notes applied macro development economics

7/25/2019 Notes Applied Macro Development Economics

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september4.

Philips curve: relationship between inflation and unemployment. In 1970's we

experienced rising inflation with the same high unemployment rate (Stagflation).

Lucas critique. Models need to have a microfoundation. Optimizing behaviour of

individuals.

What emerged: Macro based on micro.

Rise of New Classical Macroeconomics:

Incorporated rigidities (example: only a share of firms can update their prices)

New Keynesian Revival (1980s):

Main goal of policy: Reduce macroeconomic volatility.

Assumptions: Perfectly competitive firms. Only one good. No capital is flowing in or out.The market for capital, labor and commercial bank loans are competititve.

This is a typical paper from 2007. Kinda outragous assumptions.

Example (Slide 13):

Krugman: Let's stop deriving models from 1. principles of economics, and start deriving

models from empirical facts.

Representative agent implies homogenous beliefs which rules out coordination

problems. However, in the real world different views on the economy leads to

coordination failures.

Robert Solow and Sidney Winter are strong opponents to the DSGE models and the

assumptions of representative agent and rationality.

DSGE models will not be found anywhere but in Academia and Central Banks. Theprivate sector uses much simpler methods. If DSGE models are so good, why don't the

private sector use them and make better prediction and more money?

Crisis in macroeconomics and critique of the 'New' Neoclassical Synthesis:

Statistics more difficult to obtain.

Politics and corruption.

More exposed to severe exogenous shocks.

Market failures.

Self-sustaining households.

How do developing countries differ from developed countries (structural differences)?

September9.

What theory? --> new neoclassical synthesis. However, increased theoretical critique of

these models and empirical failure (lack of use in "real world").

Applied Economics = applying an established core of theory to specific applications using

empirical methods.

Classifications: World Bank income groups (ADP, Atlas method), UNDP HDI (Education,

income, health).

Solow residual is for developing countries dominated by a stochastic trend process

Operational classifications: Much more about vulnerability. A country may ask for

assistance from IMF if it cannot meet its international net payments on affordable

terms. Developing countries are in general more vulnerable (volatile income, trade

balance, etc) than developed countries.

Definition of developing countries.

Topic 1: What's different about applied development

macroeconomics?Kasper Brandt

4. september 2015

08:39

Adv. Dev. Econ. A lied Macro Pa e 1


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(unit root process).

Stylized facts. Developing countries are much more volatile and vulnerable to shocks.

Structure. Long tradition of seeing developing countries as being 'dualistic'. Does not

have to be a two sector or two market economy. It can also be three or more. Ex.:

traditional rural, informal urban, and formal urban.

Deductive: Theory --> Hypothesis --> test (Theoretical method). Very academic and

not popular in policy analysis. Therefore not used a lot by for example IMF.

Inductive: Data --> Infer patterns --> models (Statistical method). Ex: RCTs and natural

experiments. RCTs are not possible in macroeconomics, but natural experiments are

possible. Drawbacks: i) hard to find evidence of something if you don't know what to

look for or ask the right questions, ii) different statistical models give rise to different

results, iii) External validity.

Abductive (iterative): given evidence E and candidata explanations H()1, ... , H(n) of E, if

H(i) explains E better than any of the other hypotheses, infer that H(i) is closer to the

truth than any of the other hypotheses. The "Ten Commandments for Economists" by

Danny Rodrik.

Styles of economic reasoning

Starts with a question or statement

Elaboration drawing on evidence or literature

Compulsory assignment:

The applicability of new neo-classical synthesis macroeconomic models to developing

countries is limited.

Reasons why this is true or proof of contradiction.

de Long, B. (2011). Economics in crisis. "We need fewer efficient-markets

theorists and more people who work on microstructure, limits to arbitrage, andcognitive biases." That is, we need practitioners. This statement is in favour of the

inductive or abductive reasoning. Remember to say that this blog focuses on the

crisis of economics after the financial crisis, though he does say that various

economists have emphasized the possibility of a new major crisis. The crisis arises

in the fact that economics departments are not (according to the author)

reorienting themselves. They continue to appreciate theorists too much.

Use the three circles from the slides.

Colander (2013). "Koen carefully points out that, while there is a connection

between engineering and science, engineering is not applied science; rather,

science should be seen as applied engineering. By that he means that science is the

application of the engineering methodology Use the best available engineeringheuristics to solve problems to a particular problem". Thereby, Koen argues that

the abductive approach relates to engineering methodology. Since Koen argues in

favour of the engineering approach, then he must appreciate the abductive

approach the most.

When working with policy challenges in developing countries, an abductive approach

to research is appropriate.

Use new new-classical synthesis models to show that dualistic models give rise to

important insights not gained in the new neo-classical synthesis.

Important insights can be gained from the use of dualistic macroeconomics models in

developing countries.

De Long, B. (2011). May also we relevant for this question. Economics in crisis

leads to economists having to reorient themselves as practitioners rather than

theorists that have structural solutions. In contrast to Colander (2013).

De Long, B. (2015). Science is good if it is detached. However, "some economists

Should applied macroeconomists in developing countries orient themselves as

engineers rather than detached scientists?

Questions:



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have a tendency to claim that what is true about certain types of theories is true

for all theories and thus applicable to the real world". These are for example price

taking behaviour, homogenous agents, and rational expectations.

IMF (2004). "The main conclusions are as follows. First, no single model or

framework is universally applicablepolicy formulation relies on a variety of

models, techniques, and economic judgment."This is in agreement with what de

Long is saying about what is true for one theory may not be true for another. And

it is in agreement with what Colander says about non-scientific knowledge also

being important (economic judgment).

