Working Papers
2023
June 30, 2023
Is High Debt Constraining Monetary Policy? Evidence from Inflation Expectations
Description: This paper examines whether high government debt levels pose a challenge to containing inflation. It does so by assessing the impact of government debt surprises on inflation expectations in advanced- and emerging market economies. It finds that debt surprises raise long-term inflation expectations in emerging market economies in a persistent way, but not in advanced economies. The effects are stronger when initial debt levels are already high, when inflation levels are initially high, and when debt dollarization is significant. By contrast, debt surprises have only modest effects in economies with inflation targeting regimes. Increased debt levels may complicate the fight against inflation in emerging market economies with high and dollarized debt levels, and weaker monetary policy frameworks.
June 30, 2023
Unpleasant Surprises? Elections and Tax News Shocks
Description: Unanticipated changes in tax policy are likely to have different macroeconomic effects compared to anticipated changes due to several mechanisms, including fiscal foresight and policy uncertainty. It is therefore important to understand what drives such policy surprises. We explore the nature of unanticipated tax policy changes by focusing on a political economy determinant of those events, namely the timing of elections. Using monthly data for 22 advanced economies and emerging markets over the period 1990-2018, we show that implementation lags tend to be significantly longer for tax policy change announcements that are made during the pre-election periods, thereby leading to a lower likelihood of “tax news shocks”. We also find that implementation lags become much shorter for tax policy changes that are announced in the aftermath of elections, generating more frequent tax news shocks. This pattern remains similar for different tax measures or types of taxes. The findings are robust to a number of checks, including alternative definitions of tax news shocks, or to controlling for various economic and institutional factors.
June 30, 2023
The Macroeconomic Returns of Investment in Resilience to Natural Disasters under Climate Change: A DSGE Approach
Description: This paper presents a Markov switching dynamic stochastic general equilibrium model designed to evaluate the macroeconomic return of adaptation investment to natural disasters (NDs) and the impact of climate change. While the model follows the existing literature in assuming that NDs destroy a share of the public and private capital stocks and a government that can invest in adaptation at an additional cost, it adds several features that are key to the analysis, both in the near (transition) and long (steady state) terms. Those include incomplete markets, financial frictions with collateral constraints, foreign remittances, full menu of tax and government spending instruments, and endogenous climate risk premium. The model is calibrated to the case of Dominica. It finds that NDs have large and persistent negative effects on output and public finances. It also shows that adaptation investment has large returns in terms of private investment, employment, output and tax revenue in the long term, especially under climate change.
June 30, 2023
A Note of Caution on the Relation Between Money Growth and Inflation
Description: We assess the bivariate relation between money growth and inflation in the euro area and the United States using hybrid time-varying parameter Bayesian VAR models. Model selection based on marginal likelihoods suggests that the relation is statistically unstable across time in both regions. The effect of money growth on inflation weakened notably after the 1980s before strengthening after 2020. There is evidence that this time variation is related to the pace of price changes, as we find that the maximum impact of money growth on inflation is increasing in the trend level of inflation. These results caution against asserting a simple, time-invariant relationship when modeling the joint dynamics of monetary aggregates and consumer prices.
June 30, 2023
Migration, Search and Skill Heterogeneity
Description: Cross-border migration can act as an important adjustment mechanism to country-specific shocks. Yet, depending on who moves, it can have unintended consequences for business cycle stability. This paper argues that the skill composition of migration plays a critical role. When migration flows become more concentrated in skilled labor an important trade-off arises. On the one hand, migration releases unemployment pressures for the origin countries. On the other hand, it generates negative compositional effects (the so-called “brain drain” effects) and skill imbalances, which reduce supply capacity in origin countries. This paper analyses quantitatively the impact of cyclical migration in an open-economy Dynamic Stochastic General Equilibrium (DSGE) model with endogenous migration flows, trade linkages, search and matching frictions, and skill heterogeneity. I apply this framework to the case of the Greek emigration wave following the European Debt Crisis. What I find is that emigration flows implied strong negative effects for capital formation, leading to more than a 15 percentage point drop in investment. Rather than stabilizing the Greek business cycle, labor mobility led to a deeper and more protracted recession.
