Inflation Expectations and Forward Guidance

Economics master project by Marc de la Barrera, Juraj Falath, Dorian Henricot and Jean-Alexandre Vaglio (Class of 2017)

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2017. The project is a required component of every master program.


Authors:

Marc de la Barrera, Juraj Falath, Dorian Henricot and Jean-Alexandre Vaglio

Master’s Program:

Economics

Paper Abstract:

Our paper empirically investigates the impact of forward guidance announcements on inflation expectations in the Eurozone. The ECB first resorted to forward guidance on July 4, 2013 thereby expanding its array of unconventional policy instruments in the vicinity of the zero-lower bound. We use an ARCH model and identify forward guidance shocks as changes in the 2-year nominal ECB yield on specific announcement days to measure changes in daily inflation swaps of different maturities. In the process, we also separately identify the effect of quantitative easing and interest rate change announcement shocks. We find that forward guidance was successful in reviving inflation expectations in the medium to long term. Analyzing the transmission channels of forward guidance, we find evidence that both a reanchoring channel and a portfolio effect might have been at play.

chart
Sources: authors’ calculations and Thomson Reuters Datastream

Conclusions:

Forward guidance shocks have a strong impact on inflation expectations with a one point decrease in 2-year nominal ECB yields pushing inflation expectations 37bps upwards five years ahead with high significance. Normalizing, a negative shock of one standard deviation in ECB yields had a 11bps positive impact. In Campbell’s terminology (Campbell et al. (2012)), market participants’ interpretation was Odyssean. Thereby, we broadly match the results found by Hubert & Labondance (2016) for the Eurozone. Since the impact persists at all horizons, albeit with decreasing amplitude, we suggest that a reanchoring channel à la Andrade et al. (2015) explains the bulk of the transmission. ECB forward guidance announcements have thus been effective in reducing the growing gap between agents’ beliefs in future monetary policy and ECB’s targets. Our results are also consistent with a portfolio effect à la Hanson & Stein (2015). We also document that QE announcements were more effective in amplitude than forward guidance announcements, probably through a reduction in the term premium.

In contrast, studies run by Nakamura & Steinsson (2013) or Campbell et al. (2012) suggested a larger Delphic channel was at play in the US. More precisely however, they found that their results were lower than those predicted by a New Keynesian model with sticky prices. Thus, a natural extension of this paper would be to explore how our results would compare to the predictions of a New Keynesian model. Another approach would be to build a counter-factual for inflation expectations in the absence of forward guidance. In any case, given that the ECB implemented forward guidance at a time of heightened uncertainty and while long-term inflation expectations were dropping, there are reasons to believe it could have been more efficient in the Eurozone than in the US.

On the theoretical side, it is important to understand the transmission mechanisms of forward guidance within a structural model. This would allow to understand the potential gap to empirical outcomes. A number of authors have already striven to embed forward guidance within New Keynesian models and it is still an active area of research. The objective is then to derive an optimal policy function for further times of monetary policy management under the ZLB constraint.

To complete the policy recommendation, one needs to weigh out the benefits of forward guidance against its undesirable side-effects. Poloz (2014) suggested that successful forward guidance could results in increased future volatility when restoring conventional communication. Campbell et al. (2012) highlighted that central bank commitment could have a cost in terms of inflation or credibility. It would then be interesting to assess the negative externalities of forward guidance.

References:

Andrade, P., Breckenfelder, J., De Fiore, F., Karadi, P. & Tristani, O. (2015), ‘The ECB’s asset purchase programme: an early assessment’, ECB Working Paper (1956).

Campbell, J., Evans, C., Fisher, J. & Justiniano, A. (2012), ‘Macroeconomic Effects of Federal Reserve Forward Guidance’, Brookings Papers on Economic Activity 43(1), 1–80.

Hanson, S. & Stein, J. (2015), ‘Monetary policy and long-term real rates’, Journal of Financial Economics 115(3), 429–448.

Hubert, P. & Labondance, F. (2016), ‘The effect of ECB Forward Guidance on Policy Expectations’, Sciences Po publications (30).

Nakamura, E. & Steinsson, J. (2013), ‘High frequency identification of monetary non-neutrality: The information effect’, NBER Working Paper (w19260).