Scholars should see themselves as engineers who solve real-world problems

instead of detached theorists whose goal is to provide better understanding

of the economy for the sake of the understanding. If the primary goal of

macroeconomists were to provide policy advice then the methodology used

is very problematic. Macroeconomists forgot to point this out and that the

primary goal usually just is to understand the theory for the sake of model

building. It wouldn't be a problem if objective for macroeconomists was to

understand theories for the sake of understanding. However, society expect

macroeconomists to help with real-world problems, and then it is

problematic to apply theories that have been developed for the sake ofunderstanding.

"The difference between thinking about applied economics as applied

science and as engineering can be seen by considering what is at the core of

the model used. Applied science sees scientific knowledge at its core. It

excludes all non-scientific knowledge. The engineering core includes all

applied science but can include non-scientific knowledge in the core as well

as established scientific knowledge. Historical knowledge, intuitive

knowledge and guestimates are all allowed as foundations for engineering

models. This larger core opens up the analysis to a wider range of acceptable

models than does applied science."

If a situation is perfectly understood then the engineering and scienrificapproach is asymptotically the same. "But Koen emphasizes that engineers

deal with poorly understood and uncertain situations, and the less

understood, and more uncertain, the situation, the more likely the methods

will differ."

No economics crisis. "Implementing an engineering methodology instead of

a scientific methodology would lead to five changes in how applied

economics is done. See the paper for these changes. Contrary to what some

heterodox economists claim, the economics profession is not in crisis far

from it, it is highly successful in recruiting students and in being respected by

the public."

Implementation could be through university funding. Some of the funding isfor applied research while another share of the funding is for purely

scientific purposes. Thereby, research incentives would change to a more

engineering/problem-solving approach.

Colander (2013).



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Macroprudential policies. Dynamically adjusted financial regulation. Macroprudential tools

more used after the Crisis.

Other macroeconomic instruments are monetary policy and fiscal policy (e.g. debt-to-GDP

aim)

Rethinking macroeconomic policy: Introduction

Rationale from the structural adjustment loans (SALs) was to maintain growth and to

facilitate balance of payments adjustment. More specific the objective was to "reducetheir current account deficit to more manageable proportions by supporting programs

of adjustment . . . to strengthen their balance of payments, while maintaining their

growth and developmental momentum."

SALs are e.g. fiscal adjustment, getting the prices right (inflation stabilization), trade

liberalization, and in general a movement towards free markets.

Selection bias problem. Addressed by using Heckman-type selection techniques and IV

estimation.

Objective: Measure the performance of SALs. The effect from the number of loans to

macroeconomic distortions. If we believe that loans are like a pill or drug, then we would

expect a negative relationship between the number of loans and macroeconomic

distortions. But due to country-specific heterogeneity it might be the case that somecountries need more loans than other countries or that the loans do not work in every

country.

Position: Loans from the World Bank and IMF conditioned on structural adjustment have not

worked (no positive effects on policies or growth) properly.

Easterly (2005): What did structural adjustment adjust?

September16.What do we mean by macroeconomic policy:

Policy domain Elements / tools Institution

Monetary policy Money supply, deposit interest rate Central bank

Macro-prudential

policy

Financial sector regulation (like liquidity rules),

Capital controls

Financial Risk

Council in

DevelopedCountries.

Fiscal policy Annual budget --> Allocation of spending and

taxation, MTEF

Central government

Exchange rate policy

(can't be used

seperately from

monetary policy)

International reserves/Debt obligations Central bank or

government if

central bank is not

independent

Monetary policy is the most important/used macroeconomic policy since our main objective is

to stabilize inflation.Capital controls have been used extensively in the past, but it has not been used in a dynamic

way. Financial sector regulation is rather new and we have not seen the long-term implications

of this tool.

Topic 2: How has macroeconomic policy evolved in developing

countries?

Kasper Brandt14. september 2015

21:54



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Oil shock of 1973 led to huge current account deficits which led to a slowdown of

investments and growth.

Between 1973 and 1977 developing countries struggled a lot with repayments of debt.

When the second oil crisis hit many developing countries couldn't pay off their debt and

in order to stabilize balance of payment (BoP) they asked IMF and World Bank for help.

This led to the Washington Consensus of SALs.

Oil shocks

Control inflation

Guarentee essential imports

Balance of payments correction

Stabilization (mainly IMF). Short-term macroeconomics:

Sustainable public finances

BoP sustainability

Static efficiency (factor reallocation)

Dynamic efficiency (institutions)

Structural adjustment (mainly World Bank). Long-term macroeconomics:

Pursue macroeconomic stability by controlling inflation and reducing fiscal deficits.

Open-up to the rest of the world through trade and capital account liberalization.

Liberalize domestic product and factor markets through privatization and deregulation.

Basically: Market works.

Washington Consensus (1980s/1990s):

Mexico Crisis. Mexico adopted all the recommendations by IMF and World Bank. Led to

reinforcing optimism and essentially they had to devalue the peso remarkably.

East Asian financial crisis of 1997.

Lost decades of growth in Africa (1980s and 1990s)

Success in India and China show that there are other paths to growth than the

Washington Consensus.

Crisis following the Washington Consensus --> questioning the consensus:

The Washington Consensus + focus on institutions + country-specificity + more.

See table by Rodrik on slide 27.

Post-Washington Consensus

No counterfactual

Selection bias

Country heterogeneity is difficult to deal with. Maybe some countries benefit less from

these programmes than other countries.

