Search

With this Festschrift, we would like to honour Andrew Hughes Hallett on the occasion of his 60th birthday. Andrew's achievements in economics are outstanding and we will return to that again later. Moreover, he has been and still is an excellent supervisor for PhD students, whose work covers a broad range of economics. It is therefore difficult to categorize Andrew in terms of one particular field of economics. Maybe the common ground of anyone who has ever worked with Andrew is that theories always have to be tested empirically. This is why one of the areas this book emphasizes is hypothesis testing. As with Andrew's work itself, this book covers a wide variety of topics. [ABSTRACT FROM AUTHOR]

It is four decades since Phelps (1967) and Friedman (1968) unveiled the natural rate of unemployment hypothesis, and the concept of an equilibrium rate of unemployment is central to the prevailing theories of labour market behaviour and the relationship between unemployment and inflation. Moreover, the natural rate and associated unemployment gaps are seen as important reference points, typically as part of a broad range of indicators, by policy makers who need to assess short-term inflation developments and/or consider appropriate decompositions of fiscal balances into their structural and cyclical components. Yet, as surveys and symposia have illustrated (Bean 1994, Cross 1995, Journal of Economic Perspectives 1997), there remains much uncertainty both about which factors do and do not determine equilibrium rates of unemployment, and about the corresponding numerical values. [ABSTRACT FROM AUTHOR]

A number of developing countries and emerging markets have now adopted inflation targeting as a framework for monetary policy. Yet some of these countries have high structural unemployment rates. One question that has not been addressed in the monetary policy literature is the implications of inflation-targeting in the context where the unemployment rate is in the double-digit range1. The consensus view in macroeconomics within which many inflation-targeting central banks operate, summarized by Taylor (1997) and emphasized by Svensson (2003), says monetary policy cannot have long-run effects on the growth rate of output and the rate of employment. In this view, the growth rate of output in the long run is determined by the growth rate of labor productivity and the labor force. The seminal models, such as the ones in Svensson (1997, 1999), Ball (1999) and Clarida et al. (1999) among others, fall within this view. [ABSTRACT FROM AUTHOR]

When the theory of optimum currency areas was first introduced, it was considered as a theoretical analysis of fixed and flexible exchange rate regimes. With the formation of the European Economic and Monetary Union (EMU) and the introduction of the euro as its single currency in 1999, the discussion of optimum currency areas and the idea of a single monetary authority governing the monetary policy for all members of the currency union shifted from being a theoretical question to being a practical concern that had immediate policy implications. [ABSTRACT FROM AUTHOR]

Discussions about future prospects for the US dollar generally focus on whether the present level of the current account deficit is sustainable.1 If the answer is no, the subsequent question is what depreciation is required to produce a sustainable deficit (see Obstfeld and Rogoff 2004, for example). This short paper addresses both issues, but also explores two additional points. First, we examine whether a significant reduction in the value of the dollar will occur even if large deficits continue, because more net exports are required to service a growing debt burden. Second, we suggest that any depreciation in the dollar is likely to be variable across different currencies, with a relatively modest depreciation against the Euro and Sterling. The paper quantifies both effects using the FABEER model.2 [ABSTRACT FROM AUTHOR]

This paper analyses the factors which influenced the Bank of England's liquidity ratio from 1 January 1876 to the end of 1913. The liquidity ratio is defined as the ratio of gold and silver holdings to banknotes issued by the Bank of England and it is also called the "Proportion". A key aspect of the gold standard, as this period is called, was the legal obligation on the part of Central Banks to convert, on request, banknotes into gold.1 From this obligation resulted the "discipline" imposed on governments and Central Banks at the time. The minimum gold cover of notes outstanding was established by law and varied from country to country. As Central Banks could not let the gold cover of notes issued fall below the legally established minimum, it is clear that the ratio of gold to notes was constantly monitored, leading to apprehension when it was falling rapidly and/or approaching the legal minimum and to a relaxed attitude when it was increasing. [ABSTRACT FROM AUTHOR]

