Working Papers
Academic research by SF Fed economists and affiliates intended for publication in scholarly journals.
A Currency Premium Puzzle
–October 24, 2024
Tarek A. Hassan, Thomas M. Mertens, Jingye WangStandard asset pricing models reconcile high equity premia with smooth risk-free rates by inducing an inverse functional relationship between the mean and the variance of the stochastic discount factor. This highly successful resolution to closed-economy asset pricing puzzles is fundamentally problematic when applied to open economies: It requires that differences in currency returns arise almost exclusively from predictable appreciations, not from interest rate differentials. In the data, by contrast, exchange rates are largely unpredictable, and currency returns arise from persistent interest rate differentials. We show currency risk premia arising in canonical long-run risk and habit preferences cannot match this fact. We argue this tension between canonical asset pricing and international macroeconomic models is a key reason researchers have struggled to reconcile the observed behavior of exchange rates, interest rates, and capital flows across countries. The lack of such a unifying model is a major impediment to understanding the effect of risk premia on international markets.
News Selection and Household Inflation Expectations
–October 9, 2024
Ryan Chahrour, Adam Shapiro, Daniel WilsonWe examine the impact of systematic media reporting on household inflation expectations, focusing on how selective news coverage influences household responses to inflation news. In a model where monitoring all economic developments is costly, households will account for news selection when forming inflation expectations. The model implies an asymmetry: news about high inflation influences inflation expectations more than news about low inflation. Using micro panel data, we find support for this hypothesis. Exposure to news about higher prices increases household inflation expectations by approximately 0.4 percentage point, whereas exposure to news about lower prices has no discernible effect.
Corporate Debt Maturity Matters for Monetary Policy
–August 22, 2024
Joachim Jungherr, Matthias Meier, Timo Reinelt, Immo SchottWe provide novel empirical evidence that firms’ investment is more responsive to monetary policy when a higher fraction of their debt matures. In a heterogeneous firm New Keynesian model with financial frictions and endogenous debt maturity, two channels explain this finding: (1.) Firms with more maturing debt have larger roll-over needs and are therefore more exposed to fluctuations in the real interest rate (roll-over risk). (2.) These firms also have higher default risk and therefore react more strongly to changes in the real burden of outstanding nominal debt (debt overhang). Unconventional monetary policy, which operates through long-term interest rates, has larger effects on debt maturity but smaller effects on output and inflation than conventional monetary policy.
Inference for Local Projections
–August 19, 2024
Atsushi Inoue, Oscar Jorda, Guido M. KuersteinerInference for impulse responses estimated with local projections presents interesting challenges and opportunities. Analysts typically want to assess the precision of individual estimates, explore the dynamic evolution of the response over particular regions, and generally determine whether the impulse generates a response that is any different from the null of no effect. Each of these goals requires a different approach to inference. In this article, we provide an overview of results that have appeared in the literature in the past 20 years along with some new procedures that we introduce here.
Consumer and Firm Perceptions of the Aggregate Labor Market Conditions
–August 19, 2024
Marianna Kudlyak, Brandon MiskanicIn the pre-pandemic period, measures of consumer labor market perceptions correlated well with the aggregate unemployment rate. However, for more than a year during the pandemic, consumers perceived labor markets as much tighter than the high aggregate unemployment rate implied. In contrast, there is no such a departure from the historic relation if we use the jobless unemployment rate-unemployment for reasons other than temporary layoffs-as a measure of labor market tightness. Using a measure of the firm labor market perceptions from the National Federation of Independent Business, we find that during the post-pandemic period, firms perceived labor market as being tighter than what consumers perceived, given the historic relation between the two series. Furthermore, despite the vacancy-unemployment ratio was at its historic high levels during the post-pandemic period, our measure of firm perceptions signaled that the labor market was even tighter. In June-July 2024, the relations between consumer and firm perceptions and between various measures of labor market tightness are back to its pre-pandemic patterns.
Inflation Disagreement Weakens the Power of Monetary Policy
–August 13, 2024
Ding Dong, Zheng Liu, Pengfei Wang, Min WeiHouseholds often disagree in their inflation outlooks. We present novel empirical evidence that inflation disagreement weakens the power of forward guidance and conventional monetary policy. These empirical observations can be rationalized by a model featuring heterogeneous beliefs about the central banks’ inflation target. An agent who perceives higher future inflation also perceives a lower real interest rate and thus would like to borrow more to finance consumption, subject to borrowing constraints. Higher inflation disagreement would lead to a larger share of borrowing-constrained agents, resulting in more sluggish responses of aggregate consumption to changes in both current and expected future interest rates. This mechanism also provides a microeconomic foundation for Euler equation discounting that helps resolve the forward guidance puzzle.
Persistent Effects of the Paycheck Protection Program and the PPPLF on Small Business Lending
–August 13, 2024
Lora Dufresne, Mark M. SpiegelUsing bank-level U.S. Call Report data, we examine the longer-term effects of the Paycheck Protection Program (PPP) and the PPP Liquidity Facility on small business (SME) lending. Our sample runs through the end of 2023H1, by which time almost all PPP loans were forgiven or repaid. To identify a causal impact of program participation, we instrument based on historical bank relationships with the Small Business Administration and the Federal Reserve discount window prior to the onset of the pandemic. Elevated bank participation in both programs was positively associated with a substantial cumulative increase in small business lending growth. However, we find a negative impact of both programs during the final year of our sample, suggesting that the increase may not prove permanent. Our results are driven by the small and medium-sized banks in our sample, which are not stress-tested and hence not included in Y-14 banking data, illustrating the importance of considering small and medium-sized banks in evaluating the performance of SME lending programs.
Credit Supply, Prices, and Non-price Mechanisms in the Mortgage Market
–August 12, 2024
John MondragonI use an episode of relatively tight credit supply in the jumbo mortgage market to quantify the importance of price and non-price credit supply mechanisms in explaining changes in borrowing. Following market disruptions in March 2020, borrowers with jumbo loans saw significantly tighter credit supply conditions relative to borrowers with conforming loans. As a result, jumbo borrowers were 50 percent less likely to refinance and when they refinanced they borrowed 4-6 percent less than counterfactual borrowers facing looser credit conditions. The reduction in borrowing may have been caused by both an increase in the price and a change in a non-price mechanism, a decline in the availability of cash-out refinances. Decomposing the total effect into a price and cash-out channel, I find that that the cash-out channel accounts for two to three times as much of the decline as the price effect, and together both explain 70-80 percent of the total decline. This suggests that non-price mechanisms can be least as important as prices in clearing credit markets, a fact which is not adequately explained by current models of credit markets.
Local Projections
–August 12, 2024
Òscar Jordà, Alan M. Taylor
A central question in applied research is to estimate the effect of an exogenous intervention or shock on an outcome. The intervention can affect the outcome and controls on impact and over time. Moreover, there can be subsequent feedback between outcomes, controls and the intervention. Many of these interactions can be untangled using local projections. This method’s simplicity makes it a convenient and versatile tool in the empiricist’s kit, one that is generalizable to complex settings. This article reviews the state-of-the art for the practitioner, discusses best practices and possible extensions of local projections methods, along with their limitations.
Industrial Composition of Syndicated Loans and Banks’ Climate Commitments
–July 31, 2024
Galina Hale, Brigid Meisenbacher, Fernanda NechioIn the past two decades, a number of banks joined global initiatives aimed to mitigate climate change by “greening” their asset portfolios. We study whether banks that made such commitments have a different emission exposure of their portfolios of syndicated loans than banks that did not. We rely on loan-level information with global coverage combined with country-industry information on emissions. We find that all banks have reduced their loan-emission exposures over the last 8 years. However, we do not find differences between banks that did and those that did not signal their sustainability goals, with the exception of early signers of Principles of Responsible Investments (PRI), who already had lower exposure to emissions through their syndicated lending. In addition, banks that signed PRI shortened the maturity of the loans extended to highly-emitting industries but only temporarily. Thus, we conclude that banks reduced their exposure to climate transition risks on average, but voluntary climate commitments did not contribute to syndicated loan reallocation away from highly-emitting sectors.
Phillips Meets Beveridge
–July 31, 2024
Regis Barnichon, Adam ShapiroThe Phillips curve plays a central role in the macroeconomics literature. However, there is little consensus on the forcing variable that drives inflation in the model, i.e., on the appropriate measure of “slack” in the economy. In this work, we systematically assess the ability of variables commonly used in the literature to (i) predict and (ii) explain inflation fluctuations over time and across U.S. metropolitan areas. In particular, we exploit a newly constructed panel dataset with job openings and vacancy filling cost proxies covering 1982-2022. We find that the vacancy-unemployment (V/U) ratio and vacancy filling cost proxies outperform other slack measures, in particular the unemployment rate. Beveridge curve shifts—notably, movements in matching efficiency—are responsible for the superior performance of the V/U ratio over unemployment.
Snow Belt to Sun Belt Migration: End of an Era?
–July 18, 2024
Sylvain Leduc, Daniel WilsonInternal migration has been cited as a key channel by which societies will adapt to climate change. We show in this paper that this process has already been happening in the United States. Over the course of the past 50 years, the tendency of Americans to move from the coldest places (“snow belt”), which have become warmer, to the hottest places (“sun belt”), which have become hotter, has steadily declined. In the latest full decade, 2010-2020, both county population growth and county net migration rates were essentially uncorrelated with the historical means of either extreme heat days or extreme cold days. The decline in these correlations over the past 50 years is true across counties, across commuting zones, and across states. It holds for urban and suburban counties; for rural counties the correlations have even reversed. It holds for all educational groups, with the sharpest decline in correlations for those with four or more years of college. Among age groups, the pattern is strongest for age groups 20-29 and 60-69, suggestive of climate being an especially important factor for those in life stages involving long-term location choices. Given climate change projections for coming decades of increasing extreme heat in the hottest U.S. counties and decreasing extreme cold in the coldest counties, our findings suggest the “pivoting” in the U.S. climate-migration correlation over the past 50 years is likely to continue, leading to a reversal of the 20th century snow belt to sun belt migration pattern.
Pandemic Layoffs and the Role of Stay-At-Home Orders
–July 16, 2024
Marianna Kudlyak, Erin L. WolcottWe compile a novel high-frequency, detailed geographic dataset on mass layoffs from U.S. state labor departments. Using recent advances in difference-in-difference estimation with staggered treatment, we find that locally-mandated stay-at-home orders issued March 16–22, 2020 triggered mass layoffs equal to half a percent of the population in just one week. Our findings contribute to explanations for why job loss in 2020 was synchronous and catastrophic, yet temporary.
Macroeconomic Expectations and Cognitive Noise
–June 21, 2024
Yeji SungThis paper examines forecast biases through cognitive noise, moving beyond the conventional view that frictions emerge solely from using external data. By extending Sims’s (2003) imperfect attention model to include imperfect memory, I propose a framework where cognitive constraints impact both external and internal information use. This innovation reveals horizon-dependent forecast sensitivity: short-term forecasts adjust sluggishly while long-term forecasts may overreact. I explore the macroeconomic impact of this behavior, showing how long-term expectations, heavily influenced by current economic conditions, heighten inflation volatility. Moreover, structural estimation indicates that neglecting imperfect memory critically underestimates the informational challenges forecasters encounter.
A Macro Study of the Unequal Effects of Climate Change
–May 30, 2024
Stephie FriedThis paper develops a macro heterogeneous-agent model to quantify the distributional impacts of higher temperatures in the US. Households adapt to temperature by using energy and equipment for heating and cooling. A key insight is that temperature acts as a transfer from nature, augmenting household income by the value of heating or cooling provided by nature. The welfare effects of climate change vary substantially with income, increasing welfare inequality in the colder parts of the US. This heterogeneity results from the effects of climate change on transfers from nature and on households’ extensive-margin decisions to purchase heaters and air conditioners.
Understanding the Inequality and Welfare Impacts of Carbon Tax Policies
–May 30, 2024
Stephie Fried, Kevin Novan, William B. PetermanThis paper develops a general equilibrium lifecycle model to explore the welfare and inequality implications of different ways to return carbon tax revenue back to households. We find that the welfare maximizing rebate uses two thirds of carbon-tax revenue to reduce the distortionary tax on capital income while using the remaining one third to increase the progressivity of the labor-income tax. This recycling approach attains higher welfare and more equality than the lump-sum rebate approach preferred by policymakers as well as the approach originally prescribed by economists __ which called exclusively for reductions in distortionary taxes.
Reshoring, Automation, and Labor Markets Under Trade Uncertainty
–May 8, 2024
Hamid Firooz, Sylvain Leduc, Zheng LiuWe study the implications of trade uncertainty for reshoring, automation, and U.S. labor markets. Rising trade uncertainty creates incentive for firms to reduce exposures to foreign suppliers by moving production and distribution processes to domestic producers. However, we argue that reshoring does not necessarily bring jobs back to the home country or boost domestic wages, especially when firms have access to labor-substituting technologies such as automation. Automation improves labor productivity and facilitates reshoring, but it can also displace jobs. Furthermore, automation poses a threat that weakens the bargaining power of low-skilled workers in wage negotiations, depressing their wages and raising the skill premium and wage inequality. The model predictions are in line with industry-level empirical evidence.
Enhanced Unemployment Insurance Benefits in the United States during COVID-19: Equity and Efficiency
–May 6, 2024
Robert G. Valletta, Mary YilmaWe assess the effects of the historically unprecedented expansion of U.S. unemployment insurance (UI) payments during the COVID-19 pandemic. The adverse economic impacts of the pandemic, notably the pattern of job losses and earnings reductions, were disproportionately born by lower-income individuals. Focusing on household income as a broad measure of well-being, we document that UI payments almost completely offset the increase in household income inequality that otherwise would have occurred in 2020 and 2021. We also examine the impacts of the $600 increase in weekly UI benefit payments, available during part of 2020, on job search outcomes. We find that despite the very high replacement rate of lost earnings for low-wage individuals, the search disincentive effects of the enhanced UI payments were limited overall and smaller for individuals from lower-income households. These results suggest that the pandemic UI expansions improved equity but had limited consequences for economic efficiency.
Are Medicaid and Medicare Patients Treated Equally?
–April 17, 2024
Calvin Ackley, Abe Dunn, Eli Liebman, Adam ShapiroWe examine whether Medicaid recipients receive the same health care services as those on Medicare. We track the services provided to the same individual as they age into Medicare from Medicaid at age 65, becoming dual enrolled. Cost sharing remains negligible across the insurance switch, implying that observed changes in service provision reflect supply-side factors. Service provision increases by about 20 percent upon switching to Medicare, across a range of categories and treatments including high-value care. We find that 60 to 90 percent of the increase in office visits is explained by physicians averse to accepting new Medicaid patients. Geographic variation in our estimates shows that the average increase in utilization is larger in those states with lower Medicaid acceptance rates and higher Medicare acceptance rates. By contrast, we find relatively small increases in care from existing Medicaid providers. This analysis indicates that Medicaid’s smaller provider network plays a large role in limiting service provision.
Quantitative Easing, Bond Risk Premia and the Exchange Rate in a Small Open Economy
–April 15, 2024
Jens H. E. Christensen, Xin ZhangWe assess the impact of large-scale asset purchases, commonly known as quantitative easing (QE), conducted by Sveriges Riksbank and the European Central Bank (ECB) on bond risk premia in the Swedish government bond market. Using a novel arbitrage-free dynamic term structure model of nominal and real bond prices that accounts for bond-specific safety premia, we find that Sveriges Riksbank’s bond purchases raised inflation and short-rate expectations, lowered nominal and real term premia and inflation risk premia, and increased nominal bond safety premia, suggestive of signaling, portfolio rebalance, and safe asset scarcity effects. Furthermore, we document spillover effects of ECB’s QE programs on Swedish bond markets that are similar to the Swedish QE effects only after controlling for exchange rate fluctuations, highlighting the importance of exchange rate dynamics in the transmission of QE spillover effects.
Inflation Expectations, Liquidity Premia and Global Spillovers in Japanese Bond Markets
–April 11, 2024
Jens H. E. Christensen, Mark M. SpiegelWe provide market-based estimates of Japanese inflation expectations using an arbitrage-free dynamic term structure model of nominal and real yields that accounts for liquidity premia and the deflation protection afforded by Japanese inflation-indexed bonds, known as JGBi’s. We find that JGBi liquidity premia exhibit significant variation, and even switch sign. Properly accounting for them significantly lowers the estimated value of the indexed bonds’ deflation protection and affects inflation risk premium estimates. After liquidity adjustment, long-term Japanese inflation expectations have remained relatively stable at levels modestly exceeding one percent during the pandemic period. We then utilize our estimated liquidity measure to confirm the existence of statistically significant and economically meaningful spillovers to the JGBi market from global bond market illiquidity, as proxied by periods of low U.S. Treasury market depth.
A Macroeconomic Model of Central Bank Digital Currency
–April 8, 2024
Pascal Paul, Mauricio Ulate, Jing Cynthia Wu
We develop a quantitative New Keynesian DSGE model to study the introduction of a central bank digital currency (CBDC): government-backed digital money available to retail consumers. At the heart of our model are monopolistic banks with market power in deposit and loan markets. When a CBDC is introduced, households benefit from an expansion of liquidity services and higher deposit rates as bank deposit market power is curtailed. However, deposits also flow out of the banking system and bank lending contracts. We assess this welfare trade-off for a wide range of economies that differ in their level of interest rates. We find substantial welfare gains from introducing a CBDC with an optimal interest rate that can be approximated by a simple rule of thumb: the maximum between 0% and the policy rate minus 1%.
How Cyclical Is the User Cost of Labor?
–April 2, 2024
Marianna KudlyakIn employment relationships, a wage is an installment payment on an implicit long-term agreement between a worker and a firm. The price of labor that impacts firm’s hiring decisions, instead, reflects the hiring wage as well as the impact of economic conditions at the time of hiring on future wages. Measured by the labor’s user cost, the price of labor is substantially more pro-cyclical than the new-hire wage or the average wage. The strong procyclicality of the price of labor calls for other forces for cyclical labor demand to explain employment fluctuations.
Distribution of Market Power, Endogenous Growth, and Monetary Policy
–March 28, 2024
Yumeng Gu, Sanjay R. Singh
We incorporate incumbent innovation in a Keynesian growth framework to generate an endogenous distribution of market power across firms. Existing firms increase markups over time through successful innovation. Entrant innovation disrupts the accumulation of market power by incumbents. Using this environment, we highlight a novel misallocation channel for monetary policy. A contractionary monetary policy shock causes an increase in markup dispersion across firms by discouraging entrant innovation relative to incumbent innovation. We characterize the circumstances when contractionary monetary policy may increase misallocation.
The Natural Rate of Interest in the Euro Area: Evidence from Inflation-Indexed Bonds
–March 8, 2024
Jens H. E. Christensen, Sarah MouabbiThe so-called equilibrium or natural rate of interest, widely known as r*t, is a key variable used to judge the stance of monetary policy. We offer a novel euro-area estimate based on a dynamic term structure model estimated directly on the prices of bonds with cash flows indexed to the euro-area harmonized index of consumer prices with adjustments for bond-specific risk and real term premia. Despite a recent increase, our estimate indicates that the natural rate in the euro area has fallen about 2 percentage points on net since 2002 and remains negative at the end of our sample. We also devise a related measure of the stance of monetary policy, which suggests that monetary policy in the euro area was not accommodative at the height of the COVID-19 pandemic.
How Oil Shocks Propagate: Evidence on the Monetary Policy Channel
–March 8, 2024
Wataru Miyamoto, Thuy Lan Nguyen, Dmitriy Sergeyev
Using high-frequency responses of oil futures prices to prominent oil market news, we estimate the effects of oil supply news shocks when systematic monetary policy is switched off by the zero lower bound (ZLB) and when it is not (normal periods) in Japan, the United Kingdom, and the United States. We find that negative oil supply news shocks are less contractionary (and even expansionary) at the ZLB compared to normal periods. Inflation expectations increase during both periods, while the short nominal interest rates remain constant at the ZLB, pointing to the importance of monetary policy for oil shock propagation.
Would the Euro Area Benefit from Greater Labor Mobility?
–March 7, 2024
Vasco Cúrdia, Fernanda Nechio
We assess how within euro area labor mobility impacts economic dynamics in response to shocks. In the analysis we use an estimated two-region monetary union dynamic stochastic general equilibrium model that allows for a varying degree of labor mobility across regions. We find that, in contrast with traditional optimal currency area predictions, enhanced labor mobility can either mitigate or exacerbate the extent to which the two regions respond differently to shocks. The effects depend crucially on the nature of shocks and variable of interest. In some circumstances, even when it contributes to aligning the responses of the two regions, labor mobility may complicate monetary policy tradeoffs. Moreover, the presence and strength of financial frictions have important implications for the effects of labor mobility. If the periphery’s risk premium is more responsive to its indebtedness than our estimates, there are various shocks for which labor mobility may help stabilize the economy. Finally, the euro area’s economic performance following the Global Financial Crisis would not have been necessarily smoother with enhanced labor mobility.
Regional Dissent: Do Local Economic Conditions Influence FOMC Votes?
–February 26, 2024
Anton Bobrov, Rupal Kamdar, Mauricio Ulate
U.S. monetary-policy decisions are made by the 12 voting members of the Federal Open Market Committee (FOMC). Seven of these members, coming from the Federal Reserve Board of Governors, inherently represent national-level interests. The remaining five members, a rotating group of presidents from the 12 Federal Reserve districts, come instead from sub-national jurisdictions. Does this structure have relevant implications for the monetary policy-making process? In this paper, we first build a panel dataset on economic activity across Fed districts. We then provide evidence that regional economic conditions influence the voting behavior of district presidents. Specifically, a regional unemployment rate that is one percentage point higher than the U.S. level is associated with an approximately nine percentage points higher probability of dissenting in favor of looser policy at the FOMC. This result is statistically significant, robust to different specifications, and indicates that the regional component in the structure of the FOMC could matter for monetary policy.
A Post-Pandemic New Normal for Interest Rates in Emerging Bond Markets? Evidence from Chile
–February 21, 2024
Luis Ceballos, Jens H. E. Christensen, Damian Romero
Before the COVID-19 pandemic, researchers intensely debated the extent of the decline in the so-called equilibrium or natural rate of interest. Given the recent sharp increase in interest rates, we revisit this question in an emerging bond market context and offer a Chilean perspective using a dynamic term structure finance model estimated directly on the prices of individual Chilean inflation-indexed bonds with adjustments for bond-specific liquidity risk and real term premia. Beyond documenting the existence of large and time-varying liquidity risk premia in the bond prices, we estimate that the equilibrium real rate in Chile fell about 2 and a half percentage points in the 2003-2022 period and has remained low since then with model projections only suggesting a gradual reversal in coming years. Instead, recent increases in real interest rates in Chile are driven by spikes in the liquidity and term premia of inflation-indexed bond prices.
Understanding Persistent ZLB: Theory and Assessment
–February 21, 2024
Pablo Cuba-Borda, Sanjay R. SinghWe develop a theoretical framework that rationalizes two hypotheses of long-lasting low interest rate episodes: deflationary-expectations-traps and secular stagnation in a unified setting. These hypotheses differ in the sign of the theoretical correlation between inflation and output growth that they imply. Using the data from Japan over 1998:Q1-2019:Q4, we find that the data favor the expectations-trap hypothesis. The superior model fit of the expectations trap relies on its ability to generate the observed negative correlation between inflation and output growth.
The Macroeconomic Effects of Cash Transfers: Evidence from Brazil
–January 29, 2024
Arthur Mendes, Wataru Miyamoto, Thuy Lan Nguyen, Steven Pennings, Leo Feler
This paper provides new evidence on the macroeconomic impact of cash transfers in developing countries. Using a Bartik-style identification strategy, the paper documents that Brazil’s Bolsa Familia transfer program leads to a large and persistent increase in relative state-level GDP, formal employment, and informal employment. A state receiving 1% of GDP in extra transfers grows 2.2% faster in the first year, with R$100,000 of extra transfers generating five formal-equivalent jobs, half of which are informal. Consistent with a demand-side mechanism, the effects are concentrated in non-tradable sectors. However, an open-economy New Keynesian model only partially captures the high multipliers estimated.
Market-Based Estimates of the Natural Real Rate: Evidence from Latin American Bond Markets
–January 15, 2024
Luis Ceballos, Jens H. E. Christensen, Damian Romero
We provide market-based estimates of the natural real rate, that is, the steady-state short-term real interest rate, for Brazil, Chile, and Mexico. Our approach uses a dynamic term structure finance model estimated directly on the prices of individual inflation indexed bonds with adjustments for bond-specific liquidity and real term premia. First, we find that inflation-indexed […]
Monetary Tightening and Financial Stress during Supply– versus Demand–driven Inflation
–December 21, 2023
Frederic Boissay, Fabrice Collard, Cristina Manea, Adam Shapiro
The paper explores the state–dependent effects of a monetary policy tightening on financial stress, focusing on a novel dimension: whether inflation is driven by supply factors versus demand factors at the time of the policy intervention. We use local projections to estimate the effect of high frequency identified monetary policy surprises on a variety of financial stress measures, differentiating the effects based on whether inflation is supply–driven or demand–driven. We find that financial stress flares up after a monetary tightening when inflation is supply–driven whereas it remains roughly unchanged or even declines when inflation is demand–driven. Our findings point to a potential trade–off between price and financial stability when inflation is high and driven by supply factors.
Low Risk Sharing with Many Assets
–November 30, 2023
Emile A. Marin, Sanjay R. Singh
Classical contributions in international macroeconomics reconcile low international risk sharing by generating a non-traded component to exchange rates. However, when there is cross-border trade in just one domestic and one foreign-currency-denominated risk-free asset, such price movements are ruled out by no-arbitrage restrictions. Allowing for within-country heterogeneity in stochastic discount factors, we recover low risk-sharing even with cross-border trade in two risk-free assets, as long as heterogeneity increases when exchange rates depreciate.
Labor Market Stability and Fertility Decisions
–November 21, 2023
Joan Monras, Eduardo Polo-Muro, Javier Vazquez-Grenno
This paper studies how fertility decisions respond to an improvement in job stability using variation from the large and unexpected regularization of undocumented immigrants in Spain implemented during the first half of 2005. This policy change improved substantially the labor market opportunities of affected men and women, many of which left the informality of house […]
A Financial New Keynesian Model
–November 21, 2023
Thomas M. Mertens, Tony Zhang
This paper solves a standard New Keynesian model in terms of risk-neutral expectations and estimates it using a cross-section of longer-dated financial assets at a single point in time. Inflation risk premia appear in the theory and cause inflation to deviate from its target on average. We re-estimate the model based on each day’s closing […]
The Optimal Supply of Central Bank Reserves under Uncertainty
–December 1, 2023
Gara Afonso, Gabriele La Spada, Thomas M. Mertens, John C. Williams
This paper provides an analytically tractable theoretical framework to study the optimal supply of central bank reserves when the demand for reserves is uncertain and nonlinear. We fully characterize the optimal supply of central bank reserves and associated market equilibrium. We find that the optimal supply of reserves under uncertainty is greater than that absent […]
The Active Role of the Natural Rate of Unemployment
–November 29, 2023
Robert E. Hall, Marianna Kudlyak
We propose that the natural rate of unemployment may have an active role in the business cycle, in contrast to a widespread view that the rate is fairly smooth and at most only weakly cyclical. We demonstrate that the tendency to treat the natural rate as near-constant would explain the surprisingly low slope of the […]
Demographics and Real Interest Rates Across Countries and Over Time
–November 29, 2023
Carlos Carvalho, Andrea Ferrero, Felipe Mazin, Fernanda Nechio
We explore the implications of demographic trends for the evolution of real interest rates across countries and over time. To that end, we develop a tractable three-country general equilibrium model with imperfect capital mobility and country-specific demographic trends. We calibrate the model to study how low-frequency movements in a country’s real interest rate depend on […]
Perceptions about Monetary Policy
–October 29, 2023
Michael D. Bauer, Carolin E. Pflueger, Adi Sunderam
We estimate perceptions about the Federal Reserve’s monetary policy rule from panel data on professional forecasts of interest rates and macroeconomic conditions. The perceived dependence of the federal funds rate on economic conditions varies substantially over time, including over the monetary policy cycle. Forecasters update their perceptions about the Fed’s policy rule in response to […]
The Effect of U.S. Climate Policy on Financial Markets: An Event Study of the Inflation Reduction Act
–September 1, 2023
Michael Bauer, Eric A. Offner, Glenn D. RudebuschThe Inflation Reduction Act of 2022 (IRA) represents the largest climate policy action ever undertaken in the United States. Its legislative path was marked by two abrupt shifts as the likelihood of climate policy action fell to near zero and then rose to near certainty. We investigate equity price reactions to these two events, which represent major realizations of climate policy transition risk. Our results highlight the heterogeneous nature of climate policy risk exposure. We find sizable reactions that differ by industry as well as across firm-level measures of greenness such as environmental scores and emission intensities. While the financial market response to the IRA was economically significant, it did not lead to instability financial stress, suggesting that transition risks posed by climate policies even as ambitious as the IRA may be manageable.
Productivity in the World Economy During and After the Pandemic
–September 1, 2023
John G. Fernald, Huiyu LiThis paper reviews how productivity has evolved around the world since the pandemic began in 2020. Productivity in many countries has been volatile. We conclude that the broad contours of productivity growth during this period have been heavily shaped by predictable cyclical patterns. Looking at U.S. industry data, we find little evidence that the sharp rise in telework has had a notable impact, good or bad, on productivity. Stepping back, the data so far appear consistent with a continuation of the slow-productivity-growth trajectory that we faced before the pandemic.
The Effect of Second-Generation Rent Controls: New Evidence from Catalonia
–September 1, 2023
Joan Monras, Jose G. MontalvoCatalonia enacted a second-generation rental cap policy that affected only some municipalities and, within those, only units with prices above their “reference” price. We show that, as intended, the policy led to a reduction in rental prices, but with price increases at the bottom and price declines at the top of the distribution. The policy also affected supply, with exit at the top which is not compensated by entry at the bottom. We show that a model with quality differences in rental units rationalizes the empirical facts and allows us to compute the welfare consequences of the policy.
Long-Run Effects of Incentivizing Work After Childbirth
–June 1, 2023
Elira Kuka, Na’ama ShenhavThis paper identifies the impact of increasing post-childbirth work incentives on mothers’ long-run careers. We exploit variation in work incentives across mothers based on the timing of a first birth and eligibility for the 1993 expansion of the Earned Income Tax Credit. Ten to nineteen years after a first birth, single mothers who were exposed to the expansion immediately after birth (“early”), rather than 3 6 years later (“late”), have 0.62 more years of work experience and 4.2% higher earnings conditional on working. We show that higher earnings are primarily explained by improved wages due to greater work experience.
Floating Population: Migration With(Out) Family and the Spatial Distribution of Economic Activity
–August 1, 2023
Clement Imbert, Joan Monras, Marlon Seror, Yanos ZylberbergThis paper argues that migrants’ decision to bring their dependent family members shapes their consumption behavior, their choice of destination, and their sensitivity to migration barriers. We document that in China: (i) rural migrants disproportionately move to expensive cities; (ii) in these cities they live without their family and in poorer housing conditions; and (iii) they remit more, especially when living without their family. We then develop a quantitative general equilibrium spatial model in which migrant households choose whether, how (with or without their family), and where to migrate. We estimate the model using plausibly exogenous variation in wages, housing prices, and exposure to family migration costs. We use the model to estimate migration costs and relate them to migration policy. We find that hukou policies protect workers in large, expensive, and high income cities at the expense of rural households, who use remittances to overcome some of these costs.
Estimating Natural Rates of Unemployment: A Primer
–August 1, 2023
Brandyn Bok, Richard K. Crump, Christopher J. Nekarda, Nicolas Petrosky-NadeauBefore the pandemic, the U.S. unemployment rate reached a historic low that was close to estimates of its underlying longer-run value and the short-run level associated with an absence of inflationary pressures. After two turbulent years, unemployment returned to its pre-pandemic low, and the estimated underlying longer-run unemployment rate appeared largely unchanged. However, economic disruptions pushed up the short-run noninflationary rate substantially, as high as 6%. This primer examines these different measures of the natural rate of unemployment and discusses how they can provide useful insights for policymakers.
Passive Quantitative Easing: Bond Supply Effects through a Halt to Debt Issuance
–August 1, 2023
Jens H. E. Christensen, Simon Thinggaard HetlandThis article presents empirical evidence of a supply-induced transmission channel to longterm interest rates caused by a halt to government debt issuance. This is conceptually equivalent to a central bank operated asset purchase program, commonly known as quantitative easing (QE). However, as it involves neither asset purchases nor associated creation of central bank reserves, we refer to it as passive QE. For evidence, we analyze the response of Danish government bond risk premia to a temporary halt in government debt issuance announced by the Danish National Bank. The data suggest that declines in longterm yields during its enforcement reflected both reduced term premia, consistent with supply-induced portfolio balance effects, and increased safety premia, consistent with safe assets scarcity effects.
Quantitative Easing and Safe Asset Scarcity: Evidence from International Bond Safety Premia
–August 1, 2023
Jens H. E. Christensen, Nikola Mirkov, Xin ZhangThrough large-scale asset purchases, widely known as quantitative easing (QE), central banks around the world have affected the supply of safe assets by buying quasi-safe bonds in exchange for truly safe reserves. We examine the pricing effects of the European Central Bank’s bond purchases in the 2015-2021 period on an international panel of bond safety premia from four highly rated countries: Denmark, Germany, Sweden, and Switzerland. We find statistically significant negative effects for all four countries. This points to an important international spillover channel of QE programs to bond safety premia that operates by increasing the amount of truly safe assets.
Currency Areas, Labor Markets, and Regional Cyclical Sensitivity
–June 1, 2023
Katheryn N. Russ, Jay C. Shambaugh, Sanjay R. SinghIn his papers during the lead up to the birth of the European Monetary Union, Obstfeld considered whether the countries forming the EMU were sufficiently similar to survive a single monetary policy–and more importantly, whether they had the capacity to adjust to asymmetric shocks given a single monetary and exchange rate policy. The convention at the time was to take the United States as the baseline for a smoothly functioning currency union. We document the evolution of the literature on regional labor market adjustment within the United States, expanding on stylized facts illustrating how stratification in local labor market outcomes appears far more persistent today than 30 years ago in the context of what Obstfeld and Peri (1998) call non-adjustment in unemployment rates. We then extend the currency union literature by adding an additional consideration: differences in regional cyclical sensitivity. Using measures of cyclicality and Obstfeld-Peri-type non-adjustment, we explore the characteristics of places that can get left behind when local labor markets respond differently to national shocks and discuss implications for policy.
Supply or Demand? Policy Makers’ Confusion in the Presence of Hysteresis
–June 1, 2023
Antonio Fatas, Sanjay R. SinghPolicy makers need to separate between temporary demand-driven shocks and permanent shocks in order to design optimal aggregate demand policies. In this paper we study the case of a central bank that ignores the presence of hysteresis when identifying shocks. By assuming that all low frequency output fluctuations are driven by permanent technology shocks, monetary policy is not aggressive enough in response to demand shocks. In addition, we show that errors in assessing the state of the economy can be self-perpetuating if seen through the lens of the mistaken views of the policymaker. We show that a central bank that mistakes a demand shock for a supply shock, will produce permanent effects on output through their suboptimal policies. Ex-post, the central bank will see an economy that resembles what they had forecast when designing their policies. The shock is indeed persistent and this persistence validates their assumption that the shock was a supply-driven one. The interaction between forecasts, policies and hysteresis creates the dynamics of self-perpetuating errors that is the focus of this paper.
The Financial Origins of Non-Fundamental Risk
–May 1, 2023
Sushant Acharya, Keshav Dogra, Sanjay R. SinghWe formalize the idea that the financial sector can be a source of non-fundamental risk. Households’ desire to hedge against price volatility can generate price volatility in equilibrium, even absent fundamental risk. Fearing that asset prices may fall, risk-averse households demand safe assets from leveraged intermediaries, whose issuance of safe assets exposes the economy to self-fulfilling fire sales. Policy can eliminate nonfundamental risk by (i) increasing the supply of publicly backed safe assets, through issuing government debt or bailing out intermediaries, or (ii) reducing the demand for safe assets, through social insurance or by acting as a market maker of last resort.
Incorporating Diagnostic Expectations into the New Keynesian Framework
–March 1, 2023
Jean-Paul L’Huillier, Sanjay R. Singh, Donghoon YooDiagnostic expectations constitute a realistic behavioral model of inference. This paper shows that this approach to expectation formation can be productively integrated into the New Keynesian framework. Diagnostic expectations generate endogenous extrapolation in general equilibrium. We show that diagnostic expectations generate extra amplification in the presence of nominal frictions; a fall in aggregate supply generates a Keynesian recession; fiscal policy is more effective at stimulating the economy. We perform Bayesian estimation of a rich medium-scale model that incorporates consensus forecast data. Our estimate of the diagnosticity parameter is in line with previous studies. Moreover, we find empirical evidence in favor of the diagnostic model. Diagnostic expectations offer new propagation mechanisms to explain fluctuations.
Monetary Transmission through Bank Securities Portfolios
–May 1, 2024
Daniel L. Greenwald, John Krainer, Pascal PaulWe study the transmission of monetary policy through bank securities portfolios using granular supervisory data on U.S. bank securities, hedging positions, and corporate credit. Banks that experienced larger losses on their securities during the 2022-2023 monetary tightening cycle extended less credit to firms. This spillover effect was stronger for available-for-sale securities, unhedged securities, and banks that must include unrealized gains and losses in their regulatory capital. A structural model, disciplined by our cross-sectional regression estimates, shows that interest rate transmission is stronger the more banks are required to adjust their regulatory capital for unrealized value changes of securities.
Climate Change and the Geography of the U.S. Economy
–July 1, 2023
Sylvain Leduc, Daniel WilsonThis paper examines how the spatial distribution of people and jobs in the United States has been and will be impacted by climate change. Using novel county-level weather data from 1951 to 2020, we estimate the longer-run effects of climate on local population, employment, wages, and house prices using a panel polynomial distributed lag (PDL) model. This model and the long historical data help capture important aspects of local climate changes, such as trends in temperature. The historical results point to long-lasting negative effects of extreme temperatures on each of the outcomes examined. A long lag structure is necessary to appropriately capture the longer-run effects of climate change, as short-run effects are small. Using county-level weather projections based on alternative greenhouse gas emissions scenarios, we use the estimated models to project the spatial distribution of these local economic outcomes out to 2050. Our results point to substantial reallocations of people and jobs across the country over the next three decades, with mobility increasing by between 35 and nearly 100 percent depending on the scenario. Population and employment are projected to shift away from the Sunbelt and toward the North and Mountain West.
Local Projections for Applied Economics
–July 1, 2023
Oscar JordaThe dynamic causal effect of an intervention on an outcome is of paramount interest to applied macro- and micro-economics research. However, this question has been generally approached differently by the two literatures. In making the transition from traditional time series methods to applied microeconometrics, local projections can serve as a natural bridge. Local projections can translate the familiar language of vector autoregressions (VARs) and impulse responses into the language of potential outcomes and treatment effects. There are gains to be made by both literatures from greater integration of well established methods in each. This review shows how to make these connections and points to potential areas of further research.
Significance Bands for Local Projections
–May 1, 2023
Atsushi Inoue, Oscar Jorda, Guido M. KuersteinerAn impulse response function describes the dynamic evolution of an outcome variable following a stimulus or treatment. A common hypothesis of interest is whether the treatment affects the outcome. We show that this hypothesis is best assessed using significance bands rather than relying on commonly displayed confidence bands. Under the null hypothesis, we show that significance bands are trivial to construct with standard statistical software using the LM principle, and should be reported as a matter of routine when displaying impulse responses graphically.
Decomposing the Monetary Policy Multiplier
–May 1, 2023
Piergiorgio Alessandri, Oscar Jorda, Fabrizio VendittiFinancial markets play an important role in generating monetary policy transmission asymmetries in the US. Credit spreads only adjust to unexpected increases in interest rates, causing output and prices to respond more to a monetary tightening than to an expansion. At a one year horizon, the ‘financial multiplier’ of monetary policy—defined as the ratio between the cumulative responses of employment and credit spreads—is zero for a monetary expansion, -2 for a monetary tightening, and -4 for a monetary tightening that takes place under strained credit market conditions. These results have important policy implications: the central bank may inadvertently over-tighten in times of financial uncertainty.
Targeted Reserve Requirements for Macroeconomic Stabilization
–November 22, 2023
Zheng Liu, Mark M. Spiegel, Jingyi Zhang
We study the effectiveness of targeted reserve requirements (RR) as a policy tool for macroeconomic stabilization. Targeted RR adjustments were implemented in China during both the 2008-09 global financial crisis and the recent COVID-19 pandemic. We develop a model in which firms with idiosyncratic productivity can borrow from two types of banks—local or national—to finance working capital. National banks provide liquidity services, while local banks have superior monitoring technologies, such that both types coexist. Relationship banking is modeled in terms of a fixed cost of switching lenders, and banks choose to switch only under sufficiently large shocks. Reducing RR on local banks boosts leverage and aggregate output, whereas reducing RR on national banks has an ambiguous output effect. Following a large recessionary shock, a targeted RR policy that reduces RR for local banks relative to national banks can lower costs of switching lenders, stabilizing macroeconomic fluctuations. However, targeting RR in that manner also boosts local bank leverage, increasing risks of default and related liquidation losses. Our model’s mechanism is supported by bank-level empirical evidence.
A Local Projections Approach to Difference-in-Differences Event Studies
–April 1, 2023
Arindrajit Dube, Daniele Girardi, Oscar Jorda, Alan M. TaylorMany of the challenges in the estimation of dynamic heterogeneous treatment effects can be resolved with local projection (LP) estimators of the sort used in applied macroeconometrics. This approach provides a convenient alternative to the more complicated solutions proposed in the recent literature on Difference in-Differences (DiD). The key is to combine LPs with a flexible ‘clean control’ condition to define appropriate sets of treated and control units. Our proposed LP-DiD estimator is clear, simple, easy and fast to compute, and it is transparent and flexible in its handling of treated and control units. Moreover, it is quite general, including in its ability to control for pre-treatment values of the outcome and of other time-varying covariates. The LP-DiD estimator does not suffer from the negative weighting problem, and indeed can be implemented with any weighting scheme the investigator desires. Simulations demonstrate the good performance of the LP-DiD estimator in common settings. Two recent empirical applications illustrate how LP-DiD addresses the bias of conventional fixed effects estimators, leading to potentially different results.
The Transmission of Negative Nominal Interest Rates in Finland
–April 1, 2023
Simon H. Kwan, Mauricio Ulate, Ville VoutilainenDespite the implementation of negative nominal interest rates by several advanced economies in the last decade and the many papers that have been written about this novel policy tool, there is still much we do not know about the effectiveness of this instrument. The pass-through of negative policy rates to loan rates is one of the main points of contention. In this paper, we analyze the pass-through of the ECB’s changes in the deposit facility rate to mortgage rates in Finland between 2005 and 2020. We use monthly data and three different empirical methodologies: correlational event studies, high-frequency identification, and exposure-measure regressions. We provide robust evidence that there continues to be pass-through of a cut in the policy rate to mortgage rates even when the policy rate is in negative territory, but that this pass-through is smaller than when the policy rate is in positive territory. The evidence in this paper contrasts with some previous studies and provides moments that can be useful to discipline theoretical negative-rates models.
The Quality-Adjusted Cyclical Price of Labor
–March 1, 2023
Mark Bils, Marianna Kudlyak, Paulo LinsTypical measures of wages, such as average hourly earnings, fail to capture cyclicality in the effective cost of labor in the presence of (i) cyclical fluctuations in the quality of worker-firm matches, or (ii) wages being smoothed within employment matches. To address both concerns, we estimate cyclicality in labor’s user cost exploiting the longrun wage in a match to control for match quality. Using NLSY data for 1980 to 2019, we identify three channels by which hiring in a recession affects user cost: It lowers the new-hire wage; it lowers wages going forward in the match; but it also results in higher subsequent separations. All totaled, we find that labor’s user cost is highly procyclical, increasing by more than 4% for a 1 pp decline in the unemployment rate. For large recessions, like the Great Recession, that implies a decline in the price of labor of about 15%.
The Canary in the Coal Decline: Appalachian Household Finance and the Transition from Fossil Fuels
–April 1, 2023
Joshua Blonz, Brigitte Roth-Tran, Erin TrolandWe use individual-level credit data to study how recent declines in Appalachian coal mining affected household finances between 2011 and 2018. Using exogenous variation in electricity sector demand for coal, we find declines in coal demand decreased credit scores and increased financial distress within two years of coal shocks. These effects cannot be explained solely by job losses in coal mine worker households. Credit score declines and financial distress were largest among older individuals and people with lower-middle credit scores. Our results suggest the energy transition away from fossil fuels may impose meaningful costs on other fossil fuel extraction communities.
Labor Market Effects of Global Supply Chain Disruptions
–February 1, 2023
Mauricio Ulate, Jose P. Vasquez, Roman D. ZarateWe examine the labor market consequences of recent global supply chain disruptions induced by COVID-19. Specifically, we consider a temporary increase in international trade costs similar to the one observed during the pandemic and analyze its effects on labor market outcomes using a quantitative trade model with downward nominal wage rigidities. Even omitting any health related impacts of the pandemic, the increase in trade costs leads to a temporary but prolonged decline in U.S. labor force participation. However, there is a temporary increase in manufacturing employment as the United States is a net importer of manufactured goods, which become costlier to obtain from abroad. By contrast, service and agricultural employment experience temporary declines. Nominal frictions lead to temporary unemployment when the shock dissipates, but this depends on the degree of monetary accommodation. Overall, the shock results in a 0.14% welfare loss for the United States. The impact on labor force participation and welfare across countries varies depending on the initial degree of openness and sectoral deficits.