Confounding factors (national and global)

Sample size (usually a maximum of 70 developing countries)

Dynamics. Being in a macroeconomic crisis today might influence the probability of still

being in a macroeconomic crisis tomorrow.

Multiple outcomes (what should be measure when we want to evaluate the

performance of the programmes.

Why is it so difficult to evaluate whether IMF/WB programmes have been successful?

September23.Pre-Washington Consensus view was primarely neoclassical synthesis (new neoclassical

synthesis emerging). Role for government was very limited.

Washington Consensus was markets works and sound money (fiscal and monetary policy).Post-Washington Consensus had the same view as the Washington Consensus, but also

focused on institutions. That is, market works, but we need to wrap inside a nice framework of

good institutions. Due to the focus on institutions a larger role for government emerged.



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Questions:

What does research tell us (e.g. Easterly)? Overall they find little evidence of any

macroeconomic effects from WB/IMF programmes. (This would be a minimum for

an answer).

Econometric problems like selection bias, heterogeneity, reverse causality,

measurement error, etc.

Absence of evidence, not evidence of absence.

Bad advice. Look at Rodrik (2005) for more flexible considerations on the

WC. Not one golden path as has been suggested by WB/IMF.

Go further and ask why this is the case.

There is little evidence to suggest that WB/IMF programmes (SALs) have contributed to

growth and macroeconomic stability (like public debt, inflation and balance of

payments) in developing countries.

Easterly (2005):

First of all, what are the policy recommendations of WC - both underlying

principles (sound money, non distortionary policies) and specific policy content(widespread deregulation, privatization, financial liberalization). Important

distinction between underlying principles and specific policy content.

You could argue that China followed the underlying principles, but differed in their

specific policy content.

Policy recommendations of Washington Consensus (WC) are not necessary to achieve

sustained economic growth.

Rodrik (2005):

Distinction between institutions and policy-making institutions (institutions with

capacity or/and legally bounded to follow underlying principles. E.g. independent

central bank or fiscal rules).

V1: Good macroeconomic governance (policy-making institutions) is critical for the

achievement of macroeconomic stability.

There is a paper on the reading list relating to this question.

Evidence.

Opposite cases. There can be cases where these fiscal rules and central bank

independence are limiting flexibility and disimprove stability because they limit

policy.

Examples of improving macro governance. Not necessary for macroeconomic

stability.

V2: Fiscal rules and Central Bank independence can be critical for achievement ofmacroeconomic policy.

Question from Sam (V1 and V2 are the same):



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September30.Exam relevant: Start by taking a standpoint, and then argue for your case. Like the position notes.

But, it is ok also to be critical saying that under certain circumstances the standpoint taken is not true

or less true.

Stabilization. Could argue that the focus has been on stabilization.

Allocation

Distribution

Accumulation

At least four potential sub-goals:

Monetary policy and macro-prudential policy is closely linked to stabilization, while fiscalpolicy is closer linked to distribution.

c(t)_bar = certain income

c(t) = c(t)_bar * e(-(sigma^2)/2) * epsilon(t)

We want to find a situation where utility of certain income is equal to utility of actual

income times a risk premium (lambda).

The utility function can be either CRRA (constant risk aversion) or logarithmic.

ln(1 + lambda) = variance / 2 , variance = variance of consumption.

==> lambda is approximately the same as variance / 2.

Using the ln-function we get that:

Lucas' point = Too much emphasis have been put on fighting volatility in the business

cycle.

A problematic assumption is that expected shocks are stochastic. In real life they are

definetely not stochastic - they have persistance and will not necessarily return to the

trend or at least not very fast.

Gains at margin from stabilization vs. Avoiding crisis. When you get to a reasonbly

stabilized business cycle then the gains from stabilization are low. But, if you avoid crisis

by stabilizing more then more stabilization might still have severe positive effects. So the

effect from stabilizing more mainly comes from the lower probability of crisis.

Welfare costs of consumption volatility.

October2.Zimbabwe. Around 2000 Mugabe made a reform redistributing land from the white to the

African. But, the Africans receiving the land (political allies) had no experience in farming and

no interest in farming.

The interesting part is not only how much GDP declines, but the integrated income between

the counterfactual GDP and reality (volume between actual GDP curve and counterfactual GDP

curve).

It might be that the counterfactual should not start at the peak, but several years before the

peak, because the years before the shock experienced higher growth than the counterfactual

stabilizing outcomes.

==> Real money as a share of GDP (M/(P*Y)) is equal to the f(i).

Real money (M/P) is equal to GDP times the money demand function of the interest rate.

Topic 3: What priorities should macroeconomic policymakers focus

on?Kasper Brandt

27. september 2015

21:52



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==> interest rate is equal to the inverse of the money demand function ( i =

f^-1(M/(P*Y)) = g(M/(P*Y)) )

They find that their time series are not stationary, so they check for cointegration.

When you're in a situation with moderate levels of inflation the gains from reducing

inflation is rather small in a welfare context. Inflation of 10% leads to a deadweight loss

of approximately 1% of GDP.

South Africa paper on measuring welfare costs from inflation (Gupta & Uwilingiye (2008).

Gains from moving people to specific sectors (e.g. moving people from agriculture to

manufacture).

According to his results, the gains from reallocation of resources are large.

Vollrath (2009).

Differences in productivity between sectors have widened.

We would expect convergence so that the productivity of sectors became more and

more alike. However, the opposite has occured. A failed structural transformation story.

Jones & Tarp (2015).

