Discussion Papers in Economics 2004

04/1 The Impact of State and Foreign Ownership on Post-Transition Industrial Concentration: The Case of Polish Manufacturing

Kevin Amess and Barbara Roberts

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(Last updated: 02/2004)

Abstract: This paper reports an analysis of the determinants of the level and changes in Polish industrial concentration in the early post-transition era. The empirical evidence is based on a panel of 144 Polish manufacturing industries over the period 1989-1993. The results suggest that both state and foreign ownership have a significant impact on industry concentration and this relationship is U-shaped. Minimum efficient scale is found to be the only other factor to impact on industry concentration.

04/2 Market Structure, Inflation, and Price Dispersion

Mustafa Caglayan, Alpay Filiztekin, Michael T.Rauh

Adobe Acrobat (PDF) 04/2 Market Structure, Inflation, and Price Dispersion
(Last updated: 06/2004)

Abstract: In this paper, we investigate the impact of market structure on the relationship between inflation and price dispersion. We first propose a new empirical model of the relationship between inflation and dispersion with firmer theoretical foundations, and then extend the basic model to incorporate the potential effects of market structure. We estimate the basic and market structure specifications using a unique micro-level data set from Istanbul, which consists of monthly price observations from three different store types: convenience stores, open-air markets, and supermarkets. Our empirical findings support almost all of the basic and market structure predictions.

04/3 A Menu of Minimum Wage Variables for Evaluating Wages and Employment Effects: Evidence from Brazil

Sara Lemos

Adobe Acrobat (PDF) 04/3 A Menu of Minimum Wage Variables for Evaluating Wages and Employment Effects: Evidence from Brazil
(Last updated: 02/2004)

Abstract: The international literature on minimum wage greatly lacks empirical evidence from developing countries. Brazil’s minimum wage policy is a distinctive and central feature of the Brazilian economy. Not only are increases in the minimum wage large and frequent but also the minimum wage has been used as an anti-inflation policy in addition to its social role. This study estimates the effects of the minimum wage on both wages and employment using panel data techniques and Brazilian monthly household data from 1982 to 2000 at individual and regional levels. A number of conceptual and identification questions is discussed, for example: (1) Various strategies on how to best measure the effect of a constant (national) minimum wage are summarized in a “menu” of minimum wage variables and used to estimate wage and employment effects. (2) An employment decomposition that separately estimates the effect of the minimum wage on hours worked and on the number of jobs is used. Robust results indicate that an increase in the minimum wage strongly compresses the wages distribution with moderately small adverse effects on employment.

04/4 Are Wage and Employment Effects Robust to Alternative Minimum Wage Variables?

Sara Lemos

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(Last updated: 02/2004)

Abstract: A national minimum wage cannot explain variation in wages or employment across regions. Identification of the effect of the minimum wage separately from the effect of other variables on wages or employment requires regional variation. Many minimum wage variables with regional variation have been suggested in the literature. Such a variety of variables makes it difficult to compare estimates across studies. First, estimates using different minimum wage variables are not always calibrated to represent the effect of a 10% increase in the minimum wage on wages or employment. Second, different minimum wage variables might simply measure the effect of the minimum wage on different workers. Part of the controversial recent debate in the literature over the magnitude and direction of the employment effect might be that non-directly comparable estimates are being compared. This paper estimates and critically compares the effects of the minimum wage on both wages and employment using five minimum wage variables common in the literature: real minimum wage, “Kaitz index”, “fraction affected”, “fraction at” and “fraction below” the minimum wage. The data used is a Brazilian monthly household survey from 1982 to 2000. The estimates are robust and indicate that an increase in the minimum wage compresses the wages distribution with small adverse effects on employment.

04/5 Finance, Institutions and Economic Growth

Panicos Demetriades and Siong Hook Law

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(Last updated: 02/2004)

Abstract: Using data from 72 countries for the period 1978-2000, we find that financial development has larger effects on growth when the financial system is embedded within a sound institutional framework. This is particularly true for poor countries, where more finance without sound institutions is likely to fail in delivering more growth. For these countries, we find that improvements in institutions are likely to deliver much larger direct effects on growth than financial development itself. They are also likely to have positive indirect effects through the financial system, particularly when the latter is already providing large amounts of credit to the private sector.

We also find that financial development is most potent in delivering extra growth in middle-income countries. Its effects are particularly large when institutional quality is high. Institutional improvements can also deliver more growth in these countries, especially when the financial system is well developed. Finally, we also find that while the effects of financial development in high-income countries are much smaller than in middle-income countries, even in these countries financial development has larger effects on growth when institutional quality is high.

