Distortionary Effects Research Articles

Optimal Monetary and Macroprudential Policies: Gains and Pitfalls in a Model of Financial Intermediation

We estimate a quantitative general equilibrium model with nominal rigidities and financial intermediation to examine the interaction of monetary and macroprudential stabilization policies. The estimation procedure uses credit spreads to help identify the role of financial shocks amenable to stabilization via monetary or macroprudential instruments. The estimated model implies that monetary policy should not respond strongly to the credit cycle and can only partially insulate the economy from the distortionary effects of financial frictions/shocks. A counter-cyclical macroprudential instrument can enhance welfare, but faces important implementation challenges. In particular, a Ramsey planner who adjusts a leverage tax in an optimal way can largely insulate the economy from shocks to intermediation, but a simple-rule approach must be cautious not to limit credit expansions associated with effcient investment opportunities. These results demonstrate the importance of considering both optimal Ramsey policies and simpler, but more practical, approaches in an empirically grounded model.

Petroleum Product Pricing, Deregulation and Subsidies in Ghana: Perspectives on Energy Security

This paper reviews Ghana’s recent experience with downstream petroleum products pricing and deregulation and looks at its implications for the nation’s energy security needs. The Government of Ghana in June 2015 put in place a deregulation policy that had the expectation of allowing marketers and importers of petroleum products to sell directly to consumers by setting their own prices. The policy has the primary objective bring an end to government subsidies on the product which arises in from exchange rate losses and consumer subsidies. The study welcomes government’s decision to revert to the competitive market forces using automatic price formulation as this removes implicit subsidization and its distortionary effects on the economy. With the advent of full deregulation, the burden of managing forex risks will shift from the government to the BDCs and TOR, and any such losses will become their prerogative. Petroleum subsidies, if any, should be redesigned and better targeted at the poor in the form of direct cash transfers as well as entrepreneurial skills training to improve their social and living conditions. Subsidies create distortionary effects and further exacerbate fiscal pressures as government has to borrow or tap into its reserves to offset price differentials.

CCCTB: the employment factor game

The draft for a CCCTB Directive in the EU includes the suggestion for an apportionment formula which allocates taxable profits to group member corporations and to the respective Member States. The draft directive delegates the right to define one apportionment factor, the term ‘Employee’ to the Member States, which can choose a narrow or a broad definition, the latter including also atypical employment schemes. Using a game-theoretic approach we show that defining ‘Employee’ broadly so as to maximize the Member State’s share in the apportionment factor is only optimal when tax rate differences and different sizes of atypical employment schemes are disregarded. If such differentials and the multinational corporation’s reactions to different domestic definitions are included a narrow definition of ‘Employee’ yields the highest individual pay-offs to the countries involved. Our paper differs from previous research on the economic effects of the CCCTB apportionment formula as it is the first analysing the employment factor and its distortive effects. We discuss possible tax minimizing strategies for multinationals by shifting employment and develop a model to quantify these potential relocations. The results of our paper may be relevant for the European Commission and the Council, when debating the details of formula apportionment. Furthermore we show how Member States could use the ‘Employee’ definition to both minimize factor emigration and maximize factor immigration, if the factor definitions remain unchanged.

Political Economy of the 2014 Farm Bill

This article assesses the political economy of the 2014 U.S. farm bill, with a focus on the farm support safety net. The farm bill secured substantial bipartisan majorities in a politically contentious Congress. Planned outlays are predominately for nutrition assistance programs directed toward a traditional nonfarm constituency in the farm bill coalition, while annual fixed direct payments to farmers are eliminated but replaced with enhanced downside risk protection against low prices or revenue. The new support programs may prove more or less costly than the foregone fixed payments, with farmers offered a choice between a price countercyclical program with increased reference prices and a revised moving‐average revenue guarantee program. The role of insurance is enhanced, notably by replacing past support programs with a new upland cotton revenue insurance program and dairy milk‐to‐feed margin protection program. Open policy issues that are highlighted include the costs and distortionary effects of moving‐average revenue benchmarks versus fixed reference prices, the overall level of insurance premium subsidies, the potential for overlap between commodity and insurance programs, and lastly, food, environmental, and biofuels concerns that reflect the diverse portfolio of products demanded from agriculture. In an international context, we conclude that the 2014 farm safety net likely would not have been enacted had multilateral agreement been reached on the 2008 Doha Round World Trade Organization negotiating documents. Conversely, the 2014 farm bill makes achieving those limits more difficult. Research is discussed that can elucidate the ongoing political economy of U.S. farm policy and help shape future program design.

