pages)
Published in Economics Bulletin, Vol. 6, No. 6, pp. 1-8, 2006.
This article analyses export taxes in a Bertrand duopoly with product differentiation, where a home and a foreign firm both export to a third-country market. It is shown that the maximum-revenue export tax always exceeds the optimum-welfare export tax. In a Nash equilibrium in export taxes, the country with the low cost firm imposes the largest export tax. The results under Bertrand duopoly are compared with those under Cournot duopoly. It is shown that the absolute value of the export subsidy or tax under Cournot duopoly exceeds the export tax under Bertrand duopoly.
Keywords: Trade Policy; Imperfect Competition; Oligopoly
JEL Classification: F12; F13; L13

Helen Robinson and Jonathan Wadsworth (February 2006)
The Impact of the Minimum Wage on the Incidence of Second Job Holding in Britain (1163K, 34 pages)
The advent of any earnings boost, such as provided by the introduction of a minimum wage, might be expected to reduce the supply of low paid individuals wanting to hold a second job. This paper uses difference-in-differences estimation on a panel of individuals matched across successive Labour Force Surveys around the time of the introduction of the national minimum wage in the United Kingdom in order to estimate the impact of the minimum wage and its subsequent upratings on second job working. There is little evidence to suggest that the extra pay provided by the introduction of the minimum wage was sufficient to affect the incidence of second job holding significantly. However, hours worked in the main job by second job holders may have risen relative to those not covered by the minimum wage,and hours worked in second jobs may have fallen for those whose second job was initially below the minimum.
Keywords: Second jobs; minimum wages
JEL Classification: J23; J31

David Meenagh, Patrick Minford and David Peel (February 2006)
Simulating Stock Returns under switching regimes - a new test of market efficiency (1016K, 9 pages)
Published in Economics Letters, 94 (2007), pp. 235-239
A model of profits switches between four regimes with fixed probabilities,the rationally expected profits stream implies the stock market value. This efficient market model is not rejected by UK post-war time-series behaviour of either profits or the FTSE index.
Keywords: regime switching; stock returns; efficient markets; rational expectations
JEL Classification: C15; C5; G14

Kent Matthews, David Meenagh, Patrick Minford and Bruce Webb (February 2006)
Monetary regimes: is there a trade-off between consumption and employment variability? (1133K, 40 pages)
Macro models generally assume away heterogeneous welfare in assessing policies. We investigate here within two aggregative models - one with a representative agent, the other a long-used forecasting model of the UK - whether allowing for differences in welfare functions (specifically between those in continuous employment and those with frequent unemployment spells) alters the rankings of monetary policies. We find that it does but that a set of policies (money supply targeting implemented by money supply control) can be found that are robust in the sense of avoiding very poor outcomes for either of the two groups.
Keywords: Robustness; heterogenous welfare; money supply rules; interest rate setting; price level targeting
JEL Classification: E52

Laurence Copeland (February 2006)
Arbitrage Bounds and the Time Series Properties of the Discount on UK Closed-End Mutual Funds (1266K, 37 pages)
In a dataset of weekly observations over the period since 1990, the discount on UK closed-end mutual funds is shown to be nonstationary, but reverting to a nonzero long run mean. Although the long run discount could be explained by factors like management expenses etc., its short run arbitrage-free equilibrium. In time series terms, there is evidence of long memory in discounts consistent with a bounded random walk. This conclusion is supported by explicit nonlinearity tests, and by results which suggest the behaviour of the discount is perhaps best represented by one of the class of Smooth-Transition Autoregressive (STAR) models.
Keywords: Mutual Funds; ESTAR

Laurence Copeland and Yanhui Zhu (February 2006)
Hedging Effectiveness in the Index Futures Market
Forthcoming in Gregoriou, G.N. and R. Pascalau (eds.) Financial Econometrics Modelling: Derivatives Pricing and Hedge Funds and Term Structure Models, Palgrave-MacMillan, 2011.
This paper addresses the question of how far hedging effectiveness can be improved by the use of more sophisticated models of the relationship between futures and spot prices. Working with daily data from six major index futures markets, we show that, when the cost of carry is incorporated in to the model, the two series are cointegrated, as anticipated. Fitting an ECM with a GJR-GARCH model of the variance process, we derive the implied optimal hedge ratios and compare their out-of-sample hedging effectiveness with OLS-based hedges. The results suggest little or no improvement over OLS.