Stability as the primary mandate of monetary and fiscal policy (macroeconomic policies).

Stabilization as a precondition for growth. There are large gains from being intermediate

stable compared to unstable. But, there are not large gains from being stable compared

to intermediate stable. This is in accordance with the key point from the lecture - that

inflation reductions do not lead to large gains when being in a moderate/reasonable

inflation situation.

Priorities in practice:

October9.

Economic vs. Social trade-offs between employment and inflation. Economically, we

have the usual Phillips curve saying there is a trade-off between inflation and

unemployment. So how much economic activity should we sacrifice to keep inflation

down. There might be a technical trade-off, but does this trade-off transfer into social

preferences. What we see is that people usually value employment more than low

inflation.

Four main critiques of price stability focus:

Concern in the population is that devaluation will lead to inflation and increase the

prices of oil and other necesssities.

The author argues against this concern.

South Africa has a surplus labour force. Devaluation shifts relative prices in the economy

(relative price of import versus domestically produced goods). Argument: Cost of

increases in inflation is a fair price for the change in relative prices which will lead to

lower unemployment.

Cost push inflation. If a lot of imports are intermediates in domestic production

and therefore prices will rise. E.g. oil.

Wage inflation. If you have a market with low level of unemployment then wage

inflation will rise. Less severe wage inflation if the labour force is unemployed.

Different forms of inflation:

Inflation targetting less effective: External shock --> higher intermediate prices -->

higher domestic prices --> inflation

Inflation targetting might be ineffective when there are foreign (external) price shocks

and a country needs to restructure its factors of production. Inflation targetting is

probably more effective when inflation is due to internal shocks. The reason is that if the

external shocks are permanent then you need to restructure factors, while internal

shocks are within your reach of something you can change.

Blog by Michael Power: "Devaluation and inflation".



10/23

Inflation targetting more effective: Internal shock --> wage increases --> inflation

Inflation Growth Scenario

Rising Rising "Phillips Curve"

Rising Falling Incredible policy environment

Falling Rising Credible policy reform

Pham & Riedel (2013):

According to the authors we should be in the third row, but we probably are in the

second row.

It's not the central bank's mandate to restructure the labour market or SOEs, so the

government should put some emphasis on these distortions. In that sense, we could

experience falling inflation and increases in growth. At least temporarily.

The primary objective for the Chinese government is to maintain a high growth rate in

order to maintain high employment rate.

Monetary policy easing (standard response).

Administrative measures.

Explicit and implicit interventions in financial markets.

Local investment companies (quasi public, because they are allowed to earn

profits). Financed through central government and bank financing. A lot of

public investment is through these local investment companies.

Stimulus package of around 20% of GDP.

More than 60% investment rate in 2009. In most developing countries we would

be lucky to see investment rates of 20%.

The paper gives a good overview on what the Chinese government did in response tothe financial crisis.

However, not all developing countries should follow this strategy. There are trade-offs.One trade-off is the housing bubble they experience in China. Another is debt followed

by these huge investment rates. Currently, we don't know the magnitude of the debt.

Wong, C. (2013). The Fiscal Stimulus Programme and Public Governance Issues in China.

Questions:

Do long-run structural policies have a larger impact on consumption possibilities than

short-run stabilization policies?

Can cyclical output variability be completely offset by stabilization policies?

Lucas (2003):

Answer should distinguish between what kind of price stability (remember there is also

wage inflation, and not only price inflation) and the objective from price stability. Price

stability as avoiding crisis versus price stability as maintaining inflation below some X%

of GDP.

Draw on the case of China as an example where they do not only focus on inflation

targetting, and the case of South Africa where the author argues that structural changes

are also necessary.

Should macroeconomics policymakers in developing countries focus only on price stability?

Vollrath paper.

Vietnam paper.

Lucas paper which points to the need of structural change.

South African blog which points to reallocation of factors.

What structural features of developing countries should be taken into account in the design of

growth and stabilization policies?



11/23

Do have a stable Pihillips Curve? If yes, then we can fine tune. If not (Vietname case)

then we need structural changes.



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October21.Morgenstern (1963): Argue that economic statistics should only be published together with an

estimate of their error.

GDP: value of total domestic production.

Price and volume indexes.

Exchange rates: nominal, effective, real.

Interest rates: nominal, real.

We need practical definitions for:

But it is difficult to calculate these. E.g. "which nominal interest rate?", "which prices to use?",

"what should be considered part of production (how about the grey economy)?".

Value-added (output - inputs). Total values of sales in the economy minus intermediates.

Final expenditures. Y = C + I + G + (X - M)

Incomes (labour, capital). Y = r*K + w*L. What do we need? 1) wage incomes, 2) capital

income (financial interest, rental income), 3) Corporation profits, 4) Own income (grey

economy). Surveys/censuses (household budget survey, informal business survey,

agricultural survey) are the only way in which we can measure incomes when

administrative data are missing.

GDP. Three approaches:

All approaches should be similar and publishing GDP statistics should preferably use all three

methods as a robustness check.

The most applied index number is probably the Laspeyres index. It is simply just a weighted

mean of price ratios. "s(0)" is the weighting factor. In the Paasche index "s(t)" is the weighting

factor.

If we have a Laspeyres prices index and expenditure shares then we can obtain a Paasche

quantity index.

L(p) * P(q) = V

==> P(q) = V / L(p)

Each contry has many bilateral exchange rates. Denmark has bilateral exchange rate with the

euro, dollar, svenske kroner, etc. In order to have a composite measure we calculate the

effective exchange rate. Typically, we calculate a trade-weighted average. It can be

Arithmethic average and Geometric average.

