International Seminar on Macroeconomics

An NBER International Seminar on Macroeconomics took place on June 18-19. Research Associates Jeffrey A. Frankel of Harvard University and Hélène Rey of London Business School organized the meeting. These researchers' papers were presented and discussed:

Stefanie Stantcheva, Harvard University and NBER; Yazan Al-Karablieh, Harvard Kennedy School; and Evangelos Koumanakos, University of Ioannina

Improving Tax Compliance: Setting Target Taxable Margins for Greek Firms

Stantcheva, Al-Karablieh, and Koumanakos use the universe of Greek corporate tax returns data matched to financial statements data to study a voluntary and salient tax compliance program for small firms,the goal of which was to raise taxable profits. This "self-assessment" program prescribed target taxable profit margins for different types of activity such that, if firms reported profit margins above these targets in a given year, they’d be exempt from audits in that year. The researchers find that the program raises taxable profits two- to three-fold in program years for self-selecting firms but has only marginal long-lasting effects on tax reporting. Stantcheva, Al-Karablieh, and Koumanakos also find that firms can easily and substantially manipulate revenue to help meet prescribed margins. Overall, the program increased tax revenues collected from small firms, but points to a very large level of baseline under-reporting of profits.

Fernanda Nechio, Central Bank of Brazil; Bart Hobijn, Arizona State University; and Adam Shapiro, Federal Reserve Bank of San Francisco

Using Brexit to Identify the Nature of Price Rigidities

Using price quote data that underpin the official U.K. consumer price index (CPI), Nechio, Hobijn, and Shapiro analyze the effects of the unexpected passing of the Brexit referendum on the dynamics of price adjustments. The sizable depreciation of the British pound that immediately followed Brexit works as a quasi-experiment, enabling us to study the transmission of a large common marginal cost shock to inflation as well as the distribution of prices within granular product categories. A large portion of the inflationary effect is attributable to the size of price adjustments, implying that a time-dependent price-setting model can match the response of aggregate inflation reasonably well. The state-dependent model fares better in capturing the endogenous selection of price changes at the lower end of the price distribution, however, it misses on the magnitude of the adjustment conditional on selection.

Tomas Williams, George Washington University; Fernando Broner and Alberto Martin, CREI; and Lorenzo Pandolfi

Winners and Losers from Sovereign Debt Inflows

Williams, Broner, Martin, and Pandolfi study the transmission of sovereign debt inflow shocks on domestic firms. They exploit episodes of large sovereign debt inflows in six emerging countries which are due to the announcements of these countries’ inclusion in two major local currency sovereign debt indexes. The researchers show that these episodes significantly reduce government bond yields and appreciate the domestic currency, and have heterogeneous spillovers on domestic firms. Financial and government-related firms experience positive abnormal returns in the days following the announcement episodes. Instead, companies operating in tradable industries exhibit negative abnormal returns after the episodes. Williams, Broner, Martin, and Pandolfi find that the former expansionary effect is more pronounced in countries where the government bond yields drop more in response to the announcement, while the latter recessionary effect is larger in countries where the domestic currency appreciates more. Also, Williams, Broner, Martin, and Pandolfi find that firms which rely more on external financing are positively affected by these events. Their findings shed novel light on the channels through which sovereign debt inflows affect firms in recipient countries. They suggest that these inflows can contribute to reshaping the domestic economy, by increasing the importance of the non-tradable sector at the expenses of the tradable one.

Refet S. Gürkaynak, A. Hakan Kara, Burçin Kısacıkoğlu, and Sang Seok Lee, Bilkent University

Monetary Policy Surprises and Exchange Rate Abnormalities

Central banks unexpectedly tightening policy rates often observe the exchange value of their currency depreciate, rather than appreciating as predicted by standard models. Gürkaynak, Kara, Kısacıkoğlu, and Lee document this for Fed and ECB policy days using eventstudies and ask whether an information effect, where the public attributes the policy surprise to an unobserved state of the economy that the central bank is signaling by its policy may explain the abnormality. It turns out that many informational assumptions make a standard two-country New Keynesian model match this behavior. To identify the particular mechanism Gürkaynak, Kara, Kısacıkoğlu, and Lee condition on reactions of longer term interest rates in the event study and model implications for these. The researcher find that there is heterogeneity in this dimension in the eventstudy and no model with a single regime can match the evidence. Further, even after conditioning on the information effects on longer term interest rates, there may be independent information in the reaction of exchange rates.

