Fiscal and Financial Stability
selected ongoing research
"Fixed Come Hell or High Water? Selection and Prepayment of Fixed Rate Mortgages Outside the US"
(Toby Daglish and Nimesh Patel)
Abstract: We examine the decision to prepay a fixed rate mortgage in the UK, Canada, Ireland, Australia and New Zealand. These countries are characterised by having substantial fees which are associated with breaking a fixed rate mortgage. We develop a model which allows for fluctuations both in banks' wholesale rates and credit spreads. We find that households can achieve economically significant benefits both from following an optimal prepayment strategy contingent on the break fee used by their bank, and also by selection of fixed interest rate term and (where available) break fee structure.
"Excess Credit and Economic Growth"
(Lorenzo Ductor and Daryna Grechyna)
Abstract: This paper investigates the possible negative influence of financial development on economic growth. We define excess finance as the difference between the growth in the financial sector and the growth in the productive sector of the economy, under which the aggregate output decreases. Based on a panel data of 33 OECD economies, we show that in order to have smooth economic development balanced growth of both the productive (real) and the financial sectors is required. Whenever financial development exceeds the development of the productive industries by 4.5% (when measured in terms of growth rates of the two sectors output), there is a threat of reaching the productive capacity bound of the economy, with a consequent "financial" crisis. The existence of excess financial development may be justified by the theory of informational overshooting.
"The African Credit Trap"
(David Fielding, Svetlana Andrianova, Badi H. Baltagi, Panicos O. Demetriades)
Abstract: We put forward a plausible explanation of African financial underdevelopment in the form of a bad credit market equilibrium. Utilising an appropriately modified IO model of banking, we show that the root of the problem could be unchecked moral hazard (strategic loan defaults) or adverse selection (a lack of good projects). We provide empirical evidence from a large panel of African banks which suggests that loan defaults are a major factor inhibiting bank lending when the quality of regulation is poor. We also find that once a threshold level of regulatory quality has been reached, improvements in the default rate or regulatory quality do not matter, providing support for our theoretical predictions.
"On the Time Inconsistency of Optimal Monetary and Fiscal Policies With Many Consumer Goods"
(Pedro Gomis Porqueras and Begoña Dominguez)
Abstract: This paper studies optimal monetary and fiscal policies in an economy à la Lucas and Stokey (1983) and Lagos and Wright (2005) with multiple cash and credit goods. We show that optimal policies are in general time inconsistent due to insufficient number of instruments to influence future government decisions. There are two important cases where time consistency can be restored. First, if taxes in the decentralized anonymous markets are not available, the multipliers on the decentralization constraints can be utilized as additional instruments to ensure time consistency. Second, if taxes in decentralized markets are available, time consistency arises when the different cash goods satisfy the conditions necessary for optimal uniform taxation.
"Fiscal Policy With Intertemporally Non-Separable Preferences"
(Pedro Gomis Porqueras and Luca Bossi)
Abstract: In this paper, we show that Ricardian equivalence does not hold in a representative agent framework if one considers goods whose current consumption affect future marginal utilities. We find that, when the intertemporal elasticity of substitution changes over time, the timing of lump sum taxation has an asymmetric effect on current and future consumption. This in turn induces distinctive welfare consequences even if the government and individual budget constraints are unchanged in present value terms.
"Technological Progress and Financial Stability"
Abstract: This article proposes that technological progress in financial intermediation can make the economy more fragile if it is not accompanied by a proportional degree of technological progress in the real sector. In the model economy discussed, firms are operated by heterogeneous managers who differ in their ability to run a successful project. Systemic risk is defined by the characteristics of the most risky firms. If financial development outpaces technological advances in the real sector, the price of financial services decreases, allowing riskier producers to enter the market. It is concluded that commensurate rates of technological development in both the financial and real sectors are necessary for stable and balanced economic growth.
"Complex Methods in Economics: An Example of Behavioral Heterogeneity in House Prices"
(Marco van der Leij, Wilko Bolt, Maria Demertzis, and Cees Diks)
Abstract: We show how simple statistical techniques for capturing critical transitions used in natural sciences, fail to capture economic regime shifts. This implies that we need to use model-based approaches to identify critical transitions. We apply a heterogenous agents model in a standard housing market model to show that these family of models generate non-linear responses that can capture such transitions. We estimate this model for the United States and the Netherlands and find that first, the data does capture the heterogeneity in expectations and, second, that the qualitative predictions of such nonlinear models are very different to standard linear benchmarks. It would be important to identify which approach can serve best as an early warning indicator.
Calls for papers
The Southern Workshop in Macroeconomics, 26-27 April 2013
Victoria University of Wellington will host the 2013 Southern Workshop in Macroeconomics.
The keynote speakers are: Michael B. Devereux (University of British Columbia, NBER and CEPR) and Robert Kollmann (Université Libre de Bruxelles and the CEPR). To submit a paper to the workshop follow instructions in the call for papers for this event, by clicking here.
list of researchers in fiscal and financial stability