Poloz, S. (2014), ‘Integrating uncertainty and monetary policy-making: A practitioner’s perspective’, Bank of Canada Discussion Paper (2014-6).

Modeling IPP Capital and its Effect on the Labor Share

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2017. The project is a required component of every master program.


Authors:

Alfredo Andonie, Andrea Greppi, Ece Yagman, Lorenzo Pisati and Moritz Degler

Master’s Program:

Economics

Paper Abstract:

We investigate the effects of intellectual property products capital in the evolution of the labor share for five European countries. Using post-revision national accounts data, we construct a benchmark labor share with the contribution of both, traditional and IPP capital, against which we measure a counterfactual LS which isolates the effects of IPP. We report that the labor share in Austria, France, Germany, and Spain has been consistently declining, with high variation across countries. Our results show that part of this decline is explained by the inclusion and growing importance of IPP capital in the economy. A closer look at France reveals that the main channels through which IPP has an impact on the labor share are a higher depreciation rate and investment flow relative to traditional capital.

Conclusions:

Our analysis of IPP capital and its impact on the LS reveals three main findings. First, we observe a decline in the LS of Austria, France, Germany and Spain, part of which is explained by the impact of IPP capital on aggregate income. Second, a cross-country comparison discloses great variation in both the magnitude at which the LS is falling in these countries and the extent up to which IPP capital can account for such a decline. Finally, a deeper analysis for France, in which we study the dynamics and composition of its aggregate capital, allows us to identify the higher depreciation rate and investment flow of IPP capital as the main channels driving the change in the trend of the LS.

We conclude that, to an extent, the behavior of the LS attests to the transition into more IPP capital-intensive economies. Since the inclusion of intangible capital in the revised European national accounts (ESA 2010), the growing importance of IPP relative to traditional capital has altered essential properties of aggregate capital, such as the depreciation rate. In particular, these changes have translated into new dynamics and ways in which factors are allocated in the economy.

In using revised data, our analysis presents novel evidence for LS dynamics in Europe and its relation with the composition of capital in the economy. From a measurement point of view, it highlights the way in which we have begun to think differently of developments and aggregate indicators. From a theoretical point of view, it compels us to reformulate models that can accommodate these new measurements and their implications for the rest of the economy.

As a final remark, we have not attempted to establish a connection between the LS and inequality. However, the relation between the compensation to labor and the concentration of IPP capital poses interesting challenges for future research. Particularly relevant to this study are the potential ways in which a decline in the LS propelled by an increase in IPP capital maps onto the evolution of inequality.

Partial Adjustment in Policy Functions of Structural Models of Capital Structure

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2017. The project is a required component of every master program.


Authors:

Mattia Bongini

Master’s Program:

Finance

Paper Abstract:

We present a tradeoff model of capital structure to investigate the sources of adjustment costs and study how firms’ financing decisions determine partial adjustment toward target leverage ratios. The presence of market imperfections, like taxes and collateral constraints, is shown to play a decisive role in the behavior of the policy function of capital and leverage. By means of a contraction argument, we are able to show the existence of a target leverage towards which optimal leverage converges with a speed of adjustment that depends on a firm marginal productivity of capital. Our predictions are consistent with the empirical literature regarding both the magnitude of the speed of adjustment and the relationship between leverage ratios and the business cycle.

Conclusions:

In this work we showed how financial and economic frictions are able to generate a partial adjustment dynamics in leverage policy functions. In the model we studied, the key factors of this phenomenon are collateral constraints (which strike a balance between tax benefits of debt and distress costs) and firm productivity of capital. The latter, in particular, determines the speed of adjustment towards the (state-dependent) target leverage ratio.

Our model fits well several stylized facts of leverage dynamics established by the empirical literature: an example is given by the magnitude of the speed of adjustment, which falls into the confidence intervals estimated by several authors. Another one, is the countercyclical behavior of leverage dynamics with respect to the business cycle, which is due to the fact that in recessions it is easier for the collateral constraint to be binding.

