Working papers results

The objective of this study is to investigate the behaviour of monetary and fiscal authorities in the Euro area. Our main contribution is joint modelling of behaviour of the two authorities. Our investigation highlights a number of facts. The systematic monetary policies adopted by the non-German authorities in the seventies were not capable of stabilizing inflation. Such results have been achieved in the eigthies and the nineties by anchoring more tightly domestic monetary policy to German monetary policy. All the main episodes of expansionary fiscal policy occurred in the course of the eigthies and the nineties in Europe cannot be explained by the sytematic behaviour of fiscal authorities. Stabilization of inflation has been achieved independently from the lack of fiscal discipline. There are important interactions between the two authorities but they depend exclusively on the responses of governemnts expenditures and receipts to interest rate payments on the public debt.

Revised version: June 28, 2002

Despite the fast catching-up in ICT diffusion experienced by most EU countries in the last few years, information technologies have so far delivered little productivity gains in Europe. In the second half of the past decade, the growth contributions from ICT capital rose in six EU countries only (the UK, Denmark, Finland, Sweden, Ireland and Greece). Quite unlike the United States, this has not generally been associated to higher labour or total factor productivity growth rates, the only exceptions being Ireland and Greece. Particularly worrisome, the large countries in Continental Europe (Germany, France, Italy and Spain) showed stagnating or mildly declining growth contributions from ICT capital, together with definite declines in TFP growth compared to the first half of the 1990s. It looks like that the celebrated Solow paradox on the lack of correlation between ICT investment and productivity growth has fled the US to migrate to Europe.

It is rather common to have several competing forecasts for the same variable, and many methods have been suggested to pick up the best, on the basis of their past forecasting performance. As an alternative, the forecasts can be combined to obtain a pooled forecast, and several options are available to select what forecasts should be pooled, and how to determine their relative weights. In this paper we compare the relative performance of alternative pooling methods, using a very large dataset of about 500 macroeconomic variables for the countries in the European Monetary Union. In this case the forecasting exercise is further complicated by the short time span available, due to the need of collecting a homogeneous dataset. For each variable in the dataset, we consider 58 forecasts produced by a range of linear, time-varying and non-linear models, plus 16 pooled forecasts. Our results indicate that on average combination methods work well. Yet, a more disaggregate analysis reveals that single non-linear models can outperform combination forecasts for several series, even though they perform rather badly for other series so that on average their performance is not as good as that of pooled forecasts. Similar results are obtained for a subset of unstable series, the pooled forecasts behave only slightly better, and for three key macroeconomic variables, namely, industrial production, unemployment and inflation.

In this paper we evaluate the relative performance of linear, non-linear and time-varying models for about 500 macroeconomic variables for the countries in the Euro area, using real-time forecasting methodology. It turns out that linear models work well for about 35% of the series under analysis, time-varying models for another 35% and on-linear models for the remaining 30% of the series. The gains in forecasting accuracy from the choice of the best model can be substantial, in particular for longer forecast horizons.These results emerge from a detailed is aggregated analysis, while they are hidden when an average loss function is used. To explore in more detail the issue of parameter instability, we then apply a battery of tests, detecting non-constancy in about 20-30% of the time series. For these variables the forecasting performance of the time-varying and non-linear models further improves, with larger gains for a larger fraction of the series. Finally, we evaluate whether non-linear models perform better for three key macroeconomic variables: industrial production, inflation and unemployment. It turns out that this is often the case. Hence, overall, our results indicate that there is a substantial amount of instability and non-linearity in the EMU, and suggest that it can be worth going beyond linear models for several EMU macroeconomic variables.

This paper introduces Heckscher-Ohlin trade features into a two-country DSGE model, and studies the international transmission of productivity shocks through trade in goods. This framework improves upon existing international real business cycle models in generating business cycle properties comparable with the empirical evidence concerning the terms of trade and the trade balance.

Index tracking requires to build a portfolio of stocks (a replica) whose behavior is as close as possible to that of a given stock index. Typically, much fewer stocks should appear in the replica than in the index, and there should be no low frequency (persistent) components in the tracking error. Unfortunately, the latter property is not satisfied by many commonly used methods for index tracking. These are based on the in-sample minimization of a loss function, but do not take into account the dynamic properties of the index components. Instead, we represent the index components with a dynamic factor model, and develop a procedure that, in a first step, builds a replica that is driven by the same persistent factors as the index. In a second step, it is also possible to refine the replica so that it minimizes a loss function, as in the traditional approach. Both Monte Carlo simulations and an application to the EuroStoxx50 index provide substantial support for our approach.

Nowadays a considerable amount of information on the behavior of the economy is readily available, in the form of large datasets of macroeconomic variables. Central bankers can be expected to base their decisions on this very large information set, so that it can be difficult to track their decisions using small models, such as standard Taylor rules. Small scale structural VARs can suffer from a similar problem when used to highlight stylized facts or for policy simulation exercises. On the other hand, large scale structural models are hardly manageable, and still suffer from those identification problems that led to the success of VARs. In this paper we combine recent time-series techniques for the analysis of large datasets with more traditional small scale models to analyze monetary policy in Europe. In particular, we model hundreds of macroeconomic variables with a dynamic factor model, and summarize their informational content with a few estimated factors. These factors are then used as instruments in the estimation of forward looking Taylor rules, and as additional regressors in structural VARs. The latter are then used to evaluate the effects of unexpected and systematic monetary policy.

This paper studies the structure and time consistency of optimal monetary policy from a public finance perspective in an economy where agents di.er in preference for liquidity and holdings of nominal assets. I find that the presence of redistributional e.ects breaks the link between time consistency and high inflation which characterizes representative agent models of optimal fiscal and monetary policy. For a large class of economies, optimal monetary policy is time consistent. I relate these findings to key historical episodes of inflation and deflation.

This paper examines the price and quality choice by a single product risk-neutral monopolist who can delay irreversible investments required for market entry. It is shown that the price and quality she chooses at entry increase with uncertainty about the size of future demand. As opposed to a myopic monopolist she provides a quality that is socially optimal, but the moment at which she invests will be later than socially optimal. In a Stackelberg leader-follower game the leader pre-commits immediately regardless of the level of market uncertainty and may opt for the lower quality good rather than the higher quality good when market uncertainty is high.

When a foreign monopolist can either export to a host country or undertake an irreversible foreign direct investment (FDI), it is shown that the host government maximizes net domestic benefits by nearly fully subsidizing the investment cost in combination with taxing away benefits that exceed the gains from exporting. Since a higher tariff increases the firm's propensity to invest and increases tax benefits, maximizing net domestic benefits yields an optimal tariff that is higher than the one derived in previous studies that disregard the dynamics of FDI and the interaction between optimal tax and tariff policy.