Date of Degree

6-2020

Document Type

Dissertation

Degree Name

Ph.D.

Program

Economics

Advisor

Sangeeta Pratap

Committee Members

Wim Vijverberg

Lilia Maliar

Julen Esteban-Pretel

Subject Categories

Econometrics | Economics | Growth and Development | Macroeconomics

Keywords

Macroeconomics, emerging markets, informality, news shocks, capital controls

Abstract

Chapter 1. Law enforcement and the size of the informal sector.

I assemble new cross-country evidence showing that contrary to the standard view, the relationship between the size of the informal sector and tax rates is, at best, ambiguous. Law enforcement and informality also show no clear relation. Motivated by these findings, I augment a standard two-sector (formal and informal) small open economy model with endogenous law enforcement that depends on the size of the informal sector (measured by its assets) and government expenditure. I use a micro-dataset from Colombia to show that both taxes and law enforcement are necessary to match the the size of the informal sector observed in the data. In the absence of law enforcement, tax evasion incentives imply a counterfactually large informal sector. However, law enforcement motivates households to reduce the supply of capital to the informal sector, hence decreasing the probability of detection. The dependence of the latter on government expenditure creates a non-linearity between tax rates and the size of the informal sector through a Laffer curve. The model implies that lowering tax rates would not necessarily reduce the size of the informal sector since there is a trade-off with the capability of law enforcement.

Chapter 2. New shocks across countries: An empirical investigation.

We estimate the role of news shocks to total factor productivity, foreign interest rates and commodity terms of trade in explaining the variance of output and other macro aggregates in a large sample of countries. To correct for the small-sample bias of the variance decomposition estimates we develop a Bootstrap-after-Bootstrap method. We find that the mean difference of variance share of output explained by news shocks between developing and developed countries is: I) Negligible for news shocks to total factor productivity. II) Positive for news shocks to foreign interest rates (6 p.p) and to commodity terms of trade (8.3 p.p). Using cross-sectional data, we find that countries with less financial development have a larger share of output variance explained by news shocks to foreign interest rates, and countries with higher total trade of commodities to output ratio and less developed financial markets exhibit a larger share of output variance explained by news shocks to commodity terms of trade. These results suggest that to study the role of news shocks in the economy, one-sector models with only shocks to total factor productivity are not adequate, and that there must be a structural distinction regarding financial markets' development when modeling developing countries as opposed to developed in a general equilibrium framework.

Chapter 3. Financial participation, hedging, and news shocks.

Recent empirical findings show that news shocks to foreign interest rates and commodities' terms of trade, explain a larger share of variance of both output and consumption in developing countries than in developed. I build a two-sector (final goods and commodities) small open economy model with financially excluded households, and hedging against commodity price risk. Due to consumption-smoothing motives, a higher share of financially included households leads to a lower share of variance in output and consumption explained by news shocks to foreign interest rates. Likewise, due to the transmission channel via demand for inputs, a larger share of commodity exports that can be hedged leads to a lower share of variance in output and consumption explained by news shocks to commodity prices.

Chapter 4. Sticky Capital Controls.

There is much ongoing debate on the merits of capital controls as effective policy instruments. The differing perspectives are due in part to a lack of empirical studies that look at the intensive margin of controls, which in turn has prevented a quantitative assessment of optimal capital control models against the data. We contribute to this debate by addressing both positive and normative features of capital controls. On the positive side, we build a new dataset using textual analysis, from which we document a set of stylized facts of capital controls along their intensive and extensive margins for 21 emerging markets. We document that capital controls are "sticky"; that is, changes to capital controls do not occur frequently, and when they do, they remain in place for a long time. Overall, they have not been used systematically across countries or time, and there has been considerable heterogeneity across countries in terms of the intensity with which they have been used. On the normative side, we extend a model of capital controls relying on pecuniary externalities augmented by inclusion of an (S, s) cost of implementing such policies. We illustrate how this friction goes a long way toward bringing the model closer to the data. When the extended model is calibrated for each of the countries in the new dataset, we find that the size of these (S, s) costs is large, thus substantially reducing the welfare-enhancing effects of capital controls compared with the frictionless Ramsey benchmark. We conclude with a discussion of the structural interpretations of such (S, s) costs, which calls for a richer set of policy constraints when considering the use of capital controls in models of pecuniary externalities.

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