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2008-2009 Macro Seminar Papers


"Foreign Aid and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy"
Valerie Cerra (IMF) and Serpil Tekin (Univ. of Washington)

Jointly written
with Stephen J. Turnovsky (Univ. of Washington)

Thursday, Sept. 4, 12:30-2:00pm, room MC 10-100

A dynamic dependent-economy model is developed to investigate the role of the real exchange rate in determining the effects of foreign aid. If capital is perfectly mobile between sectors, untied aid has no long-run impact on the real exchange rate. A decline in the traded sector occurs because aid, being denominated in traded output, substitutes for exports in financing imports. While untied aid causes short-run real exchange appreciation, this response is very temporary and negligibly small. Tied aid, by influencing sectoral productivity, does generate permanent relative price effects. The analysis, which employs extensive numerical simulations, emphasizes the tradeoffs between real exchange adjustments, long-run capital accumulation, and economic welfare, associated with alternative forms of foreign aid.

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 "Equilibrium Portfolios and External Adjustment under Incomplete Markets"
Roberto Rigobon (MIT and NBER)
jointly written with Anna Pavlova (London Business School and CEPR)

Thursday, Sept. 11, 12:30-2:00pm, room MC10-100

Recent evidence on the importance of cross-border equity flows calls for a rethinking of the standard theory of external adjustment. The authors introduce equity holdings and portfolio choice into an otherwise conventional open-economy dynamic equilibrium model. Their model is simple and it admits an exact closed-form solution regardless of whether financial markets are complete or incomplete. The authors derive a necessary and sufficient condition under which the current account is different from zero and shed light on the relationship between market incompleteness and the current account dynamics. Furthermore, the authors revisit the current debate on the relative importance of the standard vs. the capital-gains-based (or "valuation") channels of the external adjustment and establish that in our framework they are congruent. The authors demonstrate how countries’ portfolio compositions affect the dynamics of their external accounts and argue that a description of the international adjustment mechanism is incomplete if it does not encompass portfolio choice.

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 "Emerging Market Fluctuations: What Makes The Difference?"
Constantino Hevia (World Bank)

Thursday, Sept. 18, from 12:30-2:00, room MC10-100

Economic fluctuations in emerging market and developed open economies are different. This paper interprets these differences in terms of a small open economy model in which primitive distortions induce wedges between marginal rates of substitutions and marginal rates of transformations: an efficiency wedge affects productivity, a labor wedge affects the labor-consumption choice, an investment wedge affects capital accumulation, a risk premium wedge affects the intertemporal consumption choice, and a government wedge affects total resources. This paper estimates these wedges and studies their contribution to aggregate fluctuations using Mexico and Canada as representative emerging market and advanced open economies. Fluctuations in emerging economies are due mostly by efficiency wedges and, to a lesser extent, labor wedges and risk premium wedges. Fluctuations in advanced open economies are due mostly to labor wedges and, to a lesser extent, efficiency wedges. Investment wedges do not play a significant role in any of the countries. Therefore, to understand emerging market fluctuations we need to build models in which primitive distortions induce efficiency wedges; other distortions do not seem quantitatively important.

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  "Aggregate Effects of AIDS on Development"
Raul Santaeulali-Llopis (Washington Univ.)

Thursday, Sept. 25, 12:30-2:00, room MC10-100

In this paper the author studies the consequences of the AIDS epidemic for economic development. To this purpose the author builds a population model that keeps track of the demographic transition by age-specific population groups relating the age distribution of the population of each period to the preceding one via a fertility process, a mortality process and an aging process. The author integrates this population model into a standard theory of economic development that determines the income per capita path along the process of industrialization - a transition that structurally shifts capital and labor from a Malthusian-agricultural sector to a neoclassical-industrial sector. This way, the author constructs a structural relationship between the distribution of the population across age groups and the stage of economic development - in terms of income per capita and agricultural share of output. Then, the author uses this population model to consistently identify the main channels through which AIDS, raising mortality rates of young adults and lowering fertility rates, affects populations over time: (i) reshapes the age distribution of the population, thinning the ranks of working-age groups (the share of children and old adults per worker raises by as much as 20-25% in highly infected countries), (ii) reduces population growth (by as much as .08% per percentage point of HIV prevalence),  and (iii) reduces life expectancy (by as much as 15-20 years). In addition, AIDS also (iv) reduces the individual labor efficiency of the sick with an aggregate loss of 0.3% per percentage point of HIV prevalence. When the author incorporates the AIDS epidemic as in (i)-(iv) into a model economy calibrated to an African country unaffected by AIDS, he finds that the AIDS epidemic reduces per capita income by as much as 12% at the peak of the epidemic. The author finds also that the AIDS epidemic slows down the transition from agriculture to industry by about one century for the most highly infected countries.

