Andrea Pescatori

A New Action-Based Dataset of Fiscal Consolidation

This paper presents a new dataset of fiscal consolidation for 17 OECD economies during 1978-2009. We focus on discretionary changes in taxes and government spending primarily motivated by a desire to reduce the budget deficit and not by a response to prospective economic conditions. To identify the motivation and budgetary impact of the fiscal policy changes, we examine contemporaneous policy documents, including Budgets, Budget Speeches, central bank reports, Convergence and Stability Programs submitted by the authorities to the European Commission, and IMF and OECD reports. The resulting series can be used to estimate the macroeconomic effects of fiscal consolidation.

Oil and the Great Moderation

We assess the extent to which the great US macroeconomic stability since the mid-1980s can be accounted for by changes in oil shocks and the oil share in GDP. To do this we estimate a DSGE model with an oil-producing sector before and after 1984 and perform counterfactual simulations. We nest two popular explanations for the Great Moderation: (1) smaller (non-oil) real shocks; and (2) better monetary policy. We find that the reduced oil share accounted for as much as one-third of the inflation moderation, and 13% of the growth moderation, while smaller oil shocks accounted for 11% of the inflation moderation and 7% of the growth moderation. This notwithstanding, better monetary policy explains the bulk of the inflation moderation, while most of the growth moderation is explained by smaller TFP shocks.

Debt and Growth: Is There a Magic Threshold?

Using a novel empirical approach and an extensive dataset developed by the Fiscal Affairs Department of the IMF, we find no evidence of any particular debt threshold above which medium-term growth prospects are dramatically compromised. Furthermore, we find the debt trajectory can be as important as the debt level in understanding future growth prospects, since countries with high but declining debt appear to grow equally as fast as countries with lower debt. Notwithstanding this, we find some evidence that higher debt is associated with a higher degree of output volatility.

Debt Crises and the Development of International Capital Markets

Crises on external sovereign debt are typically defined as defaults. Such a definition accurately captures debt-servicing difficulties in the 1980s, a period of numerous defaults on bank loans. However, defining defaults as debt crises is problematic for the 1990s, when sovereign bond markets emerged. In contrast to the 1980s, the 1990s are characterized by significant foreign debt-servicing difficulties but fewer sovereign defaults. In order to capture this evolution of debt markets, we define debt crises as events occurring when either a country defaults or its bond spreads are above a critical threshold. We find that our definition outperforms the default-based definition in capturing debt-servicing difficulties and, consequently, in fitting the post-1994 period. In particular, liquidity indicators are significant in explaining our definition of debt crises, while they do not play any role in explaining defaults after 1994.

Inflation-Output Gap Trade-Off With a Dominant Oil Supplier

An exogenous oil price shock raises inflation and contracts output, similar to a negative productivity shock. In the standard New Keynesian model, however, this does not generate any trade-off between inflation and output gap volatility: under a strict inflation-targeting policy, the output decline is exactly equal to the efficient output contraction in response to the shock. Modeling the oil sector from optimizing first principles rather than assuming an exogenous oil price, we show that the presence of a dominant oil supplier (OPEC) leads to inefficient fluctuations in the oil price markup. The latter reflects a dynamic distortion of the production process, and as a result, stabilizing inflation does not automatically stabilize the distance of output from first-best. Our model is a step away from discussing the effects of exogenous oil price changes and toward analyzing the implications of the underlying shocks that cause the oil price to change in the first place.

Search Frictions and the Labor Wedge

This paper shows that labor market search frictions do not explain fluctuations in the labor wedge per se. However, the introduction of extensive and intensive margin clarifies that measuring the MRS in terms of total hours artificially introduces procyclicality in the MRS. When the MRS is correctly measured in terms of hours per worker, the labor wedge obtained is less variable than the one of the competitive model. Finally, we show that it is possible to measure a strongly procyclical labor wedge when the actual data generating process is a search model that allows for movements in both margins.

Incomplete markets and households’ exposure to interest rate and inflation risk: implications for the monetary policy maker

The present paper studies optimal monetary policy when the representative agent assumption is abandoned and financial wealth heterogeneity across households is introduced. Incomplete markets make households incapable of perfectly insuring against interest rate and inflation risk, creating a trade-off between price level and debt-servicing stabilization. We derive a welfare-based loss function for the policymaker, which includes an additional target related to the cross-sectional distribution of household debt. The extent of the deviation from price stability depends on the initial level of debt dispersion. Using U.S. microdata to calibrate the model, we find an optimal inflation volatility equal to almost 20 percent of the actual volatility of the last 15 years. Finally, the paper studies the design of optimal simple implementable rules. Superinertial rules, which imply a hump-shaped interest rate response to shocks, significantly outperform standard rules.

Oil Price Volatility and the Role of Speculation

How much does speculation contribute to oil price volatility? We revisit this contentious question by estimating a sign-restricted structural vector autoregression (SVAR). First, using a simple storage model, we show that revisions to expectations regarding oil market fundamentals and the effect of mispricing in oil derivative markets can be observationally equivalent in a SVAR model of the world oil market a la Kilian and Murphy (2013), since both imply a positive co-movement of oil prices and inventories. Second, we impose additional restrictions on the set of admissible models embodying the assumption that the impact from noise trading shocks in oil derivative markets is temporary. Our additional restrictions effectively put a bound on the contribution of speculation to short-term oil price volatility (lying between 3 and 22 percent). This estimated short-run impact is smaller than that of flow demand shocks but possibly larger than that of flow supply shocks.

Leverage, investment, and optimal monetary policy

Abstract: We study optimal monetary policy in an economy where firms’ debt overhangs lead to under-investment and under-production. The magnitude of this debt-induced distortion varies over the business cycle, rising significantly during recessions. When debt is contracted in nominal terms, this distortion gives rise to a balance sheet channel for monetary policy. In the presence of real and financial shocks, the monetary authority faces a trade-off between inflation and output gap stabilization. The optimal monetary policy rule prescribes that the anticipated component of inflation should be set equal to a target level, while the unanticipated component should rise in response to adverse shocks, smoothing the debt overhang distortion and the output gap.

Debt and Growth: Is There a Magic Threshold?1

Using a novel empirical approach and an extensive dataset developed by the Fiscal Affairs Department of the IMF, we find no evidence of any particular debt threshold above which medium-term growth prospects are dramatically compromised. Furthermore, we find the debt trajectory can be as important as the debt level in understanding future growth prospects, since countries with high but declining debt appear to grow equally as fast as countries with lower debt. Notwithstanding this, we find some evidence that higher debt is associated with a higher degree of output volatility. JEL Classification Numbers: H63, O40