Sheikh Selim (January 2006)
Current Account Dynamics and Capital Mobility in Asian Small Economies (1146K, 30 pages)
Published in ICFAI Journal of Financial Economics, 4(2), pp. 66-86, June 2006.
This paper explores current account dynamics in eight small economies of Asia to examine whether or not capital flows have been excessive in these countries. Standard assumptions of perfect capital mobility and small open economy are jointly instrumental in simplifying theoretical tractability of many open economy models. In empirical estimations, however, the identification of a small open economy is often oversimplified, which makes celebrated results, such as excessive or too low capital flows in OECD economies, questionable. This paper establishes that the actual extent of capital mobility in small open economies cannot be generally too high or too low. This in turns implies that the general idea of excessive capital flows in small open economies requires revision.
Keywords: Current account dynamics; intertemporal approach; consumption-smoothing; capital mobility

Saeed Al-Muharrami, Kent Matthews and Yusuf Khabari (January 2006)
Market Structure and Competitive Conditions in the Arab GCC Banking System (990K, 25 pages)
Published in Journal of Banking and Finance, 30, 2006, pp. 3487-3501.
This paper investigates the market structure of Arab GCC banking industry during the years of 1993 to 2002 using the most frequently applied measures of concentration k-bank concentration ratio (CRk) and Herfindahl-Hirschman Index (HHI) and evaluates the monopoly power of banks over the ten years period using the "H statistic" by Panzar and Rosse. The results show that Kuwait, Saudi Arabia and UAE have moderately concentrated markets and are moving to less concentrated positions. The measures of concentration also show that Qatar, Bahrain and Oman are highly concentrated markets. The Panzar-Rosse H-statistics suggest that banks in Kuwait, Saudi Arabia and the UAE operate under perfect competition,banks in Bahrain and Qatar operate under conditions of monopolistic competition,and we are unable to reject monopolistic competition for the banking market in Oman.
Keywords: GCC countries; Concentration; Market structure; Competition; Panzar-Rosse model; k-bank concentration ratio (CRk) and Herfindahl-Hirschman Index (HHI)
JEL Classification: G21; L1; D40

Kent Matthews, Patrick Minford and Ruthira Naraidoo (January 2006)
Vicious and Virtuous Circles - The Political Economy of Unemployment in Interwar UK and USA
Published in European Journal of Political Economy, vol. 24() (2008), 605-614
The 1930s in the UK and USA is remembered as the decade of mass unemployment. We develop a model of equilibrium unemployment based on the Meltzer and Richard (1981) model of redistribution financed by distortionary taxation. This model is extended to the UK and the US interwar period to provide a theory of an endogenous natural rate of unemployment. The theory here sees the natural rate and the associated equilibrium path of unemployment as a reaction to shocks (mainly demand in nature) and the institutional structure of the economy. The channel through which these two forces feed on each other is a political economy process whereby voters react to shocks by demanding more or less social protection. The reduced form results obtained confirm a pattern of unemployment behaviour in which unemployment moves between high and low equilibria in response to shocks,and further evidence is obtained by structural estimates for the UK.
Keywords: Equilibrium unemployment; political economy; 'vicious' and 'virtuous' circles; threshold model; bootstrapping
JEL Classification: E24; C10

Kent Matthews, Victor Murinde and Tianshu Zhao (January 2006)
Competitiveness and Market Contestability of Major UK Banks (1087K, 33 pages)
Published in Journal of Banking and Finance 2007, 31, 7, pp. 2025-2042.
We undertake an empirical assessment of the competitiveness and market contestability of the major British banks post-1980 - a period of major structural changes, mergers, demutualizations and acquisitions. Specifically, we estimate and test the Rosse-Panzar model on a panel of 12 banks for the period 1980-2004,furthermore, we buttress the Rosse-Panzar methodology by estimating the ratio of Lerner indices obtained from interest rate setting equations. The sample of banks corresponds closely to the major British Banking Groups as specified by the British Banking Association. Our results confirm the consensus finding that the British banking market can be described as monopolistically competitive. We also find that on the core business of balance sheet activity, British banks have remained as competitive in the 1990s as in the 1980s. This finding is further supported by evidence from the ratio of Lerner indices for loans and deposits. However, we find a significant worsening of competitiveness on the non-core (off-balance sheet) business of the banks.
Keywords: Competitive conditions in banking; market contestability; UK
JEL Classification: G210; D240