04/6 The Effect of the Minimum Wage on Prices in Brazil

Sara Lemos

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(Last updated: 03/2004)

Abstract: There is very little empirical evidence on the effects of the minimum wage on prices in the international literature and none whatsoever for developing countries. This paper estimates the minimum wage price effect using monthly Brazilian household and firm data from 1982 to 2000 aggregated at a regional level. Empirical evidence on price effects will help to answer the question of who pays for the higher costs: firms, consumers or the unemployed. The answer to this question is a contribution to the controversial recent debate in the literature over the direction of the minimum wage employment effect. Employment might not be affected if firms are able to pass through to prices the higher labour costs associated to a minimum wage increase. In that case, consumers pay for the increase. Furthermore, if the poor consumers are those buying minimum wage labour intensive goods, or if these goods represent a large proportion of their consumption bundle, then minimum wage increases might hurt rather than aid the poor. Moreover, if minimum wage increases cause inflation, they will hurt the poor further, who disproportionately suffer from it. Robust results indicate that the minimum wage raises overall prices in Brazil. The resulting inflation is slightly higher for the poor than for the rich in the long run, smaller in low inflation periods, and larger in poorer regions.

04/7 The Effect of the Minimum Wage on Prices

Sara Lemos

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(Last updated: 03/2004)

Abstract: It is well established in the international literature that minimum wage increases compress the wages distribution. Firms respond to these higher labour costs by reducing employment, reducing profits, or raising prices. While there are hundreds of studies on the employment effect of the minimum wage, there is less than a handful studies on its profit effects, and only a couple of dozen studies on its price effects. Not only is the literature scanty on the minimum wage price effects, but also it lacks a survey on that. This survey represents an important contribution to the literature because it summarizes and critically compares over twenty price effect studies, providing a benchmark in the literature. This survey further contributes to the literature by offering an input to the recent debate over the direction of employment effects of the minimum wage. With employment and profits not significantly affected, higher prices is an obvious response to a minimum wage increase. Moreover, this survey also contributes to the literature by extending the current understanding on the minimum wage as a policy against inequality and poverty. If the minimum wage does not cause disemployment but causes inflation, it might hurt rather than aid the poor, who disproportionately suffer from inflation.

04/8 The Effects of the Minimum Wage in the Formal and Informal Sectors in Brazil

Sara Lemos

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(Last updated: 03/2004)

The minimum wage literature is very limited on empirical evidence for developing countries. This already limited literature is even more limited on the effects of the minimum wage in the informal sector, where most of the poor are. Extending the understanding of minimum wage effects both in developing countries and in particular in the informal sector is crucial if the minimum wage is to be used as a policy to help poor people in poor countries. This paper estimates wage and employment effects, accounting for sorting into the formal and informal sectors. The data used is a monthly Brazilian household survey from 1982 to 2000 at individual and regional levels. The formal and informal sectors employment effects were both found to be negative, consistent with the presence of a large spike, substantial spillover effects, and the associated compression effect in the wage distribution of both sectors. This suggests a downwards sloping labour demand curve in both sectors, challenging the standard Two Sectors Model as inadequate to explain the effect of the minimum wage on the formal and informal sectors in Brazil and in Latin America more generally.

04/9 Who gets privatised? An empirical analysis of Polish manufacturing

Katarzyna Mikolajczyk and Barbara M. Roberts

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(Last updated: 03/2004)

This paper employs a multinomial logit model to examine what determines the choice of a particular firm for a given privatisation method. A variety of hypotheses about possible determinants of ownership change are tested using an extensive data set for Polish manufacturing at the beginning of transition. The results at a firm as well as at a sector level give strong support to the hypothesis of the importance of resource constraints on the choice of ownership. Large firms with high financing requirement are more likely to be owned by outsiders. High sectoral capital intensity discourages small insider owned firms while high degree of product differentiation is a constraint for different investors, with the exception of outsiders. We also find that firm quality, measured by profitability and exporting outside the Soviet block, appeals to all types of investors but, additionally, privatisation offers outsiders ways of entering sectors with substantial entry barriers.

