Aggregate Demand Channel Research Articles

Macroeconomic Aspects of Unemployment Benefits: Evaluating the Danish Policy

ABSTRACT This article provides an assessment of the Danish public policy of lowering unemployment benefits, adopted by the Danish government in the tax reform of 2012. To do so, we employ a stock-flow consistent model in which we incorporate the central features of the Danish labour market and the unemployment insurance system. We estimate the model using quarterly data over the period 2005Q4–2020Q1. To evaluate the effects of an unemployment insurance policy, we perform counterfactual analysis by reversing public policy in relation to unemployment insurance and compare the results with the original (baseline) scenario containing the policy effects. Overall, our findings suggest that when the aggregate demand channel, amongst other relevant macroeconomic channels, is included in the assessment, the effects of unemployment benefits on economic growth, employment, and fiscal balance tend to be weaker. These findings clearly question the political decision of suppressing unemployment benefits in general and more specifically in countries with low unemployment rates such as Denmark.

Assessing the Stabilizing Effects of Unemployment Benefit Extensions

We study the stabilizing role of benefit extensions. We develop a tractable quantitative model with heterogeneous agents, search frictions, and nominal rigidities. The model allows for a stabilizing aggregate demand channel and a destabilizing labor market channel. We characterize each channel analytically and find that aggregate demand effects quantitatively prevail in the United States. When feeding in estimated shocks, the model tracks unemployment in the two most recent downturns. We find that extensions lowered unemployment by a maximum of 0.36 pp in the Great Recession, while the joint stabilizing effect of extensions and benefit compensation peaked at 1.12 pp in the pandemic. (JEL E24, E32, E43, E52, J64, J65)

The impact of (un)conventional expansionary monetary policy on income inequality – lessons from Japan

ABSTRACT This paper analyzes the impact of conventional and unconventional monetary policy on income inequality in Japan, using hitherto unexplored data from the Japan Household Panel Survey. Empirical evidence shows that expansionary monetary policy in Japan has contributed to diminishing the gender pay gap through an increase in working time of women relative to men, but also to increasing the education pay gap. These effects may have materialized via the aggregate demand channel and the labour productivity channel. In contrast, expansionary monetary policy has had no significant impact on the development of the age pay gap.

An heterogeneous-agent New-Monetarist model with an application to unemployment

A New-Monetarist model is constructed with expenditure and unemployment risks that generates equilibria with non-degenerate distribution of money holdings. Distributional effects can overturn key insights of the model with degenerate distributions, e.g., the value of money depends on the income distribution; a one-time money injection raises aggregate real balances in the short run – price adjustments look sluggish; anticipated inflation can raise output and welfare; there can be a long-run trade-off between inflation and unemployment. Distributional effects also generate a quantitatively significant aggregate demand channel through which transfers financed with money creation can raise employment, and productivity shocks are amplified.

Can monetary policy stabilise food inflation? Evidence from advanced and emerging economies

This paper addresses a long-standing political debate as how effective is monetary policy to stabilise food inflation. While a wealth of theoretical literature suggests a stabilising role of monetary policy via aggregate demand channel, there exists hardly any empirical consensus on this issue. Very recently, a limited strand of empirical literature has attempted to shed light in this arena. The present study contributes to this literature by analysing the effectiveness of aggregate demand channel in presence of production cost channel of monetary policy transmission, affecting prices positively via supply side, in a panel of developed and emerging economies for the period 2006 Q1 to 2016 Q2. We find that an unexpected monetary tightening has a positive and significant effect on food inflation in both advanced and emerging economies. Our findings suggest that in the backdrop of inflationary pressure stemming from the food sector, a monetary tightening may turn out to be destabilising for the food as well as overall inflation in the economy.

Uncertainty and Labor Market Fluctuation

We investigate how a macroeconomic uncertainty shock affects the labor market. We focus on the uncertainty transmission mechanism, for which we employ a set of worker flow indicators in addition to labor stock variables. We incorporate common factors from such indicators into a framework that can simultaneously estimate historical macroeconomic uncertainty and its impacts on the macroeconomy and labor market. We find firms defer hiring as the real option value of waiting increases. Moreover, significantly more workers are laid off while voluntary quits drop, suggesting other mechanisms such as the aggregate demand channel play a crucial role.