The Productivity Slowdown in Advanced Economies: Common Shocks or Common Trends?
–February 1, 2023
John G. Fernald, Robert Inklaar, Dimitrije RuzicThis paper reviews advanced-economy productivity developments in recent decades. We focus primarily on the facts about, and explanations for, the mid-2000s labor-productivity slowdown in large European countries and the United States. Slower total factor productivity growth was the proximate cause of the slowdown. This conclusion is robust to measurement challenges including the role of intangible assets, rankings of productivity levels, and data revisions. We contrast two main narratives for the stagnating productivity frontier: The shock of the Global Financial Crisis; and a common slowdown in productivity trends. Distinguishing these two empirically is hard, but the pre-recession timing of the U.S. slowdown suggests an important role for the common-trend explanation. We also discuss the unusual pattern of productivity growth since the start of the Covid-19 pandemic. Although it is early, there is little evidence so far that the large pandemic shock has changed the slow pre-pandemic trajectory of productivity growth.
Loose Monetary Policy and Financial Instability
–February 1, 2023
Maximilian Grimm, Oscar Jorda, Moritz Schularick, Alan M. TaylorDo periods of persistently loose monetary policy increase financial fragility and the likelihood of a financial crisis? This is a central question for policymakers, yet the literature does not provide systematic empirical evidence about this link at the aggregate level. In this paper we fill this gap by analyzing long run historical data. We find that when the stance of monetary policy is accommodative over an extended period, the likelihood of financial turmoil down the road increases considerably. We investigate the causal pathways that lead to this result and argue that credit creation and asset price overheating are important intermediating channels.
State-Dependent Local Projections: Understanding Impulse Response Heterogeneity
–February 1, 2023
James S. Cloyne, Oscar Jorda, Alan M. TaylorAn impulse response is the dynamic average effect of an intervention across horizons. We use the well-known Kitagawa-Blinder-Oaxaca decomposition to explore a response’s heterogeneity over time and over states of the economy. This can be implemented with a simple extension to the usual local projection specification that nevertheless keeps the model linear in parameters. Using our new decomposition-based approach, we show how to unpack heterogeneity in the fiscal multiplier, an object that at any point in time may depend on a number of potentially correlated factors, including existing economic conditions and the monetary response. In our application, the fiscal multiplier varies considerably with monetary policy: it can be as small as zero, or as large as 2, depending on the degree of monetary offset.
The Benefit of Inflation-Indexed Debt: Evidence from an Emerging Bond Market
–February 1, 2023
Cristhian Hernando Ruiz Cardozo, Jens H. E. ChristensenPortfolio diversification is as important to debt management as it is to asset management. In this paper, we focus on diversification of sovereign debt issuance through greater reliance on inflation-indexed bonds for a representative emerging economy, Colombia. Using an arbitrage-free dynamic term structure model of fixed-coupon and inflation-indexed bond prices, we account for inflation and liquidity risk premia and calculate the net benefit of issuing inflation-indexed bonds over nominal bonds. Our results suggest that the Colombian government could lower its funding costs by as much as 0.68 percent through increased issuance of inflation-indexed debt.
A Denial a Day Keeps the Doctor Away
–January 1, 2023
Abe Dunn, Joshua D. Gottlieb, Adam Shapiro, Daniel J. Sonnenstuhl, Pietro TebaldiWho bears the consequences of administrative problems in healthcare? We use data on repeated interactions between a large sample of U.S. physicians and many different insurers to document the complexity of healthcare billing, and estimate its economic costs for doctors and consequences for patients. Observing the back-and-forth sequences of claim denials and resubmissions for past visits, we can estimate physicians’ costs of haggling with insurers to collect payments. Combining these costs with the revenue never collected, we estimate that physicians lose 18% of Medicaid revenue to billing problems, compared with 4.7% for Medicare and 2.4% for commercial insurers. Identifying off of physician movers and practices that span state boundaries, we find that physicians respond to billing problems by refusing to accept Medicaid patients in states with more severe billing hurdles. These hurdles are quantitatively just as important as payment rates for explaining variation in physicians’ willingness to treat Medicaid patients. We conclude that administrative frictions have first-order costs for doctors, patients, and equality of access to healthcare. We quantify the potential economic gains—in terms of reduced public spending or increased access to physicians—if these frictions could be reduced, and find them to be sizable.
Fiscal Policy Design and Inflation: The COVID-19 Pandemic Experience
–January 1, 2023
Galina Hale, John Leer, Fernanda NechioFiscal support measures in response to the COVID-19 pandemic varied in their targeted beneficiaries. Relying on variability across 10 large economies, we study differences in the inflationary effects of fiscal support measures targeting consumers or businesses. Because conventional measures of real activity were distorted, we control for the underlying state of real economy using households sentiment data. We find that fiscal support measures to consumers, but not firms, had inflationary effects that manifested 5 weeks following the announcement and peaked at 12 weeks. The magnitude of the effect was larger in an environment of improving consumer sentiment.
Fiscal Policies for Job Creation and Innovation: The Experiences of US States
–January 1, 2023
Robert S. Chirinko, Daniel WilsonThis paper reviews selected fiscal policy initiatives undertaken by US states to encourage job creation and innovation. We begin with a discussion of some general considerations about the design of tax policies summarized in a tax policy design table. Four policies are reviewed: job creation tax credits, research and development tax credits, a set of tax policies targeted to the biotechnology industry, and a broad set of tax policies that attract star scientists. The experiences at the state level are used to evaluate the effectiveness of these employment and knowledge-capital tax incentives in creating jobs and spurring innovation. The paper concludes with four other considerations need to be taken into account in selecting policies.
Fiscal Stimulus Under Average Inflation Targeting
–April 1, 2023
Zheng Liu, Jianjun Miao, Dongling SuThe stimulus effects of expansionary fiscal policy under average inflation targeting (AIT) depends on both monetary and fiscal policy regimes. AIT features an inflation makeup under the monetary regime, but not under the fiscal regime. In normal times, AIT amplifies the short-run fiscal multipliers under both regimes while mitigating the cumulative multipliers. due to intertemporal substitution. In a zero-lower bound (ZLB) period, AIT reduces fiscal multipliers under a monetary regime by shortening the duration of the ZLB through expected inflation makeup. Under the fiscal regime, AIT has a nonlinear effect on fiscal multipliers because of the absence of inflation makeup and the presence of a nominal wealth effect.
Understanding Climate Damages: Consumption versus Investment
–October 1, 2022
Gregory Casey, Stephie Fried, Matthew GibsonExisting climate-economy models assume climate change has equal impacts on the productivity of firms that produce consumption and investment goods and services. We develop a model of structural change to show that the split between damage to consumption and investment productivity matters for the aggregate consequences of climate change. When investment is more vulnerable to climate, we find smaller short-run consumption losses than leading models suggest, but larger long-run consumption losses. We provide a quantitative illustration of these effects for one type of climate damage in the U.S. economy: labor productivity losses from heat stress. We find that accounting for heterogeneous damages increases the welfare cost of the climate damage from heat stress by approximately 4 to 23%, depending on the discount factor.
Projecting the Impact of Rising Temperatures: The Role of Macroeconomic Dynamics
–August 1, 2022
Gregory Casey, Stephie Fried, Ethan GoodeWe use theory and empirics to distinguish between the impact of temperature on transition (temporary) and steady state (permanent) growth in output per capita. Standard economic theory suggests that the long-run growth rate of output per capita is determined entirely by the growth rate of total factor productivity (TFP). We find evidence suggesting that the level of temperature affects the level of TFP, but not the growth rate of TFP. This implies that a change in temperature will have a temporary, but not a permanent, impact on growth in output per capita. To highlight the quantitative importance of distinguishing between permanent and temporary changes in economic growth, we use our empirical estimates and theoretical framework to project the impacts of future increases in temperature from climate change. We find losses that are substantial, but smaller than those in the existing empirical literature that assumes a change in temperature permanently affects economic growth.
The Impact of COVID on Productivity and Potential Output
–September 1, 2022
John G. Fernald, Huiyu LiThe U.S. economy came into the pandemic, and looks likely to leave it, on a slow-growth path. The near- term level of potential output has fallen because of shortfalls in labor that should reverse over time. Labor productivity, to a surprising degree, has followed an accelerated version of its Great Recession path with initially strong growth followed by weak growth. But, as of mid-2022, it appears that the overall level of labor and total factor productivity are only modestly affected. The sign of the effect depends on whether we use the strong income-side measures of pandemic output growth or the much weaker expenditure-side measures. There is considerable heterogeneity across industries. We can explain some but not all of the heterogeneity through industry differences in cyclical utilization and off-the-clock hours worked. After accounting for these factors, industries where it is easy to work from home have grown somewhat faster than they did pre-pandemic. In contrast, industries where it is hard to work from home have performed extremely poorly.
Decomposing Supply and Demand Driven Inflation
–October 1, 2022
Adam ShapiroThe extent to which either supply or demand factors drive inflation has important implications for economic policy. I propose a framework to decompose inflation into supply- and demand-driven components. I generate two new data series, the supply and demand-driven contributions to personal consumption expenditures (PCE) inflation, which quantify the degree to which either demand or supply is driving inflation in a current month. The series show expected time-series patterns. The demand-driven contribution tends to decline during recessions, while the supply-driven contribution tends to follow food and energy prices. Monetary policy tightening acts to reduce the demand-driven contribution of inflation. Oil-supply shocks act to increase the supply driven contribution, but decrease the demand-driven contribution of inflation. The decompositions can be used to test theory or by policymakers and practitioners to track inflation drivers in real time.
Inflation and Wage Growth Since the Pandemic
–April 1, 2023
Oscar Jorda, Fernanda NechioFollowing the worst of the COVID-19 pandemic, inflation surged to levels last seen in the 1980s. Motivated by vast differences in pandemic support across countries, we investigate the subsequent response of inflation and its feedback to wages. We exploit the differences in pandemic support to identify the effect that these programs had on inflation and the passthrough to wages. Our empirical approach focuses on a novel dynamic difference-in-differences method based on local projections. Our estimates suggest that an increase of 5 percentage points in direct transfers (relative to trend) translates into about a peak 3 percentage points boost to inflation and wage growth. Moreover, higher inflation accentuates the role of inflation expectations on wage setting dynamics.
House Price Responses to Monetary Policy Surprises: Evidence from the U.S. Listings Data
–August 1, 2022
Denis Gorea, Oleksiy Kryvtsov, Marianna KudlyakExisting literature documents that house prices respond to monetary policy surprises with a significant delay, taking years to reach their peak response. We present new evidence of a much faster response. We exploit information contained in listings for the residential properties for sale in the United States between 2001 and 2019 from the CoreLogic Multiple Listing Service Dataset. Using high-frequency measures of monetary policy shocks, we document that a one standard-deviation contractionary monetary policy surprise lowers housing list prices by 0.2–0.3 percent within two weeks—a magnitude on par with the effect on stock prices. House prices respond stronger to the surprises to future rates as compared to the surprise changes in the federal funds rate. Sale prices are mostly pre-determined by list prices and do not independently respond to monetary policy surprises.
A Sufficient Statistics Approach for Macro Policy Evaluation
–April 1, 2022
Regis Barnichon, Geert MestersThe evaluation of macroeconomic policy decisions has traditionally relied on the formulation of a specific economic model. In this work, we show that two statistics are sufficient to detect, often even correct, non-optimal policies, i.e., policies that do not minimize the loss function. The two sufficient statistics are (i) the effects of policy shocks on the policy objectives, and (ii) forecasts for the policy objectives conditional on the policy decision. Both statistics can be estimated without relying on a specific model. We illustrate the method by studying US monetary policy decisions.
Evergreening
–August 1, 2023
Miguel Faria-e-Castro, Pascal Paul, Juan M. SánchezWe develop a simple model of concentrated lending where lenders have incentives for evergreening loans by offering better terms to firms that are close to default. We detect such lending behavior using loan-level supervisory data for the United States. Banks that own a larger share of a firm’s debt provide distressed firms with relatively more credit at lower interest rates. Building on this empirical validation, we incorporate the theoretical mechanism into a dynamic heterogeneous-firm model to show that evergreening affects aggregate outcomes, resulting in lower interest rates, higher levels of debt, and lower productivity.
Dynastic Home Equity
–July 1, 2022
Matteo Benetton, Marianna Kudlyak, John MondragonUsing a nationally representative panel of consumer credit records for the US from 1999 to 2021, we document a positive correlation between child and parent homeownership. We propose a new causal mechanism behind this relationship based on parents extracting home equity to help finance their child’s home purchase and quantify this mechanism in several ways. First, controlling for cohort, zip code, age, and the creditworthiness of parents and children, we find that children whose parents extract equity are 60% more likely to become a homeowner than children whose homeowner-parents do not extract equity. Second, using an event study approach, we find that the increase in child homeownership occurs almost entirely in the year when parents extract equity. Third, using variation in equity extraction induced by households near leverage constraints, we find parental equity extraction increases the child’s probability of becoming a homeowner by about five times. Our results highlight the importance of familial wealth for household wealth accumulation and housing wealth in particular. A back-of-the-envelope calculation suggests that dynastic home equity increases housing wealth inequality among young adults by 20%.
Making Sense of Negative Nominal Interest Rates
–June 1, 2022
Cynthia Balloch, Yann Koby, Mauricio UlateSeveral advanced economies implemented negative nominal interest rates in the middle of the last decade, seeking to provide further monetary accommodation once cuts in positive territory had been exhausted. Negative rates affect banks in novel ways, mostly because during times of negative policy rates the interest rate that banks pay households on their deposits usually remains close to zero. In this review, we analyze the large literature that studies the impact of negative nominal interest rates, proceeding in four steps. First, we explain the theoretical channels through which negative rates affect banks. Second, we discuss the empirical findings about bank outcomes under negative rates. Third, we describe the aggregate transmission channels that influence the macroeconomic implications of a policy rate cut in negative territory. Finally, we compare the general-equilibrium models that have been used to quantify the effectiveness of negative rates and highlight why they have obtained mixed results. We conclude that, if properly implemented, negative rates are a valuable tool that central banks should not discard outright. However, negative rates can have quantifiable costs for the financial sector, and their effectiveness is likely to decline if implemented for long periods.
Housing Demand and Remote Work
–May 1, 2022
John Mondragon, Johannes WielandWhat explains record U.S. house price growth since late 2019? We show that the shift to remote work explains over one half of the 23.8 percent national house price increase over this period. Using variation in remote work exposure across U.S. metropolitan areas we estimate that an additional percentage point of remote work causes a 0.93 percent increase in house prices after controlling for negative spillovers from migration. This cross-sectional estimate combined with the aggregate shift to remote work implies that remote work raised aggregate U.S. house prices by 15.1 percent. Using a model of remote work and location choice we argue that this estimate is a lower bound on the aggregate effect. Our results imply a fundamentals-based explanation for the recent increases in housing costs over speculation or financial factors, and that the evolution of remote work is likely to have large effects on the future path of house prices and inflation.
Minimum Wage Increases and Vacancies
–January 1, 2023
Marianna Kudlyak, Murat Tasci, Didem TuzemenUsing a unique data set and a novel identification strategy, we estimate the effect of minimum wage increases on job vacancy postings. Using occupation-specific county-level vacancy data from the Conference Board’s Help Wanted Online for 2005-2018, we find that state-level minimum wage increases lead to substantial declines in existing and new vacancy postings in occupations with a larger share of workers who earn close to the prevailing minimum wage. We estimate that a 10 percent increase in the state-level effective minimum wage reduces vacancies by 2.4 percent in the same quarter, and the cumulative effect is as large as 4.5 percent a year later, in these occupations relative to the rest. The negative effect on vacancies is more pronounced for occupations where workers typically have lower educational attainment (high school or less) and in counties with higher poverty rates. We argue that our focus on vacancies versus on employment has a distinct advantage of highlighting a mechanism through which minimum wage hikes affect labor markets. Our finding of a negative effect on vacancies is not inconsistent with the wide range of findings in the literature about the effect of minimum wage change on employment, which is driven by changes in both hiring and separation margins.
In Search of Dominant Drivers of the Real Exchange Rate
–April 1, 2022
Wataru Miyamoto, Thuy Lan Nguyen, Hyunseung OhWe uncover the major drivers of each macroeconomic variable and the real exchange rate at the business cycle frequency in G7 countries. In each country, the main drivers of key macro variables resemble each other and none of those account for a large fraction of the real exchange rate variances. We then estimate the dominant driver of the real exchange rate and find that (i) the shock is largely orthogonal to macro variables and (ii) the shock generates a significant deviation of the uncovered interest parity condition. We analyze international business cycle models that are consistent with our findings.
Dale W. Jorgenson: An Intellectual Biography
–March 1, 2022
John G. FernaldDale W. Jorgenson has been a central contributor to a wide range of economic and policy issues over a long and productive career. His research is characterized by a tight integration of economic theory, appropriate data that matches the theory, and sound econometrics. His groundbreaking work on the theory and empirics of investment established the research path for the economics profession. He is a founder of modern growth accounting: Official statistics in many countries, including the United States, implement Jorgenson’s methods. Relatedly, without Jorgenson’s unflagging efforts, consistent industry KLEMS datasets for many countries—which have been widely used in recent decades for growth accounting, econometrics, and other applications—would not exist. Jorgenson is also a pioneer in econometric modeling of producer and consumer behavior and of econometrically estimated, intertemporal general equilibrium modeling for policy analysis.
The UK Productivity “Puzzle” in an International Comparative Perspective
–March 1, 2022
John G. Fernald, Robert InklaarThe UK’s slow productivity growth since 2007 has been referred to as a "puzzle", as if it were a particularly UK-specific challenge. In this paper, we highlight how the United States and northern Europe experienced very similar slowdowns. The common slowdown in productivity growth was a slowdown in total factor productivity (TFP) growth; we find little evidence that capital deepening was an important independent factor. From a conditional-convergence perspective, most of the UK slowdown follows from the slowdown at the U.S. frontier. From the mid-1980s to 2007, the UK’s relative productivity level moved closer to the level of the U.S. and northern Europe, driven by essentially complete convergence in market services TFP. In contrast, manufacturing lost ground relative to the U.S. frontier prior to 2007, and remains far below the frontier. The relative ground lost after 2007 is modest—cumulating to about 4 percentage points—and is largely attributable to somewhat unfavorable industry weights and industry-specific issues in mining, rather than a systematic UK competitiveness problem.
Macroeconomic Drivers and the Pricing of Uncertainty, Inflation, and Bonds
–December 1, 2023
Brandyn Bok, Thomas M. Mertens, John C. Williams
The correlation between uncertainty shocks, as measured by changes in the VIX, and changes in breakeven inflation rates declined and turned negative after the Great Recession. This estimated time varying correlation is shown to be consistent with the predictions of a standard New Keynesian model with a lower bound on interest rates and a trend decline in the natural rate of interest. In one equilibrium of the model, higher uncertainty raises the probability of large shocks that leave the central bank constrained by the lower bound and unable to offset negative shocks. Resulting inflation shortfalls lower average inflation rates.
Automation and the Rise of Superstar Firms
–April 1, 2023
Hamid Firooz, Zheng Liu, Yajie WangWe document evidence that the rise in automation technology contributed to the rise of superstar firms in the past two decades. We explain the empirical link between automation and industry concentration in a general equilibrium framework with heterogeneous firms and variable markups. A firm can operate a labor-only technology or, by paying a per-period fixed cost, an automation technology that uses both workers and robots as inputs. Given the fixed cost, more productive, larger firms are more likely to automate. Increased automation boosts labor productivity, enabling large, robot-using firms to expand further, which raises industry concentration. Our calibrated model does well in matching the highly skewed automation usage toward a few superstar firms observed in the Census data. Since robots substitute for labor, increased automation raises sales concentration more than employment concentration, also consistent with empirical evidence. A modest subsidy for automating firms improves welfare since productivity gains outweigh increased markup distortions.
Fiscal Capacity and Commercial Bank Lending Under COVID-19
–March 1, 2023
Joshua Aizenman, Yothin Jinjarak, Mark M. SpiegelWe investigate the implications of government indebtedness for the efficacy of expansionary government spending in encouraging commercial bank lending growth during the COVID-19 pandemic. Our sample is a large cross-section of over 3000 banks from 71 countries. To address the likely endogeneity of government assistance, we instrument for extra-normal spending using disparities in pre-existing national political characteristics. Our results indicate that bank lending did respond to fiscal capacity, as higher public debt going into the crisis weakened the expansionary effects of higher spending on bank lending at economically and statistically significant levels. Moreover, this sensitivity was higher among weaker banks, suggesting sensitivity to the perceived implications of spending for government assistance going forward. We also found greater sensitivity in high-income economies and for small and medium-sized banks. Our results are robust to a variety of robustness tests, including perturbations in specification, sample, and estimation methodology.
The Road of Federal Infrastructure Spending Passes Through the States
–February 9, 2022
Sylvain Leduc, Daniel WilsonBecause federal infrastructure spending largely takes the form of grants to state governments, the macroeconomic impact of such packages depends on the share of federal grants that “passes through” to actual infrastructure spending done by states. A low degree of pass-through would tend to mute the economic impact from federal grants, reflecting a crowd-out effect on state spending. We first revisit Knight’s (2002) influential finding of near-zero pass-through (perfect crowd out) of federal highway grants. That result is found to be specification-sensitive and is reversed completely in a longer sample, with estimates implying dollar-for-dollar pass-through of grants to spending. We then extend the analysis to allow for dynamics. We find a contemporaneous pass-through effect of about 1 and a longer-run cumulative effect of around 1.3. In the parlance of public finance, the flypaper effect is strong.
Sellin’ in the Rain: Weather, Climate, and Retail Sales
–February 1, 2022
Brigitte Roth-TranI apply a novel machine-learning based “weather index” method to daily store- level sales data for a national apparel and sporting goods brand to examine short-run responses to weather and long-run adaptation to climate. I find that even when considering potentially offsetting shifts of sales between outdoor and indoor stores, to the firm’s website, or over time, weather has significant persistent effects on sales. This suggests that weather may increase sales volatility as more severe weather shocks be- come more frequent under climate change. Consistent with adaptation to climate, I find that sensitivity of sales to weather decreases with historical experience for precipitation, snow, and cold weather events, but-surprisingly-not for extreme heat events. This suggests that adaptation may moderate some but not all of the adverse impacts of climate change on sales. Retailers can respond by adjusting their staffing, inventory, promotion events, compensation, and financial reporting.
On the Inefficiency of Non-Competes in Low-Wage Labor Markets
–February 1, 2022
Bart Hobijn, Andre Kurmann, Tristan PotterWe study the efficiency of non-compete agreements (NCAs) in an equilibrium model of labor turnover. The model is consistent with empirical studies showing that NCAs reduce turnover, average wages, and wage dispersion for low-wage workers. But the model also predicts that NCAs, by reducing turnover, raise recruitment and employment. We show that optimal NCA policy: (i) is characterized by a Hosios like condition that balances the benefits of higher employment against the costs of inefficient congestion and poaching; (ii) depends critically on the minimum wage, such that enforcing NCAs can be efficient with a sufficiently high minimum wage; and (iii) alone cannot always achieve efficiency, also true of a minimum wage-yet with both instruments efficiency is always attainable. To guide policy makers, we derive a sufficient statistic in the form of an easily computed employment threshold above which NCAs are necessarily inefficiently restrictive, and show that employment levels in current low-wage U.S. labor markets are typically above this threshold. Finally, we calibrate the model to show that Oregon’s 2008 ban of NCAs for low-wage workers increased welfare, albeit modestly (by roughly 0.1%), and that if policy makers had also raised the minimum wage to its optimal level (a 30% increase), welfare would have increased more substantially-by over 1%.
Central Bank Credibility During COVID-19: Evidence from Japan
–August 1, 2022
Jens H. E. Christensen, Mark M. SpiegelJapanese realized and expected inflation has been below the Bank of Japan’s two percent target for many years. We examine the impact of announcements of expansionary monetary and fiscal policy under COVID-19 on inflation expectations from an arbitrage-free term structure model of nominal and real yields. We find that both types of policies failed to lift inflation expectations, which instead declined notably over the pandemic period and are projected to only slowly revert back to Bank of Japan target levels. Our results therefore illustrate the challenges faced in raising well-anchored low inflation expectations.
Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics
–September 1, 2023
Mathias S. Kruttli, Brigitte Roth-Tran, Sumudu W. WatugalaWe present a framework to identify market responses to firm-level uncertainty generated from extreme weather events. The stock options of firms with establishments in a hurricane’s landfall region exhibit large, long-lasting implied volatility increases, reflecting significant uncertainty. Comparing implied volatility to subsequent realized volatility, we find that investors underreact. After Hurricane Sandy, a particularly damaging event whose landfall struck the U.S. financial center, this underreaction diminishes. Despite constituting idiosyncratic volatility shocks, hurricanes affect expected returns. Discussions between analysts, investors, and management about hurricane impacts are elevated while uncertainty is high and reveal business interruption, physical damages, insurance, and demand as predominant channels.
Turbulent Business Cycles
–February 1, 2023
Ding Dong, Zheng Liu, Pengfei WangFirm-level evidence suggests that turbulence that reshuffles firms’ productivity rankings rises sharply in recessions. An increase in turbulence reallocates labor and capital from high- to low-productivity firms, reducing aggregate TFP and the stock market value of firms. A real business cycle model with heterogeneous firms and financial frictions can generate the observed macroeconomic and reallocation effects of turbulence. In the model, increased turbulence makes high-productivity firms less likely to remain productive, reducing their expected equity values and tightening their borrowing constraints relative to low-productivity firms. This leads to a reallocation that reduces aggregate TFP. Unlike uncertainty, turbulence changes both the conditional mean and the conditional variance of the firm productivity distribution, enabling a turbulence shock to generate a recession with synchronized declines in aggregate activities.
Productivity Slowdown: Reducing the Measure of Our Ignorance
–September 1, 2021
Timo Boppart, Huiyu LiGrowth accounting suggests that the bulk of the post-2004 slowdown in output growth in the U.S. is attributed to a residual called TFP. In this paper we provide a tractable accounting framework with firm heterogeneity to link this residual to innovations, markup dispersion, and potential measurement errors. Theories of creative destruction offer rich testable predictions of how the quality upgrading of products, the process efficiency of different firms, and markup dispersion in the market interact and therefore constitute a key approach to shed light on the slowdown in TFP growth. Surveying the literature on measurement, we conclude that measurement errors is unlikely to explain the recent deceleration in TFP growth.
The Inexorable Recoveries of U.S. Unemployment
–June 1, 2022
Robert E. Hall, Marianna KudlyakUnemployment recoveries in the US have been inexorable. In the aftermath of a recession, unless another crisis intervenes, unemployment continues to glide down. Between 1948 and 2019, the annual reduction in the unemployment rate during cyclical recoveries was distributed around 0.1 log points per year. The economy seems to have an irresistible force toward restoring full employment. Occasionally, unemployment rises rapidly during an economic crisis, while most of the time, unemployment declines slowly and smoothly at a near-constant proportional rate. Similar properties hold for other measures of the US unemployment rate and for unemployment in emerging and advanced countries.
International Evidence on Extending Sovereign Debt Maturities
–July 1, 2021
Jens H. E. Christensen, Jose A. Lopez, Paul L. MusschePortfolio diversification is as important to debt management as it is to asset management. In this paper, we focus on diversification of sovereign debt issuance by examining the extension of the maximum maturity of issued debt. In particular, we examine the potential costs to the U.S. Treasury of introducing 50-year bonds as a financing option. Based on evidence from foreign government bond markets with such long-term debt, our results suggest that a 50-year Treasury bond would likely trade at an average yield that is at most 20 basis points above that of a 30-year bond. Our results based on extrapolations from a dynamic yield curve model using just U.S. Treasury yields are similar.
From Deviations to Shortfalls: The Effects of the FOMC’s New Employment Objective
–July 1, 2021
Brent Bundick, Nicolas Petrosky-NadeauThe Federal Open Market Committee (FOMC) recently revised its interpretation of its maximum employment mandate. In this paper, we analyze the possible effects of this policy change using a theoretical model with frictional labor markets and nominal rigidities. A monetary policy which stabilizes “shortfalls” rather than “deviations” of employment from its maximum level leads to higher inflation and more hiring at all times due to expectations of more accommodative future policy. Thus, offsetting only shortfalls of employment results in higher nominal policy rates on average which provide more policy space and better outcomes during a zero lower bound episode. Our model suggests that the FOMC’s reinterpretation of its employment mandate could alter the business-cycle and longer-run properties of the economy and result in a steeper reduced-form Phillips curve.
The Unemployed with Jobs and without Jobs
–February 1, 2022
Robert E. Hall, Marianna KudlyakPotential workers are classified as unemployed if they seek work but are not working. The unemployed population contains two groups—those with jobs and those without jobs. Those with jobs are on furlough or temporary layoff. This group expanded tremendously in April 2020, at the trough of the pandemic recession. They wait out periods of non-work with the understanding that their jobs still exist and that they will be recalled. We show that the resulting temporary-layoff unemployment mostly dissipated by the end of 2020. Potential workers without jobs constitute what we call jobless unemployment. Shocks that elevate jobless unemployment have much more persistent effects. Historical major adverse shocks, such as the financial crisis in 2008, created mostly jobless unemployment and consequently caused extended periods of elevated unemployment. Jobless unemployment reached its pandemic peak in November 2020, at 4.9%, modest by historical standards, and has declined at a faster-than-historical pace since.
Dynamic Labor Reallocation with Heterogeneous Skills and Uninsured Idiosyncratic Risk
–June 18, 2021
Ester Faia, Marianna Kudlyak, Ekaterina ShabalinaOccupational specificity of human capital motivates an important role of occupational reallocation for the economy’s response to shocks and for the dynamics of inequality. We introduce occupational mobility, through a random choice model with dynamic value function optimization, into a multi-sector/multi-occupation Bewley-Aiyagari model with heterogeneous income risk, liquid and illiquid assets, price adjustment costs, and in which households differ by their occupation-specific skills. Labor income is a combination of endogenous occupational wages and idiosyncratic shock. Occupational reallocation and its impact on the economy depend on the transferability of workers’ skills across occupations and occupational specialization of the production function. The model matches well the statistics on income and wealth inequality, and the patterns of occupational mobility. It provides a laboratory for studying the short- and long-run effects of occupational shocks, automation and task encroaching on income and wealth inequality. We apply the model to the pandemic recession by adding an SIR block with occupation-specific infection risk and a ZLB policy and study the impact of occupational and aggregate labor supply shocks. We find that occupational mobility may tame the effect of the shocks but amplifies earnings inequality, as compared to a model without mobility.
Fiscal Foresight and Perverse Distortions to Firm Behavior: Anticipatory Dips and Compensating Rebounds
–March 1, 2023
Robert S. Chirinko, Daniel WilsonWe study the conditions under which fiscal foresight – forward-looking agents anticipating future policy changes – results in perverse economic behavior through unintended intertemporal tradeoffs. Somewhat surprisingly, fiscal foresight by itself is far from sufficient for policy-induced incentives to perversely distort firm behavior. Rather, we show that there are two additional sets of conditions, at least one of which must hold to generate perverse behavior: (i) storable output, diminishing returns, and a non- competitive output market; (ii) “rolling base” policy design and storable output. These conditions suggest that the estimated impacts of fiscal policies may be sensitive to underlying economic or legislative characteristics and that policies targeted to specific firms or industries with unique characteristics may not be generalizable.
Monetary Policy Spillovers Under Covid-19: Evidence from U.S. Foreign Bank Subsidiaries
–June 1, 2021
Mark M. SpiegelThis paper uses Call Report data to examine the impact of home country monetary policy on foreign bank subsidiary lending in the United States during the COVID-19 pandemic. Examining a large sample of foreign bank subsidiaries and domestic U.S. banks, we find that foreign bank lending growth was positively associated with both lower home country policy rates and negative home country rates. Our point estimates indicate that a one standard deviation decrease in home country policy rates was associated with a 3.5 percentage point increase in lending growth while negative home country policy rates added an additional 3.0 percentage points on average. Disparities in sensitivity to home country rates also exist by bank size, as large banks exhibited more responsiveness to home country policy rate levels, but were less responsive to negative policy rates. Easier home country policy rates are also found to impact negatively in growth in capital ratios and bank income, in keeping with expanded foreign subsidiary activity. However, income responses to negative home country rates are mixed, in a manner suggestive of sophisticated adjustment of global bank balance sheets to changes in relative home and host country monetary policy stances. Overall, our findings confirm that the bank lending channel for global monetary policy spillovers was active during the pandemic crisis.
UI Generosity and Job Acceptance: Effects of the 2020 CARES Act
–May 1, 2023
Nicolas Petrosky-Nadeau, Robert G. VallettaWe assess labor market effects of the CARES Act $600 UI supplement. We start with direct empirical analyses of labor force transitions using monthly CPS data and imputed UI benefits. The results show moderate disincentive effects of the supplement on job finding. We rationalize this result in a dynamic model of job acceptance decisions that yields a reservation level of UI benefits at which a recipient is indifferent between unemployment and employment at their prior wage. Calculations based on the model confirm that only a small fraction of recipients of the enhanced UI benefits were likely to reject job offers.
Communicating Monetary Policy Rules
–September 1, 2022
Troy Davig, Andrew FoersterDespite the ubiquity of inflation targeting, central banks communicate their frameworks in a variety of ways. No central bank explicitly expresses their conduct via a policy rule, which contrasts with models of policy. Central banks often connect theory with practice by publishing inflation forecasts that can, in principle, implicitly convey their reaction function. We return to this central idea to show how a central bank can achieve the gains of a rule-based policy without publicly stating a specific rule. The approach requires central banks to specify an inflation target, inflation tolerance bands, and provide economic projections. When inflation moves outside the band, inflation forecasts provide a time frame over which inflation will return to within the band. We show how this communication replicates and provides the same information as a rule-based policy. The communication strategy produces a natural benchmark for assessing central bank performance. We illustrate these features in a counterfactual monetary policy history of the United States.
The Economic Gains from Equity
–April 8, 2021
Shelby R. Buckman, Laura Choi, Mary C. Daly, Lily M. SeitelmanHow much is inequity costing us? Using a simple growth accounting framework we apply standard shift-share techniques to data from the Current Population Survey (1990-2019) to compute the aggregate economic costs of persistent educational and labor market disparities by gender and race. We find significant economic losses associated with these gaps. Building on this finding, we consider which disparities generate the largest costs, paying specific attention to differences in employment, hours worked, educational attainment, educational utilization, and occupational allocation. We also examine gaps in the returns on these variables. Our findings suggest that differences in employment opportunities and educational attainment make the largest contributions by race; differences in returns on these variables also contribute materially to the total costs. Differences by gender are primarily driven by gaps in employment and hours. Given the disproportionate impact of COVID-19 on the labor market outcomes of women and people of color, as well as the fact that the U.S. population is increasingly racially diverse, these costs will only increase in the future.
Small Business Lending Under the PPP and PPPLF Programs
–April 1, 2021
Jose A. Lopez, Mark M. SpiegelWe examine the effects of the Paycheck Protection Program (PPP) and the PPP Liquidity Facility (PPPLF) on small business lending. The PPP was launched under the CARES Act of March 2020 to provide support for small businesses under the COVID-19 pandemic, while the PPPLF was an affiliated program administered by the Federal Reserve to facilitate the maintenance of liquidity among banks participating in the PPP. We use Call Report data to examine the contributions of these two programs on small business and farm lending by individual commercial banks in the United States. As participation in the programs was associated with lending to small businesses directly, we use an instrumental variables (IV) approach to identify a causal effect of the programs on lending based on historical bank relationships with the Small Business Administration that administered the PPP. Our results suggest that both the PPP and the PPPLF had a marked positive effect on growth in small business and farm lending over the first half of 2020. However, while the PPP seemed to encourage greater lending growth by banks of all asset sizes, only small- and medium-sized bank lending was significantly influenced by participation in the PPPLF. We also find that while both programs had significant positive effects on small business lending, they did not influence small loans to farms over this period, which is likely due to a structural feature of the PPP. Finally, while participation in both programs increased bank balance sheets, we find that risk-adjusted bank capital ratios actually improved with PPP and PPPLF participation.
The Impact of COVID on Potential Output
–March 3, 2021
John G. Fernald, Huiyu LiThe level of potential output is likely to be subdued post-COVID relative to its previous estimates. Most clearly, capital input and full-employment labor will both be lower than they previously were. Quantitatively, however, these effects appear relatively modest. In the long run, labor scarring could lead to lower levels of employment, but the slow pre-recession pace of GDP growth is unlikely to be substantially affected.
Inflation Expectations and Risk Premia in Emerging Bond Markets: Evidence from Mexico
–November 1, 2021
Remy Beauregard, Jens H. E. Christensen, Eric Fischer, Simon ZhuTo study inflation expectations and associated risk premia in emerging bond markets, this paper provides estimates for Mexico based on an arbitrage-free dynamic term structure model of nominal and real bond prices that accounts for their liquidity risk. In addition to documenting the existence of large and time-varying liquidity premia in nominal and real bond prices that are only weakly correlated, the results indicate that long-term inflation expectations in Mexico are well anchored close to the inflation target of the Bank of Mexico. Furthermore, Mexican inflation risk premia are larger and more volatile than those in Canada and the United States.
Seawalls and Stilts: A Quantitative Macro Study of Climate Adaptation
–January 1, 2021
Stephie FriedCan we reduce the damage from climate change by investing in seawalls, stilts, or other forms of adaptation? Focusing on the case of severe storms in the US, I develop a macro heterogeneous-agent model to quantify the interactions between adaptation, federal disaster policy, and climate change. The model departs from the standard climate damage function and incorporates the damage from storms as the realization of idiosyncratic shocks. I find that while the moral hazard effects from disaster aid reduce adaptation in the US economy, federal subsidies for investment in adaptation more than correct for the moral hazard. I introduce climate change into the model as a permanent increase in either or both the severity or probability of storms. Adaptation reduces the damage from this climate change by approximately one third. Finally, I show that modeling the idiosyncratic risk component of climate damage has quantitatively important implications for adaptation and for the welfare cost of climate change.
Climate Policy Transition Risk and the Macroeconomy
–June 1, 2022
Stephie Fried, Kevin Novan, William B. PetermanUncertainty surrounding if the U.S. will implement a federal climate policy introduces risk into the decision to invest in long-lived capital assets, particularly those designed to use, or to replace fossil fuel. We develop a dynamic, general equilibrium model to quantify the macroeconomic impacts of this climate policy transition risk. The model incorporates beliefs over the likelihood that the government adopts a climate policy causing the economy to dynamically transition to a lower carbon steady state. We find that climate policy transition risk decreases carbon emissions today by causing investment to become relatively cleaner and output to fall. This result counters the Green Paradox, which argues that climate policy risk raises emissions today by increasing incentives to extract fossil fuel, expanding its supply. Even allowing for the supply-side response, we find the demand-side response dominates, and the net effect of climate policy transition risk is still to reduce emissions today.
The Economic Status of People with Disabilities and their Families since the Great Recession
–March 1, 2021
Leila Bengali, Mary C. Daly, Olivia Lofton, Robert G. VallettaPeople with disabilities face substantial barriers to sustained employment and stable, adequate income. We assess how they and their families fared during the long economic expansion that followed the Great Recession of 2007-09, using data from the monthly Current Population Survey (CPS) and the March CPS annual income supplement. We find that the expansion bolstered the well-being of people with disabilities and in particular their relative labor market engagement. We also find that applications and awards for federal disability benefits fell during the expansion. On balance, our results suggest that sustained economic growth can bolster the labor market engagement of people with disabilities and potentially reduce their reliance on disability benefits.
Parents in a Pandemic Labor Market
–February 5, 2021
Olivia Lofton, Nicolas Petrosky-Nadeau, Lily SeitelmanGender gaps in labor market outcomes during the pandemic are largely due to differences across parents: Employment and labor force participation fell much less for fathers as compared to women and non-parent men at the onset of the pandemic; the recovery has been more pronounced for men and women without children, and; the labor force participation rate of mothers has resumed declining following the start of the school year. The latter is partially offset in states with limited school re-openings. Evidence suggests flexibility in setting work schedules offsets some of the adverse impact of the pandemic on mothers’ employment, while the ability to work from home does not.
Clouded in Uncertainty: Pursuing Financial Stability with Monetary Policy
–January 1, 2021
Sylvain Leduc
Replicating Business Cycles and Asset Returns with Sentiment and Low Risk Aversion
–March 1, 2023
Kevin J. LansingI solve for the sequences of shocks (or wedges) that allow a standard real business cycle model to exactly replicate the quarterly time paths of U.S. macroeconomic variables and asset returns since 1960. The resulting shock sequences can be grouped into three main categories: (1) shocks that affect household sentiment and preferences, (2) shocks that appear in the law of motion for capital, and (3) shocks that appear in the production function for output. For most variables including output, no single shock category is clearly dominant in explaining the observed movements in U.S. data. While some variables are driven by a single dominant shock category, the dominant category is different for each of those variables. The results imply that there is no “most important shock.” Rather, U.S. economic outcomes have been shaped by a complex and time-varying mixture of fundamental and non-fundamental disturbances.
Understanding the Size of the Government Spending Multiplier: It’s in the Sign
–January 1, 2021
Regis Barnichon, Davide Debortoli, Christian MatthesThis paper argues that an important, yet overlooked, determinant of the government spending multiplier is the direction of the fiscal intervention. Regardless of whether we identify government spending shocks from (i) a narrative approach, or (ii) a timing restriction, we find that the contractionary multiplier- the multiplier associated with a negative shock to government spending- is above 1 and largest in times of economic slack. In contrast, the expansionary multiplier- the multiplier associated with a positive shock- is substantially below 1 regardless of the state of the cycle. These results help understand seemingly conflicting results in the literature. A simple theoretical model with incomplete financial markets and downward nominal wage rigidities can rationalize our findings.
Zombies at Large? Corporate Debt Overhang and the Macroeconomy
–December 3, 2020
Oscar Jorda, Martin Kornejew, Moritz Schularick, Alan M. TaylorWith business leverage at record levels, the effects of corporate debt overhang on growth and investment have become a prominent concern. In this paper, we study the effects of corporate debt overhang based on long-run cross-country data covering the near universe modern business cycles. We show that business credit booms typically do not leave a lasting imprint on the macroeconomy. Quantile local projections indicate that business credit booms do not affect the economy’s tail risks either. Yet in line with theory, we find that the economic costs of corporate debt booms rise when inefficient debt restructuring and liquidation impede the resolution of corporate financial distress and make it more likely that corporate zombies creep along.
Accounting for Low Long-Term Interest Rates: Evidence from Canada
–July 1, 2023
Jens H. E. Christensen, Glenn D. Rudebusch, Patrick J. ShultzIn recent decades, long-term interest rates around the world have fallen to historic lows despite some recent reversal. We examine the source of this decline using a dynamic term structure model of Canadian nominal and real yields with adjustments for term, liquidity, and inflation risk premiums. Canada provides a novel perspective on this issue because of its established indexed debt market, negligible distortions from monetary quantitative easing or the zero lower bound, and absence of sovereign credit risk. We find that in the 2000-2019 period, the steady-state real interest rate fell by more than 2 percentage points, long-term inflation expectations edged down, and real bond and inflation risk premiums varied over time but showed little longer-run trend. Therefore, the drop in the equilibrium real rate appears largely to account for the lower new normal in interest rates.
The Local Economic Impact of Natural Disasters
–February 1, 2023
Brigitte Roth-Tran, Daniel WilsonWe use nearly four decades of U.S. county data to study dynamic local economic impacts of natural disasters that trigger federal aid. We find these disasters on average raise personal income per capita in the longer run (8 years out). We also find that, in the longer run, wages and home prices are higher, while employment and population are unaffected, suggesting the income boost may reflect productivity increases and greater demand for housing in supply-constrained areas or compositional shifts. Allowing for heterogeneity across disaster types, we find the longer-run income boost is driven primarily by hurricanes and tornadoes. We also find the longer-run boost increases with damages, suggestive of an important role for insurance and government aid—which are highly correlated with damages—in fueling recovery. A spatial spillover analysis suggests the longer-run net effects of local aid-inducing disasters for wider regions are near-zero.
Learning in the Oil Futures Markets: Evidence and Macroeconomic Implications
–October 1, 2020
Sylvain Leduc, Kevin Moran, Robert J. VigfussonUsing expectations embodied in oil futures prices, we examine how expectations are formed and how they affect the macroeconomic transmission of shocks. We show that an empirical framework in which investors form expectations by learning about the persistence of oil-price movements successfully replicates the fluctuations in oil-price futures since the late 1990s. We then embed this learning mechanism in a model with oil usage and storage. Estimating the model, we document that an increase in the persistence of TFP-driven fluctuations in oil demand largely account for investors’ perceptions that oil-price movements became increasingly permanent during the 2000s before declining thereafter. We show that the presence of learning alters the macroeconomic impact of shocks, making the responses time-dependent and conditional on the views of economic agents about the shocks’ likely persistence.
Trade with Nominal Rigidities: Understanding the Unemployment and Welfare Effects of the China Shock
–March 1, 2022
Andres Rodrıguez-Clare, Mauricio Ulate, Jose P. VasquezWe present a dynamic quantitative trade and migration model that incorporates downward nominal wage rigidities and show how this framework can generate changes in unemployment and labor participation that match those uncovered by the empirical literature studying the “China shock.” We find that the China shock leads to average welfare increases in most U.S. states, including many that experience unemployment during the transition. However, nominal rigidities reduce the overall U.S. gains by around one fourth. In addition, there are seven states that experience welfare losses in the presence of downward nominal wage rigidity that would have experienced gains without it.
