Jouko Vilmunen

Sovereign Risk, European Crisis Resolution Policies and Bond Yields

We study the effects of the ECB monetary policy and the European crises resolution policies on the 10 year sovereign bond yields of seven European countries. We find that some of the decisions have had significant impact on sovereign bond yields and have succeeded in reducing stress in the financial markets. However, the impact of the same policy decision might have been positive for some countries while negative for others, suggesting that contagion effects may be important. The economically most significant effects on the bond yields have been due to the announcement of ECBs Securities Market Programme.

Biased Technical Change and Capital-Labour Substitution in Finland, 1902-2003

The paper argues that a Cobb-Douglas specification may be a reasonable description of the Finnish aggregate production function when a sufficiently long time period (the 20th century) is considered. It is, however, a misleading description of the production technology for the post-WWII period. Controlling for biased technical change, the elasticity of substitution is significantly below one, close to 0.5, during 1945-2003. Given that similar results have been obtained for the U.S. economy, the analysis shows that the value of the elasticity of substitution cannot be dependent on some specific structure of economic institutions but is likely to reflect more general aspects of technology and production.

Declining labour share: Evidence of a change in the underlying production technology

The study demonstrates that the decline in the labour share in Finland can not be explained by the Cobb-Douglas production function.Instead, we propose an approach based on the constant-elasticity-of-substitution (CES) production function with labour- and capital-augmenting technical progress.The model is augmented by imperfect competition in the output market.According to the empirical results based on estimation of the first-order-conditions, the technical elasticity of substitution is significantly less than unity (0.6) and hence the Cobb-Douglas production function is rejected.The growth rate of the estimated labour-augmenting technical progress has decreased in recent years, which is not consistent with the new-economy hypothesis. Capital-augmenting technical trend has exploded during the same period, which provides a possible explanation for the rapid growth of the Solow residual.The main contributing factor behind the declining labour share is, however, the increasing mark-up. Keywords: production function, elasticity of technical substitution, input-augmenting technical progress, new economy

Estimating intertemporal elasticity of substitution in a sticky price model

Cancellation of income and substitution effect implied by King-Plosser-Rebelo (1988) preferences breaks tight coefficient restriction between the slope of the Phillips curve and the elasticity of consumption with respect to real interest rate in a sticky price macro model. This facilitates the estimation of intertemporal elasticity of substitution using full information Bayesian Maximum Likelihood techniques within a structural model. The US data from the period 1984–2007 supports low intertemporal elasticity of substitution and strongly rejects a logarithmic and an additively separable utility specification commonly applied in the New Keynesian literature.

Transmission of Monetary Policy Shocks in Finland: Evidence from Bank Level Data on Loans

We use a panel of quarterly time series observations on Finnish banks to estimate reduced form equations for the growth rate of bank loans. By allowing for individual bank specific effects in the empirical models we specifically seek evidence of a bank-lending channel for the transmission of monetary policy shocks in Finland. On the basis of our estimation results, we conclude that there is weak evidence in favour of the bank-lending channel for monetary policy shocks. Our data overlaps with the post crisis recovery of the Finnish banking sector with specific government support measures still active during the good part of the sample period. We try to capture the effects of these measures through a policy dummy variable in our empirical models. This policy dummy is highly significant, suggesting that the measures may have contributed to the growth rate of bank loans during the sample period JEL Classification: E51, E52, G21

Monetary policy and learning in an open economy

In this paper, we examine the incentives for central bank activism and caution in a two-country open-economy model with uncertainty and learning. We find that the presence of a strategic interaction between the home and foreign central banks creates an additional motivation for caution in monetary policy. An activist policy designed to help the learning of the home central bank is suboptimal since it generates a strong reaction from the foreign central bank. As joint learning by the home and foreign central banks is shown to be detrimental to welfare, the optimal policy is cautious.