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 "Misallocation and Manufacturing in China and India" 
Pete Klenow (Stanford University and NBER)
Jointly written with Chang-Tai Hsieh (University of Chicago and NBER)

Thursday, Oct. 9, 12:30-2:00, room I2-210 

Resource misallocation can lower aggregate total factor productivity (TFP). The authors use micro data on manufacturing establishments to quantify the potential extent of this misallocation in China and India compared to the U.S. in recent years. Compared to the U.S., the authors measure sizable gaps in marginal products of labor and capital across plants within narrowly-defined industries in China and India. When capital and labor are hypothetically reallocated to equalize marginal products to the extent observed in the U.S., the authors calculate manufacturing TFP gains of 30-50% in China and 40-60% in India.

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"Hierarchic Government, Endogenous Policies, and Foreign Direct Investment: Theory and Evidence From China and India"
Yong Wang (World Bank)

Thursday, Oct. 16, 12:30-2:00, room MC10-100 

 By introducing a hierarchic government structure into Grossman and Helpman (1994,1996),  the authors construct a theoretical model to explain why two developing economies with similar economic fundamentals might have diametrically di¤erent amount of inward FDI as a means of technology adoption. The key mechanism is that the provincial government’s attitude toward FDI is endogenously polarized when the negative pecuniary externality between the domestic and foreign-invested rms decreases with FDI. The provincial government chooses either prohibitively high or attractively low institutional entry cost on FDI, depending on the pro…t tax rate and the tariff rate which are determined by the central government under the influence of the special interest group. The author de…fines and characterizes the symmetric and asymmetric political equilibrium to explain the policy variables, FDI, and GDP. The aggregate FDI level is always bifurcating, either null or full, in the economy with multiple identical provinces. The horizontal interaction between identical provincial governments might magnify the policy difference or result in an asymmetric FDI allocation. The author calibrates the model to China and Indians data and also performs several counterfactual experiments. The author …finds that China-India nine-fold difference in FDI per capita CAN be ultimately due to that China's central government obtains a higher share of total tax revenue than its India counterpart. It's because China's central government bene…ts more from FDI and then has more incentives to manipulate the policy pro…le which not only admits a positive FDI supply but also induces the provincial governments to compete for rather than block FDI. A global-game analysis when the entry cost is not common knowledge is provided in the appendix.  

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"Climate Change and Economic Growth: Evidence from the Last Half Century"

Benjamin Jones (Kellogg School of Management)

Jointly written with Melissa Dell (MIT) and Ben Olken (NBER)


Thursday, Oct. 30, 12:30-2:00, room MC10-100



This paper uses annual variation in temperature and precipitation over the past 50 years to examine the impact of climatic changes on economic activity throughout the world. We find three primary results. First, higher temperatures substantially reduce economic growth in poor countries but have little effect in rich countries. Second, higher temperatures appear to reduce growth rates in poor countries, rather than just the level of output. Third, higher temperatures have wide-ranging effects in poor nations, reducing agricultural output, industrial output, and aggregate investment, and increasing political instability. Analysis of decade or longer climate shifts also shows substantial negative effects on growth in poor countries. Should future impacts of climate change mirror these historical effects, the negative impact on poor countries may be substantial.

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 "Multilateral Debt Relief throughthe Eyes of Financial Markets"
 Claudio Raddatz (World Bank)


Thursday, Nov. 13, 12:30-2:00, room MC5-100


This paper conducts an event study to assess the economic consequences of multilateral debt
relief for benefited countries. It estimates the response of the stock prices of South African
multinationals with subsidiaries in those countries to the announcement of debt relief initiatives
and shows that they exhibit a significant increase above other firms, especially around the
launching of the recent Multilateral Debt Relief Initiative (MDRI). The improvement in financial
markets' assessment of the value of these multinationals is consistent with lower expected levels
of future taxation and, overall, the results are consistent with the debt overhang argument for
debt relief.


