Published: 11.11.2022 Updated: 01.12.2022

2022

6/2022 Fiscal, Environmental, and Bank Regulation Policies in a Small Open Economy for the Green Transition
Patrick Grüning

Working paper

ABSTRACT

This study develops a small open economy dynamic stochastic general equilibrium model with green and brown intermediate goods, banks subject to capital requirements, and public investment. The domestic economy might face domestic or foreign carbon taxes and an emissions cap. The model is used to analyze which environmental, fiscal, and bank regulation policies are effective facilitators of the domestic economy’s green transition and the costs involved. Among the policies that can generate an exogenously imposed and fixed emissions reduction, most costly is the exogenous world brown energy price increase, followed by the emissions cap reduction, while the introduction of domestic carbon taxes does not change GDP in the long run. The reason for this stark difference is that domestic carbon taxes and emissions cap violation penalties are used to stimulate public green investment. However, only domestic carbon tax revenues are substantial as brown entrepreneurs do not violate the emissions cap in equilibrium. Bank regulation policies and other fiscal policies are not capable of generating large emissions reductions. During the green transition induced by domestic carbon taxes, the first years of the transition are characterized by a run on brown energy in anticipation of higher prices in the future.

Keywords: small open economy, climate transition risk, energy, environmental policy, bank regulation, public investment

JEL code: E30, F41, G28, H23, H41, Q50

5/2022 Into the Universe of Unconventional Monetary Policy: State-dependence, Interaction and Complementarities
Andrejs Zlobins

Working paper

ABSTRACT

This paper studies the interaction among non-standard monetary policy measures – the negative interest rate policy, forward guidance and quantitative easing – and their ability to substitute conventional policy rate setting when it is constrained by the effective lower bound. In this paper, the euro area serves as our laboratory since the European Central Bank has deployed all three unconventional measures in the past decade to bypass the binding effective lower bound constraint and stabilize the inflation trajectory towards the target. Our empirical setup makes use of a smooth-transition structural vector autoregression, while identification of monetary innovations is done via fusion of high frequency information with narrative sign restrictions, first introduced in Zlobins (2021b) and now further extended to isolate rate cuts in positive/negative territory, allowing to simultaneously identify the impact of both conventional and unconventional policy actions. Our findings show that unconventional measures can substitute the standard policy rate setting but their effectiveness is highly dependent on the overall policy mix and the state of the economy. However, the evidence also suggests that non-standard measures serve as complements to the conventional policy as they are particularly powerful in circumstances when standard policy rate setting loses its stabilization properties, for example, during market turbulence or when the risk of de-anchoring of inflation expectations is elevated.

Keywords: quantitative easing, negative interest rate policy, forward guidance, monetary policy, non-linearities

JEL code: C54, E50, E52, E58

4/2022 Public investment crowds in private investment – with ifs and buts
Oļegs Matvejevs, Oļegs Tkačevs

Working paper

ABSTRACT

This study explores the relationship between public and private investment using a sample of 33 industrialized economies of the OECD. The methodology relies on the fact that the relation between stocks of public and private capital can affect private investment also in the short term. We demonstrate that the immediate effect of public investment on private investment is either small or statistically insignificant, whereas in the medium to long term, extra public investment crowds in private investment as the latter adjusts in order to bring the stock of private capital closer to its long-term cointegrating relationship with public capital. The estimated median public investment multiplier over a horizon of seven years is around 2, which means that each additional dollar of public investment attracts approximately two dollars of private investment. Additionally, we examine whether the crowding-in effect depends on a country’s institutional quality and the area of public spending. We show that it gets stronger with improvements in the quality of institutions related to the rule of law, government effectiveness and control of corruption. Public investment in economic affairs, education and health infrastructure is the most effective in attracting private investment.