04/10 The Effects of the Minimum Wage on Wages, Employment and Prices

Sara Lemos

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(Last updated: 03/2004)

This paper puts together evidence for the wages, employment and price effects of the minimum wage. This overall picture will help to understand the small employment effects prevalent in the literature in the light of price effects. The data used is an under-explored monthly Brazilian household survey from 1982 to 2000, similar to the US CPS. As the international literature on the minimum wage is scanty on non-US empirical evidence, in particular on developing countries, this paper will also help to extend the current understanding on the effects of the minimum wage in developing countries. This is crucial if the minimum wage is to be used as a policy to help poor people in poor countries.

04/11 Political Variables as Instruments for the Minimum Wage

Sara Lemos

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(Last updated: 04/2004)

Following the early 1980s apparent consensus, there has been a controversial debate in the literature over the direction of the minimum wage employment effect. Explanations to non-negative effects range from theoretical to empirical identification and data issues. An explanation, however, that has not been sufficiently explored is that a non-negative effect might be an upward biased estimate of a truly negative effect, resulting from the simultaneous determination of the minimum wage and employment. This paper estimates the employment effect of the minimum wage using a number of political variables – not previously used in the literature – as excluded exogenous instruments to control for the endogeneity of the minimum wage variable. The data used is an under-explored Brazilian monthly household survey from 1982 to 2000. Robust results indicate that an increase in the minimum wage has very small adverse effects on employment.

04/12 The Effects of the Minimum Wage in the Private and Public Sectors in Brazil

Sara Lemos

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(Last updated: 04/2004)

The wage and employment effects of the minimum wage predicted by the standard neoclassical theory rely on a profit maximizing firm, not on a Government employer that can cover the higher wage bill by raising taxes, reducing expenditure, or simply printing money. If the public sector has an inelastic labour demand, the associated non-negative employment effect might offset some of the negative employment effect observed in the private sector and the overall employment effect might be less adverse. This is particularly so if the public sector is overpopulated by minimum wage workers, as in Brazil. There is very limited evidence on the minimum wage effects in developing countries, and none whatsoever on the minimum wage effects across the private and public sectors. This paper estimates the effects of the minimum wage on wages and employment in both the private and public sectors. The data used is an under-explored monthly Brazilian household survey from 1982 to 2000 at individual and regional levels. Robust results suggest that the minimum wage compresses the distribution of both sectors, but in line with a stronger effect in the private sector, more adverse employment effects in the long run are also observed in that sector. In the public sector, no evidence of adverse employment effects was uncovered.

04/13 The second moments matter: The response of bank lending behavior to macroeconomic uncertainty

Christopher F. Baum, Mustafa Caglayan, Neslihan Ozkan

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(Last updated: 05/2004)

In this paper we investigate whether macroeconomic uncertainty could distort banks’ allocation of loanable funds. To provide a road- map for our empirical investigation, we present a simple framework which demonstrates that lower uncertainty about the return from lending should lead to a more unequal distribution of lending across banks as managers take advantage of more precise knowledge of different lending opportunities. When bank-specific differences in lending opportunities are harder to predict, we should observe less cross-sectional variation in loan-to-asset ratios. Using a comprehensive U.S. commercial bank data set, we receive support for our hypothesis.

04/14 Parametric and Nonparametric Inference in Equilibrium Job Search Models

Gary Koop

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(Last updated: 08/2002)

Equilibrium job search models allow for labor markets with homogenous workers and firms to yield nondegenerate wage densities. However, the resulting wage densities do not accord well with empirical regularities. Accordingly, many extensions to the basic equilibrium search model have been considered (e.g. heterogeneity in productivity, heterogeneity in the value of leisure, etc.). It is increasingly common to use nonparametric forms for these extensions and, hence, researchers can obtain a perfect fit (in a kernel smoothed sense) between theoretical and empirical wage densities. This makes it difficult to carry out model comparison of different model extensions. In this paper, we first develop Bayesian parametric and non-parametric methods which are comparable to the existing non-Bayesian literature. We then show how Bayesian methods can be used to compare various nonparametric equilibrium search models in a statistically rigorous sense.

04/15 The Vector Floor and Ceiling Model

Gary Koop and Simon Potter

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(Last updated: 01/2000)

This paper motivates and develops a nonlinear extension of the Vector Autoregressive model which we call the Vector Floor and Ceiling model. Bayesian and classical methods for estimation and testing are developed and compared in the context of an application involving U.S. macroeconomic data. In terms of statistical significance both classical and Bayesian methods indicate that the (Gaussian) linear model is inadequate. Using impulse response functions we investigate the economic significance of the statistical analysis. We find evidence of strong nonlinearities in the contemporaneous relationships between the variables and milder evidence of nonlinearity in the conditional mean.