Future work should first address the translation of the hypotheses of Theorem 5.4 on the Lagrange multiplier into assumptions on the components of the model (the production function and the various market frictions). The next step would then be to extend the model to a full general equilibrium model to study thoroughly the effects of preference and monetary shocks on leverage dynamics. Pairing consumers’ utility maximization with firms’ financing problem would also allow to study the interaction between expected returns and partial adjustment: in such framework, the collateral constraint should probably be replaced by several credit rating inequalities determining both firm specific discount rates and target leverage ratios.

Gravity in Bank Lending within the European Union

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2017. The project is a required component of every master program.


Authors:

Saga Gudmundsdottir, Olafur Heidar Helgason, Moritz Leitner, Clíona McDonnell and Alexander Schramm

Master’s Program:

Master in Economics and Finance

Paper Abstract:

This paper investigates whether and how geographical distance matters for bank lending within and between countries in the European Union. We estimate gravity-type regressions in various specifications, incorporating novel econometric insights which have thus far not been applied in the context of bank lending. Using recently published, disaggregated data on banks’ credit exposures from the European Banking Authority, we find the elasticity of lending with respect to distance to be -1.42 in our main specification. Controlling for various factors, the negative relationship remains persistent. We argue that this relationship is largely attributable to information costs, though cultural and historical ties between countries, capital requirements, local competition and cross-border trade also play a role. The analysis highlights the enduring influence of factors which prevent full European financial integration.

Conclusions:

The broad narrative that emerges from our analysis is that a combination of deeply-entrenched and policy-based factors determine international bank lending. Firstly, issues that have historically either hindered or facilitated lending – the prohibiting effect of distance in gathering information about potential or current borrowers, and the ties between societies brought about by cultural closeness, trade or direct investment – remain significant predictors of banks’ current stocks of outstanding loans within the EU. Secondly, some of the issues that have recently been under close scrutiny by European policymakers – capital requirements and market competition – also impact lending decisions.
Our analysis has important implications. Although we have not tested directly for the current state of financial integration in the banking sector in the EU, our results imply that a borderless single market for bank loans has not yet been achieved. Despite the progression of financial market integration across the EU, distance continues to be a deterrent to international bank lending on the European level. While some of the underlying mechanisms, particularly cultural and historical ties, are difficult to address politically, others provide scope for intervention by policymakers seeking to further progress the European integration project.

Although technological advancements may have improved transparency and eased the procurement of information and communication between bank and client, it seems they have not yet eliminated information costs in banking. There is room for new technologies that would further reduce the cost of verifying and monitoring clients to allow banks to underwrite more loans internationally. Although it is beyond the scope of this paper to provide a normative analysis of optimal EU policy, we have shown that both government ownership of competing banks and differences in national capital requirements act as deterrents to lending. The key areas we have identified could be targeted to advance the goal of further financial integration in bank lending across the EU.

 

Estimating Stochastic Volatility: The Rough Side to Equity Returns

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2017. The project is a required component of every master program.


Authors:

Lukas Grimm, Jonathan Haynes and Daniel Schmitt

Master’s Program:

Finance

Paper Abstract:

This Project evaluates the forecasting performance of a Brownian Semi-Stationary (BSS) process in modelling the volatility of 21 equity indices. We implement a sophisticated Hybrid Scheme to simulate BSS processes with high efficiency and precision. These simulations are useful to price derivatives, accounting for rough volatility. Then we calibrate the BSS parameters for the realised kernel of 21 equity indices, using data from the Oxford-Man Institute. We conduct one- and ten-step ahead forecasts on six indices and find that the BSS outperforms our benchmarks, including a Log-HAR specification, in the majority of cases.

Conclusions:

