International Seminar on Macroeconomics

NBER Reporter: Summer 2000

Twenty-Third Annual International Seminar on Macroeconomics

The NBER held its twenty-third Annual International Seminar on Macroeconomics at the Bank of Finland in Helsinki on June 16 and 17. Zvi Eckstein, Tel Aviv University, and Andrew Rose, NBER and University of California, Berkeley, organized this program:

Philippe Aghion, European Bank for Reconstruction and Development; Philippe Bacchetta, Study Center Gerzensee; and Abhijit Banerjee, MIT, "Currency Crises and Monetary Policy in an Economy with Credit Constraints"

Discussants: Allan Drazen, NBER and Hebrew University of Jerusalem, and Linda S. Goldberg, Federal Reserve Bank of New York

Craig Burnside, The World Bank, and Martin S. Eichenbaum and Sergio T. Rebelo, NBER and Northwestern University, "Hedging and Financial Fragility in Fixed Exchange-Rate Regimes" (NBER Working Paper No. 7143)

Discussants: Susan M. Collins, NBER and Georgetown University, and Paolo Pesenti, Federal Reserve Bank of New York

Steven J. Davis, NBER and University of Chicago; Paul Willen, Princeton University; and Jeremy Nalewaik, University of Chicago, "On the Gains to International Trade in Risky Financial Assets" (NBER Working Paper No. 7796)

Discussants: Deborah J. Lucas, NBER and Northwestern University, and Robert G. King, NBER and University of Virginia

Jordi Gali, NBER and Universitat Pompeu Fabra; Mark Gertler, NBER and New York University; and J. David Lopez-Salido, Bank of Spain, "European Inflation Dynamics"

Discussants: Francesco Giavazzi, NBER and Bocconi University, and Jeremy Nalewaik

Juha Tarkka and David Mayes, Bank of Finland, "The Value of Publishing Official Central Bank Forecasts"

Discussants: Zvi Eckstein, and Jeffrey A. Frankel, NBER and Harvard University

Kjetil Storesletten, Stockholm University, and Amir Yaron, NBER and University of Pennsylvania, "The Welfare Cost of Business Cycles Revisited: Finite Lives and Countercyclical Variation in Earnings"

Discussants: Marianne Baxter, NBER and Boston University, and Jose-Victor Rios-Rull, NBER and University of Pennsylvania

Jonathan Eaton and Samuel S. Kortum, NBER and Boston University, "Trade in Capital Goods"

Discussants: Harry Flam, Stockholm University, and Assaf Razin, NBER and Tel Aviv University

Bent E. Sorensen, Federal Reserve Bank of Kansas City; Lisa Wu,, Ottawa; and Oved Yosha, Tel Aviv University, "Output Fluctuations and Fiscal Policy: U.S. State and Local Governments 1978-94"

Discussants: Antonio Fatas, Institut Europeen d'Administration des Affaires, and Valerie A. Ramey, NBER and University of California, San Diego

Aghion, Bacchetta, and Banerjee present a simple model of currency crises that is driven by the interplay between the credit constraints of private domestic firms and the existence of nominal price rigidities. The possibility of multiple equilibriums, including a "currency crisis equilibrium" with low output and a depreciated domestic currency, results from the following: if nominal prices are "sticky," a currency depreciation will lead to an increase in the foreign currency debt-repayment obligations of firms, and thus to a drop in their profits. In a credit-constrained economy, this reduces firms' borrowing capacity, and therefore investment and output. This in turn reduces the demand for the domestic currency and leads to a further depreciation. Aghion, Bacchetta, and Banerjee examine the impact of productivity, fiscal, and expectational shocks. They then analyze the optimal monetary policy regarding currency crises. The authors argue that currency crises can occur under both fixed and flexible exchange-rate regimes since the primary source of crises is the deteriorating balance sheet of private firms.

Currency crises that coincide with banking crises tend to share at least two elements: governments provide guarantees to domestic and foreign bank creditors; and banks do not hedge their exchange rate risk. Burnside, Eichenbaum, and Rebelo study banks' incentives to hedge exchange rate risk when government guarantees are available to foreign lenders. The authors show that guarantees completely eliminate banks' incentives to hedge the risk of a devaluation. Their model articulates one reason why governments might be tempted to provide guarantees to bank creditors: guarantees lower the domestic interest rate and lead to a boom in economic activity. But this boom comes at the cost of a more fragile banking system. In the event of a devaluation, banks renege on foreign debts and declare bankruptcy.