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"Capital Flows and Asset Trade: A Puzzle"

Aart Kraay (World Bank)

Jointly written with Jaume Ventura (CREI and Universitat Pompeu Fabra)

Thursday, Dec. 4, 12:30-2:00, room MC10-100

A striking feature of countries' net foreign assets positions is that they have been remarkably stable over the past 40 years.  Over the same period, there have been sharp declines in regulatory barriers to international asset trade and an explosion of countries' gross foreign assets and liabilities. The authors develop a tractable world equilibrium model of international capital flows that we use to (a) illustrate why this disconnect between net and gross asset trade poses a theoretical puzzle, and (b) to speculate about possible resolutions of this puzzle.

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"A Structural Model of Establishment and Industry Evolution: Evidence from Chile"
Murat Seker (World Bank)

Thursday, Dec. 18, 12:30-2:00, room MC10-100

Many recent models have been developed to fit basic facts on establishment and industry evolution. While these models yield a simple interpretation of the basic features of the data, they are too stylized to confront the micro-level data in a more formal quantitative analysis. In this paper, the author develops a model in which establishments grow by innovating new products. By introducing heterogeneity to a stylized industry evolution model, the author succeeds in explaining several features of the data, such as the thick right tail of the size distribution and the relations between age, size, and the hazard rate of exit, which had eluded existing models. In the model, heterogeneity in producer behavior arises through a combination of exogenous efficiency differences as in Melitz (2003) and accumulated innovations resulting from the past endogenous R&D investments as in Klette and Kortum (2004). Integrating these forces allows the model to perform well quantitatively in fitting data on Chilean Manufacturers. The counterfactual experiments show how producers respond to R&D subsidies and more competitive market environment.

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"Indirect, Long-term and Cumulative Effects of Natural Disasters"
Jose Miguel Albala Bertrand (University of London) and Jesus Crespo Cuaresma (University of Innsbruck)

Special debate-style double header session, co-sponsored with the Economics of Natural Disasters Seminar Series

Thursday, January 22, 12:30-2:00, room MC C1-200

On one hand, indirect, long-term and cumulative effects of disasters are little tractable to direct observation, especially at the macro level. The first speaker will argue how concepts of localization and networking, and in-built endogenous (private) reactions can have an important bearing on the importance of macroeconomic effects. The argument is that the more all-embracing and efficient the systemic network, including important private responses to disasters, the LESS likely the spreading of indirect effects and therefore their potential disaster impact on national macro-variables. This then has important implications for the appropriate role of public sector intervention: international and public responses could become more effective by harnessing such endogenous reactions and responses rather than bypassing them. Hence, the question is how to make such public ex-ante and ex-post responses systemically compatible with endogenous reactions, so as to increase the effectiveness and efficiency of disaster recovery in relation to long-term features of development.

On the other hand, it has been argued in the literature on the macroeconomic effects of natural disasters that, to the extent that natural catastrophes reduce the expected return to physical capital, rational individuals would shift their investment towards human capital. Conversely, in the framework of theoretical models with finitely-lived agents, the potential effect that natural disaster risk has on mortality would lead to a lower level of educational investment in disaster-prone countries. Building on a new global database on human capital as proxied by school enrollment, the author presents original theoretical and empirical analysis that tests these competing hypotheses by assessing empirically the relationship between natural disaster risk and investment in education. The empirical study is done by explicitly assessing the issue of model uncertainty by means of Bayesian Model Averaging. While the results in the empirical literature hitherto tend to be inconclusive, the author finds an extremely robust negative partial correlation between secondary school enrollment and natural disaster risk exposure. This result appears to be systematically related to geological disaster risk exposure.

"To Formalize or Not To Formalize? Comparisons of Microenterprise Data Southern and East Africa"
Alan Gelb (World Bank) and Vijaya Ramachandran (Center for Global Development)

Thursday, January 29, 12:30-2:00, room MC10-100

Why do firms choose to locate in the informal sector? Researchers often argue that the high cost of regulation prevents informal firms from becoming formal and productive. Our results point to a more nuanced story.

Using data from surveys of microenterprises in South Africa, Namibia, Botswana, Kenya, Uganda, Tanzania and Rwanda, we find that the labor productivity of informal firms is virtually indistinguishable from that of formal firms in East Africa but not in Southern Africa. We provide a theoretical model to explain this result, based on the key assumption that firms may evade taxes subject to a cost (or concealment cost) that is increasing and convex in the firm’s employment size. Consequently, the productivity distributions reflect the differences in concealment costs and the opportunity cost of formality in the two regions. Greater enforcement of laws and better provision of services such as finance and electricity to formally registered firms in Southern Africa means that firms are more likely to register; those that do not are likely to be operating as "survivalist" firms. But in East Africa, weak enforcement of tax payment and no significant difference in access to services between formal and informal firms means that these variables do not explain the allocation of firms across the informal-formal divide.