The distortionary effect of monetary policy: credit expansion vs. lump-sum transfers in the lab

Abstract In an experimental monetary general equilibrium economy, we assess two processes of monetary injection: credit expansion vs. lump-sum monetary transfers. In theory, both processes are neutral and exert no real effect on allocation. In the experiment, however, credit expansion leads to substantial distortions of real allocation and relative prices, and exerts a redistributive effect across subjects. By contrast, an increase in money through lump-sum transfers does not distort real allocation.

Political instability and labour market institutions

This paper investigates the relationship between political instability and labour market institutions. We develop a theoretical model in which political instability creates incentives for a government to introduce labour market regulation in the economy. The distortionary effect of regulation on unemployment effectively puts a constraint on the design of fiscal and public policies. We empirically investigate these predictions using panel data for 21 OECD countries for the period 1985–2006. Our results are consistent with the view that political instability is associated with more regulated labour markets, lower labour taxation, and lower unemployment benefit replacement rates.

Investment Distortion by Collateral Requirements: Evidence from Japanese SMEs

We examine the significance of the distortionary effect of the collateral requirement to investments in assets pledgeable for collaterals by small and medium-sized enterprises (SMEs). The theory predicts that the binding collateral constraint causes over-investment if the land price is expected to go up steeply while it causes under-investment otherwise. Our structural estimation of the Euler equation under a collateral constraint using the dataset on Japanese SMEs in the 1980s, in which the Japanese land price was skyrocketing, shows that the collateral constraint was not binding on average, whereas the estimation using data on the 1990s, during which the land price went down precipitously, shows that the constraint was binding and caused under-investment in the 1990s. This result indicates that the distortion in resource allocation resulting from the binding collateral constraint was a significant cause of the subsequent prolonged economic slump.

Distortive effects of initial‐based name disambiguation on measurements of large‐scale coauthorship networks

Scholars have often relied on name initials to resolve name ambiguities in large‐scale coauthorship network research. This approach bears the risk of incorrectly merging or splitting author identities. The use of initial‐based disambiguation has been justified by the assumption that such errors would not affect research findings too much. This paper tests that assumption by analyzing coauthorship networks from five academic fields—biology, computer science, nanoscience, neuroscience, and physics—and an interdisciplinary journal, PNAS. Name instances in data sets of this study were disambiguated based on heuristics gained from previous algorithmic disambiguation solutions. We use disambiguated data as a proxy of ground‐truth to test the performance of three types of initial‐based disambiguation. Our results show that initial‐based disambiguation can misrepresent statistical properties of coauthorship networks: It deflates the number of unique authors, number of components, average shortest paths, clustering coefficient, and assortativity, while it inflates average productivity, density, average coauthor number per author, and largest component size. Also, on average, more than half of top 10 productive or collaborative authors drop off the lists. Asian names were found to account for the majority of misidentification by initial‐based disambiguation due to their common surname and given name initials.

Central Bank Collateral Frameworks

This paper seeks to inform about a feature of monetary policy that is largely overlooked, yet occupies a central role in modern monetary and financial systems, namely central bank collateral frameworks. Their importance can be understood by the observation that the money at the core of these systems, central bank money, is injected into the economy on terms, not defined in a market, but by the collateral frameworks and interest rate policies of central banks. Using the collateral framework of the Eurosystem as a basis of illustration and case study, the paper brings to light the functioning, reach, and impact of collateral frameworks. A theme that emerges is that collateral frameworks may have distortive effects on financial markets and the wider economy. They can, for example, bias the private provision of real liquidity and thereby also the allocation of resources in the economy as well as contribute to financial instability. Evidence is presented that the collateral framework in the euro area promotes risky and illiquid collateral and, more generally, impairs market forces and discipline. The paper also emphasizes the important role of ratings and government guarantees in the Eurosystem’s collateral framework.

Inconsistent Depreciation Practice and Public Policymaking: Local Government Reform in New South Wales

Public policy based on numerical indicators – a form of ‘public management by numbers’ – has become commonplace across the world. Whereas a good deal is known about the deleterious effects of this type of policymaking – including ratcheting, output distortion and ‘gaming’ – unfortunately little attention has focused on the adverse local government policy consequences of inconsistent depreciation accruals by local authorities. This paper seeks to address this gap in the empirical literature on local government performance. After examining the use of accounting data by local government policymakers, the paper reviews available empirical evidence of inconsistent depreciation practice both in Australia and abroad. We then consider the recent New South Wales (NSW) Independent Local Government Review Panel's use of accounting ratios as supporting evidence for boundary change in local government as a case study of the adverse impact of inconsistent depreciation practice. The NSW experience clearly demonstrates the distortionary effects of empirical evidence resulting from significant variation in depreciation accruals by individual local councils. The paper concludes with an assessment of the options available to local government policymakers wishing to obtain more accurate accounting accrual data for policy formulation purposes.

