4/2017 How do firms adjust to rises in the minimum wage? Survey evidence from Central and Eastern Europe
Katalin Bodnár, Ludmila Fadejeva, Stefania Iordache, Liina Malk, Desislava Paskaleva, Jurga Pesliakaitė, Nataša Todorović Jemec, Peter Tóth, Robert Wyszyński

Working paper

We study the transmission channels for rises in the minimum wage using a unique firm-level dataset from eight Central and Eastern European countries. Representative samples of firms in each country were asked to evaluate the relevance of a wide range of adjustment channels following specific instances of rises in the minimum wage during the recent post-crisis period. The paper adds to the rest of literature by presenting the reactions of firms as a combination of strategies, and evaluates the relative importance of those strategies. Our findings suggest that the most popular adjustment channels are cuts in non-labour costs, rises in product prices, and improvements in productivity. Cuts in employment is less popular and occurs mostly through reduced hiring rather than direct layoffs. Our study also provides evidence of potential spillover effects that rises in the minimum wage can have on firms without minimum wage workers.

Keywords: minimum wage, adjustment channels, firm-level survey
JEL codes: D22, E23, J31

3/2017 Why is Education Performance so Different Across Latvian Schools?
Oļegs Krasnopjorovs

Working paper

This paper aims at identifying the school characteristics consistently associated with better performance of pupils on state exams. First, we find that exam scores are positively related to school size (the number of pupils in the respective school) and teacher salaries, but negatively – with teacher age. Meanwhile, quantitative inputs like the number of teachers and computers per pupil are not robust determinants of education performance. Second, we show that pupils in urban and rural schools would perform similarly if characteristics of these schools were the same. The Oaxaca–Ransom decomposition fully explains the urban-rural exam score gap by a greater number of pupils and higher teacher salaries in urban schools as well as by different pupil structure; in turn, pupils' ethnic origin plays in favour of rural schools. Finally, Stochastic Frontier Analysis models show that school size is a robust efficiency determinant, while school location in the Riga region or in another big city is not. The bottom line is that structural reforms involving school mergers and a rise in teacher salaries might bring non-negligible dividends in terms of education quality.

Keywords: education performance, school size, rural schools, Oaxaca–Ransom decomposition, Stochastic Frontier Analysis
JEL codes: I21, C1

2/2017 What drives export market shares? It depends! An empirical analysis using Bayesian Model Averaging
Konstantīns Beņkovskis (Latvijas Banka and Stockholm School of Economics in Riga), Benjamin Bluhm (Goethe Universität Frankfurt and ADVISORI FTC GmbH), Elena Bobeica (European Central Bank), Chiara Osbat (European Central Bank), Stefan Zeugner (European Commission)

Working paper

What drives external performance of countries? This is a recurring question in academia and policy. The factors underlying export growth are receiving great attention, as countries struggle to grow out of the crisis by increasing exports and as protectionist discourses take foot again. Despite decades of debates, it is still unclear what the drivers of external performance are and, importantly, which ones policy makers can influence. We use Bayesian Model Averaging in a panel setting to investigate the drivers of export market shares of 25 EU countries, considering a wide range of traditional indicators along with novel ones developed within the CompNet. We find that export market share growth is linked to different factors in the old and new EU Member States, with one exception: for both groups, competitive pressures from China have strongly affected export performance since the early 2000s. In the case of the old EU Member States, investment, the quality of institutions and liquidity available to firms also appear to play a role. For the new EU Member States, labour and total factor productivity are particularly important, while inward FDI matters more than domestic investment. Price competitiveness does not seem to play a very important role in either set of countries: relative export prices do show correlation with export performance for the new EU Member States, but only when they are adjusted for quality. Our results point to the importance of considering the "exporting stage" of a country when discussing export-enhancing policies.

Keywords: export shares, competitiveness, Bayesian Model Averaging
JEL codes: C23, C51, C55, F14, O52

1/2017 Wage formation, unemployment and business cycle in Latvia
Ginters Bušs

Working paper

This paper integrates the alternating-offer wage bargaining (AOB) in a fully-fledged New Keynesian open economy model, and estimates it to the Latvian data. Further on, the paper studies the model's properties and compares them to alternative specifications for labour market modelling, i.e. the Nash wage bargaining with both Taylor-type wage rigidity and without exogenously imposed wage inertia, a reduced-form sharing rule, and a reduced-form wage rule. The goal of the paper is to choose a labour market modelling specification that suits best the needs of the central bank of Latvia in terms of macroeconomic modelling and forecasting. The results indicate that the AOB model suits the Latvian labour market well. The paper concludes with a simulation of economic effects from a permanent increase in the minimum-to-average wage ratio, as observed in Latvia, and finds potentially large losses of employment and output. 