We conclude that in countries with weaker business environments such as those in East Africa, informal firms are just as likely as formal firms to increase their productivity as they grow. Thus, interventions to increase productivity and lower the cost of formality may be helpful. But in countries with strong business environments such as those in Southern Africa, owners of informal firms are likely to be better off entering the labor market as wage labor. In the latter case, investment in education or vocational training is probably more important.

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"The Subprime Turmoil: What's Old, What's New, and What's Next "
Charles Calomiris (Columbia Business School and NBER)

Thursday, February 5, 12:30-2:00, room MC10-100

This essay considers the origins of the subprime turmoil, and the way the financial system has responded to it. There are both old and new components in both the origins and the propagation of the subprime shock. In the current debacle, as in previous real estate-related financial shocks, government financial subsidies for bearing risk seem to have been key triggering factors, along with accommodative monetary policy. The primary novelty in the origins of the crisis was the central role of agency problems in asset management. Asset managers invested in subprime-related instruments in spite of obvious understatements of their risk. With respect to the propagation of the shock, much is familiar but there are important novelties, namely the protracted duration of uncertainty about the incidence of losses, the aggressive policy interventions to combat the crisis, and the ability of financial institutions to have raised more than $434 billion (as of the end of the third quarter of 2008) in new capital to mitigate the consequences of subprime losses for bank credit supply. This unique response of the financial system reflects the improvements in U.S. financial system diversification that resulted from deregulation, consolidation, and globalization. The essay concludes by considering the near term future of financial and macroeconomic performance, and the implications for monetary policy, regulatory policy, and the future of the structure of the financial services industry.

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  "Financial "Whac-a-mole": Bubbles, Commodity Prices and Global Imbalances
Pierre-Olivier Gourinchas (UC Berkeley and NBER)

Thursday, February 12, 12:30-2:00, room MC10-100

This paper provides theoretical and empirical evidence to support the proposition that three of the major global macroeconomic phenomena of recent years –the persistent global imbalances, the subprime crisis, and the volatile oil prices that followed it– are tightly interconnected. They all stem from a global environment where sound and liquid financial assets are in scarce supply. In this framework, the large recent fluctuations in oil prices are the result of the interplay between a tight oil market and the search for financial assets: Bad news in US financial markets is good news for oil as an asset; conversely, good news in the former is bad news for the latter. Our analysis also indicates that, in the short run, this endogenous response of oil prices has limited the extent of the adjustment in US’s external accounts that otherwise would have taken place in response to the US financial crisis.

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"Organizing Growth"
Esteban Rossi-Hansberg (Princeton)
Jointly written with Luis Garicano (LSE and Univ. of Chicago)

Thursday, April 2, 12:30-2:00, room MC 5-100

After many years of large drops in the cost of information and communication technology (ICT), the evidence on its impact on aggregate productivity growth continues to be mixed. We argue that this may be the result of competing economic forces. To do so, we propose a framework to study the impact of ICT on growth through its impact on organization and innovation. Agents accumulate knowledge to use available technologies and invent new ones. The use of a technology requires the development of organizations to coordinate the work of experts, which takes time. The costs and benefits of such organizations depend on the cost of ICT. We find that while advances in information technology always increase growth, improvements in communication technology may lead to lower growth and even to stagnation, as the payoff to exploiting available technologies through organizations increases relative to the payoff from innovations.

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"Noisy Real Business Cycles"
George-Marios Angeletos (MIT)
Jointly written with Jennifer La'O (MIT)

Thursday, April 9, 12:30-2:00, room MC 4-100

This paper investigates a real-business-cycle economy that features dispersed private information about the underlying aggregate shocks to productivities, tastes, and monopoly power.  The authors first highlight why dispersed information is distinct from uncertainty about the fundamentals: it is only with dispersed information that agents can face uncertainty about the level of economic activity beyond the one they face about the fundamentals. The authors next show how this type of uncertainty can (i) contribute to significant noise in the business cycle even when agents are well informed about the fundamentals; (ii) increase inertia in the response of macroeconomic outcomes to aggregate productivity shocks; (iii) induce a negative short-run response of employment to aggregate productivity; (iv) formalize a certain type of demand shocks within an RBC economy; and (v) generate cyclical variation in observed Solow residuals and labor wedges. Turning to the normative properties, the authors show that none of the aforementioned properties are symptoms of inefficiency: unless there are mark-up shocks and information is fixed, the business cycle is constrained efficient. The authors conclude with discussing a number of potential extensions and policy implications.  Prof. Angeletos will also be discussing results for optimal fiscal and monetary policy from a companion paper.