The real exchange rate tries to capture the differences in purchase power.

W(i) / P(i) = what can be bought in country i.

W(i) / ( E(ij) * P(j) ) = what can be bought in country j. E(ij) = nominal exchange rate.

Q = E(ij) * P(j) / P(i) = real exchange rate.

Real GDP index.

Laspeyres consumer price index.

Real effective exchange rate.

Real interest rates.

Pick one of the following macroeconomic aggregates:

These are complicated measures to calculate, because there are various interest rates,

different ways to measure exchange rates and prices. Especially difficult in developing

countries. Main questions when we want to calculate these measures: 1) What do you need

(which statistics)? 2) Where do you get it from (surveys, or maybe central databases in

Topic 4: What are we measuring?Kasper Brandt

21. oktober 2015

08:16



13/23

advanced countries)?

October28.

Temporary uncertainty. Usually preliminary (e.g. quarterly) statistics are measured, and

these have high uncertainty. Later, revisions take place and the statistics get more

accurate. It may take many years for the statistics to be correct or "very accurate".

Base year --> prices (fixed)

Benchmark year --> comprehensice set of national accounts estimates for ONE

benchmark year, and then use growth rate within two benchmark years based on

surveys. The older the benchmark year is the higher is the probability that you will

miss new products and services, which is problematic.

Persistent uncertainty. National accounts base year.

Data from extension agents. Simply ask an agent in a region: "How has your crops

been doing this year - good, bad, how much?".

Agricultural censuses.

Surveys.

Rainfall.

Permanent uncertainty. Informal sector is higher in Sub-Saharan Africa and Latin

America. We can get an estimate of this uncertainty in different ways.

Even regular data is usually poor in LDcs. E.g. in Mozambique CPI is calculated with data

from a few large cities, and NOT data from a representative sample.

Spatial uncertainty. You cannot get the same for dollar in Denmark as in Mozambique.

Therefore, we use PPP.

Sources of uncertainty

Base years are pretty bad for LDC. For developed countries base years are usually within

the last fice years. Also, public statistics (government accounts, balance of payments,

cpi) are delayed and not reported as fast as in developed countries.

Especially in Africa we see huge impacts of revisions. Nigeria and Ghana were adjusting

GDP upwards by around 89% and 60% respectively.

Relevance. How significant are these sources of uncertaincy.

Often GDP estimates are downward biased due to old base years. These old base years leads

to new products, services and technologies being overseen. In the old base year you naturally

didn't measure products invented after the base year. But later years will not measure these

(now invented) products, because you are only measuring what was measured in the old base

year.

October30.When calculating the real effective exchange rate we need to choose a deflator. But which one

should we choose? - CPI is heavily weighted towards non-tradables. On the slides we compare

real effective exchange rate for US and South Africa using various deflators.

In measuring real interest rate we have the same problem with deflators, but also which

nominal interest rate to use.

Can online inflation data match offline inflation measures? (since 2007 there has

been discussion on wether the offical inflation statistic is correct).

Is official inflation "wrong"?

What is the research question?

Web-scraped prices for various countries (other Latin American countries). Use

supermarket websites and their prices on food, beverages, household appliances.

Construct an online price index. They have the prices, but now the challenge is to

put weight on the products. They take a product and put it into a group (e.g. "beer

How do the authors answer?

Case studies (Argentina):



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group", "milk group", "bread group", etc.). Geometric mean of each group.

Arithmetic weighted of each group price.

Online and offline measures match in other Latin American countries. In Argentina

there is systematic differences in LEVEL of prices.

Online measure ==> inflation higher than officially estimated.

Robustness check says the same. Higher inflation than officially estimated.

What are the main findings?

Knock-one effects. If you miscalculate inflation then it will have an immediateeffect on real wages, real interest rate, etc.

Real wages has a political dimension. This leads to the relevance of an

independent statistical agency. Or, transparency. If they DO fabricate the statistics

then other people can go in an to the same calculations and find different results.

Thereby, the political incentives will be diminished.

What do we learn about measurement challenges?

Is revision on Chinas GDP reliable? Level of nominal GDP increased for 2004 (which

was the most recent year the considered).

What happened in 1998?


He applies standard retropolation methods (trend-deviation interpolation

approach). He keeps the original deviations around the trend, but the trend

changes. He compares his results from the standard technique to what the

revision reports.

How do the author answers?

GDP growth is higher for every year except for 1998.

Most "extra" growth from service.

Decline in construction growth.

He is able to replicate the results for the primary production, secondary

production and construction, but fails to replicate the revision of the servicesector using the standard approach.

Price deflator in service sector is moving around a lot. Conclusion is that they

manipulated the price deflator to generate political acceptable or "desirable" real

growth rates.


There are political incentives to manipulate with official statistics. Might move

both ways. In China the incentive was to live up to the target of 8 percentage real

growth rate. In other countries they may overvalue the growth rate in order to

say: "Look, aid is working here. Give us more". Or countries may undervalue

growth rate in order to say: "We are very poor and we need more aid".


Case studies (China):

Are PWT versions different?

What is driving the differences? If they are random and not systematic then it

might not be that big of a problem.

Are key research papers robust to use of different versions of PWT? They take key

papers that use a specific version of the PWT, and they do the same calculations

with a new version of PWT. (growth of GDP as dependent variable).


To answer the first research question they simply look at descriptive statistics. Do

the average growth rate for countries change when looking at different versions ofPWT.