Alternative Models of Interest Rate Pass-Through in Normal and Negative Territory
–September 24, 2020
Mauricio UlateIn the aftermath of the Great Recession, many countries used low or negative policy rates to stimulate the economy. These policies gave rise to a rapidly growing literature that seeks to understand and quantify their impact. A fundamental step when studying the effectiveness of low and negative policy rates is to understand their transmission to loan and deposit rates. This paper proposes two models of pass-through from policy rates to loan and deposit rates that can match important stylized facts while remaining parsimonious. These models can be used to study the transition between positive and negative policy rates and to quantify the impact of negative rates on banks.
Competitive Effects of IPOS: Evidence from Chinese Listing Suspensions
–September 23, 2020
Frank Packer, Mark M. SpiegelTheory suggests that initial public offerings (IPOs) can adversely impact listed firms, both directly by increasing intra-industry competition, and indirectly by completing related asset market spaces. However, the endogeneity of individual IPO activity hinders testing these channels. This paper examines listing suspensions in China in a panel specification that accounts for macroeconomic and financial conditions, isolating the firm-level IPO impact. We measure the competitive impact of listing suspensions through the value share of postponed firms in the IPO queue in their industry, and asset-space competition by firms’ historical covariance with a synthetic portfolio of listed firms with the IPO queue industry mix at the time of suspension. Our results support the predicted IPO effects through both channels. We also document heterogeneity in IPO effects. Stronger firms measured through a variety of proxies–benefit less from the suspension news. These results are robust to a battery of sensitivity tests.
A Simple Framework to Monitor Inflation
–June 1, 2022
Adam ShapiroThis paper proposes a simple framework to help monitor and understand movements in PCE inflation in real time. The approach is to decompose inflation using simple categorical-level regressions or systems of equations. The estimates are then used to group categories into components of PCE inflation. I review some applications of the methodology, and show how it can help explain inflation dynamics over recent episodes. The methodology shows that inflation remained low in the mid-2010s primarily because of factors unrelated to aggregate economic conditions. I also apply the methodology to the Covid-19 pandemic. The decomposition reveals that a majority of elevated inflation in core PCE inflation in the 2021 2022 period was due to "Covid-sensitive" categories, that is, those categories where prices and quantities moved the most at the onset of the pandemic. Finally, I show how the methodology can be applied in a dynamic fashion, labeling categories as either supply- or demand-driven by month. This decomposition allows one to assess the extent to which supply and demand factors are impacting inflation.
Reservation Benefits: Assessing Job Acceptance Impacts of Increased UI Payments
–August 31, 2020
Nicolas Petrosky-NadeauJob acceptance decisions weigh the value of a job against remaining unemployed. A reservation level of benefit payments exists in this dynamic decision problem at which an individual is indifferent between accepting and refusing an offer. This reservation benefit is a simple statistic summarizing the decision problem conditional on the believed state of the labor market and the weeks of Unemployment Insurance (UI) compensation remaining. Estimating the reservation benefit for a wide range of US workers suggests few would turn down an offer to return to work at the previous wage under the CARES Act expanded UI payments.
Bank Risk-Taking, Credit Allocation, and Monetary Policy Transmission: Evidence from China
–July 1, 2023
Xiaoming Li, Zheng Liu, Yuchao Peng, Zhiwei XuUsing confidential loan-level data from a large Chinese bank, we examine how Basel III implementation influenced the responses of bank risk-taking to monetary policy shocks. We use a difference-in-differences (DID) approach, exploiting disparities in lending behavior between high- and low-risk bank branches before and after the new regulations. Our findings reveal a novel risk-weighting channel through which monetary policy easing significantly reduced bank risk-taking. However, this risk reduction was achieved by shifting lending towards ostensibly low-risk state-owned enterprises (SOEs) with government guarantees, despite their lower average productivity. Our findings suggest a tradeoff facing China’s monetary policy between curbing bank risks and addressing credit misallocation.
The Credit Line Channel
–August 1, 2023
Daniel L. Greenwald, John Krainer, Pascal PaulAggregate U.S. bank lending to firms expanded following the outbreak of COVID-19. Using loan-level supervisory data, we show that this expansion was driven by draws on credit lines by large firms. Banks that experienced larger credit line drawdowns restricted term lending more, crowding out credit to smaller firms, which reacted by reducing investment. A structural model calibrated to match our empirical results shows that while credit lines increase total bank credit in bad times, they redistribute credit from firms with high propensities to invest to firms with low propensities to invest, exacerbating the fall in aggregate investment.
The Rising Cost of Climate Change: Evidence from the Bond Market
–June 1, 2021
Michael Bauer, Glenn D. RudebuschSocial discount rates (SDRs) are crucial for evaluating the costs of climate change. We show that the fundamental anchor for market-based SDRs is the equilibrium or steady-state real interest rate. Empirical interest rate models that allow for shifts in this equilibrium real rate find that it has declined notably since the 1990s, and this decline implies that the entire term structure of SDRs has shifted lower as well. Accounting for this new normal of persistently lower interest rates substantially boosts estimates of the social cost of carbon and supports a climate policy with stronger carbon mitigation strategies.
Replicating and Projecting the Path of COVID-19 with a Model-Implied Reproduction Number
–July 13, 2020
Shelby R. Buckman, Reuven Glick, Kevin J. Lansing, Nicolas Petrosky-Nadeau, Lily M. SeitelmanWe demonstrate a methodology for replicating and projecting the path of COVID-19 using a simple epidemiology model. We fit the model to daily data on the number of infected cases in China, Italy, the United States, and Brazil. These four countries can be viewed as representing different stages, from later to earlier, of a COVID-19 epidemic cycle. We solve for a model-implied effective reproduction number Rt each day so that the model closely replicates the daily number of currently infected cases in each country. For out-of-sample projections, we fit a behavioral function to the in-sample data that allows for the endogenous response of Rt to movements in the lagged number of infected cases. We show that declines in measures of population mobility tend to precede declines in the model-implied reproduction numbers for each country. This pattern suggests that mandatory and voluntary stay-at-home behavior and social distancing during the early stages of the epidemic worked to reduce the effective reproduction number and mitigate the spread of COVID-19.
Weather, Mobility, and COVID-19: A Panel Local Projections Estimator for Understanding and Forecasting Infectious Disease Spread
–February 1, 2021
Daniel WilsonThis paper develops an econometric panel data model that can be used both to identify the dynamic effects of disease transmission factors and to forecast disease spread. The empirical model is derived from the canonical SIR epidemiological model of infectious disease spread. The model is estimated using near real-time, county-level data on mobility, weather, and COVID-19 cases. Both mobility and weather are found to have significant effects on COVID-19 effects up to 70 days ahead. Predicted values from the estimated model, augmented to incorporate recent vaccinations, provide out-of-sample forecasts of COVID-19 infections at the county and national levels. Prior forecasts are shown to have been fairly accurate, especially in terms of the geographical/cross-sectional distribution of COVID-19 infections and in terms of the national aggregate forecast. The latest forecasts, using data through February 19, 2021, predict steep declines in infections in most parts of the country over the next several weeks. Nationally, infections are predicted to fall by 59% over the subsequent 30 days. Decomposing the drivers of the latest forecast, the model indicates that accumulated natural immunity (i.e., cumulative infections to date, a.k.a. “seroprevalence”) is the primary factor exerting a strong downward pull on new infections.
Does Disappointing European Productivity Growth Reflect a Slowing Trend? Weighing the Evidence and Assessing the Future
–June 29, 2020
John G. Fernald, Robert InklaarIn the years since the Great Recession, many observers have highlighted the slow pace of labor and total factor productivity (TFP) growth in advanced economies. This paper focuses on the European experience, where we highlight that trend TFP growth was already low in the runup to the Global Financial Crisis (GFC). This suggests that it is important to consider factors other than just the deep crisis itself or policy changes since the crisis. After the mid-1990s, European economies stopped converging, or even began diverging, from the U.S. level of TFP. That said, in contrast to the United States, there is some macroeconomic evidence for some northern European countries that the GFC had a further adverse impact on TFP growth. Still, the challenges for economic policy look surprisingly similar to the ones discussed prior to the Great Recession, even if the policy implications seem less clear.
Average Is Good Enough: Average-Inflation Targeting and the ELB
–June 25, 2020
Robert Amano, Stefano Gnocchi, Sylvain Leduc, Joel WagnerThe Great Recession and current pandemic have focused attention on the constraint on nominal interest rates from the effective lower bound. This has renewed interest in monetary policies that embed makeup strategies, such as price-level or average-inflation targeting. This paper examines the properties of average-inflation targeting in a two-agent New Keynesian (TANK) model in which a fraction of firms have adaptive expectations. We examine the optimal degree of history dependence under average-inflation targeting and find it to be relatively short for business cycle shocks of standard magnitude and duration. In this case, we show that the properties of the economy are quantitatively similar to those under a price-level target.
Why Has the US Economy Recovered So Consistently from Every Recession in the Past 70 Years?
–May 20, 2020
Robert E. Hall, Marianna KudlyakIt is a remarkable fact about the historical US business cycle that, after unemployment reached its peak in a recession, and a recovery began, the annual reduction in the unemployment rate was stable at around 0.55 percentage points per year. The economy seems to have had an irresistible force toward restoring full employment. There was high variation in monetary and fiscal policy, and in productivity and labor-force growth, but little variation in the rate of decline of unemployment. We explore models of the labor market’s self-recovery that imply gradual working off of unemployment following a recession shock. These models explain why the recovery of market-wide unemployment is so much slower than the rate at which individual unemployed workers find new jobs. The reasons include the fact that the path that individual job-losers follow back to stable employment often includes several brief interim jobs, sometimes separated by time out of the labor force. We show that the evolution of the labor market involves more than the direct effect of persistent unemployment of job-losers from the recession shock–unemployment during the recovery is elevated for people who did not lose jobs during the recession.
Can Pandemic-Induced Job Uncertainty Stimulate Automation?
–May 8, 2020
Sylvain Leduc, Zheng LiuThe COVID-19 pandemic has raised concerns about the future of work. The pandemic may become recurrent, necessitating repeated adoptions of social distancing measures (voluntary or mandatory), creating substantial uncertainty about worker productivity. But robots are not susceptible to the virus. Thus, pandemic-induced job uncertainty may boost the incentive for automation. However, elevated uncertainty also reduces aggregate demand and reduces the value of new investment in automation. We assess the importance of automation in driving business cycle dynamics following an increase in job uncertainty in a quantitative New Keynesian DSGE framework. We find that, all else being equal, job uncertainty does stimulate automation, and increased automation helps mitigate the negative impact of uncertainty on aggregate demand.
Unemployment Paths in a Pandemic Economy
–September 15, 2020
Nicolas Petrosky-Nadeau, Robert G. VallettaThe COVID-19 pandemic upended the U.S. economy and labor market. We explore potential paths for the official unemployment rate through 2021. Our analyses rely on historical patterns of monthly flows in and out of unemployment, adjusted for unique features of the virus economy. The possible unemployment trajectories vary widely, but absent sustained hiring activity on an unprecedented scale, unemployment could remain substantially elevated into 2021. After adjusting the unemployment rate for unique measurement challenges created by virus containment measures, we find that unemployment has followed a fast recovery track during the first six months of the pandemic.
World Productivity: 1996-2014
–March 1, 2020
Mehrdad Esfahani, John G. Fernald, Bart HobijnWe account for the sources of world productivity growth, using data for more than 36 industries and 40 major economies from 1996 to 2014, explicitly taking into account changes in the misallocation of resources in labor, capital, and product markets. Productivity growth in advanced economies slowed but emerging markets grew more quickly which kept global productivity growth relatively constant until around 2010. After that, productivity growth in all major regions slowed. Much of the volatility in world productivity growth reflects shifts in the misallocation of labor across countries and industries. Using new data on PPP-based value-added measures by country and industry, we show that about a third of these shifts is due to employment growing in countries, most notably China and India, that benefit from an international cost advantage. Markups are large and rising and impact the imputed misallocation of capital. However, they have little effect on the country-industry technology contribution to global productivity.
Innovative Growth Accounting
–April 30, 2020
Peter J. Klenow, Huiyu LiRecent work highlights a falling entry rate of new firms and a rising market share of large firms in the United States. To understand how these changing firm demographics have affected growth, we decompose productivity growth into the firms doing the innovating. We trace how much each firm innovates by the rate at which it opens and closes plants, the market share of those plants, and how fast its surviving plants grow. Using data on all nonfarm businesses from 1982-2013, we find that new and young firms (ages Oto 5 years) account for almost one-half of growth- three times their share of employment. Large established firms contribute only one-tenth of growth despite representing one-fourth of employment. Older firms do explain most of the speedup and slowdown during the middle of our sample. Finally, most growth takes the form of incumbents improving their own products, as opposed to creative destruction or new varieties.
Learning about Regime Change
–December 1, 2021
Andrew Foerster, Christian MatthesTotal factor productivity (TFP) and investment specific technology (IST) growth both exhibit regime switching behavior, but the regime at any given time is difficult to infer. We build a rational expectations real business cycle model where the underlying TFP and IST regimes are unobserved. We develop a general perturbation solution algorithm for a wide class of models with unobserved regime-switching. Using our method, we show learning about regime-switching fits the data, affects the responses to regime shifts and intra-regime shocks, increases asymmetries in the responses, generates forecast error bias even with rational agents, and raises the welfare cost of fluctuations.
Capital Flows and Income Inequality
–March 1, 2023
Zheng Liu, Mark M. Spiegel, Jingyi ZhangWe document empirical evidence that surges in capital inflows (outflows) raise (reduce) income inequality. We study the mechanism through which changes in capital flows and capital account policies can influence income distributions in a small open economy model. Our model features heterogeneous agents and financial frictions, with banks intermediating between household savings and entrepreneur investment. Inflow surges disproportionately raise entrepreneur income, exacerbating inequality, while increases in outflows boost the share of household income, alleviating inequality. Under capital-skill complementarity, capital account liberalization that induces net capital inflows raises both the skill wage premium and overall income inequality. These predictions are in line with our empirical evidence.
The Costs of Payment Uncertainty in Healthcare Markets
–April 13, 2020
Abe Dunn, Joshua D. Gottlieb, Adam Shapiro, Pietro TebaldiWhat does it cost healthcare providers to collect payment in the complex U.S. health insurance system? We study this question using rich data on repeated interactions between a large sample of physicians and many different payers, and investigate the consequences when these costs are high. Payment uncertainty is high and variable, with 19% of Medicaid visits not reimbursed after the first claim submission. In such cases, physicians either forgo substantial revenue or incur costs to collect payment. Using physician movers and practices that span state boundaries, we find that providers respond to these costs by refusing to accept Medicaid patients in states with more severe billing hurdles. This supply margin is even more responsive to these costs than to reimbursement rates. Using these supply estimates, we calculate that the costs of billing Medicaid consume one-quarter of the average revenue from a Medicaid visit. We estimate a model of the billing process, and find that the variable costs of billing each visit account for 21 percentage points of this total cost. Analyzing healthcare prices without accounting for billing costs and payment uncertainty may substantially misrepresent differences between private payers and Medicaid.
Decomposing the Fiscal Multiplier
–September 1, 2020
James S. Cloyne, Oscar Jorda, Alan M. TaylorThe fiscal “multiplier” measures how many additional dollars of output are gained or lost for each dollar of fiscal stimulus or contraction. In practice, the multiplier at any point in time depends on the monetary policy response and existing conditions in the economy. Using the IMF fiscal consolidations dataset for identification and a new decomposition-based approach, we show how to quantify the importance of these monetary-fiscal interactions. In the data, the fiscal multiplier varies considerably with monetary policy: it can be zero, or as large as 2 depending on the monetary offset. More generally, we show how to decompose the typical macro impulse response function by extending local projections to carry out the well-known Blinder-Oaxaca decomposition. This provides a convenient way to evaluate the effects of policy, state-dependence, and balance conditions for identification.
Disasters Everywhere: The Costs of Business Cycles Reconsidered
–August 9, 2020
Oscar Jorda, Moritz Schularick, Alan M. TaylorBusiness cycles are costlier and stabilization policies could be more beneficial than widely thought. This paper introduces a new test to show that all business cycles are asymmetric and resemble “mini-disasters.” By this we mean that growth is pervasively fat-tailed and non-Gaussian. Using long-run historical data, we show empirically that this is true for advanced economies since 1870. Focusing on peacetime eras, we develop a tractable local projection framework to estimate consumption growth paths for normal and financial-crisis recessions. Introducing random coefficient local projections (RCLP) we get an easy and transparent mapping from the estimates to a calibrated simulation model with disasters of variable severity. Simulations show that substantial welfare costs arise not just from the large rare disasters, but also from the smaller but more frequent mini-disasters in every cycle. On average, and in post-WW2 data, even with low risk aversion, households would sacrifice about 15 percent of consumption to avoid such cyclical fluctuations.
Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime-Switching Approach
–July 1, 2021
Gianluca Benigno, Andrew Foerster, Christopher Otrok, Alessandro RebucciWe develop a new approach to estimating DSGE models with occasionally binding borrowing constraints and apply it to Mexico’s business cycle and financial crisis history. We propose a new endogenous regime-switching specification of the borrowing constraint, develop a general perturbation method to solve the model, and estimate it using Bayesian methods. The estimated model fits the data with well-behaved shocks, identifying three crisis episodes of varying duration and intensity: the early-1980s Debt Crisis, the mid-1990s Tequila Crisis, and the late-2000s Global Financial Crisis. The estimated crisis episodes are much more persistent and in line with the data than traditional models.
Longer-Run Economic Consequences of Pandemics
–June 30, 2020
Oscar Jorda, Sanjay R. Singh, Alan M. TaylorWhat are the medium- to long-term effects of pandemics? How do they differ from other economic disasters? We study major pandemics using the rates of return on assets stretching back to the 14th century. Significant macroeconomic after-effects of pandemics persist for decades, with real rates of return substantially depressed, in stark contrast to what happens after wars. Our findings are consistent with the neoclassical growth model: capital is destroyed in wars, but not in pandemics; pandemics instead may induce relative labor scarcity and/or a shift to greater precautionary savings.
Has the Information Channel of Monetary Policy Disappeared? Revisiting the Empirical Evidence
–March 2, 2020
Lukas Hoesch, Barbara Rossi, Tatevik SekhposyanDoes the Federal Reserve have an “information advantage” in forecasting macroeconomic variables beyond what is known to private sector forecasters? And are market participants reacting only to monetary policy shocks or also to future information on the state of the economy that the Federal Reserve communicates in its announcements via an “information channel”? This paper investigates the evolution of the information channel over time. Although the information channel appears to be important historically, we find no empirical evidence of its presence in the recent years once instabilities are accounted for.
Banks, Maturity Transformation, and Monetary Policy
–October 1, 2022
Pascal PaulBanks engage in maturity transformation and the term premium compensates them for bearing the associated interest rate risk. Consistent with this view, I show that banks’ net interest margins and term premia have comoved in the United States over the last decades. On monetary policy announcement days, bank equity falls more sharply than nonbank equity following an increase in expected future short-term rates, but also responds more positively if term premia increase. These effects are reflected in bank cash-flows and amplified for banks with a larger maturity mismatch. The results reveal that banks are not immune to interest rate risk.
An Alternative Explanation for the “Fed Information Effect”
–September 1, 2021
Michael Bauer, Eric T. SwansonHigh-frequency changes in interest rates around FOMC announcements are a standard method of measuring monetary policy shocks. However, some recent studies have documented puzzling effects of these shocks on private-sector forecasts of GDP, unemployment, or inflation that are opposite in sign to what standard macroeconomic models would predict. This evidence has been viewed as supportive of a “Fed information effect” channel of monetary policy, whereby an FOMC tightening (easing) communicates that the economy is stronger (weaker) than the public had expected. We show that these empirical results are also consistent with a “Fed response to news” channel, in which incoming, publicly available economic news causes both the Fed to change monetary policy and the private sector to revise its forecasts. We provide substantial new evidence that distinguishes between these two channels and strongly favors the latter; for example, (i) regressions that include the previously omitted public economic news, (ii) a new survey that we conduct of Blue Chip forecasters, and (iii) high-frequency financial market responses to FOMC announcements all indicate that the Fed and private sector are simply responding to the same public news, and that there is little if any role for a “Fed information effect”.
Why Is Current Unemployment So Low?
–February 1, 2020
Andreas Hornstein, Marianna KudlyakCurrent unemployment, as of 2019Q4, is so low not because of unusually high job finding rates out of unemployment, but because of unusually low entry rates into unemployment. The unusually low entry rates, both from employment and from out of the labor force, reflect a long-run downward trend, and have lowered the unemployment rate trend over the recent decade. In fact, the difference between the current unemployment rate and unemployment rates at the two previous cyclical peaks in 2000 and 2007 is more than fully accounted for by the decline in its trend. This suggests that the current low unemployment rate does not indicate a labor market that is tighter than in 2000 or 2007.
Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response?
–February 5, 2020
Giancarlo Corsetti, Luca Dedola, Sylvain LeducHow should monetary policy respond to capital inflows that appreciate the currency, widen the current account deficit and cause domestic overheating? Using the workhorse open-macro monetary model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, solve for the optimal targeting rules under cooperation and characterize the constrained-optimal allocation. The answer is sharp: the optimal monetary stance is contractionary if the exchange rate pass-through (ERPT) on import prices is incomplete, expansionary if ERPT is complete–implying that misalignment and exchange rate volatility are higher in economies where incomplete pass through contains the effects of exchange rates on price competitiveness.
The Transmission of Monetary Policy under the Microscope
–February 1, 2021
Martin Blomhoff Holm, Pascal Paul, Andreas TischbirekWe investigate the transmission of monetary policy to household consumption using administrative data on the universe of households in Norway. Based on identified monetary policy shocks, we estimate the dynamic responses of consumption, income, and saving along the liquid asset distribution of households. For low-liquidity but also for high-liquidity households, changes in disposable income are associated with a sizable consumption reaction. The impact consumption response is closely linked to interest rate exposure, which is negative at the bottom but positive at the top of the distribution. Indirect effects of monetary policy gradually build up and eventually outweigh the direct effects.
Probability Assessments of an Ice-Free Arctic: Comparing Statistical and Climate Model Projections
–December 1, 2020
Francis X. Diebold, Glenn D. RudebuschThe downward trend in the amount of Arctic sea ice has a wide range of environmental and economic consequences including important effects on the pace and intensity of global climate change. Based on several decades of satellite data, we provide statistical forecasts of Arctic sea ice extent during the rest of this century. The best fitting statistical model indicates that overall sea ice coverage is declining at an increasing rate. By contrast, average projections from the CMIP5 global climate models foresee a gradual slowing of Arctic sea ice loss even in scenarios with high carbon emissions. Our long-range statistical projections also deliver probability assessments of the timing of an ice-free Arctic. These results indicate almost a 60 percent chance of an effectively ice-free Arctic Ocean sometime during the 2030s – much earlier than the average projection from global climate models.
The Long-Run Effects of Monetary Policy
–May 1, 2023
Oscar Jorda, Sanjay R. Singh, Alan M. TaylorWe document that the real effects of monetary shocks last for over a decade. Our approach relies on (1) identification of exogenous and non-systematic monetary shocks using the trilemma of international finance; (2) merged data from two new international historical cross-country databases; and (3) econometric methods robust to long-horizon inconsistent estimates. Notably, the capital stock and total factor productivity (TFP) exhibit greater hysteresis than labor. When we allow for asymmetry, we find these effects with tightening shocks, but not with loosening shocks. When extending the horizon of the responses reported in several recent studies that use alternative monetary shocks, we find similarly persistent real effects, thus supporting our main findings.
Medicaid Expansion and the Unemployed
–December 16, 2019
Thomas C. Buchmueller, Helen Levy, Robert G. VallettaWe examine how a key provision of the Affordable Care Act—the expansion of Medicaid eligibility—affected health insurance coverage, access to care, and labor market transitions of unemployed workers. Comparing trends in states that implemented the Medicaid expansion to those that did not, we find that the ACA Medicaid expansion substantially increased insurance coverage and improved access to health care among unemployed workers. We then test whether this strengthening of the safety net affected transitions from unemployment to employment or out of the labor force. We find no meaningful statistical evidence in support of moral hazard effects that reduce job finding or labor force attachment.
The Safety Premium of Safe Assets
–September 1, 2022
Jens H. E. Christensen, Nikola MirkovSafe assets usually trade at a premium thanks to high credit quality and deep liquidity. To understand the role of credit quality for such premia, we examine Swiss government bonds, which are extremely safe but not particularly liquid. We therefore refer to their premia as safety premia and quantify them using an arbitrage-free term structure model that accounts for time-varying premia in individual bond prices. We find that Swiss safety premia are large with long-lasting trends. They shifted upwards persistently following the euro launch and have been depressed recently by asset purchases of the European Central Bank.
Anchored Inflation Expectations and the Slope of the Phillips Curve
–February 1, 2023
Peter Lihn Jorgensen, Kevin J. LansingIt is conventional wisdom that the reduced form Phillips curve has become flatter in recent decades. Accordingly, we show that the statistical relationship between changes in U.S. inflation and economic activity, commonly known as the accelerationist Phillips curve, has become flatter. But in contrast, the statistical relationship between the level of inflation and economic activity, which we refer to as the “original” Phillips curve, has become steeper. By allowing for changes in the degree of anchoring of agents’ inflation forecasts, we recover a stable structural slope parameter in an estimated version of the New Keynesian Phillips curve (NKPC) from 1960 to 2019. Using a New Keynesian model with imperfect information, we show that imperfectly anchored inflation expectations, coupled with an inflation-targeting central bank, induce an upward bias in the slope of the accelerationist Phillips curve slope but a downward bias in the slope of the original Phillips curve relative to the true structural slope of the NKPC. Improved anchoring shrinks both biases, accounting for the observed changes in the slopes of the reduced form Phillips curve relationships.
Precautionary Pricing: The Disinflationary Effects of ELB Risk
–October 18, 2019
Robert Amano, Thomas J. Carter, Sylvain LeducWe construct a model to evaluate the role that the risk of future effective lower bound (ELB) episodes plays as a factor behind the persistently weak inflation witnessed in many advanced economies since the Great Recession. In our model, a range of precautionary channels cause ELB risk to affect inflation and other macroeconomic outcomes even during “normal times” when nominal rates are far away from the ELB. This behavior is enhanced through a growth channel that captures possible long-lasting output declines at the ELB. We show that ELB risk substantially weighs on inflation even when the policy rate is above the ELB. Our model also predicts substantially below-target inflation expectations and negative inflation risk premia.
Taxing Billionaires: Estate Taxes and the Geographical Location of the Ultra-Wealthy
–October 1, 2019
Enrico Moretti, Daniel WilsonWe study the effect of state-level estate taxes on the geographical location of the Forbes 400 richest Americans and its implications for tax policy. We use a change in federal tax law to identify the tax sensitivity of the ultra-wealthy’s locational choices. Before 2001, some states had an estate tax and others didn’t, but the tax liability for the ultra-wealthy was independent of their domicile state due to a federal credit. In 2001, the credit was phased out and the estate tax liability for the ultra-wealthy suddenly became highly dependent on domicile state. We find the number of Forbes 400 individuals in estate tax states fell by 35% after 2001 compared to non-estate tax states. We also find that billionaires’ sensitivity to the estate tax increases significantly with age. Overall, billionaires’ geographical location appears to be highly sensitive to state estate taxes. We then estimate the effect of billionaire deaths on state tax revenues. We find a sharp increase in tax revenues in the three years after a Forbes billionaire death, totaling $165 million for the average billionaire. In the last part of the paper, we study the implications of our findings for state tax policy. We estimate the revenue costs and benefits for each state of having an estate tax. The benefit is the one-time tax revenue gain when a wealthy resident dies, while the cost is the foregone income tax revenues over the remaining lifetime of those who relocate. Surprisingly, despite the high estimated tax mobility, we find that the benefit exceeds the cost for the vast majority of states.
BLP Estimation Using Laplace Transformation and Overlapping Simulation Draws
–October 3, 2019
Han Hong, Huiyu Li, Jessie LiWe derive the asymptotic distribution of the parameters of the Berry et al. (1995, BLP) model in a many markets setting which takes into account simulation noise under the assumption of overlapping simulation draws. We show that, as long as the number of simulation draws R and the number of markets T approach infinity, our estimator is √m = √min(R,T) consistent and asymptotically normal. We do not impose any relationship between the rates at which R and T go to infinity, thus allowing for the case of R < < T. We provide a consistent estimate of the asymptotic variance which can be used to form asymptotically valid confidence intervals. Instead of directly minimizing the BLP GMM objective function, we propose using Hamiltonian Markov chain Monte Carlo methods to implement a Laplace-type estimator which is asymptotically equivalent to the GMM estimator.
Corporate Yields and Sovereign Yields
–September 20, 2019
Julia Bevilaqua, Galina B. Hale, Eric TallmanWe document that positive association between corporate and sovereign cost of funds borrowed on global capital markets weakens during periods of unusually high sovereign yields, when corporate borrowers are able to issue debt that is priced at lower rates than sovereign debt. This state-dependent sensitivity of corporate yields to sovereign yields has not been previously documented in the literature. We demonstrate that this stylized fact is observed across countries and industries as well as for a given borrower over time and is not explained by a different composition of borrowers issuing debt during periods of high sovereign yields or by the relationship between corporate and sovereign credit ratings. We show that even if we exclude high-yield episodes that accompany financial crises and IMF programs, the sensitivity of corporate yields to sovereign yields is lower when sovereign yields are high. We propose a simple information model that rationalizes our empirical observations: when sovereign yields are high and more volatile, corporate yields are less sensitive to sovereign yields.
Complexity of Global Banks and Their Foreign Operation in Hong Kong
–September 20, 2019
Kelvin Ho, Simon H. Kwan, Edward TanThis paper studies the relation between the complexity of global banking organizations and their foreign banking operations (FBOs) in Hong Kong. Our empirical evidence indicates that the complexity of the parent company has significant effects on their Hong Kong branch’s business model, liquidity management, risk-taking, and profitability. The more complex the global banking organizations, their Hong Kong FBOs are more likely to derive a larger share of revenues from fee-based activities, and incur a higher cost of production despite enjoying a funding cost advantage. Notwithstanding the FBOs in Hong Kong may serve as a funding hub for its parent company, FBOs of more complex global banks tend to hold more liquid assets. While our empirical evidence suggests that the complexity of global banks has significant effects on FBOs risk-taking and profitability, the relation depends on how complexity is measured. For example, both the BCBS complexity score and the measure of geographic complexity are significant in explaining FBO profitability, but they have different signs. Likewise, geographic complexity and scope complexity are often found to have significantly different effects on FBOs performance. Taken together, the concept of global bank complexity has multiple dimensions, where different facets could have qualitatively different effects on FBOs in Hong Kong.
Going Negative at the Zero Lower Bound: The Effects of Negative Nominal Interest Rates
–September 20, 2019
Mauricio UlateAfter the Great Recession several central banks started setting negative nominal interest rates in an expansionary attempt, but the effectiveness of this measure remains unclear. Negative rates can stimulate the economy by lowering the rates that commercial banks charge on loans, but they can also erode bank profitability by squeezing deposit spreads. This paper studies the effects of negative rates in a new DSGE model where banks intermediate the transmission of monetary policy. I use bank-level data to calibrate the model and find that monetary policy in negative territory is between 60% and 90% as effective as in positive territory.
Riders on the Storm
–September 1, 2019
Oscar Jorda, Alan M. TaylorInterest rates in major advanced economies have drifted down and in greater unison over the past few decades. A country’s rate of interest can be thought of as reflecting movements in the global neutral rate of interest, the domestic neutral rate, and the stance of monetary policy. Only the latter is controlled by the central bank. Estimates from a state space New Keynesian model show that central bank policy explains less than half of the variation in interest rates. The rest of the time, the central bank is catching up to trends dictated by productivity growth, demography, and other factors outside of its control.
Is China Fudging Its GDP Figures? Evidence from Trading Partner Data
–August 1, 2019
John G. Fernald, Eric Hsu, Mark M. SpiegelWe propose using imports, measured as reported exports of trading partners, as an alternative benchmark to gauge the accuracy of alternative Chinese indicators (including GDP) of fluctuations in economic activity. Externally-reported imports are likely to be relatively well measured, as well as free from domestic manipulation. Using principal components, we derive activity indices from a wide range of indicators and examine their fit to (trading-partner reported) imports. We choose a preferred index of eight non-GDP indicators (which we call the China Cyclical Activity Tracker, or C-CAT). Comparison with that index and others indicate that Chinese statistics have broadly become more reliable in measuring cyclical fluctuations over time. However, GDP adds little information relative to combinations of other indicators. Moreover, since 2013, Chinese GDP growth has shown little volatility around a gradually slowing trend. Other measures, including the C-CAT and imports, do not show this reduction in volatility. Since 2017, the C-CAT slowed from well above trend to close to trend. As of mid- 2019, it was giving the same cyclical signal as GDP.
R* and the Global Economy
–August 7, 2019
Reuven GlickThis paper provides a synthesis of explanations for why the natural rate of interest, r*, has fallen over the last several decades. Demographic factors, declining productivity, slower output growth, and increasing inequality likely all have been important factors. Perhaps less recognized is the role of increasing global demand for safe assets, particularly by foreign investors. Suggestive empirical evidence is presented showing that foreign demand for U.S. safe assets, particularly government-provided assets, has increased dramatically, and may now be playing a much larger role in the determination of U.S. interest rates than in the past. In addition, the buildup before the 2007-2009 financial crisis of quasi-government and privately-supplied safe assets, held by both domestic and foreign investors, rendered the financial system more vulnerable to shocks that adversely affected the perceived degree of “safeness” they provided.
Automation, Bargaining Power, and Labor Market Fluctuations
–February 1, 2023
Sylvain Leduc, Zheng LiuWe argue that the threat of automation weakens workers’ bargaining power in wage negotiations, dampening wage adjustments and amplifying unemployment fluctuations. We make this argument based on a business cycle model with labor market search frictions, generalized to incorporate automation decisions. In the model, procyclical automation threats create endogenous real wage rigidity that amplifies labor market fluctuations. The automation mechanism is consistent with empirical evidence. It is also quantitatively important for explaining the large volatilities of unemployment and vacancies relative to that of real wages, a puzzling observation through the lens of standard business cycle models.
Aggregate Implications of Changing Sectoral Trends
–January 1, 2022
Andrew Foerster, Andreas Hornstein, Pierre-Daniel Sarte, Mark WatsonWe find disparate trend variations in TFP and labor growth across major U.S. production sectors and study their implications for the post-war secular decline in GDP growth. We describe how capital accumulation and the network structure of U.S. production interact to amplify the effects of sectoral trend growth rates in TFP and labor on trend GDP growth. We derive expressions that conveniently summarize this long-run amplification effect by way of sectoral multipliers. These multipliers are quantitatively large and for some sectors exceed three times their value added shares. We estimate that sector-specific factors have historically accounted for approximately 3/4 of long-run changes in GDP growth, leaving common or aggregate factors to explain only 1/4 of those changes. Trend GDP growth fell by nearly 3 percentage points over the post-war period with the Construction sector alone contributing roughly 1 percentage point of that decline between 1950 and 1980. Idiosyncratic changes to trend growth in the Durable Goods sector then contributed an almost 2 percentage point decline in trend GDP growth between 2000 and 2018. Remarkably, no sector has contributed any steady significant increase to the trend growth rate of GDP in the past 70 years.
Assessing Abenomics: Evidence from Inflation-Indexed Japanese Government Bonds
–October 1, 2019
Jens H. E. Christensen, Mark M. SpiegelWe assess the impact of news concerning the reforms associated with “Abenomics” using an arbitrage-free term structure model of nominal and real yields. Our model explicitly accounts for the deflation protection enhancement embedded in Japanese inflation-indexed bonds issued since 2013, which pay their original nominal principal when deflation has occurred from issue to maturity. The value of this enhancement is sizable and time-varying, with substantive impacts on estimates of expected inflation compensation. After properly accounting for deflation protection, our results suggest that Japanese inflation risk premia were mostly negative during this period. Moreover, long-term inflation expectations remained positive throughout, despite extensive spells of realized deflation. Finally, initial market responses to policy changes associated with Abenomics and afterwards were not as inflationary as they appear under standard modeling procedures, implying that the program was less “disappointing” than many perceive.
Tying Down the Anchor: Monetary Policy Rules and the Lower Bound on Interest Rates
–August 15, 2019
Thomas M. Mertens, John C. WilliamsThis paper uses a standard New Keynesian model to analyze the effects and implementation of various monetary policy frameworks in the presence of a low natural rate of interest and a lower bound on interest rates. Under a standard inflation-targeting approach, inflation expectations will be anchored at a level below the inflation target, which in turn exacerbates the deleterious effects of the lower bound on the economy. Two key themes emerge from our analysis. First, the central bank can eliminate this problem of a downward bias in inflation expectations by following an average-inflation targeting framework that aims for above-target inflation during periods when policy is unconstrained. Second, dynamic strategies that raise inflation expectations by keeping interest rates “lower for longer” after periods of low inflation can both anchor expectations at the target level and further reduce the effects of the lower bound on the economy.
Using Brexit to Identify the Nature of Price Rigidities
–April 1, 2019
Bart Hobijn, Fernanda Nechio, Adam ShapiroUsing price quote data that underpin the official U.K. consumer price index (CPI), we analyze the effects of the unexpected passing of the Brexit referendum to the dynamics of price adjustments. The sizable depreciation of the British pound that immediately followed Brexit works as a quasi-experiment, enabling us to study the transmission of a large common marginal cost shock to inflation as well as the distribution of prices within granular product categories. A large portion of the inflationary effect is attributable to the size of price adjustments, implying that a time-dependent price-setting model can match the response of aggregate inflation reasonably well. The state-dependent model fares better in capturing the endogenous selection of price changes at the lower end of the price distribution, however, it misses on the magnitude of the adjustment conditional on selection.
Market-Based Monetary Policy Uncertainty
–December 1, 2019
Michael Bauer, Aeimit Lakdawala, Philippe MuellerAn extensive literature studies the impact of monetary policy surprises-shifts in expected policy rates-on asset prices. This paper addresses the open question of how shifts in the uncertainty about future policy rates matter for the transmission of monetary policy to financial markets. To this end, we develop a novel measure of policy uncertainty based on derivative prices that can be used in event studies. We provide evidence for an FOMC uncertainty cycle, the systematic pattern of resolution of uncertainty on FOMC announcement days followed by a gradual ramp-up over the next two weeks. Furthermore, specific monetary policy actions have differential effects on uncertainty, with the most substantial shifts due to changes in the forward guidance provided by the FOMC. Changes in uncertainty have pronounced effects on asset prices, distinct from the effects of changes in expected policy rates. Moreover, the prevailing level of uncertainty determines the effectiveness of policy surprises: When uncertainty is low, monetary policy surprises have stronger effects on asset prices.
A Theory of Falling Growth and Rising Rents
–October 1, 2022
Philippe Aghion, Antonin Bergeaud, Timo Boppart, Peter J. Klenow, Huiyu LiGrowth has fallen in the U.S. amid a rise in firm concentration. Market share has shifted to low labor share firms, while within-firm labor shares have actually risen. We propose a theory linking these trends in which the driving force is falling overhead costs of spanning multiple products or a rising efficiency advantage of large firms. In response, the most efficient firms (with higher markups) spread into new product lines, thereby increasing concentration and generating a temporary burst of growth. Eventually, due to greater competition from efficient firms, within-firm markups and incentives to innovate fall. Thus our simple model can generate qualitative patterns in line with the observed trends.
The Total Risk Premium Puzzle
–March 1, 2019
Oscar Jorda, Moritz Schularick, Alan M. TaylorThe risk premium puzzle is worse than you think. Using a new database for the U.S. and 15 other advanced economies from 1870 to the present that includes housing as well as equity returns (to capture the full risky capital portfolio of the representative agent), standard calculations using returns to total wealth and consumption show that: housing returns in the long run are comparable to those of equities, and yet housing returns have lower volatility and lower covariance with consumption growth than equities. The same applies to a weighted total-wealth portfolio, and over a range of horizons. As a result, the implied risk aversion parameters for housing wealth and total wealth are even larger than those for equities, often by a factor of 2 or more. We find that more exotic models cannot resolve these even bigger puzzles, and we see little role for limited participation, idiosyncratic housing risk, transaction costs, or liquidity premiums.
A Theory of Housing Demand Shocks
–May 1, 2022
Ding Dong, Zheng Liu, Pengfei Wang, Tao ZhaHousing demand shocks in standard macroeconomic models are a primary source of house price fluctuations, but those models have difficulties in generating the observed large volatility of house prices relative to rents. We provide a microeconomic foundation for the reduced-form housing demand shocks with a tractable heterogenous-agent framework. In our model with heterogeneous beliefs, an expansion of credit supply raises housing demand of optimistic buyers and boosts house prices without affecting rents. A credit supply shock also leads to a positive correlation between house trading volumes and house prices. The theoretical mechanism and model predictions are supported by empirical evidence, and the results are robust to alternative specifications of heterogeneity.
Bond Flows and Liquidity: Do Foreigners Matter?
–December 1, 2019
Jens H. E. Christensen, Eric Fischer, Patrick ShultzIn their search for yield in the current low interest rate environment, many investors have turned to sovereign debt in emerging economies, which has raised concerns about risks to financial stability from these capital flows. To assess this risk, we study the effects of changes in the foreign-held share of Mexican sovereign bonds on their liquidity premiums. We find that recent increases in foreign holdings of these securities have played a significant role in driving up their liquidity premiums. Provided the higher compensation for bearing liquidity risk is commensurate with the chance of a major foreign-led sell-off in the Mexican government bond market, this development may not pose a material risk to its financial stability.
Aggregate Labor Force Participation and Unemployment and Demographic Trends
–February 1, 2019
Andreas Hornstein, Marianna KudlyakWe estimate trends in the labor force participation (LFP) and unemployment rates for demographic groups differentiated by age, gender, and education, using a parsimonious statistical model of age, cohort and cycle effects. Based on the group trends, we construct trends for the aggregate LFP and unemployment rate. Important drivers of the aggregate LFP rate trend are demographic factors, with increasing educational attainment being important throughout the sample and ageing of the population becoming more important since 2000, and changes of groups’ trend LFP rates, e.g. for women prior to 2000. The aggregate unemployment rate trend on the other hand is almost exclusively driven by demographic factors, with about equal contributions from an older and more educated population. Extrapolating the estimated trends using Census Bureau population forecasts and our own forecasts for educational shares, we project that over the next 10 years the trend LFP rate will decline to 61.1% from its 2018 value of 62.7%, and the trend unemployment rate will decline to 4.3% from its 2018 value of 4.7%.
Tracking Financial Fragility
–February 1, 2019
Paolo Giordani, Simon H. KwanIn constructing an indicator of financial fragility, the choice of which filter (or transformation) to apply to the data series that appear to trend in sample is often considered a technicality, but in fact turns out to matter a great deal. The fundamental assumption about the likely nature of observed trends in the data, for example, the ratio of credit to GDP, has direct effects on the measured gap or vulnerability. We discuss shortcomings of the most common filters used in the literature and policy circle, and propose a fairly simple and intuitive alternative – the local level filter. To the extent that validation will always be a challenge when the number of observed financial crises (in the US) is small, we conduct a simulation exercise to make the case. We also conduct a cross country analysis to show how qualitatively different the estimated credit gaps were as of 2017, and hence their policy implications in 29 countries. Finally, we construct an indicator of financial fragility for the US economy based on the view that systemic fragility stems mainly from high level of debts (among households and corporations) associated with high valuations for collateral assets (real estate, stocks). An indicator based on the local level filter signals elevated financial fragility in the US financial system currently, whereas the HP filter and the ten-year moving average provide much more benign readings.
Job-Finding and Job-Losing: A Comprehensive Model of Heterogeneous Individual Labor-Market Dynamics
–January 1, 2020
Robert E. Hall, Marianna KudlyakWe study the paths over time that individuals follow in the labor market, as revealed in the monthly Current Population Survey. Some people face much higher flow values from work than in a non-market activity; if they lose a job, they find another soon. Others have close to equal flow values and tend to circle through jobs, search, and non-market activities. And yet others have flow values for non-market activities that are higher than those in the market, and do not work. We develop a model that identifies and quantifies heterogeneity in dynamic individual behavior. Our model provides a bridge between research on monthly transition rates in the tradition of Blanchard and Diamond (1990) and research on economic dynamics in the tradition of Mortensen and Pissarides (1994). Our estimates discern 5 distinct types. Most unemployment comes from just two of those types. Low employment types frequently circle among unemployment, short-term jobs, and being out of the labor market. Short-term jobs play a role in the job-finding process related to the role of unemployment. These are stop-gap jobs for high-employment types and a part of circling for low-employment types. Because of their high job-finding rates, and despite their low flow values of non-work relative to work, the volatility of the future lifetime value that high-employment types derive from work and non-work is lower than for low-employment types.
The Euro Crisis in the Mirror of the EMS: How Tying Odysseus to the Mast Avoided the Sirens but Led Him to Charybdis
–February 1, 2019
Giancarlo Corsetti, Barry Eichengreen, Galina Hale, Eric TallmanWhy was recovery from the euro area crisis delayed for a decade? The explanation lies in the absence of credible and timely policies to backstop financial intermediaries and sovereign debt markets. In this paper we add light and color to this analysis, contrasting recent experience with the 1992-3 crisis in the European Monetary System, when national central banks and treasuries more successfully provided this backstop. In the more recent episode, the incomplete development of the euro area constrained the ability of the ECB and other European institutions to do likewise.