Kent Matthews, Jonathan Shepherd, Vaseekaran Sivarajasingham and Sally Benbow (January 2006)
Violence, Gender and the Price of Beer in England and Wales (993K, 25 pages)
This paper examines the influence of the real price of beer on violence-related injuries split by gender across the economic regions in England and Wales. It was concluded that alcohol prices and injury sustained in violence is causally related in both males and females. Injury of females is causally related to poverty but injury of males. However, nationwide sports events were associated only with male assault injury. Violence-related harm was significantly and independently linked to other socio-economic and demographic factors. Our results suggest that the real price of alcohol (using beer as an example) has a part to play in controlling the consumption of alcohol and the incidence of violent injury.
Keywords: Alcohol; gender; violence; price of beer
JEL Classification: K40; I30; C50;

J Daley, Kent Matthews and Keith Whitfield (January 2006)
Too-Big-To-Fail: Bank Failure and Banking Policy in Jamaica (979K, 26 pages)
Research on the causes of bank failure has focused on developed countries, particularly the United States of America. Relatively little empirical work has examined developing countries. We examine the total population of banks in Jamaica between 1992 and 1998 and find that real GDP growth, size, and managerial efficiency were the most significant factors contributing to the failure of banks. Bank failure is defined to include bailout and regulator-induced or supervised merger. Our results suggest that there were implicit 'Too-big-to-Fail' policies during this period.
Keywords: Bank failures; Too-big-to-Fail; developing economies; Jamaica
JEL Classification: G21; G28

Kent Matthews, Jonathan Shepherd and Vaseekaran Sivarajasingham (January 2006)
Violence-related injury and the Price of Beer in England and Wales (981K, 21 pages)
Published in Applied Economics 38, 2006, pp. 661-670.
This paper examines the influence of the real price of beer on violence-related injuries across the economic regions in England and Wales. The data are monthly frequency of violent-injury collected from a stratified sample of 58 National Health Service Emergency Departments 1995-2000. An econometric model based on economic, socio-demographic and environmental factors was estimated using panel techniques. We show that the rate of violence-related injury is negatively related to the real price beer, as well as economic, sporting and socio-demographic factors. The principal conclusion of the paper is that the regional distribution of the incidence of violent injury is related to the regional distribution of the price of beer. The major policy conclusion is that increased alcohol prices would result in substantially fewer violent injuries and reduced demand on trauma services.
Keywords: Violence; Alcohol; Price of Beer
JEL Classification: I18; K42

Kent Matthews and Mahadzir Ismail (January 2006)
Efficiency and Productivity Growth of Domestic and Foreign Commercial Banks in Malaysia (1029K, 24 pages)
This study examines the technical efficiency and productivity of domestic and foreign commercial banks in Malaysia 1994-2000. We find that foreign banks have a higher efficiency level than domestic banks, and that efficient banks are characterised by size but not profitability or loan quality. The main source of productivity growth is technical change rather than improvement in efficiency. The productivity of domestic banks is more susceptible to macroeconomic shocks than foreign banks but over the medium term foreign banks are only marginally superior to domestic banks.
Keywords: domestic and foreign banks; technical efficiency; Malmquist productivity index
JEL Classification: D2; G2;

Laurian Lungu, Kent Matthews and Patrick Minford (January 2006)
Partial Current Information and Signal Extraction in a Rational Expectations Macroeconomic Model: A Computational Solution. (1142K, 29 pages)
Published in Economic Modelling, 25(2), March 2008, pp. 255-273
Previous attempts at modelling current observed endogenous financial variables in a macroeconomic model have concentrated on only one observed endogenous variable - namely the short-term rate of interest. The solution method for dealing with more than one observed endogenous variable has thus far been computationally intractable. This paper applies a general search algorithm to a macroeconomic model with an observed interest rate and exchange rate to solve the signal extraction problem. The informational advantage of applying the signal extraction algorithm to all the current observed endogenous variables is examined in terms of the implication for policy from the misperceptions of specific macroeconomic shocks.
Keywords: Rational Expectations; Partial Current Information; Signal Extraction; Macroeconomic modelling
JEL Classification: E370

