Working Papers
2023
December 8, 2023
High-Dimensional Covariance Matrix Estimation: Shrinkage Toward a Diagonal Target
Description: This paper proposes a novel shrinkage estimator for high-dimensional covariance matrices by extending the Oracle Approximating Shrinkage (OAS) of Chen et al. (2009) to target the diagonal elements of the sample covariance matrix. We derive the closed-form solution of the shrinkage parameter and show by simulation that, when the diagonal elements of the true covariance matrix exhibit substantial variation, our method reduces the Mean Squared Error, compared with the OAS that targets an average variance. The improvement is larger when the true covariance matrix is sparser. Our method also reduces the Mean Squared Error for the inverse of the covariance matrix.
December 8, 2023
Feeling Rich, Feeling Poor: Housing Wealth Effects and Consumption in Europe
Description: Households across Europe are struggling with a double crisis—the worst inflation shock since the World War II and a sudden correction in house prices. There is a rich literature on how housing price cycles affect consumer spending, finding mixed results with a wide range of consumption responses to changes in housing wealth. In this paper, using quarterly data on 20 countries in Europe over the period 1980–2023, we analyze the dynamic relationship between inflation-adjusted housing wealth and consumer spending and obtain statistically significant and economically intuitive results. Household consumption responds positively and swiftly to changes in real house prices and gross disposable income as expected. Using the estimated coefficients, we can deduce that the average quarter-on-quarter decline of -1.96 percent in real house prices in the first quarter of 2023 in Europe could dampen consumer spending by about -0.51 percentage points in real terms on a cumulative basis over a horizon of eight quarters.
December 8, 2023
How Far Has Globalization Gone? A Tale of Two Regions
Description: We study the evolution of trade globalization in a set of countries in Latin America (mostly the largest ones) and Asia over the past 25 years. Relying on structural gravity models, we first estimate a proxy of trade globalization that captures the ease of trading internationally with respect to trading domestically. Results indicate that the evolution of trade globalization since the mid-1990s has been similar between the two regions, but very heterogeneous within them. Trade globalization has been particularly strong in agriculture, mining and manufacturing, but has lagged in services. The paper also documents that trade globalization has been particularly strong in agriculture, mining and manufacturing, but it lagged in services. Within region heterogeneity is associated to a set of trade policy instruments, including tariffs, non-tariff measures, WTO membership. and trade agreements. Next, we quantify the economic implications of the estimated globalization trends. Simulations of a multi-sector trade model point to heterogeneous long-term impacts of globalization on GDP—some countries exhibiting substantial gains and others experiencing large losses—, with no single sector playing a preponderant role.
December 8, 2023
Optimal Taxation of Inflation
Description: When inflation originates from distributional conflicts, shifts in inflation expectations, or energy price shocks, monetary policy (MP) is a costly stabilization instrument. We show that a tax on inflation policy (TIP), which would require firms to pay a tax proportional to the increase in their prices, would effectively correct externalities in firms’ pricing decisions, tackle excessive inflation and reduce output volatility, without exacerbating price distortions. While proposals from the 1970s saw TIP as a substitute to MP, we find that it is a complement, with TIP addressing markups and inflation expectation shocks, and MP addressing demand shocks.
December 8, 2023
Climate and Cross-Border Migration
Description: Our work is positioned at the intersection of migration and climate change—two key forces shaping the economic outlook of many countries. The analysis explores: (i) the relative importance of origincountry vs destination-country factors in explaining migration patterns; (ii) importance of climate disasters as driver of cross-border migration; and (iii) the importance of climate-driven migration on the overall impact of climate on macroeconomic outcomes. It arrives at the following main findings. First, both origin-country and destination-country contribute to explaining migration outflows from EMDEs, although only the global shocks seem important for advanced economies. Second, climate disasters are important for explaining the origincountry migration shocks in LICs and EMDEs, are especially relevant for smaller countries, and lead to migration of both genders, albeit relatively more for males out of LICs. Third, important portion of climate’s overall impact on economic outcomes—especially agricultural GDP, remittances, and inequality—is captured via climate-driven migration. Finally, higher investment in climate-resilient infrastructure can reduce the impact of climate on cross-border migration, and thereby, result in potentially important economic gains.
