ALPHABETICAL LIST (FIRST NAMED AUTHOR) OF PAPERS BEING PRESENTED AT THE CONFERENCE    H-Z

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(Last updated 26th March 2002)

The links to the papers will become live on the day they are delivered

Hanushek, Eric; Charles Ka Yui Leung; Kuzey Yilmaz

Stanford University; Chinese University of Hong Kong; University of Rochester

Redistribution through Education and Other Transfer Mechanisms

Educational subsidies are frequently justified as a method of altering the Income distribution. It is thus natural to compare education to other tax-transfer schemes designed to achieve distributional objectives. While equity-efficiency trade-offs are frequently discussed, they are rarely explicitly treated.  This paper creates a general equilibrium model of school attendance, labor supply, wage determination, and aggregate production, which is used to compare alternative redistribution devices in terms of both deadweight loss and distributional outcomes. A wage subidy generally dominates tuition subsidies in ex ante (or "opportunity") calculations, but this reverses in ex post (or "realized") calculations.  Both are generally superior to a negative income tax. With externalities in production, however, there is an unambiguous role for governmental subsidy of education, because it both raises GDP and creates a more equal income distribution.

JEL Primary Field Name: Public Finance JEL Classification: D6, H2, I2

Keywords: Endogenous Policy, Redistribution.

Harcourt, G.C.; S. Blankenburg

University of Cambridge

The debates on the representative firm and increasing returns: Then and now

The paper reviews the debates on the representative firm and increasing returns which were initiated by Clapham’s “Empty economic boxes” in 1922 and completed in the March 1930 symposium edited by Keynes in the Economic Journal with contributions by D.H. Robertson, G.F. Shove and P. Sraffa. The debates centred around the link between theory and reality and the compatibility of competitive price theory with increasing returns. These particular issues have surfaced again in the development of neoclassical endogenous growth theory from the 1980s on. We argue that the criticisms raised by Young and Sraffa in the 1920s are especially relevant for the new developments.

JEL classifications: B20, B40, O40

Harris, Richard; Catherine Robinson

University of Durham; University of Portsmouth

Productivity Spillovers to Domestic Plants from Foreign Direct Investment: Evidence from UK Manufacturing, 1974-1995

Empirical literature on the impact of FDI has considered at length the indirect spillover benefits that accrue to domestic plants as a result of FDI presence.  However, the imprecise and disparate nature of spillovers makes accurate definition and indeed measurement of them difficult to achieve.  In this paper, we consider the definition of what constitutes a spillover from FDI, and setout three main channels for spillovers; within (intra)industry, between (inter)industry and agglomeration. We then go on to measure the indirect impact of FDI on the total factor productivity of domestic plants in a number of UK manufacturing industries, 1974-1995, using a standard production function-based approach. We use data made available from the UK ARD and information derived from UK input-output tables, to establish the potential for inter-industry linkages.  Our results indicate that the competition and ‘absorption capacity’ effect at times outweighs any potential benefits, leading to negative spillovers.  We also find that inter-industry spillovers are generally more prevalent than intra-industry spillovers. Generally, we do not find the agglomeration spillover to be significant.  However, we conclude that the nature of spillovers is such that measurement techniques traditionally adopted fail to adequately explain their complex and diverse nature.

Key words Micro-based manufacturing data, foreign-owned, productivity, FDI, spillovers

JEL Codes JEL-L, JEL-O , JEL-D

Hatzipanayotou, Panos; Sajal Lahiri; Michael S.Michael

Athens University of Economics and Business; University of Essex; University of Cyprus

Reforms of Environmental Policies in the presence of Cross-border Pollution and Two-stage Clean-up

We construct a two-country model where pollution from production is transmitted across borders. Pollution abatement is undertaken sequentially by private producers and the public sector. We characterize the Nash optimal levels of the policy instruments in the two countries: emission taxes and funds allocated for public abatement activities. We examine the implications of a number of multilateral policy reforms. One of our findings is that the magnitude of the beneficial effect of a reform depends on the scope of the reform, and if it is restricted to a subset of policy instruments, then the efficacy of environmental policy reform can be greatly undermined.

Key Words: Cross-border pollution,Private pollution abatement, Public pollution abatement, multilateral policy reform.

J.E.L. Classification: Q28, H41.

Haufler, Andreas; Ian Wootton

University of Goettingen and CESifo; University of Glasgow and CEPR

Regional Tax Coordination and Foreign Direct Investment

The paper analyzes the effects of a regionally coordinated profit tax in a model with three active countries, one of which is not part of the union, and a globally mobile firm. We show that regional tax coordination can lead to two types of welfare gains. First, for investments that would take place in the region in the absence of coordination, this measure can transfer location rents from the firm to the union. Second, by internalizing all of the union's benefits from foreign direct investment, a coordinated policy attracts more investment than when member states act in isolation. Consequently, tax levels may rise or fall under regional coordination.

Keywords: tax competition, regional coordination, international investment

JEL-Classification: F15, F23, H73, H87

Hendry, David F; Michael P. Clements

University of Oxford; University of Warwick

Economic Forecasting: Some Lessons from Recent Research

We describe a general theoretical framework against which recent results in economic forecasting can be judged, including explanations for the findings of forecasting competitions, the prevalence of forecast failure, and the role of causal variables. We compare this framework to a previous formulation which was silent on the very issues of most concern to the forecaster, then describe ten aspects which our approach illuminates, and draw out their implications for model selection. Finally, we discuss ten areas where research is needed to clarify empirical findings that still lack theoretical explanations.

Keywords: Forecasting, non-stationarity, structural breaks, co-breaking, pooling, model selection.

JEL-Classification: C1, C52

Henry, Brian; Mathan Satchi; David Vines

University of Oxford

How square is the policy frontier ?

This paper assesses the implications of discounting on a result derived by Bean (1998): that in a model of monetary policy where policy acts with a lag, the outcomes of monetary policy are very similar for a wide range of weightings of the (non-discounting) monetary authority's objective function, with respect to inflation stability versus output stability.   We show that when the authority discounts the future, outcomes become more sensitive to preferences, and that it is important to take the discount rate into account when examining the  question of  how the authority's remit should be specified.

Keywords: Monetary Policy, Policy Frontier, Discounting

JEL Nos: E53, E58, E61

Henry, Peter Blair

Stanford University and NBER

The Net Present Value of Stabilizing Inflation

When countries attempt to stabilize annual inflation rates that are greater than 40 percent, the domestic stock market appreciates by 24 percent on average.  The present value of the long-run benefits to shareholders of reducing high inflation outweighs the present value of the short-run costs. In contrast, the average market response is economically weak and statistically insignificant if the pre-stabilization inflation rate is less than 40 percent.  Stock market responses also help predict the change in inflation and output in the year following stabilization efforts.  This additional result indicates that the stock market evidence for the 81 inflation stabilization episodes studied here is not spurious.  

Higson, C.; S. Holly; P. Kattuman; S. Platis

London Business School; Cambridge University; KPMG

The Business Cycle, Macroeconomic Shocks and the Cross Section: Evidence from UK Quoted Companies

Co-movements and correlations in the major macroeconomic aggregates has been the focus of much of the recent literature in business cycle research. In this paper we provide another dimension to business cycle analysis. We examine the evolution of the cross sectional distribution of the growth of UK quoted companies from 1968 to 1997 and find correlations between aggregate business cycle fluctuations and the higher moments of the cross sectional distribution. To explain this we analyse the sensitivity of firms to aggregate shocks, conditioning growth on firm size, age and industry. We find that the contemporaneous effects of aggregate shocks, both positive and negative, are significantly more pronounced for firms in the middle range of growth. This explains the cycle-related patterns in the moments of the growth rate cross section.  These findings are of importance in understanding firm level as well as business cycle dynamics.  

Key words: Business Cycles, Cross sectional Moments, Firm Growth

JEL classification:  E32, D21,D92

Hogan, Vincent; Ian Walker

University College Dublin; University of Warwick

Education Choice under Uncertainty

We apply the theory of real options to the problem of education choice when returns to education are uncertain. We show that the length of time spent in school will be an increasing function of the risk associated with education and not just the expected return. This fact has been neglected in much of the empirical literature on education.  

JEL Classification: J24, C61, D81.

Keywords: Education Choice; Dynamic Optimization, Optimal Stopping, Uncertainty.

Humphrey, Steven J.

University of Nottingham

Do Individuals Learn To Maximise Expected Utility?

Violations of expected utility theory are sometimes attributed to imprecise preferences interacting with a lack of learning opportunity in the experimental laboratory. This paper reports a test of whether conditions which facilitate objective probability learning yield decisions better described by expected utility theory than is the case in experiments devoid of learning opportunity. The data show that expected utility maximising behaviour increases with the learning opportunity, but so too do systematic violations. Learning, therefore, may exacerbate choice anomalies.  

Keywords:Common consequence effect, monotonicity, probability learning

JEL classification: D81, C91

Iyigun, Murat F.

