TAPES Conference on Public Policy and Retirement
International Seminar on Macroeconomics
Seventeenth Annual EASE Conference
NBER Conference in Beijing
Tax Policy and the Economy

TAPES Conference on Public Policy and Retirement

The NBER's TransAtlantic Public Economics Seminar (TAPES), focusing this year on Public Policy and Retirement, took place in Uppsala, Sweden on June 12-14. The following papers were discussed:

James M. Poterba, NBER and MIT; Joshua Rauh,NBER and University of Chicago; Steven F. Venti, NBER and Dartmouth College, and David A. Wise, NBER and Harvard University, "Defined Contribution Plans, Defined Benefit Plans, and the Accumulation of Retirement Wealth"
Discussants: Paul Bingley, Aarhus School of Business, and Anil Kumar, Federal Reserve Bank of Dallas

Jeffrey R. Brown and Scott Weisbenner, NBER and University of Illinois; and Nellie Liang, Federal Reserve Board of Governors, "Individual Account Investment Options and Portfolio Choice: Behavioral Lessons from 401(k) Plans"
Discussants: Brigitte Madrian, NBER and The Wharton Schoool, and Matias Eklof, Uppsala University

Helmuth Cremer and Philippe De Donder, University of Toulouse; Dario Maldonado, University del Rosario, Bogota; and Pierre Pestieau, University of Liege, "Voting over Type and Size of a Pension System When Some Individuals Are Myopic"
Discussants: Dirk Krueger, J.W. Goether University, Frankfurt; and Amy Finkelstein, NBER and MIT

Gary V. Engelhardt, Syracuse University, and Anil Kumar, "Employer Matching and 401(k) Saving: Evidence from the Health and Retirement Study" (NBER Working Paper No. 12447)
Discussants: Courtney Coile, NBER and Wellesley College, and Clemens Sialm, University of Michigan

Paul Bingley, and Gauthier Lanot, Keele University (UK), "Public Pension Programs and the Retirement of Married Couples in Denmark"
Discussants: James M. Poterba, and Arthur van Soest, Tilburg University

Monika Butler, Universitat St. Gallen, and Federica Teppa, Universitat di Torino, "Should You Take a Lump-Sum or Annuitize: Results from Swiss Pension Funds"
Discussants: Vincenzo Galasso, NBER and Universita Bocconi; and Joshua Rauh

Gene Amromin, Federal Reserve Bank of Chicago; Jennifer Huang, University of Texas; and Clemens Sialm, "The Tradeoff between Mortgage Prepayments and Tax-Deferred Savings"
Discussants: Michelle J. White, NBER and University of California, San Diego; and Scott Weisbenner

Courtney C. Coile and Phillip B. Levine, NBER and Wellesley College, "Labor Market Shocks and Retirement: Do Government Programs Matter?"
Discussants: Olivia Mitchell, NBER and University of Pennsylvania; and Monika Butler

Anders Karlstrom, Royal Institute of Technology, Stockholm; Marten Palme, Stockholm University; and Ingemar Svensson, Social Insurance Agency, Stockholm, "The Employment Effect of Stricter Rules for Eligibility to DI: Evidence from a Natural Experiment in Sweden"
Discussants: Axel Borsch-Supan, NBER and University of Mannheim, and Marie-Louise Leroux, University of Toulouse

Matias Eklof and Daniel Hallberg, Uppsala University, "Estimating Early Retirement with Special Early Retirement Offers"
Discussants: Roger H. Gordon, NBER and University of California, San Diego, and Jeffrey R. Brown

Jeffrey R. Brown and Amy Finkelstein, "Supply or Demand: Why is the Market for Long-term Care Insurance so Small?"
Discussants: Leora Friedberg, NBER and University of Virginia; and Marten Palme

Antoine Bommier, Marie-Louise Leroux, and Jean-Marie Lozachmeur, University of Toulouse, "Varying Life Expectancy and Social Security"
Discussants: Panu Poutvaara, University of Helsinki, and Philippe De Donder

The private pension structure in the United States once was dominated by defined benefit (DB) plans, but currently is divided between DB and defined contribution (DC) plans. Wealth accumulation in DC plans depends on financial market returns, while accumulation in a DB pension is very sensitive to an individual's labor market experience. Poterba and his coauthors examine how the expansion of DC plans affects the average level of private retirement wealth and the variation in retirement wealth across households. They consider the stochastic contributions of asset returns, earnings histories, and retirement plan characteristics using data from the Health and Retirement Study (HRS). The analysis simulates retirement wealth accumulation under DC and DB plans. For DC plans, the analysis matches individuals to randomly selected DC plans and draws asset returns from historical distributions. It allows for various asset allocation strategies and expense ratios. For DB plans, the analysis draws earnings histories from the HRS, and randomly assigns a pension plan to each job the individual holds. These procedures generate a distribution of potential DC and potential DB accruals that reflect the structure of DB and DC plans, the stochastic structure of earnings over the lifecycle, and the random contribution of asset returns to retirement wealth. The results provide a measure of the dispersion in prospective retirement wealth under both DB and DC regimes.