For the second research question they regress the differences between version 6.2

and 6.1 on some variables and see if they can explain the differences. To see if

there is systematic differences explained by certain factors.

How do the author answers?

Penn World Table (PWT) paper by Johnson et al.:



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They find large differences in growth rates between versions.

Systematic relationship with the distance to the base year (larger distance leads to

higher differences).

They find that some papers are robust while others are not. Papers on developing

countries and countries with bad data seem to be much less robust than papers on

developed countries. Also, papers looking at annual changes in growth rates will

suffer more from using different versions of PWT than papers using changes over a

long run. That is, frequency matters a lot.



International prices = PPP. PWT report GDP in PPP. There are challenges of

collecting international prices.

Changes in underlying national accounts. Why do these national accounts change?

e.g. rebasing.

Johnson et al. (2013) is the key study. It looks at how key articles change results

when using different versions of PWT. This relates to the "should we care" part.

What drives large differences in estimates of GDP at international prices, and should we

care?

We can bring in the China and Argentina studies as examples of why

independence and transparency is important.

Do countries neglect statistical capacity because they have other priorities?

Production of good quality statistics costs money. E.g. rebasing, household budget

surveys, labour force surveys.

Statistical agencies should focus on creating statistical capacity via independence and

transparancy.

Pretty much the same as the above question (question 2).

The IMF should promote quality and quantity of statistics.

Look at the four different sources of uncertainty and explain their impact on

potential bias on key macroeconomic variables (diagnosis).

Discuss what can be done to bring these uncertainty sources down. We want our

statistics to be timely and precise.

What can be done to reduce the scope for bias/manipulation of key statistics such as

poverty estimator?

Pretty much the same as the above question (question 4).

What are the priorities for improving the quality of macroeconomic statistics in

developing countries?

Questions:

Is there only one optimal way in which real GDP can be constructed?Is uncertainty important, and if so, are some sources more important than others?

Can we directly observe key macroeconomic variables?

Does revisions (i.e. decreasing uncertainty) alter macroeconomic research?



16/23

November3.

Stationary?

Trend-stationary?

Difference stationary? (stochastic trend/unit root process/random walk).

What kind of process?

Policy implications.

If the shock is only temporary then we do not need to do anything, because the process

is mean-reverting (returns to the trend).

If the shock is permanent then we will do a lot to avoid these negative shocks.

To what extent are shocks permanent or temporary?

If we assume presence of stochastic trend then the economy will be less able to recover

from a negative shock. This is because the past matters more when the stochastic trend

is strong.

Very important when forecasting to know whether we have a deterministic trend or a

stochastic trend.

Basicly we do not know exactly what kind of process, but we can test and get an idea of

the process.

(1) = Stationary with break.

(2) = Random walk.

(3) = Random walk with drift.

(4) = Non-stationary with deterministic trend (trend-stationary).

Examples of stationarity and non-stationarity processes:

We distinguish between unit root and non-unit root processes by using the Dickey-Fuller type

tests.

November11.DF test has null hypothesis of a unit root, while KPSS test has no unit root at the null

hypothesis. The examples from class with simulated data show that we can easily reject both

the DF test and the KPSS test when the real process is nonlinear and we only do linear unit

root tests. The same goes with level shifts.

Level shift may be caused by war or conflict (negative level shock) or by opening up for trade

and ressource finding (positive level shock).

Is there a unit root in real GDP?

What is the main research question?

They use multiple tests for various countries.

ESTAR process. Exponential smooth transition autoregressive process

Polynomial de-trending.

Non-linearity in two ways

What methods do the authors use?

Evidence that GDP may be stationary around some non-linear deterministic trend

(of unknown form).

Main findings.

Cuestas & Garratt (2011):

Topic 5: What kind of a process is GDP?Kasper Brandt

30. oktober 2015

08:14



17/23

Is real GDP stationary in Africa?

What is the main research question?

They are worried about weak DF tests and structural breaks (e.g. reforms)

To "take care" of the structural breaks they use Fourier transforms.

They take sinus and cosinus to smooth out the structural breaks (see equation (1)

in the paper). "Sophisticated non-linear approximation". "The decomposition can

pick out the structural breaks)".

Unit root test which takes into account the Fourier transform with sinus and

cosinus terms.

What methods do the authors use?

Null hypothesis: There is a unit root. In the majority of cases we accept the null

hypothesis (in 7 cases we reject the null hypothesis).

Conclusion is in contrast with the Cuestas & Garratt paper which found that for

most countries we could reject the null hypothesis.

Where are the data from? The figures on the GDP processes seem totally

unrealistic.

Main findings.

Ying et al. (2014):

November13.

Deterministic trend ---> predictable, often a function of time. E.g. linear trend.

Stochastic trend ---> unpredictable (random), but it has a permanent level effect on

GDP.

Transitory effects ---> possibly with short-term memory. It could be price spikes or short

term recessions.

Noise.

What determine e.g. GDP:

It is always possible to include a polynomial of a specific order to make a time series be trend

stationary. But, the question is if this polynomial is a meaningful trend. Does not make much

sense to have a deterministic trend following a polynomial of order 5.

Moving average is the most normal detrending tool. However, there exist much more

sophisticated tools. A popular one is the Hodrick-Prescott filter (HP filter). Higher values of the

smoothing parameter (in HP) will take us closer to the linear trend and lower values of the

smoothing parameter will take us closer to the raw data. Usually 1600 is chosen. Drawback

with HP filter: If we have a linear deterministic trend with a lot of noise then the HP filter

moves with the noise although we have a linear trend. It will not give us the linear trend that is

actually going on.