University of Colorado at Bolder

Geography, Demography, and Early Development

This paper explores the role of geography in economic development and demographic transition. It presents a growth model where survival is endogenously determined and where the odds of survival and the returns to labor are higher in geographically favorable regions. Higher life expectancy prompts parents to devote more of their resources to old-age consumption and enjoyment. Consequently, the invest relatively more in the quantity and quality of their offspring. Investment in education, together with population growth eventually triggers technological progress. As the level of technology improves and life expectancy rises along with it, a geographically advantageous economy first enters a post-Malthusian regime during which both fertility and educational attainment increase. Then, as further improvements in technology lead to a higher education premium, such an economy undergoes a demographic transition during which life expectancy continues to rise and parents have fewer but more educated children. In regions where geography is more adverse, this transition does not take place and economies remain trapped in the Malthusian regime. Thus, accounting for the role of geography in development helps to link demographic transition to geography and shows that the latter affects the economy mostly indirectly through the impact of geography on households' demographic choices. In the early stages of development, those choices in turn determine whether economies attain the scale and scope necessary for sustained economic progress. The paper also provides a framework with which to asses why geography may matter less today.  

JEL Codes:            J13, O11, O33, O40.

Jayaraman, Rajshri; Mandar Oak

University of Munich

Local Currency as a Development Strategy

The introduction of a local currency may serve as a signal of demand for local goods. Where demand uncertainty deters firms from investing in more productive technologies, such a signal improves the chances that technology choice will be optimal. The introduction of a local currency therefore always improves ex-ante efficiency and may lead to ex-post efficiency, with strictly higher levels of productivity and welfare.  

JEL Classification: O12, D82, E40

Key Words: Incomplete information, Local currency, Demand revelation, Economic development

Jordahl, Henrik; Luca Micheletto

Uppsala University; L. Bocconi University, Milan

Optimal Utilitarian Taxation and Horizontal Equity

We impose a horizontal equity constraint on the problem of finding the optimal utilitarian tax mix. The horizontal equity constraint requires that individuals with the same ability have to pay the same amount of taxes regardless of their preferences for leisure. Contrary to normal findings, we find that a good that is complementary to leisure need not be discouraged by the tax system, and that a good that normally should be discouraged by the tax system need not be taxed at a positive rate even if the economy is composed of only two private commodities plus leisure. Similarly, the marginal effective tax rate need not be equal to zero at the top when the tax mix obeys the horizontal equity constraint.  

JEL-Classification: D63, H21, H24.

Keywords: Horizontal Equity, Optimal Taxation, Heterogenous Preferences, Utilitarianism.

Kaas, Leo; Leopold von Thadden

University of Vienna; Deutsche Bundesbank Frankfurt

Budgetary Policy and Unemployment Dynamics

We consider a dynamic general equilibrium model with collective wage bargaining and investigate how unemployment dynamics are affected by two types of  budgetary policies.  In line with traditional reasoning, a balanced-budget rule amplifies fluctuations in the short run, whereas an unbalanced-budget policy dampens them.  However, the latter policy strengthens unemployment persistence by its adverse impact on growth, and may even destabilize the adjustment  path.  If this is the case, a future fiscal consolidation is needed which further raises unemployment. These results are consistent with empirical evidence on a positive cross-country relationship between government borrowing and unemployment persistence.  

Keywords:  Unemployment, Overlapping generations, Public debt

JEL classification: E24, E62, H62

Kacperczyk, Marcin; Zbigniew Kominek (YE)

University of Michigan Business School; Europe Economics Research Limited

Do Optimists Grow Faster and Invest More?

The paper discusses a two-period model of an economy with two industries, positive production externalities and random shocks to production functions. Multiple equilibria that arise in such a framework can be ranked according to agent's optimism. The equilibria with higher levels of optimism are characterized by higher economic growth, higher production growth and higher proportion of investments in externality yielding industries. Using the U.S. data, it is shown that changes in sentiment predict economic growth. Sentiment has significant positive impact on industry growth, aggregate economic growth and relative levels of investment in industries. Externality yielding industries also appear to be more affected by shifts in sentiment than non-externality yielding industries.  

JEL CLASSIFICATION: D92, G31, O16.

KEYWORDS: Sentiment, Investment, Economic Growth, Production Externalities

Kapetanios, George; Simon Price

Bank of England

Estimation and Inference in a Non-Linear State Space Model: Durable Consumption

Several ways of modelling non-linear state space models have been suggested.  The extended Kalman Filter is a tractable way of doing so.  One application is to consumer durable demand. Models explaining this  flow  are normally conditioned on the stock.  For the UK, measures of the stock are unavailable. However, it might be estimated from a non-linear state space model.  The model is estimated using  a linear approximation of the first order conditions for the household's consumption problem and the stock accumulation identity.  The results suggest there is very little time variation in depreciation rates over our sample, and that households are close to risk neutrality.  Diagnostics suggest further refinement of the model is called for.  

JEL: C50, D12, E21

KEYWORDS:  consumer durables, non-linear, state space

Kapteyn, Arie; Federica Teppa

RAND Corporation; CentER, Tilburg University

Hypothetical Intertemporal Consumption Choices

The paper extends and replicates part of the analysis by Barsky, Juster, Kimball, and Shapiro (1997), which exploits hypothetical choices among different consumption streams to infer intertemporal substitution elasticities and rates of time preference. We use a new and much larger dataset than Barsky et al. Furthermore, we estimate structural models of intertemporal choice, while parameterizing the parameters of interest as a function of relevant individual characteristics. We also consider ''behavioral'' extensions, like habit formation. Models with habit formation appear to be superior to models with intertemporally additive preferences.  

JEL classification: C5; C9; D9

Keywords: Consumer Choice; Econometric Models

Kelly, Clare; Gauthier Lanot

University College Dublin; Keele University

Consumption Patterns over Pay Periods

This paper establishes a theoretical framework to characterise the optimal behaviour of individuals who receive income periodically but make consumption decisions at frequent points during that period, when there is uncertainty with respect to prices and imperfect credit markets. We simulate the numerical solution to this model and find that optimal consumption is u-shaped over the pay period.  We apply the model to weekly expenditure data from the FES to estimate the coefficient of relative risk aversion (preliminary point estimates are around 6) and the extent of measurement error in the data (which accounts for approximately 50% of the variance in the data).  

JEL Classification: D11; D12; D91.

Key Words: Consumption; liquidity constraints; uncertainty; periodic income receipt

Kelsey, David; Frank Milne

The University of Birmingham, UK; Queens University, Canada

Monopoly Externalities and Non-Profit Maximising Firms

This paper provides a theory of a monopolist in general equilibrium. We assume that the firm's decisions are based on the preferences of shareholders and/or other stake-holders. We show that the monopolist will charge less than the profit-maximising price, since shareholders suffer part of the cost of a price rise if they are also consumers. If price discrimination is possible, the resulting equilibrium will be Pareto efficient.  We use the model to examine the effects of increasing stake-holder representation in firms.  A related result shows that a non-profit firm will produce fewer negative externalities.  

Keywords: Monopoly, stakeholder, externality, co-operative, hold-up

JEL Classification:  D52, D70, L20

Keuschnigg. Christian

University of St.Gallen, CEPR and CESifo

Venture Capital Backed Growth

The paper proposes a simple equilibrium model of venture capital, entrepreneurship and innovation. Venture capitalists not only finance but also advise start-up entrepreneurs and thereby add value to new firms. The paper demonstrates how a productive and active VC industry boosts innovation driven growth.  

Keywords: Venture capital, double moral hazard, innovation, growth.

JEL-Classification: D82, G32, O16, O40.

Koren, Miklos; Adam Szeidl

Harvard University

Pricing Illiquid Assets

The present paper investigates the portfolio allocation decisions of an investor with infinite horizon when available financial assets differ in their degrees of liquidity. A model with risk neutral agents allows us to endogenously determine the liquidity premium. With risk averse agents, we develop a nontrivial portfolio allocation problem, which enables us to calculate the demand for an illiquid asset for any given yield premium. We calibrate and numerically simulate both models. Reasonable parameter values imply a liquidity premium of 1.7\% for the risk neutral case. In the portfolio allocation problem we find that a reasonable amount of illiquidity can cause a substantial drop of demand for the asset. We are also able to calculate the price discount at which an agent would be indifferent between immediate sale and waiting for a buyer with a fundamentally justified price.  

JEL Classification: G11, G12

Keywords: Liquidity, Financial Markets, Asset Pricing, Portfolio Choice

Kou, Samuel; Steve Kou

Harvard University; Columbia University

Modeling Growth Stocks via Size Distribution

The inability to predict the earnings of growth stocks, such as biotechnology and internet stocks, leads to the high volatility of share prices and difficulty in applying the traditional valuation methods. This paper attempts to demonstrate that the high volatility of share prices can nevertheless be used in building a model that leads to a particular size distribution, which can then be applied to price a growth stock relative to its peers. The model focuses on both transient and steady state behavior of the market capitalization of the stock, which in turn is modeled as a birth-death process. In addition, the model gives an explanation to an empirical observation that the market capitalization of internet stocks tends to be a power function of their relative ranks.  

