NBER Reporter: Summer 2001

International Seminar on Macroeconomics

The NBER's 24th Annual International Seminar on Macroeconomics, organized by Jeffrey A. Frankel, NBER and Harvard University, and Francesco Giavazzi, NBER and Bocconi University, was held on June 8-9 at University College Dublin (Ireland). The following papers were discussed:

Anne Sibert, Birkbeck College, "Monetary Policy with Uncertain Central Bank Preferences"

Discussants: Mervyn King, NBER and Bank of England, and Lars Svensson, NBER and Stockholm University

Arrt Kraay, World Bank, and Jaume Ventura, NBER and MIT, "The Role of Trade in International Transmission of Business Cycles"

Discussants: Antonio Fatas, INSEAD, and James Stock, NBER and Harvard University

Eduardo Loyo, Harvard University, "Imaginary Money"

Discussants: Zvi Eckstein, Tel Aviv University, and Frank Smets, European Central Bank

Raquel Fernandez, NBER and New York University, "Education, Segregation, and Marital Sorting: Theory and an Application to U.K. Data"

Discussants: Alberto Alesina, NBER and Harvard University, and Gianluca Violante, University College London

Romain Wacziarg, Stanford University, "Structural Convergence"

Discussants: Tito Boeri, Universita Bocconi, and Peter Neary, University College Dublin

Rodney Thom and Brendan Walsh, University College Dublin, "The Effect of a Common Currency on Trade: Ireland Before and After the Sterling Link"

Discussants: William A. Branson, NBER and Princeton University, and Andrew Rose, NBER and University of California at Berkeley

Susanto Basu, NBER and University of Michigan, and John Fernald, Federal Reserve Bank of Chicago, "Aggregate Productivity and Aggregate Technology"

Discussants: Robert J. Gordon, NBER and Northwestern University, and Jean Imbs, London Business School

Philip Lane, Trinity College Dublin, and Gian Maria Milesi-Ferretti, International Monetary Fund, "External wealth, the Trade Balance, and the Real Exchange Rate"

Discussants: Barry Eichengreen, NBER and University of California at Berkeley, and Richard Portes, NBER and London Business School

Sibert analyzes the effect of unobservable central bank preferences on the actions of the central bank and on inflation. In her basic model, central bankers serve two terms. The weight that they place on output, relative to inflation, is their private information (that is, unobservable). The model shows that all but the most dovish central bankers inflate less they otherwise would in their first period in office in order to differentiate themselves from less conservative central bankers. Surprisingly, in that first period central banks also respond more to shocks than they otherwise would. Central banks may socialize central bankers, making them more conservative over time. An extension of Sibert's basic model allows central bankers' preferences to change randomly over time. If policymakers tend to become more conservative, this causes them to inflate more in their first term. Thus, the private information need not lead to lower inflation in the first period of office than in the second. A further extension of her model allows for policymakers to serve three periods in office. If the probability of a change in preferences is small, then all but the most conservative central bankers inflate less in the first period than in the second.

In industrial countries, the service sector accounts for more than two-thirds of GDP, yet trade in service accounts for only 20 percent of international trade. To a large extent this bias in trade flows reflects both technological and policy-induced barriers to trade in services that are expected to decline substantially in the next decade or two. What will be the effects of such an increase in service trade on risk sharing? Kraay and Ventura develop a stylized model of international trade and risk sharing. Since countries have different factor abundance and industries have different factor intensities, there is an incentive to trade in goods and services in order to exploit the country's comparative advantage. Because countries experience imperfectly correlated shocks to their factor productivity, there is also an incentive to trade in assets to diversify or share country risk. The authors interpret a reduction in the technological and policy barriers to trade in services as an increase in the ability to perform the first type of trade. They then explore the consequences of this reduction in barriers for the second type of trade.

Loyo considers price setting in pure units of account, linked to the means of payment through managed parities. If prices are sticky in the units in which they are set, then changes to parity may facilitate equilibrium adjustment of relative prices. Loyo derives the optimal choice of unit of account by each price setter, and the optimal parity policy. He then computes the gains for a simple calibrated economy from having multiple units of account.

Fernandez presents a model of the intergenerational transmission of education and marital sorting. Parents matter, both because of their household income and because parental human capital determines the expected value of a child's disutility from making an effort to become skilled. She shows that in the steady state an increase in segregation has potentially ambiguous effects on the fraction of individuals who become skilled, and hence on marital sorting, the personal and household income distribution, and welfare. Then, using U.K. statistics and results obtained previously for the United States, she finds that segregation is likely to have a smaller negative impact in the United Kingdom than in the United States because of the fertility and education transmission process.

Wacziarg establishes the existence of structural convergence: country pairs that converge in terms of per capita income also tend to converge in terms of their sectoral similarity, as measured by the bilateral correlation of their sectoral labor shares. This is a robust feature of the data at various levels of sectoral disaggregation and data coverage. He sheds light on some explanations for structural similarity, chiefly trade related determinants. Convergence in factor endowments accounts for approximately one-third of the extent of structural convergence. Wacziarg argues that the existence of structural convergence has important implications for our understanding of business cycles transmission, of long-run development patterns, and of the dynamics of specialization.

Thom and Walsh use the introduction of an exchange rate between Ireland and the United Kingdom in 1979 as a natural experiment to shed light on the effects of a common currency on the volume of international trade. They find that the change of exchange rate regime had no significant effect on the pattern of Irish trade. This finding casts doubt on the belief that the European Economic and Monetary Union will have a major effect on the pattern of trade between participating countries.

Aggregate productivity and aggregate technology are meaningful but distinct concepts. Basu and Fernald show that a slightly-modified Solow productivity residual measures changes in economic welfare, even when productivity and technology differ because of distortions, such as imperfect competition. Their results imply that aggregate data can be used to measure changes in welfare, even when disaggregated data are needed to measure technical change. They then present a general accounting framework that identifies several new non-technological gaps between productivity and technology, gaps reflecting imperfections and frictions in output and factor markets. They find that these gaps are important. The evidence suggests that the usual focus on one-sector models misses a rich class of important propagation mechanisms that are present only in multi-sector models.

Lane and Milesi-Ferretti examine the link between the net foreign asset position, the trade balance, and the real exchange rate. In particular, they decompose the impact of a country's net foreign asset position ("external wealth") on its long-run real exchange rate into two mechanisms: the relation between external wealth and the trade balance; and, holding fixed other determinants, the negative relation between the trade balance and the real exchange rate. They also show that the relative price of nontradables is an important channel linking the trade balance and the real exchange rate.

These papers will be published in a special issue of the European Economic Review. Many of them are also available at Books in Progress.

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