Expansionary Impact Research Articles

Macroeconomic effects of political risk shocks

I investigate the macroeconomic effects of political risk caused by conflict among politicians in a proxy VAR. Using an external instrument based on an index of US partisan conflict for identification, I find that reduced political risk has an expansionary impact: it is immediately priced into stock prices, firms start taking more risk, it increases firms’ dividend payouts, debt issuance and credit use — ultimately output rises.

The Macroeconomic Impact of Fiscal Policy Shocks: What do the Indian Data Say?

This article examines the impact of fiscal policy shocks on a set of macroeconomic variables in India, using a seasonally adjusted quarterly dataset for the period 2003–2019. The Gregory-Hansen residual-based test for cointegration and the vector error correction model (VECM) are applied, and impulse responses based on a recursive identification scheme (Cholesky decomposition) is used to assess the effects of a gross tax revenue shock and a government spending shock on economic activity, while accounting for the possibility of structural breaks. The findings indicate that an unexpected fiscal policy shock has an immediate expansionary impact on real GDP and a sudden positive effect on inflation (WPI) and the repo rate; and that the impact is permanent and away from the zero equilibrium. The careful design of policies by the central bank and the government as crucial macroeconomic stabilisation tools is imperative. JEL Classification: E6, H20, H30

Quantifying the optimal long-run level of government expenditures in Turkey

Purpose: This paper gauges the nexus between government expenditures and the output level in Turkey. Our primary research objective is to evaluate the extent to which government expenditures give rise to an increase in GDP taking the Armey curve theory as a basis for the analysis. Succinctly speaking, this theory suggests that the expansionary impact of government expenditure on income level has diminishing nature and beyond a certain threshold public spending impairs rather than accelerates economic activities for several reasons including crowding out, rent-seeking, tax hikes, and public debt surges. Methodology: In order to test the validity of this theory, we use a dataset with annual frequency covering the 1968-2019 period, which is the longest dataset used to carry out this analysis in the literature for Turkey. We set up an ARDL model to estimate the long-run coefficients required for quantifying the optimal level of government spending in Turkey. Results: According to our findings, the estimated function exhibits a concave down functional form, which implies a diminishing marginal effect of government spending on GDP, suggesting thereby that the Armey curve theory is valid for Turkey. In addition, even though government expenditure has topped out in recent years, it is still below the GDP maximising optimal level, which indicates that there is sufficient room for expansionary fiscal policies, with the caveat of a potential negative marginal impact on GDP once the optimal threshold is exceeded. Conclusion: The long-run coefficients from the ARDL estimation reveal that despite a consistent upward trend, government expenditures are still below their optimal level, which implies that there is fiscal space available to the government as far as output maximisation is concerned. However, government expenditures have been on a downward trend recently, which is contrary to output maximisation.

Reversal Interest Rate and Macroprudential Policy

Could a monetary policy loosening entail the opposite effect than the intended expansionary impact in a low interest rate environment? We demonstrate that the risk of hitting the rate at which the effect reverses depends on the capitalization of the banking sector by using a non-linear macroeconomic model calibrated to the euro area economy. The framework suggests that the reversal interest rate is located in negative territory of around −1% per annum. The possibility of the reversal interest rate creates a novel motive for macroprudential policy. We show that macroprudential policy in the form of a countercyclical capital buffer, which prescribes the build-up of buffers in good times, can mitigate substantially the probability of encountering the reversal rate, improves welfare and reduces economic fluctuations. This new motive emphasizes also the strategic complementarities between monetary policy and macroprudential policy.

The cross-border credit channel and lending standards surveys

The greater availability of bank Senior Loan Officer (SLO) surveys in the past decade is enhancing our understanding of the international bank lending channel of monetary policy. Using a Global VAR (GVAR), we find evidence that expansionary monetary policies in general resulted in lower credit standards, which in turn reinforced the thrust of monetary policy. However, at the time of announcements about unconventional monetary policies, the expansionary impact was muted likely owing to a signaling effect, i.e., signaling a downgrading of underlying economic and financial prospects. Comparisons with the United States and Eurozone economies draw attention to the special role bank-lending standards play in the monetary policy transmission mechanism.

Macroeconomic Effects of Political Risk Shocks

We investigate the macroeconomic effects of political risk in an information-rich SVAR. Using an external instrument based on an index of US partisan conflict for identification, we find that reduced political risk has expansionary impact: it is immediately priced into stock prices; increases firms’ credit availability, employment and investments while households invest and consume more — ultimately output rises. As an important driver of economic dynamics in medium to long term, the shock create an aggregate supply effect where output growth and inflation move in opposite directions, and generates a trade-off between inflation stabilization and output growth during turbulent periods.

