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Working Papers 266-299

Abstract: This article reviews David Hendry's Econometrics: Alchemy or Science?

Abstract: This paper studies the soft budget constraint problem in a principal-agent model. The agent screens projects of and makes initial investment in the projects that have passed the screening. He then finds the types of the funded projects and decides to close some of the ex post inefficient ones among them. Closing projects sends an unfavorable signal about the agent's screening effort. Under the ex ante efficient contract, the agent has incentive to refinance some of the ex post inefficient projects.

Abstract: Numerical approximations to the asymptotic distributions of recently proposed tests for structural change are presented. This enables easy yet accurate calculation of asymptotic p-values.

Abstract: This paper establishes stochastic equicontinuity for classes of mixingales. Attention is restricted to Lipschitz-continuous parametric functions. Unlike some other empirical process theory for dependent data, our results do not require bounded functions, stationary processes, or restrictive dependence conditions. Applications are given to martingale difference arrays, strong mixing arrays, and near epoch dependent arrays.

Abstract: Using comparable micro-level data from three countries, we ask what type of person works in the informal sector and whether informal workers earn lower wages than observationally equivalent workers in the formal sector. The characteristics of informal workers are similar across countries. Surprisingly, when we control for these personal characteristics, we find a significant wage premium associated with formal employment in El Salvador and Peru but a premium associated with work in the informal sector in Mexico. A model of endogenous selection offers little help in explaining the differences in wage patterns. The research casts doubt on the received wisdom that the informal sector, always and everywhere, is a poorly-paid but easily-entered refuge for those who have no other employment opportunities.

Revised version (with discussion by Steven Fazzari and Donald Hester) published in Is Bank Lending Important for the Transmission of Monetary Policy?, J. Peek and E. Rosengren, eds., Federal Reserve Bank of Boston Conference Series No. 39, June 1995.

Abstract: This paper presents a model in which "instrument uncertainty"‹that is, an uncertain mapping from monetary policy to macroeconomic outcomes‹may mitigate the inflationary bias problem that arises when efficient monetary policy rules are time- inconsistent. If the relation between monetary policy and macroeconomic outcomes is uncertain, the private sector has an incentive to scrutinize the past for clues about this relationship. This learning creates a link between past government behavior and present inflation expectations that the government can exploit to enhance its credibility. The model implies that the two conventional arguments for simple rules in monetary policy‹one stressing the central bank's poor forecasting abilities and the other stressing the perils of discretion‹may work at cross-purposes. Moreover, it provides an explanation of the cyclical behavior of inflation due to political cycles and of the correlation between the level and variance of inflation.

Abstract: This paper provides benchmarks of trade restrictiveness and year-on-year changes in trade restrictiveness using the Trade Restrictiveness Index. These benchmark measures stand in sharp contrast to standard measures. For a 28 country sample the TRI is used to compare trade policy in a recent year with free trade. Trade weighted average tariffs substantially underestimate restrictiveness measured by the 'uniform tariff equivalent' (the inverse of the TRI minus one), with the degree of underestimate positively correlated with the dispersion of the tariff structure. The rank correlation of the 'uniform tariff equivalent' and the average tariff in the sample is high, but the error implied by using the average tariff instead of the uniform tariff equivalent is substantial and variable. For a 7 case sample, year-on-year recent changes in trade policy are evaluated with the TRI and with standard measures. Here, the correlation of the TRI and changes in the standard measures is close to zero, essentially because tariff means and variances often do not move together. These conclusions appear to be robust with respect to missing data problems. The magnitude of the TRI is not very sensitive to elasticity of substitution variation, but is sensitive to the assumptions used to treat NTBs.

Abstract: In this paper, we test the multivariate model of securities' excess returns formulated by Engle et al. (1990) on an expanded set of maturities. By applying their methodology to the entire Treasury term structure, we consider the applicability of a parsimonious common factor approach to the dynamics of short-, medium-, and long-term interest rates. We extend their methodology to incorporate asymmetric GARCH representations, in which the slope of the yield curve (and its sign) affects the evolution of the conditional variance of excess returns in fixed-income and equity markets. We find this approach quite successful in explaining the comovements of excess returns on the spectrum of Treasury issues for the 1962-1992 period.

Abstract: This paper analyzes the effects of the form of ownership on the substitutability between internal and external sources of finance. In particular, we test whether financial constraints are more severe for independent firms and whether there are differences between members of large national business groups and subsidiaries of foreign multinational corporations. The results obtained from leverage and investment equations estimated for a panel of Italian companies imply that independent firms face more severe financial constraints. Moreover, such constraints are greater when cash flow decreases. Members of national groups and subsidiaries of multinational corporations are less sensitive to cash flow in their investment decisions. Leverage equations suggest, however, that there are interesting differences between the two latter categories of firms. In particular, agency costs arising from the conflict between managers and shareholders are more important for subsidiaries of multinational corporations.

Abstract: In this paper we develop a switching regression model of investment, in which the probability of a firm being financially constrained is endogenously determined. This approach allows one to address the potential problem of static and dynamic misclassification encountered where firms are sorted using a criteria chosen a priori.
The empirical results obtained for US panel data suggest that the probability of being constrained depends upon variables that capture each firm's credit worthiness, and it is also related to general macroeconomic conditions and to the tightness of monetary policy.