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"What Caused the Recession of 2008? Hints from Labor Productivity"
Casey Mulligan (Chicago)

Thursday, April 16, 12:30-2:00, room MC 5-100

A labor market tautology says that any change in labor usage can be decomposed into a movement along a marginal productivity schedule and a shift of the schedule. I calculate this decomposition for the recession of 2008, assuming an aggregate Cobb-Douglas marginal productivity schedule, and find that all of the decline in employment and hours since December 2007 is a movement along the schedule. This finding suggests that a reduction in labor supply and/or an increase in labor market distortions are major factors in the 2008 recession. The decline in aggregate consumption suggests that the reduction in labor supply (if any) is neither a wealth nor an intertemporal substitution effect. "Sticky real wages" or the emergence of significant work disincentives are possible explanations for these findings.

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"Technology Adoption and Factor Proportions in Open Economies: Theory and Evidence from the Global Computer"
Daniel Lederman and Ana Cusolito (World Bank)

Thursday, April 23, 12:30-2:00, room MC 3-570

Standard theories of international trade assume that all countries use similar and exogenous technologies in the production of any good. This paper relaxes this assumption by allowing for the adoption of various factor-complementary machines. The marriage of literatures on biased technical change and trade yields a tractable theory, which predicts that differences in factor endowments bias technical change towards particular factor intensities, and thus unit factor input requirements vary across economies. Using data on net-exports of a single industry, computers, and factor endowments for 73 countries over the period 1980-2000, the paper shows that once technological choices are considered, countries with different factor endowments can become net exporters of the same product.

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"NAFTA and the Productivity of the Business in Mexico"
Leonardo Iacovone (World Bank)
Jointly written with Rafael E. de Hoyos (Ministry of Education, Mexico)

Thursday, April 30, 12:30-2:00, room MC 7-100

Did the North American Free Trade Agreement (NAFTA) made Mexican firms more productive? If so, through which channels? We address these questions by deploying an innovative microeconometric approach that disentangles the various channels through which integration with the global markets (via international trade) can affect firm-level productivity. Our results show that NAFTA stimulated the productivity of Mexican plants via: (1) an increase in import competition and (2) a positive effect on access to imported intermediate inputs. However, the impact of trade reforms was not identical for all integrated firms with fully integrated firms benefiting more than other integrated firms. Contrary to previous results, once self-selection problems are solved, we find a rather weak relationship between exports and productivity growth.

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"Nudging Farmers to Use Fertilizer: Evidence from Kenya"
Michael Kremer (Harvard, Brookings, CGD, J-PAL, and NBER)
Jointly written with Esther Duflo (MIT) and Jonathan Robinson (UC Santa Cruz and J-PAL). 

Thursday, May. 7, 12:30-2:00, room MC7-100

Many policymakers advocate heavy subsidies to boost fertilizer use and raise agricultural productivity. In contrast, most economists assume that farmers already take advantage of potential profit opportunities, and argue that heavy subsidies are distortionary, environmentally unsound, regressive, and lead to politicization and inefficiency in fertilizer supply. In earlier work, we show that fertilizer is profitable for farmers in Western Kenya. Yet, usage is low, pointing to possible inefficiencies. In this paper, the authors build a model with a small fixed cost of purchasing fertilizer in which some farmers are present-biased and partially naïve. Farmers therefore procrastinate, postponing purchasing fertilizer until proceeds from the harvest are spent. Consistent with the model, small time-limited reductions in the cost of purchasing fertilizer at the time of harvest induce substantial increases in fertilizer use, as much as considerably larger price cuts later in the season. Such small timelimited discounts could help present-biased farmers commit to fertilizer use without substantially distorting decisions of non-procrastinating farmers and incurring other costs of heavy subsidies.