Frequency-dependent real-time effects of uncertainty in the United States: evidence from daily data

ABSTRACT In this paper, we analyse the impact of uncertainty shocks at the daily-frequency on key macroeconomic variables for the United States. In doing so, we use a vector autoregressive (VAR) model, including the inflation rate, a real-time measure of economic activity and a measure of monetary policy as endogenous variables and decompose uncertainty effects into short, medium and long-term based on a discrete-time Fourier transformation. Aggregate results (prior to decomposition) show that an increase in economic uncertainty has a significant expansionary impact on monetary policy. However, when we decompose uncertainty into its short-, medium- and long-run components, we find that economic activity is affected negatively in a statistically significant manner to shocks in low-frequency uncertainty, while, statistically significant monetary expansion is observed under shocks to relatively high frequencies of uncertainty.

Fiscal deficit targeting alongside flexible inflation targeting: India’s fiscal policy transmission

India is at the cusp of a macroeconomic policy upgrade: the government has opted for a fiscal deficit targeting rule in partial acceptance of the recommendations of the 2017 Fiscal Responsibility and Budget Management Review Committee while at the same time the central bank has adopted a flexible inflation targeting framework. This paper investigates the impact of these rules on one another using a dynamic stochastic general equilibrium (DSGE) model calibrated for the Indian economy. The study first ascertains that under a high degree of interest rate smoothing, a passive monetary policy is consistent with the fiscal deficit targeting rule in that determinacy of the price level is assured. Having established the central bank’s parameter space, the study next investigates the effect on fiscal policy transmission of varying the degree of monetary policy activeness. For positive fiscal spending shocks, more active monetary policy blunts the expansionary impact while reducing inflationary spillovers. The reverse holds for fiscal stimulus measures involving tax reductions, which are disinflationary, so that more active monetary policy amplifies the expansionary impact and mitigates the disinflationary impetus. The results highlight the need for coordination between fiscal intervention and monetary policy.

Cross-Atlantic implications of the new US policy mix

This paper will assess implications of shifting policy mix in the US for global imbalances and adjustment, with a focus on the euro area, using the European Commission’s QUEST model. Following early market euphoria after the elections on the account of expected “decisive” pro-market policies, uncertainty regarding the composition and timing of the new administration's economic policies has been the norm. Early proposals included a substantial fiscal stimulus which, combined with a tightening monetary stance, was expected to drive up long-run interest rates and the dollar, leading to widening global imbalances and potential instability. Today the expansionary impact of the fiscal plans is the subject of a heated debate while monetary policy continues to tighten steadily and risks related to a protectionist trade agenda remain pronounced. Contrary to initial expectations, real interest rates and the dollar have weakened, while global imbalances persist. Addressing policy and structural needs in the US – and abroad – is a necessary condition to rein in global imbalances. In this context, this paper will discuss the role of the G20/G7 to promote a coordinated policy approach and in particular to what extent the G20/G7 can deal with the transition from crisis management to the balancing of heterogeneous preferences among the policy makers to promote global growth and stability.

Recession and Financial Development: An Empirical Analysis

We analyse the effects of financial development on recession while controlling for potential recession factors in 129 countries using data covering the 1990-2010 period. We mainly found a nonlinear and U-shaped relationship between recession and financial development with a threshold effect of 1.1528. The financial development process presents an expansionary impact for countries with financial performance less than 1.1528, and countries with financial performance above the threshold of 1.1528 present a recessionary impact. Moreover, fuels for South Asia (SASIA) and Latin America and Caribbean (LAC) countries and financial openness for sub-Saharan Africa (SSA) countries are negatively related to recessions; countries who manage their oil production in a good manner will also reduce the probability and impact of recessions. Thus, to fight against recession, SASIA and LAC countries should well manage oil production and usage while SSA countries may manage their financial openness. To the best of our knowledge, this is the first study examining this relationship using newly primary and hitherto almost unexploited “Rare macroeconomic disasters” data from Barro and Ursua (2012) which allow us to build a more specific proxy of the variable “economic recession”.

Are Capital Inflows Expansionary or Contractionary in the Philippines?

This paper sets out to assess whether gross capital inflows to the Philippines are expansionary or contractionary in line with the model predictions and empirical findings of Blanchard et al. (2015). The results indicate that gross inflows are expansionary to output and credit growth. But contrary to the model predictions and empirical findings of Blanchard et al. (2015), we find that private bond inflows to the Philippines are expansionary. Bond inflows may have expansionary impact on output and credit growth if the exchange rate is managed, if the domestic capital market is underdeveloped, if the country receives small bond inflows, and if proceeds from debt issuance are channelled to productive investments. Similar to Blanchard et al. (2015), non-bond inflows have a positive overall impact on output and credit growth despite receiving relatively small foreign direct investment inflows.