Keywords: biotechnology and internet stocks, asset pricing, birth-death process, convergence rate, power-type distribution, regression.

Krishnan, Pramila

University of Cambridge

Cultural Norms, social Interactions and the Fertility Transition in India

Tables

Measures of cultural traits are used to test the hypothesis that the variation in fertility levels in India, both over time and across regions, can be explained by cultural factors and social interactions.  The paper examines the arguments for why culturally determined rules might affect preferences and constraints and how they interact with economic incentives to regulate fertility outcomes.  The variation in cultural norms across Indian communities is found to play a large part in explaining differences in outcomes across regions as well as determining the path of fertility decline over time.  Assuming that households have adaptive expectations over community-level fertility, there is robust evidence of social interaction effects but little support for the existence of multiple equilibria.  

JEL classification: D1, J1, O1

Keywords: social interactions, fertility transition

Kugler, Maurice

University of Southampton

International Trade when Inequality Affects Aggregate Demand

The model derives the pattern of international trade between rich and poor countries, when preferences are nonhomothetic. By and large, models of the dynamics of North-South trade impose the assumption of unit income elasticity for all consumption goods. This assumption is relaxed to incorporate the insight from Engel’s Law: The budget share allocated to necessities falls with income. </color> To account for the impact of income distribution, preferences are such that consumers rank indivisible goods according to a hierarchy of both needs and desires. The composition of the aggregate consumption basket in the integrated economy depends on both inter- and intra-national inequality. Empirical evidence from a panel of bilateral trade data among 57 countries, for which adequate income distribution measures exist, and spanning three decades supports the conjecture that high inequality in a trading partner yields less bilateral trade flows through lower imports, after controlling for both observed and unobserved heterogeneity.  

Keywords: Nonhomothetic preferences; inequality; aggregate import demand; pattern of international trade

JEL Classification: F12, F15, O11, O31

Lane, Philip R.; Gian Maria Milesi-Ferretti

Trinity College Dublin and CEPR; International Monetary Fund and CEPR

External Wealth, the Trade Balance, and the Real Exchange Rate

We examine the link between the net foreign asset position, the trade balance and the real exchange rate. In particular, we decompose the impact of a country’s net foreign asset position (‘external wealth’) on its long-run real exchange rate into two mechanisms: the relation between external wealth and the trade balance; and, holding fixed other determinants, a negative relation between the trade balance and the real exchange rate. We also provide additional evidence that the relative price of nontradables is an important channel linking the trade balance and the real exchange rate.  

JEL Classification: F21, F31, F41.

Keywords: Net foreign assets, trade balance, real exchange rate.

Larsen, Jens; Katharine Neiss; Fergal Shortall

Bank of England

Factor Utilisation and Productivity Estimates for the United Kingdom

This paper derives series for capital utilisation, labour effort and total factor productivity from a DGE model with variable utilisation and labour adjustment costs.  Capital utilisation tracks survey-based measures closely, while movements in total hours worked drive our labour effort series.  TFP is less cyclical than the traditional Solow residual, though a weighted average of capital utilisation and labour effort - aggregate factor utilisation - and the Solow residual are not closely related.  Rather, aggregate factor utilisation is correlated with detrended labour productivity, providing more evidence that differences in average and marginal labour productivity may be linked to factor hoarding.  

JEL No. E32, E22, E24, E27.

Key words: Factor utilisation, total factor productivity, business cycles.

Leaver, Clare

University College London

Bureaucratic Minimal Squawk: Theory and Evidence

Regulators appointed on finite contracts have an incentive to signal their worth to the job market. This paper shows that, if contracts are sufficiently short, this can result in "minimal squawk'' behaviour. Regulated firms publicise the quality of unfavourable decisions, aware that regulators then set favourable policies more often to keep their professional reputation intact. Terms of office vary across US states, prompting an empirical test using firm-level data from the regulation of the US electric industry. Consistent with the theory, we find that shorter terms are associated with fewer rate of return reviews and higher residential prices.  

JEL Classification: C23, C25, D73, J45

Keywords: bureaucratic behaviour, career concerns, capture, binary choice models with panel data.

Lee, Young-Sook

University of Nottingham

Intraday Predictability of Overnight Interest Rates

Lee (2001) found the overnight Eurodollar rate in London and the effective Fed funds rate exhibit similar calendar-day effects although the absolute magnitudes are less.  Explanations for the smaller calendar-day effects on the overnight Eurodollar rate include the difference between market-specific conventions in the two markets and the time difference in measuring two interest rates.  This paper investigates the relationship between the Fed funds rate at 11:30 am EST, the effective Fed funds rate and the overnight Eurodollar rate in London.  It is found that the different calendar-day effects are caused by both the difference between market structures and by data collecting time difference.  

JEL classification: E44; G15; G21

Key words: Overnight Eurodollar rate; Fed funds rate; Calendar day effects; Intraday interest rate

Leese, Robert; Paul Levine; Neil Rickman

University of Oxford and Smith Institute; University of Surrey, LBS and CEPR

The Economic Effects of Spectrum Trading

We consider a model in which Cournot-Nash oligopolistic service providers are able to trade radio spectrum licences, subject to interference constraints. The terms of trade are endogenised through Nash bargaining. When the providers are in the same (geographical) market, the incentive to trade is due to cost differences; when they are in separate markets, differential demand conditions can also stimulate trade. We show that trade can enhance the productive efficiency of service provision (by concentrating production in low cost firms) but the resulting service consumer prices may have negative welfare implications.  We then present numerical results from a program designed to simulate trading scenarios. these results illustrate a number of outcomes of allowing licence trades. We discuss a number of applications and extensions for our model and the relevance of our results for current government consultations on spectrum trading.  

KEYWORDS: Trading, Radio spectrum, Regulation

JEL CLASSIFICATION: L10, L50, L96

Leith, Campbell; Simon Wren-Lewis

University of Glasgow; University of Exeter

Compatibility Between Monetary and Fiscal Policy Under EMU

The potential importance of fiscal policy in influencing inflation has recently been highlighted, following Woodford (1998), under the heading of the 'Fiscal Theory of the Price Level' (FTPL). Some authors have suggested that this theory provides a rationale for the Pact for Stability and Growth as a necessary condition for the ECB pursuing a policy of price stability. In this paper, we relax the assumptions underpinning the FTPL by developing a two country open economy model, where each country has overlapping generations of non-Ricardian consumers who supply labour to imperfectly competitive firms which can only change their prices infrequently. We examine the case where the two countries have formed a monetary union, but where the fiscal authorities remain independent.  

JEL Codes:E10, E63.

Key Words: EMU, Stability and Growth Pact, Monetary Policy, Fiscal Policy, Fiscal Theory of the Price Level

Leonardi, Marco

London School of Economics

Product Demand Shifts and Wage Inequality

The UK and the US have experienced both rising skill premia and rising employment of skilled workers since the 1980s. These trends are typically interpreted as concurrent shifts of relative skill supplies and demands, and the demand shifts are attributed to skill biased technological change or changes in international trade patterns. If more skilled workers demand more skill intensive goods, then an exogenous increase in relative skill supplies will also induce a shift in relative demand. This channel reduces the need to rely on technology and trade to explain the patterns in the data. In this paper, I illustrate this mechanism in a simple two-sector general equilibrium model. The empirical part of the paper demonstrates that more educated and richer workers indeed demand more skill intensive goods in the UK. Calibration of the model suggests that this induced demand shift can explain 12% of the total relative demand shift in the UK between 1981 and 1993. The baseline model only explains between industry shifts in skill upgrading and wage inequality, while empirically, most of these changes took place within industries. An extension of the model with different qualities of goods and labor is also able to explain some of the within industry changes.  

Keywords: Wage Inequality, Demand Shifts, Income Elasticity.

JEL codes: J21, J31

Leontaridi, Rannia M.; Melanie E. Ward

Stirling University and CELMR; IZA and CEPR

Dying to work? An investigation into work-related stress, quitting intentions and absenteeism

The paper uses data from the International Social Surveys Program (ISSP) to investigate work-related stress among a group of 15 OECD countries.  It examines the determinants of work-related stress and explores the importance of work-related stress as a predictor of individuals' quitting behaviour and the rate of absenteeism.  We find that those individuals reporting to experience at least some stress in their current position are 25% more likely to hold intentions to quit or be absent from work than those without any job stress, with the probability of intending to quit or being absent increasing with successively higher work-related stress levels.  