June 30, 2023
An Estimated DSGE Model for Integrated Policy Analysis
Description: We estimate a New Keynesian small open economy model which allows for foreign exchange (FX) market frictions and a potential role for FX interventions for a large set of emerging market economies (EMEs) and some inflation targeting (IT) advanced economy (AE) countries serving as a control group. Next, we use the estimated model to examine the empirical support for the view that interest rate policy may not be sufficient to stabilize output and inflation following capital outflow shocks, and the extent to which FX interventions (FXI) can improve policy tradeoffs. Our results reveal significant structural differences between AEs and EMEs—in particular FX market depth—leading to different transmission of capital outflow shocks which justifies occasional use of FXI in some EMEs in certain situations. Our analysis also highlights the critical importance of accounting for the endogeneity of FXI behavior when assessing FX market depth and policy tradeoffs associated with volatile capital flows in past episodes.
June 30, 2023
Rising Child Poverty in Europe: Mitigating the Scarring from the COVID-19 Pandemic
Description: Child poverty increased dramatically during the COVID-19 pandemic. In 2020 alone, the number of children suffering from poverty in the EU increased by 19 percent, or close to 1 million. Left unaddressed, this would not only affect individuals’ life prospects and well-being but also have long-term economic implications. This paper argues that, to limit this potential scarring effect of the pandemic, policies should be deployed to reduce rapidly the number of children affected by poverty and mitigate the long-term impact of poverty. Reducing the number of children affected by poverty can be achieved by (i) labor policies and reforms that increase parental work and the labor income of poor parents and (ii) fiscal spending on family and children that can have a powerful and immediate impact. These policies need to be complemented by public investment in education and childcare, health, and housing to mitigate the long-term impact of child poverty.
June 23, 2023
Do Sovereign Wealth Funds Reduce Fiscal Policy Pro-cyclicality? New Evidence Using a Non-Parametric Approach
Description: The heightened volatility of commodity prices in recent years, reflecting the effects of the pandemic and the war in Ukraine, begs the longstanding question of the optimal fiscal policy response to commodity price shocks. Fiscal performance in most commodity-exporting countries is typically shaped by shifts in commodity prices and economic activity, often resulting in procyclical fiscal policy. One way to minimize the procyclicality of fiscal policy is to set up a stabilization Sovereign Wealth Fund (SWF). While such funds can help smooth government consumption in good and bad times, the empirical evidence of their value so far has been inconclusive. However, using an unbalanced panel dataset for 182 countries during 1980-2019, with two econometric methods that address the selection-bias problem, we provide robust evidence that stabilization SWFs do indeed help smooth government consumption by reducing fiscal policy volatility associated with commodity price fluctuations.
June 23, 2023
Foreign Currency Balance Sheets in Türkiye: Exposure and Interconnectedness
Description: As a heavily “dollarized” economy, large foreign currency mismatches exist between institutional sectors within Türkiye, as well as with non-residents. Combining several separate data sources, this working paper builds a picture of the aggregate FX exposure of the total economy. It explores the interlinkages between sectors and how they have evolved in recent years. Since the start of the pandemic, the overall net FX position of the economy deteriorated, and there has also been a considerable shift in FX risk from the private to the public sector. Especially for the central bank, this shift constrains policy space.
June 23, 2023
The IMF-World Bank Climate Policy Assessment Tool (CPAT): A Model to Help Countries Mitigate Climate Change
Description: To stabilize the climate, global greenhouse gas emissions must be cut by 25 to 50 percent by 2030 compared to 2019. Such an unprecedented rate of decarbonization necessitates climate mitigation policies across countries, notably carbon pricing, fossil fuel subsidy reform, renewable subsidies, feebates, emission rate regulations, and public investments. To design and implement effective, efficient, and equitable policies, governments need tools to assess economic, environmental, fiscal, and social impacts. To support this effort, the IMF and World Bank are making their joint Climate Policy Assessment Tool (CPAT) available to governments. CPAT is a transparent, flexible, and user-friendly model covering over 200 countries. It allows for the rapid quantification of impacts of climate mitigation policies, including on energy demand, prices, emissions, revenues, welfare, GDP, households and industries, local air pollution and health, and many other metrics. This paper describes the CPAT model, its data sources, key assumptions, and caveats.