Working papers from the Federal Reserve Bank of Dallas are preliminary drafts circulated for professional comment.

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2002 Working Papers

0206
Measurement Bias in The HICP: What Do We Know and What Do We Need to Know?
Mark A. Wynne and Diego Rodriguez-Palenzuela
Abstract: The Harmonized Index of Consumer Prices (HICP) is the primary measure of inflation in the euro area, and plays a central role in the policy deliberations of the European Central Bank (ECB). The ECB defines its Treaty mandate of price stability as ".a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2 percent [.] to be maintained over the medium term." Among the rationales given for defining price stability as prevailing at some positive measured inflation rate is the possibility that the HICP as published incorporates measurement errors of one sort or another that may cause it to systematically overstate the true rate of inflation in the euro area. This paper reviews what currently is known about the scope of measurement error in the HICP. We conclude that given the vague conceptual framework of the HICP, the scant research on price measurement issues in the EU and the ongoing improvements in the HICP, there is very little scientific basis at this time for a point (or even an interval) estimate of a positive bias in the HICP.

0205
A First Assessment of Some Measures of Core Inflation for the Euro Area
Juan-Luis Vega and Mark A. Wynne
Abstract: Core inflation plays an important role in the deliberations of monetary policymakers. In this paper we evaluate a number of measures of core inflation constructed using euro area data. In addition to the traditional exclusion-type core measures, we examine two newer ones, documenting their properties and evaluating their performance in terms of their ability to track underlying or trend inflation in real time. We focus on core measures derived from the Harmonized Index of Consumer Prices (HICP) as the European Central Bank has chosen to define its mandate for price stability in terms of this index, and because this is the only index of consumer prices that is compiled in an comparable manner across all members of the European Union. We document significant excess kurtosis in the cross-section distribution of price changes in the euro area, and show that several categories of prices are more volatile than those typically excluded from traditional measures of core inflation. Contrary to what one might expect, traditional measures of core inflation are not significantly less volatile than headline measures. We document the superior performance of alternative measures of core inflation in tracking trend inflation on average, but show that none of the various measures of core gave significant advance warning of the pickup in trend inflation at the beginning of 1999.

0204
Argentina's Recovery and "Excess" Capital Shallowing of the 1990s
Center for Latin American Economics Working Paper 0102
Finn E. Kydland and Carlos E. J. M. Zarazaga
Abstract: The paper examines Argentina’s economic expansion in the 1990s through the lens of a parsimonious neoclassical growth model. The main finding is that investment remained considerably weaker than what the model would have predicted. The resulting excessive "capital shallowing" could be identified as a weakness of the rapid economic growth of the 1990s that may have played a role in Argentina’s ultimate inability to escape the crisis that started to unfold towards the end of that decade.

0203
How Much Does International Trade Affect Business Cycle Synchronization?
William C. Gruben, Jahyeong Koo and Eric Millis
Abstract: In a recent article, Jeffrey Frankel and Andrew Rose (1998) examine the hypothesis that greater trade flows between two countries cause greater synchronicity between their business cycles. The increase in business cycle synchronicity may be seen as rationalizing a common monetary policy and, so, a shared currency. Arguing that product specialization would lower the synchronicity of business cycles, Frankel and Rose posit that a regression of output correlation on overall trade will indicate whether (positive) common demand shocks and productivity spillovers dominate or (negative) specialization effects do. The authors apply instrumental variables to confirm a causal relationship. In this paper, we refine the estimation in two ways. First, we test for instrument validity and find that the confirming null hypothesis is rejected in most cases. We find evidence to suggest that the instrumental variables method applied is inappropriate and results in inflated coefficients. We develop and apply an alternative OLS-based estimation procedure. Second, we add structure-of-trade variables to the model to separate the effects of intra- and inter-industry trade flows. Although our results suggest that the Frankel and Rose model overestimates the effect of trade on business cycle correlation, the overall results of our model are consistent with theirs. With our own model estimation, we find that specialization generally does not significantly asynchronize business cycles between two countries.

0202
State and Local Policy, Factor Markets and Regional Growth
Stephen P.A. Brown, Kathy J. Hayes and Lori L. Taylor
Abstract: A large and growing literature to explain how state and local policies affect factor markets, firm location and economic growth has developed in three distinct threads. These threads have variously emphasized how policy and natural amenities affect regional economic growth or firm location; how variations in policy and natural amenities can lead to persistent wage differentials across regions; and how regional variation in factor inputs, including public capital, affects output. In this article, we expand the modeling framework of Roback and Gyourko and Tracy to integrate these threads into a single inquiry about how state and local policies—including the provision public capital—affects factor markets and economic growth. Using the model as the basis for estimation, we find that state and local policies have a more profound influence on the private capital-to-labor ratio in a region than on private output. Furthermore, the evidence suggests that the growth of government—either in the form of services or public capital—discourages private sector growth.

Coyote Crossings: The Role of Smugglers in Illegal Immigration and Border Enforcement
Mark G. Guzman, Joseph H. Haslag and Pia M. Orrenius
Abstract: Illegal immigration and border enforcement in the United States have increased concomitantly for over thirty years. One interpretation is that U.S. border policies have been ineffective. We offer an alternative view, extending the current immigration-enforcement literature by incorporating both the practice of people smuggling and a role for nonwage income into a two-country, dynamic general equilibrium model. We state conditions under which two steady state equilibria exist: one with a low level of capital and high amount of illegal immigration and the other with a high level of capital, but relatively little migration. We then analyze two shocks: a positive technology shock to smuggling services and an increase in border enforcement. In the low-capital steady state, the capital-labor ratio declines with technological progress in smuggling, while illegal immigration increases. In the high-capital steady state, a technology shock causes the capital-labor ratio to rise while the effect on migration is indeterminate. We show that an increase in border enforcement is qualitatively equivalent to a negative technology shock to smuggling. Finally, we show that a developed country would never chose small levels of border enforcement over an open border. Moreover, a high level of border enforcement is optimal only if it significantly decreases capital accumulation. In addition we provide conditions under which an increase in smuggler technology will lead to a decline in the optimal level of enforcement.

2002 Center for Latin American Economics Working Papers

0102 (Economic Research Working Paper 0204)
Argentina's Recovery and "Excess" Capital Shallowing of the 1990s
Finn E. Kydland and Carlos E. J. M. Zarazaga
Abstract: The paper examines Argentina’s economic expansion in the 1990s through the lens of a parsimonious neoclassical growth model. The main finding is that investment remained considerably weaker than what the model would have predicted. The resulting excessive "capital shallowing" could be identified as a weakness of the rapid economic growth of the 1990s that may have played a role in Argentina’s ultimate inability to escape the crisis that started to unfold towards the end of that decade.