Why is it important to retrospectively identify growth cycles (periods of elevated/depressed

growth)? It is important because we don't want to make the same mistakes over again.

Retrospectively identifying business cycles is important because fiscal policy is dependent on

which state we are in, and we can see how e.g. inflation react to fiscal policy in certain states.

But to find out how inflation reacts in certain states we first need to identify the states

(business cycles).

Characterizing the data generating process behind GDP (deterministic or stochastic or both) is

important because it has different policy implications whether we have a deterministic trend

or a stochastic trend.

African countries have faced many more structural breaks than other regions (e.g. Europe).

This indicates that the GDP processes in Africa are more stochastic.

November18.

How convincing is the claim that GDP is stationary around a deterministic trend?

Questions



18/23

Important to show the empirics. That is why we changed the question from "how

can we determine whether GDP contains a stochastic versus deterministic trend".

Relates a lot to our papers where they test for unit roots in the GDP processes.

Satisfy the first bullit in learning objectives ("To understand the theoretical and

empiral differences between stochastic and deterministic trends in

macroeconomic time series.

To do: 1) meaning/definition of stationarity, deterministic trend, unit root,

stochastic trend. 2) evidence from the papers we have looked at. 3) how

convincing? Linear trend is not convincing. Non-linear is more convincing, but thefunction is arbitrary and a high degree polynomial is nonsense for a true process.

Look at the power of the methods (depends on the null. Often we cannot reject

because of low power).

The same procedure as the first question: meaning/definition of structural breaks,

evidence from the paper related to structural breaks, and how convincing are the

results from that paper.

This question will be put into the first question. If Sam does not merge the two

questions together then you can still use structural breaks as a subject or a

paragraph in the first question.

Can we separate structural breaks in growth from volatility?

If there is some component of GDP where there is a deterministic trend then we

have a chance of doing a reasonable approximation of future GDP (good forecast).

If there is no trend then we have no chance of doing a good forecast.

Again we have to look at the distinction between deterministic versus stochastic

trend.

Severe volatility makes it more difficult to do a good forecast.

Important to find a reasonable non-linear trend. Maybe structural breaks should

be included.

Also relates to Frankel (2011).

Of course it has large policy implications, since public investments are dependenton how many resources that are available.

What are the challenges of forecasting GDP levels over the long-run and what does thismean for policy?



19/23

November18.

This is a small example of a SAM containing households and enterprises. It could

potentially contain hundreds of rows and columns, where each column represent a

sector. Many of the cells will be empty because there is no linkage between two specific

sectors.

Every column is expenses (outflows from a sector), and every row is revenues (inflows to

a sector)

The "Table 1: Generic macroeconomic (Social) Accounting Matrix [SAM]" handed out in class.

Current Account + Capital Account + Financial Account should equal zero. It does not

equal to zero here, because they have separated "Reserves".

Indonesia's balance of payments

December2.

A = aggregate absorption

GNDI can be understood as total income available in the economy.

National accounting identities page 24 out of 72

Main symptom: persistent weakening of current account balance. That is, we need

foreign savings to finance our own consumption or investments.

Often these crisis are associated with less developed countries, because they do not

have access to short-term financing. Instead, they need to apply for long-term financing,

which takes longer time to obtain. E.g. getting a loan from IMF. Then IMF will demand

structural changes which takes time to negotiate upon.

Current account deficit is equal to changes in assets minus changes in reserves.

Old-style crisis

December4.

Faster-paced financial or balance sheet mismatch.

What to look for: 1) mismatch in currency denomination of assets and liabilities. 2)

mismatch in maturity of assets and liabilities

We need to think about if macroeconomic policies generate these mismatches.

"Stylized balance sheet". Commercial banking sector has a maturity mismatch in assets

and liabilities in this hypothetical example. They borrow short-term and invest long-

term. In this example we would be worried about a potential depreciation.

New-style crisis

Transmission of economic and/or financial crisis across border. There are a broad and

narrow type of contagion (don't know what the difference is).

Real contagion. Transmission through trade linkages. When Thai baht depreciated they

ceteris paribus become more competitive than Indonesia (that is when there is a crisis in

a net exporter country). If Thailand buys a lot from Indonesia and Thailand is hit by a

crisis, then they will buy less from Indonesia (that is when there is a crisis in a nat

importer country). So real contagion can happen if your trading partners (both importers

and exporters) experience a crisis.

Financial contagion. Crisis via external financing channels - especially access to (or costof) capital inflows. Distinguish between direct and indirect financial linkages.

Informational contagion. A crisis in one country may signal that other countries similar

to the crisis country face the same problems. At least focus is directed towards the

similar countries and analysis of the similar countries is carried out. These analysis may

Contagion

Topic 6: Monitoring economic structure and stabilityKasper Brandt

18. november 2015

09:09



20/23

reveal that these similar countries face the same or larger problems.

First, we need to define what constitutes a crisis. Maybe there is different degrees

of crisis.

Second, choose a set pf ptential crisis indicators and associated thresholds.

Third, evaluate which indicators are the best at predicting a crisis.

Signals (leading indicators)

Regression-based prediction

Market-based sentiment (not discussed here).

Early warning methods

December9.

Empirical results (describing the results in the literature).

Comment/reflect on robustness. 1) Difficulty of defining a crisis. 2) Changing

nature of crises (balance sheet mismatches?) What might have been good

indicators in the beginning is not necessarily good indicators anymore.

Practical? 1) reliable. 2) availability (how easy to get the data and what is the most

reason data).

