Contractionary Effects Research Articles

The Recession of America's New Economy — The Paradox of Low Unemployment and Stagnant Wage Growth in the United States

On September 18, the interest rate cut announced by the US Federal Reserve Board was the first interest rate cut since March 2020, and the industry generally analyzed that this will also open the curtain of the Fed's interest rate cut cycle. The Federal Reserve's practice of regulating monetary policy for its interests has improved the US economy. Still, the inhibitory effect of high interest rates on the economy is also emerging. The prolonged period of high interest rates has created a cost-of-living crisis for Americans, whose real standard of living is not as good as the economy looks. The pace of rate cuts is not expected to be as rapid as the pace of rate increases, which may have a contractionary effect on economic development in the United States and other economies. This article will start with the paradox between low unemployment and slow wage growth in the United States. The close relationship between inflation and wage levels is introduced. This analysis explores the factors contributing to the slow economic growth in the United States from various perspectives and offers predictions for the country's short- and long-term economic outlook. While domestic tensions are gradually easing in the short term, the long-term prospects for the U.S. economy appear less optimistic. This is due to enduring structural issues within the country, a significant decline in consumption levels, and external influences that continue to pose challenges to sustained growth.

EU Economic Governance as a Supranational Determinant of Health Inequalities in the Eurozone

The COVID-19 pandemic raises the question of austerity's problematic social toll for health in the south of Europe. Has EU economic governance constrained health spending? If so, have these spending levels led to inequalities, which in turn shaped responses to the pandemic? EU economic governance is often dismissed as ineffective because of its poor track record of compliance. Yet austerity is blamed for negative health outcomes. This article shows that the EU fiscal rule is a determinant of health because it affects fiscal policies of European countries. First, the analysis of EU member states during 1995–2018 shows that austerity policies affect health spending and health inequalities. Euro-area countries under the EU Excessive Deficit Procedure significantly consolidated their health spending. The contractionary effect was concentrated in southern countries, contributing to rising health inequalities across the core and periphery. Finally, the analysis shows the pandemic implications of health inequalities, as periphery countries with a track record of high consolidation display more stringent (and costly) COVID-19 response models. This analysis contributes to understanding the supranational determinants of health in the EU, showing the pervasive spillover effects of the fiscal framework on national health policies.

The nexus between local government debt risk, real estate sector, and financial stability

Rising local government debt and downturn in the real estate sector pose significant challenges to China’s economic growth and financial stability. To analyze these challenges, this paper develops a dynamic stochastic general equilibrium (DSGE) model to study the nexus between government debt risk, real estate sector, and financial stability. The findings suggest that an increase in debt risk initiated by a housing demand shock could have a persistent and magnified effect on the financial sector and the macroeconomy. The amplification mechanism originates from risk spillover and debt crowding-out effect, which trigger the negative feedback between the debt and financial risk. Longer debt maturity and the implementation of credit policy could effectively moderate the contractionary effects of this risk interaction on the economy.

Impacts of population aging on bank loan portfolios: Evidence from China

We investigate the impacts of population aging on bank lending using micro-level data from the Chinese banking industry. We find that an aging population significantly reduces the volume of bank lending. The underlying mechanism driving this trend comes from a reduction in bank deposits and a decline in banks' risk-taking. At the same time, population aging induces a structural change in banks' loan portfolios. Banks are strategically reducing the share of their loan portfolios exposed to the greater risks associated with an aging population; additionally, they utilize cross-regional operations to lessen the adverse effects of aging. The contractionary effect of population aging on bank lending is more pronounced for non-state banks and banks in highly competitive markets. These findings highlight the importance of considering population aging in assessing both the aggregate volume and the structural composition of bank loans.