Keywords: public investment, private investment, crowding in, crowding out, public investment multiplier, local projections, forecast errors, governance quality indicators

JEL code: C23, E22, E62, H54

3/2022 New Facts On Consumer Price Rigidity In The Euro Area
Erwan Gautier, Cristina Conflitti, Riemer P. Faber, Brian Fabo, Ludila Fadejeva, Valentin Jouvanceau, Jan-Oliver Menz, Teresa Messner, Pavlos Petroulas, Pau Roldan-Blanco, Fabio Rumler, Sergio Santoro, Elisabeth Wieland, Hélène Zimmer

Working paper

ABSTRACT

Using CPI micro data for 11 euro area countries covering about 60% of the euro area consumption basket over the period 2010-2019, we document new findings on consumer price rigidity in the euro area: (i) each month on average 12.3% of prices change, which compares with 19.3% in the United States; when we exclude price changes due to sales, however, the proportion of prices adjusted each month is 8.5% in the euro area versus 10% in the United States; (ii) differences in price rigidity are rather limited across euro area countries but much larger across sectors; (iii) the median price increase (resp. decrease) is 9.6% (13%) when including sales and 6.7% (8.7%) when excluding sales; cross-country heterogeneity is more pronounced for the size than for the frequency of price changes; (iv) the distribution of price changes is highly dispersed: 14% of price changes in absolute values are lower than 2% whereas 10% are above 20%; (v) the overall frequency of price changes does not change much with inflation and does not react much to aggregate shocks; (vi) changes in inflation are mostly driven by movements in the overall size; when decomposing the overall size, changes in the share of price increases among all changes matter more than movements in the size of price increases or the size of price decreases. These findings are consistent with the predictions of a menu cost model in a low inflation environment where idiosyncratic shocks are a more relevant driver of price adjustment than aggregate shocks.

Keywords: price rigidity, inflation, consumer prices, micro data

JEL code: D40, E31

2/2022 The survival of Latvian products and firms in export markets
Konstantīns Beņkovskis, Peter Jarret, Ze'ev Krill, Oļegs Tkačevs, Naomitsu Yashiro

Working paper

ABSTRACT

This paper investigates factors that contribute to the survival of export relationships at the firm and product levels using a large anonymised firm-level database for Latvia. It finds that some characteristics of exporting firms, such as a higher productivity level, larger size, lower indebtedness and higher profitability are associated with longer duration of export relationships. Firms that innovated prior to exporting are also likely to enjoy longer export spells, while participation in an EU-fund support programme did not alter duration. Younger staff and management of the firm are associated with a better survival of a new export product. Furthermore, this paper reveals novel roles of export product characteristics in survival, in particular an interesting tension between the complexity of new export products and their "distance" from the existing export bundle. While aiming high, that is, exporting products that are more complex, pays off as such products are associated with longer-lasting trade relationships, aiming too high, that is exporting new products that are far more complex than the exporter's existing product bundle, tends to lower their survival probability.

Keywords: Exports, economic complexity, trade, productivity, innovation

JEL code: F10, F14, P45, H81

1/2022 Chasing the Shadow: the Evaluation of Unreported Wage Payments in Latvia
Konstantīns Beņkovskis, Ludmila Fadejeva

Working paper

ABSTRACT

We develop a novel way to evaluate the size of unreported wage payments at employee level. It is only the reported employer-employee income data combined with firm-level financial statements and survey information on various person-level indicators that are required for this purpose. We estimate the Mincer earning regression by the Stochastic Frontier Analysis approach, proxying the unreported wage payments by the non-negative inefficiency term. Our methodology is tested on the Latvian data: we find that small and young firms engage in illegal wage payments more than other firms. Unofficial payments to employees with small reported wages are more frequent and sizeable, revealing lower wage income inequality in Latvia when the unreported wage is taken into account.