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"Monetary Policy and the Equity Premium"
David Lopez-Salido (Federal Reserve Board)
Jointly written with Christopher Gust (Federal Reserve Board)

Thursday, May 14, 12:30-2:00, room MC5-100

Recent research has emphasized that risk premia are important for understanding the monetary transmission mechanism. An important result in this literature is that unanticipated changes in monetary policy affect equity prices primarily through changes in risk rather than through changes in real interest rates. To account for this finding, the authors develop a DSGE model in which monetary policy generates endogenous movements in risk. The key feature of their model is that asset and goods markets are segmented, because it is costly for households to transfer funds between these markets, and they may only infrequently update their desired allocation of cash across these two markets. The authors model emphasizes that time-varying risk is driven by costly portfolio rebalancing of financial accounts rather than limited participation in financial markets.  The authors show that the model can account for the mean returns on equity and the risk-free rate, and generates variations in the equity premium that help explain the response of stock prices to monetary shocks.

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"Medium Term Cycles in Developing Countries"
Diego Comin (Harvard Business School and NBER)
Jointly written with Norman Loayza (World Bank), Farooq Pasha (Boston College) and Luis Servén (World Bank)

Thursday, May 21, 12:30-2:00, room MC5-100

The authors build a two country asymmetric DSGE model that embeds a structure of technology creation and di¤usion similar to the product-lifecycle. As a result, three linkages propagate the shocks to the developed economy into the developing one at different frequencies. In the short run, these shocks affect the demand for exports from the developing country. These shocks also affect variation in number of technologies exported and transferred for production to the developing country. Since technologies diffuse, on average, slowly, these mechanisms affect the technology in the developing country in the medium term. The authors calibrate the model to the US and Mexico and find that, both in the data and in the model, high frequency US fluctuations lead medium term fluctuations in Mexico. These US-driven fluctuations account for between 57% and 67% of the differential in volatility between Mexico and the US.

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"Exchange Rates and Wages in an Integrated World"
Antonio Spilimbergo and Prachi Mishra (IMF)

Thursday, May 28, 12:30-2:00, room MC4-100

The authors analyze how the pass-through from exchange rate to domestic wages depends on the degree of integration between domestic and foreign labor markets. Using data from 66 countries over the period 1981–2005,  the authors find that the elasticity of domestic wages to real exchange rate is 0.1 after a year for countries with high barriers to external labor mobility, but about 0.4 in countries with low barriers to mobility. The results are robust to the inclusion of various controls, different measures of exchange rates, and concepts of labor market integration. These findings call for including labor mobility in macro models of external adjustment. 

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"Country Size, Currency Unions, and International Asset Returns"
Tarek Hassan (Harvard)

Thursday, June 11, 12:30-2:00, room MC4-100

The fact that economies differ in size has important implications for international asset returns. The author solves for the spread on international bonds and stocks in an endowment economy with complete asset markets and non-traded goods. The model predicts that larger countries have lower real interest rates because their bonds provide insurance against shocks that affect a larger fraction of the world economy. Larger countries' bonds must therefore pay lower excess returns in equilibrium and uncovered interest parity fails. By a similar logic, stocks in the non-traded sector of larger countries also tend to pay lower excess returns. If asset markets are segmented, the introduction of a currency union lowers real interest rates and expected returns on stocks in the non-traded sector of participating countries. The author tests the predictions of the model for a panel of OECD countries and shows that they are strongly supported by the data: Investors earn lower excess returns on bonds and stocks in the non-traded sector of larger countries. Similarly, excess returns on EMU member countries' bonds and stocks in the non-traded sector fell after European monetary integration.

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"Why Don't We See Poverty Convergence?"
Martin Ravallion (World Bank)

Thursday, June 18, 12:30-2:00, room MC9-100

Consistently with models of economic growth incorporating borrowing constraints, the analysis of a new data set for 100 developing countries reveals an adverse effect on consumption growth of high initial poverty incidence at a given initial mean. A high incidence of poverty also entails a lower subsequent rate of progress against poverty at any given growth rate (and poor countries tend to experience less steep increases in poverty during recessions). Thus, for many poor countries, the growth advantage of starting out with a low mean ("conditional convergence") is lost due to their high poverty rates. The size of the middle class—measured by developing-country, not Western, standards—appears to be an important channel linking current poverty to subsequent growth and poverty reduction. However, high current inequality is only a handicap if it entails a high incidence of poverty relative to mean consumption.

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