Adverse Real Effects Research Articles

Uncertainty shocks and monetary policy rules in a small open economy

Abstract Post the great financial crisis (GFC) of 2008–2009, there has been a surge in the macroeconomics literature on aggregate uncertainty. Although the recent literature has recognized the adverse real effects of global uncertainty shocks in emerging market economies (EMEs), the role of monetary policy in offsetting these adverse effects and their link with the exchange rates is not explored in the literature. We find that the currently followed interest rate rules (IRRs) under a flexible inflation-targeting regime are ineffective in stabilizing the domestic economy during periods of high global uncertainty in the EMEs. Using a small open economy new Keynesian DSGE model with Epstein–Zin preferences and second-moment demand shocks, we compare and propose alternate monetary policy rules that significantly reduce welfare losses. We find that the best monetary policy rule in terms of welfare depends on the nature of shock that is, first-moment or second-moment shock.

Real effects of tax audits

Tax audits are a necessary component of the tax system, but policymakers and others have expressed concerns about their potentially adverse real effects. Understanding the causal effects of tax audits has been hampered by lack of data and because typically tax audits are not randomly assigned. We use administrative data from random tax audits of small businesses to examine the real effects of being subject to a tax audit. We find that audited firms are more likely to go out of business following the audit. The effect is concentrated in firms that underreport their taxes, although we find some evidence that the administrative costs of an audit also negatively affect firm survival. Among firms that continue as going concerns, we find evidence that audits have adverse effects on future revenues but no effect on future wages, employment, or investment. Finally, we find that tax audits have side benefits, causing firms to make changes to improve their tax efficiency.Supplementary InformationThe online version contains supplementary material available at 10.1007/s11142-022-09717-w.

Uncertainty Shocks and Monetary Policy Rules in a Small Open Economy

Post great financial crisis (GFC) of 2008-2009, there has been a surge in the macroeconomics literature on aggregate uncertainty. Although the recent literature has recognized adverse real effects of global uncertainty shocks in EMEs, the role of monetary policy in mitigating these effects is not studied. This paper explores the role of exchange rates (both nominal and real) and monetary policy in amplifying/ stabilizing the real effects of global uncertainty shocks in a small open economy. We reproduce stylized facts showing significant movements in exchange rates when EMEs are hit with a global uncertainty shock. We find that flexible inflation targeting regime using interest rate rules (IRRs) with floating exchange rates is ineffective in stabilizing the domestic economy during periods of high global uncertainty. Using a small open economy NK-DSGE model, we show that inflation targeting regime using exchange rate rules (ERRs) reduces welfare losses significantly compared to IRRs. This result contradicts the conventional wisdom which states that monetary policy following an IRR under floating exchange rate is welfare-maximizing in a small open economy.

Real Effects of Tax Audits: Evidence from Firms Randomly Selected for IRS Examination

Tax audits are a necessary component of the tax system but have potentially adverse real effects on firms selected for audit. This paper examines the real effects on small firms of being subjected to a tax audit, using administrative data from both random and nonrandom tax audits. We find that audited firms are less likely to continue as going concerns following the audit. However, we find that the effect is almost entirely isolated to firms that underreported their tax liability. We find little evidence that the administrative costs of an audit are associated with ceasing to operate. Among audited firms that continue as going concerns, we find evidence of adverse real effects on future revenues but no evidence of effects on wages, employment, or investment. Finally, we consider whether tax audits could also have side-benefits and find that in certain cases tax audits help firms learn and make important changes.

Firm size effects in trade credit supply and demand

Abstract By investigating trade credit usage among SMEs and large companies following the macroeconomic shock of the financial crisis of 2007/08, we identify a firm size effect, which is genuine in the sense that it cannot be entirely explained by financial constraints, external finance dependence or creditworthiness. We find that (i) SMEs, in contrast to large firms, do not display evidence for the inter-firm liquidity redistribution hypothesis. Especially large vulnerable firms did cut down trade credit provision to the detriment of small vulnerable firms. (ii) We document a general substitution effect between bank and trade credit and show that it has strengthened during the crisis among large firms, but not among SMEs. (iii) We provide evidence that the shift in trade credit financing had adverse real effects on investment behaviour of SMEs.

