KDI Journal of Economic Policy

August 2013, 2013 KDI Journal of Economic Policy Conference

• Chapter 1Inflation’s Role in Optimal Monetary-Fiscal Policy

  Eric M. Leeper ; Xuan Zhou (pp.1-60)

  We study how the maturity structure of nominal government debt affects optimal monetary and fiscal policy decisions and outcomes in a conventional new Keynesian model with a distorting tax. Key findings are: there is always a role for current and future inflation innovations to revalue government debt, reducing reliance on distorting taxes; the role of inflation in optimal fiscal financing increases with the average maturity of government debt; inflation is relatively more important as a fiscal shock absorber in high-debt than in low-debt economies; in some calibrations that are relevant to U.S. data, welfare is higher under the fully optimal monetary and fiscal policies than under the conventional optimal monetary policy with passively adjusting lump-sum taxes.

• Chapter 2Transmission Mechanisms of the Public Debt

  Tack Yun (pp.61-110)

  The first part of this paper presents the empirical IS curve that involves the real anticipated interest rate and ratio of the public debt to GDP. In particular, the empirical finding on a negative debt-elasticity of the aggregate demand opens the possibility of non-Keynesian effects of exogenous changes in the government’s real primary budget surplus, which tends to be apparent in more recent sub-sample periods. In order to consider potential theoretical foundations of the empirical IS curve, a set of different small DSGE models are discussed: Sovereign-risk based channel or Risk-premium (financial friction) based channel, Modified liquidity-effect channel, Market-segmentation (in market for government securities) channel, and Expectations channel.

• Chapter 3Growth Slowdowns Redux

  Barry Eichengreen ; Dong hyun Park ; Kwan ho Shin (pp.111-166)

  We analyze the incidence and correlates of growth slowdowns in fast-growing middle-income countries, extending the analysis of an earlier paper (Eichengreen, Park and Shin 2012). We continue to find dispersion in the per capita income at which slowdowns occur. But in contrast to our earlier analysis which pointed to the existence of a single mode at which slowdowns occur, in the neighborhood of $15,000- $16,000 2005 purchasing power parity dollars, new data point to two modes, one in the $10,000-$11,000 range and another at $15,000-$16,0000. A number of countries appear to have experienced two slowdowns, consistent with the existence of multiple modes. We conclude that high growth in middle-income countries may slow down in steps rather than at a single point in time. This implies that a larger group of countries is at risk of a growth slowdown and that middleincome countries may find themselves slowing down at lower income levels than implied by our earlier estimates. We also find that slowdowns are less likely in countries where the population has a relatively high level of secondary and tertiary education and where hightechnology products accounts for a relatively large share of exports, consistent with our earlier emphasis of the importance of moving up the technology ladder in order to avoid the middle-income trap.

• Chapter 4Pension Reform, Fiscal Impact, and Savings

  Sang-Hyop Lee (pp.167-193)

  Rapid population aging is a great concern to many governments, because it threatens the fiscal sustainability of a welfare system such as pensions and medical care and implies an increased dependency burden on the working age population. With regard to public pension systems, many governments have considered policies to reduce the economic impact of future population aging. For example, the increase in normal retirement age or a decrease in pension benefits might improve the fiscal sustainability of a country. In addition, workers might accumulate wealth in anticipation of future needs to support consumption for longer periods of retirement without pension benefits. They may do this through personal saving, employment-based funded pension systems, or publicly funded retirement programs. This response initially leads to higher savings and lower consumption, but the additional capital is growth enhancing, and eventually income per worker rises. Moreover, the incentive structure created by public pension programs can have an additional effect on individual behavior in such a way that individuals delay their retirement. This possibility is supported by previous studies on the link between pay-as-you-go retirement pension benefits and earlier retirement practices. If workers delay their retirement substantially in response to the policy change, then the aforementioned effect on savings may be muted, since the future need to support consumption for retirement decreases. The goal of this paper is two folds. First, the paper shows the impact of an increase in the normal retirement age on fiscal sustainability and labor income using the National Transfer Accounts data set. The results show that a decrease public pension benefit of older people improves government budget, but its impact on labor income is usually small which is not enough to support the consumption of the older people. Second, the paper examines the effect of the policy on savings and economic growth. The simulation results generally show that delayed retirement reduces lifecycle pension wealth for the study countries, but it is less likely to reduce savings. However, the direction and magnitudes of the reform vary substantially across countries, which provide several policy implications. First, countries differ greatly in terms of the consumption, labor force participation, and productivity of the elderly. Second, population age structures differ across countries. Third, countries vary greatly in the systems they employ to fund the consumption needs of their retirees: i.e., the reallocation system. Retirees in some countries heavily rely on publicly provided pensions and healthcare systems, while some countries rely more on savings and asset-based reallocations. Countries may need to consider these factors when they plan a future welfare reform.