Keywords: alternating-offer bargaining, DSGE model, forecasting, minimum wage
JEL codes: E0, E2, E3, F4


5/2016 The Impact of Sovereign Bond Yields on Fiscal Discipline
Oļegs Tkačevs, Kārlis Vilerts

Working paper

This paper studies the impact of sovereign bond yields on fiscal discipline against the background of unprecedentedly low interest rates in advanced economies brought about by ultra-expansionary monetary policies of recent years. By employing the panel data econometric approach for a sample of OECD, EU and euro area countries over the period 1980–2014, the study suggests a positive and statistically significant impact of long-term sovereign bond yields on primary balances (PBs), indicating that a decrease in borrowing costs leads to a statistically significant deterioration of fiscal balances. The findings herein also suggest that falling bond yields pass on to fiscal balances through increases in government expenditure rather than revenue reduction. From the economic policy perspective, these findings imply that monetary policy measures resulting in ultra-low interest rates may cause negative side effects for fiscal discipline.

Keywords: fiscal policy, fiscal reaction function, sovereign bond yields, panel data
JEL codes: E62, H62

4/2016 The role of price and cost competitiveness for intra- and extra-euro area trade of euro area countries
Elena Bobeica, Styliani Christodoulopoulou, Oļegs Tkačevs

Working paper

This paper studies the importance of price and cost competitiveness for intra- and extra-euro area trade flows of euro area countries. A standard error correction framework shows that price competitiveness is a relatively more important driver of trade flows outside the euro area as compared to those within the monetary union, especially for exports, that tend to be more sensitive to relative prices than imports. We consider various measures of competitiveness and conclude that it is difficult to single out one that outperforms the others. Using an encompassing test, measures based on labour costs appear to contain relatively more information for trade flows, particularly for exports outside the euro area.
The key policy implication is that, in order to adjust competitiveness disequilibria within the monetary union, measures, such as structural policies fostering non-price competitiveness should be pursued in the deficit countries besides those aimed at price and cost adjustments.

Keywords: price and cost competitiveness, intra- and extra-euro area trade, error correction model
JEL codes: F14, F15, F41

3/2016 Relationship Between Inflation and Economic Activity and Its Variation Over Time in Latvia
Andrejs Bessonovs, Oļegs Tkačevs

Working paper

This paper studies the relationship between inflation and economic slack in Latvia with a particular focus on its time variation. The results suggest that the Phillips curve for Latvia had been steepening before the crisis against the backdrop of rising inflation. In the more recent years, there has been tentative evidence of the Phillips curve flattening as Latvia's economy entered a period of very low inflation. If the current trend of an even weaker response of inflation to economic activity in Latvia persists and proves to be statistically significant, unconventional monetary policy instruments may be of limited effectiveness to control inflation in Latvia. This calls for structural reforms aimed at increasing competition and reducing price stickiness.

Keywords: inflation, Phillips curve, business cycles, Bayesian estimation
JEL codes: C32, C51, E31, E52

2/2016 A Term Structure of Interest Rates Model with Zero Lower Bound and the European Central Bank's Non-standard Monetary Policy Measures
Viktors Ajevskis

Working paper

This paper proposes a ZLB/shadow rate term structure of interest rates model with both unobservable factors and those of non-standard monetary policy measures. The non-standard factors include the ECB's holdings of APP and LTROs as well as their weighted average maturities. The model is approximated by the Taylor series expansion and estimated by the extended Kalman filter, using the sample from July 2009 to September 2015. The results show that the 5-year OIS rate at the end of September 2015 was about 60 basis points lower than it would have been in the case of the absence of the non-standard monetary policy measures.

Keywords: term structure of interest rates, lower bound, non-linear Kalman filter, non-standard monetary policy measures
JEL codes: C24, C32, E43, E58, G12

1/2016 CGE model with fiscal sector for Latvia
Konstantīns Beņkovskis, Eduards Goluzins, Oļegs Tkačevs

Working paper

This paper describes the first CGE model for Latvia that consists of 32 industries, 55 products and seven categories of final users. To construct the model we use Latvia's National Supply and Use tables for 2011 from the WIOD database. Special attention is devoted to the fiscal block: the model consists of five government expenditure types and five revenue sources, including such four major taxes as the personal income tax (PIT), state social insurance mandatory contributions (SSIMC), value added tax (VAT) and excise tax. We also introduce an endogenous shadow economy, the size of which depends on the level of tax rates and economic activity. These features of the model allow us to obtain rich and detailed conclusions about the effect of several fiscal measures on Latvia's economy, both in aggregate and by sector.

Keywords: CGE model, Latvia, fiscal policy
JEL codes: D58, C68, H2, H6