Allen C. Head

Measuring World Business Cycles

Using Kalman filtering and dynamic factor analysis, we decompose fluctuations in real aggregate output, consumption, and investment for the G7 countries into factors that are (i) common across all countries and aggregates, (ii) common across aggregates within a country, and (iii) specific to each data series. In quarterly data for the period 1970-1993, fluctuations in all of the aggregates contain world and country-specific common components which are significant both statistically and economically. Over this period all seven countries experience business cycle episodes primarily attributable to the world cycle and other episodes driven primarily by the country-specific factor. The share of the variance of aggregate output accounted for by the world business cycle in our estimates ranges from 13% for the U.K. to 67% for France. Also, the world common component in growth rates is more strongly serially correlated than is output growth in any of the seven countries.

Monopolistic Competition, Increasing Returns, and the Effects of Government Spending

The dynamic effects of government spending are considered in a general equilibrium model with monopolistic competition and increasing returns. In the economy, changes in the level of government spending endogenously raise total factor productivity, even though the spending itself is entirely wasteful. This leads to several results which contrast with the effects of government spending policies in environments with constant returns. A permanent increase in government spending increases the steady-state wage and may increase steady-state consumption. Also, regardless of its persistence, a temporary shock to government spending may simultaneously raise output, investment, the real wage, and consumption. Copyright 1996 by Ohio State University Press.

Aggregate fluctuations with increasing returns to specialization and scale

The effects of technology shocks in a real business cycle model with monopolistic competition and increasing returns to both specialization and scale are considered. Market power per se and increasing returns due to fixed costs have no effect on the responses of aggregate variables to a technology shock relative to those exhibited by a standard, perfectly competitive real business cycle model. In contrast, the responses of aggregates to technology shocks are reduced by returns to scale in variable factors and increased by returns to specialization. Returns to specialization and scale also affect the measurement of technology shocks. Increasing returns to scale generally cause the variance of the Solow residual to undermeasure the variance of the ‘true’ technology shock, while returns to specialization result in the opposite bias. With both types of increasing returns present, the variance of output is increased relative to a standard competitive model despite a significant reduction of the variance of technology shocks.

Common and country-specific fluctuations in productivity, investment, and the current account

Dynamic factor analysis and Kalman filtering are used to construct a measure of common economic activity for the G7 countries. Common movements are important in productivity, but account for a substantially smaller share of movements in investment, and virtually none of the variation in the current accounts. For all seven countries, country-specific investment fluctuations have a significant negative impact on the current account, while country-specific productivity movements have little effect. A multi-country dynamic general equilibrium model is analyzed which is consistent with our qualitative findings. The model overstates, however, the quantitative importance of investment fluctuations for movements in the current account.

Country size, aggregate fluctuations, and international risk sharing

Country size, measured by either population or gross domestic product (GDP), is shown to be negatively related to the variances of aggregate output, consumption and investment and positively related to the contemporaneous correlations of consumption and investment with output in a sample of fifty-six countries. These results, however, hold primarily for the high income countries of the sample. A subsample consisting of the twenty countries with the lowest per capita GDP exhibits a significant negative relationship only between investment volatility and country size- these empirical regularities are shown to be consistent with the implications of international risk sharing among counties of asymmetric sizes in an international real business cycle model. Shocks in relatively large countries constitute world-wide risk to a greater extent than do similar shocks in smaller countries. Thus foreign shocks have a greater impact on small countries, causing their aggregates to fluctuate more and their consumption and investment to be less highly correlated with domestic output.

Government Spending and Welfare with Returns to Specialization

We explore a novel channel through which government spending can stimulate consumption and welfare through its effects on aggregate productivity, without directly affecting either utility or production possibilities. In the presence of monopolistic competition and increasing returns to specialization, it is shown that government spending can partly alleviate the inefficiencies of monopolistic competition. This is because government spending generates an endogenous increase in total factor productivity by increasing the variety of intermediate goods. If the degree of increasing returns to variety is large enough, a rise in such wasteful government spending may increase consumption levels enough to increase welfare. Copyright 2000 by The editors of the Scandinavian Journal of Economics.

Monopolistic competition, technology shocks, and aggregate fluctuations

Abstract We analyze a real business cycle (RBC) model in which aggregate production exhibits increasing returns to specialization in conjunction with imperfect competition and free entry and exit of firms over the business cycle. We show that the requirements of both high variance and high persistence in technology shocks that have been noted by critics of RBC theory may arise from the assumptions of perfect competition and constant returns to scale, rather than from the general proposition that real productivity shocks can significantly account for the business cycle.

Equilibrium Price Dispersion and Rigidity: A New Monetarist Approach

Why do some sellers set prices in nominal terms that do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption. Here it is a result. We use search theory, with two consequences: prices are set in dollars since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When money increases, some sellers keep prices constant, earning less per unit but making it up on volume, so profit is unaffected. The model is consistent with the micro data. But, in contrast with other sticky-price models, money is neutral.

The CCAPM meets Euro-interest rate persistence, 1960–2000

Euro-interest rates are well-known to be persistent, as are their differentials across countries for a given maturity. The international CCAPM implies that the rates are persistent because forecasts of national consumption growth or inflation are persistent too. We examine this prediction for a panel of countries. The standard CCAPM with power utility is augmented to allow for external habit, government consumption, and adaptive learning. In all cases, we find little evidence that the persistence in Euro-rates is consistent with the CCAPM.

Has Canadian House Price Growth been Excessive

The dramatic rise in the ratio of Canadas average house price to average rent has led to speculation that there is a bubble in the Canadian housing market. Others have argued, however, that the currently high level of house prices may be rationalized by the low cost of financing, given the decline in interest rates over the last two decades. In this article, we assess these arguments through the lens of a simple asset pricing model applied to city-level data. We quantify the extent to which excess growth in Canadian house prices depends on the nature of the current regime governing real interest rates, expections of rent growth in different cities and variations in property taxes.