JEL classification: J220, J280, J630, I10

Keywords: Job stress, quits, turnover, absenteeism

Lewis, Richard; Robert McNabb; Helen Robinson; Victoria Wass

Cardiff Law School; Cardiff Business School

A comparison of two alternative methods for determining loss of future earnings following personal injury’

The law provides that any person injured through the fault of another can claim monetary compensation in the form of damages. Restitutio in integrum defines the objective and measure of damages. Damages in respect of loss of future earnings comprise the product of an estimated annual loss and an estimated number of years purchase. Estimates are made by means of intuition and precedent with little reference to labour economics. Damages calculated under an alternative methodology incorporating age-earnings profiles and conditional employment rates are compared with damages awarded in 100 adjudicated cases to reveal systematic and substantial under-compensation under the court method.  

JEL Classification: K41

Keywords: damages, earnings, disability

University of California, Berkely

Limão, Nuno

University of Maryland

Are Preferential trade Agreements with Non-trade Objectives a Stumbling Block for Multilateral Liberalization?

Increasingly, in regional agreements, large economies offer lower trade barriers in exchange for cooperation in environmental, intellectual property and other issues by small economies. What is the effect of such agreements on multilateral trade liberalization? We show that, even in the absence of trade creation or diversion, regional agreements increase the cost of multilateral tariff reductions. Such reductions decrease the threat large countries can use in regional agreements causing a loss in regional bargaining power. By explicitly modeling the interaction between regional and multilateral negotiations we show that this result is due to the WTO's most-favorite nation rules and analyze the welfare effects of strengthening and weakening them. Moreover, we show that "deepening" duty-free regional agreements requires increases in multilateral tariffs.  

JEL classification: F13; F15; F18; F42; H77.

Keywords: Multilateral trade negotiations; most-favorite nation clause; regional integration; cross-border externalities; environment; labor standards; bargaining; repeated games.

Liu, Xiaohui; Yingqi Wei

The University of Luton; Lancaster University

Export Requirements and Special Features of Inward Foreign Direct Investment in China

The paper investigates the relationship between the policy of export requirements and special features of China's inward foreign direct investment (FDI), and examines how trade-related investment measures affect the investment decisions of multinational firms. A theoretical model is constructed that allows us to analyse how location advantages affect the equilibrium regime under which multinational firms and government policy toward FDI co-exist endogenously. The model also exam the welfare effects of export requirements policy by comparing with an alternative policy - production tax. The findings from this study accord well with the evidence regarding China's inward FDI. The main results indicate that the policy of export requirements is sub-optimal.  

JEL classification: F13; F23; H21

Keywords: China; export requirements; foreign direct investment; multinational firms; production tax; welfare effect

Lommerud, Kjell Erik; Bjørn Sandvik; Odd Rune Straume

University of Bergen

Good jobs, bad jobs and redistribution

We analyse the question of optimal taxation in a dual economy, when the government is concerned about the distribution of labour income. Income inequality is caused by the presence of sunk capital investments, which creates a 'good jobs' sector due to the capture of quasi-rents by trade unions. We find that whether the government should subsidise or tax investments is crucially dependent on union bargaining strength. If unions are weak, the optimal tax policy implies a combination of investment taxes and progressive income taxation. On the other hand, if unions are strong, we find that the best option for the government is to use investment subsidies in combination with either progressive or proportional taxation, the latter being the optimal policy if the government is not too concerned about inequality and if the cost of income taxation is sufficiently high.  

Keywords: rent sharing, segmented labour markets, optimal taxation, redistribution.

JEL classification: H2, J42, J51.

Loomes, Graham; Chris Starmer; Robert Sugden

University of East Anglia; University of Nottingham; University of East Anglia

Do Anomalies Disappear in Repeated Markets?

Figs.

Many individual decision experiments have generated a variety of seemingly robust ‘anomalies’ (i.e. predictable deviations from the received theory of rational choice); by contrast, many market experiments have appeared to show strong support for the equilibrium predictions of standard theory. Moreover, some recent evidence suggests that some anomalies may decay in repeated experimental markets. This paper investigates whether markets ‘refine’ or ‘discipline’ responses so that they conform with standard theory, or whether market experience may ‘shape’ responses in ways which would warrant serious reconsideration of the foundations of standard economic theory.  

JEL Class:C91; C92; D44.

Keywords:Anomalies; auctions; experimental economics; WTP-WTA disparities; discovered preferences

Madsen, Jakob B

Brunel University

The Dynamics of Income Shares and the Wage Curve-Phillips Curve Controversy

This paper argues that the Phillips curve-wage curve controversy cannot be settled within the conventional testing frameworks and suggests an alternative test, which builds on the model of Blanchard and Katz (1997).  Using long macro data for the OECD countries, the evidence gives very strong support for the Phillips curve and indicates that wage behaviour is no different among the OECD countries.  This implies that adverse supply shocks, which push wages in excess of the full employment equilibrium, have only temporary effects on real product wages and therefore cannot explain the persistently high unemployment in most European countries.  

JEL Classification:  C23, E24, E3, J30, J60

Key words: Wage curve, Phillips curve, mean-reversion of factor shares

Mahadeva, Lavan; Gabriel Sterne

Bank of England

Inflation Targets as a Stabilisation Device

Over 80% of countries using explicit inflation targets in 2000 were doing so either as part of a disinflation strategy, or when inflation was neither low nor stable. Our illustrative theoretical model suggests annual revisions to short-run targets are endogenous to inflation outcomes during disinflation as long as the policymaker cares about misses from both the short-run target and a long-run target.  Furthermore, target revisions will are larger when the target is undershot compared to when the target is overshot.  We confirm the result using cross-country panel estimates from a unique data-set of inflation target misses in 60 countries in the 1990s. During disinflation it is therefore relatively difficult to separate decisions about target-setting from implementation. Short-term targets on a disinflation path may be more akin to conditional forecasts than policy rules, but their publication may nevertheless increase transparency and hence help policymakers to achieve lower inflation.   

JEL codes: E31 E41 E52 E58

Key words: inflation targets, disinflation, stabilisation, prerequisites

Maloney, John; Andrew Pickering; Kaddour Hadri

University of Exeter; University of Bristol; University of Liverpool

Which Type of Central Bank Smooths the Political Business Cycle?

This paper develops a dynamic model of Rational Partisan Business Cycles, wherein wage contracts overlap elections and wage setters have to make a prediction about the election result.  Uncertainty leads to pre- and post-election date output fluctuations.  Election result probabilities are imputed and then used to construct variables in electoral uncertainty.  Using data from 20 OECD countries over the period 1960-1998 left wing incumbents are found to increase output, but the increased expectation of a left wing regime reduces it.  These political effects are found to be offset by Central Bank Independence and in particular, objective independence.  

JEL Classifications: E3, E5, E6.

Keywords: Political Business Cycle, Central Bank Independence.

Manenti, Fabio M.; Ernesto Somma

Università di Padova; Università degli Studi di Bari

One-Way Compatibility, Two-Way Compatibility and Entry in Network Industries

We study the strategic choice of compatibility between two initially incompatible software packages in a two-stage game by an incumbent and an entrant firm. Consumers enjoy network externality in consumption and maximise expected surplus over the two periods. Compatibility may be achieved by means of a converter. We derive a number of results under di®erent assumptions about the nature of the converter (one-way vs two-way) and the existence of property rights. In the case of a two-way converter, which can only be supplied by the incumbent, incompatibility will result in equilibrium and depending on the strength of network externalities the incumbent may deter entry. When both firms can build a one-way converter and there are no property rights on the necessary technical specifications, the only fulfilled expectations subgame perfect equilibrium involves full compatibility. Finally, when each firm has property rights on its technical specifications, full incompatibility and preemption are again observed at the equilibrium. Entry deterrence will then occur for su±ciently strong network e®ects. The analysis generalises to any market where network externalities are present.  

J.E.L. codes: L13, L15, D43

Keywords: Network externalities, one-way compatibility, two-way compatibility, entry.

Martin, Christopher; Costas Milas

Brunel University

Modelling Monetary Policy: Inflation Targeting in Practice

This paper estimates a simple structural model of monetary policy in the UK for 1963-2000, focusing on the policy of inflation targeting introduced in 1992.  Our main findings are: i) the adoption of inflation targets led to significant changes in monetary policy giving greater weight to inflation; (ii) monetary policy post-1992 is asymmetric as policy makers respond more to upward deviation of inflation away from the target; (iii) in the post-1992 period policymakers may be attempting to keep inflation within the range of 1.4%-2.6% rather than pursuing a point target of 2.5%; (iv) monetary policy is more responsive to inflation when it is further from the target.  

JEL:  C51; C52; E52; E58

Keywords:  monetary policy, inflation targeting

Mash, Richard

University of Oxford

New Keynesian Microfoundations Revisited: A Generalised Calvo-Taylor Model and the Desirability of Inflation vs. Price Level Targeting.

Optimal monetary policy is sensitive to the Phillips curve used to represent the dynamics of inflation and output.  Most recent literature has used a New Keynesian Phillips curve based on Calvo pricing.  This paper shows that this workhorse model is not robust to relatively minor changes in its microfoundations, in particular allowing for time varying probabilitites of a firm being able to reset its price.  We derive a general model that nests Calvo and the Taylor staggering model as special cases and analyse its implications for optimal policy, including the relative desirability of inflation and price level targeting.  