04/16 Forecasting in Large Macroeconomic Panels using Bayesian Model Averaging

Gary Koop and Simon Potter

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(Last updated: 01/2003)

This paper considers the problem of forecasting in large macroeconomic panels using Bayesian model averaging. Theoretical justifications for averaging across models, as opposed to selecting a single model, are given. Practical methods for implementing Bayesian model averaging with factor models are described. These methods involve algorithms which simulate from the space defined by all possible models. We discuss how these simulation algorithms can also be used to select the model with the highest marginal likelihood (or highest value of an information criterion) in an efficient manner. We apply these methods to the problem of forecasting GDP and inflation using quarterly U.S. data on 162 time series. For both GDP and inflation, we find that the models which contain factors do out-forecast an AR(p), but only by a relatively small amount and only at short horizons. We attribute these findings to the presence of structural instability and the fact that lags of dependent variable seem to contain most of the information relevant for forecasting. Relative to the small forecasting gains provided by including factors, the gains provided by using Bayesian model averaging over forecasting methods based on a single model are appreciable.

04/17 Bayesian Semiparametric Inference in Multiple Equation Models

Gary Koop, Dale Poirier and Justin Tobias

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( Last updated: 06/2003)

This paper outlines an approach to Bayesian semiparametric regression in multiple equation models which can be used to carry out inference in seemingly unrelated regressions or simultaneous equations models with nonparametric components. The approach treats the points on each nonparametric regression line as unknown parameters and uses a prior on the degree of smoothness of each line to ensure valid posterior inference despite the fact that the number of parameters is greater than the number of observations. We derive an empirical Bayesian approach that allows us to estimate the prior smoothing hyperparameters from the data. An advantage of our semiparametric model is that it is written as a seemingly unrelated regressions model with independent Normal-Wishart prior. Since this model is a common one, textbook results for posterior inference, model comparison, prediction and posterior computation are immediately available. We use this model in an application involving a two-equation structural model drawn from the labor and returns to schooling literatures.

04/18 Semiparametric Bayesian inference in smooth coefficient models

Gary Koop and Justin Tobias

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(Last updated: 10/2003)

We describe procedures for Bayesian estimation and testing in both cross sectional and longitudinal data smooth coefficient models (with and without endogeneity problems). The smooth coefficient model is a generalization of the partially linear or additive model wherein coefficients on linear explanatory variables are treated as unknown functions of an observable covariate. In the approach we describe, points on the regression lines are regarded as unknown parameters and priors are placed on differences between adjacent points to introduce the potential for smoothing the curves. The algorithms we describe are quite simple to implement - estimation, testing and smoothing parameter selection can be carried out analytically in the cross-sectional smooth coefficient model, and estimation in the hierarchical models only involves simulation from standard distributions.

We apply our methods by fitting several hierarchical models using data from the National Longitudinal Survey of Youth (NLSY). We explore the relationship between ability and log wages and flexibly model how returns to schooling vary with measured cognitive ability. In a generalization of this model, we also permit endogeneity of schooling and describe simulation-based methods for inference in the presence of the endogeneity problem. We find returns to schooling are approximately constant throughout the ability support and that simpler (and often used) parametric specifications provide an adequate description of these relationships.

04/19 The Impact of Macroeconomic Uncertainty on Cash Holdings for Non–Financial Firms

Christopher F. Baum, Mustafa Caglayan, Neslihan Ozkan, Oleksandr Talavera

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(Last updated: 06/2004)

This paper investigates the effects of macroeconomic volatility on non–financial firms’ cash holding behavior. Using an augmented cash buffer–stock model, we demonstrate that an increase in macroeconomic volatility will cause the cross–sectional distribution of firms’ cash–to–asset ratios to narrow. We test this prediction on a panel of non–financial firms drawn from the annual COMPUSTAT database covering the period 1970–2000, and find that as macroeconomic uncertainty increases, firms behave more homogeneously. Our results are shown to be robust to the inclusion of the levels of several macroeconomic factors.