Brown and his coauthors examine how the menu of investment options made available to workers in defined contribution plans influences portfolio choice. Using unique panel data on 401(k) plans in the United States, they present three principal findings: 1) the share of investment options in a particular asset class (that is, company stock, equities, fixed income, and balanced funds) has a significant effect on aggregate participant portfolio allocations across these asset classes. Second, the vast majority of the new funds added to 401(k) plans are high-cost actively managed equity funds, as opposed to lower-cost equity index funds. Because the average share of assets invested in low-cost equity index funds declines with an increase in the number of options, average portfolio expenses increase, and average portfolio performance is thus depressed. Third, investment restrictions - such as requiring a match in company stock, or placing a ceiling on the fraction of assets that can be held in a particular asset - can change the overall risk/return profile of the portfolio much more than would be expected in a standard portfolio model. For example, restricting investment in company stock is associated with an overall reduction in all equities, not just company stock, perhaps suggesting that participants view such restrictions as a form of implicit investment advice.

Cremer and his coauthors study the determination through majority voting of a pension scheme in which society consists of far-sighted and myopic individuals. All individuals have the same basic preferences but those who are myopic tend to adopt a short-term view (instant gratification) when dealing with retirement saving. Consequently, they will find themselves with low consumption after retirement and regret their insufficient savings decisions. As a result, when voting they tend to commit themselves into forced saving. The authors consider a pension scheme that is characterized by two parameters: the payroll tax rate (that determines the size or generosity of the system) and the "Bismarckian factor" that determines how much it redistributes. Individuals vote sequentially. The authors examine how the introduction of myopic agents changes the size and the level of redistribution of the pension system. Their main result is that a flat pension system is always chosen when all individuals are of one kind (either all rational or all myopic), while a system that redistributes less may be chosen if society is composed of both myopic and rational agents. With logarithmic preferences, the size of the system increases with the proportion of those who are myopic. However, this property does not necessarily hold with more general preferences.

Employer matching of employee 401(k) contributions is a key component in pension-plan design in the United States. Using detailed administrative contribution, earnings, and pension-plan data from the Health and Retirement Study, Engelhardt and Kumar formulate a life-cycle-consistent discrete choice regression model of 401(k) participation and estimate the determinants of participation accounting for non-linearities in the household budget set induced by matching. The estimates indicate that an increase in the match rate by 25 cents per dollar of employee contribution raises 401(k) participation by 3.75 to 6 percentage points, and the estimated elasticity of participation with respect to matching ranges from 0.02-0.07. The estimated elasticity of intertemporal substitution is 0.74-0.83. Overall, the analysis reveals that matching is a rather poor policy instrument with which to increase retirement saving.

Bingley and Lanot study the economic determinants of the joint retirement process of couples. They propose a tractable, dynamic discrete choice model for the retirement decision of couples that allows for non-trivial saving behavior. They estimate the model on a sample of Danish couples of retirement age observed in the administrative database of the Danish population. The recent history of changes in a publicly financed early-retirement program provides them with the required variation in the data to insure the identification of the parameters of interest: the elasticity of retirement age with respect to incomes flows. In particular, their estimates imply a significant asymmetry in the sensitivity of retirement behavior of men and women with respect to variation in their own, or their spouse's income flows.

Butler and Teppa use a unique dataset on individual retirement decisions in Swiss pension funds to analyze the choice between an annuity and a lump sum at retirement. Their analysis suggests the existence of an "acquiescence bias," meaning that a majority of retirees chooses the standard option offered by the pensions fund or suggested by common practice. Small levels of accumulated pension capital are much more likely to be withdrawn as a lump sum, suggesting a potential moral hazard behavior or a magnitude effect. The authors hardly find evidence for adverse selection effects in the data. Single men, for example, whose money's worth of an annuity is considerably below the corresponding value of married men, are not more likely to choose the capital option.

Amromin, Huang, and Sialm show that a significant number of households can perform a tax arbitrage by cutting back on their additional mortgage payments and increasing their contributions to tax-deferred accounts (TDA). Using data from the three latest Surveys of Consumer Finances, they show that about 38 percent of U.S. households that are accelerating their mortgage payments instead of saving in tax-deferred accounts are making the wrong choice. For these households, reallocating their savings can yield a mean tax benefit of 11 to 17 cents per dollar, depending on the choice of investment assets in the TDA. In the aggregate, these misallocated savings are costing U.S. households as much as 1.5 billion dollars per year. Finally, the authors show empirically that this inefficient behavior is unlikely to be driven by liquidity or other constraints, and that self-reported debt aversion and risk aversion variables explain to some extent the preference for paying off debt obligations early and hence the propensity to forgo possible tax arbitrage.

Coile and Levine examine how unemployment affects retirement and whether the Unemployment Insurance (UI) system and Social Security (SS) system affect how older workers respond to labor market shocks. To do so, they use data from the longitudinal Health and Retirement Survey (HRS), pooled cross-sections from the March Current Population Survey (CPS), and March CPS files matched between one year and the next. They find that downturns in the labor market increase retirement transitions. The magnitude of this effect is comparable to that associated with moderate changes in financial incentives to retire and to the threat of a health shock to which older workers are exposed. Interestingly, retirements only increase in response to an economic downturn once workers become SS-eligible, suggesting that retirement benefits may help alleviate the income loss associated with a weak labor market. The authors also estimate the impact of UI generosity on retirement and find little consistent evidence of an effect. This suggests that in some ways SS may serve as a more effective form of unemployment insurance for older workers than UI.