JEL Classification: E52, E58, E22

Key words: New Keynesian Phillips Curve, Stabilisation Bias, Forward Looking Expectations, Inflation Targeting, Price Level Targeting, Calvo Pricing

Matas-Mir, Antoni; Denise R Osborn

University of Manchester

Does Seasonality Change over the Business Cycle? An Investigation using Monthly Industrial Production Series

This paper examines the proposition that the business cycle affects seasonality in industrial production, with output being switched to the traditionally low production summer months when recent (annual) growth has been strong. This is investigated through the use of a restricted threshold autoregressive model for the monthly growth rate in a total of 74 industries from 16 OECD countries. Approximately one third of the series exhibit significant nonlinearity, with this nonlinearity predominantly associated with changes in the seasonal pattern. Estimates show that the summer slowdown in many European countries is substantially reduced when recent growth has been high.  

JEL classifications: E25, E32

Keywords: Seasonality, business cycle, nonlinear models

Mongelli, Francesco Paolo

European Central Bank

“New" Views on the Optimum Currency Area Theory: What is EMU Telling US?

This paper traces the advancements of the optimum currency area theory through its successive phases: the "pioneering phase," the "cost-benefit phase," the "reassessment phase," and the "empirical phase" in which we focus mostly on Europe because there is now a wealth of data, research and other information on European integration. The thrust of the pioneering contributions is still relevant and that the analysis of the benefits and costs from monetary integration has greatly evolved. There are more benefits and some of the perceived costs are smaller than previously thought. We also need to distinguish between an "OCA question" and an "EMU question."  

JEL classification: E42, F15, F33 and F41.

Keyword: Optimum Currency Area, Economic and Monetary Integration, International Monetary Arrangements, and EMU

Moraga-Gonzalez, Jose Luis; Jean-Marie Viaene

Erasmus University Rotterdam

Procompetitive Trade Policies

We study the procompetitive effects of trade policies against a foreign oligopoly in a model of vertical product differentiation. We show that a uniform tariff policy like the Most Favored Nation (MFN) clause is welfare superior to free trade because of a pure rent-extraction effect. A nonuniform tariff policy is, in addition, procompetitive and thus yields a higher level of social welfare. The first best policy typically consists of subsidizing production of low quality and levying a tariff on production of high quality. Regional Trade Agreements (RTAs) are examples of nonuniform tariff policies. We show that these arrangements yield higher welfare than free trade and, moreover, that a RTA with a low-quality producing country yields larger gains than a RTA with a high-quality producing country.  

JEL Classification: F12, F13, F15

Keywords: Endogenous Quality, Most Favored Nation (MFN) clause, Procompetitive policies, Regional Trade Agreements

Morales, Maria F.

Universidad de Murcia

Technological Progress and the Distribution of Productivities across Sectors

This paper studies the impact of the process of technological change on the distribution of productivities and profits across sectors. We find that if technological progress affects high-tech and traditional sectors differently, the impact of changes in the determinants of economic growth may differ depending on which is the actual change. When an economy is growing faster due to an increase in the productivity of research or to a reduction of the taxes on capital accumulation, inequality will decrease. However, if faster growth is due to the presence of tax incentives to high technology sectors or to structural changes that allow a better absorption of externalities, inequality will increase.  

JEL codes: O31; O38; O40.

Keywords: inequality; distribution of profits; endogenous growth.

Moretto, Michele; Paola Valbonesi

Università di Padova

Regulating local Public Utilities by Profit-Sharing

This paper concerns "profit-sharing" within an incomplete regulatory contract where a municipality delegates a risk-neutral firm to manage a local utility. Together with a price cap regulation (PCR) mechanism, the contract envisages the possibility of the municipality revoking the contract if the firm's profits are percieved "excessively" high. We show that when this threat is credible and the cost of exercising it is not too high, a long-term efficient equilibrium arises which guarantees the firm with an appropriate level of profits. The consequent regulation timing consists of an endogenous regulatory lag where the regulation has a PCR nature, followed by a period of ROR in which the firm is motivated to adjust its price downward to avoid contract recall. We also show that excessive revocation costs make the firm an unregulated monopolist with an infinite regulatory lag where ROR looks like a pure PCR.  

Key words: Public utilities, Regulatory contracts, Profit-sharing, Stochastic games.

JEL: C73, L33, L51

Mukherjee, Arijit

Keele University

Knowledge spillover, licensing and patent protection

This paper investigates the effect of different patent regimes on R&D investment and social welfare in a duopoly market with uncertain R&D process. We find that strong patent protection increases R&D investment of at least one firm but whether both firms’ R&D investment will be more under strong patent protection is ambiguous. While ex-ante welfare is more likely to be higher under strong patent protection, ex-post welfare may be higher under strong patent protection. Whether the possibility of licensing increases both firms’ R&D investment is also ambiguous. Licensing with up-front fixed-fee can increase policy dilemma by increasing the possibility of higher ex-ante welfare under strong patent protection but higher ex-post welfare under weak patent protection. However, the results may be different for licensing contract with per-unit output royalty.  

Key Words: Knowledge spillover, Licensing, Patent protection, Uncertain R&D

JEL Classifications: D43, L13, O34

Muller, Christophe

University of Nottingham

Weakening the Strong Convexity of Preferences

In general models, the strong quasi-concavity of the objective function, which is sufficient for theoretical properties of demands in consumer theory, is often arbitrary and weaker global concavity conditions are desirable. We propose a new global concavity condition that implies, for models with \smallskip several nonlinear constraints, the local uniqueness and the smoothness of the decision functions as well as the negativity of the generalised substitution matrix. This condition can be used to specify general and flexible economic models and is easier to check than the strong quasi-concavity or the usual second order conditions over the whole domain.

JEL codes: C61, D11, D13.

Keywords: Programming Models, Consumer Economics, Household Poduction

Muñoz, Sònia

London School of Economics and CEP

The Breakdown of Credit Relations under Conditions of a Banking Crisis. A Switching Regime Approach

This paper empirically analyses the effects of a banking crisis on bank credit to the private sector for a panel of developing, developed, and transition economies for the period 1970-1998. The model illustrates how the behaviour of the bank credit function changes during a banking crisis, reflecting a generalized disruption in the stability of behavioural parameters. Usual links such as interest rate signalling on lending, and synergy between deposits and loans, fall apart. Moreover, this study gives support to Third Generation Models in their ability to predict banking crises. Based on the empirical findings, the paper then provides policy implications for monetary policy.  

JEL Classification Numbers: C35, E44, E52, G21

Keywords: Bank Supply of Credit, Banking Crises, Monetary Policy Instruments.

Newbery, David M; Georgina Santos

University of Cambridge

Estimating Urban Road Congestion Costs

Economists wishing to analyse road congestion and road pricing have usually relied on link-based speed-flow relationships. These may provide a poor description of urban congestion, which mainly arises from delays at intersections. Using the simulation model SATURN, we investigate the second-best proportional traffic reduction and find that linear speed-flow relations describe network flows quite well in eight English towns, though the predicted congestion costs and charges overstate those apparently required in our second best model. We then confront the results with feasible optimal cordon charges, and find them reasonably correlated, but imperfect predictors.  

Key words: Congestion tolls, traffic congestion, road pricing, efficient charges

JEL classification: H54, H11, R41, R48.

Neyer, Ulrike

Martin-Luther-University

Asymmetric Information in Credit Markets and Monetary Policy

This paper analyzes the consequences of asymmetric information in credit markets for monetary policy transmission mechanism. It is shown that asymmetric information can reinforce, weaken or overcompensate the effects of the conventional interest rate channel. Crucial is that informational problems lead to an external finance premium, which can be positive or negative for marginal entrepreneurs, i. e. they either have to bear the costs or actually benefit from informational problems. Monetary policy influences this premium, which implies that there is a credit channel of monetary policy due to asymmetric information, but its direction of influence is ambiguous.  

JEL classification: D 82, E 44, E 52

Keywords: Asymmetric Information, Monetary Policy, Credit Channel

Nohel, Tom; Steven Todd

Loyola University Chicago

Stock options and managerial incentives to invest

We examine the effect of stock options on managerial incentives to invest.  Our chief innovation is a model wherein firm value and executive decisions are endogenous.  Numerical solutions to our model show that managerial incentives to invest are multi-dimensional and highly sensitive to option strike prices, the manager's wealth, degree of diversification, risk aversion, and career concerns.  We find that over-investment problems are far more likely and far more severe that many researchers suggest.  Finally, firm value is not a strictly increasing function of a manager's incentive compensation or conventional pay-for-performance metrics.  Stronger managerial incentives to invest can benefit or harm a firm.  Our results should send a cautionary signal to researchers who study managerial behavior.  It is not sufficient to rely on one-dimensional risk-neutral valuation metrics, such as pay-for-performance, to describe the degree of incentive alignment between managers and shareholders.  