What are the most robust early warning indicators of economic crises, and how practical

are they for use in real time in developing countries.

Talk about other triggers of economic crisis (balance sheet mismatch crisis,

contaigion). In general, the new-style crisis.

A sustainable current account position is not sufficient to avoid an economic crisis.

Questions



21/23

December9.Gold Standard and interwar years: Exchange rate system was backed by gold.

Bretton Woords System: Only the US dollar was backed by gold. But all other currencies were

fixed to the dollar. That is, partially backed by gold.

Floating Exchanges Rates: Not backed by anything.

Nominal anchors are intermediate targets - nominal policy variables that serve to anchor

monetary policy. Examples: Inflation target, fixed exchange rate (anchor your currency

to another currency. Case of Zimbabwe: "Borrow others credibility"), commodities (gold,

but noone does this anymore), rule for rate of growth of money aggregates (used in

many developing countries. M1), more examples on slides. IMF document that explains

the different anchors: "Annual report on exchange arrangements and exchange

restrictions 2015".

What is it that maintain the value of the currency? Which nominal anchor?

Hard Peg: Very strong commitment to the fixed exchange rate. Not even the central

bank has the authority to change the exchange rate.

Soft Peg: Many different kinds of soft pegs. See slide for an overview of IMF

classifications.

In addition, we have "floating" and "free floating" exchange rates.

Distinguish between "hard pegs" and "short pegs".

The IMF classification is de facto, but subjective. Sam is generally unsure how they distinguish

between "floating" and "free floating". In Sam's view the difference is that for "floating" they

will sometimes intervene, but for "free floating" the central bank will never intervene in

international monetary markets.

Nominal FX volatility.

More on slides

IMF classify Canada as floating since 1970. Another paper says it has never been

"floating", while a third paper says it has been shifting between being "floating" and

"fixed".

Potential empirical indicators of FX (foreign exchange rate) regime

Most small developing countries prefer to fix their exchange rate.

December11.A currency board = every note and penny (M1) has to be backed by foreign currency. Think of

it like a dollar standard (like the gold standard).

How does this affect choice of regime? Evidence (data or empirical results).

The financial markets need to be very deep. If the CB is not the largest player, then

they will have difficulty in influencing the price. Therefore, very big markets

decreases the likelihood of having a fixed exchange rate. Relates to "interest ratepass through" (IRPT).

Examples: 1) Breakdown of M1: interest rates in advanced countries. 2) Jamaica

paper. 3) China.

Practical efficacy.

Institutional credibility.

Exam practice. What determines the choice of exchange rate regime?

Topic 7: Choosing the MERP regimeKasper Brandt

9. december 2015

08:53



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Fixed exchange rate. Denmark. Other countries do not have the same credibility

as Denmark.

A currency board is seen as more credible than a peg. However, in some cases

(Argentina) the currency board will not work either.

Dollarization (currency board). "Borrw other countries' credibility". Zimbabwe

stopped hyper inflation with dollarization.

If you have large domestic shocks then it is more profitable to peg the exchange

rate to another currency. However, fixing the exchange rate exposes you tointernational shocks (or just the shocks in the country you have pegged your

exchange rate to). Therefore, it is preferable when you have larger shocks than the

country where the currency has been pegged.

Example: Brazil is a good example at the moment.

Shocks.

Trade/investment (higher nominal and real exchange rates volatility tends to

dampen trade investments).

Original Sin (inability to issue external debt in own currency). Especially difficult for

small countries to obtain loans from other countries, since the other countries

have no interest in the small country's currency. In addition, if you have previously

obtained external loan of 50 million in foreign currency and devalue your owncurrency by 40%, then you have to repay 70 million. ==> incentive for stabilization

of currency.

"Exchange rate pass through" (ERPT). Refers to the magnitude and speed by which

changes in the exchange rate are reflected in domestic prices. High rate ==> less

incentive to devalue, because the new exchange rate will very fast lead to higher

prices.

Benefits/motives of foreign exchange stabilization.

Relates to the above four considerations. Argument 1, evidence. Argument 2,evidence. Four arguments and evidence for each argument.

What might lead a country to adopt another currency (e.g. US dollar or Euro) and are

there costs in doing so?

Are there genuine trade-offs? Describe main trade-offs. Evidence.

Again, we can use the four above-mentioned considerations.

Explain, using examples, what are the principal trade-offs between alternative MERP

frameworks in developing countries?

Questions



23/23

Don't write less than or more than demanded. Approximately 3 pages per question.

Quality, not quantity.

Include list of references.Do not copy the exam question or statement.

E.g. 1) Empirital results. 2) Reflection on robustness. 3) Practicality.

First argument, then evidence. Reason 1, Evidence. Reason 2, Evidence. Etc.

Structure is essential - use headings!

Conclusion. Repeat main argument/viewpoint. Maybe add some reflections if not done so

before.

Don't ignore important arguments or relevant counter-arguments. Ask yourself: is there

something missing?

Remember to refer back to the desired learning objectives.

Ability to explain fundamental concepts/ideas.

Knowledge of relevant empirical results. Case studies, and studies from the curriculum.

Bring in ideas from relevant empirical studies (from different papers).

Evaluate the quality or strength of existing arguments/evidence. Critically assess the

evidence.

Where it is relevant, reflect on policy recommendations/issues/challenges. E.g.

challenges with data availability or reliability of data.

Demonstrate understanding of curriculum. Show all the abilities below.

ExamKasper Brandt

9. december 2015

08:35

notes applied macro development economics

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