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No 122

Household Spending Dynamics: The Impact of House Price-Rent Spread and Credit Constraints

  • Abstract

    This paper explores how fluctuations in the house price-rent spread influence household spending, taking into account credit constraints. We incorporate a housing spread shock, representing changes in the future value of residential property, into a model of household decisionmaking with borrowing frictions. Using halfcentury data from 28 OECD countries, we find that housing spread shocks are more persistent than credit shocks, which induce ‘boom-bust’ dynamics. We also identify asymmetries once the joint effect of shocks to housing spread and borrowing frictions is analyzed, particularly in crisis periods, underscoring the importance of policies addressing credit conditions and household expectations to stabilize the economy when traditional tools are less effective.

    Keywords: household expectations; house price-rent spread; credit frictions; interest rates; household consumption

    JEL classification: D15, E21, E5, G51

No 114

How Do Firms Adjust When Trade Stops?

  • Abstract

    We investigate how firms adjust to the introduction of sudden, unanticipated and eventually long-lasting economic sanctions. In 2014, Russia introduced sanctions on imports from Europe, which caused an abrupt negative shock to the food production sector in Lithuania. We find that part-time employment is used as the first shock absorber, followed by investment and full-time employment. At the same time, firms dampen shock effects by expanding to other export markets. To rationalize this firm behavior, we provide a theoretical mechanism where forward-looking firms face nonconvexities in the labor market along with heterogeneous variable trade costs.

    Keywords: economic sanctions, firm adjustment margins, part-time employment, new export markets.

    JEL Classification: D22, D25, F14, F16, F51

No 87

Dancing Alone or Together: The Dynamic Effects of Independent and Common Monetary Policies

  • Abstract

    What would have been the hypothetical effect of monetary policy shocks had a country never joined the euro area, in cases where we know that the country in question actually did join the euro area? It is one thing to investigate the impact of joining a monetary union, but quite another to examine two things at once: joining the union and experiencing actual monetary policy shocks. We propose a methodology that combines synthetic control ideas with the impulse response functions to uncover dynamic response paths for treated and untreated units, controlling for common unobserved factors. Focusing on the largest euro area countries, Germany, France, and Italy, we find that an unexpected rise in interest rates depresses inflation and significantly appreciates exchange rate, whereas GDP fluctuations are less successfully controlled when a country belongs to the monetary union than would have been the case under the independent monetary policy. Importantly, Italy turns out to be the overall beneficiary, since all three channels – price, GDP, and exchange rate – deliver the desired results. We also find that stabilizing an economy within a union requires somewhat smaller policy changes than attempting to stabilize it individually, and therefore provides more policy space.

    Keywords: Dynamic causal effects; Monetary union; Price puzzle; Common factors.

    JEL codes: C14; C32; C33; E52.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 85

What Explains Excess Trade Persistence? A Theory of Habits in the Supply Chains

  • Abstract

    International trade flows are volatile, imbalanced, and fragmented across off-shored supply chains. Yet, not much is known about the mechanism through which trade flows adjust in response to shocks over time. This paper derives a dynamic gravity equation from a theory of habits in the supply chains that generates autocorrelated bilateral trade flows that are heterogeneous across different country pairs. We estimate our version of the dynamic gravity equation for 39 countries over the period of 1950-2014 and find that the transmission of local and global trade shocks is fundamentally different. We show that the trade persistence coefficient falls from 0.91 to 0.35 when we depart from the existing empirical gravity models that draw inference from the pooled coefficient estimates without controlling for the variation in the unobservable global factors. Thus, our approach escapes the excess trade persistence puzzle and adds to the explanation of the sharp decline and the rapid recovery of the global trade flows during the "Great Trade Collapse" of 2008-09. In addition to the traditional variables in the gravity equation, we also show that a cross-country habit asymmetry creates bilateral and multilateral trade imbalances, which are an important determinant of bilateral trade flows both theoretically and empirically.

