Browsing by Author "Modesto, Leonor"
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- Altruism, human capital and environmental preservation in a globalized economyPublication . Bouché, Stéphane; Modesto, LeonorThis paper analyzes the impact of trade openness on education and environmental preservation choices in a two country model where both countries only differ in their shares of skilled workers. Parents may invest in their children's education increasing their probability to become skilled and in maintenance investment in order to preserve present and future environmental quality. Under autarky, unskilled individuals in the skill scarce economy are unable to invest in education due to borrowing constraints. Moreover, only skilled individuals of the latter economy choose to invest in environmental preservation. Openness to trade modifies relative factor prices and increases pollution. This allows for human capital convergence between both economies and induces all skilled individuals to contribute to environmental preservation in the free trade equilibrium. However, overall environmental quality decreases, suggesting a potential trade-off between income convergence at the global level and environmental preservation. We also focus on the optimal allocation under free trade and conclude that a maintenance investment subsidy should be implemented for skilled individuals but not necessarily for unskilled ones.
- Competition and the risk of bank failure: breaking with the representative borrower assumptionPublication . Ferreira, Rodolphe dos Santos; Modesto, LeonorWe examine the relation between intensity of competition in the loan market and risk of bank failure, in a model with adverse selection. As well established, the presence of the two opposite margin and risk-shifting effects creates conditions for nonmonotonicity: the conventional competition-fragility view may be challenged at high interest rates. These rates may however be too high to be compatible with oligopolistic equilibrium conditions. The challenging competition-stability view has been argued in terms of a representative borrower managing the profitability-safeness trade-off under moral hazard. However, the representative borrower assumption is not innocuous, playing down by construction the margin effect. The paper considers the adverse selection situation where that trade-off is managed by banks facing heterogeneous borrowers, and shows analytically, in the case of a trapezoidal distribution of idiosyncratic and systemic risk factors, that the conventional view is always valid.
- Imperfect competition in the banking sector and economic instabilityPublication . Carli, Francesco; Lloyd-Braga, Teresa; Modesto, LeonorWe study the impact of competition in the banking sector on the emergence of endogenous cycles driven by self-fulling volatile expectations. We consider an OLG model with two sectors and two household types: workers, who consume and work when young and save through bank deposits; and entrepreneurs, who seek bank loans to finance current consumption and to invest in a productive technology that transforms the consumption good into capital. When old, entrepreneurs rent this capital to firms, who produce the consumption good using capital and labor. All markets are perfectly competitive, except the loans market where banks compete à la Cournot under free entry and exit. In the absence of externalities in the capital producing technology, more competition in the banking sector promotes the emergence of local indeterminacy and sunspots fluctuations. In contrast, under constant social returns to scale in the capital producing technology, bank market power alone triggers the emergence of local indeterminacy. With increasing social returns to scale, both market power and externalities facilitate the emergence of local indeterminacy. Additionally, when banks have market power, steady state multiplicity may emerge, opening the way to global indeterminacy and fluctuations.
- Intra-industry trade, involuntary unemployment and macroeconomic stabilityPublication . Riche, Antoine Le; Lloyd-Braga, Teresa; Modesto, LeonorWe introduce taste for variety in a one-sector model of differentiated products with productive labor externalities, considering two OLG countries, one with wage rigidity and the other with full employment. After opening the borders to capital mobility and intra-industry trade, steady state output and real wages improve in the full employment country and the saddle path stability, characterizing this country under autarky, will prevail in the globalized world if this economy is big enough. Unemployment increases in the country with wage rigidity and, for intermediate plausible values of both the current propensity to consume and of the labor externality, indeterminacy, which emerges in the rigid wage economy in autarky, will be exported to the world if this country is relatively big. Finally, we show that globalization leads to the appearance of stable deterministic cycles in activity, employment and the trade account, both through flip and Hopf bifurcations, when the world steady state is locally determinate, for empirically plausible low degrees of labor externalities. This implies that trade cycles occur in the absence of shocks to fundamentals, and even without uncertainty in expectations.
- Market distortions and local indeterminacy: a general approachPublication . Lloyd-Braga, Teresa; Modesto, Leonor; Seegmuller, ThomasWe provide a methodology to study the role of market distortions on the emergence of indeterminacy and bifurcations. It consists in introducing general specifications for the elasticities of the crucial functions defining the aggregate equilibrium dynamics of the model. This allows us to study how market distortions influence the range of values for the elasticity of input substitution under which local indeterminacy and bifurcations occur, highlighting the main channels and classes of distortions responsible for indeterminacy. Most of the specific market imperfections considered in the related literature are particular cases of our framework. Comparing them we obtain several equivalence results in terms of local dynamic properties. Applying this methodology to the Woodford [30] framework we find that distortions in the capital market, per se, do not play a major role. We further show that, for empirically plausible values of elasticity of substitution between inputs, indeterminacy requires a minimal degree of distortions. This degree seems to be high under output market distortions, while with labor market distortions the required degree is empirically plausible.
