Adverse Demand Shocks Research Articles

Understanding the Decline in the Price of Oil Since June 2014

Some observers have conjectured that the steep decline in the price of oil between June and December 2014 resulted from positive oil supply shocks in the second half of 2014. Others have suggested that a major shock to oil price expectations occurred when in late November 2014 OPEC announced that it would maintain current production levels despite the steady increase in non-OPEC oil production. Both conjectures are perfectly reasonable ex ante, yet we provide quantitative evidence that neither explanation appears supported by the data. We show that more than half of the decline in the price of oil was predictable in real time as of June 2014. We attribute $11 of this predictable decline to the cumulative effects of adverse demand shocks prior to July 2014, reflecting a slowing global economy, and $16 to positive oil supply shocks and to shocks to expected oil production that occurred prior to July 2014. The remaining oil price decline is accounted for by a shock to oil price expectations in July 2014 that lowered the demand for oil inventories and a shock to the demand for oil associated with an unexpectedly weakening economy in December 2014, which lowered the price of oil by an additional $9 and $13, respectively.

An Incentive Contract as Merger Conduct Remedy

The policy goal of merger remedies is to facilitate mergers’ potential contribution to dynamic and productive efficiencies while preserving pre-merger consumer surplus. But recent empirical scholarship shows that most remedies fail to achieve this goal. I propose an incentive contract, inspired by the theory of incentive-based regulation in general and price-cap regulation in particular, that can serve as a conduct remedy and that has strong theoretical and practical advantages relative to standard divestiture and conduct remedies. The remedy requires the merged firm to contract with a private third party to whom it makes cash payments whenever it raises price or lowers quantity or quality relative to pre-merger levels, where the payments are at least as large as the revenue gain from such actions. To cope with adverse demand shocks, the contract lets the firm sell a lower than pre-merger quantity so long as price is no higher and quality no lower than pre-merger. To cope with adverse supply shocks, the pre-merger price threshold that the contract does not allow the firm’s post-merger price to exceed can be adjusted by an index of input cost inflation. To cope with variations in product quality, the contract lets the firm vary quality so long as the post-merger product is weakly revealed-preferred by its customers to the pre-merger product. The payout structure effectively imposes a contractual obligation on the firm to preserve pre-merger consumer surplus, while giving the firm a residual claim on all merger-induced cost savings thereby eliminating moral hazard.The firm’s payouts to its contractual counterparty are contingent on the same three variables — price, quantity, and quality — that are the central terms in the firm’s own sales contracts with its customers. The same market forces, contract laws, and external auditing mechanisms that ensure adequate observability of these variables to the firm’s customers therefore ensure their observability to the counterparty. The contract does not require information on economic costs or the demand curve. In contrast to divestitures, my remedy does not require the merging firm to shed parts potentially critical to its efficiency.Standard conduct remedies suffer from risks of asymmetric information, incomplete specification, countervailing incentives, irrelevance in face of market dynamics, and agency inappropriateness for regulatory roles. In contrast, my contract conditions on variables less vulnerable to problems of asymmetric information and incomplete specification. It shapes incentives only to the minimal extent necessary to preserve consumer surplus, only as much as any other contract does, and in a way that induces the firm to find the least cost way of preserving consumer surplus. It addresses market dynamics arising from adverse demand and supply shocks and product innovation. It absolves the agencies of the fraught responsibilities of predicting merger effects and post-merger regulation. It relies on contract- and market-based mechanisms for securing the policy goals of the merger regime. It is more sensitive, specific, and implementable than standard remedies. It is potentially the most light-handed of remedies since a merged firm committed to fulfilling its part of the policy bargain will find none of its constraints binding.

PRICE SETTING PRACTICES IN GREECE: EVIDENCE FROM A SMALL‐SCALE FIRM‐LEVEL SURVEY

ABSTRACTThe paper documents the price setting practices followed by some 400 or so firms operating in Greece. Survey replies reveal a low percentage of firms changing prices with frequency higher than annual and staggering of price changes during the year. As to firms’ reactions to unexpected shocks, prices appear to adjust sluggishly to cost shocks with asymmetries in price adjustment across positive and negative shocks. Adjustments to increases in costs appear speedier than those to reductions in demand. The data confirm a result found for other countries: the existence of cross‐sectional variations in price setting strategies and in the extent to which prices are adjusted in reaction to unexpected shocks. The results suggest a positive association between, on the one hand, product market competition and, on the other hand, state‐dependent pricing, frequent price changes and the likelihood of a price adjustment following an adverse demand shock.

