Cost Of Lower Output Research Articles

Debt Sustainability and Fiscal Space in a Heterogeneous Monetary Union: Normal Times Vs the Zero Lower Bound

In this paper we study fiscal policy effects and fiscal space for countries in a monetary union with different levels of public debt. We develop a dynamic stochastic general equilibrium (DSGE) model of a two-country monetary union, calibrated to match the characteristics of Spain and Germany, in which debt sustainability is endogenously determined a la Bi (2012) to shape the responses of the risk premium on public debt. Policy shocks change the market’s expectation about future primary surplus, producing a direct effect on the sovereign risk premium and macroeconomic responses of the economy. In normal times the costs of a government spending driven fiscal consolidation in the high-debt country are greatly diminished when this consolidation improves endogenously its debt sustainability prospects. Fiscal consolidations in both members of the monetary union decrease real interest rates and amplify the reduction in risk premium in the highly-indebted country, improving union-wide output in the long run, but at the cost of lower output in the low-debt country in the short term. On the contrary, when monetary policy is constrained at the zero lower bound, the risk premium channel arising from the endogenous determination of debt sustainability becomes muted. In the ZLB, a fiscal consolidation generates deflation expectations which increase the real interest rate and may compensate partially or completely, depending on the calibration, the benefits from a lower risk premium. In this context, a fiscal expansion in the low-debt country and a consolidation in the high-debt country delivers the greater positive impact on union-wide output. Finally, the risk premium channel only affects countries with medium or low levels of public debt indirectly through the negative spillovers from other high-debt members of the monetary union.

Fiscal Consolidation Under Imperfect Credibility

This paper examines the effects of expenditure-based fiscal consolidation when credibility as to whether the cuts will be long-lasting is imperfect. We contrast the impact limited credibility has when the consolidating country has the means to tailor monetary policy to its own needs, with the impact when the country is a small member of a currency union with a negligible effect on interest rates and on nominal exchange rates of the currency union. We find two key results. First, in the case of an independent monetary policy, the adverse impact of limited credibility is relatively small, and consolidation can be expected to reduce government debt at a relatively low output cost given that monetary policy provides more accommodation than it would under perfect credibility. Second, the lack of monetary accommodation under currency union membership implies that the output cost may be significantly larger, and that progress in reducing government debt in the short and medium term may be limited under imperfect credibility.

Fiscal consolidation under imperfect credibility

This paper examines the effects of expenditure-based fiscal consolidation when credibility as to whether the cuts will be long-lasting is imperfect. We contrast the impact limited credibility has when the consolidating country has the means to tailor monetary policy to its own needs, with the impact when the country is a small member of a currency union with a negligible effect on interest rates and on nominal exchange rates of the currency union. We find two key results. First, in the case of an independent monetary policy, the adverse impact of limited credibility is relatively small, and consolidation can be expected to reduce government debt at a relatively low output cost given that monetary policy provides more accommodation than it would under perfect credibility. Second, the lack of monetary accommodation under currency union membership implies that the output cost may be significantly larger, and that progress in reducing government debt in the short and medium term may be limited under imperfect credibility.

Fiscal Consolidation Under Imperfect Credibility

This paper examines the effects of expenditure-based fiscal consolidation when credibility as to whether the cuts will be long-lasting is imperfect. We contrast the impact limited credibility has when the consolidating country has the means to tailor monetary policy to its own needs, with the impact when the country is a small member of a currency union with a negligible effect on interest rates and on nominal exchange rates of the currency union. We find two key results. First, in the case of an independent monetary policy, the adverse impact of limited credibility is relatively small, and consolidation can be expected to reduce government debt at a relatively low output cost given that monetary policy provides more accommodation than it would under perfect credibility. Second, the lack of monetary accommodation under currency union membership implies that the output cost may be significantly larger, and that progress in reducing government debt in the short and medium term may be limited under imperfect credibility.