It Takes a Regime Shift: Recent Developments in Japanese Monetary Policy through the Lens of the Great Depression

Last week, we witnessed one of the most exciting developments in monetary policymaking since the 1930s. The Japanese central bank staged an honest-to-goodness regime shift. The Bank of Japan went beyond vague promises and cheap talk. As I will describe in more detail later, it took dramatic actions and pledged convincingly to do whatever it takes to end deflation in Japan. The theoretical reasons why this regime shift may be important are well understood by economists. Persistent deflation and anemic growth suggest that Japan continues to suffer from a shortfall of demand. But their policy interest rate is already at the zero lower bound. Furthermore, riskier, long-term rates are also very low— suggesting that unconventional policies such as large-scale asset purchases are unlikely to do much to further reduce nominal rates. As discussed by Paul Krugman, Gauti Eggertsson and Michael Woodford, and others, if unconventional monetary policy can raise expected inflation, this can push down real interest rates even though nominal rates cannot fall. 1 This, in turn, can raise aggregate demand by stimulating interest

Market Penetration of Biodiesel

This research examines in detail the technology and economics of substituting biodiesel for diesel #2. This endeavor examines three areas. First, the benefits of biodiesel are examined, and the technical problems of large-scale implementation. Second, the biodiesel production possibilities are examined for soybean oil, corn oil, tallow, and yellow grease, which are the largest sources of feedstocks for the United States. Examining in detail the production possibilities allows to identity the extent of technological change, production costs, byproducts, and greenhouse gas (GHG) emissions. Finally, a U.S. agricultural model, FASOMGHG was used to predict market penetration of biodiesel, given technological progress, variety of technologies and feedstocks, market interactions, energy prices, and carbon dioxide equivalent prices.FASOMGHG has several interesting results. First, diesel fuel prices have an expansionary impact on the biodiesel industry. The higher the diesel fuel prices, the more biodiesel is produced. However, given the most favorable circumstances, the maximum biodiesel market penetration is 9% in 2030 with a wholesale diesel price of $4 per gallon. Second, the two dominant sources of biodiesel are from corn and soybeans. Sources like tallow and yellow grease are more limited, because they are byproducts of other industries. Third, GHG prices have an expansionary impact on the biodiesel prices, because biodiesel is quite GHG efficient. Finally, U.S. government subsidies on biofuels have an expansionary impact on biodiesel production, and increase market penetration at least an additional 3%.

The Evolution of Homeownership Rates in Selected OECD Countries: Demographic and Public Policy Influences

Homeownership rates have increased significantly in many OECD countries over recent decades. Using micro-econometric decomposition techniques, this paper shows that part of this increase can be explained by changes in the characteristics of households, including age, household structure, income and education. Nevertheless, a significant portion of the change in homeownership rates remains unexplained by shifts in household characteristics, leaving a potential role for public policy in explaining developments in homeownership rates. Panel estimates suggest that the relaxation of down-payment constraints on mortgage loans has increased homeownership rates among credit-constrained households over recent decades, resulting in a rise in the aggregate homeownership rate that is comparable with the impact of population ageing. In countries where tax relief on mortgage debt financing is generous, however, the expansionary impact of mortgage market innovations on homeownership is smaller. This is consistent with the tendency for such housing tax relief to be capitalised into real house prices, which may crowd-out some financially constrained households from homeownership at the margin. The impact of housing policies regulating the functioning of the rental market, such as rent regulation and provisions for tenure security, on tenure choice is also explored. JEL classification: R21, R31, G21, H24. Keywords: Housing markets, homeownership, mortgage markets, financial regulation, taxation.

A quartet of asset pricing models in nominal and real economies

This paper studies the equity premium implications of a canonical New Keynesian model with investment. We find that the presence of a time-varying marginal cost dampens the expansionary impact of a positive technology shock. With a given fraction of firms standing ready to satisfy demand at predetermined prices, the variations in the marginal utility of consumption attributed to technology shocks can easily be smoothed. Thus, technology shocks contribute little to the equity premium. Under a standard monetary policy rule, the real effect of monetary policy shocks is too weak and short-lived to generate a reasonable equity premium.

Production Stages and the Transmission of Technological Progress

We develop and estimate a DSGE model which realistically assumes that many goods in the economy are produced through more than one stage of production. Firms produce differentiated goods at an intermediate stage and a final stage, post different prices at both stages, and face stage-specific technological change. Wage-setting households are imperfectly competitive with respect to labor skills. Intermediate-stage technology shocks explain most of short-run output fluctuations, whereas final-stage technology shocks only have a small impact. Despite the dominance of technology shocks, the model predicts a near-zero correlation between hours worked and the return to work and mildly procyclical real wages. The factors mainly responsible for these findings are an input-output linkage between firms operating at the different stages and movements in the relative price of goods. We show that, depending the source, a technology improvement may either have a contractionary or expansionary impact on employment.