This project confirms the findings of Gatheral et al. (2014) and Bennedsen et al. (2016) that volatility is indeed both rough and persistent across a wide range of equity indices. We have explored the advantage of using a Brownian Semi-Stationary (BSS) process to model volatility enabling the user to calibrate both stylised facts in contrast to previous generations of fractal processes, like Fractional Brownian Motion. We have successfully implemented simulation methods so that a BSS process can be incorporated within a continuous time asset pricing equation to price options and other exotic derivatives. We then calibrated the parameters for the BSS model using the realised kernel of 21 equity indices. Our parameter estimates confirm the expected roughness and persistence in the series. The parameter for roughness, α, was quite stable across the cross-section of indices, but fluctuated over time. α averaged -0.37 and ranged from −0.33 to −0.42, implying much more roughness than the α = 0 implied by Standard Brownian Motion. Estimates of the long memory parameter, λ, were less stable, ranging from 0.0041 to 0.0230. We identify an issue when using MoM estimation that suggests MoM may be sub-optimal for BSS-Gamma forecasting. We forecast with six indices that cover a broad geographical spread and have stable lambda estimates. For the one-step ahead forecast we find that the BSS model outperformed two of our three benchmarks consistently under both MSE and QL loss functions. The BSS beat the Log-HAR benchmark in the case of the index with the longest memory, while it was slightly worse for the other five indices. For the ten-step ahead forecast, under the MSE loss function, the BSS model outperformed all benchmarks consistently for five out of six indices. Under the QL loss function the BSS outperforms all benchmarks, and this outperformance is always statistically significant.
Areas for further research would include investigating the forecasting accuracy of the BSS Power Kernel using a wider range of asset class, such as commodities, real estate funds and foreign exchange rates. Further robustness checks could test the performance of BSS against the family of fractional volatility models. It would also be interesting to further explore the relationship of ξ and its link with the variance swap curve.

 

The full version of this Master Project can be found here

 

 

Gender Differentials in Returns to Education in Developing Countries

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2017. The project is a required component of every master program.


Authors:

Ignatius Barnardt, Golschan Khun Jush, Thies Wollesen, Samuel Hayden and Eva Sotosek

Master’s Program:

Economics and Finance

Paper Abstract:

We investigate a possible gender gap in returns to education using data from the World Bank’ STEP program for seven developing and emerging countries. We control for cognitive skills, non-cognitive skills and parental education – previously unobserved due to unavailability of data – to investigate how this heterogeneity is playing a role in estimating the gender differential in educational returns. We also model selection using the Heckman two-step estimation procedure to examine whether selection may be driving this phenomenon. Our findings suggest that gender gaps in returns to education are not as prominent in the countries in our sample as previously suggested. We also find that controlling for unobserved heterogeneity on the one hand, and selection on the other, has different effects in different countries, highlighting the importance of understanding individual countries’ labour markets in detail before drawing conclusions regarding the existence of a gender gap in returns to education.

Conclusions:

This paper explores gender gaps in returns to education for seven developing and emerging countries. First, we investigate the existence of such a gap in a standard Mincerian framework. We find a significant returns gap in only two countries, namely Ukraine and Ghana, while the estimates for the other countries are centred relatively tightly around statistically insignificant point estimates close to zero. Using quantile regressions to dig deeper does not materially affect our findings, although it does allow us to specify that the returns gaps estimated for Ghana and Ukraine are significant at two out of three quartiles of the wage distribution, and that in Vietnam there is a small but significant returns gap at the upper two quartiles of the distribution. These findings are important in providing context for the existing literature, showing that returns premiums in favour of females are not universally prevalent in developing countries for urban wage workers. This suggests that where large, significant returns gaps have been found in the literature, this seems to be driven to a large extent by other segments of the labour market.

Second, we use our novel dataset to analyse the extent to which controlling for previously unobserved heterogeneity, namely cognitive skills, personality traits and family background, affect OLS estimates of the returns gap. We find that controlling for these STEP variables does not materially affect our baseline estimates for Bolivia, Colombia, Georgia, Kenya and Vietnam (where the estimated gap remains insignificant and close to zero), or for Ukraine, where the estimated gap is of similar magnitude and remains significant. Only in Ghana we find that adding the STEP controls has a material effect, reducing the point estimate of the gap substantially and rendering it insignificant. The results of the quantile regressions qualify this finding somewhat, showing that controlling for the STEP variables does make a difference for estimates of the gap at certain quantiles of the distribution in Ukraine and Vietnam. Overall, our finding regarding the importance of these sources of previously unobserved heterogeneity is cautiously negative: although they do appear to make a small difference for the level estimates and have an important effect in Ghana, they do not appear to be universal sources of endogeneity in estimating the returns gap for urban wage workers.