JEL Classification:  G31, G34, J33, L22.

Keywords:  executive compensation, stock options, incentives, corporate investment.

Nolan, Anne

Trinity College Dublin

The Determinants of Urban Households' Transport Decisions: A Microeconometric Study using Irish Data

This paper uses Irish micro-data to analyse the determinants of urban households' transport decisions by estimating elasticities of demand for car ownership, car use and public transport with respect to income and various household socio-demographic characteristics. This paper uses expenditure data to examine car and public transport use and analyses the latter decision for separate samples of households, namely, those owning one car and those owning no car. A binary probit model is estimated for the car ownership decision, while for the car use and public transport expenditure decisions, Tobit models adjusted for heteroscedastic and non-normal errors are estimated.  

JEL Classification: D12, R41

Keywords: household, car ownership, transport expenditure, probit, Tobit.

Nolan, Brian; Donal O'Neill

ESRI, Dublin; NUI Maynooth, Ireland

Evaluating the Impact of a National Minimum Wage: Evidence from a New Survey of Firms

In April 2000 the Irish government introduced a national minimum wage of £4.40  an hour. This paper uses data from a specially designed panel survey of firms to estimate the labour market effects of this change. Initial results show that employment growth among firms with low wage workers prior to the legislation was not significantly different to that for firms not affected by the legislation. However, this measure of the minimum wage bite is likely to overestimate the number of firms affected by the legislation. When we use a more refined measure of the minimum wage bite, which takes account of general wage growth in the economy we find the minimum wage may have had a statistically significantly negative effect on employment for the small number of firms most severely affected by the legislation.  

JEL Classification: J3, I3

Keywords: Minimum wages, Firm-Level Data

Ota, Masako; Peter G. Moffatt

University of East Anglia

The Within-household Schooling Decision: A Study of Children in Rural Andhra Pradesh

Using microdata from a field survey of children in rural Andhra Pradesh, India, we estimate econometric models which aim to identify the key explanatory factors in the school versus out-of-school dichotomy.  The approach differs from that of many other previous studies of child schooling, by focusing on the effects of sibling competition within the household.  The value of this approach is confirmed by our findings that the schooling decision depends as much on the child's characteristics and position within the household, as on the circumstances of the household taken as a unit.  

JEL classifications: C25,J13.

Key words: Child labour, Schooling, Birth order, Sibling composition, Intra-household decision-making, India

Pain, Nigel

National Institute of Economic and Social Research

A Fairytale Ending Or The Same Old Story? The New Economy and Economic Growth in the United States.

This paper uses a production function approach to put the recent contribution of the New Economy to US economic growth into perspective by undertaking an analysis of the sources of technical progress in the business sector over the post-war period. We model jointly a pair of factor demand equations derived consistently from an underlying CES production technology, and explicitly endogenise technical progress. Knowledge accumulation via R&D and education are found to be the main sources of technical progress, but there is evidence of significant structural change after 1995 which can be removed by allowing for externalities from investment in information processing equipment and software. Labour augmenting technical progress is estimated to be over 2 per cent per annum faster since 1995 than can otherwise be explained.  

JEL Codes: O4, O3, E2

Keywords: growth, technical progress, knowledge accumulation, New Economy

Panteghini, Paolo; Carlo Scarpa

Università di Brescia

Incentives to (irreversible) investments under different regulatory regimes

This paper addresses the issue of how regulatory constraints affect firm's investment choices when the firm has the option to delay investment. The "RPI-x" rule is compared to a profit sharing rule, which increases the x factor in case profits go beyond a given level. It is shown that these rules are identical in their impact on investment choices, in that the change in the option value exactly compensates the change in the ``direct'' profitability of investment. The result is then analysed in the light of option theory and explained on the basis of the ``bad news principle''.  

JEL Classification: L51, D92, G31

Keywords: regulation, investment, RPI-x, profit sharing.

Paton, David; Leighton Vaughan Williams

Nottingham University Business School; Nottingham Trent University

'Quarbs' and Efficiency in Spread Betting Markets: can you beat the book?

In this paper, we examine a relatively novel form of gambling, index (or spread) betting, that mirrors (and indeed overlaps with) practices in conventional financial markets.  In this form of betting, a number of bookmakers quote a bid-offer spread about the result of some future event, and bettors are invited to buy (sell) at the top (bottom) end of the quoted spreads.  We hypothesise that the existence of an outlying spread may provide uninformed traders with information that can be used to develop improved trading strategies.  Using conditional moment tests on data from a popular spread betting market in the United Kingdom, we find that in the presence of a number of price-setters, the market mid-point is indeed a better predictor of asset values than the outlying price.  We further show that this information can be used to develop trading strategies that lead to returns that are consistently positive and superior to those from noise trading and, in some cases, significantly so.  

JEL Classification: D82, G12, G14.

Keywords: Quarbs, market efficiency, betting.

Pudney, Stephen

University of Leicester

The Road to Ruin? Sequences of initiation to drug use and offending by young people in Britain

The routes by which young people develop offending behaviour are very varied and strongly influenced by family background. A good understanding of the temporal sequences of  first experiences of illicit drug use and other offending behaviour is needed before any plausible attempt can be made to investigate causal "gateway" effects. In this paper we develop and apply a statistical method for analysing the behavioural sequences observed in the 1998 Youth Lifestyles Survey. Gateway effects are found to be small after controlling for observable and unobservable characteristics.  

KEYWORDS: illicit drugs, gateway effect, youth crime, random effects.

JEL CLASSIFICATION: I120, K420

Rehme, Günther

Technische Universität Darmstadt

Why Run a Million Regressions? Endogenous Policy and Cross-Country Growth Empirics

This paper analyses the link between growth and public policy when the latter depends on economically important fundamentals. When policy is endogenous the measured effects  of policy on growth will generally be biased. Using a widely quoted theoretical model, the signs of the biases are derived. It is shown that the usually reported effects on growth of tax rate variables related to GDP, the ratio of public investment to total investment and the ratio of redistributive transfers to GDP are generally biased downwards. Based on these signed biases the paper discusses some empirical results that seem puzzling from a theoretical viewpoint.  

Keywords: Growth, Public Policy, Cross-Sectional Models

JEL Classification: O4, C2

Reid, Gavin C

University of St Andrews

Flexibility in the Small Firm: the dynamics of market re-positioning and scale adjustment in the early stages of the life cycle

This paper examines flexibility in the small firm in two ways.  First, it looks at the re-positioning of their main product markets that firms undertake in the early life cycle, in an attempt to best exploit their niche advantages.  The market extent variables used are: local, regional, Scottish, national, and international.  A transition probability approach is taken, estimating the probability of moving from one market are to another in a unit period.  In this way, it is possible to compare the long run equilibrium of such a process, with the period by period adjustment.  This examination of short run adjustment to a long period equilibrium provides insights into small firm flexibility as regards market area and niche exploitation.  It is found that the speed of adjustment of small firms is relatively rapid, and they typically get close to the long period equilibrium in just a few periods of adjustment.  This suggests high flexibility in the exploitation of market areas.  Secondly, the paper estimates a model of the dynamics of small firm sales growth.  This is a variant of a Gibrat's law type of model. It is shown that rapid sales growth is often achieved in the early life cycle.  This process is log-linear in size, dynamically stable, and implies a plausible value for the long run equilibrium size of the small firm.  Over short periods, of just a few years, however, most small firms were yet still below their equilibrium sizes, though a systematic tendency towards equilibrium was observed.  Thus pervasive flexibility was evident in small firm behaviour, both in terms of niche exploitation and growth.  Greater flexibility was observed in niche exploitation, as compared to overall scale.  

Key words: Markov chains, Gibrat's Law, flexibility, Scottish small firms

JEL Classification Numbers: D21, L11, M13, R32

Bocconi University, Italy

JEL classification codes: D82, G28. 

Keywords: liquidity providers, pre-trade transparency, automated markets.

Sarno, Lucio; Giorgio Valente

University of Warwick and Centre for Economic Policy Research

Modelling and Forecasting Stock Returns:  Exploiting the Futures Market, Regime Shifts and International Spillovers

Figs: 1, 2, 3

A large empirical literature has reported that the futures market contains valuable information for explaining stock returns and that stock returns display significant cross-correlations internationally.  A parallel literature has recorded evidence that the distribution of stock returns is close to a mixture of normal distributions and that Markov switching models may therefore provide an adequate characterization of stock returns data.  This paper ties together these strands of research in that we propose a vector equilibrium correction model of stock returns that exploits the information in the futures market, while also allowing for regime-switching behavior and international spillovers across stock market indices.  Using data for three major stock market indices since 1988, we find that our model significantly outperforms a number of alternative models in sample on the basis of standard statistical criteria.  In an out-of-sample forecasting exercise, the model produces some of the highest R^2 hitherto recorded in the literature and beats all of the competing models considered on the basis of density forecast accuracy.  

JEL classification: G10; G13.