Volatility After-Effects: Evidence from the Field

We propose and test the idea that investor perceptions exhibit volatility ‘after-effects’ whereby perceived volatility is distorted after prolonged exposure to extreme volatility levels. Using VIX to measure perceived volatility in S&P 500 stocks, we find evidence of significant perceptual distortions in the aftermath of volatility regimes, consistent with the after-effect theory and recent experimental evidence. These distortions are larger after both stronger and longer volatility regimes, and are absent after volatility changes that are not preceded by extreme volatility levels, consistent with the after-effect theory and inconsistent with alternative explanations. Our study shows that perceptual biases can have a significant distortionary effect on asset prices, even in very actively traded financial securities.

Trade in Environmental Goods: A Review of the WTO Appellate Body's Ruling in US Countervailing Measures (China)

In this paper we claim that, in the WTO Appellate Body (AB)’s ruling in US — Countervailing Measures (China), the AB decision has not put in question the practice of imposing countervailing duties (CVDs). While the US has formally “lost” the case, a change in the procedures and tests used to motivate the CVD will allow the US to continue using this policy tool on the specified products. From an economic point of view, this is not welcome news since CVDs have the standard distortionary effects of tariffs and could go against environmental goals. From a political-economy point of view, the CVDs in this case appear driven by pressure of domestic manufacturers of clean energy technology and products.

The Distortionary Effect of Monetary Policy: Credit Expansion vs. Lump-Sum Transfers in the Lab

In an experimental monetary general equilibrium economy, we assess two processes of monetary injection: credit expansion vs. lump-sum monetary transfers. In theory, both processes are neutral and exert no real effect on allocation. In the experiment, however, credit expansion leads to substantial distortions of real allocation and relative prices, and exerts a redistributive effect across subjects. By contrast, an increase in money through lump-sum transfers does not distort real allocation.

Distortive Effects of International Institutions: The Technical Capabilities of Japanese Firms and the International Institution for Standardization

Distortive Effects of International Institutions: The Technical Capabilities of Japanese Firms and the International Institution for Standardization

Statement for Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Financial Institutions and Consumer Protection -- Hearing on 'Examining the GAO Report on Expectations of Government Support for Bank Holding Companies' Held July 31, 2014

On July 31, 2014, the US Senate Subcommittee on Financial Institutions and Consumer Protection of the Committee on Banking, Housing and Urban Affairs held a hearing entitled Examining the GAO Report on Expectations of Government Support for Bank Holding Companies. The hearing was related to a report of the Government Accountability Office (GAO) that became public on that day and which focused on assessing the possible funding advantage that large bank holding companies considered too big to fail might benefit from. This document represents the statement (without appendices) that I submitted to accompany my testimony in this hearing. The statement discusses whether large bank holding companies can, or actually might, fail, and, if so, how, addressing the difficulties associated with failure through bankruptcy as well as through the new FDIC-led resolution mechanism under Title II of the Dodd-Frank Act. My conclusion is that based on what we know today, it is virtually impossible, and there is clearly no way to assert that the large banking holding companies can go through either process without causing significant instability. This discussion highlights the critical importance of effective regulation of the indebtedness levels (or leverage) of these bank holding companies, which can be done through so-called capital regulation. I argue that the reform of these regulations is dangerously insufficient and flawed, thus exacerbating the problem of too-big-to-fail unnecessarily. I discuss the basic framework of trying to estimate the subsidies associated with expectations for government support and make a set of observations on various attempts at this estimation. But I argue that the exact size of the subsidies is less relevant than the perverse and extremely distortive effects of the subsidies, which are due to the manner in which the subsidies are delivered. By enabling the institutions to borrow at terms that do not reflect appropriately the risks taken, implicit guarantees add to the distortion of a tax code that penalize equity funding relative to debt, thus encouraging and rewarding dangerous, excessive and inefficient levels of borrowing and reckless conduct. The overall effect is to widen the persistent gap between the interest of those who make decisions within the banks and what serves the broader public. I conclude with a set of urgent policy recommendations, warning that failure to take action to counter the distorted incentives puts the public at excessive risk and maintains harmful inefficiencies in the economy.