Third, we examine the importance of controlling for selection in estimating the returns differential using the Heckman two-step procedure, dropping Kenya from our sample due to missing data. Here we find that after controlling for selection, our point estimates of the returns gap remain insignificant in Ghana, Georgia and Vietnam, albeit with a relatively high point estimate in Georgia. Similarly, our estimate of the returns gap in Ukraine does not change considerably and remains significant. In contrast, we obtain higher and significant point estimates of the returns gap in Bolivia and Colombia. As explained above, this somewhat counterintuitive result is due to positive selection of females into employment in Bolivia and Colombia, and the positive relationship between education levels and probability of employment. Interestingly, in the two countries where selection appears to be important, we found earlier that controlling for the STEP variables did not have an observable effect. Our findings therefore suggest that it is likely to be important to control for selection when estimating returns gaps in developing countries, even if only to exclude the possibility of selection bias. In addition, our approach suggests that selection is likely to operate through channels other than cognitive or non-cognitive abilities, or parental background.

Taken together, our findings show that, at least for urban wage workers in the countries in our sample, a returns premium for females may not be as prevalent as previously suggested. We also find that controlling for potential sources of endogeneity, such as unobserved heterogeneity and selection, substantially changes the estimates of the gender returns gap in three out of seven of the countries in our sample. This highlights the importance of considering these channels to avoid the risk of biased estimation. This paper therefore represents a starting point for more detailed research, which could zoom in on the existence and drivers of returns differentials in individual countries, and overcome some of the limitations of this paper by extending it to rural areas and using samples with a larger number of clusters. These findings are also relevant to policy makers, since they demonstrate the importance of understanding the characteristics and dynamics of each country’s individual labour market prior to making policy proposals.

Vaccine-preventable Childhood Disease and Adult Human Capital: Evidence from the 1967 Measles Eradication Campaign in the United States

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program.


Authors:
Philipp Barteska, Sonja Dobkowitz, Maarit Olkkola, Michael Rieser, Pengfei Zhao

Master’s Program:

Economics

Abstract:

Measles is currently one of the leading causes of death for young children worldwide. We analyze the impact of measles prevention on later-life human capital outcomes by taking advantage of a measles eradication campaign implemented in 1967 in the United States. We provide evidence with a difference-in-differences design from the 2000 US census micro-sample for the following statistically significant results: the campaign increased completed years of schooling by two weeks, the probability of completing high school by 0.32 per cent and decreased the probability of being unemployed by 4.26 per cent. Due to the exogenous timing of the eradication campaign, we argue that these results can be interpreted causally. To the best of our knowledge our paper is the first one to document adult human capital impacts of early-life measles exposure using a natural experiment.

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Figure 1: Yearly Cases of Measles in the United States

Empirical strategy:

The 1967 measles eradication campaign led to an unprecedented drop in reported measles exposure in the US, as depicted in figure 1.

Our empirical strategy uses the fact that there is variation in measles exposure between states prior to the eradication campaign: the decrease in incidence is highest in those states with the highest incidence rates, as depicted in the first stage relationship in figure 2. This allows for a difference-in-differences design, exploring whether the states that had higher prior exposure to the disease gained more in human capital outcomes than the states with less exposure, controlling for pre-existing state-level linear time trends and state fixed-effects among other controls.

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Figure 2: Decline 1966-1970

We also perform placebo interventions to test the robustness of our results. As depicted in figure 3, the only positive and statistically significant impacts are found for 1967, the actual intervention year. This lends more support to the causal interpretation of our results.

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Figure 3: Placebo Interventions Around Cutoff

Conclusion:

In this paper we show suggestive evidence that exposure to a previously common childhood disease can have negative impacts on educational attainment in adulthood, although the effect sizes are not large. This finding strengthens the literature on the early-life origins of human capital.

Our results are for the most part relevant for developing countries, many of which have not yet achieved the vaccination levels required for herd immunity.

Full project available here

Data sources:

IPUMS-USA, University of Minnesota, www.ipums.org.

Project Tycho, University of Pittsburgh, www.tycho.pitt.edu

Aspirations and Academic Achievement: The Spillover Effects of Beca 18 on Educational Outcomes of Younger Students

Elena Costarelli, Rosamaría Dasso Arana, and Bárbara Sparrow Alcázar analyze the effect of being near a Beca 18 beneficiary -a new scholarship program for high school students- on the academic achievement of second grade children.