Efectos y canales de transmisión del tipo de cambio sobre la producción sectorial en Colombia

Este artículo busca determinar el impacto que tiene el tipo de cambio en el crecimiento de la producción de los sectores de la economía colombiana entre los años 2000 y 2015. Para ello se estimó una regresión con datos de panel utilizando el método de Mínimos Cuadrados Ordinarios Completamente Modificados, el cual permite corregir los problemas de endogeneidad y correlación serial propios de la cointegración entre las variables. Adicionalmente, con esta investigación se pretende identificar los canales, tanto de oferta como de demanda, que son relevantes en la transmisión de los efectos del tipo de cambio a la producción. Los resultados obtenidos muestran que el tipo de cambio tiene un efecto significativo y positivo sobre la producción sectorial en Colombia, con una elasticidad alrededor de 0,7, siendo los sectores de la construcción y la minería los que más responden a variaciones en el tipo de cambio. También se encontró que el grado de comercio exterior (canal de demanda agregada) es la principal explicación de las diferencias sectoriales en cuanto al impacto del tipo de cambio sobre la producción.

Slowdown in Bank Credit Growth: Aggregate Demand or Bank Non-performing Assets?

We estimate the determinants of credit and of non-performing assets (NPAs) using a firm and a bank panel with data up to 2015 in order to test bank lending against the aggregate demand channel as an explanation for slow Indian credit growth. The results support demand as the key constraint. Only demand variables affect corporate credit for a broad set of firms. Balance sheet weakness reduced credit only for a narrow subset of indebted firms in a difference-in-difference type analysis. Even so, sales remained the dominant variable. From the bank panel, the asset quality review (AQR) did have a strong negative effect on advances but gross NPAs did not. While high interest rates and low growth raised NPAs, so did past credit. Low demand not only reduced credit, it also increased NPAs. That the capital adequacy ratio (CAR) significantly reduces NPAs points to the productivity of fund infusion. When other determinants are controlled, bank ownership does not affect NPA ratios, again supporting external shocks as causal. The results suggest that apart from structural reform to clean balance sheets, recovery of demand is necessary for revival of credit growth. JEL Classification: G21, E51

On the Optimal Speed of Sovereign Deleveraging with Precautionary Savings

We study the interaction between sovereign risk and aggregate demand. We obtain two main results. First, the aggregate demand channel creates a trade-off between the recessionary impact of fiscal consolidation and the risk of a future sovereign debt crisis. Risk aversion has a large impact on output losses and on welfare. Second, we find that savers and borrowers disagree about the optimal path of sovereign deleveraging. The sovereign risk channel can therefore explain some of the rise in political disagreement about fiscal policy. We use a calibrated version of the model to shed light on sovereign deleveraging in the Eurozone.

The effect of oil shocks and cyclicality in hiding Indian twin deficits

PurposeThe purpose of this paper is to estimate the relationship between the current account (CA) and fiscal deficit (FD), and the real exchange rate for India, for the managed float period 1996 Q2 to 2015 Q4, after controlling for output growth and oil shocks. It also examines the cyclicality of the CA, the size of each shock, and assesses whether aggregate demand, forward-looking smoothing, or supply shocks dominate outcomes.Design/methodology/approachThe authors use several variants of structural vector autoregression (SVAR), implemented with quarterly Indian data, to control for effects of oil prices, and the output cycle, and then see how FD shocks affect the current account deficit (CAD) and the real exchange rate. For robustness, the authors tried different identifications, changed variable definitions, added new variables, or substituted with other variables. The cyclicality issue is addressed by examining the effect of growth shocks. The relative size of each shock is assessed through co-movement decompositions of the forecast errors. Responses to shocks help identify dominant influences on India’s CAD.FindingsThe CAD is found to be countercyclical. A FD shock raises the CAD, but high impact growth shocks and large variance oil shocks lead to overall divergence of the deficits. There is some support for the aggregate demand channel, but it is moderated by supply shocks and compositional effects. Consumption is sticky rather than forward-looking.Originality/valueThe paper contributes to the literature by including supply shocks, compositional effects, cyclicality, real interest and exchange rate in a theoretically and empirically consistent way for the analysis of twin deficits. The large empirical literature on twin deficits in EMs has not yet done this. There is no study using quarterly data in an SVAR allowing the dynamic relationship between the variables to be explored. The extensions bring in the supply side and compositional effects qualify the working of both the channels, with empirical exercises supporting theoretical predictions.