283. Robert G. Murphy, "Macroeconomic Policy Implications of Oil in Colombia" (11/1994)

Abstract: This paper develops and applies a small econometric model to illustrate the likely short-term macroeconomic effects on the economy of Colombia resulting from the recent discovery and planned development of new oil resources. In performing the analysis, the paper considers various assumptions concerning government fiscal, monetary, and exchange-rate policies so as to assess the ability of policy to influence the effects that the oil discovery will have on the economy. Comparisons of these alternative policy simulations strongly suggest that appropriate macroeconomic policies can reduce significantly the negative consequences of the "Dutch disease," the symptoms of which are reflected in an over-valued exchange rate and declining non-oil export and import-competing sectors. The simulations also demonstrate, however, that some degree of relative price adjustment will be needed for the Colombian economy. In particular, attempts to limit relative price adjustment through the real exchange rate simply force the requisite relative price adjustment to occur through domestic price inflation in reducing the real purchasing power of the peso. Managing this tradeoff between domestic price inflation and real appreciation of the exchange rate should be the overriding concern of macroeconomic policy.

282. Richard Arnott, "Alleviating Traffic Congestion: Alternatives to Road Pricing" (09/1994)

Abstract: Economists' favorite remedy for traffic congestion is road pricing. Not only is road pricing based on sound economic principles, but also given current technology it could be implemented at reasonable cost and in a flexible and sophisticated manner. But there are serious obstacles to the widespread adoption of road pricing. There are problems of phase-in: the fixed costs of introducing any system of road pricing, as well as the problems of coordinating road pricing across jurisdictions, including standardization and the treatment of out-of-towners. Political acceptability is an even more serious obstacle. How can congestion pricing be "sold" to economically unsophisticated voters who are justifiably suspicious of any new government taxes and charges? This paper will not argue against road pricing, though it will point out some of the difficulties associated with the policy that economists have tended to ignore or to gloss over. Rather, it will examine some of the alternatives to road pricing. More specifically, it will focus on two related questions, one positive, one normative, on the assumption that congestion pricing is not introduced, at least on city streets. The positive question: What are the likely effects of policies other than road pricing on alleviating road congestion? The normative question: What mix of policies (road pricing excluded) would be most effective in alleviating traffic congestion? Throughout the focus will be on urban traffic congestion. Alternatives to road pricing can be grouped into five categories: 1. Expansion and upgrading of existing road capacity; 2. Expansion and upgrading of mass transit; 3. Regulation; 4. Information; 5. Non-road transport pricing. While the emphasis of the paper will be on qualitative analysis, there will be some attempts at quantification via back-of-the-envelope calculations.

A revised version (January 1996) of this paper, now entitled "Time-Varying Risk Premia in the Foreign Currency Futures Basis," may be downloaded in Adobe Acrobat format (192 K): published in Journal of Futures Markets 16:7, 735-755.

Abstract (revised January 1996): Significant time-varying risk premia exist in the foreign currency futures basis, and these risk premia are meaningfully correlated with common macroeconomic risk factors from equity and bond markets. The stock index dividend yield and the bond default and term spreads in the U.S. markets help forecast the risk premium component of the foreign currency futures basis. The specific source of risk matters, but the relationships are robust across currencies. The currency futures basis is positively associated with the dividend yield and negatively associated with the spread variables. These correlations cannot be attributed to the expected spot price change component of the currency futures basis, thus establishing the presence of a time-varying risk premium component in the currency futures basis.

280. Richard Arnott, "The Economics of Residential Real Estate Brokerage" (06/1994)

279. Chongen Bai, Shan Li, "Capital Structure and Product Market Strategy" (07/1994)

Abstract: This paper develops a general framework to analyze the relationship between a firm's capital structure and its product market strategy and presents a taxonomy of whether debt makes a firm tough or soft in product market competition and how strategic considerations affect the leverage of a firm based on the nature of the firm's agency problem and the characteristics of the product market. We then review the related literature and point out unexplored linkages between capital structure and product market strategies. Finally, we discuss the empirical implications of our theoretical results.

278. Martin Fleming, John Jordan, and Kathleen Lang, "Macroeconomic Policy and Methodological Misdirection in the National Income and Product Accounts" (09/1994)

277. Chongen Bai and Yijiang Wang, "Specific Human Capital Investment and Turnover Under Uncertainty" (07/1994)

Abstract: An equilibrium model of labor contracts under asymmetric information is developed. A profit-maximizing firm offers a wage but retains the right to lay off the worker based on its private observation of the worker's productivity ex post. The worker invests in specific human capital, unobservable to the firm, to improve the retention probability. It is shown that, under not very restrictive conditions, productivity uncertainty has adverse effects on the firm's wage offer to the worker, the worker's investment in firm-specific human capital, employment stability, and average productivity. A comparison between American and Japanese firms is made to explore the implication of the finding.