Ethan Ilzetzki and Keyu Jin, London School of Economics

The Puzzling Change in the International Transmission of U.S. Macroeconomic Policy Shocks

Using five separate identification methods, Ilzetzki and Jin demonstrate a dramatic change over time in the international transmission of US macroeconomic shocks. International spillovers from US monetary policy, government spending, and tax policy shocks take on a different nature the 21st century than they did in post-Bretton Woods period. Their analysis is based on the a panel of 17 high income and emerging market economies. Prior to the 1990s, the US dollar appreciated, and ex-US industrial production declined, in response to increases in the US Federal Funds rate, as predicted by textbook open economy models. Similarly, fiscal policies leading to interest rate increases appreciated the dollar and lead to output contractions. The past three decades have seen a shift, whereby increases in US interest rates depreciate the US dollar but stimulate the rest of the world economy. Ilzetzki and Jin sketch a simple theory of exchange rate determination in face of interest-elastic risk aversion that rationalizes these findings.

Kalina Manova, University College London; Davin Chor, Dartmouth College and NBER; and Zhihong Yu, Nottingham University

Growing Like China: Firm Performance and Global Production Line Position

Global value chains have fundamentally transformed international trade and development in recent decades. Manova, Chor, and Yu use matched firm-level customs and census data and Input-Output tables for China to examine how firms position themselves in global production lines and how this position evolves with performance over the firm lifecycle. They document a sharp rise in import upstreamness, stable export downstreamness, and rapid expansion in production stages conducted in China over the 1992-2014 period, both in the aggregate and within firms over time. Firms span more production stages as they grow more productive, bigger and more experienced. This expansion is accompanied by a rise in input purchases, value added in production, and fixed cost levels and shares. It is ultimately associated with higher profits despite flat profit margins. The researchers rationalize these patterns with a stylized model of the firm lifecycle with complementarity between economies of scope and scale. Manova, Chor, and Yu conclude with suggestive cross-country panel evidence to inform promising avenues for future research.

Maurice Obstfeld, University of California, Berkeley and NBER; Eugenio M. Cerutti, International Monetary Fund; and Haonan Zhou, Princeton University

Covered Interest Parity Deviations: Macrofinancial Determinants

This paper studies how several macrofinancial factors are associated over time with the evolution of covered interest parity (CIP) deviations in the decade after the global financial crisis. Changes in a number of risk- and policy-related factors have a significant association with the evolution of CIP deviations. Key measures of FX market liquidty and intermediaries' risk-taking capacity are strongly correlated with the cross-currency basis (the deviation from CIP), and the close relationship between broad U.S. dollar strength and the basis is driven mainly by a common factor depending on other safe-haven currencies' comovements. Postcrisis monetary policies also play a role, as demonstrated by the relationship between CIP deviations, central bank balance sheet, and term premia. Further highlighting the role of bank regulation, Obstfeld, Cerutti, and Zhou offer evidence that the year-end dynamics of the three-month dollar basis depend on financial regulations targeting global systemically important financial institutions. Data on central bank swap line draws at quarter ends yield a lower-bound estimate of how much regulation-induced dollar funding shortages affect the basis.

Stephanie Schmitt-Grohé and Martín Uribe, Columbia University and NBER

Reviving the Salter-Swan Small Open Economy Model

In this paper, Schmitt-Grohé and Uribe provide microfoundations to the Salter-Swan policy framework, a graphical apparatus designed to ascertain the exchange-rate and fiscal stance of a policymaker with internal and external economic targets. The environment is an infinite-horizon small open economy producing tradable and nontradable goods that takes world prices and world interest rates as given and is populated by optimizing households and firms. The economy is subject to terms-of-trade and interest-rate shocks. The internal target of the government is the unemployment rate and the external target is the current account. Downward nominal wage rigidity and incomplete asset markets serve as the rationale for meaningful policy intervention.

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