The Cyclical Dynamics of Investment: The Role of Financing and Irreversibility Constraints

This paper develops a rich decision theoretic dynamic ¯rm model that analyzes productivity and interest rate shocks. The model is used to analyze the cyclical dynamics of fixed and inventory investment and in particular asks whether constraints to the flow of funds can generate the frequently overlooked fact that investment in input inventories leads investment in fixed capital in business cycle frequencies. To account for this regularity the model proposes a combination of irreversibility and financing constraints. The usefulness of this explanation in relation to competing hypotheses, relies on the fact that it is also consistent with a list of facts from the inventory research. In addition it is shown that under persistent shocks, financing constraints are sufficient but not necessary to explain procyclicality. This implies that fixed investment cash flow regressions may not be informative for the presence of capital market imperfections because positive correlations can arise even under perfect capital markets. Last, analysis of interest rate shocks implies that the effects on inventory spending are quite small in relation to effects arising from productivity shocks.Financing Constraints, Inventories, Investment, Perturbation methods, Time-to-build

The Greek Debt Crisis: Likely Causes, Mechanics and Outcomes

We use insights from the literature on currency crises to offer an analytical treatment of the crisis in the market for Greek government bonds. We argue that the crisis itself and its escalating nature are very likely to be the result of: (a) steady deterioration of Greek macroeconomic fundamentals over 2001-2009 to levels inconsistent with long-term EMU participation; and (b) a double shift in markets’ expectations, from a regime of credible commitment to future EMU participation under an implicit EMU/German guarantee of Greek fiscal liabilities, to a regime of non-credible EMU commitment without fiscal guarantees, respectively occurring in November 2009 and February/March 2010. We argue that the risk of contagion to other periphery EMU countries is significant; and that without extensive structural reforms the sustainability of the EMU is in question.currency crises, bonds market, expectations, fiscal guarantees, contagion

External Sovereign Debt in a Monetary Union: Bailouts and the Role of Corruption

We build a tractable stylized model of external sovereign debt and endogenous international interest rates. In corrupt economies with rent-seeking groups stealing public resources, a politico-economic equilibrium is characterized by permanent fiscal impatience which leads to excessive issuing of sovereign bonds. External creditors envision the corrupt economy’s fiscal impatience and buy its bonds at higher interest rates. In turn, this interest-rate increase exacerbates the problem of oversupplying debt, leading the economy to a perfect-foresight trap. In incorrupt countries which have entered a high-interest-rate/high debt-GDP-ratio trap because an immediately recent disaster has caused a sudden jump to a high outstanding debt-GDP ratio, we show that bailout plans with controlled interest rates can help in reducing debt-GDP ratios after some time. On the contrary, under corruption, we show that bailouts are ineffective unless rent-seeking groups are eradicated.sovereign debt, world interest rates, international lending, rent seeking

Money and Information in a New Neoclassical Synthesis Framework

We consider an (otherwise standard) New Neoclassical Synthesis theoretical framework that allows a role for money. Money in our model has an informational role which consists in facilitating the estimation of the unobserved shocks that drive potential output and thus the state of the economy. For this purpose we estimate a small-scale sticky price model using Bayesian techniques. Our findings support the view that money has information value. This is reflected in higher precision in terms of unobserved model concepts such as the natural rate of output. Moreover, our results highlight how modelling money demand can provide insights about structural features of the economy that may be important for the design of interest rate rules. Focusing on money also allows for a step towards resolving the price puzzle. Money demand shocks can confound monetary policy shocks to generate a perverse price response in vector autoregressions (VAR).DSGE models; New Keynesian models; Money; Monetary Policy; Bayesian analysis

The Greek debt crisis: likely causes, mechanics and outcomes

We use insights from the literature on currency crises to offer an analytical treatment of the crisis in the market for Greek government bonds. We argue that the crisis itself and its escalating nature are very likely to be the result of: (a) steady deterioration of Greek macroeconomic fundamentals over 2001-2009 to levels inconsistent with longterm EMU participation; and (b) a double shift in markets’ expectations, from a regime of credible commitment to future EMU participation under an implicit EMU/German guarantee of Greek fiscal liabilities, to a regime of non-credible EMU commitment without fiscal guarantees, respectively occurring in November 2009 and February/March 2010. We argue that the risk of contagion to other periphery EMU countries is significant; and that without extensive structural reforms the sustainability of the EMU is in question

Firms’ financing dynamics around lumpy capacity adjustments

We study how firms adjust their financial positions around the times when they undertake lumpy adjustments in capital or employment. Using U.S. firm level data, we document systematic patterns of cash and debt financing around lumpy adjustment, remarkably similar across capital and employment. Firm-specific fundamentals reflected in Tobin’s Q, profitability and productivity are leading indicators of lumpy adjustment. Cash and debt capacity are actively manipulated, and contribute significantly quantitatively, to increase financial resources in anticipation of the expansion of firm capacity. Lumpy contractions in productive capacity follow years where firms reduce cash balances and hold above average levels of debt. During and after contractions, firms rebuild cash and reduce debt growth significantly in a concerted effort to restore financial resources by adjusting their productive operations