Keywords: stock returns; futures; forecasting; nonlinearity; regime switching.

Schmidt, Ulrich; Horst Zank

Christian-Albrechts-Universität zu Kiel, The University of Manchester

An Axiomatization of Linear Cumulative Prospect Theory with Applications to Portfolio Selection and Insurance Demand

The present paper combines loss attitudes and linear utility by providing an axiomatic analysis of corresponding preferences in a cumulative prospect theory (CPT) framework. CPT is one of the most promising alternatives to expected utility theory since it incorporates loss aversion, and linear utility for money receives increasing attention since it is often concluded in empirical research, and employed in theoretical applications. Rabin (2000) emphasizes the importance of linear utility, and highlights loss aversion as an explanatory feature for the disparity of significant small-scale risk aversion and reasonable large-scale risk aversion. In a sense we derive a two-sided variant of Yaari s dual theory, i.e. nonlinear probability weights in the presence of linear utility. The first important difference is that utility may have a kink at the status quo, which allows for the exhibition of loss aversion. Also, we may have different probability weighting functions for gains than for losses. The central condition of our model is termed independence of common increments. The applications of our model to portfolio selection and insurance demand show that CPT with linear utility has more realistic implications than the dual theory since it implies only a weakened variant of plunging.  

Keywords: cumulative prospect theory, linear utility, insurance demand, loss aversion, risk aversion.

JEL Classification Numbers: D81, G11, G22.

Schmidt, Ulrich; Horst Zank

Christian-Albrechts-Universität zu Kiel, The University of Manchester

Risk Aversion in Cumulative Prospect Theory

This paper characterizes the conditions for risk aversion in cumulative prospect theory where risk aversion is defined in the strong sense (Rothshild Stiglitz 1970). Under weaker assumptions than differentiability we show that risk aversion implies convex weighting functions for gains and for losses but not necessarily a concave utility function. Also, we investigate the exact relationship between loss aversion and risk aversion. We illustrate the analysis by considering two special cases of cumulative prospect theory and show that risk aversion and convex utility may coexist.  

Keywords: cumulative prospect theory, strong risk aversion, loss aversion, convex utility.

JEL Classification Number: D81

Schnellenbach, Jan

University of St Gallen

Tax Morale, Leviathan and the Political Process: A Theoretical Approach

It is proposed that a more accurate predicition of tax evasion activity than in the standard portfolio-choice model can be derived even for risk-neutral individuals if psychological costs are considered. Contrary to earlier models integrating psychological costs they are systematically derived by assuming a relationship between cognitive dissonance, taxpayer satisfaction with public policy and taxes evaded. It is shown that this approach to modelling tax evasion can bridge a gap to the literature from economic psychology on the same topic by accounting for several influences that traditionally play a role there, but are neglected in the portfolio-choice model.  

JEL-Classification: H26, Z13

Keywords: tax evasion; tax morale; cognitive dissonance; informal institutions

Sensier, Marianne; Dick van Dijk

University of Manchester; Erasmus University Rotterdam

Short-term Volatility versus Long-term Growth: Evidence in US Macroeconomic Time Series

We test for a change in the volatility of 215 US macroeconomic time series over the period 1960-1996.  We find that about 90% of these series have experienced a break in volatility during this period.  This result is robust to controlling for instability in the mean and business cycle nonlinearities.  Real variables have seen a reduction in volatility since the early 1980s, which is accompanied by lower but steadier output growth.  Furthermore, nominal variables have seen temporary increases in their volatility around the early 1980s.  This suggests the existence of a trade-off between short-term volatility and the long-term pattern of growth.  

JEL: C52, E32.

Keywords: volatility, growth, structural change test, business cycle non-linearity.

Serlenga, Laura; Yongcheol Shin; Andy Snell

University of Edinburgh

A Panel Data Approach to testing Anomaly Effects in Factor Pricing Models

There has been a large anomaly literature where firm specific characteristics such as leverage, past returns, dividend-yield, earnings-to-price ratios and book-to-market ratios as well as size help explain cross sectional returns. These anomalies that have been attributed to market inefficiency could be the result of a mis-specification of the underlying factor pricing model. The most popular approach to detecting these anomaly effects has been the two pass (TP) cross-sectional regression models, advanced by Black, Jensen and Scholes (1972) and Fama and MacBeth (1973). However, it is well-established that the TP method suffers from the errors in variables problem, because estimated betas are used in place of true betas in the second stage cross sectional regression. In this paper we address the issue of testing for factor price misspecification via the panel data approach. It is a salient fact that conventional approaches have completely ignored the benefits of using panel data techniques. Perhaps one of the main reasons for this neglect is that in factor pricing models, all betas are heterogeneous in the first pass time series regression. As a result there is no room for exploiting the panel dimension since there are no homogeneous coefficients to estimate. If our interest lies solely in testing the significance of these characteristics, we can show how to construct a theoretically coherent example to which panel data techniques dealing with both homogeneous and heterogeneous parameters can be applied. Panel-based anomaly tests have one clear advantage over TP-based tests; they are based on full information maximum likelihood estimates so that they do not suffer from the errors in variable problem and have all the usual asymptotic properties associated with likelihood tests. The empirical illustration shows the importance of market to book and market value in helping explain asset returns.  

JEL Classification: C12, C13, G12.

Key Words: Excess returns, market efficiency, anomaly effects, pooled ML estimation.

Sonedda, Daniela

University College London, University of Novara

Employment Effects of Progressive Taxation in a Unionised Economy

One of the main arguments against a public finance solution to unemployment is that, at least in the long run, the tax burden is passed onto labour. This paper presents a general equilibrium model on the relation among tax progressivity, wage setting and employment where changes in labour taxation affect the labour market equilibrium. It is shown that the relation of interest depends on the initial level of taxation and on the labour tax parameter allowed to vary (marginal-average, personal income-payroll taxes). On the basis of a calibration exercise for Italy and the US, the qualitative analysis of the model is supported and the effects are quantified. In particular, larger employment effects are determined by a reduction in both the average (personal income\payroll)\ tax rates. Taking as a benchmark for our policy experiment the actual fiscal reform during the period 1978-97, variations in the employment rate implied by our model are quite close to those empirically observed.  

Keywords: Tax Progression; Labour Supply; Work Sharing; Employment

JEL Classification: H24; J22; J23; J51

Srinivasan, Naveen; Patrick Minford; Francesco Perugini

Cardiff Business School

The Observational Equivalence of Taylor Rule and Taylor-type Rules

In a variety of recent papers, researchers have found that interest rate behaviour approximately follows a Taylor rule. From this they have concluded that the central bank is following a Taylor rule as its monetary policy  reaction function. We show that such interest rate behaviour results when the central bank may be following quite different monetary policy rules from the one proposed by Taylor. In other words an interest rate relation with output and inflation does not identify a central bank reaction function.  

JEL classifications: D5, E4, E52

Keywords: observational equivalence; monetary policy rules

Stark, Oded; You Qiang Wang

University of Oslo and University of Vienna; The Chinese University of Hong Kong

A Theory of Self-Segregation as a Response to Relative Deprivation

We model group formation as a response to relative deprivation. We employ a simple measure of relative deprivation. We show that the process of deprivation-induced self-selection into groups reaches a unique steady state. We study the social welfare implications of the deprivation-induced process of group formation and show that when individuals are left to pursue their betterment the resulting state tends to fall short of the best social outcome. We present several implications of the model including federalism and the demand for secession.  

JEL classification: A13; D71; R23

Keywords: Self-segregation; Group-formation; Relative deprivation; Social welfare

Stewart, Mark B.

University of Warwick

The Impact of the Introduction of the UK Minimum Wage on the Employment Probabilities of Low Wage Workers

This paper uses individual-level longitudinal data from three contrasting datasets (LFS, BHPS and NES) to estimate the impact of the introduction of the UK minimum wage (in April 1999) on the probability of subsequent employment among those whose wages would have had to be raised to comply with the new minimum.  A difference-in-differences estimator is used based on position in the wage distribution.  The estimated effect is insignificantly different from zero for all four demographic groups considered.  The evidence is consistent across the three datasets and is robust to an extensive range of modifications considered.  

Keywords:  Minimum wage, employment determination, labour demand, difference-in-differences estimator.

JEL classifications:  J38, J23.

Strulik, Holger

University of Hamburg

The Role of Human Capital and Population Growth in R&D-Based Models of Economic Growth

Human capital accumulation is introduced into a growth model with R&D-driven expansion in variety and quality and knowledge spillovers from both research activities. Economic growth is not longer uniquely tied to population growth as previous growth models without scale effects suggest. The model predicts that economic growth depends positively on the rate of human capital accumulation and positively or negatively on population growth. It is therefore harder to reject by empirical evidence. Long-run growth is compatible with a stable population. As in previous studies the market generates the optimal growth rate but possibly a suboptimal level of the growth path. I calibrate the model with U.S. data and investigate whether the market provides too little or too much R&D.  