The output effect of fiscal consolidation plans

We show that the correct experiment to evaluate the effects of a fiscal adjustment is the simulation of a multi-year fiscal plan rather than of individual fiscal shocks. Simulation of fiscal plans adopted by 16 OECD countries over a 30-year period supports the hypothesis that the effects of consolidations depend on their design. Fiscal adjustments based upon spending cuts are much less costly, in terms of output losses, than tax-based ones and have especially low output costs when they consist of permanent rather than stop-and-go changes in taxes and spending. The difference between tax-based and spending-based adjustments appears not to be explained by accompanying policies, including monetary policy. It is mainly due to the different responses of business confidence and private investment.

Stock markets and the costs of banking crises

Purpose – This paper aims to investigate whether stock markets can reduce the output costs of banking crises. The work is motivated by Alan Greenspan’s claim that capital markets serve as a financial “spare tire” in the event of a banking crisis. Design/methodology/approach – We test the impact of stock market capitalization, liquidity and turnover on the output losses of 76 banking crises in 66 countries over the period of 1975-2008. Findings – Our results indicate that stock markets can mitigate the effect of banking crises on economic activity. There is also some evidence that foreign equity holdings lower output costs. Practical implications – These results suggest that the development of equity markets will contribute to reducing the costs of banking crises. Such development, however, should be accompanied by adequate supervisory and regulatory oversight. Originality/value – Our analysis is the first direct empirical investigation of the impact of stock markets on the output costs of banking crises. This paper demonstrates that equity markets can lessen the severity of such crises.

Effects of Job Security Laws in a Shirking Model with Heterogeneous Workers

This paper explores the policy implications of job security laws. It extends Carter and De Lancey's (1997) efficiency wage model from the assumption of two types of workers to allow for infinite types of workers. One key difference between the models is that the proportion of nonshirking workers in equilibrium is an exogenous constant in their model, whereas it is an endogenous variable in this study. They find that a job security law increases the welfare of both shirkers and nonshirkers without reducing output. In this setting, it is shown that the law may increase the welfare of both shirkers and nonshirkers at the cost of lower output, or it may result in higher output, but the welfare effect of workers is uncertain.

Effects of Job Security Laws in a Shirking Model with Heterogeneous Workers

This paper explores the policy implications of job security laws. It extends Carter and De Lancey's (1997) efficiency wage model from the assumption of two types of workers to allow for infinite types of workers. One key difference between the models is that the proportion of nonshirking workers in equilibrium is an exogenous constant in their model, whereas it is an endogenous variable in this study. They find that a job security law increases the welfare of both shirkers and non‐shirkers without reducing output. In this setting, it is shown that the law may increase the welfare of both shirkers and nonshirkers at the cost of lower output, or it may result in higher output, but the welfare effect of workers is uncertain.

Assessment of the Relationship Between Productivity and Performance Quality in the U.S. Domestic Airline Industry

Output quality in the context of transportation productivity is investigated. The major findings relate to two distinctions: network density versus capacity utilization and productivity versus input cost efficiency. It was found that greater transportation network density is associated with increased productivity, lower output costs, and most interestingly, improved output quality. In contrast, increased capacity utilization is not associated with lower output costs or with improved quality. For the productivity versus efficiency distinction, increased productivity is associated with lower total output costs and greater output quality yet higher input costs. Thus, higher factor input costs can be justified on the basis of output costs and quality advantages. Implications for governmental policy and managerial decision making are that improvements in network density and productivity are more likely to have lasting benefits than are increases in capacity utilization or input efficiency.

The Effects of Forward-Versus Backward-Looking Wage Indexationon Price Stabilization Programs

A standard open-economy model is used to show that price stabilization programs are more likely to succeed if labor contracts specify forward-looking wage indexation. Compared with contracts specifying backward-looking wage indexation or wages based on static expectations, such contracts will result in a greater reduction in inflation with lower output costs, smaller misalignment of real wages, smaller outflows of reserves, smaller disruptions caused by policy announcements, and a reduced impact of some shocks during price stabilization programs. These results are generally true whether or not capital is mobile and whether or not expectations are rational.