Nominal GDP futures targeting

Central banks have recently done a poor job of stabilizing the path of nominal expenditures. The adverse demand shock of 2008–2009 led to a severe recession in the United States and Europe. Monetary policy could be greatly improved with a regime of “targeting the forecast,” or setting policy so that the expected growth in nominal GDP is equal to the central bank's target growth rate. This goal could be accomplished by setting up a nominal GDP prediction market and then adjusting the monetary base to stabilize nominal GDP futures prices. The market, not central banks, would set the level of the monetary base and short-term interest rates under this sort of policy regime. Modest adjustments in such a regime could address many previous criticisms of futures targeting.

Demand collapse or credit crunch to firms? Evidence from the World Bank's financial crisis survey in Eastern Europe

This paper assesses whether the primary effect of the global crisis on Eastern European firms took the form of an adverse demand shock or a credit crunch. Using a unique firm survey conducted by the World Bank in six Eastern European countries during the 2008–2009 financial crisis, the paper shows that the drop in demand for firms' products and services was overwhelmingly reported as the most damaging adverse effect of the crisis. Other “usual suspects”, such as rising debt or reduced access to credit, were reported as minor. The paper also finds that the changes in firms' sales and installed capacity are significantly and robustly correlated with different demand sensitivity measures of the sector in which the firms operate. However, they are not robustly correlated with various proxies for firms' credit needs.

Optimal discretionary monetary policy in a micro-founded model with a zero lower bound on nominal interest rate

This paper investigates optimal discretionary monetary policy under the zero lower bound on the nominal interest rate (ZLB) in the case of a distorted steady state due to monopoly and taxation. Solving a fully nonlinear micro-founded (FNL) model using a global method, I find that the central bank in a more distorted economy would cut the interest rate less aggressively under a particularly adverse demand shock. This occurs because inflation and nominal interest rates are higher on average, making the ZLB less likely to bind and causing the economy to escape from the ZLB sooner. However, the social planner would choose the optimal inflation rate of approximately zero. The result emerges because the unconditional benefit of avoiding the ZLB is not big enough to offset the cost of higher relative price dispersion when inflation is significantly positive. In addition, I show that the conventional linear-quadratic (LQ) method is inaccurate in the case of a sufficiently distorted steady state.

Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries

We propose and solve a small-scale New-Keynesian model with Markov sunspot shocks that move the economy between a targeted-inflation regime and a deflation regime and fit it to data from the U.S. and Japan. For the U.S. we find that adverse demand shocks have moved the economy to the zero lower bound (ZLB) in 2009 and an expansive monetary policy has kept it there subsequently. In contrast, Japan has experienced a switch to the deflation regime in 1999 and remained there since then, except for a short period. The two scenarios have drastically different implications for macroeconomic policies. Fiscal multipliers are about 20% smaller in the deflationary regime, despite the economy remaining at the ZLB. While a commitment by the central bank to keep rates near the ZLB doubles the fiscal multipliers in the targeted-inflation regime (U.S.), it has no effect in the deflation regime (Japan).

A defense of moderation in monetary policy

This paper examines the implications of uncertainty about the effects of monetary policy for optimal monetary policy with an application to the current situation. Using a stylized macroeconomic model, I derive optimal policies under uncertainty for both conventional and unconventional monetary policies. According to an estimated version of this model, the US economy is currently suffering from a large and persistent adverse demand shock. Optimal monetary policy absent uncertainty would quickly restore real GDP close to its potential level and allow the inflation rate to rise temporarily above the longer-run target. By contrast, the optimal policy under uncertainty is more muted in its response. As a result, output and inflation return to target levels only gradually. This analysis highlights three important insights for monetary policy under uncertainty. First, even in the presence of considerable uncertainty about the effects of monetary policy, the optimal policy nevertheless responds strongly to shocks: uncertainty does not imply inaction. Second, one cannot simply look at point forecasts and judge whether policy is optimal. Indeed, once one recognizes uncertainty, some moderation in monetary policy may well be optimal. Third, in the context of multiple policy instruments, the optimal strategy is to rely on the instrument associated with the least uncertainty and use alternative, more uncertain instruments only when the least uncertain instrument is employed to its fullest extent possible.

Oil price uncertainty, monetary policy and the macroeconomy: The Canadian perspective

This paper revisits the link between oil price uncertainty and macroeconomy in the context of a net oil exporting country, Canada. Results obtained from alternative Structural VAR models suggest that while shocks to oil price level do not affect the aggregate level of output, the oil price uncertainty exerts considerable impacts on the Canadian economy. It is found that oil price uncertainty makes a major contribution to overall variations in the output level. Results also show that higher oil price uncertainty significantly decreases both output and price levels, resembling an adverse demand shock. Oil price uncertainty causes output to decline in most of the sub-sectors including durable and non-durable manufacturing. It is found that the Central Bank of Canada reacts with an expansionary monetary policy to oil price uncertainty shocks.