Dynamics of Investment Behaviour in Finland: Aggregate and Firm Level Evidence

In this paper we estimate reduced form investment equations for Finland using aggregate as well as firm-level panel data.We obtain significant estimates of the accelerator and user-cost effects on investment with both aggregate and firm level data, but these effects appear to be stronger at the aggregate level.Although the response of firms investment spending to shifts in monetary policy seems to be quantitatively nontrivial, it is surprisingly weak according to the results with firm-level data, and a considerable amount of heterogeneity also exists across firms in this respect. The firm-level estimates do not provide evidence for the existence of binding financing constraints in firms investment spending, at least among the sampled large firms, as we cannot obtain a significant coefficient estimate on the cash flow variable. Key words: accelerator, user cost, transmission of monetary policy, panel data

Unemployment in a Small Open Economy: Finland and New Zealand

Unemployment is now the key issue for economic policy in the OECD and Europe in particular.By examining data from the period 1962- 1996 for two highly different small open OECD economies, Finland and New Zealand, in a VE? model this paper seeks to cast light on three questions: the degree to which unemployment has been the result of slow adjustment to large external shocks; the degree to which differences in labour market structures can lead to different responses to shocks; the importance of the exchange rate and the external sector in resolving the problmems.The approach uses a fairly general model of the labour market that includes wages, unemployment, the capital stock and the terms of trade.It uses cointegration analysis to establish long-run relationships among the four variables.In the case of Finland we find that the shoji-run response of unemployment to shocks (to the long-run relationship) is large relative to the response of real wage and the terms of trade.In New Zealand on the other hand both real wages and the terms of trade, in particular, adjust more rapidly. As a result the burden of short-run adjustment in the New Zealand economy appears to fall more heavily on (relative) prices.Since the unemployment rate in both countries displays hysteresis, these results suggest that relative price adjustment in the New Zealand economy is more effective in preventing adverse aggregate shocks from becoming adverse unemployment shock. Keywords: unemployment, open economy, structural change, labour market

Anticipated Monetary Policy and the Dynamic Behaviour of the Term Structure of Interest Rates

This paper investigates the measurement of anticipated interest rate policy and the effects of these expectations on the term structure of nominal interest rates.It is shown that, under the expectations hypothesis, the level of long-term interest rates depends on three factors: the level of the monetary policy interest rate, ie the steering rate; the spread between the market interest rate and the steering rate; and market expectations of the next steering rate change.The theoretical model builds on the assumption that market participants have only imperfect knowledge of the mechanism whereby changes in the steering rate are determined.As a consequence, expectations formation, although realistic, need not be entirely rational.Steering rate changes take the form of discrete jumps and occur infrequently on a daily scale.Given these assumptions, discussion of the determination of the term structure is related to the literature on uncertainty about monetary policy regimes and small samples, ie peso problems. Empirical analysis based on Nelson-Siegel estimates of the daily yield curves in Finland in the period 1 January 1993 to 31 October 1997 complements the theoretical discussion.The observed differences between estimated market expectations and actual tender rate changes are quite large in the sample, particularly for the longer maturities.The approach applied in this study is promising, not only in the sense of potentially providing estimates of market expectations concerning future discrete changes in monetary policy interest rates but also in the sense of its apparent potential in accounting for the often reported poor empirical performance of the expectations hypothesis. Keywords: term structure of interest rates, expectations, target changes, peso problems

The Effects of Transmission Uncertainty on the Flexibility-Credibility Tradeoff in Monetary Policy

In this paper we address the issue of how parameter uncertainty affects the optimal degree of central bank conservatism.The analysis is conducted in the standard macroeconomic model of a monetary policy game embedding an expectational Phillips-curve. Multiplicative Brainard uncertainty is added to the model.This means that the central banks policy instrument has a stochastic impact on inflation.This type of uncertainty is particularly interesting, since it affects the credibility-flexibility tradeoff in monetary policymaking.We show that if the flexibility problem dominates, an increase in uncertainty reduces optimal conservatism. However, increases in uncertainty can also require increases in the optimal degree of conservatism.This happens when the central bank has a sufficiently large credibility problem.This is particularly clear in the case of the introduction of uncertainty at the margin. Furthermore, the coefficient of variation of inflation appears to contain useful information about the relative size of the credibility problem and, hence, about how incipient uncertainty can affect optimal conservatism in actual economies. Keywords: credibility, flexibility, monetary policy, conservatism, uncertainty