Karlstrom, Palme, and Svensson study the effect of a reform of the Swedish disability insurance (DI) program whereby the special eligibility rules for workers aged 60-64 were abolished. They first use a differences-in-differences approach to study changes in the disability take-up compared to that of the 55-to-59-age group. Then they use a similar approach to study to what extent the employment effect of the reform is "crowded out" by an increase in the use of sick pay insurance, contributing to the well known increase in spending in that program, and/or unemployment insurance. In an extended analysis, they study the effect of firm closure on employment and use of different labor market insurance programs in different age groups before and after the reform.

Eklof and Hallberg analyze retirement behavior in Sweden during the 1990s with a focus on voluntary early retirement. They observe in the data that a non-negligible fraction of early retirees receive higher occupational pension benefits than regulated in the collectively agreed contracts. This is consistent with "buy-outs," also called early retirement pensions, where employers offer employees more generous pension programs if they agree on early retirement. Neglecting such offers produces biased estimates of the individuals' responses to financial incentives in the retirement decision. The available register data is limited such that access to early retirement pensions is only indirectly recorded for early retirees, and not recorded at all for non-retirees. This creates an error-in-variables problem in the retirement equation and a sample-selection problem in the access-to-early-retirement pension equation. The authors propose an estimation strategy whereby the retirement decision and the access to early pension are estimated in a simultaneous equation system, yielding unbiased estimates of the model parameters. They apply the model using detailed Swedish register data. They illustrate that the early retirement probabilities would decrease by 10-30 percent if early retirement pensions were absent.

Long-term care represents one of the largest uninsured financial risks facing the elderly in the United States. Brown and Finkelstein present evidence of supply-side market failures in the private long-term care insurance market. In particular, the typical policy purchased exhibits premiums marked up substantially above expected benefits. It also provides very limited coverage relative to the total expenditure risk. However, the authors present additional evidence suggesting that the existence of supply-side market failures is unlikely, by itself, to be sufficient to explain the very small size of the private long-term care insurance market. In particular, they find enormous gender differences in pricing that do not translate into differences in coverage, and they show that more comprehensive policies are widely available, if seldom purchased, at similar loads to purchased policies. This suggests that factors limiting demand for insurance are also likely to be important in this market. The evidence here also sheds light on the likely nature of these demand-side factors.

Bommier and his coauthors study the normative problem of redistribution between individuals who differ in their life span. They discuss important aspects related to the objective function in such a setting and argue that aversion to multi-period inequality and risk aversion with respect to the length of life should be taken into account. Then, they study the properties of the social optimum both with full information and asymmetric information.

These papers will be published in a special edition of the Journal of Public Economics. They will also be available at "Books in Progress" on the NBER's website.

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International Seminar on Macroeconomics

The NBER's 29th Annual International Seminar on Macroeconomics, organized by Lucrezia Reichlin, Director General of the European Central Bank, and Kenneth D. West, NBER and University of Wisconsin, took place in Estonia on June 16-17. Jeffrey A. Frankel, NBER and Harvard University, and Francesco Giavazzi, NBER and Bocconi University, served as co-chairs. These papers were discussed:

Giancarlo Corsetti, European University Institute; Luca Dedola, European Central Bank; and Sylvain Leduc, Federal Reserve Board, "Productivity, External Balance, and Exchange Rates: Evidence on the Transmission Mechanism Among G7 Countries"
Discussants: Susanto Basu, Boston College and NBER, and Robert Kollman, University of Paris XII

Lans Bovenberg, Tilburg University, and Harald Uhlig, Humboldt University,

"Pension Systems and the Allocation of Macroeconomic Risk"
Discussants: Henning Bohn, University of California, Santa Barbara, and Philippe Weil, Universite Libre de Bruxelles and NBER

Troy Davig, Federal Reserve Bank of Kansas, and Eric M. Leeper, Indiana University and NBER, "Threshold Regime Switching: Spillovers, Asymmetries, and Preemptive Actions"
Discussants: Richard H. Clarida, Columbia University and NBER, and Jesper Linde, Sveriges Riksbank

Chryssi Giannitsarou, University of Cambridge, and Andrew Scott, London Business School, "The Inflation of Rising Government Debt -- Should We Be Worried?"
Discussants: Domenico Giannone, Universite Libre de Bruxelles, and Eric M. Leeper

Julio J. Rotemberg, Harvard University and NBER, "Cyclical Wages in a Search-and-Bargaining Model with Large Firms"

Discussants: Rodolfo Manuelli, University of Wisconsin, and Antonella Trigari, Universita Bocconi

Morten O. Ravn, European University Institute, " The Consumption-Tightness Puzzle"
Discussants: Kai Christoffel, European Central Bank, and Julio J. Rotemberg

Linda L. Tesar, University of Michigan and NBER, "Production Sharing and Business Cycle Synchronization in the Accession Countries"
Discussants: Paul Bergin, University of California, Davis and NBER, and Aurelijus Dabusinskas, Bank of Estonia

Francis X. Diebold, University of Pennsylvania and NBER, and Kamil Yilmaz, Koc University, "Volatility Contagion"
Discussants: Michael Binder, University of Frankfurt, and Kathryn M. E. Dominguez, University of Michigan and NBER