A Defense of Moderation in Monetary Policy

This paper examines the implications of uncertainty about the effects of monetary policy for optimal monetary policy with an application to the current situation. Using a stylized macroeconomic model, I derive optimal policies under uncertainty for both conventional and unconventional monetary policies. According to an estimated version of this model, the U.S. economy is currently suffering from a large and persistent adverse demand shock. Optimal monetary policy absent uncertainty would quickly restore real GDP close to its potential level and allow the inflation rate to rise temporarily above the longer-run target. By contrast, the optimal policy under uncertainty is more muted in its response. As a result, output and inflation return to target levels only gradually. This analysis highlights three important insights for monetary policy under uncertainty. First, even in the presence of considerable uncertainty about the effects of monetary policy, the optimal policy nevertheless responds strongly to shocks: uncertainty does not imply inaction. Second, one cannot simply look at point forecasts and judge whether policy is optimal. Indeed, once one recognizes uncertainty, some moderation in monetary policy may well be optimal. Third, in the context of multiple policy instruments, the optimal strategy is to rely on the instrument associated with the least uncertainty and use alternative, more uncertain instruments only when the least uncertain instrument is employed to its fullest extent possible.

A Market-Driven Nominal GDP Targeting Regime

Central banks have recently done a dreadful job of stabilizing the path of nominal expenditures. The adverse demand shock of 2008–9 led to a severe recession in the United States and Europe. Monetary policy could be greatly improved with a regime of “targeting the forecast,” or setting policy so that the expected growth in nominal GDP is equal to the central bank’s target growth rate. This goal could be accomplished by setting up a nominal GDP futures market and then adjusting the monetary base to stabilize nominal GDP futures prices. The market, not central banks, would set the level of the monetary base and short-term interest rates under this sort of policy regime. Modest adjustments in such a regime could address many previous criticisms of futures targeting.

Real-Time Macroeconomic Monitoring: Real Activity, Inflation, and Interactions

We sketch a framework for monitoring macroeconomic activity in real-time and push it in new directions. In particular, we focus not only on real activity, which has received most attention to date, but also on inflation and its interaction with real activity. As for the recent recession, we find that (1) it likely ended around July 2009; (2) its most extreme aspects concern a real activity decline that was unusually long but less unusually deep, and an inflation decline that was unusually deep but brief; and (3) its real activity and inflation interactions were strongly positive, consistent with an adverse demand shock.

Real-Time Macroeconomic Monitoring: Real Activity, Inflation, and Interactions

We sketch a framework for monitoring macroeconomic activity in real-time and push it in new directions. In particular, we focus not only on real activity, which has received most attention to date, but also on inflation and its interaction with real activity. As for the recent recession, we find that (1) it likely ended around July 2009; (2) its most extreme aspects concern a real activity decline that was unusually long but less unusually deep, and an inflation decline that was unusually deep but brief; and (3) its real activity and inflation interactions were strongly positive, consistent with an adverse demand shock.

Real-Time Macroeconomic Monitoring: Real Activity, Inflation, and Interactions

We sketch a framework for monitoring macroeconomic activity in real-time and push it in new directions. In particular, we focus not only on real activity, which has received most attention to date, but also on inflation and its interaction with real activity. As for the recent recession, we find that (1) it likely ended around July 2009; (2) its most extreme aspects concern a real activity decline that was unusually long but less unusually deep, and an inflation decline that was unusually deep but brief; and (3) its real activity and inflation interactions were strongly positive, consistent with an adverse demand shock.

How to Turn a Recession into a Depression: The Role of the Media, of the Politicians, and of the Political Analysts

By modifying slightly a standard neoclassical-synthesis macroeconomic model, this paper investigates the effects of an adverse supply or demand shock on output, employment, investment, prices, interest rates, and the exchange rate. The paper focuses on the possibility of the magnification of these effects by the media, the politicians, and the political analysts, who induce herd behavior by overstating the size of the shock. I find that such behavior destabilizes the economy by magnifying the amplitude of the business cycle and by hurting private investment, which might cause expansions to be shorter and contractions to last longer.

Wages and the Risk of Displacement

In this paper a simultaneous-equations model of firm closing and wage determination is developed in order to analyse how wages adjust to unfavorable shocks that raise the risk of displacement through firm closing, and to what extent a wage change affects the exit likelihood. Using a longitudinal matched worker-firm data set from Portugal, the results show that the fear of job loss generates wage concessions instead of compensating differentials. A novel result that emerges from this study is that firms with a higher incidence of minimum wage earners are more vulnerable to adverse demand shocks due to their inability to adjust wages downward. In fact, minimum wage restrictions were seen to increase the failure rates.