JEL Classification:  E10, O31, O40

Keywords: Human Capital, Population Growth, Semi-Endogenous Economic

Growth, R&D-Spillovers

Sugita, Katsuhiro

University of Warwick

Testing for Cointegration Rank Using Bayes Factors

This paper proposes Bayesian methods for estimating the cointegration rank in an automatic way using Bayes factors. First, we consider natural conjugate priors for computing Bayes factors for the adjustment term. Since using conjugate priors requires that we assign the prior parameters of which we often do not have prior information, and testing by Bayes factor is very sensitive to the parameters, we propose in this paper using the maximum likelihood estimators for the prior parameters. Then, we show the case of using non-informative priors. Since normal Bayes factor cannot be computed with non-informative priors, we apply the intrinsic Bayes factor (IBF) proposed by Berger and Pericchi (1996). Monte Carlo simulations show that using Bayes factor with conjugate priors and the IBF with non-informative priors produce fairly good results. The methods proposed here are also applied for selecting the appropriate lags, or other tests for a VAR model.  

Key words: Cointegration; MCMC; Bayes factor

JEL classification: C11; C12; C32

Suhrcke, Marc

UNICEF Innocenti Research Centre

Preferences for inequality: East vs. West

This paper analyses 1999 data from a large international survey to examine whether attitudes to inequality differ between East and West even after the 'conventional' determinants of attitudes are controlled for. Results suggest that a decade after the breakdown of communism, people in transition countries are indeed significantly more "egalitarian"-minded than those living in the West, even after the actual level of income inequality and a series of other determinants of attitudes are taken into account. The results have implications for the political support for reform policy, in particular for the political feasibility of future welfare state reforms in these countries.  

JEL classification: D30, D63, P5

Keywords: Inequality, transition countries, attitudes

Szymanski, Stefan

Imperial College Management School

Competitive Balance and Income Redistribution in Team Sports

This paper starts with the observation that in most individualistic sports (e.g. golf, tennis, boxing) rewards are highly dependent on performance, while in most team sports direct rewards are almost independent of performance. This paper takes the perspective of Contest (Tournament) Theory and considers the incentive properties of revenue sharing agreements which are performance independent and performance related. The analysis is extended to balance-dependent income such as collective broadcast contracts.  

Keywords: Team sports, contest (tournament) theory

JEL classification numbers: L83, D72

Taylor, Nicholas

Cardiff Business School

Autoregressive hidden Markov switching\\models of count data

This paper introduces an alternative hidden Markov switching model. In particular, an autoregressive hidden Markov switching model of count data is formulated and applied to financial data. Through application of this new model, a theoretically-motivated representation of the dynamics of the number of orders placed per unit of time (referred to as \emph{order-flow}) on the London Stock Exchange is provided. Using the economic arguments of Rock (1996), the suitability of a 2-state autoregressive hidden Markov switching model is demonstrated in this context. This model provides the best fit amongst competing discrete-valued time series models. Moreover, the parameters of this model are found to vary in a predictable manner according to whether the morning, lunch time, or afternoon trading sessions are considered.  

Key Words: Discrete-valued, time series, Markov models.

JEL Classification Code: G14; C32

Tonks, Ian

University of Bristol

Performance Persistence of Pension Fund Managers

This paper examines persistence over time in the performance of fund managers responsible for making the investment decisions of UK pension funds. Previous work on UK pension funds found little evidence of fund manager persistence, but we argue that this may have been due to survivorship bias in the construction of these data samples, which may have disguised true persistence. Using a large sample of pension funds over the period 1983-97 in which there is less survivorship bias, we find strong evidence of persistence in abnormal returns generated by fund managers over one year time horizons.  

Keywords: Pension funds, fund management, performance measurement

JEL classification: G23

Tzavara, Dionisia; Paul Levine; Neil Rickman

University of Surrey; University of Surrey, LBS and CEPR

Market entry and roll-out with product differentiation

This paper examines a general problem exemplified by post-auction (third generation---`3G') mobile telecommunications markets.  When entering these (or any other) markets, firms must often decide on the degree of coverage (`roll-out') they wish to achieve.  Prior investment must be sunk in order to achieve the desired (or mandated) coverage level. We study the private and social incentives of a would-be entrant into a market with horizontal product differentiation when choosing its level of roll-out. The endogenous extent of entry influences downstream retail prices; Bertrand or local monopoly pricing or a mixed strategy equilibrium may emerge. Importantly, entry may involve too much or too little roll-out from a social perspective, thus suggesting that regulatory intervention may be appropriate to achieve desired levels of competition in such settings.  

KEYWORDS: Coverage, Roll-Out, Entry, Regulation

JEL CLASSIFICATION: L10, L50

Vera-Hernandez, Marcos

University College London

Structural Estimation with a Randomized Trial of a Principal Agent Model of Medical Insurance with Moral Hazard

Despite the importance of principal-agent models in the development of modern economic theory, there are few estimations of these models. We contribute to fill this gap in a field where moral hazard has traditionally been considered important: the utilization of health care services. This paper presents a model where the individual decides to have treatment or not when she suffers an illness spell. The decision is taken on the basis of comparing benefits and out-of-pocket monetary costs of treatment. In the paper, we recover the estimates of the corresponding principal agent model and obtain an approximation to the optimal contract.  

JEL: C35, D82, I1, G22.

Keywords: Optimal contracts, Experiments, Health care insurance

von Graevenitz, Georg

University College London

The complementarity of RJVs and R&D subsidies when absorptive capacity matters

This paper introduces a model of coordination of research paths into the theory of Research Joint Ventures (RJVs). A comparison of RJVs and licensing by non-cooperative firms shows that the latter may be unable to co-ordinate on complementary research paths whereas RJVs are always able to do this. This happens when the acquisition of absorptive capacity is costly. It is shown that the policies of promoting RJVs and subsidizing R&D are complementary, whereas either policy by itself may reduce welfare. Finally it is shown that costly absorptive capacity gives rise to a welfare loss that is very difficult to address.

JEL classification:   L13, O3

Keywords:  Joint Ventures, Absorptive capacity, Licensing

von Kalckreuth, Ulf

Economic Research Centre of the Deutsche Bundesbank

Monetary Transmission in Germany: New Perspectives on Financial Constraints

and Investment Spending

This paper assesses the importance of the interest rate and credit channels on business fixed investment in the German manufacturing sector. Our panel of financial statements contains 44,345 observations for 6,408 firms. Using firm specific user cost data, we uncover a rather solid interest channel. A transitory increase in nominal interest rates by 100 basis points would depress investment demand by almost 4% within the first year. Furthermore, our direct measure of creditworthiness allows us to identify a balance-sheet channel. Quantitatively, however, this balance-sheet channel seems to be of secondary importance.  

JEL Codes: E5, E2

Keywords:  Monetary Transmission, Firm Investment, User Cost, Financial Constraints, Credit Channel

Vuri, Daniela

European University Institute

Propensity Score Estimates of the Effect of Fertility on Marital Dissolution

In recent years many studies have reported significant empirical associations between fertility and marital dissolution. Whether this is a causal effect or only a correlation is not clear. This issue is explored by using matching methods. First the effect of ''having children'' (binary treatment) on marital disruption is investigated. Then, the method is extended to the case of ``number of children in the household'' (multi-valued treatment). The main findings indicate that parents do not divorce less in the presence of children but they only postpone the decision to divorce until children get older.  

Keywords: Fertility; Marital dissolution; Propensity score methods; Counterfactual

Jel Classification: C12, C2, J12, J13

Wallis, Kenneth F.

University of Warwick

Chi-squared tests of interval and density forecasts, and the Bank of England's fan charts

This paper reviews recently proposed likelihood ratio tests of goodness-of-fit and independence of interval forecasts.   It recasts them in the framework of Pearson chi-squared statistics, and extends them to density forecasts.   Two further recent developments are also incorporated, namely a more informative decomposition of the goodness-of-fit statistic, and the calculation of exact P-values.   Examples considered are the US Survey of Professional Forecasters density forecasts of inflation and the Bank of England fan charts.   This first evaluation of the Bank forecasts finds that the fan charts fan out too quickly, and the excessive concern with the upside risks was not justified.  

JEL: C53, E37

Keywords: Forecast evaluation; interval forecasts; density forecasts; likelihood ratio tests; chi-squared tests; exact inference; Bank of England inflation forecasts

Zitouna, M. Habib

Paris 1 Panthéon-Sorbonne University and CNRS

Globalization, Fragmentation and Intra-Firm trade

What are the theoretical determinants of intra-firm trade between identical countries? This paper focuses on firm and sectorial characteristics to state that this pattern of trade can be associated to low level of intermediate goods trade costs compared with those on final goods and markups imposed by upstream local producers, and multinational firms' technological structure such that scale economies are at the firm-level for downstream sector and plant-level for upstream one.  

JEL Codes: F21 - F23.

Keywords: Foreign Direct Investment, Intra-Firm trade, Fragmentation.