Simon Feeny, Max Gillman and Mark N. Harris (December 2005)
Econometric Accounting of the Australian Corporate Tax Rates: a Firm Panel Example (1064K, 25 pages)
The paper presents an econometric accounting of the effective corporate tax rate in Australia for the years 1993 to 1996. The estimation is a panel of Australian firms that uses a specially gathered financial data base. Using fixed and random effects, the model specifies that the statutory tax rate is estimated as the constant term of the model. An ability to find an estimated statutory tax rate that is close to the actual rate suggests a certain confidence in the estimated effects of the others factors affecting the effective tax rate. The results show importance for interest expenses, depreciation allowances, debt/asset structures, and the foreign ownership of firms. There is support for an Australian role as a preferential tax location.
Keywords: Effective tax rate; accounting model; panel data; random and fixed effects
JEL Classification: H25; E62

Max Gillman and Michal Kejak (December 2005)
Inflation and Balanced-Path Growth with Alternative Payment Mechanisms (1236K, 36 pages)
Published in Economic Journal, Vol 115 (January): 247-270.
The paper shows that contrary to conventional wisdom an endogenous growth economy with human capital and alternative payment mechanisms can robustly explain major facets of the long run inflation experience. A negative inflation-growth relation is explained, including a striking non-linearity found repeatedly in empirical studies. A set of Tobin (1965) effects are also explained and, further, linked in magnitude to the growth effects through the interest elasticity of money demand. Undisclosed previously, this link helps fill out the intuition of how the inflation experience can be plausibly explained in a robust fashion with a model extended to include credit as a payment mechanism.
Keywords: Human capital; cash-in-advance; interest-elasticity; credit production
JEL Classification: O42; E31; E22

Szilárd Benk, Max Gillman and Michal Kejak (December 2005)
A Comparison of Exchange Economies within a Monetary Business Cycle (1103K, 28 pages)
Published in The Manchester School
The paper sets out a monetary business cycle model with three alternative exchange technologies, the cash-only, shopping time, and credit production models. The goods productivity and money shocks affect all three models, while the credit model has in addition a credit productivity shock. The paper compares the performance of the models in explaining the puzzles of the monetary business cycle theory. The credit model improves the ability to explain the procyclic movement of monetary aggregates, inflation and the nominal interest rate.
Keywords: Cash-in-advance; credit production; cycle; inflation
JEL Classification: E13; E32; E44

Szilárd Benk, Max Gillman and Michal Kejak (December 2005)
Credit Shocks in the Financial Deregulatory Era: Not the Usual Suspects (1213K, 30 pages)
Published in Review of Economic Dynamics
The paper constructs credit shocks using data and the solution to a monetary business cycle model. The model extends the standard stochastic cash-in-advance economy by including the production of credit that serves as an alternative to money in exchange. Shocks to goods productivity, money, and credit productivity are constructed robustly using the solution to the model and quarterly US data on key variables. The contribution of the credit shock to US GDP movements is found, and this is interpreted in terms of changes in banking legislation during the US financial deregulation era. The results put forth the credit shock as a candidate shock that matters in determining GDP, including in the sense of Uhlig (2003).
Keywords: Business cycle; credit shocks; financial deregulation
JEL Classification: E32; E44

Patrick Minford, Eric Nowell and Bruce Webb (December 2005)
Would price-level targeting destabilise the economy? (1244K, 26 pages)
When indexation is endogenous price level targeting slightly adds to economic stability, contrary to widespread fears to the contrary. The aggregate supply curve flattens and the aggregate demand curve steepens, increasing stability in the face of supply shocks.
Keywords: Inflation; targeting; price-level rule; Price level target; indexation; monetary regime; endogenous contracts; stationarity; stability
JEL Classification: E31; E42; E52