Estimating the Natural Interest Rate for the Euro Area and Luxembourg

This paper estimates the natural real interest rate that is consistent with stable inflation and output at its potential for the euro area and Luxembourg. The natural interest rate provides a benchmark for assessing the monetary policy stance, as policy is contractionary when real interest rates rise above the natural rate and expansionary when real interest rates fall below this level. We follow Laubach and Williams (2003) in using a small backward-looking macroeconomic model to estimate the time-varying natural interest rate as an unobservable variable. For the euro area, our results suggest the natural interest rate has been fairly stable since 1970 and confirm its decline over the last decade. For Luxembourg, our estimate of the natural interest rate is much higher, reflecting higher potential growth. The results suggest that the single monetary policy may have an expansionary impact in recent years, especially in Luxembourg.

Monetary and Fiscal Management: Framework and Evidences

Macroeconomic management should contribute to higher economic growth without disturbing the macroeconomic stability, which is essential for attaining sustained higher level of economic growth. Sound macroeconomic management would also improve the external sector competitiveness of the economy on a sustainable basis, a precondition for reducing the external sector vulnerability of the economy. Balance of payments crises and foreign debt problems are often caused and aggravated by imprudent fiscal policy the solution of which would involve some combination of cutting public spending and raising additional revenue, thereby freeing resources for export and debt servicing. With increased fiscal expansion or fiscal deficit, current account deficit widens and the level of government debt in proportion to GDP increases accordingly. Unsustainable fiscal deficit would encourage capital flight which would deteriorate the debt problem. Monetary policy seeks to regulate money supply and thereby liquidity by changing the availability and cost of credit for influencing the volume of aggregate demand in the economy and, therefore, inflation. The usual expansionary impact of fiscal policy is offset by a rise in the value of the currency. Under fixed exchange rates, only fiscal policy can affect income. The normal potency of monetary policy is lost because the money supply is dedicated to maintaining the exchange rate at the announced fixed level. Only a system of floating exchange rates leaves monetary policy free to pursue other goals, such as employment or prices. As the most important instrument in implementing the monetary policy, the central bank buys or sells government securities, which affects the level of liquidity and short-term interest rates that prompt the banks to let their reserves grow at a level consistent with the objectives of monetary policy. It can be expected that the role of the monetary policy to contribute to create sound macroeconomic fundamentals and foster sustained economic growth through increased emphasis on the secondary market operation will remain potent in the days to come. Economic Journal of Nepal Vol.29(2) 2006 pp.63-76

Economic Reactions to Public Finance Consolidation: A Survey of the Literature

The paper reviews the theoretical and empirical literature that has investigated the conditions under which a contractionary fiscal policy is effective in reducing debt and deficit, but does not have a negative effect on growth. The issue is central to macroeconomics and policy making, given that many countries are currently facing increasing fiscal imbalances, with additional pressure coming in the medium term from population ageing. The paper concludes that the theoretical impact of fiscal policy on aggregate demand and economic activity depends largely on the conceptual framework considered and its assumptions about the world. Empirical studies based on macro-econometric model simulations find evidence that fiscal consolidations lead initially to production losses, while they can result in a higher output in the medium term. Empirical studies focusing on episodes of changes in fiscal policies provide in turn evidence that under certain circumstances austerity measures may have an expansionary impact on the economy.

Monetary Policy Making: Challenges in an Open Economy

Whether Central Bank should habitually intervene or should not intervene at all with the exchange rate movements is a burgeoning question. If we accept intervention, the question arises as to what should be the extent of Reserve Bank of India's intervention to contain the expansionary impact of global capital inflows? The ramifications of 'RBI's intervention' has given rise to many complexities which need exploration. This will help to delineate the possible mechanisms to overcome the trade-off between the various objectives of monetary policy. Indian experience reveals that the large inflows of foreign capital put upward pressure on exchange rate; monetary expansion resulting from intervention tends to exert upward pressure on domestic price level. This raises the issue of an appropriate exchange rate policy and price policy. There is, thus, an imperative to study the various monetary policy instruments, goals and policy variables in the wake of the changed scenario. The research paper inter alia would focus on the following: · Reasons involved towards changing character of 'reserve money'; · Emerging challenges in terms of 'exchange rate management' and 'domestic price stability'; · An analysis of the efficacy of the existing instruments used to tackle the challenges; · To suggest alternative policy options for tackling challenges.