Fabio Ghironi

Endogenous Entry, Product Variety, and Business Cycles

This paper builds a framework for the analysis of macroeconomic fluctuations that incorporates the endogenous determination of the number of producers and products over the business cycle. Economic expansions induce higher entry rates by prospective entrants subject to sunk investment costs. The sluggish response of the number of producers generates a new and potentially important endogenous propagation mechanism for business cycle models. The return to investment determines household saving decisions, producer entry, and the allocation of labor across sectors. Our framework replicates several features of business cycles and predicts procyclical profits even for preference specifications that imply countercyclical markups.

Net Foreign Assets and the Exchange Rate: Redux Revived

We revisit Obstfeld and Rogoffs (1995) results on exchange rate dynamics in a two-country, monetary model with incomplete asset markets, stationary net foreign assets, and endogenous nominal interest rate setting a la Taylor (1993). Under flexible prices, the nominal exchange rate exhibits a unit root. However, todays exchange rate also depends on the stock of real net foreign assets accumulated in the previous period. The predictive power of net assets for the exchange rate is stronger the closer assets to non-stationary and the higher the degree of substitutability between domestic and foreign goods in consumption. When prices are sticky, the exchange rate still exhibits a unit root. The current level of the exchange rate depends on the past GDP differential, along with net foreign assets. Endogenous monetary policy and asset dynamics have consequences for exchange rate overshooting under both flexible and sticky prices.

Monetary Rules for Emerging Market Economies

We compare the performance of a currency board arrangement, inflation targeting, and dollarization in a small open, developing economy with liberalized capital account. We focus explicitly on the transmission of shocks to currency and country risk premia in international financial markets and on the role of fluctuations in premia in the propagation of other shocks. We calibrate our model on Argentina. The framework fits the data relatively well in that it matches the second moments of several key macro variables. Welfare analysis suggests that dollarization is preferable to the alternative regimes we consider because it removes the volatility that originates from the currency premium. However, a currency board can match dollarization if the central bank holds a sufficiently large stock of foreign reserves on average.

Does It Matter (for Equilibrium Determinacy) What Price Index the Central Bank Targets

What inflation rate should the central bank target? We address determinacy issues related to this question in a two-sector model in which prices can differ in equilibrium. We assume that the degree of nominal price stickiness can vary across the sectors and that labor is immobile. The contribution of this paper is to demonstrate that a modified Taylor Principle holds in this environment. If the central bank elects to target sector one, and if it responds with a coefficient greater than unity to price movements in this sector, then this policy rule will ensure determinacy across all sectors. The results of this paper have at least two implications. First, the equilibrium-determinacy criterion does not imply a preference to any particular measure of inflation. Second, since the Taylor Principle applies at the sectoral level, there is no need for a Taylor Principle at the aggregate level.

EMU and Enlargement

We speculate about how Europes monetary union will evolve in the next five to ten years. We concentrate on what is likely to be the most important change in that period, namely, the increased number and heterogeneity of the participating states. New members will be sharply different from the incumbents in terms of their per capita incomes and economic structures. We concentrate on the implications of this development for the structure, organization and operation of the monetary union. We focus on the implications for the conduct of monetary policy of voting and representation rules on the ECB Board on the grounds that these will have to change with the accession of additional members. We focus on prudential supervision and lending in the last resort on the grounds that the inclusion of countries with recently-created and still-developing financial systems will be among the most prominent consequences of EMU enlargement. We focus on the coordination of fiscal policies on the grounds that the fiscal positions and problems of the accession economies will differ from those of the incumbents. And we focus on labor market flexibility on the grounds that labor-market effects will be among the leading consequences of the admission of new members.

Towards New Open Economy Macroeconometrics

I estimate the structural parameters of a small open economy model using data from Canada and the United States. The model improves upon the recent literature in open economy macroeconomics from an empirical perspective. I estimate parameters by using non-linear least squares at the single-equation level. Estimates of most parameters are characterized by small standard errors and are in line with the findings of other studies. I also develop a plausible way of constructing measures for non-observable variables. To verify if multiple-equation regressions yield significantly different estimates, I run full information maximum likelihood, system-wide regressions. The results of the two procedures are similar. Finally, I illustrate a practical application of the model, showing how a shock to the U.S. economy is transmitted to Canada under an inflation targeting monetary regime.

Monetary Policy and Business Cycles with Endogenous Entry and Product Variety [with Comments and Discussion]

This paper studies the role of endogenous producer entry and product creation for monetary policy analysis and business cycle dynamics in a general equilibrium model with imperfect price adjustment. Optimal monetary policy stabilizes product prices, but lets the consumer price index vary to accommodate changes in the number of available products. The free-entry condition links the price of equity (the value of products) with marginal cost and markups and hence with inflation dynamics. No-arbitrage between bonds and equity links the expected return on shares, and thus the financing of product creation, with the return on bonds, affected by monetary policy via interest rate setting. This new channel of monetary policy transmission through asset prices restores the Taylor Principle in the presence of capital accumulation (in the form of new production lines) and forward-looking interest rate setting, unlike in models with traditional physical capital. We also study the implications of endogenous variety for the New Keynesian Phillips curve and business cycle dynamics more generally, and we document the effects of technology, deregulation, and monetary policy shocks, as well as the second moment properties of our model, by means of numerical examples.

Currency areas, international monetary regimes, and the employment-inflation tradeoff

We show that the employment-inflation tradeoff facing a central bank depends on the size of the economy for which it sets monetary policy. For inflation-averse central banks, the tradeoff improves the smaller the relevant economy. The tradeoff facing the region whose central bank controls the exchange rate in a managed exchange rate regime does not change moving to a symmetric flexible exchange rate regime. Instead, the core region in an asymmetric regime faces a worse tradeoff than under flexible exchange rates. Equipped with these results, we explore the issue of the optimal size of a currency area both in a two and in a three-region world.

Transatlantic Trade-Offs in the Age of Balanced Budgets and European Monetary Union

We develop a model of monetary and fiscal policies appropriate for considering U.S.-European policy interactions in an era of near-balanced budgets and European monetary union. We study the determinants of policy trade-offs and incentives for central banks and governments across the Atlantic. Smaller, more open economies face more favorable trade-offs, since openness enhances policy effectiveness via the exchange-rate channel. Changes in Europes monetary arrangements do not affect U.S. trade-offs, although they alter the trade-offs facing European policy-makers. Fiscal trade-offs depend crucially on the extent to which fiscal policy is distortionary. Changes in taxes and spending move both employment and inflation in the desired direction following a worldwide supply shock when spending is financed with distortionary taxes.

The domestic and international effects of interstate U.S. banking

This paper studies the domestic and international effects of the transition to an interstate banking system implemented by the U.S. since the late 1970s in a dynamic, stochastic, general equilibrium model with endogenous producer entry. Interstate banking reduces the degree of local monopoly power of financial intermediaries. We show that the an economy that implements this form of deregulation experiences increased producer entry, real exchange rate appreciation, and a current account deficit. The rest of the world experiences a long-run increase in GDP and consumption. Less monopoly power in financial intermediation results in less volatile business creation, reduced markup countercyclicality, and weaker substitution effects in labor supply in response to productivity shocks. Bank market integration thus contributes to a moderation of firm-level and aggregate output volatility. In turn, trade and financial ties between the two countries in our model allow also the foreign economy to enjoy lower GDP volatility in most scenarios we consider. The results of the model are consistent with features of the U.S. and international business cycle after the U.S. began its transition to interstate banking.