Helmuts Azacis and Roberto Burguet (December 2005)
Incumbency and Entry in License Auctions: The Anglo-Dutch Auction Meets Other Simple Alternatives (1128K, 32 pages)
Published in International Journal of Industrial Organization, 26(3), pp. 730-745, May 2008
The existence of ex-ante strong incumbents may constitute a barrier to entry in auctions for goods such as licenses. Introducing inefficiencies that favor entrants is a way to induce entry and thus create competition. Designs such as the Anglo-Dutch auction have been proposed with this goal in mind. We first show that indeed the Anglo- Dutch auction fosters entry and increases the revenues of the seller. However, we argue that a more eective way could be to stage the allocation of the good so that each stage reveals information about the participants. We show that a sequence of English auctions, with high reserve prices in early rounds, is a procedure with this property that is more efficient than any one-stage entry auction. Moreover, it also dominates the Anglo-Dutch auction in terms of seller's revenues.

Helmuts Azacis (December 2005)
Double Implementation in a Market for Indivisible Goods with a Price Constraint (1098K, 22 pages)
Published in Games and Economic Behaviour, 62(1), pp. 140-154, January 2008.
I consider the problem of assigning agents to indivisible objects, in which each agent pays a price for his object and all prices sum to a given constant. The objective is to select an assignment-price pair that is envy-free with respect to the agents' true preferences. I propose a simple mechanism whereby agents announce valuations for all objects and an envy-free allocation is selected with respect to these announced preferences. I prove that the proposed mechanism implements both in Nash and strong Nash equilibrium the set of true envy-free allocations.
Keywords: Indivisible Goods; Envy-Freeness; Implementation; Strong Nash Equilibrium
JEL Classification: C78; C71; D78

Patrick Minford and Naveen Srinivasan (December 2005)
Opportunistic Monetary Policy: an Alternative Rationalization (1084K, 17 pages)
Published in Journal of Economics and Business, 58, October-November 2006, pp. 366-372
This paper offers an alternative rationalization for opportunistic behaviour i.e., a gradual disinflation strategy where policymakers react asymmetrically to supply shocks, opting to disinflate only in recessionary period. Specifically, we show that adaptive expectations combined with asymmetry in the Phillips curve of a specific sort together provide an optimizing justification for opportunism. However, the empirical basis for these conditions to be satisfied in the current low-inflation context of most OECD countries remains however to be established.
Keywords: Deliberate disinflation; Opportunistic disinflation
JEL Classification: E52; E58

James Foreman-Peck and Laurian Lungu (December 2005)
Fiscal Devolution and Dependency (996K, 31 pages)
Forthcoming in Applied Economics
Public spending devolution in practice is widely seen as more appropriate for addressing varied political aspirations within state boundaries than is tax devolution. A drawback is that devolved public spending may be subject to irresistible upward pressure, as illustrated by 'formula drift' of the United Kingdom devolved administrations. By crowding out the private sector such public spending can exacerbate the problem it was originally intended to alleviate. When taxpayers do not value increases in government output at least as highly as the private goods and services they must forgo to finance them, then the public sector is too large. This paper estimates a three sector Hecksher-Ohlin model of the economy with the greatest relative rise of the public spending ratio in the United Kingdom, Wales. Simulation of the model shows a net gain in emp loyment from a one percent cut in income tax matched by a corresponding reduction in government spending. This result is consistent with the current level of intergovernmental transfers being excessive.
Keywords: Fiscal Devolution; Small Open Economy Modelling; Crowding Out
JEL Classification: R15; R58

Max Gillman and Dario Cziráky (December 2005)
Money Demand in an EU Accession Country: A VECM Study of Croatia (1115K, 32 pages)
Published in Bulletin of Economic Research, April 2006 58(2) pp. 73-159
The paper estimates the money demand in Croatia using monthly data from 1994 to 2002. A failure of the Fisher equation is found and adjustment to the standard money demand function is made to include the inflation rate as well as the nominal interest rate. In a two-equation cointegrated system, a stable money demand shows rapid convergence back to equilibrium after shocks. This function performs better than an alternative using the exchange rate instead of the inflation rate, as in the "pass-through" literature on exchange rates. The results provide a basis for inflaton rate forecasting and suggest the ability to use inflation targeting goals in transition countries during the EU accession process. Finding a stable money demand also limits the scope for central bank "inflation bias".