Corsetti and his coauthors investigate the international transmission of productivity shocks in a sample of five G-7 countries. Using long-run restrictions, they identify for each country shocks that permanently increase domestic labor productivity in manufacturing (their measure of tradable goods) relative to an aggregate of the other G-7 countries. According to standard theory, they find that these shocks raise relative consumption, deteriorate net exports, and raise the relative price of non-tradable goods, in full accord with the Harrod-Balassa-Samuelson hypothesis. Moreover, the deterioration of the external account is fairly persistent, especially for the United States. The response of the real exchange rate and (their proxy for) the terms of trade differ across countries: both prices appreciate in the largest and least open economies in the sample; they depreciate in the smaller and more open economies. These findings question the conventional view that supply shocks worsen the terms of trade of a country on impact, providing an empirical contribution to the current debate on the correction of global imbalances. Productivity growth in the U.S. manufacturing sector does not necessarily deteriorate the U.S. terms of trade, nor improve the U.S. trade deficit, at least in the short and medium run.

Bovenberg and Uhlig explore the optimal risk sharing arrangement between generations in an overlapping generations model with endogenous growth. They allow for non-separable preferences, paying particular attention to the risk aversion of the old as well as overall "life-cycle" risk aversion. They provide a fairly tractable model, which can serve as a starting point for exploring these issues in models with a larger number of periods of life, and show how it can be solved. They provide a general risk sharing condition, and discuss its implications. They explore the properties of the model quantitatively. Among the key findings are the following: first, the old bear a smaller burden of the risk in productivity surprises if old-age risk-aversion is smaller than life-cycle risk aversion, but a larger one if the old-age risk aversion is higher. Second, consumption of the young and the old always move in the same direction, even for population growth shocks. This result is in contrast to the result of a fully funded decentralized system without risk sharing between generations. Third, persistent increases in longevity will lead to lower total consumption of the old (and thus certainly lower per-period consumption of the old) as well as the young and higher work effort of the young. The additional resources are instead used to increase growth and future output, resulting in higher consumption of future generations.

Davig and Leeper make changes in monetary policy rules (or regimes) endogenous. Changes are triggered when certain endogenous variables cross certain specified thresholds. The implications of threshold switching are examined in three models to illustrate that: 1) cross-regime spillovers can be quantitatively important; 2) symmetric shocks can have asymmetric effects; 3) endogenous switching is a natural way to formally model preemptive policy actions. In a conventional calibrated model, preemptive policy reaps benefits by shifting agents' expectations, enhancing the effectiveness of policy and yielding a quantitatively significant "preemption dividend."

The intertemporal budget constraint of the government implies a relationship between the ratio of current liabilities and: the primary deficit and future values for the deficit, narrow money, inflation, interest rates, and GDP growth. Giannitsarou and Scott evaluate the ability of this framework to explain the fiscal behavior of the G7 since 1970. They show how debt is normally financed through changes in the primary deficit (90 percent) with less substantial roles being played by inflation (2 percent) and GDP growth (5-10 percent). They then use this framework to consider the implications of demographic factors for government finances. Using projections for each country's future deficits and the impact on interest rates and growth rates, they provide upper bounds for the impact of demography on inflation, based on unchanged fiscal policies, and then calculate the required fiscal adjustment necessary to maintain stable inflation.

Rotemberg presents a complete general equilibrium model with flexible wages where the degree to which wages and productivity change when cyclical employment changes is roughly consistent with postwar U.S. data. Firms with market power are assumed to bargain simultaneously with many employees, each of whom finds himself matched with a firm only after a process of search. When employment increases as a result of reductions in market power, the marginal product of labor falls. This fall tempers the bargaining power of workers and thus dampens the increase in their real wages. The procyclical movement of wages is dampened further if the posting of vacancies is subject to increasing returns.

Ravn introduces a labor force participation choice into a standard, labor market matching model embedded in a dynamic stochastic general equilibrium set-up. He models the participation choice as a trade-off between forgoing the expected benefits of actively searching and the costs of engaging in a labor market search. In contrast to models with constant labor force participation, the model that he analyzes induces symmetry between firms' and workers' search decisions, since both sides of the labor market vary the search effort at the extensive margins. Ravn shows that this set-up is of considerable analytical convenience and that the introduction of participation choice leads to a strong tendency for procyclical unemployment, very low volatility of labor market tightness, and a positively sloped Beveridge curve.

Tesar provides a quantitative assessment of the role of trade in the transmission of business cycles within and between the regions of East and West Europe. The model allows for trade in intermediate inputs that are substitutes in production and for "nearshoring" in which intermediate inputs from East and West are complements. The model is calibrated to data on aggregate and bilateral trade flow, relative country sizes, and the extent of nearshoring. The model suggests that expanded East-West trade will produce positive output co-movements within Europe. However, the two types of trade also produce very different dynamics for consumption and labor supply. Thus, one's view of whether trade makes business cycles "more similar" across Europe or not depends both on the nature of trade and on the metric one uses to assess business cycle synchronization.