Beca 18 Peru

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program. Photo: PRONABEC


Authors:
Elena CostarelliRosamaría Dasso Arana, Bárbara Sparrow Alcázar

Master’s Program:
Economics

Abstract:

Using administrative data from the Ministry of Education in Peru, we analyze the effect of being near a Beca 18 beneficiary -a new scholarship program for high school students- on the academic achievement of second grade children. Previous literature suggests that information about the potential returns to education plays an important role on students’ achievement. Our hypothesis is that having a fellow nearby might change the perception of younger children and of their parents about returns to education, thus leading them to invest more on it. We use a difference in difference approach to test this hypothesis in a school panel data setting. As we are interested in the effect of information transmission, we use GPS location data to identify which schools are near a Beca 18 beneficiary. We test for several distance specifications with consistent results. Our findings suggest a positive spillover effect of the program on younger children in both reading and math performance.

Introduction:

Access to tertiary education is a well-known motivation for students to perform better at school. Good students are usually the ones that are able to attend better universities which in turn allows them to improve their living conditions. This is true in most developed countries, where access to good quality higher education is a possibility for most students. However, in the case of many developing countries, market failures and government limitations do not allow students to consider this possibility.

When facing the decision of educating their children, many families may consider it to be an unprofitable investment. Little information about the benefits of education in terms of higher future income and the lack of success stories among people close to them may all contribute to this perception. In this regard, the impact of a program that makes access to tertiary education may possibly affect the way people value education in a significant way. If parents and children are aware that been a good student may have a tangible future reward, their investment decisions may change.

Access to tertiary education is greatly limited to children from poor families in Peru. To address this issue, the Peruvian government recently created the Beca 18 program. Beca 18 is a merit/need based scholarship program that targets students applying to higher education institutions such as universities and technical institutes. The program gives selected students the opportunity of attending the best tertiary schools in the country. Before the program existed, even access to public universities was very limited. Beca 18 can be considered as one of the first real opportunities for children of low resources in Peru to access high quality tertiary education.

Current literature suggests that there is a positive relationship between policies that increase the perceived returns of education and educational outcomes among children. There is also evidence that supports that future access to scholarships and merit based programs may encourage better school performance. In this paper, we will analyze the impact of Beca 18 on the school performance of second grade children. To do this, we use test score data from the Ministry of Education and administrative records from the Beca 18 program. Using a difference in difference approach, we were able to identify a positive impact of being near a program beneficiary on both math and reading proficiency outcomes. 

Conclusions:

Our results suggest that the Beca 18 program has relevant spillover effects on the educational outcomes of younger children. Guided by our conceptual framework, we would expect this result to be a consequence of the fact that children and parents exposed to Beca 18 beneficiaries update their information about perceived returns to education, leading them to invest more time and resources in obtaining better educational results.

We also find that effects on math test scores are stronger and more robust to several specifications than effects on reading test scores. This result is consistent with findings of other studies suggesting that math scores are more quickly affected by changes in study behavior. We also find that the effect of being near a beneficiary decreases as the distance to the school of the beneficiary increases. This result is consistent with our hypothesis that the improvements in educational outcomes are a result of information transmission.

Another result worth discussing is that we found that the effect of the program is larger when the number of beneficiaries nearby increases. This suggests that investment decisions are affected by how likely it is to get the scholarship. It may also suggest that the investment decision may vary if there are more people acting as role models.

Overall, our results are relevant from a policy perspective. We present evidence that the program has relevant spillover effects that should be considered when evaluating its benefits. As public programs in Peru are under continuous scrutiny, further evidence that supports the program’s effectiveness is of greatly useful to ensure its continuity. Also, as our results suggest that the number of beneficiaries matter for investment decisions, the expansion of the program could lead to even greater spillover effects.

It is still important to note that the effects found here are not the main intended effects of Beca 18: the scholarship program was designed as a supply side policy intervention. Our findings support the idea that this program can have important demand side effects worth considering. We would also expect for these effects to increase over time: the success stories of current beneficiaries in the labor market could lead to an even greater increase of the expected returns of education.

 

Pulling together or tearing apart? Ethnic heterogeneity, natural shocks and common pool resources in rural Malawi

water

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program.