Unravelling the devaluation puzzle: Empirical insights into the transmission channel on balance of payments and output in Ethiopia

Background Empirical studies on the impact of devaluation in developing countries, including Ethiopia, have revealed diverse and mixed results. The effects can be positive or negative depending on the specific economic context and policies in place.This study addresses the devaluation puzzle by providing a more comprehensive and nuanced understanding of how devaluation affects the balance of payments and output. Methods To achieve this, we employ a recursive structural vector autoregressive (SVAR) model focusing on Ethiopia from 2001Q1 to 2023Q4. Results The findings reveal that exchange rate shocks negatively affect the balance of payments in both the short and long run, with a greater impact observed in the short run. Shocks in other variables, such as foreign exchange rate reserves, inflation, and interest rates, exert a stronger influence on the balance of payments than the exchange rate itself in the long run. In addition, shocks in the exchange rate significantly impact foreign exchange rate reserves in the long run, highlighting the complex dynamics of exchange rates and the indirect nature of the exchange rate channel. Exchange rate shocks also negatively impact output growth in both the short and long run. Conclusion The study concludes that devaluation has a contractionary effect through various channels. Devaluation increases the money supply, leading to inflationary pressures and a decline in output. It also increases interest rates, which further reduces output. In addition, devaluation reduces foreign exchange reserves, resulting in a fall in the balance of payments and a decrease in output. We suggest policymakers prioritize exchange rate stability through practical monetary and fiscal policies. In general, International financial institutions, particularly the National Bank of Ethiopia, should reconsider their devaluation-focused policies, considering the complexities and potential negative consequences associated with devaluation.

Revisiting the effects of conventional and unconventional monetary policies

SummaryThis paper extends the discussion on the effects of the two distinctive monetary surprises in the literature. First, we show that the proxy of conventional monetary shock Granger causes the endogenous variables in the vector autoregressive model. Second, we provide evidence that the existing model can be exposed to a weak instrument problem. With our alternative model mitigating these concerns, the second monetary shock can be interpreted as unconventional monetary news in general. The estimation results show contractionary effect of the unconventional policy. We find increases in output after a positive conventional monetary surprise, suggesting an important Fed's information effect.

CONTACT-INTENSITY, DISRUPTIONS IN THE CULTURAL SECTOR AND WAGE INEQUALITY: A MODEL OF COVID-19 CRISIS AND ITS IMPACT

COVID-19 has adverse impacts on contact-intensive sectors, viz., manufacturing, tourism, and the entertainment sector (ES). In a general equilibrium (GE) model with online, entertainment and informal sectors employing skill, unskilled, and capital, we show that COVID-19 could cause polarization pushing contact-intensive entertainment industry on the brink of collapse while the other two survive. Dual roles of factor intensity and contact intensity (CI) contribute to such finite changes, triggering inter-skill wage inequality. This is the first of its kind to offer a theoretical mechanism capturing the contractionary effects on contact-intensive sectors and wage inequality. These results match with the literature emphasizing the hardships faced by the cultural sector.

Monetary policy surprises on the banking sector: The role of the information and pure monetary shocks

This paper analyzes how monetary policy surprises in Chile affects the real and financial sector separating between a pure monetary policy shock and an information shock. Using inter-day movements of futures of interest rate in the banking system, we identify an information shock when labor data is released and a pure monetary policy shock when the central bank reveals their interest rate decision, and their effects are quantified through an external vector autoregression model. Our results suggest that a pure monetary policy shock produce an appreciation of nominal exchange rate, and contractionary effects on the economy. However, an information shock does not necessarily produce adverse effects. This paper contribute to the literature in two dimensions: studying the effect of the main driver behind the central bank announcements, and their transmission to the banking sector and consequently to the real and monetary sector.

The economic impact of general vs. targeted lockdowns: New insights from Italian municipalities

In response to COVID-19, most governments implemented either general or geographically targeted lockdowns. While the contractionary effects of general lockdowns have been well-documented, this paper is the first to contrast the economic impacts of the two approaches in a quasi-experimental setting. To this aim, we construct a high-frequency database combining unique information from mobile devices and administrative data across Italian municipalities. Using difference-in-differences approaches, our results confirm that general lockdowns considerably reduced mobility and employment, but we also find that localised measures only led to modest declines in mobility with minimal additional impact on employment. Focusing on the distributional consequences, we show that economic activity decreased less in wealthier communities with a higher capacity for telework. Moreover, short-time work schemes, serving as automatic stabilizers, predominantly benefited affluent areas. We conclude that an optimal policy mix involves targeted lockdown measures, complemented by adequate social policies and infrastructure investment.