Optimal Monetary Policy Regime Switches
–September 1, 2020
Andrew FoersterAn economy that switches between high and low growth regimes creates incentives for the monetary authority to change its rule. As lower growth tends to produce lower real interest rates, the monetary authority has an incentive to increase the inflation target and increase the degree of inertia in setting rates in an attempt to keep the nominal rate away from the zero lower bound. An optimizing monetary authority therefore responds to permanently lower growth by slightly increasing both the inflation target and inertia; focusing solely on the inflation target ignores a key margin of adjustment. With repeated growth rate regime switches, an optimal monetary rule that switches at the same time internalizes both the direct effects of growth regime change and the indirect expectation effects generated by switching in policy. The switching rule improves economic outcomes relative to a constant rule. A constant rule may be preferred if the monetary authority attempts a switching rule but implements the wrong rule with high enough frequency.
Taking the Fed at its Word: A New Approach to Estimating Central Bank Objectives using Text Analysis
–November 1, 2019
Adam Shapiro, Daniel WilsonWe propose a new approach to estimating central bank preferences, including the implicit inflation target, that requires no priors on the underlying macroeconomic structure nor observation of monetary policy actions. Our approach entails directly estimating the central bank’s objective function from the sentiment expressed by policymakers in their internal meetings. We apply the approach to the objective function of the U.S. Federal Open Market Committee (FOMC). The results challenge two key aspects of conventional wisdom regarding FOMC preferences. First, the FOMC had an implicit inflation target of approximately 1½ percent on average over our baseline 2000 – 2013 sample period, which was below average realized inflation. Second, the FOMC’s loss depends strongly on output growth and stock market performance and less so on their perception of the current economic slack.
Monetary Policy Frameworks and the Effective Lower Bound on Interest Rates
–June 1, 2019
Thomas M. Mertens, John C. WilliamsThis paper applies a standard New Keynesian model to analyze the effects of monetary policy in the presence of a low natural rate of interest and a lower bound on interest rates. Under a standard inflation-targeting approach, inflation expectations will be anchored at a level below the inflation target, which in turn exacerbates the deleterious effects of the lower bound on the economy. Two key themes emerge from our analysis. First, the central bank can mitigate this problem of a downward bias in inflation expectations by following an average-inflation targeting framework that aims for above-target inflation during periods when policy is unconstrained. Second, a dynamic strategy such as price-level targeting that raises inflation expectations when inflation is low can both anchor expectations at the target level and potentially further reduce the effects of the lower bound on the economy.
Inflation Globally
–December 1, 2018
Oscar Jorda, Fernanda NechioThe Phillips curve remains central to stabilization policy. Increasing financial linkages, international supply chains, and managed exchange rate policy have given core currencies an outsized influence on the domestic affairs of world economies. We exploit such influence as a source of exogenous variation to examine the effects of the recent financial crisis on the Phillips curve mechanism. Using a difference-in-differences approach, and comparing countries before and after the 2008 financial crisis sorted by whether they endured or escaped the crisis, we are able to assess the evolution of the Phillips curve globally.
Examining the Sources of Excess Return Predictability: Stochastic Volatility or Market Inefficiency?
–January 1, 2022
Kevin J. Lansing, Stephen F. LeRoy, Jun MaWe use a consumption based asset pricing model to show that the predictability of excess returns on risky assets can arise from only two sources: (1) stochastic volatility of fundamental variables, or (2) departures from rational expectations that give rise to predictable investor forecast errors and market inefficiency. While controlling for stochastic volatility, we find that a variable which measures non-fundamental noise in the Treasury yield curve helps to predict 1-month-ahead excess stock returns, but only during sample periods that include the Great Recession. For these sample periods, higher noise predicts lower excess stock returns, implying that a shortage of arbitrage capital in financial markets caused excess returns to drop below the levels justified by fundamentals. The statistical significance of the predictor variables that control for stochastic volatility are also typically sensitive to the sample period. Measures of implied and realized stock return variance cease to be significant when the COVID-influenced data from early 2020 onward is included.
When Hosios Meets Phillips: Connecting Efficiency and Stability to Demand Shocks
–February 1, 2021
Nicolas Petrosky-Nadeau, Etienne Wasmer, Philippe WeilIn an economy with frictional goods and labor markets there exist a price and a wage that implement the constrained efficient allocation. This price maximizes the marginal revenue of labor, balancing a price and a trading effect on firm revenue, and this wage trades off the benefits of job creation against the cost of turnover in the labor market. We show under bargaining over prices and wages that a double Hosios condition: (i) implements the constrained efficient allocation; (ii) also minimizes the elasticity of labor market tightness and job creation to a demand shock, and; (iii) that the relative response of wages to that of unemployment to changes in demand flattens as workers lose bargaining power, and it is steepest when there is efficient rent sharing in the goods market between consumers and producers, thereby relating changes in the slope of a wage Phillips curve to the constrained efficiency of allocations.
Uncertainty and Fiscal Cliffs
–September 1, 2018
Troy Davig, Andrew FoersterLarge pending fiscal policy changes, such as in the United States in 2012 or in Japan with consumption taxes, often generate considerable uncertainty. “Fiscal cliff” episodes have several features: an announced possible future change, a skewed set of possible out-comes, the possibility that implementation may not actually occur, and a known resolution date. This paper develops a model capturing these features and studies their impact. Fiscal cliff uncertainty shocks have immediate impact, with a magnitude that depends on the probability of implementation, which generates economic volatility. The possibility of fiscal cliffs lowers economic activity even in periods of relative certainty.
Taylor Rule Estimation by OLS
–September 1, 2021
Carlos Carvalho, Fernanda Nechio, Tiago TristaoOrdinary Least Squares (OLS) estimation of monetary policy rules produces potentially inconsistent estimates of policy parameters. The reason is that central banks react to variables, such as inflation and the output gap, that are endogenous to monetary policy shocks. Endogeneity implies a correlation between regressors and the error term – hence, an asymptotic bias. In principle, Instrumental Variables (IV) estimation can solve this endogeneity problem. In practice, however, IV estimation poses challenges, as the validity of potential instruments depends on various unobserved features of the economic environment. We argue in favor of OLS estimation of monetary policy rules. To that end, we show analytically in the three-equation New Keynesian model that the asymptotic OLS bias is proportional to the fraction of the variance of regressors due to monetary policy shocks. Using Monte Carlo simulations, we then show that this relationship also holds in a quantitative model of the U.S. economy. Since monetary policy shocks explain only a small fraction of the variance of regressors typically included in monetary policy rules, the endogeneity bias tends to be small. For realistic sample sizes, OLS outperforms IV. Finally, we estimate a standard Taylor rule on different subsamples of U.S. data and find that OLS and IV estimates are quite similar.
Optimal Capital Account Liberalization in China
–May 1, 2020
Zheng Liu, Mark M. Spiegel, Jingyi ZhangChina maintains tight controls over its capital account. Its current policy regime also features financial repression, under which banks are required to extend funds to state-owned enterprises (SOEs) at favorable terms, despite their lower productivity than private firms on average. We incorporate these features into a general equilibrium model. Our model illustrates a tradeoff between aggregate productivity and inter-temporal allocative efficiency from capital account liberalization under financial repression. As a result, along a transition path with a declining SOE share, welfare-maximizing policy calls for rapid removal of financial repression, but gradual liberalization of the capital account.
Extrapolating Long-Maturity Bond Yields for Financial Risk Measurement
–May 1, 2019
Jens H. E. Christensen, Jose A. Lopez, Paul L. MusscheInsurance companies and pension funds have liabilities far into the future and typically well beyond the longest maturity bonds trading in fixed-income markets. Such long-lived liabilities still need to be discounted, and yield curve extrapolations based on the information in observed yields can be used. We use dynamic Nelson-Siegel (DNS) yield curve models for extrapolating risk-free yield curves for Switzerland, Canada, France, and the U.S. We find slight biases in extrapolated long bond yields of a few basis points. In addition, the DNS model allows the generation of useful financial risk metrics, such as ranges of possible yield outcomes over projection horizons commonly used for stress-testing purposes. Therefore, we recommend using DNS models as a simple tool for generating extrapolated yields for long-term interest rate risk management.
Real Business Cycles, Animal Spirits, and Stock Market Valuation
–August 1, 2018
Kevin J. LansingThis paper develops a real business cycle model with five types of fundamental shocks and one "equity sentiment shock" that captures animal spirits-driven fluctuations. The representative agent’s perception that movements in equity value are partly driven by sentiment turns out to be close to self-fulfilling. I solve for the sequences of shock realizations that allow the model to exactly replicate the observed time paths of U.S. consumption, investment, hours worked, the stock of physical capital, capital’s share of income, and the S&P 500 market value from 1960.Q1 onwards. The model-identified sentiment shock is strongly correlated with survey-based measures of U.S. consumer sentiment. Counterfactual scenarios with the model suggest that the equity sentiment shock has an important influence on the paths of most U.S. macroeconomic variables.
Why Have Negative Nominal Interest Rates Had Such a Small Effect on Bank Performance? Cross Country Evidence
–June 1, 2018
Jose A. Lopez, Andrew K. Rose, Mark M. SpiegelWe examine the effect of negative nominal interest rates on bank profitability and behavior using a cross-country panel of over 5,100 banks in 27 countries. Our data set includes annual observations for Japanese and European banks between 2010 and 2016, which covers all advanced economies that have experienced negative nominal rates, including currency union members as well as both fixed and floating exchange rates countries. When we compare negative nominal interest rates with low positive rates, banks experience losses in interest income that are almost exactly offset by savings on deposit expenses and gains in non-interest income, including capital gains on securities and fees. We find heterogeneous effects of negative rates: floating exchange rates, small banks, and banks with low deposit ratios drive most of our results. Low-deposit banks have enjoyed particularly striking gains in non-interest income, likely from capital gains on securities. There have only been modest differences between high and low deposit-ratio banks’ changes in interest expenses; high deposit banks do not seem disproportionately vulnerable to negative rates. Overall, our results indicate surprisingly benign implications of negative rates for commercial banks thus far.
Uncertainty and Hyperinflation: European Inflation Dynamics after World War I
–June 1, 2018
Jose A. Lopez, Kris James MitchenerFiscal deficits, elevated debt-to-GDP ratios, and high inflation rates suggest hyperinflation could have potentially emerged in many European countries after World War I. We demonstrate that economic policy uncertainty was instrumental in pushing a subset of European countries into hyperinflation shortly after the end of the war. Germany, Austria, Poland, and Hungary (GAPH) suffered from frequent uncertainty shocks – and correspondingly high levels of uncertainty – caused by protracted political negotiations over reparations payments, the apportionment of the Austro-Hungarian debt, and border disputes. In contrast, other European countries exhibited lower levels of measured uncertainty between 1919 and 1925, allowing them more capacity with which to implement credible commitments to their fiscal and monetary policies. Impulse response functions show that increased uncertainty caused a rise in inflation contemporaneously and for a few months afterward in GAPH, but this effect was absent or much more limited for the other European countries in our sample. Our results suggest that elevated economic uncertainty directly affected inflation dynamics and the incidence of hyperinflation during the interwar period.
Global Financial Cycles and Risk Premiums
–May 1, 2018
Oscar Jorda, Moritz Schularick, Alan M. Taylor, Felix WardThis paper studies the synchronization of financial cycles across 17 advanced economies over the past 150 years. The comovement in credit, house prices, and equity prices has reached historical highs in the past three decades. The sharp increase in the comovement of global equity markets is particularly notable. We demonstrate that fluctuations in risk premiums, and not risk-free rates and dividends, account for a large part of the observed equity price synchronization after 1990. We also show that U.S. monetary policy has come to play an important role as a source of fluctuations in risk appetite across global equity markets. These fluctuations are transmitted across both fixed and floating exchange rate regimes, but the effects are more muted in floating rate regimes.
Regional Consumption Responses and the Aggregate Fiscal Multiplier
–December 1, 2022
Bill Dupor, Marios Karabarbounis, Marianna Kudlyak, M. Saif MehkariWe use regional variation in the American Recovery and Reinvestment Act (2009-2012) to analyze the effect of government spending on consumer spending. Our consumption data come from household-level retail purchases in the Nielsen scanner data and auto purchases from Equifax credit balances. We estimate that a $1 increase in county-level government spending increases local non-durable consumer spending by $0.29 and local auto spending by $0.09. We translate the regional consumption responses to an aggregate fiscal multiplier using a multiregional, New Keynesian model with heterogeneous agents, incomplete markets, and trade linkages. Our model is consistent with the estimated positive local multiplier, a result that distinguishes our incomplete markets model from models with complete markets. At the zero lower bound, the aggregate consumption multiplier is twice as large as the local multiplier because trade linkages propagate the effect of government spending across regions.
What to Expect from the Lower Bound on Interest Rates: Evidence from Derivatives Prices
–September 1, 2020
Thomas M. Mertens, John C. WilliamsThis paper analyzes the effects of the lower bound for interest rates on the distributions of inflation and interest rates. We study a stylized New Keynesian model where the policy instrument is subject to a lower bound to motivate the empirical analysis. Two equilibria emerge: In the “target equilibrium,” policy is unconstrained most or all of the time, whereas in the “liquidity trap equilibrium,” policy is mostly or always constrained. We use options data on future interest rates and inflation to study whether the decrease in the natural real rate of interest leads to forecast densities consistent with the theoretical model. Qualitatively, we find that the evidence is consistent with the theoretical predictions in the target equilibrium and find no evidence in favor of the liquidity trap equilibrium. Quantitatively, while the lower bound has a sizable effect on the distribution of future interest rates, its impact on forecast densities for inflation is relatively modest. We develop a lower bound indicator that captures the effects of the lower bound on the distribution of interest rates.
U.S. Monetary Policy and Fluctuations of International Bank Lending
–January 1, 2018
Stefan Avdjiev, Galina HaleThere is no consensus in the empirical literature on the direction in which U.S. monetary policy affects cross-border bank lending. We find robust evidence that the impact of the U.S. federal funds rate on cross-border bank lending in a given period depends on the prevailing international capital flows regime and on the level of the two main components of the federal funds rate: macro fundamentals and monetary policy stance. During episodes in which bank lending from advanced to emerging economies is booming, the relationship between the federal funds rate and cross-border bank lending is positive and mostly driven by the macro fundamentals component, which is consistent with a search-for-yield behavior by internationally-active banks. In contrast, during episodes of stagnant growth in bank lending from advanced to emerging economies, the relationship between the federal funds rate and bank lending is negative, mainly due to the monetary policy stance component of the federal funds rate. The latter set of results is driven by the lending to emerging markets, which is consistent with the international bank-lending channel and flight-to-quality behavior by internationally-active banks.
Monitoring Banking System Connectedness with Big Data
–April 1, 2018
Galina Hale, Jose A. LopezThe need to monitor aggregate financial stability was made clear during the global financial crisis of 2008-2009, and, of course, the need to monitor individual financial firms from a microprudential standpoint remains. However, linkages between financial firms cannot be observed or measured easily. In this paper, we propose a procedure that generates measures of connectedness between individual firms and for the system as a whole based on information observed only at the firm level; i.e., no explicit linkages are observed. We show how bank outcome variables of interest can be decomposed, including with mixed-frequency models, for how network analysis to measure connectedness across firms. We construct two such measures: one based on a decomposition of bank stock returns, the other based on a decomposition of their quarterly return on assets. Network analysis of these decompositions produces measures that could be of use in financial stability monitoring as well as the analysis of individual firms’ linkages.
The Rate of Return on Everything, 1870–2015
–December 1, 2017
Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, Alan M. TaylorThis paper answers fundamental questions that have preoccupied modern economic thought since the 18th century. What is the aggregate real rate of return in the economy? Is it higher than the growth rate of the economy and, if so, by how much? Is there a tendency for returns to fall in the long-run? Which particular assets have the highest long-run returns? We answer these questions on the basis of a new and comprehensive dataset for all major asset classes, including—for the first time—total returns to the largest, but oft ignored, component of household wealth, housing. The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015, and our new evidence reveals many new insights and puzzles.
Endogenous Forecast Switching Near the Zero Lower Bound
–November 1, 2019
Kevin J. LansingA representative agent contemplates the possibility of an occasionally binding zero lower bound (ZLB) on the nominal interest rate that is driven by switching between two local equilibria, labeled the "targeted" and "deflation" solutions, respectively. This view turns out to be true in simulations, thus validating the agent’s beliefs. I solve for the time series of stochastic shocks and endogenous forecast weights that allow the model to exactly replicate the observed time paths of U.S. data since 1988. The data since the start of the ZLB episode in 2008.Q4 are best described as a time-varying mixture of the two local equilibria
Historical Patterns of Inequality and Productivity around Financial Crises
–March 1, 2022
Pascal PaulTo understand the determinants of financial crises, previous research focused on developments closely related to financial markets. In contrast, this paper considers changes originating in the real economy as drivers of financial instability. To this end, I assemble a novel data set of long-run measures of income inequality, productivity, and other macrofinancial indicators for advanced economies. I find that rising top income inequality and low productivity growth are robust predictors of crises, and their slowmoving trend components largely explain these relations. Moreover, recessions that are preceded by such developments are deeper than recessions without such ex-ante trends.
A Macroeconomic Model with Occasional Financial Crises
–November 1, 2019
Pascal PaulFinancial crises occur out of prolonged and credit-fueled boom periods and, at times, they are initiated by relatively small shocks that can have large effects. Consistent with these empirical observations, this paper extends a standard macroeconomic model to include financial intermediation, long-term loans, and occasional financial crises. Within this framework, intermediaries raise their lending and leverage in good times, thereby building up financial fragility. Crises typically occur at the end of a prolonged boom, initiated by a moderate adverse shock that triggers a liquidation of existing investment, a contraction in lending, and ultimately a deep and persistent recession.
Term Structure Analysis with Big Data
–September 1, 2017
Martin M. Andreasen, Jens H. E. Christensen, Glenn D. RudebuschAnalysis of the term structure of interest rates almost always takes a two-step approach. First, actual bond prices are summarized by interpolated synthetic zero-coupon yields, and second, a small set of these yields are used as the source data for further empirical examination. In contrast, we consider the advantages of a one-step approach that directly analyzes the universe of bond prices. To illustrate the feasibility and desirability of the onestep approach, we compare arbitrage-free dynamic term structure models estimated using both approaches. We also provide a simulation study showing that a one-step approach can extract the information in large panels of bond prices and avoid any arbitrary noise introduced from a first-stage interpolation of yields.
Measuring Heterogeneity in Job Finding Rates among the Non-Employed Using Labor Force Status Histories
–January 1, 2018
Marianna Kudlyak, Fabian LangeWe construct a novel measure of the duration of joblessness using the labor force status histories in the four-month CPS panels. For those out of the labor force (OLF) and the unemployed, the job finding rate declines with the duration of joblessness. This duration measure dominates other existing measures in the CPS for predicting transitions from non-employment to employment. For those OLF, the variation in job finding rates explained by the duration of joblessness is five times larger than the variation explained by the self-reported desire to work or reasons for not searching. For the unemployed, the job finding rate declines with the self-reported duration of unemployment only to the extent that this variable correlates with the duration of joblessness. The two duration measures are not equivalent, and the discrepancy between them is not a classification error. Instead, the self-reports of unemployment durations refer to how long the respondent looked for work, often disregarding short-term jobs or including periods of employment while searching. Using our novel measure, we provide new estimates of the duration distribution of the unemployed and reexamine current approaches to misclassification error in the CPS.
Safe Collateral, Arm’s-Length Credit: Evidence from the Commercial Real Estate Market
–September 1, 2017
Lamont Black, John Krainer, Joseph NicholsThere are two main creditors in commercial real estate: arm’s-length investors and banks. We model commercial mortgage-backed securities (CMBS) as the less informed source of credit. In equilibrium, these investors fund properties with a low probability of distress and banks fund properties that may require renegotiation. We test the model using the 2007-2009 collapse of the CMBS market as a natural experiment, when banks funded both collateral types. Our results show that properties likely to have been securitized were less likely to default or be renegotiated, consistent with the model. This suggests that securitization in this market funds safe collateral.
Leaning Against the Credit Cycle
–August 1, 2017
Paolo Gelain, Kevin J. Lansing, Gisle J. NatvikHow should a central bank act to stabilize the debt-to-GDP ratio? We show how the persistent nature of household debt shapes the answer to this question. In environments where households repay mortgages gradually, surprise interest hikes only weakly influence household debt, and tend to increase debt-to-GDP in the short run while reducing it in the medium run. Interest rate rules with a positive weight on debt-to-GDP cause indeterminacy. Compared to inflation targeting, debt-to-GDP stabilization calls for a more expansionary policy when debt-to-GDP is high, so as to deflate the debt burden through inflation and output growth.
Calibrating Macroprudential Policy to Forecasts of Financial Stability
–August 1, 2017
Scott A. Brave, Jose A. LopezThe introduction of macroprudential responsibilities at central banks and financial regulatory agencies has created a need for new measures of financial stability. While many have been proposed, they usually require further transformation for use by policymakers. We propose a transformation based on transition probabilities between states of high and low financial stability. Forecasts of these state probabilities can then be used within a decision-theoretic framework to address the implementation of a countercyclical capital buffer, a common macroprudential policy. Our policy simulations suggest that given the low probability of a period of financial instability at year-end 2015, U.S. policymakers need not have engaged this capital buffer.
Interest Rates Under Falling Stars
–October 1, 2019
Michael Bauer, Glenn D. RudebuschMacro-finance theory implies that trend inflation and the equilibrium real interest rate are fundamental determinants of the yield curve. However, empirical models of the terms structure of interest rates generally assume that these fundamentals are constant. We show that accounting for time variation in these underlying long-run trends is crucial for understanding the dynamics of Treasury yields and predicting excess bond returns. We introduce a new arbitrage-free model that captures the key role that long-run trends play for interest rates. The model also provides new, more plausible estimates of the term premium and accurate out-of-sample yield forecasts.
Interest-Rate Liberalization and Capital Misallocations
–January 1, 2020
Zheng Liu, Pengfei Wang, Zhiwei XuWe study the consequences of interest-rate liberalization in a two-sector general equilibrium model of China. The model captures a key feature of China’s distorted financial system: state-owned enterprises (SOEs) have greater incentive to expand production and easier access to credit than private firms. In this second-best environment, interest-rate liberalization can improve capital allocations within each sector, but can also exacerbate misallocations across sectors. Under calibrated parameters, the liberalization policy can reduce aggregate productivity and welfare unless other policy reforms are also implemented to alleviate SOEs’ distorted incentives or improve private firms’ credit access.
The Disappointing Recovery of Output after 2009
–June 1, 2017
John G. Fernald, Robert E. Hall, James H. Stock, Mark W. WatsonU.S. output has expanded only slowly since the recession trough in 2009, even though the unemployment rate has essentially returned to a precrisis, normal level. We use a growth-accounting decomposition to explore explanations for the output shortfall, giving full treatment to cyclical effects that, given the depth of the recession, should have implied unusually fast growth. We find that the growth shortfall has almost entirely reflected two factors: the slow growth of total factor productivity, and the decline in labor force participation. Both factors reflect powerful adverse forces that are largely unrelated to the financial crisis and recession—and that were in play before the recession.
Clearing the Fog: The Predictive Power of Weather for Employment Reports and their Asset Price Responses
–September 1, 2017
Daniel WilsonThis paper exploits vast granular data – with over one million county-month observations – to estimate a dynamic panel data model of weather’s local employment effects. The fitted county model is then aggregated and used to generate in-sample and rolling out-of-sample (“nowcast”) estimates of the weather effect on national monthly employment. These nowcasts, which use only employment and weather data available prior to a given employment report, are significantly predictive not only of the surprise component of employment reports but also of stock and bond market returns on the days of employment reports.
Approximating Multisector New Keynesian Models
–September 1, 2017
Carlos Carvalho, Fernanda NechioA three-sector model with a suitably chosen distribution of price stickiness can closely approximate the response to aggregate shocks of New Keynesian models with a much larger number of sectors, allowing for their estimation at much reduced computational cost.
The TIPS Liquidity Premium
–July 1, 2020
Martin M. Andreasen, Jens H. E. Christensen, Simon RiddellWe introduce an arbitrage-free term structure model of nominal and real yields that accounts for liquidity risk in Treasury inflation-protected securities (TIPS). The novel feature of our model is to identify liquidity risk from individual TIPS prices by accounting for the tendency that TIPS, like most fixed-income securities, go into buy-and-hold investors’ portfolios as time passes. We find a sizable and countercyclical TIPS liquidity premium, which helps our model to match TIPS prices. Accounting for liquidity risk also improves the model’s ability to forecast inflation and match surveys of inflation expectations, although these series are not included in the estimation.
Is There an On-the-Run Premium in TIPS?
–September 1, 2017
Jens H. E. Christensen, Jose A. Lopez, Patrick ShultzIn the U.S. Treasury market, the most recently issued, or so-called “on-the-run,” security typically trades at a price above those of more seasoned but otherwise comparable securities. This difference is known as the on-the-run premium. In this paper, yield spreads between pairs of Treasury Inflation-Protected Securities (TIPS) with identical maturities but of separate vintages are analyzed. Adjusting for differences in coupon rates and values of embedded deflation options, the results show a small, positive premium on recently issued TIPS – averaging between one and four basis points – that persists even after new similar TIPS are issued and hence is different from the on-the-run phenomenon observed in the nominal Treasury market.
The Time-Varying Effect of Monetary Policy on Asset Prices
–April 1, 2019
Pascal PaulThis paper studies how monetary policy jointly affects asset prices and the real economy in the United States. I develop an estimator that uses high-frequency surprises as a proxy for the structural monetary policy shocks. This is achieved by integrating the surprises into a vector autoregressive model as an exogenous variable. I use current short-term rate surprises because these are least affected by an information effect. When allowing for time-varying model parameters, I find that, compared to the response of output, the reaction of stock and house prices to monetary policy shocks was particularly low before the 2007-09 financial crisis.
International Transmission of Japanese Monetary Shocks Under Low and Negative Interest Rates: A Global Favar Approach
–April 1, 2017
Mark M. Spiegel, Andrew TaiWe examine the implications of Japanese monetary shocks under recent very low and sometimes negative interest rates to the Japanese economy as well as three of its major trading partners: Korea, China and the United States. We follow the literature in using movements in 2-year Japanese government bond rates as proxies for changes in monetary conditions in the neighborhood of the zero lower bound. We examine the implications of shocks to the 2-year rate in a series of factor-augmented vector autoregressive – or FAVAR – models, in which both local and global conditions are proxied by latent factors generated from domestic economic indicators and weighted indicators of major trading partners, respectively. Our results suggest that shocks to 2-year Japanese rates do have substantive impacts on Japanese economic activity and inflation in conditions of low or even negative short-term rates. However, we find only modest global spillovers from Japanese monetary policy shocks, as their impact on the economic conditions of major Japanese trading partners is muted, particularly relative to the impact of innovations in 2-year U.S. Treasury yields over the same period.
A New Normal for Interest Rates? Evidence from Inflation-Indexed Debt
–February 1, 2019
Jens H. E. Christensen, Glenn D. RudebuschThe downtrend in U.S. interest rates over the past two decades may partly reflect a decline in the longer-run equilibrium real rate of interest. We examine this issue using dynamic term structure models that account for time-varying term and liquidity risk premiums and are estimated directly from prices of individual inflation-indexed bonds. Our finance-based approach avoids two potential pitfalls of previous macroeconomic analyses: structural breaks at the zero lower bound and misspecification of output and inflation dynamics. We estimate that the longer-run equilibrium real rate has fallen about 2 percentage points and appears unlikely to rise quickly.
Bank Capital Redux: Solvency, Liquidity, and Crisis
–March 1, 2017
Oscar Jorda, Bjorn Richter, Moritz Schularick, Alan M. TaylorHigher capital ratios are unlikely to prevent a financial crisis. This is empirically true both for the entire history of advanced economies between 1870 and 2013 and for the post-WW2 period, and holds both within and between countries. We reach this startling conclusion using newly collected data on the liability side of banks’ balance sheets in 17 countries. A solvency indicator, the capital ratio has no value as a crisis predictor; but we find that liquidity indicators such as the loan-to-deposit ratio and the share of non-deposit funding do signal financial fragility, although they add little predictive power relative to that of credit growth on the asset side of the balance sheet. However, higher capital buffers have social benefits in terms of macro-stability: recoveries from financial crisis recessions are much quicker with higher bank capital.
Generalized Matching Functions and Resource Utilization Indices for the Labor Market
–February 1, 2017
Andreas Hornstein, Marianna KudlyakIn the U.S. labor market unemployed individuals that are actively looking for work are more than three times as likely to become employed as those individuals that are not actively looking for work and are considered to be out of the labor force (OLF). Yet, on average, every month twice as many people make the transition from OLF to employment than do from unemployment. Based on these observations we have argued in Hornstein, Kudlyak, and Lange (2014) for an alternative measure of resource utilization in the labor market, a non-employment index, which is more comprehensive than the standard unemployment rate. In this article we show how the NEI fits into recent extensions of the matching function which is a standard macroeconomic approach to model labor markets with frictions, how it affects estimates of the extent of labor market frictions, and how these frictions have changed in the Great Recession.
Missing Growth from Creative Destruction
–August 1, 2018
Philippe Aghion, Antonin Bergeaud, Timo Boppart, Peter J. Klenow, Huiyu LiWhen products exit due to entry of better products from new producers, statistical agencies typically impute inflation from surviving products. This understates growth if creatively-destroyed products improve more than surviving products. Accordingly, the market share of surviving products should shrink. Using entering and exiting establishments to proxy for creative destruction, we estimate missing growth in U.S. Census data on non-farm businesses from 1983–2013. We find: (i) missing growth is substantial — around half a percentage point per year; but (ii) missing growth did not accelerate much after 2005, and therefore does not explain the sharp slowdown in growth since then.
De-leveraging or De-risking? How Banks Cope with Loss
–December 1, 2019
Rhys M. Bidder, John R. Krainer, Adam ShapiroWe use variation in banks’ loan exposure to industries adversely affected by the oil price declines of 2014 to explore how they respond to a net worth shock. Using granular data obtained under the Fed’s stress testing programs we show that exposed banks tightened credit on corporate lending and on mortgages that they would ultimately hold on their balance sheet. However, they expanded credit for mortgages to be securitized, particularly those that are government-backed. Thus, banks re-balance their portfolio so as to lower their average risk weight, rather than scaling back the size of their balance sheet, as looking at on-balance-sheet corporate or residential lending alone would suggest. These results show the importance of taking a cross-balance sheet perspective when examining bank behavior. In addition, in terms of the ultimate ‘credit channel’ to firms and households, we show precisely how borrowers substitute to alternative financing when banks they initially borrow from tighten credit. In showing that there was ultimately a minimal impact on borrowers’ overall funding, we provide a benchmark for crisis-period studies, which typically find a powerful credit channel effect.
The Effects of Quasi-Random Monetary Experiments
–May 1, 2018
Oscar Jorda, Moritz Schularick, Alan M. TaylorThe trilemma of international finance explains why interest rates in countries that fix their exchange rates and allow unfettered cross-border capital flows are largely outside the monetary authority’s control. Using historical panel-data since 1870 and using the trilemma mechanism to construct an external instrument for exogenous monetary policy fluctuations, we show that monetary interventions have very different causal impacts, and hence implied inflation-output trade-offs, according to whether: (1) the economy is operating above or below potential; (2) inflation is low, thereby bringing nominal rates closer to the zero lower bound; and (3) there is a credit boom in mortgage markets. We use several adjustments to account for potential spillover effects including a novel control function approach. The results have important implications for monetary policy.
Measuring News Sentiment
–March 1, 2020
Adam Shapiro, Moritz Sudhof, Daniel WilsonThis paper demonstrates state-of-the-art text sentiment analysis tools while developing a new time-series measure of economic sentiment derived from economic and financial newspaper articles from January 1980 to April 2015. We compare the predictive accuracy of a large set of sentiment analysis models using a sample of articles that have been rated by humans on a positivity/negativity scale. The results highlight the gains from combining existing lexicons and from accounting for negation. We also generate our own sentiment-scoring model, which includes a new lexicon built specifically to capture the sentiment in economic news articles. This model is shown to have better predictive accuracy than existing, “off-the-shelf”, models. Lastly, we provide two applications to the economic research on sentiment. First, we show that daily news sentiment is predictive of movements of survey-based measures of consumer sentiment. Second, motivated by Barsky and Sims (2012), we estimate the impulse responses of macroeconomic variables to sentiment shocks, finding that positive sentiment shocks increase consumption, output, and interest rates and dampen inflation.
Intergenerational Linkages in Household Credit
–December 1, 2016
Andra C. Ghent, Marianna KudlyakWe document novel, economically important correlations between children’s future credit risk scores, default, and homeownership status and their parents’ credit characteristics measured when the children are in their late teens. A one standard deviation higher parental credit risk score when the child is 19 is associated with a 24 percent reduction in the likelihood that the child goes bankrupt by age 29, a 36 percent lower likelihood of other serious default, a 35 point higher child credit score, and a 23 percent higher chance of the child becoming a homeowner. The linkages persist after controlling for parental income. The linkages are stronger in cities with lower intergenerational income mobility, implying that common factors might drive both. Existing measures of state-level educational policy have limited effects on the strength of the linkages. Evidence from a sample of siblings suggests that the linkages might be largely due to family fixed effects.
Measuring the Effects of Dollar Appreciation on Asia: A Favar Approach
–November 1, 2016
Zheng Liu, Mark M. Spiegel, Andrew TaiExchange rate shocks have mixed effects on economic activity in both theory and empirical VAR models. In this paper, we extend the empirical literature by considering the implications of a positive shock to the U.S. dollar in a factor-augmented vector autoregression (FAVAR) model for the U.S. and three large Asian economies: Korea, Japan and China. The FAVAR framework allows us to represent a country’s aggregate economic activity by a latent factor, generated from a broad set of underlying observable economic indicators. To control for global conditions, we also include in the FAVAR a “global conditions index,” which is another latent factor generated from the economic indicators of major trading partners. We find that a dollar appreciation shock reduces economic activity and inflation not only for the U.S. economy, but also for all three Asian economies. This result, which is robust to a number of alternative specifications, suggests that in spite of their disparate economic structures and policy regimes, the dollar appreciation shock affects the Asian economies primarily through its impact on U.S. aggregate demand; and this demand channel dominates the expenditure-switching channel that affects a country’s export competitiveness.
“Conditional PPP” and Real Exchange Rate Convergence in the Euro Area
–October 1, 2016
Paul R. Bergin, Reuven Glick, Jyh-Lin WuWhile economic theory highlights the usefulness of flexible exchange rates in promoting adjustment in international relative prices, flexible exchange rates also can be a source of destabilizing shocks. We find that when countries joining the euro currency union abandoned their national exchange rates, the adjustment of real exchange rates toward their long-run equilibrium surprisingly became faster. To investigate, we distinguish between differing rates of purchasing power parity (PPP) convergence conditional on alternative shocks, which we refer to as “conditional PPP.” We find that the loss of the exchange rate as an adjustment mechanism after the introduction of the euro was more than compensated by the elimination of the exchange rate as a source of shocks, in combination with faster adjustment in national prices. These findings support claims that flexible exchange rates are not necessary to promote long-run international relative price adjustment.
Mortgage Selection: Interactive Effects of House Price Appreciation and Mortgage Pricing Components
–March 1, 2019
Frederick Furlong, David Lang, Yelena TakhtamanovaResearch has shown evidence of a link between house price appreciation and the selection of mortgage financing options: Higher appreciation is associated with higher take-up rates for adjustable-rate mortgages relative to fixed-rate mortgages. Research also finds that mortgage interest rates and their underlying components are important determinants of take-up rates among mortgage financing options. In this paper we show that house price appreciation can have important interactive effects with those other determinants of mortgage financing outcomes. We focus on the period from 2000 to 2007, an episode marked by rapid house price appreciation along with a persistent and notable increase in the use of adjustable-rate mortgage financing, including alternative mortgage products. Empirical analysis indicates that higher house price appreciation dampened the estimated effect of the mortgage pricing components on the probabilities of mortgage financing outcomes. The results, which are especially robust for fixed-rate and adjustable-rate mortgages that are fully amortized, are not driven solely by markets with especially high rates of house price appreciation. Moreover, after taking into account the interactive effects with mortgage pricing components, house price appreciation has relatively little additional effect on take-up rates among mortgage financing options.
Currency Unions and Regional Trade Agreements: EMU and EU Effects on Trade
–October 1, 2016
Reuven GlickThe effects of the European Economic and Monetary Union (EMU) and European Union (EU) on trade are separately estimated using an empirical gravity model. Employing a panel approach with both time-varying country and dyadic fixed effects on a large span of data (across both countries and time), it is found that EMU and EU each significantly boosted exports. EMU expanded European trade by 40% for the original members, while the EU increased trade by almost 70%. Newer members have experienced even higher trade as a result of joining the EU, but more time is necessary to see the effects of their joining EMU.
Stress Testing with Misspecified Models
–September 1, 2016
Rhys Bidder, Raffaella Giacomini, Andrew McKennaStress testing has become an important component of macroprudential regulation yet its goals and implementation are still being debated, reflecting the difficulty of designing such frameworks in the context of enormous model uncertainty. We illustrate methods for responding to possible misspecifications in models used for assessing bank vulnerabilities. We show how ‘exponential tilting’ allows the incorporation of external judgment, captured in moment conditions, into a forecasting model as a partial correction for misspecification. We also make use of methods from robust control to seek the most relevant dimensions in which a regulator’s forecasting model might be misspecified – a search for a ‘worst case’ model that is a ‘twisted’ version of the regulator’s initial forecasting model. Finally, we show how the two approaches can be blended so that one can search for a worst case model subject to restrictions on its properties, informed by the regulator’s judgment. We demonstrate the methods using the New York Fed’s CLASS model, a top-down capital stress testing framework that projects the effect of macroeconomic scenarios on U.S. banking firms.
FDI Effects on the Labor Market of Host Countries
–September 1, 2016
Galina Hale, Mingzhi XuThis paper surveys literature on impact of foreign direct investments (FDI) on host country’s labor market, including employment, wages, labor productivity, skill premium, and inequality. Meta-analysis of empirical findings suggests that there is solid consensus with respect to wages: in both developing and developed countries FDI leads to higher wages in target firms and industries. Majority of the papers also find positive productivity spillovers as well as increase in skill premium as a result of FDI, especially in developing economies. We analyze all the findings together to address possible mechanisms of FDI effects on labor in target firms, in competing firms, and in vertically related firms. We present a stylized model that is consistent with many empirical regularities found in meta-analysis of empirical literature.
Estimating Matching Efficiency with Variable Search Effort
–December 1, 2016
Andreas Hornstein, Marianna KudlyakWe introduce a simple representation of endogenous search effort into the standard matching function with job-seeker heterogeneity. Using the estimated augmented matching function, we study the sources of changes in the average employment transition rate. In the standard matching function, the contribution of matching efficiency is decreasing in the matching function elasticity. In contrast, for our matching function with variable search effort and small matching elasticity, search effort is procyclical, accounting for most of the transition rate volatility; and the decline of the aggregate matching efficiency accounts for a small part of the decline in the transition rate after 2007. For a large matching elasticity, search effort is countercyclical, and large movements in matching efficiency compensate for that; and the decline in the matching efficiency accounts for a large part of the decline in the transition rate after 2007. The data on employment transition rates provide evidence for endogenous search effort but do not separately identify cyclicality of search effort and matching elasticity.
Macrofinancial History and the New Business Cycle Facts
–September 1, 2016
Oscar Jorda, Moritz Schularick, Alan M. TaylorIn advanced economies, a century-long near-stable ratio of credit to GDP gave way to rapid financialization and surging leverage in the last forty years. This “financial hockey stick” coincides with shifts in foundational macroeconomic relationships beyond the widely-noted return of macroeconomic fragility and crisis risk. Leverage is correlated with central business cycle moments, which we can document thanks to a decade-long international and historical data collection effort. More financialized economies exhibit somewhat less real volatility, but also lower growth, more tail risk, as well as tighter real-real and real-financial correlations. International real and financial cycles also cohere more strongly. The new stylized facts that we discover should prove fertile ground for the development of a new generation of macroeconomic models with a prominent role for financial factors.
Revisiting the Behavior of Small and Large Firms during the 2008 Financial Crisis
–December 1, 2016
Marianna Kudlyak, Juan M. SánchezGertler and Gilchrist (1994) provide seminal evidence for the prevailing view that adverse shocks are propagated via credit constraints. Under this view, the deep recession that followed the 2008 financial crisis is often interpreted as the propagation of the initial “credit shock.” Following Gertler and Gilchrist (1994)’s methodology, we study the behavior of small and large firms during the episodes of credit disruption and extend the analysis to the 2008 financial crisis and NBER-dated recessions. We find that large firms’ short-term debt and sales contracted relatively more than those of small firms during the 2008 financial crisis and during most recessions since 1969. These results, which we show are robust to changes in the business cycle dating procedure, suggest that an alternative view may be needed to understand the prolonged recession following the 2008 financial crisis.
The Impact of Weather on Local Employment: Using Big Data on Small Places
–June 1, 2017
Daniel WilsonThis paper exploits vast granular data – over 10 million county-industry-month observations – to estimate dynamic panel data models of weather’s short-run employment effects. I estimated the contemporaneous and cumulative effects of temperature, precipitation, snowfall, the frequency of very hot days, the frequency of very cold days, and natural disasters on private nonfarm employment growth. The short-run effects of weather vary considerably across sectors and regions. Favorable weather in one county has positive spillovers to nearby counties but negative spillovers to distant counties. Local climate mediates weather effects: economies are less sensitive to types of weather they are accustomed to.
Does Greater Inequality Lead to More Household Borrowing? New Evidence from Household Data
–August 1, 2016
Olivier Coibion, Yuriy Gorodnichenko, Marianna Kudlyak, John MondragonUsing household-level debt data over 2000-2012 and local variation in inequality, we show that low-income households in high-inequality regions (zip-codes, counties, states) accumulated less debt (relative to their income) than low-income households in lower-inequality regions, contrary to the prevailing view. Furthermore, the price of credit is higher and access to credit is harder for low-income households in high-inequality versus low-inequality regions. Lower quantities combined with higher prices suggest that the debt accumulation pattern by household income across areas with different inequality is a result of credit supply rather than credit demand. We propose a lending model to illustrate the mechanism.
Sentiments and Economic Activity: Evidence from U.S. States
–October 1, 2017
Jess Benhabib, Mark M. SpiegelWe examine whether sentiment influences aggregate demand by studying the relationship between the Michigan Survey expectations concerning national output growth and future economic activity at the state level. We instrument for local sentiments with political outcomes, positing that agents in states with a higher share of congressmen from the political party of the sitting President will be more optimistic. This instrument is strong in the first stage, and our results confirm a positive relationship between sentiments and future state economic activity that is robust to a battery of sensitivity tests.
Reassessing Longer-Run U.S. Growth: How Low?
–August 1, 2016
John G. FernaldWhat is the sustainable pace of GDP growth in the United States? A plausible point forecast is that GDP per capita will rise well under 1 percent per year in the longer run, with overall GDP growth of a little over 1-1/2 percent. The main drivers of slow growth are educational attainment and demographics. First, rising educational attainment will add less to productivity growth than it did historically. Second, because of the aging (and retirements) of baby boomers, employment will rise more slowly than population (which, in turn, is projected to rise slowly relative to history). This modest growth forecast assumes that productivity growth is relatively “normal,” if modest—in line with its pace for most of the period since 1973. An upside risk is that we see another burst of information-technology-induced productivity growth similar to what we saw from 1995 to 2004.
Recent Flattening in the Higher Education Wage Premium: Polarization, Skill Downgrading, or Both?
–August 1, 2016
Robert G. VallettaWage gaps between workers with a college or graduate degree and those with only a high school degree rose rapidly in the United States during the 1980s. Since then, the rate of growth in these wage gaps has progressively slowed, and though the gaps remain large, they were essentially unchanged between 2010 and 2015. I assess this flattening over time in higher education wage premiums with reference to two related explanations for changing U.S. employment patterns: (i) a shift away from middle-skilled occupations driven largely by technological change (“polarization”); and (ii) a general weakening in the demand for advanced cognitive skills (“skill downgrading”). Analyses of wage and employment data from the U.S. Current Population Survey suggest that both factors have contributed to the flattening of higher education wage premiums.
The Social Cost of Near-Rational Investment
–August 1, 2016
Tarek A. Hassan, Thomas M. MertensWe show that the stock market may fail to aggregate information even if it appears to be efficient, and that the resulting decrease in the information content of prices may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors when forming expectations about future productivity. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When prices reflect less information, the conditional variance of stock returns rises, causing an increase in uncertainty and costly distortions in consumption, capital accumulation, and labor supply.
A Risk-based Theory of Exchange Rate Stabilization
–May 1, 2020
Tarek A. Hassan, Thomas M. Mertens, Tony ZhangWe develop a novel, risk-based theory of the effects of exchange rate stabilization. In our model, the choice of exchange rate regime allows policymakers to make their currency, and by extension, the firms in their country, a safer investment for international investors. Policies that induce a country’s currency to appreciate when the marginal utility of international investors is high lower the required rate of return on the country’s currency and increase the world-market value of domestic firms. Applying this logic to exchange rate stabilizations, we find a small economy stabilizing its bilateral exchange rate relative to a larger economy can increase domestic capital accumulation, domestic wages, and even its share in world wealth. In the absence of policy coordination, small countries optimally choose to stabilize their exchange rates relative to the currency of the largest economy in the world, which endogenously emerges as the world’s “anchor currency.” Larger economies instead optimally choose to oat their exchange rates. The model therefore predicts an equilibrium pattern of exchange rate arrangements that is remarkably similar to the one in the data.