The real effects of forced sales of corporate bonds

What are the real effects of forced sales of corporate securities? Our theoretical analysis shows that model uncertainty can generate distorted negative (positive) capital investment effects during price declines (reversals) in equilibrium when there is information feedback from financial markets. Empirically, we find that forced sales of corporate bonds by financial institutions had a significant negative impact on the capital investment and product market competitiveness — measured by market shares and price-cost margins — of exposed firms during the financial crisis. These adverse real effects on exposed firms were also vertically transmitted to their suppliers and customers.

A Simple Analytical Model of the Adverse Real Effects of Inflation

AbstractThe essential insight advanced in this paper is that the claim that inflation can impair growth makes most sense in the context of a monetary production economy, wherein a role for money in the determination of real activity is posited from the very start. We construct a model of inflation and growth that distinguishes between the properties of various qualitatively different inflation regimes. It is then shown how some of these regimes, by undermining confidence in various nominal contracts that are central to the process of accumulation in a monetary production economy, can adversely affect growth.

Corporate Debt Structure and the Financial Crisis

We present a DSGE model where firms optimally choose among alternative instruments of external finance. The model is used to explain the evolving composition of corporate debt during the financial crisis of 2008–09, namely, the observed shift from bank finance to bond finance, at a time when the cost of market debt rose above the cost of bank loans. We show that the flexibility offered by banks on the terms of their loans and firms' ability to substitute among alternative instruments of debt finance are important to shield the economy from adverse real effects of a financial crisis.

A simple analytical model of the adverse real effects of inflation

The essential insight advanced in this paper is that the claim that inflation can impair growth makes most sense in the context of a monetary production economy, wherein a role for money in the determination of real activity is posited from the very start. We construct a model of inflation and growth that distinguishes between the properties of various qualitatively different inflation regimes. It is then shown how some of these regimes, by undermining confidence in various nominal contracts that are central to the process of accumulation in a monetary production economy, can adversely affect growth.

Corporate Debt Structure and the Financial Crisis

We present a DSGE model where firms optimally choose among alternative instruments of external finance. The model is used to explain the evolving composition of corporate debt during the financial crisis of 2008-09, namely the observed shift from bank finance to bond finance, at a time when the cost of market debt rose above the cost of bank loans. We show that the flexibility offered by banks on the terms of their loans and firms’ ability to substitute among alternative instruments of debt finance are important to shield the economy from adverse real effects of a financial crisis.

The role of the financial sector in economic development: the Malaysian case

In this paper, we empirically examine the finance-economic development relations for the case of Malaysia. Using a battery of time series econometric techniques, we document robust evidence suggesting favorable output effects of financial market development. Likewise, there are consistent results showing the adverse real effects of financial volatility. The results of the development of financial intermediaries, however, are fragile. Moreover, the development of the financial markets hinges crucially on macro-economic performance and financial stability of the country. However, the process of financial market development is likely to be accompanied by financial volatility, leaving Malaysia with the trade-off between financial development and financial volatility. Lastly, we obtain limited evidence indicating the complementarity between financial market and banking sector developments.

Are There Adverse Real Effects from Monetary Policy Coordination? Some Evidence from Austria, Belgium and the Netherlands

A central hypothesis and concern of some skeptics of European monetary union is that monetary policy coordination to secure a peg to the German mark (DM) will tie real economic performance, especially the unemployment rate, to that in Germany. Evidence on this hypothesis can be found in Austria, Belgium and the Netherlands, however, where currencies have been tightly pegged to the mark since 1979, 1986 and 1984, respectively. This paper reviews the theoretical link between a country's real performance and its coordination with foreign economic policy. It uses the three countries' Phillips curves to gauge real economic performance; it tests whether Phillips curve parameters have shifted adversely following the introduction of the DM-peg and whether any such shift is related to German unemployment rate movements. The article concludes that coordination does not have adverse economic effects on real economic performance.

The role of inflation uncertainty in Germany: Friedman's hypothesis revisited

The paper reconsiders Friedman's (1977) proposition that increased inflation uncertainty may have adverse real effects for the German case. A proxy for the unobservable uncertainty variable is obtained from the Kalman-filtering estimation of a time-varying parameter model of inflation. This measure is introduced into an output equation that also includes anticipated and unanticipated inflation, thus allowing tests of both the Friedman and the Macro Rational Expectations hypotheses. The empirical evidence does not provide strong support for Friedman's view. Unanticipated inflation, on the other hand, seems to play a significant role for German output growth in the short run.