    Keywords: Dynamic Gravity Equation; Habits; Trade Persistence; Trade Imbalance; Global Shocks; Parameter Heterogeneity.                                                                                                                                                                   
    JEL codes: C23, F14, F41, F62.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 84

Global Impacts of US Monetary Policy Uncertainty Shocks

  • Abstract

    We build a new empirical model to estimate the global impact of an increase in the volatility of US monetary policy shocks. Specifically, we admit time-varying variances of local structural shocks from a stochastic volatility specification. By allowing for rich dynamic interaction between the endogenous variables and time-varying volatility in the global setting, we find that US interest rate uncertainty not only drives local output and inflation volatility, but also causes declines in output, inflation, and the interest rate.  Moreover, we document strong global impacts, making the world move in a very synchronous way. Crucially, spillback effects are found to be significant even for the US economy.

    Keywords: US Monetary Policy, Volatility Shocks, Uncertainty, Global Economy.

    JEL Codes: C32, C54, E52, E58, F44.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 66

Does It Matter When Labor Market Reforms Are Implemented? The Role of the Monetary Policy Environment

  • Abstract

    Do labor market reforms initiated in periods of loose monetary policy yield different outcomes from those that were introduced in periods when monetary tightening prevailed? Since economic theory usually pays attention to the steady state change and ignores business cycle interactions of structural reforms, we connect local projection methodology with the Mallow’s Cp averaging criterion to arrive at an inference that does not require knowledge of the exact functional form, is robust to mis-specification, admits non-linearities, and cross-sectional dependence and addresses uncertainty regarding interactions between labor reforms and macroeconomy. We also develop a test to check the importance of monetary policy for any horizon and the entire impulse response function, taking the multiple testing problem into account. We document that replacement rates deliver substantially different outcomes on real GDP, inflation and real effective exchange rate, whereas labor activation schemes bear different effects on unemployment in low- and high-interest rate environments. There is also evidence of monetary policy trend playing an important role as well as increasing synchronized monetary and labor market policies across European countries.

    JEL Codes: C33, C54, E52, E62, J08, J38.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 45

The knotty interplay between credit and housing

  • Abstract

    We employ the recent Jordà et al. (2016) and Knoll et al. (2017) datasets to investigate the long-run relationship between house prices and credit volume, allowing for interest rate, real exchange rate and real gross domestic product (GDP). We refine the analysis using more recent data at the quarterly-level to define relevant co-integrating relationships across a number of European economies. Housing, GDP and credit cross-sectional averages are included in the analysis to detect potential spill-over effects. Empirical results indicate cross-country heterogeneities and an uneven feedback mechanism between credit and housing – the full loop is established only for several countries in the dataset. Important results relate to the statistical properties of the housing time series. Grouping countries for panel-like econometric exercises may lead to spurious regression results, poor inference and misleading policy implications. Short-run dynamics, compared to the long-run may often lead to contradicting policy advice if the order of integration of the house price series is not properly accounted for. Accounting for spatial patterns of house prices which cannot be attributed to global output shocks may provide useful insights into policy making.

    JEL Codes: C21, E51, O18, R31.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 39

Spatial nexus in crime and unemployement in times of crisis

  • Abstract

    Space is important. In this paper we use the global financial crisis as an exogenous shock to the German labor market to elucidate the spatial nexus between crime and unemployment. Our contribution is twofold: first, we lay down a parsimonious spatial labor market model with search frictions, criminal opportunities, and, unlike earlier analyses, productivity shocks which link criminal engagement with employment status. Second, we seek empirical support using data on the 402 German regions and years 2009 - 2010, in a setting that not only allows for crime spatial multipliers but also circumvents reverse causality by exploiting exogenous changes in unemployment due to the crisis. As predicted by our theory, the destruction of the lowest productivity matches, measured by increases in unemployment rates, has a significant impact on pure property crime (housing burglary and theft of/from motor vehicles) and street crime. The analysis offers important implications for local government policy.

