Francesco Franco

The Number of Bank Relationships and Borrowing Costs: The Role of Information Asymmetries

This paper provides new evidence on the effect of bank competition on the cost of lending, in an environment of reduced information asymmetries between firms and banks. We construct a simple model linking the number of bank relationships, the cost of lending and bank competition. Banks are exposed to more competition if the firm has many ongoing bank relationships that improve her threat point when negotiating borrowing costs. Moreover, increased competition in the banking sector might mitigate (substitute) or amplify (complement) this effect. Using a unique data set from Portugal, we find that when a firm borrows from one additional bank, the interest rate on bank loans for this firm becomes 9 to 20 basis points lower on average. In addition, we find that when local bank competition is more intense firms can benefit more from simultaneously engaging in several banking relationships, hence providing evidence of complementarity between competition and the number of bank relationships. However, we do not observe these effects for the smallest and youngest firms.

Adjusting to External Imbalances within the EMU, the Case of Portugal

From 1995 to 2010 Portugal has accumulated a negative international asset position of 110 percent of GDP. In a developed and aging economy the number is astonishing and any argument to consider it sustainable must rely on extremely favorable forecasts on growth. Portuguese policy options are reduced in number: no autonomous monetary policy, no currency to devaluate, and limited discretion in changing fiscal deficits and government debt. To start the necessary deleveraging a remaining possible policy is a budget-neutral change of the tax structure that increases private saving and net exports. An increase in the VAT and a decrease in the employer’s social security contribution tax can achieve the desired outcome in the short run if they are complemented with wage moderation. To obtain a substantial improvement in competitiveness and a large decrease in consumption, the changes in the tax rates have to be large. While a precise quantitative assessment is difficult, the initial increase in the effective VAT rate needed to allow the social security tax to decrease by 16 percentage points (pp) is approximately 10 pp. Such a large increase in the effective VAT rate could be obtained by raising most of the reduced VAT rates to the new general VAT rate of 23 percent. The empirical analysis shows that over time the suggested tax swap could generate surpluses and improve the trade balance. A temporary version of the suggested tax-swap has the attractiveness to achieve a sharper increase in the private saving rate maintaining the short run gains in competitiveness. Finally, the temporary version of the fiscal devaluation could be the basis for an automatic stabilizer to external imbalances within a monetary union.

Fiscal Consolidation Programs and Income Inequality

Following the Great Recession, many European countries implemented fiscal consolidation policies aimed at reducing government debt. Using three independent data sources and three different empirical approaches, we document a strong positive relationship between higher income inequality and stronger recessive impacts of fiscal consolidation programs across time and place. To explain this finding, we develop a life-cycle, overlapping generations economy with uninsurable labor market risk. We calibrate our model to match key characteristics of a number of European economies, including the distribution of wages and wealth, social security, taxes and debt, and study the effects of fiscal consolidation programs. We find that higher income risk induces precautionary savings behavior, which decreases the proportion of credit-constrained agents in the economy. Credit-constrained agents have less elastic labor supply responses to fiscal consolidation achieved through either tax hikes or public spending cuts, and this explains the relationship between income inequality and the impact of fiscal consolidation programs. Our model produces a cross-country correlation between inequality and the fiscal consolidation multipliers, which is quite similar to that in the data.

Economic Change and the Aggregate Production Function

The aggregate production function is at the center of contemporaneous macroeconomics. Both growth and business cycle theories offer predictions that depend on the specification of the aggregate technology. In this paper I postulate that the specification of the aggregate technology is endogenous and I study if the aggregate production function mutates in response to changes in the economic environment. To some extent the previous statement is obvious: the aggregate production function is, leaving existence issues aside, the aggregation of all the micro-technologies present in the economy. If the micro-technologies change in time so should do the aggregate technology. I define the aggregate short-run technology and the aggregate long-run technology respectively a mapping from the variable input to output and a mapping from aggregate investment to future capacity. To study mutations that affect short run fluctuations I consider the aggregate output elasticity with respect to the labor supply shocks. To study mutations that affect the long-run I consider the elasticity of capacity with respect to investment. I use a detailed dataset that covers the US manufactirung sector. The results show that the short-run elasticity does not appear to have changed in the sample while the long-run as increased. Finally I show that the long-run technology is a complicated function but that is well approximated by a Cobb-Douglas.