• Chapter 5Demographic Changes, Economic Growth, and Fiscal Rules in a General Equilibrium Model of Overlapping Generations

  Dong won Lee ; Weh-sol Moon (pp.194-215)

• Chapter 6Trade Liberalization, Growth, and Bi-polarization in Korean Manufacturing: Evidence from Microdata

  Chin Hee Hahn (pp.216-246)

  This paper examined the effect of trade liberalization or globalization, more broadly, on plants’ growth as well as on “bi-polarization”. To do so, we reviewed the possible theoretical mechanisms put forward by recent heterogeneous firm trade theories, and provided available microevidence from existing empirical studies on Korean manufacturing sector. Above all, the empirical evidence provided in this paper strongly suggests that globalization promoted growth of Korean manufacturing plants. Specifically, evidence suggests that exporting not only increases within-plant productivity but also promotes introduction of new products and dropping of old products. However, the empirical evidence also suggest that globalization has some downsides: widening productivity differences across plants and rising wage inequality between skilled and unskilled workers. Specifically, trade liberalization widens the initial productivity differences among plants through learning from export market participation as well as through interactions between exporting and R&D, both of which increase plants’ productivity. We also show that there is only a small group of large and productive “superstar” plants engaged in both R&D and exporting activity, which can fully utilize the potential benefits from globalization. Finally, we also show evidence that trade liberalization interacts with innovation to increase the skilled-unskilled wage inequality.

• Chapter 7Did China Tire Safeguard Save U.S. Workers?

  Sung hoon Chung ; Joon hyung Lee ; Thomas Osang (pp.247-281)

  It has been well documented that trade adjustment costs to workers due to globalization are significant and that temporary trade barriers have been progressively used in many countries, especially during periods with high unemployment rates. Consequently, temporary trade barriers are perceived as a feasible policy instrument for securing domestic jobs in the presence of increased globalization and economic downturns. However, no study has assessed whether such temporary barriers actually save domestic jobs. To overcome this deficiency, we evaluate the China-specific safeguard case on consumer tires petitioned by the United States. Contrary to claims made by the Obama administration, we find that total employment and wages in the tire industry were unaffected by the safeguard using the ‘synthetic control’ approach proposed by Abadie et al. (2010). Further analysis reveals that this result is not surprising as we find that imports from China are completely diverted to other exporting countries due to the strong presence of multinational corporations in the world tire market, leaving the subject tire prices in the U.S. unchanged.

• Chapter 8Korea’s Income Inequality: The Trend and Major Issues

  Kyung soo Choi (pp.282-339)

• Chapter 9Development Effectiveness of the Paris Declaration: An Empirical Evaluation

  Kye Woo Lee (pp.340-367)

  This study aims to assess the development effectiveness of the Paris Declaration (2005). Using data collected by the OECD/DAC from 78 developing countries for the period 2005~2010, this study evaluates the role played by the Paris Declaration principles alone and in interaction with aid in promoting per-capita GDP growth. The analysis shows that the overall net impact of aid on promoting economic growth has been negative. However, aid effectiveness has been enhanced by the sound policies or institutions and some Paris Declaration (PD) principles. Of the five principles of the PD, only the alignment and, to some extent, mutual accountability principles of the PD did show a significant and positive role in making aid more effective for economic growth of aid recipient countries. Therefore, OECD’s statement that the PD enhances aid effectiveness is supported only partially. These findings have significant implications for the importance accorded to sound policies and institutions in the growth literature, and for future international development cooperation agenda.