Asymmetric response of domestic production to exchange rate changes: Evidence from southeast Asian countries

This study explores the asymmetric effects of real effective exchange rate variation on domestic output in nine South East Asian nations. The study is the first thorough study on this issue for these countries. The results show that exchange rate fluctuations have asymmetric long‐run and short‐run effects on production in most nations. However, the findings vary across nations. Appreciation has a contractionary effect on production in most countries, while depreciation has an expansionary effect. In certain economies, an appreciation boosts domestic output whereas a depreciation diminishes it. Such conclusions can only be reached if appreciations and depreciations are separated, using non‐linear models.

Fiscal Consolidation and Firm Growth in Developing Countries: Evidence from Firm-Level Data

Despite a longstanding debate around the economic effects of fiscal consolidation policies, relatively few studies have focused on developing countries, and even fewer have paid attention to the growth implications at firm level. Using a unique narrative dataset based on contemporaneous policy documents to identify changes in fiscal policy aimed at reducing the accumulation of public debt, we investigate the effects of fiscal consolidation on the growth of 118,279 firms in 98 developing countries from 2006 to 2018. The results indicate that a one percentage point increase in fiscal consolidation as a share of GDP leads, on average, to a decline in firm growth of 3.97 percentage points. This decline is reduced when consolidation is large. We also find that debt-driven consolidation based on tax hikes is more contractionary than that based on spending cuts, though this contractionary effect is mitigated when spending cuts exceed 1.5 percent of GDP. While the negative effect of fiscal consolidation on firm performance is more pronounced in large and non-exporting firms, the effect is not statistically important in low-debt-risk developing countries.

Unintended Consequences of Central Bank Lending in Financial Crises

Abstract I investigate the macroeconomic impact of central bank funding becoming a more attractive funding source to financial intermediaries in times of crisis. I show that the requirement to pledge collateral has a contractionary effect on private credit, everything else equal, and thereby reduces the expansionary effect that such lending otherwise has. I use an estimated New Keynesian model with financial frictions to show that the collateral effect explains the limited growth of Italian banks’ private credit in response to the European Central Bank’s three-year longer-term refinancing operations. Finally, I explore whether changes in lending policy can offset the cumulative negative effects from the collateral effect.

Are gross financial inflows expansionary or contractionary? Evidence from emerging economies

This paper put to the test two hypotheses. First, do gross financial inflows lead to an expansionary or contractionary effect in emerging economies? Second, do different financial inflows exhibit diverse impacts on domestic output and if there is any aggregation bias? However, our work ameliorates the existing literature by tackling the problem of slope heterogeneity and cross-correlated errors by adopting dynamic common-correlated predictors. The analysis further identify different regimes in the regression relationships, considering our sample includes significant global financial imbalances, global financial crisis, taper tantrum period, etc. We find that all types of gross financial inflows, except gross debt inflows, are expansionary. However, there is evidence of possible aggregation bias in using aggregated gross financial flows. Our findings imply that a distinction between different types of financial inflows is necessary to make informed policy recommendations since policies based on aggregate inflows may be ill-advised. Further, emerging markets should focus on encouraging direct and portfolio equity inflows and improving local financial markets’ absorptive capacities in borrower countries to improve welfare gains.

Oil price uncertainty, financial distress and real economic activities: Evidence from China

This paper studies the transmission of oil price uncertainty (OPU) shock to real economic activities by focusing on the role of financial condition. We find that financial stress is an important link in the propagation of OPU shock based on China’s macro- and firm-level data. We document significant decrease in real economic activities as oil price uncertainty increases by using SVAR, and further suggest that the contractionary effect of oil price uncertainty is more pronounced under high financial stress. Firm-level evidence consistently shows that heightened financial distress cost – resulted from oil price uncertainty – suppresses investments. OPU shock may cause financial distress through mechanisms of credit crunch, firm volatility and exchange rate uncertainty.