Although much has been made of the possibility of contagion in global asset markets following the late-1990s Asian crisis, the evidence remains mixed and controversial. Diebold and Yilmaz progress by formulating and examining precise and separate measures of return spillovers (multivariate linkages via the conditional means of returns) and volatility spillovers (multivariate linkages via the conditional variances of returns). Return contagion and volatility contagion then emerge as periods of return spillover bursts and volatility spillover bursts, respectively. Moreover, this framework facilitates study of both crisis and non-crisis episodes, including secular trends in spillovers. This turns out to be empirically important: in an extensive analysis of 16 global equity markets, there is striking evidence of divergent behavior in return spillovers versus volatility spillovers. Moving through the 1990s to the present, return spillovers display an upward trend but no contagion, whereas volatility spillovers display no trend but strong contagion.

The MIT Press will publish these papers in an annual conference volume later this year. They are also available at "Books in Progress" on the NBER's website.

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Seventeenth Annual EASE Conference

The NBER, the University of Tokyo, the China Center for Economic Research, the Chung-Hua Institution for Economic Research, the Hong Kong University of Science and Technology, the Korea Development Institute, the Productivity Commission of Australia, the Singapore Management University, and the Tokyo Center for Economic Research jointly sponsored the NBER's 17th Annual East Asian Seminar on Economics on June 22-24. Takatoshi Ito, University of Tokyo and NBER, and Andrew K. Rose, University of California, Berkeley and NBER, organized the conference, which focused on "International Financial Issues Around the Pacific-Rim." These papers were discussed:

Peter B. Henry, Stanford University and NBER, and Prakash Kannan, Stanford University, "Growth and Returns in Emerging Markets"
Discussants: Takatoshi Ito, and Etsuro Shioji, Hitotsubashi University

Shin-ichi Fukuda and Yoshifumi Kon, University of Tokyo, "International Currency and the U.S. Current Account Deficits"
Discussants: Linda S. Goldberg, Federal Reserve Bank of New York and NBER, and Andrew K. Rose

Lee-Rong Wang, Chung-Hua Institution for Economic Research, "Financial Liberalization under the WTO and Its Relationship with the Macroeconomy"
Discussants: Shin-ichi Fukuda, and Roberto Mariano, Singapore Management University

Michael P. Dooley, University of California, Santa Cruz and NBER; David Folkerts-Landau, Deutsche Bank; and Peter M. Garber, Deutsche Bank and NBER, "Life on the Tri-Polar Sphere: How Should Interest and Exchange Rates Realign Next?"
Discussants: Barry Eichengreen, University of California, Berkeley and NBER, and John Simon, Reserve Bank of Australia

Eiji Ogawa, Hitotsubashi University, and Kentaro Kawasaki, Toyo University, "Adopting a Common Currency Basket Arrangement into the ‘ASEAN Plus Three'"
Discussants: Michael P. Dooley, and Kiyotaka Sato, Yokohama National University

Takatoshi Ito, and Yuko Hashimoto, Toyo University, "Price Impacts of Deals and Predictability of the Exchange Rate Movements"
Discussants: Peter M.Garber, and Eli Remolona, Bank for International Settlements

Chulsoo Kim, Sookmyung Women's University, "Current Account, Government Budget, and World Output Shares"
Discussants: Ashvin Ahuja, Bank of Thailand, and Peter N. Kriz, Singapore Management University

Inseok Shin and Changyun Park, Korea Development Institute, "Stock Market Opening and the Cost of Capital: The Case of Korea"
Discussants: Yuko Hashimoto and Chulsoo Kim

Kyoji Fukao and Miho Takizawa, Hitotsubashi University; Keiko Ito, Senshu University; and Hyeog Ug Kwon, Nihon University, "Cross-Border Acquisitions and Target Firms' Performance: Evidence from Japanese Firm-Level Data"
Discussants: Chatib Basri, University of Indonesia, and Roberto Mariano

Barry Eichengreen, and Pipat Luengnaruemitchai, IMF, "Bond Markets as Conduits for Capital Flows: How Does Asia Compare?"
Discussants: Eiji Ogawa and Eli Remolona

Linda S. Goldberg, and Jose Manuel Campa, IESE, "Pass Through of Exchange Rates to Consumption Prices: What Has Changed and Why?"
Discussants: Chatib Basri and Kiyotaka Sato

Chung-Shu Wu and Jin-Lung Lin, Academia Sinica, "The Relationship between Openness and Inflation in Asian 4 and G 7"
Discussants: Peter B. Henry and John Simon

Jianhuai Shi, CCER, "Are Currency Revaluations Contractionary in China?"
Discussants: Ashvin Ahuja, Bank of Thailand, and Dante Canlas, University of the Philippines

According to Henry and Kannan, from 1976 to 2005 the emerging economies grew at an average rate of 5.1 percent per year, roughly twice the average growth rate of the United States. In contrast, average annual stock returns for emerging markets over the same time period were 7.78 percent, a number that is not significantly higher than the corresponding figure for the United States. On the other hand, average expected returns in emerging economies are greater than expected returns in the United States. Realized returns in emerging markets generally exceed expected returns, but the differential between the two (unexpected capital gains), has been larger in Latin America than in Asia.