• Chapter 10Quantifying the Speculative Component in the Real Price of Oil: The Role of Global Oil Inventories

  Lutz Kilian ; Thomas K. Lee (pp.368-398)

  One of the central questions of policy interest in recent years has been how many dollars of the inflation-adjusted price of oil must be attributed to speculative demand for oil stocks at each point in time. We develop statistical tools that allow us to address this question, and we use these tools to explore how the use of two alternative proxies for global crude oil inventories affects the empirical evidence for speculation. Notwithstanding some differences, overall these inventory proxies yield similar results. While there is evidence of speculative demand raising the price in mid-2008 by between 5 and 14 dollars, depending on the inventory specification, there is no evidence of speculative demand pressures between early 2003 and early 2008. As a result, current policy efforts aimed at tightening the regulation of oil derivatives markets cannot be expected to lower the real price of oil in the physical market. We also provide evidence that the Libyan crisis in 2011 shifted expectations in oil markets, resulting in a price increase of between 3 and 13 dollars, depending on the inventory specification. With regard to tensions with Iran in 2012, the implied price premium ranges from 0 to 9 dollars.

• Chapter 11The Welfare Cost of Structural Uncertainty

  Young Il Kim (pp.399-419)

  It may be of interest to analyze how much of welfare gains may be achieved by mitigating consumption fluctuations over the business cycles. The structure that generates the consumption fluctuation may be even unknown; thus, the unknown structure may bring in additional welfare costs. This paper derives the welfare measure under the Epstein-Zin preference as well as under the CRRA preference and expresses them in terms of the moment-generating function. In addition, it considers the structural uncertainty in the consumption fluctuation in comparison with a known-fixed structure and analyzes how much the structural uncertainty may contribute to welfare costs. Based on calibration exercises, it shows that consumption fluctuations may entail non-trivial welfare costs and incorporating the structural uncertainty into the data generating process may bring in bigger welfare costs.

• Chapter 12Evaluation of Survey of Professional Forecasters in Greenbook Forecast Error Loss

  Tae-Hwy Lee ; Yiyao Wang (pp.420-449)

  Greenbook forecasts are used in making monetary policy. If private sectors use forecasts that are in line with Greenbook in making their economic decision they will be benefited from the Fed’s monetary policy. Unfortunately Greenbook becomes available to the public with 5 year lag. Therefore the alternative forecasts from Survey of Professional Forecasters (SPF) have been valuable substitute. Users of SPF would want to choose elements of the survey which are closest to Greenbook to guide their decision making. In practice, the median of SPF is widely used. However, whether the median is superior to other forecasts in the survey is not clear. This paper evaluates percentiles of SPF to find which percentiles of SPF are in line with the Greenbook forecasts in terms of forecast rationality, predictive ability, and forecast encompassing. Overall, most of rational SPF percentiles are as predictive as Greenbook for output growth forecast but not for inflation forecast. All SPF percentiles are encompassed by Greenbook. While the best SPF percentile of output growth forecast is found near the median SPF, the best SPF percentile of inflation forecast is far below the SPF median. Hence, the SPF-median over-predicts inflation.

• Chapter 13Market Structure and Cost Pass-through in Retail

  Gee Hee Hong ; Nicholas Li (pp.450-526)

  We examine the extent to which vertical and horizontal market structure can together explain incomplete retail pass-through. To answer this question, we use scanner data from a large U.S. retailer to estimate product level pass-through for three different vertical structures: national brands, private label goods not manufactured by the retailer and private label goods manufactured by the retailer. Our findings emphasize that accounting for the interaction of vertical and horizontal structure is important for understanding how market structure affects pass-through, as a reduction in double-marginalization can raise passthrough directly but can also reduce it indirectly by increasing market share.

• Chapter 14The Dynamic Relations between Market Returns and Two Types of Risk with Business Cycles

  Xiaoquan Jiang ; Bong Soo Lee (pp.527-569)

  We examine the dynamic relations among market returns, market risk, and idiosyncratic risk around business cycles. Compared to the conventional view, which treats market and idiosyncratic risks separately, we first find that excess market return anticipates negative market risk and idiosyncratic risk, suggesting market return’s role as an economic indicator, with the relation stronger in recessions. Second, idiosyncratic risk helps predict positive market risk, mainly in early part of recessions, suggesting a dynamic evolution from idiosyncratic risk to market risk. Third, market risk helps predict negative idiosyncratic risk, suggesting market risk may substitute idiosyncratic risk to some extent.