Authors:
Andrea Bacilieri, Abhijeet Khanna, Irene Pañeda FernandezJonathan Stern

Master’s Program:
Economics

Abstract:

This paper examines how ethnic heterogeneity may affect the ability of Malawian rural households to solve collective action problems. The collective action challenges are natural shocks -floods, droughts, and irregular rain and availability of common pool resources – an irrigation system, a forest, and common pasture land. We measure household welfare through maize harvest and annual consumption. We find that ethnic polarization and fractionalization are unambiguously bad for maize harvest but, under natural shocks, the size of this negative relationship is reduced. This may be due to the way natural shocks cross ethnic lines and facilitate the overcoming of ethnic differences. The bad effects of polarization remain unchanged in the presence of a shock, suggesting that this is a more intransigent problem. With respect to consumption, we find diminishing returns to increased polarization, becoming negative for high levels of polarization. Results are strongest in the presence of a communal forest. This may be due to the repeated and continuous nature of communal forest management, and the way that polarization may facilitate the formation of coherent bargaining factions.

maize

Summary:

In this paper we explore the effects of ethnic fractionalization and polarization in the presence of natural shocks and common pool resources. By greater fractionalization we mean a smaller probability that any two individuals come from the same ethnic group.  Polarization is a related concept which also takes into account the size of the bargaining factions- polarization being highest with two equally sized groups.

Our hypotheses were that ethnic heterogeneity would worsen the impact of shocks, and affect detrimentally the economic benefit derived from common pool resources. We sought to test these hypotheses by constructing a novel dataset for Malawi which combines indices of ethnic fractionalization and polarization calculated at the Territorial Authority level using the 2008 census and the Malawi Integrated Household Panel Survey for the year 2013. We argue for the exogeneity of our heterogeneity indices based on the low level of change in the ethnic makeup of Malawi over the past four years and the low level of migration within the country.

In the first part of our analysis we regress the log of maize harvest on the presence of shocks such as drought,  flood and irregular rain interacted with our ethnic heterogeneity indices and a set of agricultural, climate, household and community controls. We find that ethnic polarization and fractionalization are unambigiously bad for maize harvest. Counter to our expectations, we find that fractionalization appears to lessen the impact of a drought or irregular rain on harvest, although the net effect of increases in fractionalization remains bad for harvests. We posit tentatively that the reduction in the effect of  fractionalization in the presence of a shock could be due to the way natural shocks may cross ethnic lines and facilitate the overcoming of ethnic diff erences. The bad effects of polarization remain unchanged in the presence of a shock, suggesting that this is a more intransigent problem, and potentially a cause of enduring local level conflict.

In the second part of our analysis we regress the log of consumption on the presence of common pool resources such as forests, irrigation systems and common pasture land. We find no signicant relationship between consumption and fractionalization after testing both linear and quadratic specications. For polarization we find a quadratic relationship with consumption, which is strongest in the presence of a communal forest. This suggests that a certain degree of polarization could help communal forest management, with diminishing returns to increased polarization, becoming negative for high levels of polarization. We posit that this may be due to the repeated and continuous nature of communal forest management, and the way that polarization may facilitate the formation of coherent bargaining factions.

Through an exploration of the correlations between our ethnic heterogeneity indices and a set of community characteristics we find that greater  heterogeneity is negatively correlated with school quality and the availability of agricultural inputs. These results cast some doubt on the exogeneity of ethnic heterogeneity. However given that the ethnic indices are slow moving over time, these correlations may also suggest some of the mechanisms by which fractionalization and polarization aff ect economic development in rural Malawi. Further work might seek to explore further these mechanisms, and whether the empirical findings of this paper can be replicated in other countries and contexts.

Download the paper

Price parity in two-sided markets: a new perspective

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program.


Authors:
Sara Del Vecchio, César Ulate

Master’s Program:

Competition and Market Regulation

Paper Abstract:

Online platforms are believed to be beneficial to consumers in a number of ways. They facilitate consumers’ search and comparison, which in turn fosters competition between sellers. They drive the so called long tail effect that increases the variety of products offered, improving the consumer’s ability to find the right match for their needs. Platforms might adopt some particular measures aimed at protecting their profits, and potentially the viability of their business model. In the past few years, many online platforms have been under the scrutiny of various competition authorities regarding a particular clause they include in their contracts with sellers commonly called ’price parity clause’ or more specifically Across Platform Parity Agreement (APPA), this limits the seller’s ability to set lower prices (or better conditions) on other sale channels. At face value, price parity seems like a restriction on sellers’ pricing abilities which benefits consumers, as they can enjoy increased value service at apparently no additional cost.

