Agency costs and asymmetric information in a small open economy: a dynamic general equilibrium model

This paper assesses the effects of agency costs and asymmetric information in credit markets. Asymmetric information and agency costs occur whenever lenders delegate control over resources to borrowers, leading to adverse selection, moral hazard and monitoring costs because of the inability to monitor borrowers costlessly. Financial intermediaries can help overcome this imperfect information, leading to a more efficient allocation of resources. Macroeconomic models currently used by policy makers generally disregard credit market conditions. The basis of the analysis follows Carlstrom and Fuerst (1997). The model is extended to an open economy with a floating exchange rate and slowly adjusting goods prices. Moreover, a government and an inflation targeting monetary authority are introduced. The foreign sector is incorporated following McCallum and Nelson (1999). Firms use imported commodity inputs to produce output. They sell the output to domestic and foreign consumers and exports are a function of the real exchange rate and foreign demand. Incorporating a foreign sector has at least two implications. First, an open economy faces the possibility of shocks that originate from the rest of the world. Second, with a floating exchange rate, movements in the relative price of currencies affect the supply and demand of products and factors of production. The framework of the analysis is a dynamic general equilibrium model with microeconomic foundations, where agents’ decisions are derived from optimising behaviour. The model is calibrated for New Zealand. The steady states with and without agency costs are derived and the effects of these costs on business cycle fluctuations are assessed. A decline in the information asymmetry between borrowers and lenders leads to lower agency costs and an increase in the long-run level of steady state capital, investment and output. The presence of agency costs also affects the business cycle and the monetary authority’s response to shocks in the economy. Moreover, the exchange rate is subject to larger cyclical swings in the presence of agency costs, leading to additional substitution effects as imports are a production input. One of the key results in Carlstrom and Fuerst (1997), a hump shaped response of output and investment to a productivity shock, still prevails in the small open economy set-up. The diffrerences in the adjustment paths of the model with and without agency costs following a shock to the economy provide evidence of quantitatively important effects of agency costs and information asymmetries. The finding suggests that macroeconomic models that do not explicitly account for asymmetric information in credit markets provide an incomplete description of the economy.open economy, agency costs, asymmetric information, dynamic general equlibrium analysis

A stochastic overlapping generations real business cycle model of a small open economy

A stochastic, discrete time version of Blanchard's model of Perpetual Youth (Blanchard [1985]) is extended to an open economy with both tradable and nontradable goods. Some illustrative numerical simulations, based on parameter values taken from the existing real business cycle literature, are used to evaluate the comparative impact of productivity shocks on the tradable and nontradable goods sectors. It is shown that productivity shocks on the traded good sector leads to a positive correlation between aggregate output and the trade balance - aggregate output ratio. In contrast, productivity shocks on the non-traded good sector produces a negative correlation when the intertemporal elasticity of substitution between the current and future consumption is greater than the temporal elasticity of substitution between traded and non-traded good consumption

Nominal Wage Stickiness and the Natural Rate Hypothesis: An Empirical Analysis

Nominal Wage Stickiness and the Natural Rate Hypothesis An Empirical Analysis Abstract This paper studies a model in which nominal wages are predetermined at the expected market clearing level, firms bear costs of adjusting labor, and households have non-time-separable utility functions. It is shown that even if nominal wages are determined one period earlier and fixed only over a period, serially uncorrelated innovations in the price level affect aggregate employment arbitrarily far into the future, Nevertheless, the model satisfies the natural rate hypothesis. The empirical result shows that the slope of the statistical Phillips curve implied by the estimates of parameters is big. The result also shows enough serial persistence in employment

Business Cycles in Korea: Is there any stylised feature?

This paper seeks to present the detailed empirical study of contemporary business fluctuations in Korea. It follows the methodology of modem business cycle research in conducting an atheoretical statistical analysis of the cyclical properties of key aggregate time series. Analysis shows that many of the cyclical regularities documented for developed countries also exist in Korean business cycles. Those regularities include the relative volatilities of many expenditure components and the co-movement of real and nominal variables with output. Particularly notable one is the counter-cyclicality of prices. Counter-cyclicality of prices signals the importance of supply side shocks in Korean business fluctuations. It has been revealed in the analysis that the fluctuation in the import price of oil may have been the major source of Korean business cycles. Analysis has also revealed that there are some idiosyncrasies in Korean business cycles. Net exports are significantly pro-cyclical and lead the cycle for most of the period under study

The impact of monetary policy on New Zealand business cycles and inflation variability

This paper uses the open economy structural VAR model developed in Buckle, Kim, Kirkham, McLellan and Sharma (2002) to evaluate the impact of monetary policy on New Zealand business cycles and inflation variability and the output/ inflation variance trade-off. The model includes a forward- looking Taylor Rule to identify monetary policy and the impact of monetary policy is evaluated by deriving a monetary policy index using a procedure suggested by Dungey and Pagan (2000). Monetary policy has generally been counter-cyclical, thereby reducing business cycles and inflation variability. Exceptions are in 1993 when monetary policy accentuated the business cycle upswing and in 1998 when monetary policy accentuated the recession, although its impact in 1998 was small relative to the impact of adverse climatic conditions. During the initial years of inflation targeting monetary policy tended to simultaneously reduce inflation and output variability. From 1996 to 2001 monetary policy was less effective in reducing inflation and output variability. This latter period included a brief experiment with a Monetary Conditions Index, the Asian crisis and a large adverse domestic climate shock.Monetary policy; inflation targeting, business cycles; open economy; structural VAR models; inflation, interest rates, exchange rates, climate; international linkages

