Dominant Firms, Barriers to Entry Capital and Entry Dynamics

Recent literature in Industrial Organization has shown that the threat of entry limits the price setting power of dominant firms and stimulates the incumbents to increase innovations ---both leading to welfare improvements. On the other hand dominant firms as incumbents strive to build up entry preventing capital. In such an environment of heterogeneous firms, we study the dynamics of competition as suggested in an earlier paper by Brock (1983). When dominant firms face a threat of the competitive fringe’s entry in the industry they, therefore, will have an incentive to prevent it. Investing into barriers to entry capital through engaging in production activities with increasing returns and high adjustment cost of investment as well as through advertising, lobbying and patents the dominant firm can create thresholds above which fringe firms cannot induce price competition and stimulate innovations. The dominant firms thus face two types of investment: Entry-deterring investment and investment in physical capital for production activities. Depending on how the competitive fringe responds to the first type of investment, complex dynamics, multiple steady states and thresholds, separating different domains of attraction, may emerge. Since the effectiveness of entry-deterring investment depends in part on regulatory rules set and enforced by antitrust institutions, we show how an antitrust and competition policy can be designed that may prevent the build up of entry preventing capital strengthening incentives for price competition and innovationsentry-deterring investment

Asset Markets and Monetary Policy

Monetary policy has pursued the concept of inflation targeting. This has been implemented in many countries. Here interest rates are supposed to respond to an inflation gap and output gap. Despite long term continuing growth of the world financial assets, recently, monetary policy, in particular in the U.S. after the subprime credit crisis, was challenged by severe disruptions and a meltdown of the financial market. Subsequently, academics have been in search of a type of monetary policy that does allow to influence in an appropriate manner the investor's behavior and, thus, the dynamics of the economy and its financial market. The paper suggests a dynamic portfolio approach. It allows one to study the interaction between investors` strategic behavior and monetary policy. The article derives rules that explain how monetary authorities should set the short term interest rate in interaction with inflation rate, economic growth, asset prices, risk aversion, asset price volatility, and consumption rates. Interesting is that the inflation rate needs to have a certain minimal level to allow the interest rate to be a viable control instrument. A particular target interest rate has been identified for the desirable optimal regime. If the proposed monetary policy rule is applied properly, then the consumption rate will remain stable and the inflation rate can be kept close to a minimal possible level. Empirical evidence is provided to support this view. Additionally, in the case of an economic crisis the proposed relationships indicate in which direction to act to bring the economy back on track.risk aversion; interest rate; dynamic portfolio; consumption rate; inflation; monetary policy; benchmark approach

Hedging speculation, and investment in balance-sheet triggered currency crises

This paper explores the linkage between corporate risk management strategies, investment, and economic stability in an open economy with a flexible exchange rate regime. Firms use currency futures contracts to manage their exchange rate exposure – caused by balance sheet effects as in Krugman (2000) – and therefore their investments’ sensitivity to currency risk. We find that, depending on whether futures contracts are used for risk reduction (i.e., hedging) or risk taking (i.e., speculation), the implied magnitudes of recessions and booms are decreased or increased. Corporate risk management can therefore substantially affect economic stability on the macrolevel.Mundell-Fleming-Tobin model, foreign-debt financed investment, currency crises, real crises, currency futures, hedging, speculation

Corporate currency hedging and currency crises

We examine the impact of corporate currency hedging on economic stability by introducing hedging activity in a Mundell-Fleming-Tobin framework for analyzing currency and financial crises. The ratio between hedged and unhedged firms is modelled depending on firm size as well as hedging costs. The results indicate that, with an increasing fraction of hedged firms in an economy, the magnitude of a crisis decreases and from a specific hedging level onwards currency crises are ruled out. In order to improve corporate risk management access to hedging instruments should be made possible and hedging costs should be reduced.Mundell-Fleming-Tobin model, currency crises, currency hedging, hedging costs

Testing Sustainability of German Fiscal Policy. Evidence for the Period 1960 – 2003

In this paper we test whether German public debt has been sustainable by resorting to a test proposed by Bohn (1998). We apply non-parametric and semi-parametric regressions with time depending coefficients. This test shows that the mean of the coefficient relevant for sustainability has been significantly positive over the time period considered. However, there is a negative trend in that coefficient which seems to have ceased to decline only in the middle to late 1990s. Further, we find evidence that the response of the primary deficit is a U-shaped function of the debt ratio which first declines and then rises after a certain threshold of the debt ratio is exceeded.public debt, intertemporal budget constraint, varying coefficient model, non-parametric estimation

Currency Runs, International Reserves Management and Optimal Monetary Policy Rules

This paper studies the design of optimal monetary policy rules for emerging economies confronted to sharp capital outflows and speculative attacks. We extend Taylor type monetary policy rules by allowing the central bank to give some weight to the level of precautionary foreign reserve balances as one of its targets. We show that a currency crisis scenario can easily occur when the weight is zero, and that it can be avoided when the weight is positive. The impacts of the central bank's monetary control on the output level, the inflation rate, the exchange rate, and the foreign reserve level are investigated as well. By applying both the Hamiltonian as well as the Hamilton-Jacobi-Bellman (HJB) equation (the latter leading to a dynamic programming formulation of the problem), we can explore safe domains of attractions in a variety of complicated model variants. Given the uncertainties the central banks faces, we also show of how central banks can enlarge safe domains of attraction.Currency Crises, Capital Outflows, Monetary Policy Rules

East German Unemployment from a Macroeconomic Perspective

When reviewing the literature concerning the development of the Eastern German economy, a too rigid labor market and its respective institutions are considered as the main source of the persistent high unemployment rates and the slow economic performance. However, when important macroeconomic variables are considered a significant decline in investment in new technologies is observed. In addition, we find evidences that the decline in investment might be affected by the steady migration of young and skilled workers to West Germany. The decline in the proportion of skilled workers induces firms not to invest in Eastern Germany which leads to a general decline in job creating activities irrespective rigid labor markets and generous social benefits. In the recent paper we employ a rather standard Dynamic General Equilibrium model in order to study the effects of a decline in the proportion of skilled workers as well as the impacts of increasing benefit payments. Furthermore, we assume equilibrium unemployment due to search and matching frictions on the labor market. This approach enables us further to consider job creating activities of the firms. We show that an emigration shock of skilled- workers is capable to reproduce the findings for the decline in economic activity. This effect is strengthened by assuming generous social benefit payments

The perils of debt deflation in the Euro area - a multi regime model

Academic research and policy makers in the Euro area are currently concerned with the threat of debt deflation and secular stagnation in Europe. Empirical evidence seems to suggest that secular stagnation and debt deflation in the Euro area may be rather slowly developing. Yet what appears as major peril is that debt deflation with a lack of economic growth, rising real interest rates and further rising debt may trigger household defaults, defaults of firms and banks, rise of risk premia, and default risk of certain sectors of the economy or sovereign defaults. It is this rising default and financial risk then that may lead to a regime change to a slowly moving debt crisis with high financial risk and high financial stress. In order to explore those issues, a macro policy model of Svensson type is introduced, exhibiting a regime of low and high financial stress. Then, a four dimensional multi-regime VAR is employed to an Euro area data set to support the theoretical model and the claim that in particular Southern Euro area countries are affected by debt deflation and financial market stress