December 6, 2023
Macro-Financial Impacts of Foreign Digital Money
Description: We develop a two-country New Keynesian model with endogenous currency substitution and financial frictions to examine the impact on a small developing economy of a stablecoin issued in a large foreign economy. The stablecoin provides households in the domestic economy with liquidity services and an additional hedge against domestic inflation. Its introduction amplifies currency substitution, reducing bank intermediation and weakening monetary policy transmission, worsening the impacts of recessionary shocks and increasing banking sector stress. Capital controls raise stablecoin adoption as a means of circumvention, increasing exposure to spillovers from foreign shocks. Unlike a domestic CBDC, a ban on stablecoin payments can alleviate these effects.
December 1, 2023
Navigating the Well-Being Effects of Monetary Policy: Evidence from the Euro Area
Description: Central banks have recently adjusted their communication strategies to enhance engagement with the general public, yet there is limited understanding of public sentiment regarding monetary policy announcements. This paper investigates whether monetary policy announcements influence household (subjective) well-being in Germany over the period 2002-2018 and finds that tightening surprises reduce life satisfaction. Notably, the impact of a one standard deviation monetary policy shock on well-being is equivalent to a 4% decline in household income. This effect is particularly pronounced among middle-aged individuals and those belonging to the middle-class.
December 1, 2023
Housing Affordability: A New Dataset
Description: The rapid increase in house prices in the past few years, including during the COVID-19 pandemic, raises concerns about housing affordability. The price-to-income ratio is a widely-used indicator of affordability, but does not take into account important factors such as the cost of financing. The aim of this paper is to construct a measure of housing affordability that takes these factors into account for a large set of countries and long period of time. The resulting dataset covers an unbalanced panel of 40 countries over the period from 1970Q1 to 2021Q4. For each country, the index measures the extent to which a median-income household can qualify for a mortgage loan to purchase an average-priced home. To gauge the performance of the constructed indices, we compare them to other readily-available mesures of affordability and examine the evolution of the indices over time to understand the relevant drivers, including in a regression analysis to assess the extent to which government housing programs could contribute to improving affordability.
December 1, 2023
Climate Change Mitigation and Policy Spillovers in the EU’s Immediate Neighborhood
Description: EU’s neighborhood countries (EUN) have lagged the EU on emissions mitigation; coal-heavy power generation and industrial sectors are a key factor. They have also trailed EU countries in emissions mitigation policies since 2000, with little use of market-based instruments, and they still have substantial fossil fuel subsidies. Increasingly stringent EU mitigation policies are asociated with lower emissions in EUN. Overall output effects of the CBAM, in its current form, would be limited, though exports and emissions-intensive industries could be heavily impacted. A unilaterally adopted economywide carbon tax of $75 per ton would significantly lower emissions by 2030, with minimal consequences for output or household welfare, though a safety net for the affected workers may be necessary. To become competitive today by attracting green FDI and technology, overcoming infrastructure constraints and integrating into EU’s supply chains, EUN countries would be well served to front load decarbonization, rather than postpone it for later.
November 30, 2023
Geoeconomic Fragmentation: What’s at Stake for the EU
Description: Geoeconomic fragmentation (GEF) is becoming entrenched worldwide, and the European Union (EU) is not immune to its effects. This paper takes stock of GEF policies impinging on—and adopted by—the EU and considers how exposed the EU is through trade, financial and technological channels. Motivated by current policies adopted by other countries, the paper then simulates how various measures—raising costs of trade and technology transfer and fossil fuel prices, and imposition of sectoral subsidies—would affect the EU economy. Due to its high-degree of openness, the EU is found to be exposed to GEF through multiple channels, with simulated losses that differ significantly across scenarios. From a welfare perspective, this suggests the need for a cautious approach to GEF policies. The EU’s best defence against GEF is to strengthen the Single Market while advocating for a multilateral rules-based trading system.