The Rise of Services and Balanced Growth in Theory and Data

We investigate the effect of structural transformation on the process of economic growth. Using a two-sector growth model we show that, in addition to Baumol’s cost disease, structural transformation from goods to services generates other predictions that are in line with cross-country growth facts: an increase in the real investment rate, a decline in the real interest rate and the marginal product of capital and an acceleration of investment-specific technological change as the share of services increases. The model calibrated to U.S. data can account for the elasticity of real investment rates to the share of services measured in cross-country data

Net Foreign Assets, Productivity and Real Exchange Rates in Constrained Economies

Empirical evidence suggests that real exchange rates (RER) behave differently in developed and developing countries. We develop an exogenous 2-sector growth model in which RER determination depends on the country's capacity to borrow from international capital markets. The country faces a constraint on capital inflows. With high domestic savings, the country converges to the world per capita income and RER only depends on productivity spread between sectors (Balassa-Samuelson effect). If the constraint is too tight and/or domestic savings too low, RER depends on both net foreign assets (transfer effect) and productivity. We then analyze the empirical implications of the model and find that, in accordance with the theory, RER is mainly driven by productivity and net foreign assets in constrained countries and exclusively by productivity in unconstrained countries.Real exchange rate; capital inflows constraint; overlapping generations

Efficiency and production frontiers in the aftermath of recessions: international evidence

The relationship between recessions and productivity growth has been the focus of an important body of theoretical and empirical research in the last two decades. We contribute to this literature by presenting new evidence on the evolution of productivity in the aftermath of recessions. Our method allows us to distinguish between frontier and (in-)efficiency effects of recessions. We present international evidence for a panel of 70 countries for the 1960-2000 period. Our results reveal that the average cumulative impact of recessions on productivity up to four years after its end is negative and significant. This, however, results from a mixture of mechanisms. The level of frontier production increases, but the rate of technical progress decreases, leading to a fall in frontier production. Efficiency also falls, lending support for the idea that recessions tend to reduce, rather than increase, economic restructuring. Long and deep recessions are also shown to have distinctive impacts on productivity

Dynamic network model of banking system stability

This paper presents a dynamic model of banking interactions, which uses interbank connections to study the stability of the banking system. The dynamic model extends previous work on network models of the banking system taking inspiration from large scale, complex, interconnected systems studied within the domain of engineering. The banking system is represented as a network where nodes are individual banks and the links between any two banks consist of interbank loans and borrowing. The dynamic structure of the model is represented as a set of differential equations, which, to the best of our knowledge, is an original characteristic of our approach. This dynamic structure not only allows us to analyse systemic risk but also to incorporate an analysis of control mechanisms. Uncertainty is introduced in the system by applying stochastic shocks to the bank deposits, which are assigned as an exogenous signal. The behaviour of the system can be analysed for different initial conditions and parameter sets. This paper shows some preliminary results under different combinations of bank reserve ratios, bank capital sizes and different degrees of bank inter-connectedness. The results show that both reserve ratio and link rate have a positive effect on the stability of the system in the presence of moderate shocks. However, for high values of the shocks, high reserve ratios may have a detrimental effect on the survival of banks. In future work, we will apply strategies from the domain of control engineering to the dynamic model to characterise more formally the stability of the banking network

Appropriate Technology and Balanced Growth

We provide a general theoretical characterization of how firm's technology choice on a technology frontier determines the long-run elasticity of substitution between capital and labor. We show that the shape of the frontier determines factor shares and the elasticity of substitution between capital and labor. If there are adjustment costs to technology choice, the short- and long-run elasticities differ, with the long-run always higher. If the technology frontier is log-linear, the production function becomes Cobb-Douglas in the long run but, consistent with empirical evidence, short-run dynamics are characterized by gross complementarity. The approach is easily implementable and yields a powerful way to introduce CES-type production functions in macroeconomic models. We provide an illustration within an estimated dynamic general equilibrium model and show that the use of our production technology provides a good match for the short- and medium-run behavior of the US labor share

Introduction: Special Issue on ‘Macroeconomics of Climate Change’

Climate change is one of the most serious risks facing humanity. Temperature rises can lead to catastrophic climate and natural events that threaten livelihoods. From rising sea levels to flooding, bush fires, extreme temperatures and droughts, the economic and human cost is too large to ignore. More than 190 world leaders got together in Glasgow during November 2021 at the UN’s COP26 climate change summit to discuss progress on the Paris Agreement (COP21) and to agree on new measures to limit global warming. In Paris, countries agreed to limit global warming to well below 2° and aim for 1.5° as well as to adapt to the impacts of a changing climate and raise the necessary funding to deliver on these aims. However, actions to date were not nearly enough as highlighted by the IPCC (2018) special report. The world is still on track to reach warming above 3° by 2100. As evident from figure 1, global temperatures have been on a steadily increasing path since the start of the 20th century and this process has substantially accelerated since the beginning of the 1980s. This has been unevenly distributed, with temperatures in the Northern hemisphere being a full 1°C higher than for the 1961–1990 average, whilst temperatures in the Southern hemisphere have increased by almost 0.5°C

Reallocation effects of recessions and financial crises: An industry-level analysis

We characterize the behavior of disaggregate manufacturing sectors for a large set of developed and emerging markets around recession dates. We uncover some relevant stylized facts. The dispersion in value added growth rates in developed economies is counter-cyclical, whereas for emerging countries it is pro-cyclical. Recoveries are more productivity-driven in developed countries as opposed to employment-driven for emerging markets. Around recession episodes sectoral-level misallocation of resources does not significantly change in developed economies, whereas it increases in emerging economies during financial crises. Therefore, there is no evidence that recessions improve the allocation of resources across industries

Selecting structural innovations in DSGE models

Dynamic stochastic general equilibrium (DSGE) models are typically estimated assuming the existence of certain structural shocks that drive macroeconomic fluctuations. We analyze the consequences of estimating shocks that are “nonexistent” and propose a method to select the economic shocks driving macroeconomic uncertainty. Forcing these nonexisting shocks in estimation produces a downward bias in the estimated internal persistence of the model. We show how these distortions can be reduced by using priors for standard deviations whose support includes zero. The method allows us to accurately select shocks and estimate model parameters with high precision. We revisit the empirical evidence on an industry standard medium‐scale DSGE model and find that government and price markup shocks are innovations that do not generate statistically significant dynamics

Fundamental shock selection in DSGE models

DSGE models are typically estimated assuming the existence of certain structural shocks that drive macroeconomic fluctuations. We analyze the consequences of introducing nonfundamental shocks for the estimation of DSGE model parameters and propose a method to select the structural shocks driving uncertainty. We show that forcing the existence of non-fundamental structural shocks produces a downward bias in the estimated internal persistence of the model. We then show how these distortions can be reduced by allowing the covariance matrix of the structural shocks to be rank deficient using priors for standard deviations whose support includes zero. The method allows us to accurately select fundamental shocks and estimate model parameters with precision. Finally, we revisit the empirical evidence on an industry standard medium-scale DSGE model and find that government, price, and wage markup shocks are non-fundamental