Fukuda and Kon provide some theoretical and empirical support to the view that a remarkable change in international capital flows would help to explain recent increases in the U.S. current account deficits. They first provide a simple open economy model, in which an increased motive for liquid foreign assets can cause large current account surpluses against the country that issues an international currency. Their dynamic analysis reveals that the current account surpluses are likely to remain large for years, accompanied by substantial depreciation of the real exchange rate against the international currency. Second, they provide empirical support for the theoretical implications. They show that there were not only large increases in foreign exchange reserves in East Asian economies but also substantial depreciation of East Asian real exchange rates against the U.S. dollar even after the economies recovered from the crisis. They then provide noteworthy regressions based on the Balassa-Samuelson model. They observe world-wide undervaluation of real exchange rates against the U.S. dollar after the Asian crisis. The degree of undervaluation was more conspicuous among the East Asian economies. Their results support the view that the U.S. current account deficit is not "made in the U.S.A." but is attributable to some events external to the United States.

Wang focuses on the relationship between the liberalization of the financial sector, competition within the sector, and the sector's overall contribution to economic growth. To identify such relationships, he follows the approach adopted in Eschenbach, Francois, and Schuknecht (2000), which involves cross-country growth regressions and includes a number of variables that seem to perform robustly in the literature. His contribution is mainly to adjust the way in which financial liberalization is measured based on the financial commitments under the General Agreement on Trade in Services, by following the method presented by Hoekman (1995) and other related studies. He finds that, based on the GATS commitments in overall financial sectors throughout four modes of supply offered by 93 WTO members, the degree of liberalization in terms of market access and national treatment are highly correlated. Under mode 1 (cross-border supply), 2 (consumption abroad), and 3 (commercial presence), the degree of liberalization in regard to market access is positively correlated with the income level; however, there is no such link under mode 4 (movement of natural persons). When compared with the performance in terms of liberalization across the four modes, higher income members have, on average, the highest level of market access liberalization under mode 2. However, in regard to the national treatment part, mode 3 appears to have the highest degree of liberalization regardless of the income level. Wang also finds that there is a positive pattern linking the financial sector competition indicators with his measure of financial sector liberalization, and economic growth with the financial sector competition. His findings, in a way that is similar to Eschenbach, Francois, and Schuknecht (2000), suggest that moving from a closed to a relatively open regime is correlated with significant pro-competitive pressures, and ultimately with large differences in growth rates.

Dooley and his co-authors examine the behavior of interest rates and exchange rates following a variety of shocks to the international monetary system. Their analysis suggests that real interest rates in the United States and Europe will remain low relative to historical cyclical experience for an extended period but converge slowly toward normal levels. During this adjustment interval, the United States will continue to absorb a disproportionate share of world savings. After a substantial initial appreciation, the floating currencies will remain constant relative to the dollar in the undisturbed background system. In real terms, the dollar and the floating currencies will eventually have to depreciate relative to the managed currencies.

Ogawa and Kawasakiinvestigate whether the region composed of "ASEAN plus three countries" is an optimum currency area. They focus on whether the Japanese yen could be regarded as an "insider" currency along with other East Asian currencies, or whether it is still an "outsider" which is used as a target currency of foreign exchange rate policy for other East Asian countries. They use a Dynamic OLS methodology to estimate the long-term relationship among the East Asian currencies in a currency basket. Their empirical results indicate that the Japanese yen works as an exogenous variable in the cointegration system during a pre-crisis period while it works as an endogenous one during a post-crisis period. This implies that the Japanese yen could be regarded as an insider currency, along with other East Asian currencies, after the crisis although it is regarded as an outsider currency, along with the U.S. dollar and the euro, before the Asian crisis.

Ito and Hashimoto examine the price impact and the predictability of exchange rate movement using the transaction data recorded in the electronic brokering system of the spot foreign exchange market. With the institutional change in markets in recent years (such as the widespread use of computers in the FOREX markets), traders tend not to accumulate large positions during the day and to square positions at the end of business hours. In this analysis, the authors examine the impact of order flows on the price quotation and movements: whether deals at the ask (bid) side will cause the exchange rate to depreciate (appreciate) depends on the depth of market. Then, they examine whether deals done at period t predict the price movement for the next period, t+1, using information that is contained in the dataset. They find that coefficients are significantly different from zero for both 5-minute and 1-minute forecast horizons, but the significance disappears in the 30-minute interval. Also, t-statistics become larger as the prediction window becomes shorter. Price impacts of deals on one side of the market, that likely reflect order flows, are significant but short-lived. If one is in the market and observe these phenomena on the real-time basis, then price movements in the next few minutes may be predictable.

Engel and Rogers (2006) build a model in which a country will run a current account deficit if the discounted sum of its future shares of world GDP exceeds its current share of world GDP. They ask if current account balance can be explained with private savings, implicitly holding government budget balance and investment constant. Kim instead asks if current account balance can be explained with private savings and government budget balance, implicitly holding only investment constant. By introducing rule-of-thumb consumers into Engel and Rogers (2006) methodology, she can determine whether the recent tax cuts have caused the recent increases in the U.S. current account deficit. Furthermore, with a government budget balance modeled explicitly, this paper asks whether we can explain the large current account surpluses of the emerging economies of East Asia.

Shin and Park study changes in the cost of capital after stock market opening based on the Korean experience. They use firm-level panel regression approaches, focusing on the relationship between foreign participation rates and the dividend yield. They find that the larger the foreign participation rate, the lower is the dividend yield. But, the relationship is only significant in the post-crisis period when the Korean stock market is fully opened and the foreign participation rate is relatively higher. The results are different from the existing studies based on cross-country data that find the effect of market opening isrealized in the early stage of opening.