We build a stylized model and we show that platforms can increase welfare and have pro-competitive effects, while price parity clauses are generally harmful for consumers surplus and welfare, nevertheless they can be good if they are indispensable for the platform viability.

Introduction:

The price parity clause included in platforms’ contracts with sellers, can be categorized as narrow or wide according to the scope of the price limitation. As illustrated in the figure below a ‘narrow APPA’ (the purple rectangular in the figure) refers to a clause where the seller is restricted from charging a lower price on their direct channel. By contrast, a ’wide APPA’ (the orange rectangular in the figure) is when the seller is limited from setting a lower price not only on their own website but also on any other competing platform. This will allow the platform to make claims, such as the ’best price guarantee’ as shown in the figure.

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Narrow & Wide Across-Platform Parity Agreements

Online platforms often argue that they need to include this constraint on seller’s price, otherwise consumers would just free ride on the platform services, and then complete the transaction on the seller’s own website which offers a lower price. At the same time, such clause in the seller-platform contract might generate anticompetitive effects, In particular, they may raise costs for sellers, which in turn are reflected into higher prices for consumers. Sellers pay a fee to intermediaries, which are insulated from competitive pressure due to the price parity clause itself.

Indeed, in the past few years many online intermediaries have been under the scrutiny of various competition authorities regarding APPAs that they were including in their contracts with sellers. There have been several cases across the world related to this clause, starting from the Apple eBook case in 2013, until the recent series of investigations in Europe regarding the online travel agent Booking.com.

In particular, the Booking.com case shows some inconsistencies in the decisions across Europe, in most of the countries (including UK, France, Italy and Sweden), Booking.com settled by agreeing to allow online travel agents, to offer lower room rates via Booking.com’s competitors, by dropping its wide APPA, restoring competition between online travel agencies. The commitments do allow Booking.com to retain its narrow APPA for prices and booking conditions, ensuring hotels offer the same rates and conditions that are provided on their own direct website. In Germany, instead, the Bundeskartellamt decided also to prohibit the narrow APPA. Nevertheless, in France they recently passed a Law (la Loi Macron) whereby they made APPAs illegal per se, with the aim of liberalising the economy and boosting growth. Furthermore, would be desirable more guidance on how to set out the most appropriate theory of harm in order to have convergence at European level in relation to these clauses.

Modeling Approach:

In this paper we build a stylised model with three different types of rational agents: (i) sellers, (ii) platforms and (iii) consumers. They all take sequential decisions in an infinitely repeated game. We include different search costs for consumers depending on the channel used to search and purchase a product. We focus only on pure strategies that lead to a particular Sub-Game Perfect Nash Equilibrium (SPNE) where all agents participate. We compare this SPNE across different scenarios: from the setting where there is a monopoly platforms, to the setting where we have competing platforms. We look at the equilibrium prices and welfare that arise in each of these scenarios with and without narrow and wide APPAs. Finally, we compare it to the counter-factual where no platform operates in the market.

Findings and Conclusion:

In terms of policy approach towards these clauses, our findings are in line with great part of the literature with respect to wide APPAs. Our model suggests that under no condition this clause can have pro-competitive effects, therefore the current European move towards a prohibition seems economically sound and sensible. With regards to narrow APPAs, instead, we believe the current call in many European countries for an outright ban could be detrimental for welfare, as it overlooks the benefits that platforms bring to the market. Indeed, we find that under some conditions these clauses despite limiting competition, do lead to efficiencies that the authorities should take into account.

We conclude that the existence of a platform is in general good, because as a first order effect it increases the number of transactions and reduces search costs for consumers. However, we find that prices will only be lower if there is effective competition between platforms. Furthermore, if the platform is not able to recover its costs though sales, then the viability of the platform may depend on the existence of the APPA. Hence, as shown the narrow APPA decreases welfare unless it is indispensable for the platform to operate.