Aid Volatility and Poverty Traps

This paper studies the impact of aid volatility in a two-period model where production may occur with either a traditional or a modern technology. Public spending is productive and "time to build" requires expenditure in both periods for the modern technology to be used. The possibility of a poverty trap induced by high aid volatility is first examined in a benchmark case where taxation is absent. The analysis is then extended to account for self insurance (taking the form of a first-period contingency fund) financed through taxation. An increase in aid volatility is shown to raise the optimal contingency fund. But if future aid also depends on the size of the contingency fund (as a result of a moral hazard effect on donors' behavior), the optimal policy may entail no self insurance.

Linking Representative Household Models with Household Surveys for Poverty Analysis A Comparison of Alternative Methodologies

We compare three approaches to linking macro models with representative households and micro household income data in terms of their implications for measuring the poverty and distributional effects of poverty reduction strategies. These approaches are a simple micro- accounting method, an extension of that method to account for changes in employment structure, and the Beta distribution approach. Even though in our simulation exercises the three methods do not lead to fundamentally different results in absolute terms, we show that potential differences in the measurement of distributional and poverty effects of policy shocks can be very large.Applied General Equilibrium Models, Poverty, Income Distribution, Policy Evaluation

Demand Systems with Unit Values: A Comparsion of Two Specifications

The availability of quantity information along with expenditure information in some household surveys allows the estimation of price reactions on the basis of unit values. We compare two specifications that have been proposed in this context by Deaton (1990) and Crawford et al. (1997) in order to take account of quality effects reflected in the unit values. Using simulated data for a two-good model, and keeping Marshallian elasticities fixed, we compare true and pseudo-true quantity and quality elasticities. Expenditure elasticities are close, but we find large differences in price elasticities and even sign reversals. This suggests that, while convenient in the situation where prices are not observable, these specifications lack flexibility. --consumer demand,unit values,quality,pseudo-true values

Capital requirements and business cycles with credit market imperfections

The business cycle effects of bank capital regulatory regimes are examined in a New Keynesian model with credit market imperfections and a cost channel of monetary policy. Key features of the model are that bank capital increases incentives for banks to monitor borrowers, thereby reducing the probability of default, and excess capital generates benefits in terms of reduced regulatory scrutiny. Basel I and Basel II-type regulatory regimes are defined, and the model is calibrated for a middle-income country. Simulations of supply and demand shocks show that, depending on the elasticity that relates the repayment probability to the capital-loan ratio, a Basel II-type regime may be less procyclical than a Basel I-type regime.Banks&Banking Reform,Debt Markets,Access to Finance,Economic Theory&Research,Emerging Markets

Sudden Floods, Prudential Regulation and Stability in an Open Economy

We develop a dynamic stochastic model of a middle-income, small open economy with a two-level banking intermediation structure, a risk-sensitive regulatory capital regime, and imperfect capital mobility. Firms borrow from a domestic bank and the bank borrows on world capital markets, in both cases subject to an endogenous premium. A sudden flood in capital flows generates an expansion in credit and activity, and asset price pressures. Countercyclical regulation, in the form of a Basel III-type rule based on real credit gaps, is effective at promoting macroeconomic stability (defined in terms of the volatility of a weighted average of inflation and the output gap) and financial stability (defined in terms of the volatility of a composite index of the nominal exchange rate and house prices). However, because the gain in terms of reduced volatility may exhibit diminishing returns, a countercyclical regulatory rule may need to be supplemented by other, more targeted, macroprudential instruments.

Loan loss provisioning rules, procyclicality and financial volatility

Interactions between loan-loss provisioning regimes and business cycle fluctuations are studied in a dynamic stochastic general equilibrium model with credit market imperfections. With a specific provisioning system, provisions are triggered by past due payments. With a dynamic system, both past due payments and expected losses over the whole business cycle are accounted for, and provisions are smoothed over the cycle. Numerical experiments with a parameterized version of the model show that a dynamic provisioning regime can be highly effective in mitigating procyclicality of the financial system. The results also indicate that the combination of a credit gap-augmented Taylor rule and a dynamic provisioning system with full smoothing may be the most effective way to mitigate real and financial volatility associated with financial shocks

Capital Regulation, Monetary Policy and Financial Stability

This paper examines the roles of bank capital regulation and monetary policy in mitigating procyclicality and promoting macroeconomic and financial stability. The analysis is based on a dynamic stochastic model with imperfect credit markets. Macroeconomic (financial) stability is defined in terms of the volatility of nominal income (real house prices). Numerical experiments show that even if monetary policy can react strongly to inflation deviations from target, combining a credit-augmented interest rate rule and a Basel III-type countercyclical capital regulatory rule may be optimal for promoting overall economic stability. The greater the degree of interest rate smoothing, and the stronger the policymaker’s concern with macroeconomic stability, the larger is the sensitivity of the regulatory rule to credit growth gaps.

On the Inconsistency of the Ordinary Least Squares Estimator for Spatial Autoregressive Processes

This paper investigates the asymptotic properties of the ordinary least squares estimator for spatial autoregressive models. We show that this estimator is biased as well as inconsistent for the parameters regardless of the distribution of the error term. Illustrative examples are also provided.Consistency of OLS estimator; Spatial processes

Using Surveys of Business Perceptions as a Guide to Growth-Enhancing Fiscal Reforms

This paper assesses the merits of using surveys of business perceptions of growth constraints as a guide to growth-enhancing fiscal policy reforms. Using endogenous growth models in which the government levies an income tax to provide public inputs to the production of private firms, the paper demonstrates that business perceptions of growth constraints are subject to systematic biases except when firms compare different types of public services or different types of public capital. In particular firms can be expected to systematically over-estimate the growth-enhancing effects of lower tax rates, and under- estimate the growth-enhancing effects of greater provision of public capital. It is then shown that these theoretical predictions regarding how firms rank constraints correspond closely to the observed ranking of constraints by firms in the World Bank's Enterprise Surveys