The Outlook for U.S. Labor-Quality Growth
–July 1, 2016
Canyon Bosler, Mary C. Daly, John G. Fernald, Bart HobijnOver the past 15 years, labor-quality growth has been very strong—defying nearly all earlier projections—and has added around 0.5 percentage points to an otherwise modest U.S. productivity picture. Going forward, labor quality is likely to add considerably less and may even be a drag on productivity growth in the medium term. Using a variety of methods, we project that potential labor-quality growth in the longer run (7 to 10 years out) is likely to fall in the range of 0.1 to 0.25 percent per year. In the medium term, labor-quality growth could be lower or even negative, should employment rates of low-skilled workers make a cyclical rebound towards pre-recession levels. The main uncertainties in the longer run are whether the secular decline in employment of low-skilled workers continues and whether the Great Recession pickup in educational attainment represents the start of a new boom or is simply a transitory reaction to a poor economy.
The Intensity of Job Search and Search Duration
–July 1, 2016
R. Jason Faberman, Marianna KudlyakWe use panel data on individual applications to job openings on a job search website to study search intensity and search duration. Our data allow us to control for the composition of job seekers and changes in the number of available job openings over the duration of search. We find that (1) the number of applications sent by a job seeker declines over the duration of search, and (2) longer-duration job seekers send relatively more applications per week throughout their entire search. The latter finding contradicts the implications of standard labor search models. We argue that these models fail to capture an income effect in search effort that causes job seekers with the lowest returns to search to exert the highest effort. We present evidence in support of this idea.
A Portfolio Model of Quantitative Easing
–February 1, 2018
Jens H. E. Christensen, Signe KrogstrupThis paper presents a portfolio model of asset price effects arising from central bank large scale asset purchases, or quantitative easing (QE). Two financial frictions—segmentation of the market for central bank reserves and imperfect asset substitutability—give rise to two distinct portfolio effects. One is well known and derives from the reduced supply of the purchased assets. The other is new, runs through banks’ portfolio responses to reserves expansions, and is independent of the types of assets purchased. The results imply that central bank reserve expansions can affect long-term bond prices even in the absence of long-term bond purchases.
Measuring the Natural Rate of Interest: International Trends and Determinants
–December 1, 2016
Kathryn Holston, Thomas Laubach, John C. WilliamsU.S. estimates of the natural rate of interest—the real short-term interest rate that would prevail absent transitory disturbances—have declined dramatically since the start of the global financial crisis. For example, estimates using the Laubach-Williams (2003) model indicate the natural rate in the United States fell to close to zero during the crisis and has remained there through the end of 2015. Explanations for this decline include shifts in demographics, a slowdown in trend productivity growth, and global factors affecting real interest rates. This paper applies the Laubach-Williams methodology to the United States and three other advanced economies—Canada, the Euro Area, and the United Kingdom. We find that large declines in trend GDP growth and natural rates of interest have occurred over the past 25 years in all four economies. These country-by-country estimates are found to display a substantial amount of comovement over time, suggesting an important role for global factors in shaping trend growth and natural rates of interest.
The Weak Job Recovery in a Macro Model of Search and Recruiting Intensity
–February 1, 2019
Sylvain Leduc, Zheng LiuWe show that cyclical fluctuations in search intensity and recruiting intensity are quantitatively important for explaining the weak job recovery from the Great Recession. We demonstrate this result using an estimated labor search model that features endogenous search and recruiting intensity. Since the textbook model with free entry implies constant recruiting intensity, we introduce a cost of vacancy creation, so that firms respond to aggregate shocks by adjusting both vacancies and recruiting intensity. Fluctuations in search and recruiting intensity driven by shocks to productivity and the discount factor help bridge the gap between the actual and model-predicted job filling rate.
The Pre-Great Recession Slowdown in Productivity
–April 1, 2016
Gilbert Cette, John G. Fernald, Benoit MojonIn the years since the Great Recession, many observers have highlighted the slow pace of productivity growth around the world. For the United States and Europe, we highlight that this slow pace began prior to the Great Recession. The timing thus suggests that it is important to consider factors other than just the deep crisis itself or policy changes since the crisis. For the United States, at the frontier of knowledge, there was a burst of innovation and reallocation related to the production and use of information technology in the second half of the 1990s and the early 2000s. That burst ran its course prior to the Great Recession. Continental European economies were falling back relative to that frontier at varying rates since the mid-1990s. We provide VAR and panel-data evidence that changes in real interest rates have influenced productivity dynamics in this period. In particular, the sharp decline in real interest rates that took place in Italy and Spain seem to have triggered unfavorable resource reallocations that were large enough to reduce the level of total factor productivity, consistent with recent theories and firm-level evidence.
Why Has the Cyclicality of Productivity Changed? What Does It Mean?
–April 1, 2016
John G. Fernald, J. Christina WangU.S. labor and total factor productivity have historically been procyclical—rising in booms and falling in recessions. After the mid-1980s, however, TFP became much less procyclical with respect to hours while labor productivity turned strongly countercyclical. We find that the key empirical “fact” driving these changes is reduced variation in factor utilization—conceptually, the workweek of capital and labor effort. We discuss a range of theories that seek to explain the changes in productivity’s cyclicality. Increased flexibility, changes in the structure of the economy, and shifts in relative variances of technology and “demand” shocks appear to play key roles.
Measuring the Effect of the Zero Lower Bound on Monetary Policy
–December 1, 2016
Carlos Carvalho, Eric Hsu, Fernanda NechioThe Zero Lower Bound (ZLB) on interest rates is often regarded as an important constraint on monetary policy. To assess how the ZLB affected the Fed’s ability to conduct policy, we estimate the effects of Fed communication on yields of different maturities in the pre-ZLB and ZLB periods. Before the ZLB period, communication affects both short and long-dated yields. In contrast, during the ZLB period, the reaction of yields to communication is concentrated in longer-dated yields. Our findings support the view that the ZLB did not put such a critical constraint on monetary policy, as the Fed retained some ability to affect long-term yields through communication.
Demographics and Real Interest Rates: Inspecting the Mechanism
–April 1, 2016
Carlos Carvalho, Andrea Ferrero, Fernanda NechioThe demographic transition can affect the equilibrium real interest rate through three channels. An increase in longevity-or expectations thereof-puts downward pressure on the real interest rate, as agents build up their savings in anticipation of a longer retirement period. A reduction in the population growth rate has two counteracting effects. On the one hand, capital per-worker rises, thus inducing lower real interest rates through a reduction in the marginal product of capital. On the other hand, the decline in population growth eventually leads to a higher dependency ratio (the fraction of retirees to workers). Because retirees save less than workers, this compositional effect lowers the aggregate savings rate and pushes real rates up. We calibrate a tractable life-cycle model to capture salient features of the demographic transition in developed economies, and find that its overall effect is a reduction of the equilibrium interest rate by at least one and a half percentage points between 1990 and 2014. Demographic trends have important implications for the conduct of monetary policy, especially in light of the zero lower bound on nominal interest rates. Other policies can offset the negative effects of the demographic transition on real rates with different degrees of success.
The Intensive and Extensive Margins of Real Wage Adjustment
–March 1, 2016
Mary C. Daly, Bart HobijnUsing 35 years of data from the Current Population Survey we decompose fluctuations in real median weekly earnings growth into the part driven by movements in the intensive margin-wage growth of individuals continuously full-time employed-and movements in the extensive margin-wage differences of those moving into and out of full-time employment. The relative importance of these two margins varies significantly over the business cycle. When labor markets are tight, continuously full-time employed workers drive wage growth. During labor market downturns, the procyclicality of the intensive margin is largely offset by net exits out of full-time employment among workers with lower earnings. This leads aggregate real wages to be largely acyclical. Most of the extensive margin effect works through the part-time employment margin. Notably, the unemployment margin accounts for little of the variation or cyclicality of median weekly earnings growth.
Does the United States have a Productivity Slowdown or a Measurement Problem?
–March 1, 2016
David M. Byrne, John G. Fernald, Marshall B. ReinsdorfAfter 2004, measured growth in labor productivity and total factor productivity (TFP) slowed. We find little evidence that the slowdown arises from growing mismeasurement of the gains from innovation in information-technology (IT)-related goods and services. First, mismeasurement of IT hardware is significant prior to the slowdown and because the domestic production of these products has fallen, the quantitative effect on productivity is larger in the 1995-2004 period than since, despite mismeasurement worsening for some types of IT. Hence, our adjustments make the slowdown in labor productivity worse. The effect on TFP is more muted. Second, many of the tremendous consumer benefits from smartphones, Google searches, and Facebook are, conceptually, non-market: Consumers are more productive in using their nonmarket time to produce services they value. These benefits raise consumer well-being but do not imply that market-sector production functions are shifting out more rapidly than measured. Moreover, estimated gains in non-market production are too small to compensate for the loss in overall well-being from slower market-sector productivity growth. In addition to IT, other measurement issues we can quantify (such as increasing globalization and fracking) are also quantitatively small relative to the slowdown.
Credit-Fuelled Bubbles
–March 1, 2016
Antonio Doblas-Madridy, Kevin J. LansingIn the context of recent housing busts in the United States and other countries, many observers have highlighted the role of credit and speculation in fueling unsustainable booms that lead to crises. Motivated by these observations, we develop a model of credit-fuelled bubbles in which lenders accept risky assets as collateral. Booming prices allow lenders to extend more credit, in turn allowing investors to bid prices even higher. Eager to profit from the boom for as long as possible, asymmetrically informed investors fuel and ride bubbles, buying overvalued assets in hopes of reselling at a profit to a greater fool. Lucky investors sell the bubbly asset at peak prices to unlucky ones, who buy in hopes that the bubble will grow at least a bit longer. In the end, unlucky investors suffer losses, default on their loans, and lose their collateral to lenders. In our model, tighter monetary and credit policies can reduce or even eliminate bubbles. These findings are in line with conventional wisdom on macro prudential regulation, and stand in contrast with those obtained by Galí (2014) in an overlapping generations context.
Shock Transmission through Cross-Border Bank Lending: Credit and Real Effects
–June 1, 2017
Galina Hale, Tumer Kapan, Camelia MinoiuWe study the transmission of financial shocks across borders through international bank connections. Using data on cross-border interbank loans among 6,000 banks during 1997-2012, we estimate the effect of banks’ direct and indirect exposures to banks in countries experiencing systemic banking crises (“crisis exposures”) on profitability, credit, and the performance of borrower firms. We show that direct crisis exposures reduce bank returns and tighten credit conditions through lower loan volumes and higher rates on new loans. Indirect crisis exposures amplify these effects. Crisis exposures reduce firm growth and investment even in countries not experiencing banking crises themselves, thus transmitting shocks across borders.
Disentangling Goods, Labor, and Credit Market Frictions in Three European Economies
–December 1, 2015
Thomas Brzustowski, Nicolas Petrosky-Nadeau, Etienne WasmerWe build a flexible model with search frictions in three markets: credit, labor, and goods markets. We then apply this model (called CLG) to three different economies: a flexible, finance-driven economy (the UK), an economy with wage moderation (Germany), and an economy with structural rigidities (Spain). In the three countries, goods and credit market frictions play a dominant role in entry costs and account for 75% to 85% of total entry costs. In the goods market, adverse supply shocks are amplified through their propagation to the demand side, as they also imply income losses for consumers. This adds up to, at most, an additional 15% to 25% to the impact of the shocks. Finally, the speed of matching in the goods market and the credit market accounts for a small fraction of unemployment: Most of the variation in unemployment comes from the speed of matching in the labor market.
Not So Disconnected: Exchange Rates and the Capital Stock
–December 1, 2015
Tarek A. Hassan, Thomas M. Mertens, Tony ZhangWe investigate the link between stochastic properties of exchange rates and differences in capital-output ratios across industrialized countries. To this end, we endogenize capital accumulation within a standard model of exchange rate determination with nontraded goods. The model predicts that currencies of countries that are more systemic for the world economy (countries that face particularly volatile shocks or account for a large share of world GDP) appreciate when the price of traded goods in world markets is high. These currencies are better hedges against consumption risk faced by international investors because they appreciate in bad" states of the world. As a consequence, more systemic countries face a lower cost of capital and accumulate more capital per worker. We estimate our model using data from seven industrialized countries with freely floating exchange rate regimes between 1984 and 2010 and show that cross-country variation in the stochastic properties of exchange rates accounts for 72% of the cross-country variation in capital-output ratios. In this sense, the stochastic properties of exchange rates map to fundamentals in the way predicted by the model.
Credit Frictions and Optimal Monetary Policy
–December 1, 2015
Vasco Cúrdia, Michael WoodfordWe extend the basic (representative-household) New Keynesian model of the monetary transmission mechanism to allow for a spread between the interest rate available to savers and borrowers. We find variation in these spreads over time has consequences both for the equilibrium relation between the policy rate and aggregate expenditure and for the relation between real activity and inflation. Nonetheless, the target in the basic model provides a good approximation to optimal policy. Such a “flexible inflation target” can be implemented by a central-bank reaction function that is similar to a forward-looking Taylor rule, but adjusted for changes in current and expected future credit spreads.
Cyclical and Market Determinants of Involuntary Part-Time Employment
–March 1, 2018
Leila Bengali, Catherine van der List, Robert G. VallettaThe fraction of the U.S. workforce identified as involuntary part-time workers rose to new highs during the U.S. Great Recession and came down only slowly in its aftermath. We assess the determinants of involuntary part-time work using an empirical framework that accounts for business cycle effects and persistent structural features of the labor market. We conduct regression analyses using state-level panel and individual data for the years 2003-2016. The results indicate that the persistent market-level factors, most notably shifting industry composition, can largely explain sustained elevation in the incidence of involuntary part-time work since the recession.
Unconventional Monetary Policy and the Dollar: Conventional Signs, Unconventional Magnitudes
–November 1, 2015
Reuven Glick, Sylvain LeducWe examine the effects of unconventional monetary policy surprises on the value of the dollar using high-frequency intraday data and contrast them with the effects of conventional policy tools. Identifying monetary policy surprises from changes in interest rate future prices in narrow windows around policy announcements, we find that monetary policy surprises since the Federal Reserve lowered its policy rate to the effective lower bound have had larger effects on the value of the dollar. In particular, we document that the impact on the dollar has been roughly three times that following conventional policy changes prior to the 2007-08 financial crisis.
Sticker Shocks: Using VAT Changes to Estimate Upper-Level Elasticities of Substitution
–October 1, 2017
Bart Hobijn, Fernanda NechioWe estimate the upper-level elasticity of substitution between goods and services of a nested aggregate CES preference specification. We show how this elasticity can be derived from the long-run response of the relative price of a good to a change in its VAT rate. We estimate this elasticity using new data on changes in VAT rates across 74 goods and services for 25 E.U. countries from 1996 through 2015. Depending on the level of aggregation, we find a VAT pass-through rate between 0.4 and 0.7. This implies an upper-level elasticity of 3, at the lowest level of aggregation with 74 categories, and 1 (Cobb-Douglas preferences) at a high level of aggregation that distinguishes 10 categories of goods and services.
Measuring the Natural Rate of Interest Redux
–October 1, 2015
Thomas Laubach, John C. WilliamsPersistently low real interest rates have prompted the question whether low interest rates are here to stay. This essay assesses the empirical evidence regarding the natural rate of interest in the United States using the Laubach-Williams model. Since the start of the Great Recession, the estimated natural rate of interest fell sharply and shows no sign of recovering. These results are robust to alternative model specifications. If the natural rate remains low, future episodes of hitting the zero lower bound are likely to be frequent and long-lasting. In addition, uncertainty about the natural rate argues for policy approaches that are more robust to mismeasurement of natural rates.
Robust Bond Risk Premia
–May 1, 2017
Michael Bauer, James D. HamiltonA consensus has recently emerged that variables beyond the level, slope, and curvature of the yield curve can help predict bond returns. This paper shows that the statistical tests underlying this evidence are subject to serious small-sample distortions. We propose more robust tests, including a novel bootstrap procedure specifically designed to test the spanning hypothesis. We revisit the analysis in six published studies and find that the evidence against the spanning hypothesis is much weaker than it originally appeared. Our results pose a serious challenge to the prevailing consensus.
Aggregation Level in Stress Testing Models
–September 1, 2015
Galina Hale, John Krainer, Erin McCarthyWe explore the question of optimal aggregation level for stress testing models when the stress test is specified in terms of aggregate macroeconomic variables, but the underlying performance data are available at a loan level. Using standard model performance measures, we ask whether it is better to formulate models at a disaggregated level (“bottom up”) and then aggregate the predictions in order to obtain portfolio loss values or is it better to work directly with aggregated models (“top down”) for portfolio loss forecasts. We study this question for a large portfolio of home equity lines of credit. We conduct model comparisons of loan-level default probability models, county-level models, aggregate portfolio-level models, and hybrid approaches based on portfolio segments such as debt-to-income (DTI) ratios, loan-to-value (LTV) ratios, and FICO risk scores. For each of these aggregation levels we choose the model that fits the data best in terms of in-sample and out-of-sample performance. We then compare winning models across all approaches. We document two main results. First, all the models considered here are capable of fitting our data when given the benefit of using the whole sample period for estimation. Second, in out-of-sample exercises, loan-level models have large forecast errors and underpredict default probability. Average out-of-sample performance is best for portfolio and county-level models. However, for portfolio level, small perturbations in model specification may result in large forecast errors, while county-level models tend to be very robust. We conclude that aggregation level is an important factor to be considered in the stress-testing model design.
Robust Stress Testing
–September 1, 2015
Rhys Bidder, Andrew McKennaDespite the general consensus that stress testing has been useful in financial and macro-prudential regulation, test techniques are still being debated. This paper proposes using robust forecasting analysis to construct adverse scenarios using a benchmark model that includes a modified worst-case distribution. These scenarios give regulators a way to identify vulnerabilities, while acknowledging that models may be misspecified in unknown ways.
Is China Fudging its Figures? Evidence from Trading Partner Data
–September 1, 2015
John G. Fernald, Eric Hsu, Mark M. SpiegelHow reliable are China’s GDP and other data? We address this question by using trading-partner exports to China as an independent measure of its economic activity from 2000-2014. We find that the information content of Chinese GDP improves markedly after 2008. We also consider a number of plausible, non-GDP indicators of economic activity that have been identified as alternative Chinese output measures. We find that activity factors based on the first principal component of sets of indicators are substantially more informative than GDP alone. The index that best matches activity in-sample uses four indicators: electricity, rail freight, an index of raw materials supply, and retail sales. Adding GDP to this group only modestly improves in-sample performance. Moreover, out of sample, a single activity factor without GDP proves the most reliable measure of economic activity.
Currency Unions and Trade: A Post‐EMU Mea Culpa
–July 1, 2015
Reuven Glick, Andrew K. RoseIn our European Economic Review (2002) paper, we used pre‐1998 data on countries participating in and leaving currency unions to estimate the effect of currency unions on trade using (then‐) conventional gravity models. In this paper, we use a variety of empirical gravity models to estimate the currency union effect on trade and exports, using recent data which includes the European Economic and Monetary Union (EMU). We have three findings. First, our assumption of symmetry between the effects of entering and leaving a currency union seems reasonable in the data but is uninteresting. Second, EMU typically has a smaller trade effect than other currency unions; it has a mildly stimulating effect at best. Third and most importantly, estimates of the currency union effect on trade are sensitive to the exact econometric methodology; the lack of consistent and robust evidence undermines confidence in our ability to reliably estimate the effect of currency union on trade.
Leveraged Bubbles
–August 1, 2015
Oscar Jorda, Moritz Schularick, Alan M. TaylorWhat risks do asset price bubbles pose for the economy? This paper studies bubbles in housing and equity markets in 17 countries over the past 140 years. History shows that not all bubbles are alike. Some have enormous costs for the economy, while others blow over. We demonstrate that what makes some bubbles more dangerous than others is credit. When fueled by credit booms, asset price bubbles increase financial crisis risks; upon collapse they tend to be followed by deeper recessions and slower recoveries. Credit-financed housing price bubbles have emerged as a particularly dangerous phenomenon.
Bond Vigilantes and Inflation
–August 1, 2015
Andrew K. Rose, Mark M. SpiegelWe explore the relationship between inflation and the existence of a local domestic‐currency bond market. Domestic bond markets allow governments to inflate away their debt obligations, but also create a potential anti-inflationary force of bond holders. We develop a simple model where bond issuance may lead to political pressure on the government to choose a lower inflation rate. We then check this prediction empirically, finding that inflation‐targeting countries with bond markets experience inflation approximately three to four percentage points lower than those without. This effect is insensitive to a variety of estimation strategies and methods to account for potential endogeneity.
Protecting Working-Age People with Disabilities: Experiences of Four Industrialized Nations
–June 1, 2015
Richard V. Burkhauser, Mary C. Daly, Nicolas ZiebarthAlthough industrialized nations have long provided public protection to working-age individuals with disabilities, the form has changed over time. The impetus for change has been multifaceted: rapid growth in program costs; greater awareness that people with impairments are able and willing to work; and increased recognition that protecting the economic security of people with disabilities might best be done by keeping them in the labor market. We describe the evolution of disability programs in four countries: Germany, the Netherlands, Sweden, and the United States. We show how growth in the receipt of publicly provided disability benefits has fluctuated over time and discuss how policy choices played a role. Based on our descriptive comparative analysis we summarize shared experiences that have the potential to benefit policymakers in all countries.
Physician Competition and the Provision of Care: Evidence from Heart Attacks
–May 1, 2017
Abe Dunn, Adam ShapiroWe study the impact of competition among physicians on service provision and patients’ health outcomes. We focus on cardiologists treating patients with a first-time heart attack treated in the emergency room. Physician concentration has a small but statistically significant effect on service utilization. A one-standard deviation increase in cardiologist concentration causes a 5 percent increase in cardiologist service provision. Cardiologists in more concentrated markets perform more intensive procedures, particularly, diagnostic procedures—services in which the procedure choice is more discretionary. Higher concentration also leads to fewer readmissions, implying potential health benefits. These findings are potentially important for antitrust analysis and suggest that changes in organizational structure in a market, such as a merger of physician groups, not only influences the negotiated prices of services, but also service provision.
The Effect of State Taxes on the Geographical Location of Top Earners: Evidence from Star Scientists
–March 1, 2017
Enrico Moretti, Daniel WilsonWe quantify how sensitive is migration by star scientist to changes in personal and business tax differentials across states. We uncover large, stable, and precisely estimated effects of personal and corporate taxes on star scientists’ migration patterns. The long run elasticity of mobility relative to taxes is 1.8 for personal income taxes, 1.9 for state corporate income tax and -1.7 for the investment tax credit. While there are many other factors that drive when innovative individual and innovative companies decide to locate, there are enough firms and workers on the margin that state taxes matter.
Domestic Bond Markets and Inflation
–February 1, 2015
Andrew K. Rose, Mark M. SpiegelAbstract This paper explores the relationship between inflation and the existence of a local, nominal, publicly-traded, long-maturity, domestic-currency bond market. Bond holders are exposed to capital losses through inflation and therefore represent a potential anti-inflationary force; we ask whether their influence is apparent both theoretically and empirically. We develop a simple theoretical model with heterogeneous agents where the issuance of such bonds leads to political pressure on the government to choose a lower inflation rate. We then check this prediction empirically using a panel of data, examining inflation before and after the introduction of a domestic bond market. Inflation-targeting countries with a bond market experience inflation approximately three to four percentage points lower than those without one. This effect is economically and statistically significant; it is also insensitive to a variety of estimation strategies, including using political and fiscal variables suggested by theory to account for the potential endogeneity of domestic bond issuance. Notably, we do not find a similar effect for short-term or foreign-currency bonds.
Does Medicare Part D Save Lives?
–September 1, 2015
Abe Dunn, Adam ShapiroWe examine the impact of Medicare Part D on mortality for the population over the age of 65. We identify the effects of the reform using variation in drug coverage across counties before the reform was implemented. Studying mortality rates immediately before and after the reform, we find that cardiovascular-related mortality drops significantly in those counties most affected by Part D. Estimates suggest that up to 26,000 more individuals were alive in mid-2007 because of the Part D implementation in 2006.
The Effect of Extended Unemployment Insurance Benefits: Evidence from the 2012-2013 Phase-Out
–January 1, 2015
Henry S. Farber, Jesse Rothstein, Robert G. VallettaUnemployment Insurance benefit durations were extended during the Great Recession, reaching 99 weeks for most recipients. The extensions were rolled back and eventually terminated by the end of 2013. Using matched CPS data from 2008-2014, we estimate the effect of extended benefits on unemployment exits separately during the earlier period of benefit expansion and the later period of rollback. In both periods, we find little or no effect on job-finding but a reduction in labor force exits due to benefit availability. We estimate that the rollbacks reduced the labor force participation rate by about 0.1 percentage point in early 2014.
Explaining the Boom-Bust Cycle in the U.S. Housing Market: A Reverse-Engineering Approach
–February 1, 2018
Paolo Gelain, Kevin J. Lansing, Gisle J. NatvikWe use a quantitative asset pricing model to "reverse-engineer" the sequences of shocks to housing demand and lending standards needed to replicate the boom-bust patterns in U.S. housing value and mortgage debt from 1993 to 2015. Conditional on the observed paths for U.S. real consumption growth, the real mortgage interest rate, and the supply of residential fixed assets, a specification with random walk expectations outperforms one with rational expectations in plausibly matching the patterns in the data. Counterfactual simulations show that shocks to housing demand, housing supply, and lending standards were important, but movements in the mortgage interest rate were not.
Resolving the Spanning Puzzle in Macro-Finance Term Structure Models
–May 1, 2016
Michael Bauer, Glenn D. RudebuschMost existing macro-finance term structure models (MTSMs) appear incompatible with regression evidence of unspanned macro risk. This “spanning puzzle” appears to invalidate those models in favor of new unspanned MTSMs. However, our empirical analysis supports the previous spanned models. Using simulations to investigate the spanning implications of MTSMs, we show that a canonical spanned model is consistent with the regression evidence; thus, we resolve the spanning puzzle. In addition, direct likelihood-ratio tests find that the knife-edge restrictions of unspanned models are rejected with high statistical significance, though these restrictions have only small effects on cross-sectional fit and estimated term premia.
Betting the House
–December 1, 2014
Oscar Jorda, Moritz Schularick, Alan M. TaylorIs there a link between loose monetary conditions, credit growth, house price booms, and financial instability? This paper analyzes the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. We exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions. We use novel instrumental variable local projection methods to demonstrate that loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era.
A Dynamic Model of Price Signaling, Consumer Learning, and Price Adjustment
–November 1, 2014
Matthew Osborne, Adam ShapiroWe examine a model of consumer learning and price signaling where price and quality are optimally chosen by a monopolist. Through numerical solution and simulation of the model we find that price signaling causes the firm to raise its prices, lower its quality, and dampen the degree to which it passes on cost shocks to price. We identify two mechanisms through which signaling affects pass-through. The first is static: holding quality fixed, price signaling increases the curvature of demand relative to the case where quality is known, which ultimately acts to dampen how prices respond to changes in cost. The second is dynamic: a firm that engages in signaling recognizes that changing prices today affects consumer beliefs about the relationship between prices and quality in the future. We also find that signaling can lead to asymmetric pass-through. If the cost of adjusting quality is sufficiently high, then cost increases pass through to a greater extent than cost decreases.
Financial Frictions, the Housing Market, and Unemployment
–November 1, 2014
William A. Branch, Nicolas Petrosky-Nadeau, Guillaume RocheteauWe develop a two-sector search-matching model of the labor market with imperfect mobility of workers, augmented to incorporate a housing market and a frictional goods market. Homeowners use home equity as collateral to finance idiosyncratic consumption opportunities. A financial innovation that raises the acceptability of homes as collateral raises house prices and reduces unemployment. It also triggers a reallocation of workers, with the direction of the change depending on firms’ market power in the goods market. A calibrated version of the model under adaptive learning can account for house prices, sectoral labor flows, and unemployment rate changes over 1996-2010.
The International Transmission of Shocks through the Lens of Foreign Banks in Hong Kong
–January 1, 2023
Kelvin Ho, Cho-hoi Hui, Simon H. Kwan, Eric T.C. WongThis paper studies the international transmission of shocks through the foreign bank lending channel. We find evidence that foreign banks whose parent is headquartered in a country experiencing a financial crisis significantly reduce their lending in the host country. Our results are based on studying foreign banks in Hong Kong during the 2008 US financial crisis and the 2010 European sovereign debt crisis. However, we do not find an overall decline in bank lending during the foreign crisis. Banks from crisis country with a higher deposit ratio reduced lending less. Banks from crisis country with preference for liquidity reduced lending more, consistent with liquidity hoarding during crisis.
Shopping Time
–September 1, 2014
Nicolas Petrosky-Nadeau, Etienne Wasmer, Shutian ZengThe renewal of interest in macroeconomic theories of search frictions in the goods market requires a deeper understanding of the cyclical properties of the intensive margins in this market. We review the theoretical mechanisms that promote either procyclical or countercyclical movements in time spent searching for consumer goods and services, and then use the American Time Use Survey to measure shopping time through the Great Recession. Average time spent searching declined in the aggregate over the period 2008-2010 compared to 2005-2007, and the decline was largest for the unemployed who went from spending more to less time searching for goods than the employed. Cross-state regressions point towards a procyclicality of consumer search in the goods market. At the individual level, time allocated to different shopping activities is increasing in individual and household income. Overall, this body of evidence supports procyclical consumer search effort in the goods market and a conclusion that price comparisons cannot be a driver of business cycles.
The Great Mortgaging: Housing Finance, Crises, and Business Cycles
–September 1, 2014
Oscar Jorda, Moritz Schularick, Alan M. TaylorThis paper unveils a new resource for macroeconomic research: a long-run dataset covering disaggregated bank credit for 17 advanced economies since 1870. The new data show that the share of mortgages on banks’ balance sheets doubled in the course of the 20th century, driven by a sharp rise of mortgage lending to households. Household debt to asset ratios have risen substantially in many countries. Financial stability risks have been increasingly linked to real estate lending booms which are typically followed by deeper recessions and slower recoveries. Housing finance has come to play a central role in the modern macroeconomy.
Explaining Exchange Rate Anomalies in a Model with Taylor-rule Fundamentals and Consistent Expectations
–June 1, 2016
Kevin J. Lansing, Jun MaWe introduce boundedly-rational expectations into a standard asset-pricing model of the exchange rate, where cross-country interest rate differentials are governed by Taylor-type rules. Agents augment a lagged-information random walk forecast with a term that captures news about Taylor-rule fundamentals. The coefficient on fundamental news is pinned down using the moments of observable data such that the resulting forecast errors are close to white noise. The model generates volatility and persistence that is remarkably similar to that observed in monthly exchange rate data for Canada, Japan, and the U.K. Regressions performed on model-generated data can deliver the well-documented forward premium anomaly.
The Extent and Cyclicality of Career Changes: Evidence for the U.K.
–August 1, 2014
Carlos Carrillo-Tudela, Bart Hobijn, Powen She, Ludo VisschersUsing quarterly data for the U.K. from 1993 through 2012, we document that in economic downturns a smaller fraction of unemployed workers change their career when starting a new job. Moreover, the proportion of total hires that involves a career change for the worker also drops in recessions. Together with a simultaneous drop in overall turnover, this implies that the number of career changes declines during recessions. These results indicate that recessions are times of subdued reallocation rather than of accelerated and involuntary structural transformation. We back this interpretation up with evidence on who changes careers, which industries and occupations they come from and go to, and at which wage gains.
Financial Crises and the Composition of Cross-Border Lending
–August 1, 2014
Eugenio Cerutti, Galina Hale, Camelia MinoiuWe examine the composition and drivers of cross-border bank lending between 1995 and 2012, distinguishing between syndicated and non-syndicated loans. We show that on-balance sheet syndicated loan exposures, which account for almost one third of total cross-border loan exposures, increased during the global financial crisis due to large drawdowns on credit lines extended before the crisis. Our empirical analysis of the drivers of cross-border loan exposures in a large bilateral dataset leads to three main results. First, banks with lower levels of capital favor syndicated over other kinds of cross-border loans. Second, borrower country characteristics such as level of development, economic size, and capital account openness, are less important in driving syndicated than non-syndicated loan activity, suggesting a diversification motive for syndication. Third, information asymmetries between lender and borrower countries became more binding for both types of cross-border lending activity during the recent crisis.
The Rise in Home Currency Issuance
–May 1, 2016
Galina Hale, Peter Jones, Mark M. SpiegelFirms in countries outside global financial centers have traditionally found it difficult to place bonds in international markets in their own currencies. Looking at a large sample of private international bond issues in the last 20 years, however, we observe an increase in bonds denominated in issuers’ home currencies. This trend appears to have accelerated notably after the global financial crisis. We present a model that illustrates how the global financial crisis could have had a persistent impact on home currency bond issuance. The model shows that firms that issue for the first time in their home currencies during disruptive episodes, such as the crisis, find their relative costs of issuance in home currencies remain lower after conditions return to normal, partly due to the increased depth of the home currency debt market. Empirically, we show that increases in home currency foreign bond issuance occurred predominantly in advanced economies with good fundamentals and especially in the aftermath of the crisis. Consistent with the predictions of the model, financial firms – which are more homogeneous than their non-financial counterparts – in countries with stable inflation and low government debt increased home currency issuance by more. Our results point to the importance of both global financial market conditions and domestic economic policies in the share of home currency issuance.
Transmission of Quantitative Easing: The Role of Central Bank Reserves
–June 1, 2016
Jens H. E. Christensen, Signe KrogstrupWe argue that the issuance of central bank reserves per se can matter for the effect of central bank large-scale asset purchases—commonly known as quantitative easing—on long-term interest rates. This effect is independent of the assets purchased, and runs through a reserve-induced portfolio balance channel. For evidence we analyze the reaction of Swiss long-term government bond yields to announcements by the Swiss National Bank to expand central bank reserves without acquiring any long-lived securities. We find that declines in long-term yields following the announcements mainly reflected reduced term premiums suggestive of reserve-induced portfolio balance effects.
Monetary Policy and Real Exchange Rate Dynamics in Sticky-Price Models
–April 1, 2019
Carlos Carvalho, Fernanda Nechio, Fang YaoWe study how real exchange rate dynamics are affected by monetary policy in dynamic, stochastic, general equilibrium, sticky-price models. Our analytical and quantitative results show that the source of interest rate persistence – policy inertia or persistent policy shocks – is key. In the presence of persistent monetary shocks, increasing policy inertia may decrease real exchange rate persistence, hampering the ability of sticky-price models to generate persistent real exchange rate deviations from parity.
Long-Run Risk is the Worst-Case Scenario
–May 1, 2016
Rhys Bidder, Ian Dew-BeckerWe study an investor who is unsure of the dynamics of the economy. Not only are parameters unknown, but the investor does not even know what order model to estimate. She estimates her consumption process nonparametrically – allowing potentially infinite-order dynamics – and prices assets using a pessimistic model that minimizes lifetime utility subject to a constraint on statistical plausibility. The equilibrium is exactly solvable and we show that the pricing model always includes long-run risks. With risk aversion of 4.7, the model matches major facts about asset prices, consumption, and dividends. The paper provides a novel link between ambiguity aversion and non-parametric estimation.
Productivity and Potential Output Before, During, and After the Great Recession
–June 1, 2014
John G. FernaldU.S. labor and total-factor productivity growth slowed prior to the Great Recession. The timing rules explanations that focus on disruptions during or since the recession, and industry and state data rule out “bubble economy” stories related to housing or finance. The slowdown is located in industries that produce information technology (IT) or that use IT intensively, consistent with a return to normal productivity growth after nearly a decade of exceptional IT-fueled gains. A calibrated growth model suggests trend productivity growth has returned close to its 1973-1995 pace. Slower underlying productivity growth implies less economic slack than recently estimated by the Congressional Budget Office. As of 2013, about ¾ of the shortfall of actual output from (overly optimistic) pre-recession trends reflects a reduction in the level of potential.
A Wedge in the Dual Mandate: Monetary Policy and Long-Term Unemployment
–May 1, 2014
Glenn D. Rudebusch, John C. WilliamsIn standard macroeconomic models, the two objectives in the Federal Reserve’s dual mandate—full employment and price stability—are closely intertwined. We motivate and estimate an alternative model in which long-term unemployment varies endogenously over the business cycle but does not affect price inflation. In this new model, an increase in long-term unemployment as a share of total unemployment creates short-term tradeoffs for optimal monetary policy and a wedge in the dual mandate. In particular, faced with high long-term unemployment following the Great Recession, optimal monetary policy would allow inflation to overshoot its target more than in standard models.
Recent Extensions of U.S. Unemployment Benefits: Search Responses in Alternative Labor Market States
–May 1, 2014
Robert G. VallettaIn response to the 2007-09 “Great Recession,” the maximum duration of U.S. unemployment benefits was increased from the normal level of 26 weeks to an unprecedented 99 weeks. I estimate the impact of these extensions on job search, comparing them with the more limited extensions associated with the milder 2001 recession. The analyses rely on monthly matched microdata from the Current Population Survey. I find that a 10-week extension of UI benefits raises unemployment duration by about 1.5 weeks, with little variation across the two episodes. This estimate lies in the middle-to-upper end of the range of past estimates
Has U.S. Monetary Policy Tracked the Efficient Interest Rate?
–May 1, 2014
Vasco Cúrdia, Andrea Ferrero, Ging Cee Ng, Andrea TambalottiInterest rate decisions by central banks are universally discussed in terms of Taylor rules, which describe policy rates as responding to inflation and some measure of the output gap. We show that an alternative specification of the monetary policy reaction function, in which the interest rate tracks the evolution of a Wicksellian efficient rate of return as the primary indicator of real activity, fits the U.S. data better than otherwise identical Taylor rules. This surprising result holds for a wide variety of specifications of the other ingredients of the policy rule and of approaches to the measurement of the output gap. Moreover, it is robust across two different models of private agents’ behavior.
Labor Markets in the Global Financial Crisis: The Good, the Bad and the Ugly
–April 1, 2014
Mary C. Daly, John G. Fernald, Oscar Jorda, Fernanda NechioThis note examines labor market performance across countries through the lens of Okun’s Law. We find that after the 1970s but prior to the global financial crisis of the 2000s, the Okun’s Law relationship between output and unemployment became more homogenous across countries. These changes presumably reflected institutional and technological changes. But, at least in the short term, the global financial crisis undid much of this convergence, in part because the affected countries adopted different labor market policies in response to the global demand shock.
The Euro and the Geography of International Debt Flows
–December 1, 2014
Galina Hale, Maurice ObstfeldGreater financial integration between core and peripheral EMU members not only had an effect on both sets of countries but also spilled over beyond the euro area. Lower interest rates allowed peripheral countries to run bigger deficits, which inflated their economies by allowing credit booms. Core EMU countries took on extra foreign leverage to expose themselves to the peripherals. We present a stylized model that illustrates possible mechanisms for these developments. We then analyze the geography of international debt flows using multiple data sources and provide evidence that after the euro’s introduction, core EMU countries increased their borrowing from outside of EMU and their lending to the EMU periphery. Moreover, we present evidence that large core EMU banks’ lending to periphery borrowers was linked to their borrowing from outside of the euro area.
Inflation Expectations and the News
–March 1, 2014
Michael BauerThis paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS breakeven rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, both unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical relationship. The sensitivity of inflation compensation to macroeconomic data surprises is substantial, and it explains a sizable share of the macro response of nominal rates. The paper also documents that survey expectations of inflation exhibit significant comovement with variation in nominal interest rates, as well as significant responses to macroeconomic news.
Did Consumers Want Less Debt? Consumer Credit Demand Versus Supply in the Wake of the 2008-2009 Financial Crisis
–February 1, 2014
Reint Gropp, John Krainer, Elizabeth LadermanWe explore the sources of household balance sheet adjustment following the collapse of the housing market in 2006. First, we use microdata from the Federal Reserve Board’s Senior Loan Officer Opinion Survey to document that banks cumulatively tightened consumer lending standards more in counties that experienced a house price boom in the mid-2000s than in nonboom counties. We then use the idea that renters, unlike homeowners, did not experience an adverse wealth shock when the housing market collapsed to examine the relative importance of two explanations for the observed deleveraging and the sluggish pickup in consumption after 2008. First, households may have optimally adjusted to lower wealth by reducing their demand for debt and implicitly, their demand for consumption. Alternatively, banks may have been more reluctant to lend in areas with pronounced real estate declines. Our evidence is consistent with the second explanation. Renters with low risk scores, compared to homeowners in the same markets, reduced their levels of nonmortgage debt and credit card debt more in counties where house prices fell more. The contrast suggests that the observed reductions in aggregate borrowing were more driven by cutbacks in the provision of credit than by a demand-based response to lower housing wealth.
Monetary Policy Effectiveness in China: Evidence from a FAVAR Model
–February 1, 2014
John G. Fernald, Mark M. Spiegel, Eric T. SwansonWe use a broad set of Chinese economic indicators and a dynamic factor model framework to estimate Chinese economic activity and inflation as latent variables. We incorporate these latent variables into a factor-augmented vector autoregression (FAVAR) to estimate the effects of Chinese monetary policy on the Chinese economy. A FAVAR approach is particularly well-suited to this analysis due to concerns about Chinese data quality, a lack of a long history for many series, and the rapid institutional and structural changes that China has undergone. We find that increases in bank reserve requirements reduce economic activity and inflation, consistent with previous studies. In contrast to much of the literature, however, we find that changes in Chinese interest rates also have substantial impacts on economic activity and inflation, while other measures of changes in credit conditions, such as shocks to M2 or lending levels, do not once other policy variables are taken into account. Overall, our results indicate that the monetary policy transmission channels in China have moved closer to those of Western market economies.
Scraping By: Income and Program Participation After the Loss of Extended Unemployment Benefits
–April 1, 2017
Jesse Rothstein, Robert G. VallettaMany Unemployment Insurance (UI) recipients do not find new jobs before exhausting their benefits, even when benefits are extended during recessions. Using SIPP panel data covering the 2001 and 2007-09 recessions and their aftermaths, we identify individuals whose jobless spells outlasted their UI benefits (exhaustees) and examine household income, program participation, and health-related outcomes during the six months following UI exhaustion. For the average exhaustee, the loss of UI benefits is only slightly offset by increased participation in other safety net programs (e.g., food stamps), and family poverty rates rise substantially. Self-reported disability also rises following UI exhaustion. These patterns do not vary dramatically across the UI extension episodes, household demographic groups, or broad income level prior to job loss. The results highlight the unique, important role of UI in the U.S. social safety net.
Mortgage Choice in the Housing Boom: Impacts of House Price Appreciation and Borrower Type
–March 1, 2014
Frederick T. Furlong, David Lang, Yelena TakhtamanovaThe U.S. housing boom during the first part of the past decade was marked by rapid house price appreciation and greater access to mortgage credit for lower credit-rated borrowers. The subsequent collapse of the housing market and the high default rates on residential mortgages raise the issue of whether the pace of house price appreciation and the mix of borrowers may have affected the influence of fundamentals in housing and mortgage markets. This paper examines that issue in connection with one aspect of mortgage financing, the choice among fixed-rate and adjustable-rate mortgages. This analysis is motivated in part by the increased use of adjustable-rate mortgage financing, notably among lower credit-rated borrowers, during the peak of the housing boom. Based on analysis of a large sample of loan level data, we find strong evidence that house price appreciation dampened the influence of a number of fundamentals (mortgage pricing terms and other interest rate related metrics) that previous research finds to be important determinants of mortgage financing choices. With regard to the mix of borrowers, the evidence indicates that, while low risk-rated borrowers were affected on the margin more by house price appreciation, on balance those borrowers tended be at least as responsive to fundamentals as high risk rated borrowers. The higher propensity of low credit-rated borrowers to choose adjustable-rate financing compared with high credit-rated borrowers in the housing boom appears to have been related to borrower credit risk metrics. Given the evidence related to loan pricing terms, other interest rate metrics and fixed effects, the relation of credit risk to mortgage financing choice seems more consistent with considerations such as credit constraints, risk preferences, and mortgage tenor than just a systematic lack of financial sophistication among higher credit risk borrowers.
Breaking the “Iron Rice Bowl:” Evidence of Precautionary Savings from the Chinese State-Owned Enterprises Reform
–November 1, 2017
Hui He, Feng Huang, Zheng Liu, Dongming ZhuWe estimate the importance of precautionary saving by using the large-scale reform of state-owned enterprises (SOEs) in China in the late 1990s as a natural experiment to identify changes in income uncertainty. Before the reform, SOE workers enjoyed similar job security as government employees. The reform caused massive layoffs in the SOEs, but government employees kept their iron rice bowl." The changes in the relative unemployment risks for SOE workers after the reform provide a clean identification of income uncertainty. Furthermore, we focus on individuals with government assigned jobs to mitigate potential self-selection biases. We estimate that precautionary savings account for about 40 percent of SOE household wealth accumulation between 1995 and 2002. We also find evidence that demographic groups more vulnerable to unemployment risks accumulated more precautionary wealth in response to the reform.
Can Spanned Term Structure Factors Drive Stochastic Yield Volatility?
–January 1, 2014
Jens H. E. Christensen, Jose A. Lopez, Glenn D. RudebuschThe ability of the usual factors from empirical arbitrage-free representations of the term structure — that is, spanned factors — to account for interest rate volatility dynamics has been much debated. We examine this issue with a comprehensive set of new arbitrage-free term structure specifications that allow for spanned stochastic volatility to be linked to one or more of the yield curve factors. Using U.S. Treasury yields, we find that much realized stochastic volatility cannot be associated with spanned term structure factors. However, a simulation study reveals that the usual realized volatility metric is misleading when yields contain plausible measurement noise. We argue that other metrics should be used to validate stochastic volatility models
The Future of U.S. Economic Growth
–January 1, 2014
John G. Fernald, Charles I. JonesModern growth theory suggests that more than 3/4 of growth since 1950 reflects rising educational attainment and research intensity. As these transition dynamics fade, U.S. economic growth is likely to slow at some point. However, the rise of China, India, and other emerging economies may allow another few decades of rapid growth in world researchers. Finally, and more speculatively, the shape of the idea production function introduces a fundamental uncertainty into the future of growth. For example, the possibility that artificial intelligence will allow machines to replace workers to some extent could lead to higher growth in the future.