Sheikh Selim (November 2005, updated November 2010)
The Social Cost of Optimal Taxes in an Imperfectly Competitive Economy (1405K, 33 pages)
In this paper we calibrate the social cost of optimal taxes in a class of imperfectly competitive economies and examine the correspondence of this social cost with the number of tax instruments and the number and the sources of distortions. We calibrate the Ramsey equilibrium for three standard models of imperfect competition. These settings are different in number of sources of market distortion and number of tax instruments. Our calibration clearly shows that optimal taxes in an imperfectly competitive economy incur lower social cost than those in a competitive economy, implying that they are generally more efficient as competition enhancing policy tools. We find that optimal taxes in our models can cost up to 48% less forgone consumption relative to those in a competitive market economy.
Keywords: Optimal taxation; Ramsey Problem; Welfare Cost
JEL Classification: D42; E62; H21; H30

Sheikh Selim (November 2005, updated July 2006)
Taxing Capital in an Imperfectly Competitive Economy (1053K, 30 pages)
Evidence of declining trend in OECD economies' income tax rates and the concern of enhancing competition in the US and the EU product markets subtly motivate the question if low income tax rates are optimal in an imperfectly competitive economy. This paper examines optimal income tax policy in a dynamic neoclassical model with monopoly distortions. A capital subsidy, motivated by low private returns to capital, provides strong incentive to invest, but the adverse welfare effect of investment is not perceived by capital owners. Since profit seeking investment worsens second best welfare, and this effect is only perceived by the government, there is a strong motivation to tax capital. The paper presents a numerical characterization of the Ramsey policy and shows that switching to a Ramsey policy involving a capital tax is welfare improving.
Keywords: Optimal taxation; Monopoly power; Ramsey policy
JEL Classification: D42; E62; H21; H30

James Foreman-Peck (November 2005)
Lessons from Italian Monetary Unification (1079K, 24 pages)
This paper examines whether the states brought together in the Italian monetary union of the nineteenth century constituted an optimum monetary area, either before or after unification. Interest rate shocks indicate close relations between states in northern Italy but negative correlations between the North and the South before unification, suggesting some advantages of continued Southern monetary independence. The proportion of Southern Italian trade with the North was small, in contrast to intra- Northern trade, and therefore monetary independence imposed a light burden. Changes in the wheat market indicate that the South and North after unification (though not probably because of it) increasingly specialised according to their comparative advantages. Coupled with differences in economic behaviour of the Southern economy, this meant that monetary policies appropriate for the North were less so for the South. In the face of agricultural shocks originating in the New World and in France, the South would have gained from depreciating its exchange rate against the North or against the non-Italian world. As it was, nineteenth century Italian monetary union did not create the conditions for its own success, contrary to the findings of Frankel and Rose (1998) for the later twentieth century.
JEL Classification: E42; N23; F15; F33

Patrick Minford and David Peel (November 2005)
On the equality of Real Interest Rates across borders in Integrated Capital Markets (1044K, 9 pages)
Published in Open Economies Review, 18(1), 2007
The purpose in this letter is first to review briefly the empirical results on the relationship between real interest rates and real exchange rates,this empirical literature provides little support for the hypothesis of Roll that expected real interest rates are equal in general. Our second aim is to discuss the theoretical conditions that have to be met for his hypothesis to hold.
Keywords: Real interest rates; Real Exchange rates; Roll
JEL Classification: F31; C22; C51

David Meenagh, Patrick Minford, Eric Nowell and Prakriti Sofat (November 2005, updated March 2010)
Can a Real Business Cycle Model without price and wage stickiness explain UK real exchange rate behaviour? (1152K, 21 pages, previously published as "Can a pure Real Business Cycle Model explain the real exchange rate?")
This paper establishes the ability of a Real Business Cycle model to account for real exchange rate behaviour, using UK data. We show that a productivity simulation is capable of explaining initial real appreciation with subsequent depreciation to a lower steady state. The model is tested by the method of indirect inference, bootstrapping the errors to generate 95% confidence limits for a time-series representation of the real exchange rate, as well as for various key data moments. The results suggest RBC models can explain real exchange rate movements.
Keywords: Real Exchange Rate; Productivity; Real Business Cycle; Bootstrap; Indirect Inference
JEL Classification: E32; F31; F41