Keywords: unreported wage, tax evasion, Mincer earning regression, income distribution

JEL code: E26, H26, J08, J31

2021

3/2021 Choosing the European Fiscal Rule
Ginters Bušs, Patrick Grüning, Oļegs Tkačevs

Working paper

ABSTRACT

Contributing to the ongoing discussions at the European Union level about the potential simplification of its fiscal framework, we evaluate the economic and public finance stabilization properties of two benchmark fiscal rules – the structural balance rule and the expenditure growth rule – using a New Keynesian small open economy model. If these fiscal rules are implemented one at a time, having just an expenditure growth rule tends to yield more stable macroeconomic outcomes, but more volatile public finances, as compared to having only a structural balance rule. Much of the quantitative differences in relative volatilities can be accounted for by the modifications of the public expenditure definition in the expenditure growth rule, in particular, the removal of debt service payments. Accounting for debt service payments in fiscal rules strengthens the monetary-fiscal policy interaction but it may turn vicious to macroeconomic stability at business cycle frequencies. Strong-enough debt correction for either fiscal rule contains public debt volatility at little expense to macroeconomic stability in the long run. The households' welfare gain from having the expenditure growth rule instead of the structural balance rule is 4% for a small country in a monetary union and 5% for a country with sovereign monetary policy.

Keywords: fiscal policy, DSGE, small open economy, fiscal-monetary policy interaction

JEL code: E0, E2, E3, E6, F4, H2, H3, H6

2/2021 On the Time-varying Effects of the ECB's Asset Purchases 
Andrejs Zlobins

Working paper

ABSTRACT

This paper (re-)evaluates the effectiveness of central bank asset purchases in the euro area given their prominent role in the ECB's response to the pandemic as well as the evidence from the US suggesting diminishing returns of this policy measure over time. We analyse their macroeco- nomic impact in the euro area using a time-varying parameter structural vector autoregression with stochastic volatility and perform identification via sign and zero restrictions of Arias et al. (2018), their fusion with high frequency information approach akin to Jarocin´ski and Karadi (2020) and a novel method which merges high frequency identification with narrative sign re- strictions of Antolin-Diaz and Rubio-Ramirez (2018). We find that the potency of the ECB's asset purchases to lift inflation has indeed considerably declined over time with several factors contributing to a more muted response of prices to central bank asset purchases. Our results show that the reanchoring channel is no longer active while the counterproductive effects via the mechanism outlined in Boehl et al. (2020), which we dub the capacity utilization channel, have emerged lately and are further complemented with disinflationary effects stemming from the cost channel. Also, the effects passed through more standard transmission channels of central bank asset purchases like portfolio rebalancing and signalling, while still significant, appear to be less persistent recently. Overall, our findings point to a diminishing returns of the ECB's asset purchases to stabilize inflation and its expectations in the euro area.

Keywords: quantitative easing, central bank asset purchases, monetary policy, euro area, non-linearities

JEL code: C54, E50, E52, E583

1/2021 Gauging the Effect of Influential Observations on Measures of Relative Forecast Accuracy in a Post-COVID-19 Era: Application to Nowcasting Euro Area GDP Growth
Boriss Siliverstovs

Working paper

ABSTRACT

The previous research already emphasised the importance of investigating the predictive ability of econometric models separately during expansions and recessions (Chauvet and Potter (2013), Siliverstovs (2020), Siliverstovs and Wochner (2020)). Using the data for the pre-COVID period, it has been shown that ignoring asymmetries in a model's forecasting accuracy across the business cycle phases typically leads to a biased judgement of the model's predictive ability in each phase. In this study, we discuss the implications of data challenges posed by the COVID-19 pandemic on econometric model estimates and forecasts. Given the dramatic swings in GDP growth rates across a wide range of countries during the coronavirus pandemic, one can expect that the asymmetries in the models' predictive ability observed during the pre-COVID period will be further exacerbated in the post-COVID era. In such situations, recursive measures that dissect the models' forecasting ability observation by observation allow to gain detailed insights into the underlying causes of one model's domination over the others. In this paper, we suggest a novel metric referred to as the recursive relative mean squared forecast error (based on rearranged observations) or R2MSFE(+R). We show how this new metric paired with the cumulated sum of squared forecast error difference (CSSFED) of Welch and Goyal (2008) highlights significant differences in the relative forecasting ability of the dynamic factor model and naive univariate benchmark models in expansions and recessions that are typically concealed when only point estimates of relative forecast accuracy are reported.

Keywords: COVID-19, nowcasting, GDP, euro area

JEL code: C22, C52, C53