Economic Fluctuations and Stabilization Policies

Economic fluctuations refer to ups and downs in the levels and/or rates of changes in the economic goal variables like real national income (GOP), inflation rate, and the rate of unemployment. Stabilization policies are the tools in the hands of the policy-makers to counter economic fluctuations and these include fiscal policy, monetary policy, and foreign exchange rate policy. This paper analyses the extent and depth of all major fluctuations (business cycles) across the G-7 countries, India, China, Malaysia, and the world as a whole during the Great Oepression and the last 40 years, identifies the major cause behind each significant departure from the trend, and examines the theoretical limitations as well as the actual application of the various policies to tame those business cycles. This paper finds that: Business cycles are universal. Each of the countries under analysis here has experienced an overall positive growth rate but also a negative growth rate, generally in more than one year, during the period of this study. Further, the standard deviation of the growth rate as a percentage of the growth rate (called the coefficient of variation) is sizeable in all countries as it varies between a low of 41 per cent in Malaysia and a high of 96 per cent in the UK. Business cycles are not always synchronized across countries. During the Great Depression and stagflation periods, most countries suffered from similar maladies but such a synchronization was rarely found in other times. For example, Japan performed relatively better during the 1950s and 1960s, and China and the South-East Asian economies enjoyed that position during the 1980s and 1990s. Further, while every country has experienced a negative growth rate, there is no year in the last 50 years in which the growth rate was negative in all countries. The world as a whole, of course, has always enjoyed a positive growth rate. Business cycles have become milder over time. During the Great Depression, output fell by over two digit rates in many countries japan experienced a two-digit growth rate in most of the years during 1960s, 1980s, and 1990s, but lately, the growth rate in most countries is hovering around 2 to 5 per cent. Business cycles are caused by varying events. While the adverse demand shock caused the Great Depression, the adverse supply shock triggered the stagflation and economic reforms have been responsible for hyperinflation, financial crises, and prosperity. always been applied in the right perspective. During the Great Depression, the nominal money supply should have increased but it fell and the government expenditure rose but only marginally. The simple correlation and multiple regression analysis' results for the three select countries suggest that while the monetary policy was conducted as an anti-cyclical tool in lndia, it was pro-cyclical in the US and China, and quite the opposite was the case with regard to the conduct of fiscal policy. The cycles are bad and it is unfortunate that the stabilization policies do not offer panacea to tame them fully. However, it is heartening to find that economic fluctuations have become milder over time and the credit for this goes to the innovative developments in the macroeconomic theory and to the improvements in the practice of stabilization policies. Though cycles are unlikely to be eradicated, there is now only little fear of severe crises in future like the Great Depression or stagflation.

Capital Stock, Unemployment and Wages in the UK and Germany

This paper is concerned with the view that capital formation is an important variable in the determination of unemployment and wages in Germany and the UK. Adverse demand shocks affect employment and investment. When shocks reverse, unemployment may not fall to previous levels due to insufficient capital. The empirical results show that unemployment has risen in the last twenty years in both countries due to insufficient investment. Policies that are aimed at stimulating investment may have a permanent effect on unemployment in Germany and the UK.

A Generalized Theory of Output Determination

The literature on economic activity and unemployment in recent years contains several references to the possibility that high unemployment and low, relative to a trend, levels of output can be linked with capital shortages. Goudie and Meeks (1988, 1991) have argued that company bankruptcies may well (depending on how the firm is disposed of) produce large discontinuous drops in employment and output. Bruno and Sachs (1985), van der Ploeg (1987), and Burda (1988) have all examined the impact of adverse demand and supply shocks on capital stock and its further consequences on the economy as a whole from a neoclassical perspective. Blanchard (1988) has also explored the possibility that a sustained period of unemployment may lead to capital reduction and therefore to an increase in the equilibrium levels of unemployment. Van de Klundert and van Schaik (1990) analyze the impact of demand shocks on the capital stock and thence output within a Keynesian framework with price inertia. Rowthorn (1994) develops a model to examine the role of capital stock within a NAIRU framework and concludes that low investment has been a significant factor behind the rise in unemployment in Western Europe and that a major reduction in unemployment will require large-scale investment. Ballabriga et al. (1993), in empirical work based on a disequilibrium model, suggest capital constraints have periodically been important in Spain and that up to one-third of Spanish unemployment is due to structural factors. Finally, Bean (1994) has shown that in Europe the relationship between unemployment and capacity utilization has shifted outward since 1967. This contrasts sharply with the experience in the United States, where the relationship between capacity utilization and unemployment has been relatively stable. The European experience is consistent with capital scrapping in recessions reducing potential output. More references will be

A currency crisis model with an optimising policymaker

A model is presented in which the abandonment of a fixed exchange rate regime is triggered by an optimising policymaker who wants to loosen monetary policy and boost aggregate demand. Agents in the foreign exchange market know the policymaker's objective function and build expectations of a regime switch into interest differentials. The resulting rise in interest rates affects the policymaker's decision to switch regime. It is shown that a rational expectations equilibrium exists where the fixed rate is abandoned in response to adverse demand shocks. In some circumstances multiple equilibria arise which may lead to self-fulfilling crises.