An important issue in relation to fiscal policy is to strike a balance between "stabilisation" and "sustainability". The aim of this paper is to discuss what we consider to be the consensus view on fiscal policy design which seems to have emerged in recent years. This view has two pillars. First, automatic stabilisers should be allowed to work since they are rule based, whereas discretionary policies should only be allowed in exceptional cases. The motivation for this "escape clause only" is that if a more flexible use of discretion is allowed for in the conduct of fiscal policy, it could easily lead to a deficit bias. Second, the structural balance should, "on average" over the business cycle, be in balance or surplus. For example, the Stability and Growth Pact stresses the need to ensure "a medium-term budgetary position of close to balance or in surplus", and in Sweden the fiscal policy framework has been formulated with a requirement of ensuring a given budget surplus (currently 2 % of GDP) on average over the business cycle. Ideally, this type of policy design would guarantee not only that fiscal policy can be used for stabilisation purposes but also that fiscal sustainability problems can be avoided. [ABSTRACT FROM AUTHOR]

In this paper we analyze the monetary transmission mechanism. In general, the monetary transmission mechanism describes how policy-induced changes in the nominal money stock or the short-term nominal interest rate impact on real variables such as aggregate output and employment. Specific channels of monetary transmission operate through the effects that monetary policy has on interest rates, exchange rates, equity and real estate prices, bank lending and firm balance sheets (Ireland 2005). Recent research on the transmission mechanism seeks to understand how these channels work in the context of dynamic, stochastic, general equilibrium models (e.g. Barran et al. 1995; Boivin and Giannoni 2006; Fukuda 1993; Golinelli and Rovelli 2005; Goodhart and Hofmann 2005; Kim 2003; Lütkepohl and Wolters 2003). [ABSTRACT FROM AUTHOR]

It has been eight years since the Economic and Monetary Union (EMU) displaced the European Monetary System (EMS), with the euro becoming the legal successor to the European Currency Unit (ECU). Studies on macroeconomic, international economic and microeconomic issues surrounding this important international monetary development have flourished in the economics and finance literature. There is, however, one question that has received no attention: Has the move to EMU changed the behaviour of exchange rate correlations between the euro (ECU) and other currencies? This question has to do with the debates on the success and prospects of the euro, and so deserves exploration in this short paper. Specifically, our study is motivated by the following considerations. [ABSTRACT FROM AUTHOR]

The primary objective of this paper is the empirical evaluation of the theoretical postulate by Sapir and Sekkat (1999) that the adoption of a single election day throughout the Economic and Monetary Union (EMU) of the European Union (EU) might be welfare improving. They find that the desirability of an electoral area (a common or synchronized election day) between two countries is enhanced when the spillovers between these countries are large and positive, and when they face symmetric shocks. With its asymmetric architecture of economic policy making, EMU is forced by EU law (EC treaty) to coordinate economic (primarily fiscal) policy between its politically independent member states in order not to foil the centralized monetary policy of the ECB. Economic policy coordination is exercised in EMU by a whole range of coordination processes and instruments, of which the Stability and Growth Pact (SGP) is the most prominent one in the field of fiscal policy. As a consequence of economic policy coordination we are already on the right track towards a "European business cycle". However, as economic policy making (with the exception of monetary policy) is still a competence of the EMU member states, further areas of coordination are welcome. One area where EMU's member states are still exerting uncoordinated influence (and hence, different shocks) on the economy is the different election dates. [ABSTRACT FROM AUTHOR]

The adoption of a single currency in Europe has introduced an asymmetry in the level of monetary and fiscal governance. The monetary instrument is given to a central supra-national authority with a view to safeguarding areawide price stability, whereas the fiscal instrument is still within the hands of individual governments. Decisions on the management of the monetary instrument are thus taken at the EMU (European Economic and Monetary Union) level, whereas the use of the fiscal instrument is decided separately at the level of the nation states. The merits of this institutional arrangement in terms of helping achieve price stability have been rigorously analysed in the literature and agreed upon among EMU policy makers. What is less obvious, and perhaps more uncertain in the future however (especially in view of further enlargement), is the role that the fiscal instrument will acquire in this asymmetric set-up. The argument put forward in the literature is that in the absence of a national monetary instrument, governments are more likely to resort to a greater than otherwise use of their fiscal instrument. What will that mean for macroeconomic stability in general and for prices more specifically? It is often quoted that excessive use of the fiscal instrument can jeopardise price stability. And the question that arises as a result is whether European countries are more likely to use their fiscal instrument now than in the past, and if they are, whether this will make the European Central Bank's objective of price stability more difficult to attain. [ABSTRACT FROM AUTHOR]