Modernization and Discrete Measures of Democracy
–January 1, 2014
Jess Benhabib, Alejandro Corvalen, Mark M. SpiegelWe reassess the empirical evidence for a positive relationship between income and democracy, commonly known as the “modernization hypothesis,” using discrete democracy measures. While discrete measures have been advocated in the literature, they pose estimation problems under fixed effects due to incidental parameter issues. We use two methods to address these issues, the bias-correction method of Fernandez-Val, which directly computes the marginal effects, and the parameterized Wooldridge method. Estimation under the Fernandez-Val method consistently indicates a statistically and economically important role for income in democracy, while under the Wooldridge method we obtain much smaller and not always statistically significant coefficients. A likelihood ratio test rejects the pooled full sample used under the Wooldridge estimation method against the smaller fixed effects sample that only admits observations with changing democracy measures. Our analysis therefore favors a positive role for income in promoting democracy, but does not preclude a role for institutions in determining democratic status as the omitted countries under Fernandez Val-fixed effect method appear to differ systematically by institutional quality measures which have a positive impact on democratization.
Disability Benefit Growth and Disability Reform in the U.S.: Lessons from Other OECD Nations
–December 1, 2013
Richard V. Burkhauser, Mary C. Daly, Duncan McVicar, Roger WilkinsUnsustainable growth in program costs and beneficiaries, together with a growing recognition that even people with severe impairments can work, led to fundamental disability policy reforms in the Netherlands, Sweden, and Great Britain. In Australia, rapid growth in disability recipiency led to more modest reforms. Here we describe the factors driving unsustainable DI program growth in the U.S., show their similarity to the factors that led to unsustainable growth in these other four OECD countries, and discuss the reforms each country implemented to regain control over their cash transfer disability program. Although each country took a unique path to making and implementing fundamental reforms, shared lessons emerge from their experiences.
Modeling Yields at the Zero Lower Bound: Are Shadow Rates the Solution?
–December 1, 2013
Jens H. E. Christensen, Glenn D. RudebuschRecent U.S. Treasury yields have been constrained to some extent by the zero lower bound (ZLB) on nominal interest rates. In modeling these yields, we compare the performance of a standard affine Gaussian dynamic term structure model (DTSM), which ignores the ZLB, and a shadow-rate DTSM, which respects the ZLB. We find that the standard affine model is likely to exhibit declines in fit and forecast performance with very low interest rates. In contrast, the shadow-rate model mitigates ZLB problems significantly and we document superior performance for this model class in the most recent period.
A Probability-Based Stress Test of Federal Reserve Assets and Income
–December 1, 2013
Jens H. E. Christensen, Jose A. Lopez, Glenn D. RudebuschTo support the economy, the Federal Reserve amassed a large portfolio of long-term bonds. We assess the Fed’s associated interest rate risk — including potential losses to its Treasury securities holdings and declines in remittances to the Treasury. Unlike past examinations of this interest rate risk, we attach probabilities to alternative interest rate scenarios. These probabilities are obtained from a dynamic term structure model that respects the zero lower bound on yields. The resulting probability-based stress test finds that the Fed’s losses are unlikely to be large and remittances are unlikely to exhibit more than a brief cessation.
Sovereigns versus Banks: Credit, Crises, and Consequences
–February 1, 2014
Oscar Jorda, Moritz Schularick, Alan M. TaylorTwo separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies. However, the two may interact in important and understudied ways. This paper examines the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt. However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression. We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870: (i) in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; (ii) the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and (iii) the path of recovery is worse still when a credit-fueled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now.
Physician Payments Under Health Care Reform
–March 1, 2014
Abe Dunn, Adam ShapiroThis study examines the impact of major health insurance reform on payments made in the health care sector. We study the prices of services paid to physicians in the privately insured market during the Massachusetts health care reform. The reform increased the number of insured individuals as well as introduced an online marketplace where insurers compete. We estimate that, over the reform period, physician payments increased at least 10.8 percentage points relative to control areas. Payment increases began around the time legislation passed the House and Senate–the period in which there was a high probability of the bill eventually becoming law. This result is consistent with fixed-duration payment contracts being negotiated in anticipation of future demand and competition.
The Impact of Reserves Practices on Bank Opacity
–July 1, 2014
Giuliano Iannotta, Simon H. KwanThis paper finds that banking firms’ unexpected loan loss provisions had a significant effect of increasing bank opacity, both before and during the 2007-09 financial crisis. Furthermore, during the financial crisis, the extent to which banks delayed loan loss recognition is found to have had a significant effect on bank opacity, confirming an important concern raised by the Financial Crisis Advisory Group. Overall, banks’ practices in managing reserves seem to have a material impact on their opacity.
A Regime-Switching Model of the Yield Curve at the Zero Bound
–January 1, 2016
Jens H. E. ChristensenThis paper presents a regime-switching model of the yield curve with two states. One is a normal state, the other is a zero-bound state that represents the case when the monetary policy target rate is at its zero lower bound for a prolonged period. The model delivers estimates of the time-varying probability of exiting the zero-bound state, and it outperforms standard three- and four-factor term structure models as well as a shadow rate model at matching short-rate expectations and the compression in yield volatility near the zero lower bound.
Optimal Monetary Policy and Capital Account Restrictions in a Small Open Economy
–February 1, 2015
Zheng Liu, Mark M. SpiegelDeclines in interest rates in advanced economies during the global financial crisis resulted in surges in capital flows to emerging market economies and triggered advocacy of capital control policies. We evaluate the effectiveness for macroeconomic stabilization and the welfare implications of the use of capital account policies in a monetary DSGE model of a small open economy. Our model features incomplete markets, imperfect asset substitutability, and nominal rigidities. In this environment, policymakers can respond to fluctuations in capital flows through capital account policies such as sterilized interventions and taxing capital inflows, in addition to conventional monetary policy. Our welfare analysis suggests that optimal sterilization and capital controls are complementary policies.
Shocks and Adjustments
–July 1, 2017
Mary C. Daly, John G. Fernald, Oscar Jorda, Fernanda NechioThe manner firms respond to shocks reflects fundamental features of labor, capital, and commodity markets, as well as advances in finance and technology. Such features are integral to constructing models of the macroeconomy. In this paper we document secular shifts in the margins firms use, in aggregate, to adjust to shocks that have consequences for the economy’s cyclical behavior. These new business cycle facts on the comovement of output and its inputs are a natural complement to analyzing output and its expenditure components. Our findings shed light on the changing cyclicality of productivity in response to different shocks.
Factor Specificity and Real Rigidities
–August 1, 2016
Carlos Carvalho, Fernanda NechioWe develop a multisector model in which capital and labor are free to move across firms within each sector, but cannot move across sectors. To isolate the role of sectoral specificity, we compare our model with otherwise identical multisector economies with either economy-wide or firm-specific factor markets. Sectoral factor specificity generates within-sector strategic substitutability and tends to induce across-sector strategic complementarity in price setting. Our model can produce either more or less monetary non-neutrality than those other two models, depending on parameterization and the distribution of price rigidity across sectors. Under the empirical distribution for the U.S., our model behaves similarly to an economy with firm-specific factors in the short-run, and later on approaches the dynamics of the model with economy-wide factor markets. This is consistent with the idea that factor price equalization might take place gradually over time, so that firm-specificity may serve as a reasonable short-run approximation, whereas economy-wide markets are likely a better description of how factors of production are allocated in the longer run.
Implications of Labor Market Frictions for Risk Aversion and Risk Premia
–September 1, 2014
Eric T. SwansonA flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along both margins can greatly alter the household’s attitudes toward risk, as shown in Swanson (2012). The present paper analyzes how frictional labor markets affect that analysis. Risk aversion is higher: 1) in recessions, 2) in countries with more frictional labor markets, and 3) for households that have more difficulty finding a job. These predictions are consistent with empirical evidence from a variety of sources. Traditional, fixed-labor measures of risk aversion show no stable relationship to the equity premium in a standard real business cycle model with search frictions, while the closed-form expressions derived in the present paper match the equity premium closely.
Frequency Shifting
–March 1, 2018
Rhys BidderWhat determines the frequency domain properties of a stochastic process? How much risk comes from high frequencies, business cycle frequencies or low frequency swings? If these properties are under the influence of an agent, who is compensated by a principal according to the distribution of risk across frequencies, then the nature of this contracting problem will affect the spectral properties of the endogenous outcome. We imagine two thought experiments: in the first, the principal is myopic with regard to certain frequencies – his understanding of the true process is intermediated through a filter – and the agent chooses to hide risk by shifting power from frequencies to which the regulator is attuned to those to which he is not. Thus, the regulator is fooled into thinking there has been an overall reduction in risk when, in fact, there has simply been a frequency shift. In the second thought experiment, the regulator is not myopic, but simply cares more about risk from certain frequencies, perhaps due to the preferences of the constituents he represents or because certain types of market incompleteness make certain frequencies of risk more damaging. We model this intuition by positing a filter design problem for the agent and also by a particular type of portfolio selection problem, in which the agent chooses among investment projects with different spectral properties. While abstract, these models suggest important implications for macroprudential policy and regulatory arbitrage.
Doubts and Variability: A Robust Perspective on Exotic Consumption Series
–January 1, 2018
Rhys Bidder, Matthew E. SmithConsumption-based asset-pricing models have experienced success in recent years by augmenting the consumption process in ‘exotic’ ways. Two notable examples are the Long-Run Risk and rare disaster frameworks. Such models are difficult to characterize from consumption data alone. Accordingly, concerns have been raised regarding their specification. Acknowledging that both phenomena are naturally subject to ambiguity, we show that an ambiguity-averse agent may behave as if Long-Run Risk and disasters exist even if they do not or exaggerate them if they do. Consequently, prices may be misleading in characterizing these phenomena since they encode a pessimistic perspective of the data-generating process.
The Decline of the U.S. Labor Share
–September 1, 2013
Michael Elsby, Bart Hobijn, Aysegül SahinOver the past quarter century, labor’s share of income in the United States has trended downwards, reaching its lowest level in the postwar period after the Great Recession. Detailed examination of the magnitude, determinants and implications of this decline delivers five conclusions. First, around one third of the decline in the published labor share is an artifact of a progressive understatement of the labor income of the self-employed underlying the headline measure. Second, movements in labor’s share are not a feature solely of recent U.S. history: The relative stability of the aggregate labor share prior to the 1980s in fact veiled substantial, though offsetting, movements in labor shares within industries. By contrast, the recent decline has been dominated by trade and manufacturing sectors. Third, U.S. data provide limited support for neoclassical explanations based on the substitution of capital for (unskilled) labor to exploit technical change embodied in new capital goods. Fourth, institutional explanations based on the decline in unionization also receive weak support. Finally, we provide evidence that highlights the offshoring of the labor-intensive component of the U.S. supply chain as a leading potential explanation of the decline in the U.S. labor share over the past 25 years.
Does Quantitative Easing Affect Market Liquidity?
–December 1, 2018
Jens H. E. Christensen, James M. GillanWe argue that central bank large-scale asset purchases—commonly known as quantitative easing (QE)—can reduce priced frictions to trading through a liquidity channel that operates by temporarily increasing the bargaining power of sellers in the market for the targeted securities. For evidence we analyze how the Federal Reserve’s second QE program that included purchases of Treasury inflation-protected securities (TIPS) affected a measure of liquidity premiums in TIPS yields and inflation swap rates. We find that, for the duration of the program, the liquidity premium measure averaged about 10 basis points lower than expected. This suggests that QE can improve market liquidity.
The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy
–September 1, 2013
Oscar Jorda, Alan M. TaylorElevated government debt levels in advanced economies have risen rapidly as sovereigns absorbed private sector losses and cyclical deficits blew up in the Global Financial Crisis and subsequent slump. A rush to fiscal austerity followed but its justifications and impacts have been heavily debated. Research on the effects of austerity on macroeconomic aggregates remains unsettled, mired by the difficulty of identifying multipliers from observational data. This paper reconciles seemingly disparate estimates of multipliers within a unified framework. We do this by first evaluating the validity of common identification assumptions used by the literature and find that they are largely violated in the data. Next, we use new propensity score methods for time-series data with local projections to quantify how contractionary austerity really is, especially in economies operating below potential. We find that the adverse effects of austerity may have been understated.
Semiparametric Estimates of Monetary Policy Effects: String Theory Revisited
–August 1, 2013
Joshua D. Angrist, Oscar Jorda, Guido M. KuersteinerWe develop flexible semiparametric time series methods that are then used to assess the causal effect of monetary policy interventions on macroeconomic aggregates. Our estimator captures the average causal response to discrete policy interventions in a macro-dynamic setting, without the need for assumptions about the process generating macroeconomic outcomes. The proposed procedure, based on propensity score weighting, easily accommodates asymmetric and nonlinear responses. Application of this estimator to the effects of monetary restraint shows the Fed to be an effective inflation fighter. Our estimates of the effects of monetary accommodation, however, suggest the Federal Reserve’s ability to stimulate real economic activity is more modest. Estimates for recent financial crisis years are similar to those for the earlier, pre-crisis period.
Temptation and Self-Control: Some Evidence and Applications
–August 1, 2013
Kevin X.D. Huang, Zheng Liu, John Q. ZhuThis paper studies the empirical relevance of temptation and self-control using household-level data from the Consumer Expenditure Survey. We construct an infinite-horizon consumption-savings model that allows, but does not require, temptation and self-control in preferences. In the presence of temptation, a wealth-consumption ratio, in addition to consumption growth, becomes a determinant of the asset-pricing kernel, and the importance of this additional pricing factor depends on the strength of temptation. To identify the presence of temptation, we exploit an implication of the theory that a more tempted individual should be more likely to hold commitment assets such as IRA or 401(k) accounts. Our estimation provides empirical support for temptation preferences. Based on our estimates, we explore some quantitative implications of this class of preferences for capital accumulation in a neoclassical growth model and the welfare cost of the business cycle.
Land Prices and Unemployment
–March 1, 2016
Zheng Liu, Jianjun Miao, Tao ZhaWe integrate the housing market and the labor market in a dynamic general equilibrium model with credit and search frictions. We argue that the labor channel, combined with the standard credit channel, provides a strong transmission mechanism that can deliver a potential solution to the Shimer (2005) puzzle. The model is confronted with U.S. macroeconomic time series. The estimation results account for two prominent facts observed in the data. First, land prices and unemployment move in opposite directions over the business cycle. Second, a shock that moves land prices also generates the observed large volatility of unemployment.
Measuring the Effect of the Zero Lower Bound on Yields and Exchange Rates in the U.K. and Germany
–August 1, 2013
Eric T. Swanson, John C. WilliamsThe zero lower bound on nominal interest rates began to constrain many central banks’ setting of short-term interest rates in late 2008 or early 2009. According to standard macroeconomic models, this should have greatly reduced the effectiveness of monetary policy and increased the efficacy of fiscal policy. However, these models also imply that asset prices and private-sector decisions depend on the entire path of expected future short-term interest rates, not just the current level of the monetary policy rate. Thus, interest rates with a year or more to maturity are arguably more relevant for asset prices and the economy, and it is unclear to what extent those yields have been affected by the zero lower bound. In this paper, we apply the methods of Swanson and Williams (2013) to medium- and longer-term yields and exchange rates in the U.K. and Germany. In particular, we compare the sensitivity of these rates to macroeconomic news during periods when short-term interest rates were very low to that during normal times. We find that: 1) USD/GBP and USD/EUR exchange rates have been essentially unaffected by the zero lower bound, 2) yields on German bunds were essentially unconstrained by the zero bound until late 2012, and 3) yields on U.K. gilts were substantially constrained by the zero lower bound in 2009 and 2012, but were surprisingly responsive to news in 2010–11. We compare these findings to the U.S. and discuss their broader implications.
The Effect of Capital Controls and Prudential FX Measures on Options-Implied Exchange Rate Stability
–September 1, 2013
Marius del Giudice Rodriguez, Thomas WuHas the recent wave of capital controls and prudential foreign exchange (FX) measures been effective in promoting exchange rate stability? We tackle this question by studying a panel of 25 countries/currencies from July 1, 2009, to June 30, 2011. We calculate daily measures of exchange rate volatility, absolute crash risk, and tail risk implied in currency option prices, and we construct indices of capital controls and prudential FX measures taking into account the exact date when policy changes are implemented. Using a difference-in-differences approach, we find evidence that (i) tightening controls on nonresidents suppresses daily exchange rate fluctuations at the cost of increasing the frequency of outliers, (ii) easing controls on residents truly improves exchange rate stability over all dimensions, and (iii) tightening prudential FX measures not specific to derivative markets reduces absolute crash risk and tail risk, with no effect on volatility.
Assessing the Historical Role of Credit: Business Cycles, Financial Crises, and the Legacy of Charles S. Peirce
–July 1, 2013
Oscar JordaThis paper provides a historical overview on financial crises and their origins. The objective is to discuss a few of the modern statistical methods that can be used to evaluate predictors of these rare events. The problem involves prediction of binary events and therefore fits modern statistical learning, signal processing theory, and classification methods. The discussion also emphasizes the need to supplement statistics and computational techniques with economics. A forecast’s success in this environment hinges on the economic consequences of the actions taken as a result of the forecast, rather than on typical statistical metrics of prediction accuracy.
Monetary Policy Expectations at the Zero Lower Bound
–May 1, 2015
Michael Bauer, Glenn D. RudebuschWe show that conventional dynamic term structure models (DTSMs) estimated on recent U.S. data severely violate the zero lower bound (ZLB) on nominal interest rates and deliver poor forecasts of future short rates. In contrast, shadow-rate DTSMs account for the ZLB by construction, capture the resulting distributional asymmetry of future short rates, and achieve good forecast performance. These models provide more accurate estimates of the most likely path for future monetary policy—including the timing of policy liftoff from the ZLB and the pace of subsequent policy tightening. We also demonstrate the benefits of including macroeconomic factors in a shadow-rate DTSM when yields are constrained near the ZLB.
State Incentives for Innovation, Star Scientists and Jobs: Evidence from Biotech
–July 1, 2013
Enrico Moretti, Daniel WilsonWe evaluate the effects of state-provided financial incentives for biotech companies, which are part of a growing trend of placed-based policies designed to spur innovation clusters. We estimate that the adoption of subsidies for biotech employers by a state raises the number of star biotech scientists in that state by about 15 percent over a three year period. A 10% decline in the user cost of capital induced by an increase in R&D tax incentives raises the number of stars by 22%. Most of the gains are due to the relocation of star scientist to adopting states, with limited effect on the productivity of incumbent scientists already in the state. The gains are concentrated among private sector inventors. We uncover little effect of subsidies on academic researchers, consistent with the fact that their incentives are unaffected. Our estimates indicate that the effect on overall employment in the biotech sector is of comparable magnitude to that on star scientists. Consistent with a model where workers are fairly mobile across states, we find limited effects on salaries in the industry. We uncover large effects on employment in the non-traded sector due to a sizable multiplier effect, with the largest impact on employment in construction and retail. Finally, we find mixed evidence of a displacement effect on states that are geographically
Are State Governments Roadblocks to Federal Stimulus? Evidence on the Flypaper Effect of Highway Grants in the 2009 Recovery Act
–April 15, 2016
Sylvain Leduc, Daniel WilsonWe examine how state governments adjusted spending in response to the large temporary increase in federal highway grants under the 2009 American Recovery and Reinvestment Act (ARRA). The mechanism used to apportion ARRA highway grants to states allows us to isolate exogenous changes in these grants. We find that states increased highway spending over 2009 to 2011 more than dollar-for-dollar with the ARRA grants they received. We examine whether rent- seeking efforts could help explain this result. We find states with more political contributions from the public-works sector tended to spend more out of their ARRA highway funds than other states.
A Defense of Moderation in Monetary Policy
–July 1, 2013
John C. WilliamsThis paper examines the implications of uncertainty about the effects of monetary policy for optimal monetary policy with an application to the current situation. Using a stylized macroeconomic model, I derive optimal policies under uncertainty for both conventional and unconventional monetary policies. According to an estimated version of this model, the U.S. economy is currently suffering from a large and persistent adverse demand shock. Optimal monetary policy absent uncertainty would quickly restore real GDP close to its potential level and allow the inflation rate to rise temporarily above the longer-run target. By contrast, the optimal policy under uncertainty is more muted in its response. As a result, output and inflation return to target levels only gradually. This analysis highlights three important insights for monetary policy under uncertainty. First, even in the presence of considerable uncertainty about the effects of monetary policy, the optimal policy nevertheless responds strongly to shocks: uncertainty does not imply inaction. Second, one cannot simply look at point forecasts and judge whether policy is optimal. Indeed, once one recognizes uncertainty, some moderation in monetary policy may well be optimal. Third, in the context of multiple policy instruments, the optimal strategy is to rely on the instrument associated with the least uncertainty and use alternative, more uncertain instruments only when the least uncertain instrument is employed to its fullest extent possible.
Bank Linkages and International Trade
–February 1, 2016
Sergey Borisov, Julian Caballero, Christopher Candelaria, Galina HaleWe uncover a new channel through which international finance is related to international trade: formation of international bank linkages increases exports. Bank linkages are measured for each pair of countries in each year as a number of bank pairs in these two countries that are connected through cross-border syndicated lending. Using a gravity approach to model trade with a full set of fixed effects (source-year, target-year, source-target), we find that new connections between banks in a given country-pair lead to an increase in trade flows between these countries in the following year. We conjecture that the mechanism for this effect is the role bank linkages play in reducing export risk and present six sets of results supporting this conjecture. In particular, using industry–level trade data and controlling for country-pair-year and industry fixed effects, we find that new bank linkages have larger impacts on trade in industries with more differentiated goods, i.e. industries which tend to be subject to more export risk. Moreover, for U.S. banks , we can show that bank linkages are positively associated with foreign letter of credit exposures. Finally, we find that the formation of new bank linkages creates trade diversions from countries competing for similar imports.
Inequality and Mortality: New Evidence from U.S. County Panel Data
–May 1, 2013
Mary C. Daly, Daniel WilsonA large body of past research, looking across countries, states, and metropolitan areas, has found positive and statistically significant associations between income inequality and mortality. By contrast, in recent years more robust statistical methods using larger and richer data sources have generally pointed to little or no relationship between inequality and mortality. This paper aims both to document how methodological shortcomings tend to positively bias this statistical association and to advance this literature by estimating the inequality-mortality relationship. We use a comprehensive and rich new data set that combines U.S. county-level data for 1990 and 2000 on age-race-gender-specific mortality rates, a rich set of observable covariates, and previously unused Census data on local income inequality (Gini index and three income percentile ratios). Using panel data estimation techniques, we find evidence of a statistically significant negative relationship between mortality and inequality. This finding that increased inequality is associated with declines in mortality at the county level suggests a change in course for the literature. In particular, the emphasis to date on the potential psychosocial and resource allocation costs associated with higher inequality is likely missing important offsetting positives that may dominate.
China’s Financial Linkages with Asia and the Global Financial Crisis
–May 1, 2013
Reuven Glick, Michael HutchisonThis paper presents empirical evidence on asset market linkages between China and Asia and how these linkages have shifted during and after the global financial crisis of 2008-2009. We find only weak cross-country linkages in longer-term interest rates, but much stronger linkages in equity markets. This finding is consistent with the greater development and liberalization of equity markets relative to bond markets in China, as well as increasing business and trade linkages in the region. We also find that the strength of the correlation of equity prices changes between China and other Asia countries increased markedly during the crisis and has remained high in recent years. We attribute this development to greater “attentiveness” of international investors to China’s role as a source and destination of equity finance during the crisis rather than to any greater financial deepening and liberalization, as China did not implement any major policy measures during this period. By contrast, the transmission of U.S. equity returns to Asian countries decreased after the crisis.
The Effects of Unconventional and Conventional U.S. Monetary Policy on the Dollar
–May 1, 2013
Reuven Glick, Sylvain LeducWe examine the effects of unconventional and conventional monetary policy announcements on the value of the dollar using high-frequency intraday data. Identifying monetary policy surprises from changes in interest rate futures prices in narrow windows around policy announcements, we find that surprise easings in monetary policy since the crisis began have had significant effects on the value of the dollar. We document that these changes are comparable to the effects of conventional policy changes prior to the crisis.
Is Asia Decoupling from the United States (Again)?
–May 1, 2013
Sylvain Leduc, Mark M. SpiegelThe recovery from the recent global financial crisis exhibited a decline in the synchronization of Asian output with the rest of the world. However, a simple model based on output gaps demonstrates that the decline in business cycle synchronization during the recovery from the global financial crisis was exceptionally steep by historical standards. We posit two potential reasons for this exceptionally steep decline: First, financial markets during this recovery improved from particularly distressed conditions relative to previous downturns. Second, monetary policy during the recovery from the crisis was constrained in western economies by the zero bound, but less so in Asia. To test these potential explanations, we examine the implications of an increase in corporate bond spreads similar to that which took place during the recent European financial crisis in a 3‐region open‐economy DSGE model. Our results confirm that global business cycle synchronization is reduced when zero‐bound constraints across the world differ. However, we find that the impact of reduced financial contagion actually goes modestly against our predictions.
Do Extended Unemployment Benefits Lengthen Unemployment Spells? Evidence from Recent Cycles in the U.S. Labor Market
–April 1, 2013
Henry S. Farber, Robert G. VallettaIn response to the Great Recession and sustained labor market downturn, the availability of unemployment insurance (UI) benefits was extended to new historical highs in the United States, up to 99 weeks as of late 2009 into 2012. We exploit variation in the timing and size of UI benefit extensions across states to estimate the overall impact of these extensions on unemployment duration, comparing the experience with the prior extension of benefits (up to 72 weeks) during the much milder downturn in the early 2000s. Using monthly matched individual data from the U.S. Current Population Survey (CPS) for the periods 2000-2005 and 2007-2012, we estimate the effects of UI extensions on unemployment transitions and duration. We rely on individual variation in benefit availability based on the duration of unemployment spells and the length of UI benefits available in the state and month, conditional on state economic conditions and individual characteristics. We find a small but statistically significant reduction in the unemployment exit rate and a small increase in the expected duration of unemployment arising from both sets of UI extensions. The effect on exits and duration is primarily due to a reduction in exits from the labor force rather than a decrease in exits to employment (the job finding rate). The magnitude of the overall effect on exits and duration is similar across the two episodes of benefit extensions. Although the overall effect of UI extensions on exits from unemployment is small, it implies a substantial effect of extended benefits on the steady-state share of unemployment in the cross-section that is long-term.
Downward Nominal Wage Rigidities Bend the Phillips Curve
–January 1, 2014
Mary C. Daly, Bart HobijnWe introduce a model of monetary policy with downward nominal wage rigidities and show that both the slope and curvature of the Phillips curve depend on the level of inflation and the extent of downward nominal wage rigidities. This is true for the both the long-run and the short-run Phillips curve. Comparing simulation results from the model with data on U.S. wage patterns, we show that downward nominal wage rigidities likely have played a role in shaping the dynamics of unemployment and wage growth during the last three recessions and subsequent recoveries.
Estimating Shadow-Rate Term Structure Models with Near-Zero Yields
–June 1, 2013
Jens H. E. Christensen, Glenn D. RudebuschStandard Gaussian affine dynamic term structure models do not rule out negative nominal interest rates—a conspicuous defect with yields near zero in many countries. Alternative shadow-rate models, which respect the nonlinearity at the zero lower bound, have been rarely used because of the extreme computational burden of their estimation. However, by valuing the call option on negative shadow yields, we provide the first estimates of a three-factor shadow-rate model. We validate our option-based results by closely matching them using a simulation-based approach. We also show that the shadow short rate is sensitive to model fit and specification.
Persistence of Regional Inequality in China
–March 1, 2013
Christopher Candelaria, Mary C. Daly, Galina HaleRegional inequality in China appears to be persistent and even growing in the last two decades. We study potential explanations for this phenomenon. After making adjustments for the difference in the cost of living across provinces, we find that some of the inequality in real wages could be attributed to differences in quality of labor, industry composition, labor supply elasticities, and geographical location of provinces. These factors, taken together, explain about half of the cross-province real wage difference. Interestingly, we find that inter-province redistribution did not help offset regional inequality during our sample period. We also demonstrate that inter-province migration, while driven in part by levels and changes in wage differences across provinces, does not offset these differences. These results imply that cross-province labor market mobility in China is still limited, which contributes to the persistence of cross-province wage differences.
On the Importance of the Participation Margin for Market Fluctuations
–February 1, 2013
Michael Elsby, Bart Hobijn, Aysegül SahinConventional analyses of cyclical fluctuations in the labor market ascribe a minor role to the labor force participation margin. In contrast, a flows-based decomposition of the variation in labor market stocks reveals that transitions at the participation margin account for around one-third of the cyclical variation in the unemployment rate. This result is robust to adjustments of data for spurious transitions, and for time aggregation. Inferences from conventional, stocks-based analyses of labor force participation are shown to be subject to a stock-flow fallacy, neglecting the offsetting forces of worker flows that underlie the modest cyclicality of the participation rate. A novel analysis of history dependence in worker flows demonstrates that a large part of the contribution of the participation margin can be traced to cyclical fluctuations in the composition of the unemployed by labor market attachment.
Price Setting in an Innovative Market
–February 1, 2013
Adam Copeland, Adam ShapiroWe examine how the confluence of competition and upstream innovation influences downstream firms’ profit-maximizing strategies. In particular, we analyze how, in light of these forces, the downstream firm sets the price of the product over its life cycle. We focus on personal computers (PCs) and introduce two novel data sets that describe prices and sales in the industry. Our main result is that a vintage-capital model that combines a competitive market structure with a rapid rate of innovation is well able to explain the observed paths of prices, as well as sales and consumer income, over a typical PC’s product cycle. The analysis implies that rapid price declines are not caused by upstream innovation alone, but rather by the combination of upstream innovation and a competitive environment.
House Prices, Expectations, and Time-Varying Fundamentals
–May 1, 2014
Paolo Gelain, Kevin J. LansingWe investigate the behavior of the equilibrium price-rent ratio for housing in a standard asset pricing model and compare the model predictions to survey evidence on the return expectations of real-world housing investors. We allow for time-varying risk aversion (via external habit formation) and time-varying persistence and volatility in the stochastic process for rent growth, consistent with U.S. data for the period 1960 to 2013. Under fully-rational expectations, the model significantly underpredicts the volatility of the U.S. price-rent ratio for reasonable levels of risk aversion. We demonstrate that the model can approximately match the volatility of the price-rent ratio in the data if near-rational agents continually update their estimates for the mean, persistence and volatility of fundamental rent growth using only recent data (i.e., the past 4 years), or if agents employ a simple moving-average forecast rule for the price-rent ratio that places a large weight on the most recent observation. These two versions of the model can be distinguished by their predictions for the correlation between expected future returns on housing and the price-rent ratio. Only the moving-average model predicts a positive correlation such that agents tend to expect high future returns when prices are high relative to fundamentals—a feature that is consistent with a wide variety of survey evidence from real estate and stock markets.
Monetary Regime Change and Business Cycles
–October 1, 2012
Vasco Cúrdia, Daria FinocchiaroThis paper proposes a simple method to structurally estimate a model over a period of time containing a regime shift. It then evaluates to which degree it is relevant to explicitly acknowledge the break in the estimation procedure. We apply our method on Swedish data, and estimate a DSGE model explicitly taking into account the monetary regime change in 1993, from exchange rate targeting to inflation targeting. We show that ignoring the break in the estimation leads to spurious estimates of model parameters including parameters in both policy and non-policy economic relations. Accounting for the regime change suggests that monetary policy reacted strongly to exchange rate movements in the first regime, and mostly to inflation in the second. The sources of business cycle fluctuations and their transmission mechanism are significantly affected by the exchange rate regime.
Rare Shocks, Great Recessions
–January 1, 2013
Vasco Cúrdia, Daniel L. Greenwald, Marco Del NegroWe estimate a DSGE model where rare large shocks can occur, by replacing the commonly used Gaussian assumption with a Student-t distribution. Results from the Smets and Wouters (2007) model estimated on the usual set of macroeconomic time series over the 1964-2011 period indicate that the Student-t specification is strongly favored by the data even when we allow for low-frequency variation in the volatility of the shocks, and that the estimated degrees of freedom are quite low for several shocks that drive U.S. business cycles, implying an important role for rare large shocks. This result holds even if we exclude the Great Recession period from the sample. We also show that inference about low-frequency changes in volatility and in particular, inference about the magnitude of the Great Moderation is different once we allow for fat tails.
Decomposing Medical-Care Expenditure Growth
–November 1, 2012
Abe Dunn, Eli Liebman, Adam ShapiroMedical-care expenditures have been rising rapidly, accounting for almost one-fifth of GDP in 2009. In this study, we assess the sources of the rising medical-care expenditures in the commercial sector. We employ a novel framework for decomposing expenditure growth into four components at the disease level: service price growth, service utilization growth, treated disease prevalence growth, and demographic shift. The decomposition shows that growth in prices and treated prevalence are the primary drivers of medical-care expenditure growth over the 2003 to 2007 period. There was no growth in service utilization at the aggregate level over this period. Price and utilization growth were especially large for the treatment of malignant neoplasms. For many conditions, treated prevalence has shifted towards preventive treatment and away from treatment for late-stage illnesses.
House Lock and Structural Unemployment
–April 1, 2013
Robert G. VallettaA recent decline in internal migration in the United States may have been caused in part by falling house prices, through the “lock in” effects of financial constraints faced by households whose housing debt exceeds the market value of their home. I analyse the relationship between such “house lock” and the elevated levels and persistence of unemployment during the recent recession and its aftermath, using data for the years 2008-11. Because house lock is likely to extend job search in the local labour market for homeowners whose home value has declined, I focus on differences in unemployment duration between homeowners and renters across geographic areas differentiated by the severity of the decline in home prices. The empirical analyses rely on microdata from the monthly Current Population Survey (CPS) files and an econometric method that enables the estimation of individual and aggregate covariate effects on unemployment durations using repeated cross-section data. I do not uncover systematic evidence to support the house-lock hypothesis.
Beveridge Curve Shifts across Countries since the Great Recession
–July 1, 2013
Bart Hobijn, Aysegül SahinWe document the shift in the Beveridge curve in the U.S. since the Great Recession. We argue that a decline in quits, the relatively poor performance of the construction sector, and the extension of unemployment insurance benefits have largely driven this shift. We then introduce a method to estimate fitted Beveridge curves for other OECD countries for which data on vacancies and employment by job tenure are available. We show that Portugal, Spain, and the U.K. also experienced rightward shifts in their Beveridge curves. Besides the U.S., these are among the countries with the highest house price and construction employment declines in our sample.
Top Incomes, Rising Inequality, and Welfare
–June 1, 2016
Kevin J. Lansing, Agnieszka MarkiewiczWe introduce permanently-shifting income shares into a growth model with two types of agents. The model exactly replicates the U.S. time paths of the top quintile income share, capital’s share of income, and key macroeconomic variables from 1970 to 2014. Welfare effects depend on changes in the time pattern of agents’ consumption relative to a counterfactual scenario that holds income shares and the transfer-output ratio constant. Short-run declines in workers’ consumption are only partially offset by longer-term gains from higher transfers and more capital per worker. The baseline simulation delivers large welfare gains for capital owners and nontrivial welfare losses for workers.
The Macroeconomic Effects of Large-Scale Asset Purchase Programs
–October 1, 2012
Han Chen, Vasco Cúrdia, Andrea FerreroWe simulate the Federal Reserve second Large-Scale Asset Purchase program in a DSGE model with bond market segmentation estimated on U.S. data. GDP growth increases by less than a third of a percentage point and inflation barely changes relative to the absence of intervention. The key reasons behind our findings are small estimates for both the elasticity of the risk premium to the quantity of long-term debt and the degree of financial market segmentation. Absent the commitment to keep the nominal interest rate at its lower bound for an extended period, the effects of asset purchase programs would be even smaller.
The Economic Security Index: A New Measure for Research and Policy Analysis
–October 1, 2012
Stuart Craig, Jacob S. Hacker, Gregory Huber, Austin Nichols, Philipp Rehm, Mark Schlesinger, Robert G. VallettaThis paper presents the Economic Security Index (ESI), a new, more comprehensive measure of economic insecurity. By combining data from multiple surveys, we create an integrated measure of volatility in available household resources, accounting for fluctuations in income and out-of pocket medical expenses, as well as financial wealth sufficient to buffer against these shocks. We find that insecurity has risen steadily since the mid-1980s for virtually all subgroups of Americans, albeit with cyclical ups and downs. We also find, however, that there is substantial disparity in the degree to which different groups are exposed to economic risk. As the ESI derives from a data-independent conceptual foundation, it can be measured using different data sources. We find that the degree and disparity by which insecurity has risen is robust across these sources.
Housing Supply and Foreclosures
–September 1, 2012
William Hedberg, John KrainerWe explore the role of foreclosure inventories in a model of housing supply. The foreclosure variable is necessary to account for the steep and sustained drop in new construction activity following the U.S. housing market bust beginning in 2006. There is modest evidence that local banking conditions play a role in determining housing starts. Even with state-level foreclosures and banking variables in the model, there is a sizeable post-2006 residual common to all states. We argue that, in addition to observable macro and local factors, housing starts in the Great Recession have been weighed down in part by aggregate uncertainty factors
A Quarterly, Utilization-Adjusted Series on Total Factor Productivity
–April 1, 2014
John G. FernaldThis paper describes a real-time, quarterly growth-accounting database for the U.S. business sector. The data on inputs, including capital, are used to produce a quarterly series on total factor productivity (TFP). In addition, the dataset implements an adjustment for variations in factor utilization—labor effort and the workweek of capital. The utilization adjustment follows Basu, Fernald, and Kimball (BFK, 2006). Using relative prices and input-output information, the series are also decomposed into separate TFP and utilization-adjusted TFP series for equipment investment (including consumer durables) and “consumption” (defined as business output less equipment and consumer durables).
Productivity and Potential Output before, during, and after the Great Recession
–September 1, 2012
John G. FernaldThis paper makes four points about the recent dynamics of productivity and potential output. First, after accelerating in the mid-1990s, labor and total-factor productivity growth slowed after the early to mid 2000s. This slowdown preceded the Great Recession. Second, in contrast to some informal commentary, productivity performance during the Great Recession and early in the subsequent recovery was roughly in line with previous experience during deep recessions. In particular, the evidence suggests substantial labor and capital hoarding. During the recovery, measures of factor utilization fairly quickly rebounded, and TFP and labor productivity returned to their anemic mid-2000s trends. Third, a plausible benchmark for the slower pace of underlying technology along with demographic assumptions from the Congressional Budget Office imply steady-state GDP growth of just over 2 percent per year–lower than most estimates. Finally, during the recession and recovery, potential output grew even more slowly– reflecting especially the effect of weak investment on growth in capital input. Half or more of the shortfall of actual output relative to pre-recession estimates of the potential trend reflects a reduction in potential.
Risk Aversion, Risk Premia, and the Labor Margin with Generalized Recursive Preferences
–September 1, 2013
Eric T. SwansonA flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along both margins greatly alters the household’s attitudes toward risk, as shown by Swanson (2012). The present paper extends that analysis to the case of generalized recursive preferences, as in Epstein and Zin (1989) and Weil (1989), including multiplier preferences, as in Hansen and Sargent (2001). Understanding risk aversion for these preferences is especially important because they are the primary mechanism being used to bring macroeconomic models into closer agreement with asset pricing facts. Measures of risk aversion commonly used in the literature—including traditional, fixed-labor measures and Cobb-Douglas composite-good measures—show no stable relationship to the equity premium in a standard macroeconomic model, while the closed-form expressions derived in this paper match the equity premium closely. Thus, measuring risk aversion correctly—taking into account the household’s labor margin—is necessary for risk aversion to correspond to asset prices in the model.
Relative Status and Well-Being: Evidence from U.S. Suicide Deaths
–September 1, 2012
Mary C. Daly, Norman J. Johnson, Daniel WilsonWe assess the importance of interpersonal income comparisons using data on suicide deaths. We examine whether suicide risk is related to others’ income, holding own income and other individual and environmental factors fixed. We estimate models of the suicide hazard using two independent data sets: (1) the National Longitudinal Mortality Study and (2) the National Center for Health Statistics’ Multiple Cause of Death Files combined with the 5 percent Public Use Micro Sample of the 1990 decennial census. Results from both data sources show that, controlling for own income and individual characteristics, individual suicide risk rises with others’ income.
Infrastructure Spending as Fiscal Stimulus: Assessing the Evidence
–February 1, 2016
Sylvain Leduc, Daniel WilsonTransportation spending often plays a prominent role in government efforts to stimulate the economy during downturns. Yet, despite the frequent use of transportation spending as a form of fiscal stimulus, there is little known about its short- or medium-run effectiveness. Does it translate quickly into higher employment and economic activity or does it impact the economy only slowly over time? This paper reviews the empirical findings in the literature for the United States and other developed economies and compares the effects of transportation spending to those of other types of government spending.
Mussa Redux and Conditional PPP
–September 1, 2012
Paul R. Bergin, Reuven Glick, Jyh-Lin WuLong half-lives of real exchange rates are often used as evidence against monetary sticky price models. In this study we show how exchange rate regimes alter the long-run dynamics and half-life of the real exchange rate, and we recast the classic defense of such models by Mussa (1986) from an argument based on short-run volatility to one based on long-run dynamics. The first key result is that the extremely persistent real exchange rate found commonly in post Bretton Woods data does not apply to the preceding fixed exchange rate period in our sample, where the half-live was roughly half as large. This result suggests a reinterpretation of Mussa’s original finding, indicating that up to two thirds of the rise in variance of the real exchange rate in the recent floating rate period is actually due to the rise in persistence of the response to shocks, rather than due to a rise in the variance of shocks themselves. This result also suggests a way to resolve the “PPP puzzle,” reconciling real exchange rate persistence with volatility. The second key result explains the rise in persistence over time by identifying underlying shocks using a panel VECM model. Shocks to the nominal exchange rate induce more persistent real exchange rate responses compared to price shocks, and these shocks became more prevalent under a flexible exchange rate regime.
Capital Controls and Optimal Chinese Monetary Policy
–January 1, 2015
Chun Chang, Zheng Liu, Mark M. SpiegelChina’s external policies, including capital controls, managed exchange rates, and sterilized interventions, constrain its monetary policy options for maintaining macroeconomic stability following external shocks. We study optimal monetary policy in a dynamic stochastic general equilibrium (DSGE) model that incorporates these “Chinese characteristics.” The model highlights a monetary policy tradeoff between domestic price stability and costly sterilization. The same DSGE framework allows us to evaluate the welfare implications of alternative liberalization policies. Capital account and exchange rate liberalization would have allowed the Chinese central bank to better stabilize the external shocks experienced during the global financial crisis.
International Channels of the Fed’s Unconventional Monetary Policy
–December 1, 2013
Michael Bauer, Christopher J. NeelyPrevious research has established that the Federal Reserve’s large scale asset purchases (LSAPs) significantly influenced international bond yields. We use dynamic term structure models to uncover to what extent signaling and portfolio balance channels caused these declines. For the U.S. and Canada, the evidence supports the view that LSAPs had substantial signaling effects. For Australian and German yields, signaling effects were present but likely more moderate, and portfolio balance effects appear to have played a relatively larger role than in the U.S. and Canada. Portfolio balance effects were small for Japanese yields and signaling effects basically nonexistent. These findings about LSAP channels are consistent with predictions based on interest rate dynamics during normal times: Signaling effects tend to be large for countries with strong yield responses to conventional U.S. monetary policy surprises, and portfolio balance effects are consistent with the degree of substitutability across international bonds, as measured by the covariance between foreign and U.S. bond returns.
House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy
–February 1, 2013
Paolo Gelain, Kevin J. Lansing, Caterina MendicinoProgress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully-rational expectations have difficulty producing large swings in house prices and household debt that resemble the patterns observed in many industrial countries over the past decade. We show that the introduction of simple moving-average forecast rules for a subset of agents can significantly magnify the volatility and persistence of house prices and household debt relative to otherwise similar model with fully-rational expectations. We evaluate various policy actions that might be used to dampen the resulting excess volatility, including a direct response to house price growth or credit growth in the central bank’s interest rate rule, the imposition of a more restrictive loan-to-value ratio, and the use of a modified collateral constraint that takes into account the borrower’s wage income. Of these, we find that a debt-to-income type constraint is the most effective tool for dampening overall excess volatility in the model economy. While an interest-rate response to house price growth or credit growth can stabilize some economic variables, it can significantly magnify the volatility of others, particularly inflation.
Uncertainty Shocks are Aggregate Demand Shocks
–May 1, 2015
Sylvain Leduc, Zheng LiuWe show that to capture the empirical effects of uncertainty on the unemployment rate, it is crucial to study the interactions between search frictions and nominal rigidities. Our argument is guided by empirical evidence showing that an increase in uncertainty leads to a large increase in unemployment and a significant decline in inflation, suggesting that uncertainty partly operates via an aggregate demand channel. To understand the mechanism through which uncertainty generates these macroeconomic effects, we incorporate search frictions and nominal rigidities in a DSGE model. We show that an option-value channel that arises from search frictions interacts with a demand channel that arises from nominal rigidities, and such interactions magnify the effects of uncertainty to generate roughly 60 percent of the observed increase in unemployment following an uncertainty shock.