A Structural VAR Approach to Estimating Budget Balance Targets

The Fiscal Responsibility Act 1994 states that, as a principle of responsible fiscal management, a New Zealand government should ensure total Crown debt is at a prudent level by ensuring total operating expenses do not exceed total operating revenues. In this paper a structural VAR model is estimated to evaluate the impact on the government's cash operating surplus (or budget balance) of four independent disturbances: supply, fiscal, real private demand, and nominal disturbances. Based on the distribution of these disturbances, stochastic simulations are undertaken to derive the level of the ex ante cash budget balance needed to achieve an actual cash budget balance, at a given level of probability, at some future time horizon.Budget target; Fiscal policy; Fiscal Responsibility Act; Structural VAR; Stochastic Simulation

New Zealand's Current Account Deficit: Analysis based on the Intertemporal Optimisation Approach

New Zealand's Current Account of the Balance of Payments has been persistently in deficit since the early 1970s and increased markedly during the late 1990s. Is this a cause for significant concern? This paper tackles this question by evaluating New Zealand's external solvency, the degree of optimality of the intertemporal consumption smoothing through its current account, and whether its international financial capital flows have been used in an optimal (consumption-smoothing) fashion. We carry out statistical tests in relation to external solvency. We also estimate a "benchmark" consumption-smoothing component for its current account based on an intertemporal optimisation model in order to carry out tests of the optimality of the size and volatility of the current account. We could not reject the hypotheses that New Zealand's current account was consistent with optimal smoothing, that the external solvency condition has been satisfied, and that there is "no excess volatility" in international financial capital flows.current account; intertemporal; consumption-smoothing; New Zealand

Key features of New Zealand business cycles

Within a modern business cycle framework, this paper utilises basic statistical techniques to reexamine stylised empirical facts associated with business cycles in New Zealand since the midl 960's. The approach is essentially a bivariate one, and uses Hodrick-Prescott methodology for trend computations. Point estimates and GMM standard errors are presented for the amplitude of each variable's deviations from trend, degree of contemporaneous cyclicality and phase shift. Many relationships change markedly over time and, at least with this methodology, it is not easy to establish many "regularities" with confidence. "Real variable regularity" in a broad sense is confirmed, but a number of our other stylised empirical facts and uncertainties are not consistent with outcomes usually associated with prominent theoretical business cycle models. In particular, domestic price fluctuations in New Zealand have been basically countercyclical, and the real net exports share of GDP does not seem to have moved countercyclically over the past decade. No systematic cyclical tendency has been discovered for fluctuations in government purchases, and the scale of changes affecting the monetary sector over the past decade continues to present difficulties for establishing "financial regularities"

A structural VAR model of the New Zealand business cycle

This paper develops a new open economy structural VAR model of the New Zealand economy. The model adopts techniques introduced by Cushman and Zha (1997) and Dungey and Pagan (2000) to identify international and domestic shocks and dynamic responses to these shocks in a small open economy. The international variables are block exogenous and the model includes restrictions on contemporaneous and lagged variables. Novel features include the introduction of an expanded set of domestic financial variables not captured in previous New Zealand VAR models, the use of a forward looking Taylor Rule to identify monetary policy, and the introduction of a climate variable to capture the impact of climatic conditions on the business cycle. Key results to emerge are the significant influence of international variables on the New Zealand business cycle, the importance of separately identifying import price and export price shocks, and the significant influence of climate.Open economy; structural VAR models; business cycles; climate; commodity prices; international linkages; financial conditions.

Pacific rim business cycle analysis: Dating, volatility and synchronisation

We report preliminary results from analytical work on business cycle turning points, volatility, and synchronisation for New Zealand and its major (Pacific Rim) trading partners. Principal conclusions are that: New Zealand's (real GDP) business cycles have been synchronised primarily with those of the "Pacific Rim" countries of Australia and the United States of America, rather than with any "European cycle" associated with (West) Germany or with Japanese cycles. It seems too soon to be able to establish meaningful business cycle synchronisations between New Zealand and any of China, Korea, Taiwan, Hong Kong and Singapore, despite the current importance of the latter countries as trading partners for New Zealand. There was a clear disturbance during the mid-to late-1980s of New Zealand's strong procyclical business cycle synchronisation with both Australia and the US. The fast growing Asian economies of China, Hong Kong, Korea and Singapore have displayed the highest business cycle volatilities; New Zealand and Taiwan have also recorded high volatility on average; while Australia, the US, West Germany and Japan have displayed relatively lower average volatility. With the possible exception of New Zealand (and Japan), this is consistent with the high growth rate countries exhibiting high business cycle volatility and our lower growth rate countries displaying relatively lower volatility. Business cycle volatility has varied over time for all countries, with the possible exception of Japan. The volatilities of China, Korea, Taiwan and Singapore having been moving steadily lower over time