When individuals are risk adverse, they dislike volatility in consumption. In an environment where economic fluctuations are driven by exogenous real shocks, governments try to prevent these exogenous real shocks from inducing consumption volatility. Taking the process that determines these exogenous fluctuations as given, there are two methods through which the government can intervene and prevent excessive consumption volatility. They can use the various tools of government, like monetary policy or government consumption, to smooth aggregate demand and aggregate output in the face of these exogenous shocks. Similarly they can allow fluctuations in output, but use fiscal policy through direct taxes and transfers to smooth any consumption fluctuations. It should be clear from the title that this paper will focus on the latter method. In a currency union like the euro zone, individual national governments ceded their national monetary policies to the European Central Bank. Thus individual governments in the euro zone no longer have monetary policy as a tool to prevent country-specific real shocks from driving fluctuations in country-specific output. As will be clear in a later section, this paper will not model the role of government consumption in smoothing output fluctuations (see Fatás and Mihov 1999, for a discussion on the output stabilizing role of government spending). Instead this paper will focus on the role of a government tax and transfer scheme in smoothing consumption fluctuations given fluctuations in output. [ABSTRACT FROM AUTHOR]

This paper develops an endogenous coalition formation framework suitable for studying a design of international macroeconomic policy coordination between an arbitrary number of countries and monetary authorities in the presence of (possibly multiple) monetary unions. In analyzing the feasibility of policy cooperation, we follow the approach proposed by the recent literature on the non-cooperative theory of coalition formation, which includes Bloch (1995, 1996), Yi (1997), Ray and Vohra (1997, 1999), Finus (2001) and Finus and Rundshagen (2001, 2003). These models share the common framework of a two-stage structure. In the first stage, coalitions are formed. In the second stage of the game (the stabilization phase), assuming all coalition structures as given, the model is solved by methods of linear quadratic differential games. [ABSTRACT FROM AUTHOR]

Problems of macroeconomic stabilization policies have been analyzed by means of optimal control theory since the early seventies [see, for example, Kendrick (1981)]. However, with the emergence of the New Classical Macroeconomics, this theoretical framework has been increasingly questioned. In particular, Kydland's and Prescott's (1977) claim that government's stabilization policies derived by optimum control methods might be time-inconsistent when private-sector agents have rational expectations of policy-makers' behaviour has been regarded as a serious argument against the use of optimum control theory in macroeconomics, although the real-world importance of time-inconsistent behaviour is still controversial. [For an early theoretical critique, see Hughes Hallett (1986a); for empirical analyses, Ireland (1999), Boschen and Weise (2004), among others.] Later research on time-inconsistency indicates that dynamic game theory is a more appropriate tool for analyzing stabilization policy problems because more than one decision-maker has to be considered explicitly. Therefore over the last three decades, a large number of studies of macroeconomic stabilization policies (as well as of other areas in economics) have made use of the concepts and results of the theory of dynamic games. [ABSTRACT FROM AUTHOR]

One of the most pervasive trends in modern macroeconomics is the use of microeconomic theory to derive the behavioural equations of a macroeconomic model. This is frequently accomplished by the invocation of a single "representative agent", whose own optimising decisions are then scaled up to represent the aggregate behaviour of all consumers in the economy. On the positive side, these strong assumptions permit the marriage of micro and macroeconomic analysis, with the behaviour of the economy at aggregate level directly explicable in terms of individual optimising behaviour. In addition, the preferences of the representative agent are often used to rank different policy outcomes. In the words of Woodford (2001): "An important advantage of using a model founded on private-sector optimisation to analyze the consequences of alternative policy rules is that there is a natural welfare criterion in the context of such a model, provided by the preferences of private agents that are displayed in the structural relations that determine the effects of alternative policies." This usage of microfounded models to provide a welfare-metric evaluation marks an important new step in quantitative economic policy. Previously, the task of economic theory was typically confined to the positive role of quantifying the likely effects of various policies. The normative task of ranking policy outcomes, or of specifying the "optimal policy", was left to the policymaker, who would simply choose according to his own volition from the menu of possible outcomes given by the positive economic analysis. [ABSTRACT FROM AUTHOR]

The purpose of this paper is to honour Andrew Hughes Hallett. We think that a convenient way to do this is to outline the evolution of the theory of economic policy, in which he has played such a decisive role, from the classical contributions of Frisch, Hansen, Tinbergen and Theil to the present day when a sort of "new" theory of economic policy seems to have emerged from the ashes of the old one. [ABSTRACT FROM AUTHOR]