Working papers results

We study the effects on the optimal monetary policy design problem of allowing for deviations from the law of one price in import goods prices. We reach three basic results. First, we show that incomplete pass-through renders the analysis of monetary policy of an open economy fundamentally different from the one of a closed economy, unlike canonical models with perfect pass-through which emphasize a type of isomorphism. Second, and in response to efficient productivity shocks, incomplete pass-through has the effect of generating endogenously a short-run tradeoff between the stabilization of inflation and of the output gap. This holds independently of the measure of inflation being targeted by the monetary authority. Third, in studying the optimal program under commitment relative to discretion, we show that the former entails a smoothing of the deviations from the law of one price, in stark contrast with the established empirical evidence. In addition, an optimal commitment policy always requires, relative to discretion, more stable nominal and real exchange rates.

The extraordinary success of the U.S. economy and the parallel growth slowdown of the large European countries and Japan in the 1990s bear a simple rationale. The United States has eventually benefited from the effective adoption of information technologies. The introduction of the newly installed IT capital has not instead enhanced aggregate capital accumulation and TFP growth in Europe and Japan. At least on impact, IT capital has mainly displaced existing capital and methods of production rather than supplementing them. The limited growth-enhancing effects from information technologies in countries other than the United States have occurred in the IT-producing sectors, while the IT-using industries havecontributed the bulk of productivity gains in the United States.

This paper presents evidence on the geographical dimension of the IT revolution in the U.S. economy. BEA and Census data show that, although neither IT diffusion nor the productivity revival was geographically narrow, the matching of the two across the U.S. states has been far from perfect. The late 1990s productivity acceleration mostly occurred in those states specialized in the production of IT goods & services as well as of non-IT durable goods. When those states are excluded from the sample, the remaining states do not exhibit any significant acceleration in productivity. In particular, the association between productivity gains and IT use is at best weak at the state level. This contrasts with previous aggregate and sector evidence, where the importance of both IT production and use was stressed.

We derive a set of stylized facts on the effects of non-systematic fiscal policy in the four largest countries of the Euro area, and discuss their implications for the fiscal policy coordination debate, for the effectiveness of fiscal shocks in stabilizing the economies, and for the interaction of fiscal and monetary policy. We find relevant differences across countries in the effects of non-systematic fiscal policy, and substantial uncertainty about the size of these effects, which casts doubts on the possibility of a fiscal coordination. Moreover, expenditure shocks are usually rather ineffective in increasing output growth or reducing its volatility, and can require deficit financing. Tax policies also appear to have minor effects on output, and tax cuts could also require deficit financing. Finally, fiscal shocks appear to have an impact on interest rates, either direct or trough the output gap and inflation while, in general, the effects of monetary policy on disbursements and receipts seem to be minor.

Two competing methods have been recently developed to estimate large-scale dynamic factor models based, respectively, on static and dynamic principal components. In this paper we use two large datasets of macroeconomic variables for the US and for the Euro area to evaluate in practice the relative performance of the two approaches to factor model estimation. The comparison is based both on the relative goodness of fit of the models, and on the usefulness of the factors when used in the estimation of forward looking Taylor rules, and as additional regressors in monetary VARs. It turns out that dynamic principal components provide a more parsimonious summary of the information, but the overall performance of the two methods is very similar, in particular when a common information set is adopted. Moreover, the information extracted from the large datasets turns out to be quite useful for the empirical analysis of monetary policy.

Has the spurt of IT-centered innovations of the 1990s resulted in sizably higher productivity growth? This question, first raised in the US and later on in Europe and the rest of the world, has not been given a firm answer yet. This paper adds to the evidence on Europe by looking at a seemingly ideal new economy laboratory, i.e. the sectors of Finland. We find three main results. First, Nokia was absolutely crucial in getting all started. Second, much the same as in the US, TFP productivity gains spilled over onto few other sectors and cyclical factors did play a role in boosting productivity in the second part of the 1990s. Third, nevertheless, the timing and the sector distribution of productivity gains are strongly and negatively related to the dynamics of the machinery and equipment sector price deflator. This is suggestive that productivity gains cannot simply be the side effect of fortunate cyclical circumstances.

Recent financial research has provided evidence on the predictability of asset returns. In this paper we consider the results contained in Pesaran-Timmerman(1995), which provided evidence on predictability over the sample 1959-1992. We show that the extension of the sample to the ninetie weakens considerably the statistical and economic significance of the predictability of stock returns based on earlier data. We propose an extension of their framework, based on the explicit consideration of model uncertainty under rich parameterizations for the predictive models.
We propose a novel methodology to deal with model uncertainty based on thick modeling, i.e. on considering a multiplicity of predictive models rather than a single predictive model. We show that portfolio allocations based on a thick modelling strategy sistematically overperforms thin modelling.

Recent empirical evidence suggests a negative relationship between trade integration and income per capita convergence. We show that moderate reductions in trade posts can generate sizable increases in income per capita divergence in a neoclassical two-country model of trade and growth. The welfare of both countries, however, rises with trade integration due to changes in their consumption time paths. Our setup sheds light on the striking nonlinear growth in the trade share of output since World War II: a linear fall in trade costs over time produces an exponential increase in the trade share of GDP. Concerning the empirical relationship between openness and technological progress, we perform an exercise that cautions against the use of aggregate production functions to obtain Solow residuals: two countries that reduce their trade costs and experience no technological progress are measured to have positive TFP growth rates if an aggregate production function is used for that purpose.

A feature of new economic geography model is their mathematical intractability. This intractability results from the fact that the functional relationship between the indirect utility differential and the state variable cannot be found explicitly. We illustrate three methods that can be utilized to approximate the unknown function. These methods are simple and give a remarkable improvement in the precision of approximation with respect to the commonly utilized Lagrange approximation. Precision of approximation is important in models that feature catastrophic behavior. We apply these methods to the core-periphery model. Naturally, they can be applied to all cases of unknown functional relationships.