The Industry-Occupation Mix of U.S. Job Openings and Hires
–July 1, 2012
Bart HobijnI introduce a method that combines data from the U.S. Current Population Survey, Job Openings and Labor Turnover Survey, and state-level Job Vacancy Surveys to construct annual estimates of the number of job openings in the U.S. in the Spring by industry and occupation. I present these estimates for 2005-2011. The results reveal that: (i) During the Great Recession job openings for all occupations declined. (ii) Job openings rates and vacancy yields vary a lot across occupations. (iii) Changes in the occupation mix of job openings and hires account for the bulk of the decline in measured aggregate match efficiency since 2007. (iv) The majority of job openings in all industries and occupations are filled with persons who previously did not work in the same industry or occupation.
Real Exchange Rate Dynamics in Sticky-Price Models with Capital
–July 1, 2012
Carlos Carvalho, Fernanda NechioThe standard argument for abstracting from capital accumulation in sticky-price macro models is based on their short-run focus: over this horizon, capital does not move much. This argument is more problematic in the context of real exchange rate (RER) dynamics, which are very persistent. In this paper we study RER dynamics in sticky-price models with capital accumulation. We analyze both a model with an economy-wide rental market for homogeneous capital, and an economy in which capital is sector specific. We find that, in response to monetary shocks, capital increases the persistence and reduces the volatility of RERs. Nevertheless, versions of the multi-sector sticky-price model of Carvalho and Nechio (2011) augmented with capital accumulation can match the persistence and volatility of RERs seen in the data, irrespective of the type of capital. When comparing the implications of capital specificity, we find that, perhaps surprisingly, switching from economy-wide capital markets to sector-specific capital tends to decrease the persistence of RERs in response to monetary shocks. Finally, we study how RER dynamics are affected by monetary policy and find that the source of interest rate persistence – policy inertia or persistent policy shocks – is key.
Pricing Deflation Risk with U.S. Treasury Yields
–July 1, 2014
Jens H. E. Christensen, Jose A. Lopez, Glenn D. RudebuschWe use an arbitrage-free term structure model with spanned stochastic volatility to determine the value of the deflation protection option embedded in Treasury inflation protected securities (TIPS). The model accurately prices the deflation protection option prior to the financial crisis when its value was near zero; at the peak of the crisis in late 2008 when deflationary concerns spiked sharply; and in the post-crisis period. During 2009, the average value of this option at the five-year maturity was 41 basis points on a par-yield basis. The option value is shown to be closely linked to overall market uncertainty as measured by the VIX, especially during and after the 2008 financial crisis.
The Response of Interest Rates to U.S. and U.K. Quantitative Easing
–May 1, 2012
Jens H. E. Christensen, Glenn D. RudebuschWe analyze the declines in government bond yields that followed the announcements of plans by the Federal Reserve and the Bank of England to buy longer-term government debt. Using empirical dynamic term structure models, we decompose these declines into changes in expectations about future monetary policy and changes in term premiums. We find that declines in U.S. Treasury yields mainly reflected lower policy expectations, while declines in U.K. yields appeared to reflect reduced term premiums. Thus, the relative importance of the signaling and portfolio balance channels of quantitative easing may depend on market institutional structures and central bank communications policies.
Empirical Simultaneous Prediction Regions for Path-Forecasts
–May 1, 2012
Oscar Jorda, Malte Knuppel, Massimiliano MarcellinoThis paper investigates the problem of constructing prediction regions for forecast trajectories 1 to H periods into the future–a path forecast. We take the more general view that the null model is only approximative and in some cases it may be altogether unavailable. As a consequence, one cannot derive the usual analytic expressions nor resample from the null model as is usually done when bootstrap methods are used. The paper derives methods to construct approximate rectangular regions for simultaneous probability coverage which correct for serial correlation. The techniques appear to work well in simulations and in an application to the Greenbook path forecasts of growth and inflation.
Roads to Prosperity or Bridges to Nowhere? Theory and Evidence on the Impact of Public Infrastructure Investment
–June 1, 2012
Sylvain Leduc, Daniel WilsonWe examine the dynamic macroeconomic effects of public infrastructure investment both theoretically and empirically, using a novel data set we compiled on various highway spending measures. Relying on the institutional design of federal grant distributions among states, we construct a measure of government highway spending shocks that captures revisions in expectations about future government investment. We find that shocks to federal highway funding has a positive effect on local GDP both on impact and after 6 to 8 years, with the impact effect coming from shocks during (local) recessions. However, we find no permanent effect (as of 10 years after the shock). Similar impulse responses are found in a number of other macroeconomic variables. The transmission channel for these responses appears to be through initial funding leading to building, over several years, of public highway capital which then temporarily boosts private sector productivity and local demand. To help interpret these findings, we develop an open economy New Keynesian model with productive public capital in which regions are part of a monetary and fiscal union. We show that the presence of productive public capital in this model can yield impulse responses with the same qualitative pattern that we find empirically.
Lost in Translation? Teacher Training and Outcomes in High School Economics Classes
–April 1, 2013
K. Jody Hoff, Jane S. Lopus, Robert G. VallettaUsing data from a 2006 survey of California high school economics classes, we assess the effects of teacher characteristics on student achievement. We estimate value-added models of outcomes on multiple choice and essay exams, with matched classroom pairs for each teacher enabling random-effects and fixed-effects estimation. The results show a substantial impact of specialized teacher experience and college-level coursework in economics. However, the latter is associated with higher scores on the multiple-choice test and lower scores on the essay test, suggesting that a portion of teachers’ content knowledge may be “lost in translation” when conveyed to their students.
Measuring the Effect of the Zero Lower Bound on Medium- and Longer-Term Interest Rates
–January 1, 2013
Eric T. Swanson, John C. WilliamsThe federal funds rate has been at the zero lower bound for over four years, since December 2008. According to many macroeconomic models, this should have greatly reduced the effectiveness of monetary policy and increased the efficacy of fiscal policy. However, standard macroeconomic theory also implies that private-sector decisions depend on the entire path of expected future short term interest rates, not just the current level of the overnight rate. Thus, interest rates with a year or more to maturity are arguably more relevant for the economy, and it is unclear to what extent those yields have been constrained. In this paper, we measure the effects of the zero lower bound on interest rates of any maturity by estimating the time-varying high-frequency sensitivity of those interest rates to macroeconomic announcements relative to a benchmark period in which the zero bound was not a concern. We find that yields on Treasury securities with a year or more to maturity were surprisingly responsive to news throughout 2008–10, suggesting that monetary and fiscal policy were likely to have been about as effective as usual during this period. Only beginning in late 2011 does the sensitivity of these yields to news fall closer to zero. We offer two explanations for our findings: First, until late 2011, market participants expected the funds rate to lift off from zero within about four quarters, minimizing the effects of the zero bound on medium and longer-term yields. Second, the Fed’s unconventional policy actions seem to have helped offset the effects of the zero bound on medium- and longer-term rates.
Do People Understand Monetary Policy?
–April 1, 2014
Carlos Carvalho, Fernanda NechioWe combine questions from the Michigan Survey about future information, unemployment, and interest rates to investigate whether households are aware of the basic features of U.S. monetary policy. Our findings provide evidence that some households form their expectations in a way that is consistent with a Taylor (1993)-type rule. We also document a large degree of variation in the pattern of responses over the business cycle. In particular, the negative relationship between unemployment and interest rates that is apparent in the data only shows up in households’ answers during periods of labor market weakness.
Central Bank Announcements of Asset Purchases and the Impact on Global Financial and Commodity Markets
–December 1, 2011
Reuven Glick, Sylvain LeducWe present evidence on the effects of large-scale asset purchases by the Federal Reserve and the Bank of England since 2008. We show that announcements about these purchases led to lower long-term interest rates and depreciations of the U.S. dollar and the British pound on announcement days, while commodity prices generally declined despite this more stimulative financial environment. We suggest that LSAP announcements likely involved signaling effects about future growth that led investors to downgrade their U.S. growth forecasts lowering long-term US yields, depreciating the value of the U.S. dollar, and triggering a decline in commodity prices. Moreover, our analysis illustrates the importance of controlling for market expectations when assessing these effects. We find that positive U.S. monetary surprises led to declines in commodity prices, even as long-term interest rates fell and the U.S. dollar depreciated. In contrast, on days of negative U.S. monetary surprises, i.e. when markets evidently believed that monetary policy was less stimulatory than expected, long-term yields, the value of the dollar, and commodity prices all tended to increase.
The Labor Market in the Great Recession: An Update
–October 1, 2011
Michael Elsby, Bart Hobijn, Aysegül Sahin, Robert G. VallettaSince the end of the Great Recession in mid-2009, the unemployment rate has recovered slowly, falling by only one percentage point from its peak. We find that the lackluster labor market recovery can be traced in large part to weakness in aggregate demand; only a small part seems attributable to increases in labor market frictions. This continued labor market weakness has led to the highest level of long-term unemployment in the U.S. in the postwar period, and a blurring of the distinction between unemployment and nonparticipation. We show that flows from nonparticipation to unemployment are important for understanding the recent evolution of the duration distribution of unemployment. Simulations that account for these flows suggest that the U.S. labor market is unlikely to be subject to high levels of structural long-term unemployment after aggregate demand recovers.
A Chronology of Turning Points in Economic Activity: Spain, 1850-2011
–November 1, 2011
Travis J. Berge, Oscar JordaThis paper codifies in a systematic and transparent way a historical chronology of business cycle turning points for Spain reaching back to 1850 at annual frequency, and 1939 at monthly frequency. Such an exercise would be incomplete without assessing the new chronology itself and against others —this we do with modern statistical tools of signal detection theory. We also use these tools to determine which of several existing economic activity indexes provide a better signal on the underlying state of the economy. We conclude by evaluating candidate leading indicators and hence construct recession probability forecasts up to 12 months in the future.
When Credit Bites Back: Leverage, Business Cycles, and Crises
–October 1, 2012
Oscar Jorda, Moritz Schularick, Alan M. TaylorThis paper studies the role of credit in the business cycle, with a focus on private credit overhang. Based on a study of the universe of over 200 recession episodes in 14 advanced countries between 1870 and 2008, we document two key facts of the modern business cycle: financial-crisis recessions are more costly than normal recessions in terms of lost output; and for both types of recession, more credit-intensive expansions tend to be followed by deeper recessions and slower recoveries. In additional to unconditional analysis, we use local projection methods to condition on a broad set of macroeconomic controls and their lags. Then we study how past credit accumulation impacts the behavior of not only output but also other key macroeconomic variables such as investment, lending, interest rates, and inflation. The facts that we uncover lend support to the idea that financial factors play an important role in the modern business cycle.
Land-Price Dynamics and Macroeconomic Fluctuations
–September 1, 2011
Zheng Liu, Pengfei Wang, Tao ZhaWe argue that positive co-movements between land prices and business investment are a driving force behind the broad impact of land-price dynamics on the macroeconomy. We develop an economic mechanism that captures the co-movements by incorporating two key features into a DSGE model: We introduce land as a collateral asset in firms’ credit constraints and we identify a shock that drives most of the observed fluctuations in land prices. Our estimates imply that these two features combine to generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through the joint dynamics of land prices and business investment.
Prepayment and Delinquency in the Mortgage Crisis Period
–September 1, 2011
John Krainer, Elizabeth LadermanWe study the interaction of borrower mortgage prepayment and mortgage delinquency during the period between 2001 and 2010. We show that when house prices flattened and began their subsequent decline, borrowers had increasingly slow prepayments and that this decline in prepayment rates roughly coincided with the sharp increase in their delinquency rates. Low credit score borrowers, in particular, display a pronounced negative correlation between default rates and prepayment rates. Shortfalls of actual prepayment rates from predicted rates based on an estimated prepayment model suggest that, in addition to the effects of declining house prices, tighter lending standards also may have played a role in weak prepayment activity.
Evidence and Implications of Regime Shifts: Time-Varying Effects of the U.S. and Japanese Economies on House Prices in Hawaii
–July 1, 2012
John Krainer, James A. WilcoxWe show that local house prices may be driven almost entirely by the demands of one identifiable group for several years and then by demands of another group at other times. We present evidence that house prices in Hawaii were subject to such regime shifts. Prices responded to demands associated with U.S. incomes and wealth for most years from 1975 through 2008. For about a decade starting in the middle of the 1980s, after the Japanese yen appreciated dramatically and Japanese housing and stock market wealth soared, however, house prices in Hawaii responded to Japanese incomes and wealth. Estimated models with these regime shifts outperformed conventional, constant coefficient models. The regime-shifting model helps explain why, when, and by how much the volatility and the elasticities of house prices in Hawaii with respect to the incomes and wealth of the U.S. and Japan varied over time
Dissecting Aggregate Real Wage Fluctuations: Individual Wage Growth and the Composition Effect
–May 1, 2012
Mary C. Daly, Bart Hobijn, Theodore S. WilesUsing data from the Current Population Survey from 1980 through 2011 we examine what drives the variation and cyclicality of the growth rate of real wages over time. We employ a novel decomposition technique that allows us to divide the time series for median weekly earnings growth into the part associated with the wage growth of persons employed at the beginning and end of the period (the wage growth effect) and the part associated with changes in the composition of earners (the composition effect). The relative importance of these two effects varies widely over the business cycle. When the labor market is tight job switchers get large wage increases, making them account for half of the variation in median weekly earnings growth over our sample. Their wage growth, as well as that of job-stayers, is procyclical. During labor market downturns, this procyclicality is largely offset by the change in the composition of the workforce, leading aggregate real wages to be almost non-cyclical. Most of this composition effect works through the part-time employment margin. Remarkably, the unemployment margin neither accounts for much of the variation in nor much of the cyclicality of median weekly earnings growth.
Currency Crises
–September 1, 2011
Reuven Glick, Michael M. HutchisonA currency crisis is a speculative attack on the foreign exchange value of a currency, resulting in a sharp depreciation or forcing the authorities to sell foreign exchange reserves and raise domestic interest rates to defend the currency. This article discusses analytical models of the causes of currency and associated crises, presents basic measures of the incidence of crises, evaluates the accuracy of empirical models in predicting crises, and reviews work measuring the consequences of crises on the real economy. Currency crises have large measurable costs on the economy, but our ability to predict the timing and magnitude of crises is limited by our theoretical understanding of the complex interactions between macroeconomic fundamentals, investor expectations and government policy.
The Signaling Channel for Federal Reserve Bond Purchases
–April 1, 2013
Michael Bauer, Glenn D. RudebuschPrevious research has emphasized the portfolio balance effects of Federal Reserve bond purchases, in which a reduced bond supply lowers term premia. In contrast, we find that such purchases have important signaling effects that lower expected future short-term interest rates. Our evidence comes from a model-free analysis and from dynamic term structure models that decompose declines in yields following Fed announcements into changes in risk premia and expected short rates. To overcome problems in measuring term premia, we consider bias-corrected model estimation and restricted risk price estimation. In comparison with other studies, our estimates of signaling effects are larger in magnitude and statistical significance.
Nominal Interest Rates and the News
–January 1, 2014
Michael BauerThis paper provides new estimates of the impact of monetary policy actions and macroeconomic news on the term structure of nominal interest rates. The key novelty is to parsimoniously capture the impact of news on all interest rates using a simple no-arbitrage model. The different types of news are analyzed in a common framework by recognizing their heterogeneity, which allows for a systematic comparison of their effects. This approach leads to novel empirical findings: First, monetary policy causes a substantial amount of volatility in both short-term and long-term interest rates. Second, macroeconomic data surprises have small and mostly insignificant effects on the long end of the term structure. Third, the term-structure response to macroeconomic news is consistent with considerable interest-rate smoothing by the Federal Reserve. Fourth, monetary policy surprises are multidimensional while macroeconomic surprises are one-dimensional.
Gender Ratios at Top PhD Programs in Economics
–August 1, 2011
Galina Hale, Tali RegevAnalyzing university faculty and graduate student data for the top-ten U.S. economics departments between 1987 and 2007, we find that there are persistent differences in gender composition for both faculty and graduate students across institutions and that the share of female faculty and the share of women in the entering PhD class are positively correlated. We find, using instrumental variables analysis, robust evidence that this correlation is driven by the causal effect of the female faculty share on the gender composition of the entering PhD class. This result provides an explanation for persistent underrepresentation of women in economics, as well as for persistent segregation of women across academic fields.
Dollar Illiquidity and Central Bank Swap Arrangements during the Global Financial Crisis
–August 1, 2011
Andrew K. Rose, Mark M. SpiegelWhile the global financial crisis was centered in the United States, it led to a surprising appreciation in the dollar, suggesting global dollar illiquidity. In response, the Federal Reserve partnered with other central banks to inject dollars into the international financial system. Empirical studies of the success of these efforts have yielded mixed results, in part because their timing is likely to be endogenous. In this paper, we examine the cross-sectional impact of these interventions. Theory consistent with dollar appreciation in the crisis suggests that their impact should be greater for countries that have greater exposure to the United States through trade and financial channels, less transparent holdings of dollar assets, and greater illiquidity difficulties. We examine these predictions for observed cross-sectional changes in CDS spreads, using a new proxy for innovations in perceived changes in sovereign risk based upon Google-search data. We find robust evidence that auctions of dollar assets by foreign central banks disproportionately benefited countries that were more exposed to the United States through either trade linkages or asset exposure. We obtain weaker results for differences in asset transparency or illiquidity. However, several of the important announcements concerning the international swap programs disproportionately benefited countries exhibiting greater asset opaqueness.
New Evidence on Cyclical and Structural Sources of Unemployment
–May 1, 2011
Zinzhu Chen, Prakash Kannan, Prakash Loungani, Bharat TrehanWe provide cross-country evidence on the relative importance of cyclical and structural factors in explaining unemployment, including the sharp rise in U.S. long-term unemployment during the Great Recession of 2007-09. About 75% of the forecast error variance of unemployment is accounted for by cyclical factors–real GDP changes (Okun’s law), monetary and fiscal policies, and the uncertainty effects emphasized by Bloom (2009). Structural factors, which we measure using the dispersion of industry-level stock returns, account for the remaining 25%. For U.S. long-term unemployment the split between cyclical and structural factors is closer to 60-40, including during the Great Recession.
Could the U.S. Treasury Benefit from Issuing More TIPS?
–June 1, 2012
Jens H. E. Christensen, James M. GillanYes. We analyze the economic benefit of Treasury Inflation Protected Securities (TIPS) issuance by estimating the inflation risk premium that penalizes nominal Treasuries vis-a-vis TIPS and the cost derived from TIPS liquidity disadvantage. To account for the latter, we introduce a novel model-independent range for the liquidity premium in TIPS exploiting additional information from inflation swaps. We also adjust our model estimates for finite-sample bias. The resulting measure provides a lower bound to the benefit of TIPS, which is positive on average. Thus, our analysis suggests that the Treasury could save billions of dollars by significantly expanding its TIPS program.
Monetary and Macroprudential Policy in a Leveraged Economy
–April 1, 2015
Sylvain Leduc, Jean-Marc NatalWe examine the optimal monetary policy in the presence of endogenous feedback loops between asset prices and economic activity. We reconsider this issue in the context of the financial accelerator model and when macroprudential policies can be pursued. Absent macroprudential policy, we first show that the optimal monetary policy leans considerably against movements in asset prices and risk premia. We show that the optimal policy can be closely approximated and implemented using a speed-limit rule that places a substantial weight on the growth of financial variables. An endogenous feedback loop is crucial for this result, and price stability is otherwise quasi-optimal. Similarly, introducing a simple macroprudential rule that links reserve requirements to credit growth dampens the endogenous feedback loop, leading the optimal monetary policy to focus on price stability.
Bank Relationships, Business Cycles, and Financial Crises
–July 1, 2011
Galina HaleThe importance of information asymmetries in the capital markets is commonly accepted as one of the main reasons for home bias in investment. We posit that effects of such asymmetries may be reduced through relationships between banks established through bank-to-bank lending and provide evidence to support this claim. To analyze dynamics of formation of such relationships during 1980-2009 time period, we construct a global banking network of 7938 banking institutions from 141 countries. We find that recessions and banking crises tend to have negative effects on the formation of new connections and that these effects are not the same for all countries or all banks. We also find that the global financial crisis of 2008-09 had a large negative impact on the formation of new relationships in the global banking network, especially by large banks that have been previously immune to effects of banking crises and recessions.
The Impact of Creditor Protection on Stock Prices in the Presence of Credit Crunches
–April 1, 2011
Galina Hale, Assaf Razin, Hui TongData show that better creditor protection is correlated across countries with lower average stock market volatility. Moreover, countries with better creditor protection seem to have suffered lower decline in their stock market indexes during the current financial crisis. To explain this regularity, we use a Tobin q model of investment and show that stronger creditor protection increases the expected level and lowers the variance of stock prices in the presence of credit crunches. There are two main channels through which creditor protection enhances the performance of the stock market: (1) The credit-constrained stock price increases with better protection of creditors; (2) The probability of a credit crunch leading to a binding credit constraint falls with strong protection of creditors. We find strong empirical support for both predictions using data on stock market performance, amount and cost of credit, and creditor rights protection for 52 countries over the period 1980-2007. In particular, we find that crises are more frequent in countries with poor creditor protection. Using propensity score matching we also show that during crises stock market returns fall by more in countries with poor creditor protection.
Correcting Estimation Bias in Dynamic Term Structure Models
–April 1, 2012
Michael Bauer, Glenn D. Rudebusch, Jing (Cynthia) WuThe affine dynamic term structure model (DTSM) is the canonical empirical finance representation of the yield curve. However, the possibility that DTSM estimates may be distorted by small-sample bias has been largely ignored. We show that conventional estimates of DTSM coefficients are indeed severely biased, and this bias results in misleading estimates of expected future short-term interest rates and of long-maturity term premia. We provide a variety of bias-corrected estimates of affine DTSMs, both for maximally-flexible and over-identified specifications. Our estimates imply short rate expectations and term premia that are more plausible from a macro-finance perspective.
Trust in Public Institutions over the Business Cycle
–March 1, 2011
Betsey Stevenson, Justin WolfersWe document that trust in public institutions—and particularly trust in banks, business and government—has declined over recent years. U.S. time series evidence suggests that this partly reflects the pro-cyclical nature of trust in institutions. Cross-country comparisons reveal a clear legacy of the Great Recession, and those countries whose unemployment grew the most suffered the biggest loss in confidence in institutions, particularly in trust in government and the financial sector. Finally, analysis of several repeated cross-sections of confidence within U.S. states yields similar qualitative patterns, but much smaller magnitudes in response to state-specific shocks.
Extracting Deflation Probability Forecasts from Treasury Yields
–February 1, 2011
Jens H. E. Christensen, Jose A. Lopez, Glenn D. RudebuschWe construct probability forecasts for episodes of price deflation (i.e., a falling price level) using yields on nominal and real U.S. Treasury bonds. The deflation probability forecasts identify two "deflation scares" during the past decade: a mild one following the 2001 recession, and a more serious one starting in late 2008 with the deepening of the financial crisis. The estimated deflation probabilities are generally consistent with those from macroeconomic models and surveys of professional forecasters, but they also provide high frequency insight into the views of financial market participants. The probabilities can also be used to price the deflation option embedded in real Treasury bonds.
Reestablishing the Income-Democracy Nexus
–February 1, 2011
Jess Benhabib, Alejandro Corvalen, Mark M. SpiegelA number of recent empirical studies have cast doubt on the “modernization theory” of democratization, which posits that increases in income are conducive to increases in democracy levels. This doubt stems mainly from the fact that while a strong positive correlation exists between income and democracy levels, the relationship disappears when one controls for country fixed effects. This raises the possibility that the correlation in the data reflects a third causal characteristic, such as institutional quality. In this paper, we reexamine the robustness of the income-democracy relationship. We extend the research on this topic in two dimensions: first, we make use of newer income data, which allows for the construction of larger samples with more within-country observations. Second, we concentrate on panel estimation methods that explicitly allow for the fact that the primary measures of democracy are censored with substantial mass at the boundaries, or binary censored variables. Our results show that when one uses both the new income data available and a properly non linear estimator, a statistically significant positive income-democracy relationship is robust to the inclusion of country fixed effects.
Let’s Twist Again: A High-Frequency Event-Study Analysis of Operation Twist and Its Implications for QE2
–February 1, 2011
Eric T. SwansonThis paper undertakes a modern event-study analysis of Operation Twist and compares its effects to those that should be expected for the recent quantitative policy announced by the Federal Reserve, dubbed "QE2". We first show that Operation Twist and QE2 are similar in magnitude. We identify six significant, discrete announcements in the course of Operation Twist that potentially could have had a major effect on financial markets, and show that four did have statistically significant effects. The cumulative effect of these six announcements on longer-term Treasury yields is highly statistically significant but moderate, amounting to about 15 basis points. This estimate is consistent both with Modigliani and Sutch’s (1966) time series analysis and with the lower end of empirical estimates of Treasury supply effects in the literature.
Asset Pricing with Concentrated Ownership of Capital and Distribution Shocks
–August 1, 2015
Kevin J. LansingThis paper develops a production-based asset pricing model with two types of agents and concentrated ownership of physical capital. A temporary but persistent “distribution shock” causes the income share of capital owners to fluctuate in a procyclical manner, consistent with U.S. data. The concentrated ownership model significantly magnifies the equity risk premium relative to a representative-agent model because the capital owners’ consumption is more-strongly linked to volatile dividends from equity. With a steady-state risk aversion coefficient around 4, the model delivers an unlevered equity premium of 3.9% relative to short-term bonds and a premium of 1.2% relative to long-term bonds.
The Wage Premium Puzzle and the Quality of Human Capital
–February 1, 2011
Milton H. Marquis, Wuttipan Tantivong, Bharat TrehanThe wage premium for high-skilled workers in the United States, measured as the ratio of the 90th-to-10th percentiles from the wage distribution, increased by 20 percent from the 1970s to the late 1980s. A large literature has emerged to explain this phenomenon. A leading explanation is that skill-biased technological change (SBTC) increased the demand for skilled labor relative to unskilled labor. In a calibrated vintage capital model with heterogeneous labor, this paper examines whether SBTC is likely to have been a major factor in driving up the wage premium. Our results suggest that the contribution of SBTC is very small, accounting for about 1/20th of the observed increase. By contrast, a gradual and very modest shift in the distribution of human capital across workers can easily account for the large observed increase in wage inequality.
A Rising Natural Rate of Unemployment: Transitory or Permanent?
–September 1, 2011
Mary C. Daly, Bart Hobijn, Aysegül Sahin, Robert G. VallettaThe U.S. unemployment rate has remained stubbornly high since the 2007-2009 recession leading many to conclude that structural, rather than cyclical, factors are to blame. Relying on a standard job search and matching framework and empirical evidence from a wide array of labor market indicators, we examine whether the natural rate of unemployment has increased since the recession began, and if so, whether the underlying causes are transitory or persistent. Our analyses suggest that the natural rate has risen over the past several years, with our preferred estimate implying an increase from its pre-recession level of close to a percentage point. An assessment of the underlying factors responsible for this increase, including labor market mismatch, extended unemployment benefits, and uncertainty about overall economic conditions, implies that only a small fraction of this increase is likely to be persistent.
Evidence on Financial Globalization and Crisis: Capital Raisings
–January 1, 2011
Galina HaleFinancial globalization opened international capital markets to investors and firms all over the world. Foreign capital raisings by firms have increased substantially since the early 1990s in terms of equity as well as debt. I review the literature on the determinants and patterns of cross-border capital raisings and their effects on developments of domestic markets, highlighting the differences between mature and emerging economies. I focus on the effects the introduction of the euro had on European and global capital markets by bringing into existence a currency area comparable in size to that of the United States. Finally, I discuss the effects of financial crises on foreign capital raisings and review capital raisings during the 2007-09 global financial crisis.
Restrictions on Risk Prices in Dynamic Term Structure Models
–March 1, 2016
Michael BauerRestrictions on the risk-pricing in dynamic term structure models (DTSMs) tighten the link between cross-sectional and time-series variation of interest rates, and make absence of arbitrage useful for inference about expectations. This paper presents a new econometric framework for estimation of affine Gaussian DTSMs under restrictions on risk prices, which addresses the issues of a large model space and of model uncertainty using a Bayesian approach. A simulation study demonstrates the good performance of the proposed method. Data for U.S. Treasury yields calls for tight restrictions on risk pricing: only level risk is priced, and only changes in the slope affect term premia. Incorporating the restrictions changes the model-implied short-rate expectations and term premia. Interest rate persistence is higher than in a maximally-flexible model, hence expectations of future short rates are more variable–restrictions on risk prices help resolve the puzzle of implausibly stable short-rate expectations in this literature. Consistent with survey evidence and conventional macro wisdom, restricted models attribute a large share of the secular decline in long-term interest rates to expectations of future nominal short rates.
Cross-Country Causes and Consequences of the Crisis: An Update
–January 1, 2011
Andrew K. Rose, Mark M. SpiegelWe update Rose and Spiegel (2010a, b) and search for simple quantitative models of macroeconomic and financial indicators of the "Great Recession" of 2008-09. We use a cross-country approach and examine a number of potential causes that have been found to be successful indicators of crisis intensity by other scholars. We check a number of different indicators of crisis intensity, and a variety of different country samples. While countries with higher income and looser credit market regulation seemed to suffer worse crises, we find few clear reliable indicators in the pre-crisis data of the incidence of the Great Recession. Countries with current account surpluses seemed better insulated from slowdowns.
Have We Underestimated the Likelihood and Severity of Zero Lower Bound Events?
–January 1, 2011
Hess Chung, Jean-Philippe Laforte, David L. Reifschneider, John C. WilliamsBefore the recent recession, the consensus among researchers was that the zero lower bound (ZLB) probably would not pose a significant problem for monetary policy as long as a central bank aimed for an inflation rate of about 2 percent; some have even argued that an appreciably lower target inflation rate would pose no problems. This paper reexamines this consensus in the wake of the financial crisis, which has seen policy rates at their effective lower bound for more than two years in the United States and Japan and near zero in many other countries. We conduct our analysis using a set of structural and time series statistical models. We find that the decline in economic activity and interest rates in the United States has generally been well outside forecast confidence bands of many empirical macroeconomic models. In contrast, the decline in inflation has been less surprising. We identify a number of factors that help to account for the degree to which models were surprised by recent events. First, uncertainty about model parameters and latent variables, which were typically ignored in past research, significantly increases the probability of hitting the ZLB. Second, models that are based primarily on the Great Moderation period severely understate the incidence and severity of ZLB events. Third, the propagation mechanisms and shocks embedded in standard DSGE models appear to be insufficient to generate sustained periods of policy being stuck at the ZLB, such as we now observe. We conclude that past estimates of the incidence and effects of the ZLB were too low and suggest a need for a general reexamination of the empirical adequacy of standard models. In addition to this statistical analysis, we show that the ZLB probably had a first-order impact on macroeconomic outcomes in the United States. Finally, we analyze the use of asset purchases as an alternative monetary policy tool when short-term interest rates are constrained by the ZLB, and find that the Federal Reserve’s asset purchases have been effective at mitigating the economic costs of the ZLB. In particular, model simulations indicate that the past and projected expansion of the Federal Reserve’s securities holdings since late 2008 will lower the unemployment rate, relative to what it would have been absent the purchases, by 1-1/2 percentage points by 2012. In addition, we find that the asset purchases have probably prevented the U.S. economy from falling into deflation.
Which Industries are Shifting the Beveridge Curve?
–October 1, 2011
Regis Barnichon, Michael Elsby, Bart Hobijn, Aysegül SahinThe negative relationship between the unemployment rate and the job openings rate, known as the Beveridge curve, has been relatively stable in the U.S. over the last decade. Since the summer of 2009, in spite of firms reporting more job openings, the U.S. unemployment rate has not declined in line with the Beveridge curve. We decompose the recent deviation from the Beveridge curve into different parts using data from the Job Openings and Labor Turnover Survey (JOLTS). We find that most of the current deviation from the Beveridge curve can be attributed to a shortfall in hires per vacancy. This shortfall is broad-based across all industries and is particularly pronounced in construction, transportation, trade, and utilities, and leisure and hospitality. Construction alone accounts for more than half of the Beveridge curve gap.
The State of the Safety Net in the Post-Welfare Reform Era
–October 1, 2010
Marianne Bitler, Hilary W. HoynesThe passage of the 1996 welfare reform bill led to sweeping changes to the central U.S. cash safety net program for families with children. Importantly, along with other changes, the reform imposed lifetime time limits for receipt of welfare de facto ending the entitlement nature of cash welfare for poor families with children in the United States. Despite dire predictions about poverty and deprivation, the previous research shows that caseloads declined and employment increased, with no detectible increase in poverty or worsening of child-well-being. We re-evaluate these results in light of the severe recession which began in December 2007. In particular, we examine how the cyclicality of the response of program caseloads and family wellbeing has been altered by the implementation of welfare reform. We find that use of food stamps and non-cash safety net program participation have become significantly more responsive across economic cycles after welfare reform, going up more after reform when unemployment increases. By contrast, there is no evidence that cash welfare for families with children is more responsive after reform, and some evidence that it might be less so. There is some evidence that poverty increases more with the unemployment rate after reform (and no evidence that poverty increases less with unemployment after reform). We find that reform has led to no significant effects on the cyclical responsiveness of food consumption, food insecurity, health insurance, household crowding, or health.
The Happiness-Suicide Paradox
–February 1, 2010
Mary C. Daly, Andrew J. Oswald, Daniel Wilson, Stephen WuSuicide is an important scientific phenomenon. Yet its causes remain poorly understood. This study documents a paradox: the happiest places have the highest suicide rates. The study combines findings from two large and rich individual‐level data sets—one on life satisfaction and another on suicide deaths—to establish the paradox in a consistent way across U.S. states. It replicates the finding in data on Western industrialized nations and checks that the paradox is not an artifact of population composition or confounding factors. The study concludes with the conjecture that people may find it particularly painful to be unhappy in a happy place, so that the decision to commit suicide is influenced by relative comparisons.
On Variance Bounds for Asset Price Changes
–May 1, 2015
Kevin J. LansingThis paper considers variance bounds for stock price changes in a general setting that allows for ex-dividend stock prices, risk averse investors, and exponentially-growing dividends. I show that providing investors with more information about future dividends can either increase or decrease the variance of stock price changes, depending on some key parameters, namely, those governing the properties of dividends and the stochastic discount factor. This finding contrasts with the results of Engel (2005) who shows that news about future dividends will always decrease the variance of stock price changes in a specialized setting with cum-dividend stock prices and risk neutral investors.
Subjective Well-Being, Income, Economic Development and Growth
–September 1, 2010
Daniel W. Sacks, Betsey Stevenson, Justin WolfersWe explore the relationships between subjective well-being and income, as seen across individuals within a given country, between countries in a given year, and as a country grows through time. We show that richer individuals in a given country are more satisfied with their lives than are poorer individuals, and establish that this relationship is similar in most countries around the world. Turning to the relationship between countries, we show that average life satisfaction is higher in countries with greater GDP per capita. The magnitude of the satisfaction-income gradient is roughly the same whether we compare individuals or countries, suggesting that absolute income plays an important role in influencing well-being. Finally, studying changes in satisfaction over time, we find that as countries experience economic growth, their citizens‘ life satisfaction typically grows, and that those countries experiencing more rapid economic growth also tend to experience more rapid growth in life satisfaction. These results together suggest that measured subjective well-being grows hand in hand with material living standards.
The 2007-09 Financial Crisis and Bank Opaqueness
–September 1, 2010
Mark J. Flannery, Simon H. Kwan, Mahendrarajah NimalendranDoubts about the accuracy with which outside investors can assess a banking firm’s value motivate many government interventions in the banking market. The recent financial crisis has reinforced concerns about the possibility that banks are unusually opaque. Yet the empirical evidence, thus far, is mixed. This paper examines the trading characteristics of bank shares over the period from January 1990 through September 2009. We find that bank share trading exhibits sharply different features before vs. during the crisis. Until mid‐2007, large (NYSE‐traded) banking firms appear to be no more opaque than a set of control firms, and smaller (NASD‐traded) banks are, at most, slightly more opaque. During the crisis, however, both large and small banking firms exhibit a sharp increase in opacity, consistent with the policy interventions implemented at the time. Although portfolio composition is significantly related to market microstructure variables, no specific asset category(s) stand out as particularly important in determining bank opacity.
Foreign Stock Holdings: The Role of Information
–September 1, 2014
Fernanda NechioUsing the Survey of Consumer Finances data about individual stocks ownership, I compare households’ decision to invest in domestic versus foreign stocks. The data show that information plays a larger role in households’ decision to enter foreign stock markets. Households that invest in foreign stocks are more sophisticated in their sources of information – they use the Internet more often as a main source of information, talk to their brokers, trade more frequently, and shop more for investment opportunities. Adding to the wedge between the two groups of investors, foreign stock owners are also substantially wealthier, more educated, and less risk averse than households who focus on domestic stocks only. Furthermore, ownership of foreign stocks increases if the household is headed by women.
Job Creation Tax Credits, Fiscal Foresight, and Job Growth: Evidence from U.S. States
–November 1, 2016
Robert S. Chirinko, Daniel WilsonThis paper studies fiscal foresight — alterations of current behavior by forward-looking agents in anticipation of future policy changes – using variation in state job creation tax credits (JCTCs). Nearly half of the U.S. states enacted JCTCs between 1990 and 2007, and their unique experiences provide a rich source of information for assessing the quantitative importance of fiscal foresight. We investigate whether JCTCs affect employment growth before, at, and after the time they go into effect. A theoretical model identifies three key conditions necessary for fiscal foresight, captures the effects of the rolling base feature of JCTCs, and generates several empirical predictions. We evaluate these predictions in a difference-in-difference regression framework applied to monthly panel data on employment, the JCTC effective and legislative dates, and various controls. Failing to account for the distorting effects of fiscal foresight can result in upwardly biased estimates of the impact of the JCTC fiscal policy by as much as 34%. We also find that the cumulative effect of the JCTCs is positive, but it takes several years for the full effect to be realized. The cost per job created is approximately $18,000, which is low relative to cost estimates of recent federal fiscal programs. This figure implies a fiscal multiplier on JCTC tax expenditures of about 1.66.
Risk Aversion, Investor Information, and Stock Market Volatility
–April 1, 2014
Kevin J. Lansing, Stephen F. LeRoyThis paper employs a standard asset pricing model to derive theoretical volatility measures in a setting that allows for varying degrees of investor information about the dividend process. We show that the volatility of the price-dividend ratio increases monotonically with investor information but the relationship between investor information and equity return volatility (or equity premium volatility) can be non-monotonic, depending on risk aversion and other parameter values. Under some plausible calibrations and information assumptions, we show that the model can match the standard deviations of equity market variables in long-run U.S. data. In the absence of concrete knowledge about investors’ information, it becomes more difficult to conclude that observed volatility in the data is excessive.
Entry Dynamics and the Decline in Exchange-Rate Pass-Through
–September 1, 2010
Christopher J. Gust, Sylvain Leduc, Robert J. VigfussonThe degree of exchange-rate pass-through to import prices is low. An average passthrough estimate for the 1980s would be roughly 50 percent for the United States implying that, following a 10 percent depreciation of the dollar, a foreign exporter selling to the U.S. market would raise its price in the United States by 5 percent. Moreover, substantial evidence indicates that the degree of pass-through has since declined to about 30 percent. Gust, Leduc, and Vigfusson (2010) demonstrate that, in the presence of pricing complementarity, trade integration spurred by lower costs for importers can account for a significant portion of the decline in pass-through. In our framework, pass-through declines solely because of markup adjustments along the intensive margin. In this paper, we model how the entry and exit decisions of exporting firms affect pass-through. This is particularly important since the decline in pass-through has occurred as a greater concentration of foreign firms are exporting to the United States. We find that the effect of entry on pass-through is quantitatively small and is more than offset by the adjustment of markups that arise only along the intensive margin. Even though entry has a relatively small impact on pass-through, it nevertheless plays an important role in accounting for the secular rise in imports relative to GDP. In particular, our model suggests that over 3/4 of the rise in the U.S. import share since the early 1980s is due to trade in new goods. Thus, a key insight of this paper is that adjustment of markups that occur along the intensive margin are quantitatively more important in accounting for secular changes in pass-through than adjustments that occur along the extensive margin.
Credit Constraints and Self-Fulfilling Business Cycles
–September 1, 2011
Zheng Liu, Pengfei WangWe argue that credit constraints not just amplify fundamental shocks, they can also lead to self-fulfilling business cycles. To make this point, we study a model in which productive firms are credit constrained, with credit limits determined by equity value. A drop in equity value tightens credit constraints and reallocates resources from productive to unproductive firms. This reallocation reduces aggregate productivity and further depresses equity value and further tightens credit constraints, generating a financial multiplier that amplifies the effects of fundamental shocks. At the aggregate level, credit externality manifests as increasing returns and thus can lead to self-fulfilling business cycles.
If You Try, You’ll Get By: Chinese Private Firms’ Efficiency Gains from Overcoming Financial Constraints
–January 1, 2011
Galina Hale, Cheryl LongIn this paper we demonstrate that private firms in China have more difficult access to external finance than state owned firms and argue that they make adjustments to reduce their demand for external funds. In particular, we show that private firms have lower levels of inventory and trade credit and that these levels decrease with the difficulty of obtaining external finance. Nevertheless, we find no evidence that these lower levels of inventory and trade credit lead to lower productivity or profitability.
Asset Class Diversification and Delegation of Responsibilities between Central Banks and Sovereign Wealth Funds
–September 1, 2010
Joshua Aizenman, Reuven GlickThis paper presents a model comparing the optimal degree of asset class diversification abroad by a central bank and a sovereign wealth fund. We show that if the central bank manages its foreign asset holdings in order to meet balance of payments needs, particularly in reducing the probability of sudden stops in foreign capital inflows, it will place a high weight on holding safer foreign assets. In contrast, if the sovereign wealth fund, acting on behalf of the Treasury, maximizes the expected utility of a representative domestic agent, it will opt for relatively greater holding of more risky foreign assets. We also show how the diversification differences between the strategies of the bank and SWF is affected by the government’s delegation of responsibilities and by various parameters of the economy, such as the volatility of equity returns and the total amount of public foreign assets available for management.
China’s Monetary Policy and the Exchange Rate
–September 1, 2010
Aaron Mehrotra, Jose R. Sanchez-FungThe paper models monetary policy in China using a hybrid McCallum-Taylor empirical reaction function. The feedback rule allows for reactions to inflation and output gaps, and to developments in a trade-weighted exchange rate gap measure. The investigation finds that monetary policy in China has, on average, accommodated inflationary developments. But exchange rate shocks do not significantly affect monetary policy behavior, and there is no evidence of a structural break in the estimated reaction function at the end of the strict dollar peg in July 2005. The paper also runs an exercise incorporating survey-based inflation expectations into the policy reaction function and meets with some success.
Growth Accounting with Misallocation: Or, Doing Less with More in Singapore
–May 1, 2010
John G. Fernald, Brent NeimanWe derive aggregate growth-accounting implications for a two-sector economy with heterogeneous capital subsidies and monopoly power. In this economy, measures of total factor productivity (TFP) growth in terms of quantities (the primal) and real factor prices (the dual) can diverge from each other as well as from true technology growth. These distortions potentially give rise to dynamic reallocation effects that imply that change in technology needs to be measured from the bottom up rather than the top down. We show an example, for Singapore, of how incomplete data can be used to obtain estimates of aggregate and sectoral technology growth as well as reallocation effects. We also apply our framework to reconcile divergent TFP estimates in Singapore and to resolve other empirical puzzles regarding Asian development.
Fiscal Spending Jobs Multipliers: Evidence from the 2009 American Recovery and Reinvestment Act
–October 1, 2011
Daniel WilsonThis paper estimates the “jobs multiplier” of fiscal stimulus spending using the state-level allocations of federal stimulus funds from the American Recovery and Reinvestment Act (ARRA) of 2009. Because the level and timing of stimulus funds that a state receives was potentially endogenous, I exploit the fact that most of these funds were allocated according to exogenous formulary allocation factors such as the number of federal highway miles in a state or its youth share of population. Cross-state IV results indicate that ARRA spending in its first year yielded about eight jobs per million dollars spent, or $125,000 per job.
Technology Diffusion and Postwar Growth
–June 1, 2010
Diego Comin, Bart HobijnIn the aftermath of World War II, the world’s economies exhibited very different rates of economic recovery. We provide evidence that those countries that caught up the most with the U.S. in the postwar period are those that also saw an acceleration in the speed of adoption of new technologies. This acceleration is correlated with the incidence of U.S. economic aid and technical assistance in the same period. We interpret this as supportive of the interpretation that technology transfers from the U.S. to Western European countries and Japan were an important factor in driving growth in these recipient countries during the postwar decades.
The Illusive Quest: Do International Capital Controls Contribute to Currency Stability?
–May 1, 2010
Reuven Glick, Michael M. HutchisonWe investigate the effectiveness of capital controls in insulating economies from currency crises, focusing in particular on both direct and indirect effects of capital controls and how these relationships may have changed over time in response to global financial liberalization and the greater mobility of international capital. We predict the likelihood of currency crises using standard macroeconomic variables and a probit equation estimation methodology with random effects. We employ a comprehensive panel data set comprised of 69 emerging market and developing economies over 1975-2004. Both standard and duration-adjusted measures of capital control intensity (allowing controls to "depreciate" over time) suggest that capital controls have not effectively insulated economies from currency crises at any time during our sample period. Maintaining real GDP growth and limiting real overvaluation are critical factors preventing currency crises, not capital controls. However, the presence of capital controls greatly increases the sensitivity of currency crises to changes in real GDP growth and real exchange rate overvaluation, making countries more vulnerable to changes in fundamentals. Our model suggests that emerging markets weathered the 2007-08 crisis relatively well because of strong output growth and exchange rate flexibility that limited overvaluation of their currencies.