Fukao and his co-authors examine whether a firm is chosen as an acquisition target based on its productivity level, profitability, and other characteristics, and whether the performance of Japanese firms that were acquired by foreign firms improves after the acquisition. They use Japanese firm-level data for the period from 1994-2002. In their previous study of the Japanese manufacturing sector, they found that acquisitions by foreigners brought larger and quicker improvements in total factor productivity (TFP) and profit rates. However, one may argue that firms acquired by foreign firms showed better performance simply because foreign investors acquired more promising Japanese firms than Japanese investors did. In order to address this selection-bias problem, the authors combine a difference-in-differences approach with propensity-score matching techniques in this study. The basic idea of matching is that they look for firms who were not acquired by foreign firms but had similar characteristics to those acquired by foreigners. Using these firms as control subjects, and comparing the acquired firms and the control subjects, the authors ask whether firms acquired by foreigners show greater improvement in performance than firms not acquired by foreigners. Results from both unmatched samples and from matched samples show that foreign acquisitions improved target firms' productivity and profitability significantly more and quicker than acquisitions by domestic firms. Moreover, there is no positive impact on target firms' profitability in the case of both within-group in-in acquisitions and in-in acquisitions by domestic outsiders. In fact, in the manufacturing sector, the return on assets even deteriorates one year and two years after within-group in-in acquisition, while the TFP growth rate is higher after within-group in-in acquisition than after by-outsider in-in acquisition. These results imply that in the case of within-group in-in acquisitions, parent firms may be trying to quickly restructure acquired firms even at the cost of deteriorating profitability.

Eichengreen and Luengnaruemitchai use data on the extent to which residents of one country hold the bonds of issuers resident in another as a measure of financial integration or interrelatedness, asking how Asia compares with Europe and Latin America and with the base case in which the purchaser and issuer of the bonds reside in different regions. Not surprisingly, they find that Europe is head and shoulders above other regions in terms of financial integration. More interesting is that Asia already seems to have made some progress on this front compared to Latin America and other parts of the world. The contrast with Latin America is largely explained by stronger creditor and investor rights, more expeditious and less costly contract enforcement, and greater transparency that lead to larger and better developed financial systems in Asia, something that is conducive to foreign participation in local markets and to intra-regional cross holdings of Asian bonds generally. Further results based on a limited sample suggest that one factor holding back investment in foreign bonds in East Asia may be limited geographical diversification by mutual funds, in turn reflecting a dearth of appropriate assets. Asian Bond Fund 2, by creating a passively managed portfolio of local currency bonds potentially attractive to mutual fund managers and investors, may help to relax this constraint.

The sensitivity of border prices to exchange rates is much higher than the sensitivity of retail prices of similar goods to exchange rates. The distribution sector and imported input use play important roles in driving a wedge between these two levels of exchange rate pass through. Campa and Goldberg present cross-country evidence on sector-specific import-price sensitivity to exchange rates, and on changes over time in this sensitivity. They also document how changes over time in expenditures on local distribution and on the use of imported inputs in production should influence retail price sensitivity to exchange rates.

Investigating a sample of 114 countries, Romer (1993) found a significant negative relationship between openness and inflation. But for a cross-section dataset that covers so many countries, and may include some with a unique economic structure, these empirical results may be significantly distorted. In addition, to represent a country's characteristics by period-averaged indexes may not reflect the actual phenomenon. In their paper, Wu and Lin adopt a panel data set that includes some NICs and G7 countries in order to reinvestigate the relationship between openness and inflation. Since the number of countries they discuss is only thirteen, it is relatively easy for them to review the patterns of openness and inflation of each country. Moreover, using the panel data, they can verify the time-consistency theory by examining the corollary of the theory: that the effect of monetary expansion on output is smaller in a more open economy. Their empirical results show that openness and inflation do not have a regular relationship, as argued by Romer(1993), and that there exists no certain relationship between openness and the impact of money supply.

Shi empirically assesses the effects of the renminbi (RMB) real exchange rates on China's output. The econometrics of the paper show that even after sources of spurious correlation and reverse causation are controlled for, RMB revaluation has led to a decline in China's output – this suggests that RMB revaluations do tend to be contractionary. The paper provides some possible explanations of this finding, and point out that the it does not imply that China should continue to maintain an undervalued RMB.

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NBER Conference in Beijing

The eighth annual NBER-CCER Conference on China and the World Economy, jointly sponsored by the National Bureau of Economic Research and the China Center for Economic Research at Beijing University, took place in Beijing on June 28-July 1.

At this conference, the discussion topics included: China's role in the world economy; the importance of international capital flows; monetary policy under fixed exchange rates; FDI and economic growth; the effect of social capital on poverty; regulation issues; human capital and its relation to growth and inequality; and the measurement of productivity.

U.S. participants at this year's conference were: NBER President Martin Feldstein and Professor Shang-Jin Wei, who is currently on leave from the NBER at the IMF, both serving as the U.S. conference organizers; NBER researchers Alberto F. Alesina of Harvard University; Ernst R. Berndt, James M. Poterba, and Nancy L. Rose of MIT; William J. Collins of Vanderbilt University; Mark Duggan, University of Maryland; Gordon H. Hanson, University of California, San Diego; Casey Mulligan, University of Chicago; and Michael Woodford, Columbia University.

