Harris Dellas

Trade interdependence and the international business cycle

A stochastic, general equilibrium model of the world economy is developed to analyze the contribution of trade interdependence to international business cycles. We test some of the implications of the model using data from ten major industrial countries and a variety of detrending techniques to calculate the cyclical component of output. We find that the significance of trade in the transmission of economic disturbances across countries is not robust to the choice of the detrending method. In general, the role of trade interdependence is moderate and seem to have been stronger in the period before 1973.

International portfolio nondiversification and exchange rate variability

Abstract Incomplete international portfolio diversification is implied by an equilibrium models of exchange rates with nontraded goods. The model can also explain the greater correlation between consumption and income within a country than between consumption across countries. Nontraded goods make more stringent the elasticity conditions required to explain exchange rate variability resulting from current productivity disturbances though not from disturbances to fiscal policies or the prospective return to investment. The model is also consistent with international real interest rate differentials, changes over time in the current account and relative wealth across nations, and observed time-series properties of exchange rates.

Wage Rigidity and Monetary Union

We compare monetary union to flexible exchange rates in an asymmetric, three-country model with active monetary policy. Unlike Friedmans (1953) case for flexible rates, we find that countries with high degree of nominal wage rigidity are better off in a monetary union. Their benefits increase with the size of the union and the degree of wage rigidity of its members. Those with relatively more flexible wages fare better under a flexible rate regime. Their cost of participation in a monetary union increases with the unions level of wage rigidity as well as its tolerance of inflation variability. Taking into account actual asymmetries in the EU we find that the status quo (France and Germany in EMU, the UK pursuing a flexible rate) represents the best monetary arrangement for each of these countries. All three would likely be worse off if the UK joined EMU.

A real model of the world business cycle

Abstract In this paper a stochastic, two country, log-linear, infinite horizon model is used to analyze the generation and transmission of economic fluctuations across countries. It is argued that following a country specific supply disturbance, production interdependence and unitary elasticities in consumption and production are sufficient to generate comovements in aggregate economic activity, investment, and trade that are persistent over time and positively correlated across countries. However, the empirical analysis carried out for the USA, Japan, Germany, and UK for the 1960–82 period suggests that common shocks rather than trade links are responsible for this pattern of comovements.

Fiscal Multipliers in Recessions

The Great Recession, and the fiscal response to it, has revived interest in the size of fiscal multipliers. Standard business cycle models have difficulties generating multipliers greater than one. And they also cannot produce any significant state-dependence in the size of the multipliers over the business cycle. In this paper we employ a variant of the Curdia-Woodford model of costly financial intermediation and show that fiscal multipliers can be strongly state dependent in a countercyclical manner. In particular, a fiscal expansion during a recession may lead to multiplier values exceeding two, while a similar expansion during an economic boom would produce multipliers falling short of unity. This pattern obtains if the spread (the financial friction) is more sensitive to fiscal policy during recessions than during expansions, a feature that is present in the data. Our results are consistent with recent empirical work documenting the state contingency of multipliers.

Optimal Monetary and Prudential Policies

The recent financial crisis has highlighted the interconnectedness between macroeconomic and financial stability and has raised the question of whether and how to combine the corresponding main policy instruments (interest rate and bank-capital requirements). This paper offers a characterization of the jointly optimal setting of monetary and prudential policies and discusses its implications for the business cycle. The source of financial fragility is the socially excessive risk-taking by banks due to limited liability and deposit insurance. We characterize the conditions under which locally optimal (Ramsey) policy dedicates the prudential instrument to preventing inefficient risk-taking by banks; and the monetary instrument to dealing with the business cycle, with the two instruments co-varying negatively. Our analysis thus identifies circumstances that can validate the prevailing view among central bankers that standard interest-rate policy cannot serve as the first line of defense against financial instability. In addition, we also provide conditions under which the two instruments might optimally co-move positively and countercyclically.

Exchange Rate Systems and Macroeconomic Stability

We examine macroeconomic stability and the properties of the international transmission of business cycles under three exchange rate systems: a flexible, a unilateral peg and a single currency. The subjects of study are Germany and France. EMU increases output and decreases inflation variability in Germany but it has the opposite effect in France. It induces a strong negative international transmission of country specific supply shocks and amplifies the role of German supply shocks. These two facts may complicate ECB policy-making.

Self-Fulfilling Expectations, Speculative Attack, and Capital Controls

This paper examines the endogenous implementation of capital controls in the context of a fixed exchange rate regime. It is shown that if there exists a nonzero probability that the policymakers response to a significant decrease in official foreign reserves will be the introduction of controls, a speculative attack may occur even when current and expected monetary policy is consistent with a permanently viable, control-free, fixed exchange rate regime. Consequently, capital controls may be the outcome of self-fulfilling expectations rather than the result of imprudent economic policies. Copyright 1993 by Ohio State University Press.(This abstract was borrowed from another version of this item.)

Financial Development and Stock Returns: A Cross-Country Analysis

We examine stock returns in a cross section of emerging and mature markets (47countries) between 1980-99. The level of financial development turns out to be an important determinant of the performance of stock returns. In general, a deeper and higher quality banking system decreases the volatility of stock returns. It also contributes to a greater synchronization in the movements of domestic and world returns and the same obtains when the stock market is liquid.

The Global Implications of Regional Exchange Rate Regimes

We examine the implications of a regional, fixed exchange rate regime for global exchange rate volatility. The concept of the optimum currency area turns out to play an important role. The formation of a regional regime tends to decrease global volatility when countries are symmetric. The effects tend to be ambiguous in the case of asymmetries. The reduction in global volatility is larger when the rest of the world has more rigid labor markets than the peggers. When the exchange rate management is done mostly by countries with relatively more flexible labor markets. And in the presence of a negative correlation in productivity shocks across countries.