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Fiscal and monetary policy under financial market imperfections

Priority areas of development: economics
2015
The project has been carried out as part of the HSE Program of Fundamental Studies.

Goal of research: Revision of the principles of macroeconomic policy design during the post-crisis period in the presence of the imperfections of financial sector, derivation of the optimal monetary policy rules for Russian economy, evaluating the relation between expected default costs and the probability of default, finding out the role of preference uncertainty for fiscal and monetary policy interactions, comparison of forecasting performance of Bayesian VAR with some competing models, and studying the role of the Dutch disease in the structural changes in the Russian economy in 1995-2009.

Methodology: Estimation of a DSGE model, using multivariate optimization methods based on Newton's method for finding the optimal coefficients. Moreover, construction of an overlapping generations model with the fully-funded pension system and fiscal policy. Then the out-of-sample point forecasts, which are ranked based on their RMSFE, are obtained with Bayesian VAR, frequentist VAR, and random walk. For studying the questions related to economic growth a two-sector unified growth model and a non-balanced exogenous growth model with three sectors of production are developed. The demand and supply effects are analyzed through the decomposition of structural changes.

Empirical base of research: databases of the Federal State Statistics Service (http://www.gks.ru), the International Monetary Fund (http://www.imf.org/en/Data), the Central Bank of the Russian Federation (http://www.сbr.ru), KLEMS (http://www.worldklems.net/data.htm), the Federal Reserve System (http://www.federalreserve.gov/econresdata/statisticsdata.htm), Global Trade Alert (http://www.globaltradealert.org/), the World Bank (http://databank.worldbank.org), the U.S. Bureau of Economic Analysis (http://www.bea.gov/), Bloomberg Professional (http://www.bloomberg.com/professional/), and OECD (https://data.oecd.org/).

Results of research: We develop an approach which allows embedding an agent-based model of financial market in the financial accelerator DSGE model. Moreover, we show that the optimal level of the exchange rate flexibility in Russia is lower than its estimated value for the period after 2008. It means that the Bank of Russia should continue stabilizing interventions in the foreign exchange market during the transition to the inflation targeting. Furthermore, we conclude that in the case of high default costs there can be two equilibria. On the one hand, in the “good” equilibrium households' investment in foreign assets is low, revenue from labor tax collection is high and the probability of default is low. On the other hand, in the “bad” equilibrium households hedge against losses associated with default by investing large proportion of their income in foreign assets. This reduces labor supply, decreases revenues from labor tax collection and raises the probability of default. Therefore, high default costs may tighten fiscal limits and increase the probability of an excusable default. Moreover, we show that uncertain government preferences lead to more expansionary monetary policy and more contractionary fiscal policy. As a result, inflation bias is aggravated: expected inflation increases, while expected output drops. Nevertheless, if fiscal multiplier is certain, preference uncertainty does not matter anymore. In addition, we show that a lot of Russian macroeconomic indicators can be forecasted by Bayesian VAR more accurately than by the competing models. Finally, we conclude that the Dutch disease considerably influences the dynamics of employment in the industrial sector, explaining up to 80% of variation. The other factors such as supply-side factors, and the changes in employment in public service sector leads also to the decline the employment in manufacturing sector, but their cumulated effect is relatively low.

Level of implementation, recommendations on implementation or outcomes of the implementation of the results: The approach that we develop in our study can be used for eliminating the inability of DSGE models to analyze stochastic and volatile dynamics of financial markets. Moreover, the optimal monetary rules that we derive in this project can be useful during the transition to the inflation targeting regime by the Bank of Russia. Also the model which we develop can be used for forecasting of any macroeconomic aggregate series in the framework of applied macroeconomic research. Finally, the result that higher taxes on foreign assets held by domestic agents may increase revenues from labor tax collection and relax fiscal limits can be useful for fiscal authorities. In general, most of the results of this project can be used as policy implications because nowadays the problems of financial repression, sovereign default, and the interaction between fiscal and monetary policy are considered as the issues of current importance for many countries.

Publications:


Демешев Б. Б., Малаховская О. А. Картографирование BVAR / Высшая школа экономики. Серия WP12 "Научные доклады лаборатории макроэкономического анализа". 2015. № 4.
Veselov D. A. Democratization and Barriers to Entry in a Two-Dimensional Voting Model / Centre d'Economie de la Sorbonne. Series cesdoc:13050 "Documents de travail du Centre d'Economie de la Sorbonne". 2015.
Веселов Д. А. Политические режимы, перераспределение и формирование общества открытого доступа // Экономический журнал Высшей школы экономики. 2015. Т. 19. № 4. С. 395-422.
Sokolova A., Havránek T., Rusnák M. Habit Formation in Consumption: A Meta-Analysis / Charles University. Series 15/2015 "IES Working Papers". 2015.
Pekarski S. Tight Money and the Sustainability of Public Debt / NRU Higher School of Economics. Series EC "Economics". 2015. No. WP BRP 95/EC/2015.
Kuznetsova O., Merzlyakov S. The Role of Uncertain Government Preferences for Fiscal and Monetary Policy Interaction / NRU Higher School of Economics. Series WP BRP "Economics/EC". 2015. No. 102.
Кузнецова О. С., Мерзляков С. А. Информационная политика Банка России / Высшая школа экономики. Серия WP12 "Научные доклады лаборатории макроэкономического анализа". 2015. № 02.
Демешев Б. Б., Малаховская О. А. Сравнение случайного блуждания, VAR, BVAR Литтермана при прогнозировании выпуска, индекса цен и процентной ставки / Высшая школа экономики. Серия WP12 "Научные доклады лаборатории макроэкономического анализа". 2015. № 3.
Isakov K., Pekarski S. E. Financial Repression and Laffer Curves / NRU Higher School of Economics. Series WP BRP "Economics/EC". 2015. No. 113/EC/2015.
Yarkin A., Veselov D. A. The Great Divergence revisited: industrialization, inequality and political conflict in the unified growth model / NRU Higher School of Economics. Series EC "Economics". 2015. No. 118.
Shulgin A. G. Monetary regime choice and optimal rationing of credit at official rate: the case of Russia / NRU Higher School of Economics. Series WP BRP "Economics/EC". 2015. No. WP BRP 103/EC/2015.
Шульгин А. Г. Оптимизация простых правил монетарной политики на базе оцененной DSGE-модели // Журнал Новой экономической ассоциации. 2015. Т. 26. № 2. С. 64-98.
Demeshev B., Malakhovskaya O. A. Forecasting Russian macroeconomic indicators with BVAR / National Research University Higher School of Economics. Series WP BRP "Basic research program". 2015. No. 105.
Норкина О. А., Пекарский С. Э. Нерыночное размещение долга как финансовая репрессия // Журнал Новой экономической ассоциации. 2015. № 28. С. 31-55.
Veselov D. A., Yarkin A. Endogenous institutions and conflict in the model of transition from stagnation to growth, in: XVI Апрельская международная научная конференция по проблемам развития экономики и общества: в 4 кн. / Отв. ред.: Е. Г. Ясин. Кн. 1. М. : Издательский дом НИУ ВШЭ, 2016. P. 571-581.
Веселов Д. А. Политические режимы и формирование институтов общего доступа // В кн.: XVI Апрельская международная научная конференция по проблемам развития экономики и общества: в 4 кн. / Отв. ред.: Е. Г. Ясин. Кн. 1. М. : Издательский дом НИУ ВШЭ, 2016. С. 477-487.
Pekarski S. E. Tight Money and the Sustainability of Public Debt // International Journal of Central Banking. 2017. Vol. 13. No. 1. P. 191-223.