04/20 An Investigation of Thresholds in Air Pollution-Mortality Effects

Gary Koop and Lise Tole

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(Last updated: 05/2004)

In this paper we introduce and implement new techniques to investigate threshold effects in air pollution-mortality relationships. Our key interest is in measuring the dose-response relationship above and below a given threshold level where we allow for a large number of potential explanatory variables to trigger the threshold effect. This is in contrast to existing approaches that usually focus on a single threshold trigger. We allow for a myriad of threshold effects within a Bayesian statistical framework that accounts for model uncertainty (i.e. uncertainty about which threshold trigger and explanatory variables are appropriate). We apply these techniques in an empirical exercise using daily data from Toronto for 1992-1997. We investigate the existence and nature of threshold effects in the relationship between mortality and ozone (O3), total particulate matter (PM) and an index of other conventionally occurring air pollutants. In general, we find the effects of our considered pollutants on mortality to be statistically indistinguishable from zero with no evidence of thresholds. The one exception is ozone, for which results present an ambiguous picture. Ozone has no significant effect on mortality when we exclude threshold effects from the analysis. Allowing for thresholds we find a positive and significant effect for this pollutant when the threshold trigger is the average change in ozone two days ago. However, this significant effect is not observed after controlling for PM.

04/21 The Political Economy of Financial Development

Sourafel Girma and Anja Shortland

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(Last updated: 10/2004)

Political economy theories of financial development argue that in countries where a narrow elite controls political decisions, financial development may be obstructed to deny access to finance to potential competitors. We use panel data on developed and developing countries from 1975-2000 to examine this hypothesis, as well as looking at the effect of regime stability on financial development. Our results show that the degree of democracy and political stability are significant explanatory factors in determining the speed of financial development. The banking sector benefits from regime stability and increasing democracy, while stock market capitalisation grows fastest in fully democratic regimes.

04/22 The Effect of the Minimum Wage on Prices across Income Levels in Brazil

Sara Lemos

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(Last updated: 08/2004)

With small employment responses becoming prevalent in the literature, the minimum wage is just a program that transfers money from one group to another. If the poor are the consumers of minimum wage labour intensive goods, or if these goods represent a large proportion of their consumption bundle, then minimum wage increases might hurt rather than aid the poor. Furthermore, if such increases raise overall prices, they might again hurt the poor, who disproportionately suffer from inflation. Extending the understanding of minimum wage effects on prices and in developing countries is crucial if the minimum wage is to be used as a policy to help poor people in poor countries. This paper estimates the effect of the minimum wage on prices paid by low, medium and high income consumers using monthly Brazilian household and firm data from 1982 to 2000. Robust results indicate that the minimum wage raises overall prices in Brazil. The resulting inflation is two times higher for the poor than it is for the rich in the short run and four times higher in the long run.

If the poor are the consumers of minimum wage labour intensive goods, or if these goods represent a large proportion of their consumption bundle, then minimum wage increases might hurt rather than aid the poor. This paper estimates the effect of the minimum wage on prices paid by low, medium and high income consumers using monthly Brazilian household and firm data from 1982 to 2000. Robust results indicate that the minimum wage raises overall prices in Brazil. The resulting inflation is two times higher for the poor than it is for the rich in the short run and four times higher in the long run.

04/23 Do Stock Markets Value Firm-Level Technical Efficiency? Some UK Evidence

Kevin Amess and Sourafel Girma

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(Last updated: 08/2004)

An empirical model determining the relationship between changes in firm-level productivity and changes in firm value is estimated using an unbalanced panel of 706 public limited companies observed over the period 1996-2002. The main findings are: (1) changes in technical efficiency and labour productivity are reflected in changes in the value of manufacturing firms, and (2) changes in earnings per share and return on capital employed explain changes in the value of service sector firms but technical efficiency and labour productivity do not. For manufacturing firms, the evidence is consistent with the stock market valuing the adoption of better management practices that lead to better resource utilisation.

04/24 Empirical Equations to Estimate the Effect of the Minimum Wage on Prices

Sara Lemos

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(Last updated: 08/2004)

The few price effect studies available in the literature are grounded on the standard theory prediction that if employers do not respond to minimum wage increases by reducing employment or profits, they respond by raising prices. However, none of them explicitly discusses the theoretical model underlying their empirical equation specification. This paper discusses two simple price equation specifications, assuming perfect and imperfect competition in the output market. Each of these was estimated assuming two different production functions. The data used is a Brazilian household and firm survey from 1982 to 2000. Robust results indicate that the minimum wage raises overall prices in Brazil.

04/25 Anticipated Effects of the Minimum Wage on Prices

Sara Lemos

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(Last updated: 08/2004)

There is little empirical evidence on the effect of minimum wage increases on prices, particularly for developing countries. This paper estimates this effect using monthly Brazilian household and firm data over 18 years. As minimum wage increases in Brazil are large, frequent and affect a sizable fraction of the labor force, they affect aggregate prices. Because of this expected price effect, rational agents may take such increases as a signal for future price and wage bargains. Indeed, robust results indicate that the minimum wage raises overall prices not only on the month of the increase, but also in the two months before.