    JEL Codes: C31, J64, K42, R10.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 37

Evolution of bilateral capital flows to developing countries at intensive and extensive margins

  • Abstract

    Online appendix (727.1 KB download icon)

    Motivated by the rise in capital flows to low-income countries (LICs), we examine the nature of these flows and the factors affecting foreign investors’ decision. Recognizing the presence of fixed investment costs, we analyze capital flows at both intensive and extensive margins. To fix ideas, we resort to the gravity literature for the estimating relationships which we embed into a two-tier econometric framework with cross-sectional dependence. Our main finding is that market entry costs are statistically and economically very detrimental to LICs. We also obtain the gravity-type relationship for the destination income unconditionally but not after conditioning on relevant variables, as well as establish labor productivity as a robust attractor of capital inflows.

    JEL Codes: C33, C34, F21, F62, O16.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 33

Labour market institutions in open economy

  • Abstract

    This paper builds a theoretical model that introduces frictional unemployment in a two-sector multi-worker heterogeneous firms model with a dynamic matching process. In doing so, we have a rich environment that combines product, labour, and international markets. A change in labour market policies (unemployment benefits and employment contingent subsidies) transforms the share of exporters and affects average productivity. Empirical evidence confirms a robust positive effect of employment subsidies on openness, little, if any, impact of subsidies and a positive effect of replacement rate on unemployment. Closure of equilibrium plays an important role to explain data facts about employment subsidies: using sectoral arbitrage condition, subsidies cease affecting unemployment and make openness grow, consistently with the empirical evidence. Unemployment benefits, on the other hand, make unemployment and openness rise, independently of sectoral reallocations. In addition, we find that unemployment benefits bear different policy implications with regards to international coordination than employment subsidies.

    JEL Codes: E24, F12, F16.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 1

Openness and structural labour market reforms: Counterfactuals for Lithuania

  • Abstract

    This paper deals with the macroeconomic responses to labour market reforms; something of utmost importance in times of monetary policy reaching its limits to affect real economy. We shed more light on the plausible macroeconomic reactions to the ex ante (planned but not implemented yet) reforms in the labour market, taking a currently proposed Social Model in Lithuania as an example. Not only contributing to the current debate on the efficacy of announced structural reforms, we also add to the literature on policy evaluation by assessing reforms from a global perspective. Omission of an international dimension could lead to seriously biased results on policy effects for any open and small economy. Taking trade connectivity and openness into account, we demonstrate macroeconomic reactions to shocks in unemployment benefits, active labour market policies, and tax wedge on the reforming economy. We contrast the results with the approach when global interdependencies are ignored – still a standard practice. Using a satellite model for the intermediate trade, we link the global framework with the sectoral extensive margin, which changes some of the initial findings. A discussion on counterfactuals, which use both cross-sectional and temporal dimensions to tackle anticipation effects, is also presented.

    JEL Codes: C33, C54, E62, J38.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 21

Global perspective on structural labour market reforms in Europe

  • Abstract

    Appendix (6.9 MB download icon)

    Recent turbulent times have once again demonstrated how important flexible product and labour markets are to dampen the effects of adverse economic shocks. A number of labour market reforms have been implemented to enhance economic resilience and flexibility. However, accounting for the efficacy of policy interventions requires going beyond national boundaries and evaluating international interactions and global interdependencies, which may strengthen or weaken economic responses. Concentrating on open European economies, this paper deals with labour market institutions and structural reforms in a general equilibrium framework, which allows to analyse the intricate connections between labour policy choices and international trade (openness), paying special attention to labour market policy shocks. Amid discussions about a fiscal union in Europe, we empirically demonstrate that labour market policies can have positive and negative spillovers to trading partners, thereby calling for coordinated policies within a trading bloc. We answer three types of questions: what would have happened had all economies implemented structural labour market reforms simultaneously? How heterogeneous are responses in a single economy to shocks conducted in every other country? Relatedly, how heterogeneous are responses by all economies to a reform in one given economy?

    JEL Codes: C32, C33, E24, F12, F16.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.