276. Chongen Bai, "Specific Human Capital Investment and Wage Profiles" (11/1992)

275. Christopher F. Baum and Olin Liu, "An Alternative Strategy for Estimation of a Nonlinear Model of the Term Structure of Interest Rates" (08/1994)

Abstract: This paper develops and tests a nonlinear general equilibrium model of the term structure of interest rates based on the framework of Cox, Ingersoll and Ross (CIR, 1985). The contributions of this paper to the literature are both theoretical and empirical. The theoretical advantages of the general equilibrium model developed in this paper over the CIR model are (a) the risk premium is endogenously derived as a nonlinear function of the instantaneous interest rate. (b) The nonlinear model shows that the term premium need not be strictly increasing in maturity as in CIR's model; it can be either increasing or humped, a result that is consistent with recent findings by Fama (1984) and McCulloch (1987). (c) Yields of different maturities are not perfectly correlated, but exhibit positive correlations. A partial differential equation for valuing the discount bond price is presented, and a closed-form expression is derived. The term structure of interest rates derived from this nonlinear model may be increasing, decreasing, humped or inverted, depending on parameter values.
In an empirical application of the model, we develop a strategy for estimation which permits analysis of the modelÕs temporal stability. Our modelÐlike that of CIRÐexpresses the underlying stochastic process as a highly nonlinear function of two fundamental, time-invariant parameters. Many researchers have found that general equilibrium models such as CIRÕs provide quite poor explanations of the evolution of the term structure of interest rates. As an alternative strategy to that of fitting the fundamental parameters, we employ nonlinear system estimation of the unrestricted reduced-form parameters with a moving-window strategy in order to capture the term structure volatility caused by factors other than the instantaneous interest rate. We purposefully do not impose any law of motion on the estimated volatilities. This methodology is shown to have strong predictive power for the observed term structure of interest rates, both in-sample and out-of-sample.

Abstract: Standard models of hyperinflation use a money demand function based on asset- market considerations: households adjust their real balances according to expected inflation, which is the negative of the real rate of return to money. But these models yield inaccurate and sometimes counterintuitive predictions. One is that if a hyperinflation is a price-level bubble, then hyperinflation is possible at any rate of money growth. Another is that, for some equilibria, an increase in a government's reliance on seignorage reduces rather than raises the steady-state inflation rate. This paper proposes an alternative way to look at hyperinflation based on a careful description of the microeconomics of monetary exchange. Money is primarily an institution required to finance consumption and only incidentally a financial asset. The decision to accept money is a decision to engage in monetary exchange, and a hyperinflation occurs when most households choose to abstain from monetary exchange. The macroeconomic implications of this model are more appealing than those of the traditional models. First, while a hyperinflation in my model may have the same properties as a price-level bubble, this "bubble" is very unlikely when money growth is low and inevitable when money grows too quickly. Second, a greater reliance on seignorage increases the rate of inflation, and can ultimately cause a hyperinflation. The model also mimics the non-monotonic path of real balances as inflation accelerates. Finally, the model suggests that it may be very difficult to restore a currency's place in exchange after a hyperinflation.

Abstract: This paper rehabilitates effective protection. The usual definition of the effective rate of protection is the percentage change in value added per unit induced by the tariff structure. The problem is that in general equilibrium this measure corresponds to no economically interesting magnitude. The effective rate of protection for sector j is defined here as the uniform tariff which is equivalent to the actual differentiated tariff structure in its effects on the rents to residual claimants in sector j. This definition applies to general as well as partial equilibrium economic structures, has obvious relevance for political economy models and seems to correspond to the motivation for the early effective protection literature. Like the earlier effective rate formula, the concept is operational using the widely available set of Computable General Equilibrium (CGE) models.

Abstract: This paper is a guide to welfare cost measurement with all the basic elements of fiscal policy active in a representative consumer economy. By developing a simple dual framework which nevertheless is more general than the special cases usually employed, we are able to clear up several confusions in the literature on the welfare cost of tax changes. We argue for the natural dominance of a single measure of welfare cost. We do a similar analysis of the parallel literature on government project evaluation, and are able to clear up the confusing concept of the marginal social cost of funds.

Abstract: Anti-dumping is often defended as a pressure valve which reduces more illiberal forms of protectionist pressure. In the domino dumping model of Anderson (1992, 1993) this need not be true as exporters dump to obtain market access in the event of a VER. The contribution of this paper is to show that anti-dumping opens a channel for strategic lobbying through which lobbying commitments can have favorable effects on the decisions of exporting firms, and through which antidumping enforcement can encourage lobbying. Thus a "de-politicizing" institution can perversely be responsible for politicizing trade policy all the more.

Abstract: In this paper we investigate whether financial liberalization improves the efficiency with which investment funds are allocated. We develop a simple measure of efficiency and apply it to firm level panel data for Indonesia and Ecuador. We find evidence that financial liberalization has indeed improved the allocation of investment, particularly in Indonesia.

Other Working Papers

WP 526-         | WP 501-525  | WP 476-500  | WP 451-475  | WP 426-450
WP 401-425  | WP 376-400  |  WP 351-375  | WP 326-350  | WP 300-325

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