The entire conference program with links to other related information is available on the NBER's web site at www.nber.org/china.

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Tax Policy and the Economy

The NBER's Twenty-first Annual Conference on Tax Policy and the Economy, organized by James M. Poterba of NBER and MIT, took place in Washington, DC on September 14. These papers were discussed:

Jeffrey R. Brown, University of Illinois and NBER; Norma Coe, Tilburg University; and Amy Finkelstein, MIT and NBER, "Medicaid Crowd-Out of Private Long-Term Care Insurance Demand: Evidence from the Health and Retirement Survey"

Martin Feldstein, Harvard University and NBER, and Daniel Altman, NBER, "Unemployment Insurance Saving Accounts" (NBER Working Paper No. 6860)

John F. Cogan, Stanford University; R. Glenn Hubbard, Columbia University and NBER; and Daniel P. Kessler, Stanford University and NBER, "Evaluating Effects of Tax Preferences on Health Care Spending and the Budget"

Laurence J. Kotlikoff, Boston University and NBER, and David Rapson, Boston University, "Does It Pay, at the Margin, to Work and Save? -- Measuring Effective Marginal Taxes on Americans' Labor Supply and Saving"

Gilbert E. Metcalf, Tufts University and NBER, "Federal Tax Policy Towards Energy"

Brown, Coe, and Finkelstein provide empirical evidence of Medicaid crowd out of the demand for private long-term care insurance. Using data from the Health and Retirement Survey, they estimate that a $10,000 decrease in the level of assets an individual can keep while qualifying for Medicaid would increase private long-term care insurance coverage by 1.1 percentage points. This implies that if every state in the country moved from their current Medicaid asset eligibility requirements to the most stringent Medicaid eligibility requirements allowed by federal law – a change that would decrease average household assets protected by Medicaid by about $25,000 – demand for private long-term care insurance would rise by 2.7 percentage points. While this represents a 30 percent increase in insurance coverage relative to the baseline ownership rate of 9.1 percent, it also indicates that the vast majority of households would still find it unattractive to purchase private insurance.

Feldstein and Altman ask whether unemployment insurance (UI) savings accounts based on a moderate saving rate can finance a significant share of unemployment payments or whether the concentration of unemployment among a relatively small number of individuals implies that the such account balances would typically be negative, forcing individuals to rely on government benefits with the same adverse effects that characterize the current UI system.They use data from the Panel Study on Income Dynamics. Their analysis indicates that almost all individuals would have positive UI Savings Account (UISA) balances and therefore remain sensitive to the cost of unemployment compensation. Even among individuals who experience unemployment, most would have positive account balances at the end of their unemployment spell. These findings suggest that the cost to taxpayers of forgiving the negative UISA balances is less than half of the taxpayer cost of the current UI system.

Virtually all observers of health policy agree that the tax preference for employer-provided health insurance -- under which employer contributions to employee health insurance are deductible to the employer and non-taxable to the employee -- encourages overconsumption of health services in the United States. By making health spending in general, and insured health spending in particular, appear less costly, the tax preference gives employees the incentive to take compensation as health insurance rather than cash, even if they would otherwise prefer not to. Despite this, policymakers over the past 30 years have sought to level the tax playing field by expanding rather than eliminating the tax preference to include out-of-pocket spending. Cogan, Hubbard, and Kessler calculate the consequences for health spending and the federal budget of an above-the-line deduction for out-of-pocket health spending. They show how the response of spending to this expansion in the tax preference can be specified as a function of a small number of behavioral parameters that have been estimated in the existing literature. They compare their estimates to those from other researchers. And, they use their analysis to derive some implications for tax policy toward Health Savings Accounts.

Kotlikoff and Rapson perform a detailed analysis of taxes and saving over the life cycle. Their paper offers four main takeaways. First, thanks to the incredible complexity of the U.S. fiscal system, it's impossible for anyone to understand her incentive to work, save, or contribute to retirement accounts absent highly advanced computer technology and software. Second, the U.S. fiscal system provides most households with very strong reasons to limit their labor supply and saving. Third, the system offers very high-income young and middle aged households, as well as most older households, tremendous opportunities to arbitrage the tax system by contributing to retirement accounts. Fourth, the patterns by age and income of marginal net tax rates on earnings, marginal net tax rates on saving, and tax-arbitrage opportunities can be summarized in one word: bizarre.

Metcalf surveys federal tax policy on energy, focusing on programs that affect both energy supply and demand. He briefly discusses the distributional and incentive impacts of many of these incentives. In particular, he makes a rough calculation of the impact of tax incentives for domestic oil production on world oil supply and prices. He finds that the incentives for domestic production have negligible impact on world supply or prices, despite the United States being the third largest oil producing country in the world. Finally, Metcalf presents results from a model of electricity pricing to assess the impact of the federal tax incentives directed at electricity generation. He finds that nuclear power and renewable electricity sources benefit substantially from accelerated depreciation. Further, the production and investment tax credits make clean coal technologies cost-competitive with pulverized coal and wind and biomass cost-competitive with natural gas.

These papers will be published by the MIT Press as Tax Policy and the Economy, Volume 21. They are also available at "Books in Progress" on the NBER's website.

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