04/26 Prior Elicitation in Multiple Change-point Models

Gary Koop and Simon M. Potter

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(Last updated: 09/2004)

This paper discusses Bayesian inference in change-point models. Existing approaches involve placing a (possibly hierarchical) prior over a known number of change-points. We show how two popular priors have some potentially undesirable properties (e.g. allocating excessive prior weight to change-points near the end of the sample) and discuss how these properties relate to imposing a fixed number of changepoints in-sample. We develop a new hierarchical approach which allows some of of change-points to occur out-of sample. We show that this prior has desirable properties and handles the case where the number of change-points is unknown. Our hierarchical approach can be shown to nest a wide variety of change-point models, from timevarying parameter models to those with few (or no) breaks. Since our prior is hierarchical, data-based learning about the parameter which controls this variety occurs.

04/27 Bayesian Approaches to Cointegration

Gary Koop, Rodney Strachan, Herman van Dijk and Mattias Villani

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(Last updated: 09/2004)

04/28 Competition and Growth in Neo-Schumpeterian Models

Vincenzo Denicolò, Piercarlo Zanchettin

04/28 Competition and Growth in Neo-Schumpeterian Models
(Last updated: 10/2004)

We study the effect of product market competition on the incentives to innovate and the economy’s rate of growth in an endogenous growth model. We extend previous works in industrial organization by assuming that innovation is sequential and cumulative, and early endogenous growth models by accounting for the possibility that in each period many asymmetric firms (i.e., an endogenously determined number of successive innovators) are simultaneously active. We identify the price effect, the front loading of profits, and the productive efficiency effect associated with an increase in competitive pressure. The price effect reduces the incentives to innovate, but both the front loading of profits and the productive efficiency effect raise the incentives to innovate. We demonstrate circumstances in which the productive efficiency effect dominates the price effect. In these circumstances, the front loading of profits and the fact that the productive efficiency effect dominates the price effect compound to make the equilibrium rate of growth increase with the intensity of competition.

04/29 Are Americans More Gung-Ho Than Europeans? Some Evidence From Tourism in Israel During the Intifada

David Fielding and Anja Shortland

Adobe Acrobat (PDF) 04/29 Are Americans More Gung-Ho Than Europeans? Some Evidence From Tourism in Israel During the Intifada
(Last updated: 01/2005)

Analysis of cross-sectional data on tourism to Israel during the Intifada period reveals some of the factors driving the behaviour of tourists from different countries. A large part of the heterogeneity in the observed response of different nationalities can be explained by socio-economic characteristics, some of which suggest differences in attitudes towards the risk associated with violence in Israel. Analysis of time-series data reveals the relative importance of different dimensions of violence in explaining the decline in tourism.

04/30 The Role of Politics and Institutions in LDC Currency Devaluations

Anja Shortland

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(Last updated: 12/2004)

This paper examines political, institutional and economic determinants of exchange rate performance in less developed countries in the 1990s. It models exchange rate depreciations as two separate processes, firstly a process determining whether a currency is devalued and secondly a process determining the size of devaluation. The paper utilizes the most recent political and institutional data as well as a new index of central bank governor turnover in the 1990s to examine the relative importance of political and economic factors. While institutional and political factors dominate the probability of devaluation, the size of devaluations is mainly governed by economic factors.

04/31 Forecasting and Estimating Multiple Change-point Models with an Unknown Number of Change-points

Gary M. Koop and Simon M. Potter

Adobe Acrobat (PDF) 04/31 Forecasting and Estimating Multiple Change-point Models with an Unknown Number of Change-points
(Last updated: 11/2004)

This paper develops a new approach to change-point modeling that allows the number of change-points in the observed sample to be unknown. The model we develop assumes regime durations have a Poisson distribution. It approximately nests the two most common approaches: the time varying parameter model with a change-point every period and the change-point model with a small number of regimes. We focus considerable attention on the construction of reasonable hierarchical priors both for regime durations and for the parameters which characterize each regime. A Markov Chain Monte Carlo posterior sampler is constructed to estimate a change-point model for conditional means and variances. Our techniques are found to work well in an empirical exercise involving US GDP growth and inflation. Empirical results suggest that the number of change-points is larger than previously estimated in these series and the implied model is similar to a time varying parameter (with stochastic volatility) model.

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