Research

Empirical evidence shows that developing countries with transparent institutions receive procyclical Official Development Aid (ODA) while developing countries with opaque institutions receive acyclical or countercyclical ODA. This paper provides a dynamic equilibrium model of optimal aid policy that quantitatively accounts for this fact. In the model, the donor wants to (a) encourage actions by the aid receiving government that increase output and (b) smooth out economic fluctuations. The transparency of institutions in the country affects the donor's ability to distinguish downturns caused by exogenous shocks, from those caused by government actions. The solution to the donor's mechanism design problem is dependent on the transparency of government actions. If the donor has good information about government actions, aid policy is countercyclical and aid acts as insurance. However, if the donor is unable to perfectly infer the cause of the downturn, aid policy is procyclical to encourage unobservable good actions. The model predicts a similar pattern for ODA commitments for the following year which is supported by the data. For countries with opaque institutions procyclical aid is the result of optimal policies given the information constraints of donors.

This paper documents a new fact: the correlation between official development assistance (ODA) and GDP is negatively related to the quality of institutions. This fact reconciles conflicting empirical results about the correlation between ODA and GDP in the literature. For instance, Pallage and Robe (2001) find a positive correlation in two thirds of African economies and half of non-African developing economies, but Rand and Tarp (2002) find no correlation in a different set of developing countries. First, once institutions are accounted for, African economies are not treated differently by donors. Second, the sample in Rand and Tarp (2002) comprises developing economies which have relatively good institutions, therefore, those countries receive acyclical or countercyclical aid. Differences in institutional indicators that measure corruption, rule of law, government effectiveness and government transparency are particularly important. The results are found to be robust to several modifications, including within and between country variation and different sources of institutional quality measures.

Procyclical fiscal policy can be caused by either procyclical government expenditure, countercyclical taxes or both. The majority of models which try to explain procyclical fiscal policy as the result of optimal policy have procyclical government expenditures. This paper develops a model which optimally generates procyclical fiscal policy while keeping government expenditures acyclical. Instead, taxes are optimally countercyclical. The model uses endogenous sovereign default to generate an environment where interest rates are lower in booms than in recessions. If household's have insufficient access to financial instruments it is optimal for the government to lower taxes and borrow during booms. This enables impatient households to benefit from the lower interest rates by helping the consumer bring consumption forward.

Some useful cost of living calculations for prospective graduate students in economics at the University of Maryland, College Park (UMCP)

I calculated how much a fully funded economics graduate student at UMCP has available to spend from their stipend after paying: taxes, health insurance, mandatory university fees and rent. (For all your offers, ask the graduate secretary/or current students for help with the figures, it should only take them 20mins or so to find the necessary data).

NOTE: As of Fall 2008, stipends have now substantially increased. At the request of the department I have removed the document from my website. I still recommend redoing this calculation to compare the real value of competing offers.

According to the OECD, latest edition of "Taxing Wages", employees face a higher tax wedge of 24.2%2 in the UK compared to only 21.7% in the US. These are of course average tax wedges. In the UK, the higher tax rates bite earlier so I wanted to compare what would be my income tax wedge given my low income.

I find that my 'effective' tax wedge is actually lower in the UK, than in the US. In the UK my tax wedge is 16% compared to 19% in the US. I use the word 'effective' because I include health insurance payments in the US because I am not eligible for healthcare programs funded by the state. Excluding health insurance payments, my tax wedges in the UK and the US are roughly the same at 16%. More ...

I carefully compare the cost of living for a PhD student in the Washington DC area to another PhD student in London. I find that the real exchange rate is approximately 1.9 US Dollars per Pound Sterling. This is remarkably close to the prevailing market exchange rate and significantly higher than the real exchange rate derived in the Penn World Tables. My results suggest that comparisons about real incomes for low income households between the USA and the UK overestimate real incomes in the US relative to those in the UK.

The literature on the New Phillips Curve (NPC) started off with an analysis of pricing behaviour in economies that are closed. In the spirit of Batini, Jackson and Nickell (2000), here we focus on the open-economy aspects of the NPC. More specifically, we estimate open-economy NPCs based on either Calvo, Taylor or time-dependent contracts a la Dotsey, King and Wolman (1999) for seven industrialized open-economy countries. We then look at which NPC can better replicate the data in each of these countries. Our results suggest that in most countries: (i) the NPC model works well, and captures the data well, whatever the underlying contract specification; (ii) the NPCs based on Taylor and time-dependent contracts tend to suggest more myopia in price setting than NPCs based on Calvo; (iii) openness matters more for price determination when contracts last longer.

Keywords: inflation dynamics, Calvo contracts, Taylor contracts, time-dependent contracts, open economy.

JEL Classification Codes: E37, E52, E58

We follow Fuhrer (2000) in estimating via Maximum Likelihood a log-linear consumption function on UK data. In doing so we consider various habit formation assumptions. We show that a model of purely "external" habits as in Fuhrer (2000) fits the UK data remarkably well, and possibly in a superior way than US data where, according to our estimates, consumers' habits look more "internal" in that they appear indexed to past average consumption of only a subset of (peer) consumers in the economy, rather than total past per capita consumption. We also find that for about one seventh of UK consumers, current consumption equals current income; a strong violation of the permanent income hypothesis. Embedded in a sticky price-sticky inflation open-economy monetary model, the model that we estimate helps mimic the hump-shaped response of the output gap to income and interest rate shocks observed in the UK. Estimates of output Euler equations for the UK using a similar method agree with our general results. The consumption and output models that we estimate forecast significantly better than unrestricted open-economy VARs.

Keywords: consumption, habit formation, output gap channel

JEL Classification Codes: D12, E52, E43