Aggregate Demand and the Dynamics of Unemployment

We introduce an aggregate demand externality into the Mortensen-Pissarides model of equilibrium unemployment. Because firms care about the demand for their products, an increase in unemployment lowers the incentives to post vacancies which further increases unemployment. This positive feedback creates a coordination problem among firms and leads to multiple equilibria. We show, however, that the multiplicity disappears when enough heterogeneity is introduced in the model. In this case, the unique equilibrium still exhibits interesting dynamic properties. In particular, the importance of the aggregate demand channel grows with the size and duration of shocks, and multiple stationary points in the dynamics of unemployment can exist. We calibrate the model to the U.S. economy and show that the mechanism generates additional volatility and persistence in labor market variables, in line with the data. In particular, the model can generate deep, long-lasting unemployment crises.

Monetary policy and stock price dynamics with limited asset market participation

We study a New-Keynesian DSGE model subject to limited asset market participation (LAMP) and assess whether monetary policy should respond to stock prices for what concerns the determinacy and the learnability (E-stability) of the Rational Expectations Equilibrium (REE). We find that interest rate rules granting a positive response to stock prices facilitate both the determinacy and the E-stability of the fundamental REE when the degree of LAMP is sufficiently large to generate an inverted aggregate demand channel of monetary policy transmission. Moreover, according to our analysis, policy rules responding to stock prices appear to perform better than more standard rules responding to output with respect to both equilibrium determinacy and aggregate welfare.

Uncertainty Shocks are Aggregate Demand Shocks

We show that to capture the empirical effects of uncertainty on the unemployment rate, it is crucial to study the interactions between search frictions and nominal rigidities. Our argument is guided by empirical evidence showing that an increase in un\certainty leads to a large increase in unemployment and a significant decline in inflation, suggesting that uncertainty partly operates via an aggregate demand channel. To understand the mechanism through which uncertainty generates these macroeconomic effects, we incorporate search frictions and nominal rigidities in a DSGE model. We show that an option-value channel that arises from search frictions interacts with a demand channel that arises from nominal rigidities, and such interactions magnify the effects of uncertainty to generate roughly 60 percent of the observed increase in unemployment following an uncertainty shock.

What Explains High Unemployment? The Aggregate Demand Channel

We show that deterioration in household balance sheets, what we refer to as the housing net worth channel, played a significant role in the sharp decline in U.S. employment between 2007 and 2009. Using geographical variation across U.S. counties, we show that counties with a larger decline in housing net worth experience a larger decline in non-tradable employment. This result is not driven by industry-specific supply-side shocks, exposure to the construction sector, policy-induced business uncertainty, or contemporaneous credit supply tightening. We find little evidence of labor market adjustment in response to the housing net worth shock. There is no expansion in the tradable sector in affected counties, and the correlation between the housing net worth decline and job losses in the tradable sector is zero. There is no evidence of wage adjustment, or of net labor emigration out of affected counties either.

An Econometric Analysis of the Impact of Real Effective Exchange Rate on Economic Activities in Nepal

This paper tests the relationship between REER and GDP on the Nepalese economy. In the literature, two channels of transmission exist for the real exchange rate to affect economic activities; these are the aggregate demand channel and the aggregate supply channel. The traditional view has it that the real exchange rate operates through the aggregate demand channel. This means that the depreciation of the real exchange rate enhances the international competitiveness of domestic goods, boosts net exports and eventually enlarges GDP. The aggregate supply channel, on the other hand, purports that the depreciation of the real exchange rate increases the cost of production and helps redistribute income in favour of the rich. These two effects lower aggregate demand causing economic contraction. The empirical study shows that the traditional view holds for Nepal and implies that Nepal should at least keep the real exchange rate constant.