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Reforms, Exchange Rates and Monetary Commitment: A Panel Analysis for OECD Countries

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Abstract

The paper investigates the link between monetary policy and structural reforms in open economies. We test three hypotheses: (a) the Calmfors hypothesis that the degree of reforms is higher in the case of autonomous policy and lower in the case of commitment, (b) the TINA hypothesis which implies a positive impact of a monetary policy rule on the extent of reforms, and (c) a third factors hypothesis. In our empirical analysis on panel data of 23 OECD countries from 1980–2000 we find little evidence for the Calmfors hypothesis, but evidence in favor of the TINA argument for labor market and regulatory reform.

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Notes

  1. OECD (2005) applies a consistent procedure to derive policy priorities to foster growth across OECD countries and identifies labor market reforms as being particularly important in, e.g., the Euro area. However, this does not at all imply that reforms in other areas are unimportant. Hence, we analyze a variety of different reform measures in the empirical part.

  2. We are grateful to an anonymous referee to point out this problem.

  3. Consistent with the implications of the imperfect competition/bargaining model of Blanchard and Giavazzi (2003), the estimates by Nicoletti and Scarpetta (2005) suggest that restrictive regulations have curbed employment rates significantly in countries where no product market reforms were implemented. These effects appear to have been magnified by the interaction of such regulations with labor market settings that provide a strong bargaining power to insiders, suggesting that rent sharing tends to depress employment. The implication is that significant employment gains can be obtained by deregulating product markets in overly regulated countries. Moreover, these employment gains are likely to be higher in countries that have rigid labor markets.

  4. A possible explanation is that, in the wake of liberalisation, employment is boosted both by the expansion of activity and entry and by a shrinking wage-productivity gap, as insiders lose their leverage on rents. When labor markets are more flexible, employment gains are smaller because they are obtained only through the first channel. This evidence is consistent with recent computable general equilibrium studies showing that the employment effects of deregulation are stronger in centralized bargaining settings than in decentralized ones.

  5. Again, we are grateful to an anonymous referee for this argument.

  6. Since we do not exclude complementarities among reforms ex ante, we see a clear need of controlling the starting institutional conditions in each country—the need for reforms.

  7. Ellis and Thoma (1990) estimate rational partisan theory approaches for open economies. In their study, party-specific inflation rates lead to party specific differences in exchange rate movements.

  8. The 23 OECD economies correspond to the category high-income industrialized countries in the World Development Indicators database (World Bank 2002) and cover Australia, Canada, the former EU-15, Iceland, Japan, New Zealand, Norway, Switzerland and the United States.

  9. We use the chain-weighted EFW index (Gwartney et al. 2003), which corrects for the limited availability of some components over time. Such chain-linked correction is only available for the summary indicator, however. For the sub-areas money and banking system, government size, freedom to trade, market regulation and labor market regulation, we have to rely on uncorrected data instead. Missing data for indicator elements may distort the value of the sectoral indicators and distort the accuracy of these measures of economic reform.

  10. The de facto measure improves on the de jure classification of IMF (2003) since it takes into account that de jure exchange rate regimes are not necessarily applied in practice. This has especially been the case in developing, but also in industrialized countries. Austria, e.g., had a de facto fixed exchange rate regime vis-à-vis Germany for a long time without being a formal member of the exchange rate mechanism of the EMS. See Hochreiter and Tavlas (2005).

  11. Reinhart and Rogoff (2002) include freely falling rates as an additional category. We add the cases of freely falling rates to the free-float category, however.

  12. Note that the political constraints may restrict changes in either direction, however. They may limit both liberalization and the restriction of economic freedom. Further evidence may be derived from an interaction between political constraints and the government’s programmatic orientation. This extension is beyond the paper’s focus, however. Herz and Vogel (2005) and Pitlik (2004) provide an in-depth discussion of the impact of political constraints.

  13. The Sargan test for instrument validity is taken from the two-step estimates, however, because the one-step statistics tends to over-reject the test in the presence of heteroskedasticity (Arellano and Bond 1991).

  14. The effect is limited however. Given the estimates in Table 3, a one percentage-point inflation increase leads to 0.06 additional points on the reform index during the subsequent decade.

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Acknowledgements

We would like to thank Jean-Yves Gnabo for his excellent and helpful discussion of an earlier version of this paper at the 10th International Conference on Macroeconomic Analysis and International Finance, May 25–27, 2006, Rethymno/Crete, and two anonymous referees for their stimulating comments and suggestions. We gratefully acknowledge the delivery of data from Stefan Pitlik and Andreas Freytag.

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Authors and Affiliations

  1. Department of Economics, University of Hohenheim, 70599, Stuttgart, Germany

    Ansgar Belke

  2. University of Bayreuth, Bayreuth, Germany

    Bernhard Herz & Lukas Vogel

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  1. Ansgar Belke
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  2. Bernhard Herz
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Correspondence to Ansgar Belke.

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Belke, A., Herz, B. & Vogel, L. Reforms, Exchange Rates and Monetary Commitment: A Panel Analysis for OECD Countries. Open Econ Rev 18, 369–388 (2007). https://doi.org/10.1007/s11079-007-9042-8

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