The effectiveness of a negative interest rate policy

In a dynamic stochastic general equilibrium model that is calibrated for the euro area, a negative interest rate policy (NIRP) can have contractionary effects on the economy when interest rates on household deposits reach the zero lower bound, and such deposits are the only source of bank funding and household savings. However, by introducing additional assets to households’ portfolios and alternative sources of bank funding, such as bank bonds, the NIRP becomes expansionary. Because both features characterize the euro area well, they are essential to study the effectiveness of NIRP policies.

Factor-Augmented Vector Autoregression with narrative identification. An application to monetary policy in the US

We extend the Bayesian Factor-Augmented Vector Autoregressive model (FAVAR) to incorporate an identification scheme based on an external instrument approach. Using this novel modelling framework, we show that a monetary policy tightening in the United States has contractionary effects on the economy. Moreover, accounting for a large information set seems to help mitigate price and real economic puzzles in the estimated impulse responses.

Financial Crises and the Transmission of Monetary Policy to Consumer Credit Markets

Abstract How does creditor health affect the pass-through of monetary policy to households? Using data on the universe of U.S. credit unions, I document that creditor asset losses increase the sensitivity of consumer credit to monetary policy. Identification exploits plausibly exogenous variation in asset losses and high-frequency identification of monetary policy shocks. Weaker lenders can respond more if they face financial frictions that easing alleviates. The estimates imply constraints on monetary policy become more costly in financial crises featuring creditor asset losses and that an additional benefit of monetary easing is that it weakens the causal, contractionary effect of asset losses. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online

Uncertainty shocks in emerging economies: A global to local approach for identification

The paper investigates the effects of uncertainty shocks in emerging economies (EMEs). I construct novel measures of uncertainty for fifteen small EMEs and to address endogeneity I instrument them with fluctuations in global uncertainty. My results show that uncertainty shocks have substantial contractionary effects on GDP, stock prices and local currencies and the recessionary effect is much stronger in EMEs compared to advanced economies (AEs). I also estimate a negative co-movement between prices and output which triggers a delayed monetary tightening in correspondence to the inflationary peak. Counterfactual scenarios reveal that in the absence of uncertainty shocks, the fall in GDP recorded in EMEs during the 2008–2009 crisis would have been attenuated by around 2%.

Effects of LTV announcements in EU economies

Earlier empirical studies on the effects of macroprudential policies focus on implementation dates and, in most cases, ignore potential anticipation effects. In this paper, we collect monthly data on announcements of loan-to-value (LTV) ratio restrictions covering 18 EU economies during the period 2000–2019. We show that announcements of LTV tightening policies can have a sizeable negative impact on household credit, house prices, and household durable goods consumption. We find that the estimated contractionary effects on household credit are driven by announcements with delayed implementation, whereas the effects on house prices are driven by announcements with quick implementation. We also show that the above contractionary effects are stronger following announcements of binding actions and actions without speed limits, suggesting that the design of macroprudential policies matters for their effectiveness.

Re-examining money demand function for South Asian economies

This study explores the stability of the money demand function in South Asia using the cash-in-advance theory of cointegrated monetary predictors. Due to the stationarity of the variables, the study employs CS-ARDL (cross-sectional augmented autoregressive distributed lags), and the ARDL models for panel and country-specific analysis, respectively. The short- and long-term elasticities disclose robust and significant statistical evidence of a nexus between the real monetary aggregate and the predictors, in the panel and across South Asia. The findings also reveal that real income, the real exchange rate, and foreign interest rates positively influence the real monetary aggregate, whereas the domestic interest rate and the inflation rate have contractionary effects. Besides, the results indicate that the money demand function is stable in Bangladesh, Bhutan, India, Pakistan, and the Maldives, while the findings support only partial stability in Afghanistan, Nepal, and Sri Lanka. The findings suggest that South Asian countries make significant allowance for the vital substitutional effects of currency on domestic holdings when articulating monetary policies. It also suggests that South Asian countries may need to build stronger coordination with respect to their monetary attempts as a “regional bloc” rather than autonomous monetary policies.