- Sovereign debt, fiscal policy, and macroeconomic instabilityPublication . Carli, Francesco; Modesto, LeonorWe study the relation between capital accumulation, fiscal policy, and sovereign debt dynamics in a small open economy. The government maximizes spending, facing borrowing constraints and a conditionality requirement. Debt dynamics are forward looking, being driven by the endogenous borrowing constraint. Current debt is determined by expectations about the government's ability to finance itself in the future, opening the room for indeterminacy. If the government believes it may issue more debt next period, the borrowing constraint relaxes, and current debt increases. The government invests more in productive activities, generating a boom which increases tax revenues. However, as this increase does not repay the additional debt, the government will issue more debt next period, confirming initial expectations. To exclude explosive trajectories, tax revenues must increase enough to repay the outstanding debt and reduce future debt emission. This is possible only with a sufficiently procyclical tax rate. In this case, if productive externalities are large enough, the economy exhibits local and global indeterminacy, as steady-state multiplicity is also obtained. Avoiding sufficiently procyclical tax rates, the government can prevent local and global fluctuations driven by self-fulfilling volatile expectations. This differs from the general wisdom that procyclical tax rates should be used for stabilization.
- Tax rate variability and public spending as sources of indeterminacyPublication . Lloyd-Braga, Teresa; Modesto, Leonor; Seegmuller, ThomasWe consider a constant returns to scale, one sector economy with segmented asset markets of the Woodford type. We analyze the role of public spending, financed by labor income and consumption taxation, on the emergence of indeterminacy. We find that what is relevant for indeterminacy is the variability of the distortion introduced by government intervention. We show that the degree of public spending externalities in preferences affects the combinations between the tax rate and its variability under which indeterminacy occurs. Moreover, we find that consumption taxes can lead to local indeterminacy when asset markets are segmented.
- Testing the rationality of expectations using aggregate dataPublication . Modesto, LeonorIn this paper it is argued that tests of rationality of expections based on aggregate data, specifically when the aggregate expectations series come from business survey data, are not conclusive. In fact it is shown that even when individual agents have rational expectations, aggregate expectations series and aggregate prediction errors should not pass the traditional rationality tests. This can account for the observed persistent correlation in deviations of real GNP from trend in a Lucas-supply function without the need of a lagged output variable. But it also suggests that the macroeconomic implications of rational expectations will be weakened.
- The effects of CSF 1994-1999 on the Portuguese economyPublication . Modesto, Leonor; Neves, Pedro DuarteThis paper tries to assess the macroeconomic effects of the CSF 1994-99 on the Portuguese economy using the macroeconomic HERMIN-Portugal model. To that end, after briefly presenting the main characteristics of the model and providing an overview of the Portuguese CSF programmes, we offer a detailed description of the methodology used in the quantification of the effects of those CSF programmes. The contribution to growth of these programmes, both separately and jointly, is analysed and compared with a stylised projection of the Portuguese economy used as benchmark. A major novelty of the current work is the consideration of supply effects. The simulation exercises performed show that die CSF 1994-99 package has potentially important effects on the Portuguese economy. This work suggests that the injection of the CSF funds could trigger a response pattern that would increase die level of GDP by more than amount injected.
- The failure of stabilization policy: balanced-budget fiscal rules in the presence of incompressible public expendituresPublication . Abad, Nicolas; Lloyd-Braga, Teresa; Modesto, LeonorWe consider an infinite horizon neoclassical model with a government that (i) balances its budget at each point in time, (ii) faces unavoidable (incompressible) public expenditures, and (iii) further uses a fiscal rule for the share of variable government spending in output with the purpose of stabilizing the economy. We show that insulating this economy from belief driven fluctuations is not possible if the government finances these two components of public spending using a distortionary proportional income tax. In this case, we always have steady state multiplicity (two steady states) and global indeterminacy, while local indeterminacy is also possible. More precisely, even if a sufficiently procyclical share of the variable government spending component in output is still able to eliminate local indeterminacy, two saddle steady states prevail, so that, depending on expectations, the economy may either converge to the low steady state or to the high steady state. This implies that a regime switching rational expectation equilibrium, where the economy switches between paths converging to the two different steady states, easily arises. As expectations influence long run outcomes, our model is able to generate large and sudden expansions and contractions in response to expectation shocks.