On the long-term macroeconomic effects of social spending in the United States

We estimate the long-term impact of changes in social security and social protection spending on economic performance in the United states. We estimate a VAR model relating GDP, unemployment rates, saving rates and social spending. Our results suggest that social spending has significant distortionary effects in the labour markets as measured by its long-term effects on the unemployment rate, which translate into a detrimental effect on long-term output, this despite a positive, albeit small, effect on the gross savings rate. There are important policy implications of these results. If one considers the systems as they are, any further expansion in their generosity would have detrimental long-term effects. These detrimental effects, however, are neither an indictment of social spending nor evidence against extension of benefits. What they highlight is the need to carefully consider the financing mechanisms currently used and the need to align benefits and contributions in the pension component of social security and the need to find a tax revenue mix that is less distortionary for the unfunded benefits.

Feeding finance: a critical account of the shifting relationships between finance, food and farming

Whether in the form of commodity index funds, farmland investment funds or commodities trading by agri-food companies, there is evidence of an increasingly close relationship between finance, food and agriculture. While these developments have received some critical attention of late, existing accounts of the ‘financialization of food’ are limited to the extent that they view finance as an external force with emphasis placed on the unnaturalness of its relationship with agriculture and its distortive effects on agricultural markets. Recognizing that finance and agriculture have a long history, this paper offers a more nuanced account of the place of financialization in the agricultural sector. Specifically, it examines how agriculture's emergence as an investment opportunity has reconfigured the terrain of agricultural interests and logics while creating new knowledge demands and agricultural visibilities. These dynamics are explored through a case study of the role of finance and processes of financialization in the recent demise of the Canadian Wheat Board as a state marketing agency. Through this discussion, the paper offers valuable insights into not only the reworking of agriculture as a particular type of financial space, but also the nature and limits of financialization itself as a way of engaging with the world beyond urban financial centres.

Evidence of Distortionary Effects of Decoupled Payments in U.S. Indica Rice Production

Using a generalized method of moments technique for dynamic panels we estimate the acreage response of indica rice production in the U.S. to decoupled payments under the 1996 and 2002 farm bills. We find that these payments exert significant effects on the number of acres planted and, although the response is inelastic, a given change in decoupled payments may have a greater effect on acreage planted than an equal change in payments directly linked to output. Thus, even purely decoupled payments may be vulnerable to WTO sanction or de minimis limits. This research also suggests that the subsidy formula in the proposed 2014 farm bill will have a reduced distortionary effect compared to existing policies.

Measuring Firm-Level Productivity Convergence in the UK: The Role of Taxation and R&D Investment

This paper examines the direct effects of corporate tax on firm productivity along with the interaction effects of tax policy and R&D activity on productivity at firm level for over 13,062 firms during 2004-2011. Our main findings are first, that there is evidence for productivity convergence and we find that there is a positive robust relationship between R&D and firm productivity, whereas tax policy has a negative distortionary effect on TFP. Second, firms with greater export orientation do not seem to achieve much improvement in productivity, whereas the favourable productivity effect in the case of R&D-based firms suggests that if there are tax incentives in place for R&D type activity, it can promote innovation and drive productivity convergence (lagging firms closing the technology gap with those at the frontier), particularly so when there is a continued decline in overall economic activity. The results also show a significant non-linear effect of tax rate on firm-level productivity, identifying an inverse U-shaped relationship.

Field experiments of success-breeds-success dynamics

Seemingly similar individuals often experience drastically different success trajectories, with some repeatedly failing and others consistently succeeding. One explanation is preexisting variability along unobserved fitness dimensions that is revealed gradually through differential achievement. Alternatively, positive feedback operating on arbitrary initial advantages may increasingly set apart winners from losers, producing runaway inequality. To identify social feedback in human reward systems, we conducted randomized experiments by intervening in live social environments across the domains of funding, status, endorsement, and reputation. In each system we consistently found that early success bestowed upon arbitrarily selected recipients produced significant improvements in subsequent rates of success compared with the control group of nonrecipients. However, success exhibited decreasing marginal returns, with larger initial advantages failing to produce much further differentiation. These findings suggest a lesser degree of vulnerability of reward systems to incidental or fabricated advantages and a more modest role for cumulative advantage in the explanation of social inequality than previously thought.