Davis, Willen, and Nalewaik develop and implement a framework for quantifying the gains to international trade in risky financial assets. They show that standard theory with full participation in the asset market implies enormous gains to trade when asset returns are calibrated to observed risk premiums. This gains-to-trade puzzle is closely related to, but distinct from, the equity-premium puzzle. While very high risk aversion rationalizes the equity premium in standard models, it merely alters the form of the gains-to-trade puzzle. In contrast, limited participation in asset markets can simultaneously address the equity premium and the gains-to-trade puzzles. The authors identify three reasons for limited international risk sharing. First, the requirement that asset markets span the space of national output shocks fails in a serious way. Second, for many countries the cost of using financial assets to hedge national output shocks greatly exceeds the benefits. Third, limited participation reduces the feasible gains from international risk sharing.

Gali, Gertler, and Lopez-Salido provide evidence on the fit of the New Phillips Curve (NPC) for the Euro area over the period 1970-98. They use the NPC as a tool to compare the characteristics of European versus U.S. inflation dynamics. They also analyze the factors underlying inflation inertia by examining the cyclical behavior of marginal costs, labor productivity, and real wages. Some of their findings can be summarized as follows: 1) the NPC fits Euro-area data very well, possibly better than it fits the U.S. data; 2) the degree of price stickiness implied by the estimates is substantial but in line with survey evidence and U.S. estimates; 3) inflation dynamics in the Euro area appear to have a stronger forward-looking component (that is, less inertia) than in the United States; 4) labor market frictions, as manifested in the behavior of the wage markup, appear to have played a key role in shaping the behavior of marginal costs and, consequently, inflation in Europe.

Tarkka and Mayes analyze whether Central Banks should publish their macroeconomic forecasts and what could be gained in monetary policy if they did. They show that disclosing a Central Bank's assessment of the prevailing inflationary pressures in the form of a forecast improves macroeconomic performance, even if this assessment is imprecise. This is because it makes policy more predictable. Tarkka and Mayes also investigate what the useful content of the forecasts is if they are published, and whether it makes a difference if these official forecasts are "unconditional" -- in the sense of incorporating the Central Bank's forecasts of its own policy as well -- or "conditional" on some other policy assumption. The analysis comes out in favor of publishing unconditional forecasts, which reveal the intended results of monetary policy.

Storesletten and Yaron investigate the welfare costs of business cycles in an economy with heterogeneous agents with finite lives. These agents face uninsurable labor risk which is correlated countercyclically with aggregate productivity shocks. The authors find large welfare gains from eliminating business-cycle fluctuations. Almost all of those gains are attributable to eliminating business-cycle variations in the variance of idiosyncratic risk. The direct effects of simply smoothing aggregate productivity shocks, or the general equilibrium effects associated with changes in aggregate savings and prices, are very small. Storesletten and Yaron also find that the average welfare gain is actually smaller in this type of economy than in a similar economy in which agents are infinitely lived. However, the distribution of welfare gains is highly sensitive to age and the composition of wealth.

Eaton and Kortum develop a model of trade and growth in which advances in technology are embodied in capital. Although technological innovations are highly concentrated in a few advanced countries, the benefits of better technology are distributed more evenly around the world because of the export of capital goods. The authors use the model to confront data on production and trade in capital goods and on the variation in prices of capital goods around the world. They also examine the extent to which barriers to trade in capital goods can explain productivity differences.

What are the cyclical properties of U.S. state and local government fiscal policies, Sorensen, Wu, and Yosha ask. The budget surpluses of local, and in particular state, governments are procyclical for both short- and medium-term horizons. Such surpluses are the result of strongly procyclical revenues and weakly procyclical expenditures. The budget surpluses of trust funds and utilities are also procyclical. This holds true whether aggregate (U.S.-wide) fluctuations are controlled for or not. Federal grants to state and local governments also are procyclical, but this is because of aggregate fluctuations. Federal grants are actually countercyclical with respect to state-level fluctuations. The cyclical patterns of state and local budget surpluses are affected by various political institutions: for example, budget surpluses are less procyclical in conservative states or in states with stringent balanced budget rules. Finally, there is no direct evidence that state and local off-budget accounts are more procyclical where balanced budget rules are tighter.

These papers and discussions will be published in a special edition of the European Economic Review. In advance of the publication of the journal, most of the papers will be available at Books in Progress.

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