The Micro-Macro Disconnect of Purchasing Power Parity
–May 1, 2010
Paul R. Bergin, Reuven Glick, Jyh-Lin WuThe persistence of aggregate real exchange rates is a prominent puzzle, particularly since adjustment of international relative prices in microeconomic data is much faster. This paper finds that adjustment to the law of one price in disaggregated data is not just a faster version of the adjustment to purchasing power parity in the aggregate data; while aggregate real exchange rate adjustment works primarily through the foreign exchange market, adjustment in disaggregated data is a qualitatively distinct process, working through adjustment in local-currency goods prices. These distinct adjustment dynamics appear to arise from distinct classes of shocks generating macro and micro price deviations. A vector error correction model nesting aggregate and disaggregated relative prices permits identification of distinct macroeconomic and good-specific shocks. When half-lives are estimated conditional on shocks, the macro-micro disconnect puzzle disappears: microeconomic relative prices adjust to macro shocks just as slowly as do aggregate real exchange rates. These results provide evidence against theories of real exchange rate behavior based on sticky prices and on heterogeneity across goods.
Optimal Monetary Policy in Open Economies
–June 1, 2010
Giancarlo Corsetti, Luca Dedola, Sylvain LeducThis chapter studies optimal monetary stabilization policy in interdependent open economies, by proposing a unified analytical framework systematizing the existing literature. In the model, the combination of complete exchange-rate pass-through ("producer currency pricing") and frictionless asset markets ensuring efficient risk sharing results in a form of open-economy "divine coincidence": in line with the prescriptions in the baseline New Keynesian setting, the optimal monetary policy under cooperation is characterized by exclusively inward-looking targeting rules in domestic output gaps and GDP-deflator inflation. The chapter then examines deviations from this benchmark, when cross-country strategic policy interactions, incomplete exchange-rate pass-through ("local currency pricing") and asset market imperfections are accounted for. Namely, failure to internalize international monetary spillovers results in attempts to manipulate international relative prices to raise national welfare, causing inefficient real exchange rate fluctuations. Local currency pricing and incomplete asset markets (preventing efficient risk sharing) shift the focus of monetary stabilization to redressing domestic as well as external distortions: the targeting rules characterizing the optimal policy are not only in domestic output gaps and inflation, but also in misalignments in the terms of trade and real exchange rates, and cross-country demand imbalances.
Monetary Policy Mistakes and the Evolution of Inflation Expectations
–May 1, 2011
Athanasios Orphanides, John C. WilliamsWhat monetary policy framework, if adopted by the Federal Reserve, would have avoided the Great Inflation of the 1960s and 1970s? We use counterfactual simulations of an estimated model of the U.S. economy to evaluate alternative monetary policy strategies. We show that policies constructed using modern optimal control techniques aimed at stabilizing inflation, economic activity, and interest rates would have succeeded in achieving a high degree of economic stability as well as price stability only if the Federal Reserve had possessed excellent information regarding the structure of the economy or if it had acted as if it placed relatively low weight on stabilizing the real economy. Neither condition held true. We document that policymakers at the time both had an overly optimistic view of the natural rate of unemployment and put a high priority on achieving full employment. We show that in the presence of realistic informational imperfections and with an emphasis on stabilizing economic activity, an optimal control approach would have failed to keep inflation expectations well anchored, resulting in high and highly volatile inflation during the 1970s. Finally, we show that a strategy of following a robust first-difference policy rule would have been highly effective at stabilizing inflation and unemployment in the presence of informational imperfections. This robust monetary policy rule yields simulated outcomes that are close to those seen during the period of the Great Moderation starting in the mid-1980s.
Financial Crisis and Bank Lending
–May 1, 2010
Simon H. KwanThis paper estimates the amount of tightening in bank commercial and industrial (C&I) loan rates during the financial crisis. After controlling for loan characteristics and bank fixed effects, as of 2010:Q1, the average C&I loan spread was 66 basis points or 23 percent above normal. From about 2005 to 2008, the loan spread averaged 23 basis points below normal. Thus, from the unusually loose lending conditions in 2007 to the much tighter conditions in 2010:Q1, the average loan spread increased by about 1 percentage point. I find that large and medium-sized banks tightened their loan rates more than small banks; while small banks tended to tighten less, they always charged more. Using loan size to proxy for bank-dependent borrowers, while small loans tend to have a higher spread than large loans, I find that small loans actually tightened less than large loans in both absolute and percentage terms. Hence, the results do not indicate that bank-dependent borrowers suffered more from bank tightening than large borrowers. The channels through which banks tightened loan rates include reducing the discounts on large loans and raising the risk premium on more risky loans. There also is evidence that noncommitment loans were priced significantly higher than commitment loans at the height of the liquidity shortfall in late 2007 and early 2008, but this premium dropped to zero following the introduction of emergency liquidity facilities by the Federal Reserve. In a cross section of banks, certain bank characteristics are found to have significant effects on loan prices, including loan portfolio quality, capital ratios, and the amount of unused loan commitments. These findings provide evidence on the supply-side effect of loan pricing.
Simple and Robust Rules for Monetary Policy
–April 1, 2010
John B. Taylor, John C. WilliamsThis paper focuses on simple normative rules for monetary policy which central banks can use to guide their interest rate decisions. Such rules were first derived from research on empirical monetary models with rational expectations and sticky prices built in the 1970s and 1980s. During the past two decades substantial progress has been made in establishing that such rules are robust. They perform well with a variety of newer and more rigorous models and policy evaluation methods. Simple rules are also frequently more robust than fully optimal rules. Important progress has also been made in understanding how to adjust simple rules to deal with measurement error and expectations. Moreover, historical experience has shown that simple rules can work well in the real world in that macroeconomic performance has been better when central bank decisions were described by such rules. The recent financial crisis has not changed these conclusions, but it has stimulated important research on how policy rules should deal with asset bubbles and the zero bound on interest rates. Going forward the crisis has drawn attention to the importance of research on international monetary issues and on the implications of discretionary deviations from policy rules.
Expectations and Economic Fluctuations: An Analysis Using Survey Data
–February 1, 2010
Sylvain Leduc, Keith SillUsing survey-based measures of future U.S. economic activity from the Livingston Survey and the Survey of Professional Forecasters, we study how changes in expectations, and their interaction with monetary policy, contribute to fluctuations in macroeconomic aggregates. We find that changes in expected future economic activity are a quantitatively important driver of economic fluctuations: a perception that good times are ahead typically leads to a significant rise in current measures of economic activity and inflation. We also find that the short-term interest rate rises in response to expectations of good times as monetary policy tightens. Our results provide quantitative evidence on the importance of expectations-driven business cycles and on the role that monetary policy plays in shaping them.
Do Banks Propagate Debt Market Shocks?
–December 1, 2013
Galina Hale, João A. C. SantosRecent financial crisis demonstrated that the banking system can be a pathway for shock transmission. In this paper, we analyze how banks transmit shocks that hit the debt market to their borrowers. Our paper shows that when banks experience a shock to the cost of their bond financing, they pass a portion of their extra costs or savings to their corporate borrowers. While banks do not offer special protection from bond market shocks to their relationship borrowers, they also do not treat all of them equally. Relationship borrowers that are not bank-dependent are the least exposed to bond market shocks via their bank loans. In contrast, banks pass the highest portion of the increase in their cost of bond financing to their relationship borrowers that rely exclusively on banks for external funding. These findings show that banks put more weight on the informational advantage they have over their relationship borrowers than on the prospects of future business with these borrowers. They also show a potential side effect of the recent proposals to require banks to use CoCos or other long-term funding.
The Labor Market in the Great Recession
–March 1, 2010
Michael Elsby, Bart Hobijn, Aysegül SahinThis paper documents the adjustment of the labor market during the recession, and places it in the broader context of previous postwar downturns. What emerges is a picture of labor market dynamics with three key recurring themes: 1. From the perspective of a wide range of labor market outcomes, the 2007 recession represents the deepest downturn in the labor market in the postwar era. 2. Until recently, the nature of labor market adjustment in the current recession has displayed a notable resemblance to that observed in past severe downturns. 3. During the latter half of 2009, however, the path of adjustment has exhibited important departures from that seen in prior deep recessions.
Aggregation and the PPP Puzzle in a Sticky Price Model
–August 1, 2010
Carlos Carvalho, Fernanda NechioWe study the purchasing power parity (PPP) puzzle in a multi-sector, two-country, sticky-price model. Across sectors, firms differ in the extent of price stickiness, in accordance with recent microeconomic evidence on price setting in various countries. Combined with local currency pricing, this leads sectoral real exchange rates to have heterogeneous dynamics. We show analytically that in this economy, deviations of the real exchange rate from PPP are more volatile and persistent than in a counterfactual one-sector world economy that features the same average frequency of price changes, and is otherwise identical to the multi-sector world economy. When simulated with a sectoral distribution of price stickiness that matches the microeconomic evidence for the U.S. economy, the model produces a half-life of deviations from PPP of 39 months. In contrast, the half-life of such deviations in the counterfactual one-sector economy is only slightly above one year. As a by-product, our model provides a decomposition of this difference in persistence that allows a structural interpretation of the different approaches found in the empirical literature on aggregation and the real exchange rate. In particular, we reconcile the apparently conflicting findings that gave rise to the "PPP Strikes Back debate" (Imbs et al. 2005a,b and Chen and Engel 2005).
Should the Central Bank Be Concerned About Housing Prices?
–December 1, 2010
Karsten Jeske, Zheng LiuHousing is an important component of the consumption basket. Since both rental prices and goods prices are sticky, the literature suggests that optimal monetary policy should stabilize both types of prices, with the optimal weight on rental inflation proportional to the housing expenditure share. In a two-sector DSGE model with sticky rental prices and goods prices, however, we find that the optimal weight on rental inflation in the Taylor rule is small–much smaller than that implied by the housing expenditure share. We show that the asymmetry in policy responses to rent inflation versus goods inflation stems from the asymmetry in factor intensity between the two sectors.
Bond Currency Denomination and the Yen Carry Trade
–February 1, 2010
Christopher A. Candelaria, Jose A. Lopez, Mark M. SpiegelWe examine the determinants of issuance of yen-denominated international bonds over the period from 1990 through 2010. This period was marked by low Japanese interest rates that led some investors to pursue "carry trades," which consisted of funding investments in higher interest rate currencies with low interest rate, yen-denominated obligations. In principle, bond issuers that have flexibility in their funding currency could also conduct a carry-trade strategy by funding in yen during this low interest rate period. We examine the characteristics of firms who appeared to have adopted this strategy using a data set containing almost 80,000 international bond issues. Our results suggest that there was a movement towards issuing in yen in the international bond markets starting in 2003, but this appears to have ended with the outbreak of the global financial crisis in 2007. Furthermore, the breakdown of carry-trade conditions in 2007 corresponds to a resurgence in the ability of economic fundamentals, such as the volume of trade with Japan, to explain the decision to issue international bonds denominated in yen.
Inaccurate Age and Sex Data in the Census PUMS Files: Evidence and Implications
–January 1, 2010
J. Trent Alexander, Michael Davern, Betsey StevensonWe discover and document errors in public use microdata samples ("PUMS files") of the 2000 Census, the 2003-2006 American Community Survey, and the 2004-2009 Current Population Survey. For women and men ages 65 and older, age- and sex-specific population estimates generated from the PUMS files differ by as much as 15% from counts in published data tables. Moreover, an analysis of labor force participation and marriage rates suggests the PUMS samples are not representative of the population at individual ages for those ages 65 and over. PUMS files substantially underestimate labor force participation of those near retirement ages and overestimate labor force participation rates of those at older ages. These problems were an unintentional by-product of the misapplication of a newer generation of disclosure avoidance procedures carried out on the data. The resulting errors in the public use data could significantly impact studies of people ages 65 and older, particularly analyses of variables that are expected to change by age.
Expectations Traps and Coordination Failures: Selecting Among Multiple Discretionary Equilibria
–August 1, 2010
Richard Dennis, Tatiana KirsanovaDiscretionary policymakers cannot manage private-sector expectations and cannot coordinate the actions of future policymakers. As a consequence, expectations traps and coordination failures can occur and multiple equilibria can arise. To utilize the explanatory power of models with multiple equilibria it is first necessary to understand how an economy arrives to a particular equilibrium. In this paper, we employ notions of learnability, self-enforceability, and properness to motivate and develop a suite of equilibrium selection criteria. Central among these criteria are whether the equilibrium is learnable by private agents and jointly learnable by private agents and the policymaker. We use two New Keynesian policy models to identify the strategic interactions that give rise to multiple equilibria and to illustrate our equilibrium selection methods. Importantly, unless the Pareto-preferred equilibrium is learnable by private agents, we find little reason to expect coordination on that equilibrium.
Macro-Finance Models of Interest Rates and the Economy
–January 1, 2010
Glenn D. RudebuschDuring the past decade, much new research has combined elements of finance, monetary economics, and macroeconomics in order to study the relationship between the term structure of interest rates and the economy. In this survey, I describe three different strands of such interdisciplinary macro-finance term structure research. The first adds macroeconomic variables and structure to a canonical arbitrage-free finance representation of the yield curve. The second examines bond pricing and bond risk premiums in a canonical macroeconomic dynamic stochastic general equilibrium model. The third develops a new class of arbitrage-free term structure models that are empirically tractable and well suited to macro-finance investigations.
Can Lower Tax Rates Be Bought? Business Rent-Seeking and Tax Competition Among U.S. States
–June 1, 2010
Robert S. Chirinko, Daniel WilsonThe standard model of strategic tax competition – the non-cooperative tax-setting behavior of jurisdictions competing for a mobile capital tax base – assumes that government policymakers are perfectly benevolent, acting solely to maximize the utility of the representative resident in their jurisdiction. We depart from this assumption by allowing for the possibility that policymakers also may be influenced by the rent-seeking (lobbying) behavior of businesses. Businesses recognize the factors affecting policymakers’ welfare and may make campaign contributions to influence tax policy. This extension to the standard strategic tax competition model implies that business contributions may affect not only the levels of equilibrium tax rates but also the slope of the tax reaction function between jurisdictions. Thus, business campaign contributions may directly influence business tax rates, as well as indirectly shape tax competition, and enhance or retard the mobility of capital across jurisdictions. Based on a panel of 48 U.S. states and unique data on business campaign contributions, our empirical work uncovers four key results. First, we document a significant direct effect of business contributions on tax policy. Second, the economic value of a $1 business campaign contribution in terms of lower state corporate taxes is approximately $6.65. Third, the slope of the reaction function between tax policy in a given state and the tax policies of its competitive states is negative, and this slope is robust to business campaign contributions. Fourth, we document the sensitivity of the empirical results to state effects.
Do Credit Constraints Amplify Macroeconomic Fluctuations?
–December 1, 2009
Zheng Liu, Pengfei Wang, Tao ZhaPrevious studies on financial frictions have been unable to establish the empirical significance of credit constraints in macroeconomic fluctuations. This paper argues that the muted impact of credit constraints stems from the absence of a mechanism to explain the observed persistent comovements between housing prices and business investment. We develop such a mechanism by incorporating two key features into a DSGE model: we identify shocks that shift the demand for collateral assets and we allow productive agents to be credit-constrained. A combination of these two features enables our model to successfully generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through credit constraints.
Financial Choice in a Non-Ricardian Model of Trade
–November 1, 2009
Katheryn N. Russ, Diego ValderramaWe join the new trade theory with a model of choice between bank and bond financing to show the differential effects of financial policy on the distribution of firm size, welfare, aggregate output, gains from trade, and the real exchange rate in a small open economy. Increasing bank efficiency and reducing bond transaction costs both increase welfare but have opposite effects on the extensive margin of trade, aggregate exports, and the real exchange rate. Increasing the degree of trade openness increases firms’ relative demand for bond versus bank financing. We identify a financial switching channel for gains from trade where increasing access to export markets allows firms to overcome high fixed costs of bond issuance to secure a lower marginal cost of capital.
Risk Aversion, the Labor Margin, and Asset Pricing in DSGE Models
–October 1, 2009
Eric T. SwansonIn dynamic stochastic general equilibrium (DSGE) models, the household’s labor margin as well as consumption margin affects Arrow-Pratt risk aversion. This paper derives simple, closed-form expressions for risk aversion that take into account the household’s labor margin. Ignoring the labor margin can lead to wildly inaccurate measures of the household’s true attitudes toward risk. We show that risk premia on assets computed using the stochastic discount factor are proportional to Arrow-Pratt risk aversion, so that measuring risk aversion correctly is crucial for understanding asset prices. Closed-form expressions for risk aversion in DSGE models with generalized recursive preferences and internal and external habits are also derived.
A Theory of Banks, Bonds, and the Distribution of Firm Size
–October 1, 2009
Katheryn N. Russ, Diego ValderramaWe draw on stylized facts from the finance literature to build a model where altering the relative costs of bank and bond financing changes the entire distribution of firm size, with implications for the aggregate capital stock, output, and welfare. Reducing transactions costs in the bond market increases the output and profits of mid-sized firms at the expense of both the largest and smallest firms. In contrast, reducing the frictions involved in bank lending promotes the expansion of the smallest firms while all other firms shrink, even as it increases the profitability of both small and mid-size firms. Although both policies increase aggregate output and welfare, they have opposite effects on the extensive margin of production–promoting bond issuance causes exit while cheaper bank credit induces entry. When reducing transactions costs in one market, the resulting increase in output and welfare are largest when transactions costs in the other market are very high.
The Role of Capital Service-Life in a Model with Heterogenous Labor and Vintage Capital
–October 1, 2009
Milton H. Marquis, Wuttipan Tantivong, Bharat TrehanWe examine how the economy responds to both disembodied and embodied technology shocks in a model with vintage capital. We focus on what happens when there is a change in the number of vintages of capital that are in use at any one time and on what happens when there is a change in the persistence of the shocks hitting the economy. The data suggest that these kinds of changes took place in the U.S. economy in the 1990s, when the pace of embodied technical progress appears to have accelerated. We find that embodied technology shocks lead to greater variability (of output, investment and labor allocations) than disembodied shocks of the same size. On the other hand, a decrease in the number of vintages in use at any time (such as is likely to occur when the pace of technical progress accelerates) tends to reduce the volatility of output and also to differentiate the initial response of the economy to the two shocks.
Heeding Daedalus: Optimal Inflation and the Zero Lower Bound
–October 1, 2009
John C. WilliamsThis paper reexamines the implications of the zero lower bound on interest rates for monetary policy and the optimal choice of steady-state inflation in light of the experience of the recent global recession. There are two main findings. First, the zero lower bound did not materially contribute to the sharp declines in output in the United States and many other economies through the end of 2008, but it is a significant factor slowing recovery. Model simulations imply that an additional 4 percentage points of rate cuts would have kept the unemployment rate from rising as much as it has and would bring the unemployment and inflation rates more quickly to steady-state values, but the zero bound precludes these actions. This inability to lower interest rates comes at the cost of $1.7 trillion of foregone output over four years. Second, if recent events are a harbinger of a significantly more adverse macroeconomic climate than experienced over the preceding two decades, then a 2 percent steady-state inflation rate may provide an inadequate buffer to keep the zero bound from having noticeable deleterious effects on the macroeconomy assuming the central bank follows the standard Taylor Rule. In such an adverse environment, stronger systematic countercyclical fiscal policy and/or alternative monetary policy strategies can mitigate the harmful effects of the zero bound with a 2 percent inflation target. However, even with such policies, an inflation target of 1 percent or lower could entail significant costs in terms of macroeconomic volatility.
Mortgage Loan Securitization and Relative Loan Performance
–November 1, 2011
John Krainer, Elizabeth LadermanWe compare the ex ante observable risk characteristics, the default performance, and the pricing of securitized mortgage loans and mortgage loans retained by the original lender. We find that privately securitized fixed and adjustable-rate mortgages are riskier ex ante than lender-retained loans or loans securitized through the government sponsored agencies. We do not find any evidence of differential loan performance for privately securitized fixed-rate mortgages. However, we do find evidence that privately securitized adjustable-rate mortgages performed worse than retained mortgages, even after controlling for a large number of risk factors. Despite the higher measures of ex ante risk, the loan rates on privately securitized adjustable-rate mortgages were lower than for retained mortgages.
A State Level Database for the Manufacturing Sector: Construction and Sources
–October 1, 2009
Katheryn N. Russ, Diego ValderramaThis document describes the construction of and data sources for a state-level panel data set measuring output and factor use for the manufacturing sector. These data are a subset of a larger, comprehensive data set that we currently are constructing and hope to post on the FRBSF website in the near future. The comprehensive data set will cover the U.S. manufacturing sector and may be thought of as a state-level analog to other widely used productivity data sets such as the industry-level NBER Productivity Database or Dale Jorgenson’s "KLEM" database or the country-level Penn World Tables, but with an added emphasis on adjusting prices for taxes. The selected variables currently available for public use are nominal and real gross output, nominal and real investment, and real capital stock. The data cover all fifty states and the period 1963 to 2006.
Mortgage Default and Mortgage Valuation
–September 1, 2009
John Krainer, Stephen F. LeRoy, Munpyung OWe study optimal exercise by mortgage borrowers of the option to default. Also, we use an equilibrium valuation model incorporating default to show how mortgage yields and lender recovery rates on defaulted mortgages depend on initial loan-to-value ratios when borrowers default optimally. The analysis treats both the frictionless case and the case in which borrowers and/or lenders incur deadweight costs upon default. The model is calibrated using data on California mortgages. We find that the model’s principal testable implication for default and mortgage pricing–that default rates and yield spreads will be higher for high loan-to-value mortgages–is borne out empirically.
Household Inflation Experiences in the U.S.: A Comprehensive Approach
–September 1, 2009
Bart Hobijn, Kristin Mayer, Carter Stennis, Giorgio TopaWe present new measures of household-specific inflation experiences based on comprehensive information from the Consumer Expenditure Survey (CEX). We match households in the Interview and the Diary Surveys from the CEX to produce both complete and detailed pictures of household expenditures. The resulting household inflation measures are based on a more accurate and detailed description of household expenditures than those previously available. We find that our household-based inflation measures track aggregate measures such as the CPI-U quite well and that the addition of Diary Survey data induces small but significant differences in the measurement of household inflation. The distribution of inflation experiences across households exhibits a large amount of dispersion over the entire sample period. In addition, we uncover a significantly negative relationship between mean inflation and inflation inequality across households.
Cross-Country Causes and Consequences of the 2008 Crisis: International Linkages and American Exposure
–September 1, 2009
Andrew K. Rose, Mark M. SpiegelThis paper models the causes of the 2008 financial crisis together with its manifestations, using a Multiple Indicator Multiple Cause (MIMIC) model. Our analysis is conducted on a cross-section of 85 countries; we focus on international linkages that may have allowed the crisis to spread across countries. Our model of the cross-country incidence of the crisis combines 2008 changes in real GDP, the stock market, country credit ratings, and the exchange rate. We explore the linkages between these manifestations of the crisis and a number of its possible causes from 2006 and earlier. The causes we consider are both national (such as equity market run-ups that preceded the crisis) and, critically, international financial and real linkages between countries and the epicenter of the crisis. We consider the United States to be the most natural origin of the 2008 crisis, though we also consider six alternative sources of the crisis. A country holding American securities that deteriorate in value is exposed to an American crisis through a financial channel. Similarly, a country which exports to the United States is exposed to an American downturn through a real channel. Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to find strong evidence that international linkages can be clearly associated with the incidence of the crisis. In particular, countries heavily exposed to either American assets or trade seem to behave little differently than other countries; if anything, countries seem to have benefited slightly from American exposure.
Cross-Country Causes and Consequences of the 2008 Crisis: Early Warning
–July 1, 2009
Andrew Rose, Mark M. SpiegelThis paper models the causes of the 2008 financial crisis together with its manifestations, using a Multiple Indicator Multiple Cause (MIMIC) model. Our analysis is conducted on a cross-section of 107 countries; we focus on national causes and consequences of the crisis, ignoring crosscountry “contagion” effects. Our model of the incidence of the crisis combines 2008 changes in real GDP, the stock market, country credit ratings, and the exchange rate. We explore the linkages between these manifestations of the crisis and a number of its possible causes from 2006 and earlier. We include over sixty potential causes of the crisis, covering such categories as: financial system policies and conditions; asset price appreciation in real estate and equity markets; international imbalances and foreign reserve adequacy; macroeconomic policies; and institutional and geographic features. Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to link most of the commonly-cited causes of the crisis to its incidence across countries. This negative finding in the cross-section makes us skeptical of the accuracy of “early warning” systems of potential crises, which must also predict their timing.
Monetary Policy Response to Oil Price Shocks
–August 1, 2009
Jean-Marc NatalHow should monetary authorities react to an oil price shock? The New Keynesian literature has concluded that ensuring complete price stability is the optimal thing to do. In contrast, this paper argues that a meaningful trade-off between stabilizing inflation and the welfare relevant output gap arises in a distorted economy once one recognizes (i) that oil (energy) cannot be easily substituted by other factors in the short-run, (ii) that there is no fiscal transfer available to policymakers to neutralize the steady-state distortion due to monopolistic competition, and (iii) that increases in oil prices also directly affect consumption by raising the price of fuel, heating oil, and other energy sources. While the first two conditions are necessary to introduce a microfounded monetary policy trade-off, the third one makes it quantitatively significant. The optimal precommitment monetary policy relies on unobservables and is therefore hard to implement. To address this concern, I derive a simple interest rate feedback rule that mimics the optimal plan in all relevant dimensions but that depends only on observables, namely core inflation, oil price inflation, and the growth rate of output.
Welfare-Based Optimal Monetary Policy with Unemployment and Sticky Prices: A Linear-Quadratic Framework
–May 1, 2009
Federico Ravenna, Carl E. WalshIn this paper, we derive a linear-quadratic model for monetary policy analysis that is consistent with sticky prices and search and matching frictions in the labor market. We show that the second-order approximation to the welfare of the representative agent depends on inflation and "gaps" that involve current and lagged unemployment. Our approximation makes explicit how the costs of fluctuations are generated by the presence of search frictions. These costs are distinct from the costs associated with relative price dispersion and fluctuations in consumption that appear in standard new Keynesian models. We use the model to analyze optimal monetary policy under commitment and discretion and to show that the structural characteristics of the labor market have important implications for optimal policy.
Foreign Entry into Underwriting Services: Evidence from Japan’s “Big Bang” Deregulation
–June 1, 2009
Jose A. Lopez, Mark M. SpiegelWe examine the impact of foreign underwriting activity on bond markets using issue-level data in the Japanese "Samurai" and euro-yen bond markets. Firms choosing Japanese underwriters tend to be Japanese, riskier, and smaller. We find that Japanese underwriting fees, while higher overall on average, are actually lower after conditioning for issuer characteristics. Moreover, firms tend to sort properly in their choice of underwriter, in the sense that a switch in underwriter nationality would be predicted to result in an increase in underwriting fees. Finally, we conduct a matching exercise to examine the 1995 liberalization of foreign access to the "Samurai" bond market, using yen-denominated issues in the euro-yen market as a control. Foreign entry led to a statistically and economically significant decrease in underwriting fees in the Samurai bond market, as spreads fell by an average of 23 basis points. Overall, our results suggest that the market for underwriting services is partially segmented by nationality, as issuers appear to have preferred habitats, but entry increases market competition.
Do Central Bank Liquidity Facilities Affect Interbank Lending Rates?
–June 1, 2009
Jens H. E. Christensen, Jose A. Lopez, Glenn D. RudebuschIn response to the global financial crisis that started in August 2007, central banks provided extraordinary amounts of liquidity to the financial system. To investigate the effect of central bank liquidity facilities on term interbank lending rates, we estimate a six-factor arbitrage-free model of U.S. Treasury yields, financial corporate bond yields, and term interbank rates. This model can account for fluctuations in the term structure of credit risk and liquidity risk. A significant shift in model estimates after the announcement of the liquidity facilities suggests that these central bank actions did help lower the liquidity premium in term interbank rates.
The Welfare Consequences of Monetary Policy
–April 1, 2009
Federico Ravenna, Carl E. WalshWe explore the distortions in business cycle models arising from inefficiencies in price setting and in the search process matching firms to unemployed workers, and the implications of these distortions for monetary policy. To this end, we characterize the tax instruments that would implement the first best equilibrium allocations and then examine the trade-offs faced by monetary policy when these tax instruments are unavailable. Our findings are that the welfare cost of search inefficiency can be large, but the incentive for policy to deviate from the inefficient flexible-price allocation is in general small. Sizable welfare gains are available if the steady state of the economy is inefficient, and these gains do not depend on the existence of an inefficient dispersion of wages. Finally, the gains from deviating from price stability are larger in economies with more volatile labor flows, as in the U.S.
The Paradox of Declining Female Happiness
–May 1, 2009
Betsey Stevenson, Justin WolfersBy many objective measures the lives of women in the United States have improved over the past 35 years, yet we show that measures of subjective well-being indicate that women’s happiness has declined both absolutely and relative to men. The paradox of women’s declining relative well-being is found across various datasets, measures of subjective well-being, and is pervasive across demographic groups and industrialized countries. Relative declines in female happiness have eroded a gender gap in happiness in which women in the 1970s typically reported higher subjective well-being than did men. These declines have continued and a new gender gap is emerging—one with higher subjective well-being for men.
Survey Measures of Expected Inflation and the Inflation Process
–February 1, 2010
Bharat TrehanThis paper uses data from surveys of expected inflation to learn how expectations processes have changed following recent changes in the behavior of inflation. Households do not appear to have recognized the change in the process, and are placing substantially more weight than appears warranted on recent inflation data when forming expectations about inflation over the next year. At first glance, professional forecasters do appear to have changed how they predict inflation. But a closer look at the data reveals that professionals are relying on core rather than headline inflation, and are placing too much weight on recent core inflation data. These errors show up in a noticeable (absolute and relative) deterioration in the forecast accuracy of both households and professionals.
The International Dimension of Productivity and Demand Shocks in the US Economy
–May 1, 2009
Giancarlo Corsetti, Luca Dedola, Sylvain LeducIdentifying productivity and real demand shocks in the US with sign restrictions based on standard theory, we provide evidence on real and financial channels of their international propagation. Productivity gains in US manufacturing have substantial macroeconomic effects, raising US consumption, investment and the terms of trade, relative to the rest of the world, while lowering US net exports. Significant international financial adjustment occurs via a rise in the global value of the US stock market, portfolio shifts in US foreign assets and liabilities, and especially real dollar appreciation. Positive demand shocks to US manufacturing also lead to real appreciation and raise investment, but have otherwise limited effects on trade flows. This evidence suggests a fundamental role of cross-country endogenous demand and wealth movements in shaping international macroeconomic interdependence.
The Effect of an Employer Health Insurance Mandate on Health Insurance Coverage and the Demand for Labor: Evidence from Hawaii
–April 1, 2011
Thomas C. Buchmueller, John DiNardo, Robert G. VallettaWe examine the effects of the most durable employer health insurance mandate in the United States, Hawaii’s Prepaid Health Care Act, using Current Population Survey data covering the years 1979 to 2005. We find that Hawaii’s law increased insurance coverage over time for worker groups with low rates of coverage in the voluntary market. We find no statistically significant support for the hypothesis that the mandate reduced wages and employment probabilities. Instead, its primary detectable effect was an increased reliance on part-time workers who are exempt from the law. We arrive at these conclusions in part by use of a variation of the classical Fisher permutation test that compares the magnitude of the estimated “Hawaii effect” to “placebo effects” estimated for the other US states.
Beyond Kuznets: Persistent Regional Inequality in China
–November 1, 2010
Christopher Candelaria, Mary C. Daly, Galina HaleRegional inequality in China appears to be persistent and even growing in the past two decades. We study potential offsetting factors and interprovincial migration to shed light on the sources of this persistence. We find that some of the inequality could be attributed to differences in quality of labor, industry composition, and geographical location of provinces. We also demonstrate that interprovincial migration, while driven in part by wage differences across provinces, does not offset these differences. Finally, we find that interprovincial redistribution did not help offset regional inequality during our sample period.
The Olympic Effect
–March 1, 2009
Andrew K. Rose, Mark M. SpiegelEconomists are skeptical about the economic benefits of hosting "mega-events" such as the Olympic Games or the World Cup, since such activities have considerable cost and seem to yield few tangible benefits. These doubts are rarely shared by policymakers and the population, who are typically quite enthusiastic about such spectacles. In this paper, we reconcile these positions by examining the economic impact of hosting mega-events like the Olympics; we focus on trade. Using a variety of trade models, we show that hosting a mega-event like the Olympics has a positive impact on national exports. This effect is statistically robust, permanent, and large; trade is around 30% higher for countries that have hosted the Olympics. Interestingly however, we also find that unsuccessful bids to host the Olympics have a similar positive impact on exports. We conclude that the Olympic effect on trade is attributable to the signal a country sends when bidding to host the games, rather than the act of actually holding a mega-event. We develop a political economy model that formalizes this idea, and derives the conditions under which a signal like this is used by countries wishing to liberalize.
What Do We Know and Not Know about Potential Output?
–March 1, 2009
Susanto Basu, John G. FernaldPotential output is an important concept in economics. Policymakers often use a one-sector neoclassical model to think about long-run growth, and often assume that potential output is a smooth series in the short run–approximated by a medium- or long-run estimate. But in both the short and long run, the one-sector model falls short empirically, reflecting the importance of rapid technical change in producing investment goods; and few, if any, modern macroeconomic models would imply that, at business cycle frequencies, potential output is a smooth series. Discussing these points allows us to discuss a range of other issues that are less well understood, and where further research could be valuable.
Unemployment Dynamics in the OECD
–February 1, 2011
Michael W. L. Elsby, Bart Hobijn, Aysegül SahinWe provide a set of comparable estimates for the rates of inflow to and outflow from unemployment using publicly available data for fourteen OECD economies. We then devise a method to decompose changes in unemployment into contributions accounted for by changes in inflow and outflow rates for cases where unemployment deviates from its flow steady state, as it does in many countries. Our decomposition reveals that fluctuations in both inflow and outflow rates contribute substantially to unemployment variation within countries. For Anglo-Saxon economies we find approximately a 15:85 inflow/outflow split to unemployment variation, while for Continental European and Nordic countries, we observe much closer to a 45:55 split. Using the estimated flow rates we compute gross worker flows into and out of unemployment. In all economies we observe that increases in inflows lead increases in unemployment, whereas outflows lag a ramp up in unemployment.
CONDI: A Cost-Of-Nominal-Distortions Index
–February 1, 2009
Stefano Eusepi, Bart Hobijn, Andrea TambalottiWe construct a price index with weights on the prices of different PCE goods chosen to minimize the welfare costs of nominal distortions: a cost-of-nominal-distortions index (CONDI). We compute these weights in a multisector New Keynesian model with time-dependent price setting, calibrated using U.S. data on the dispersion of price stickiness and labor shares across sectors. We find that the CONDI weights mostly depend on price stickiness and are less affected by the dispersion in labor shares. Moreover, CONDI stabilization leads to negligible welfare losses compared to the optimal policy and is better approximated by core rather than headline inflation targeting. An even better approximation of the CONDI can be obtained with an adjusted core index that covers total expenditures excluding autos, clothing, energy, and food at home, but that includes food away from home.
EAD Calibration for Corporate Credit Lines
–January 1, 2009
Gabriel Jiménez, Jose A. Lopez, Jesús SaurinaManaging the credit risk inherent to a corporate credit line is similar to that of a term loan, but with one key difference. For both instruments, the bank should know the borrower’s probability of default (PD) and the facility’s loss given default (LGD). However, since a credit line allows the borrowers to draw down the committed funds according to their own needs, the bank must also have a measure of the line’s exposure at default (EAD). Our study, which is based on a census of all corporate lending within Spain over the last 20 years, provides the most comprehensive overview of corporate credit line use and EAD calculations to date. Our analysis shows that defaulting firms have significantly higher credit line usage rates and EAD values up to five years prior to their actual default. Furthermore, we find that there are important variations in EAD values due to credit line size, collateralization, and maturity. While our results are derived from data for a single country, they should provide useful benchmarks for further academic, business and policy research into this underdeveloped area of credit risk management.
Sources of Macroeconomic Fluctuations: A Regime-Switching DSGE Approach
–April 1, 2010
Zheng Liu, Daniel F. Waggoner, Tao ZhaWe examine the sources of macroeconomic economic fluctuations by estimating a variety of medium-scale DSGE models within a unified framework that incorporates regime switching both in shock variances and in the inflation target. Our general framework includes a number of different model features studied in the literature. We propose an efficient methodology for estimating regime-switching DSGE models. The model that best fits the U.S. time-series data is the one with synchronized shifts in shock variances across two regimes and the fit does not rely on strong nominal rigidities. We find little evidence of changes in the inflation target. We identify three types of shocks that account for most of macroeconomic fluctuations: shocks to total factor productivity, wage markup, and the capital depreciation rate.
Consumption-Habits in a New Keynesian Business Cycle Model
–December 1, 2008
Richard DennisConsumption-habits have become an integral component in new Keynesian models. However, consumption-habits can be modeled in a host of different ways and this diversity is reflected in the literature. I examine whether different approaches to modeling consumption habits have important implications for business cycle behavior. Using a standard new Keynesian business cycle model, I show that, to a first-order log-approximation, the consumption Euler equation associated with the additive functional form for habit formation encompasses the multiplicative function form. Empirically, I show that whether consumption habits are internal or external has little effect on the model’s business cycle characteristics.
Inflation Expectations and Risk Premiums in an Arbitrage-Free Model of Nominal and Real Bond Yields
–January 1, 2010
Jens H. E. Christensen, Jose A. Lopez, Glenn D. RudebuschDifferences between yields on comparable-maturity U.S. Treasury nominal and real debt, the so-called breakeven inflation (BEI) rates, are widely used indicators of inflation expectations. However, better measures of inflation expectations could be obtained by subtracting inflation risk premiums from the BEI rates. We provide such decompositions using an estimated affine arbitrage-free model of the term structure that captures the pricing of both nominal and real Treasury securities. Our empirical results suggest that long-term inflation expectations have been well anchored over the past few years, and inflation risk premiums, although volatile, have been close to zero on average.
Sovereign Wealth Funds: Stylized Facts about Their Determinance and Governance
–December 1, 2008
Joshua Aizenman, Reuven GlickThis paper presents statistical analysis supporting stylized facts about sovereign wealth funds (SWFs). It discusses the forces leading to the growth of SWFs, including the role of fuel exports and ongoing current account surpluses, and large hoarding of international reserves. It analyzes the degree to which measures of SWF governance and transparency compare with national norms of behavior. We provide evidence that many countries with SWFs are characterized by effective governance but weak democratic institutions, as compared to other nonindustrial countries. We also present a model with which we compare the optimal degree of diversification abroad by a central bank versus that of a sovereign wealth fund. We show that if the central bank manages its foreign assets with the objective of reducing the probability of sudden stops, it will place a high weight on the downside risk of holding risky assets abroad and will tend to hold primarily safe foreign assets. In contrast, if the sovereign wealth fund, acting on behalf of the Treasury, maximizes the expected utility of a representative domestic agent, it will opt for relatively greater holding of more risky foreign assets. We discuss how the degree of a country’s transparency may affect the size of the foreign asset base entrusted to a wealth fund’s management, and show that, for relatively low levels of public foreign assets, assigning portfolio management independence to the central bank may be advantageous. However, for a large enough foreign asset base, the opportunity cost associated with the limited portfolio diversification of the central bank induces authorities to establish a wealth fund in pursuit of higher returns.
Navigating the Trilemma: Capital Flows and Monetary Policy in China
–December 1, 2008
Reuven Glick, Michael M. HutchisonIn recent years China has faced an increasing trilemma–how to pursue an independent domestic monetary policy and limit exchange rate flexibility, while at the same time facing large and growing international capital flows. This paper analyzes the impact of the trilemma on China’s monetary policy as the country liberalizes its goods and financial markets and integrates with the world economy. It shows how China has sought to insulate its reserve money from the effects of balance of payments inflows by sterilizing through the issuance of central bank liabilities. However, we report empirical results indicating that sterilization dropped precipitously in 2006 in the face of the ongoing massive buildup of international reserves, leading to a surge in reserve money growth. We estimate a vector error correction model linking the surge in China’s reserve money to broad money, real GDP, and the price level. We use this model to explore the inflationary implications of different policy scenarios. Under a scenario of continued rapid reserve money growth (consistent with limited sterilization of foreign exchange reserve accumulation) and strong economic growth, the model predicts a rapid increase in inflation. A model simulation using an extension of the framework that incorporates recent increases in bank reserve requirements also implies a rapid rise in inflation. By contrast, model simulations incorporating a sharp slowdown in economic growth lead to less inflation pressure even with a substantial buildup in international reserves.
The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks
–March 1, 2009
Glenn D. Rudebusch, Eric T. SwansonThe term premium on nominal long-term bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data–an example of the "bond premium puzzle." However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors have recursive Epstein-Zin preferences and face long-run economic risks. We show that introducing Epstein-Zin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model’s ability to fi t key macroeconomic variables. Long-run real and nominal risks further improve the model’s ability to fit the data with a lower level of household risk aversion.
The Adjustments of Hours and Real Wages to Technology Shocks: Assessing the Role of Nominal Rigidities
–August 1, 2011
Zheng Liu, Louis PhaneufNominal rigidities are generally viewed as important for the transmission of monetary policy. We argue that nominal rigidities are important also for the transmission of technology shocks, especially for explaining their effects on hours and real wages. Evidence suggests that a positive technology shock leads to a short-run decline in labor hours and a gradual rise in real wages. We examine the ability of an RBC model augmented with real frictions, a pure sticky-price model, a pure sticky-wage model, and a model combining sticky prices and sticky wages in accounting for this evidence. We find that, according to this metric, the model with nominal wage and price rigidities is more successful than others. This finding is robust and holds true for a relatively small Frisch elasticity of hours and a relatively high frequency of price reoptimization that are consistent with microeconomic evidence.
Exporting Deflation? Chinese Exports and Japanese Prices
–April 1, 2008
Christian Broda, David WeinsteinBetween 1992 and 2002, the Japanese Import Price Index (IPI) registered a decline of almost 9 percent and Japan entered a period of deflation. We show that much of the correlation between import prices and domestic prices was due to formula biases. Had the IPI been computed using a pure Laspeyres index like the CPI, the IPI would have hardly moved at all. A Laspeyres version of the IPI would have risen 1 percentage point per year faster than the official index. Second we show that Chinese prices did not behave differently from the prices of other importers. Although Chinese prices are substantially lower than the prices of other exporters, they do not exhibit a differential trend. However, we estimate that the typical price per unit quality of a Chinese exporter fell by half between 1992 and 2005. Thus the explosive growth in Chinese exports is attributable to growth in the quality of Chinese exports and the increase in new products being exported by China.
China’s Exporters and Importers: Firms, Products, and Trade Partners
–June 1, 2008
Kalina Manova, Zhiwei ZhangThis paper provides a detailed overview of China’s participation in international trade using newly available data on the universe of globally engaged Chinese firms over the 2003-2005 period. We document the distribution of trade flows and product- and trade-partner intensity across both exporting and importing firms and study the relationship between firms’ intensive and extensive margins of trade. We also compare trade patterns across firms of different organizational structure, distinguishing between domestic private firms, domestic state‐owned firms, foreign-owned firms, and joint ventures. We explore the variation in foreign ownership across sectors, and find results consistent with recent theoretical and empirical work on the role of credit constraints and contractual imperfections in international trade and investment. Finally, we examine the rapid expansion of China’s trade over the 2003-2005 period, and decompose it into its extensive and intensive margins. We also use monthly data and study the frequent churning and reallocation of trade flows across firms and across products and trade partners within firms.
Why Do Foreigners Invest in the United States?
–October 1, 2008
Kristin J. ForbesWhy are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less-developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and there is no evidence that foreigners invest in the United States based on diversification motives. The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.
Current Account Dynamics and Monetary Policy
–November 1, 2008
Andrea Ferrero, Mark Gertler, Lars E. O. SvenssonWe explore the implications of current account adjustment for monetary policy within a simple two country SGE model. Our framework nests Obstfeld and Rogoff’s (2005) static model of exchange rate responsiveness to current account reversals. It extends this approach by endogenizing the dynamic adjustment path and by incorporating production and nominal price rigidities in order to study the role of monetary policy. We consider two different adjustment scenarios. The first is a "slow burn" where the adjustment of the current account deficit of the home country is smooth and slow. The second is a "fast burn" where, owing to a sudden shift in expectations of relative growth rates, there is a rapid reversal of the home country’s current account. We examine several different monetary policy regimes under each of these scenarios. Our principal finding is that the behavior of the domestic variables (for instance, output, inflation) is quite sensitive to the monetary regime, while the behavior of the international variables (for instance, the current account and the real exchange rate) is less so. Among different policy rules, domestic inflation targeting achieves the best stabilization outcome of aggregate variables. This result is robust to the presence of imperfect pass-through on import prices, although in this case stabilization of consumer price inflation performs similarly well.
When Bonds Matter: Home Bias in Goods and Assets
–November 1, 2008
Nicolas Coeurdacier, Pierre-Olivier GourinchasRecent models of international equity portfolios exhibit two potential weaknesses: (1) the structure of equilibrium equity portfolios is determined by the correlation of equity returns with real exchange rates, yet empirically equities don’t appear to be a good hedge against real exchange rate risk; (2) Equity portfolios are highly sensitive to preference parameters. This paper solves both problems. It first shows that, in more general and realistic environments, the hedging of real exchange rate risks occurs through international bond holdings since relative bond returns are strongly correlated with real exchange rate fluctuations. Equilibrium equity positions are then optimally determined by the correlation of equity returns with the return on nonfinancial wealth, conditional on the bond returns. The model delivers equilibrium portfolios that are well-behaved as a function of the underlying preference parameters. We find reasonable empirical support for the theory for G-7 countries. We are able to explain short positions in domestic currency bonds for all G-7 countries, as well as significant levels of home equity bias for the U.S., Japan, and Canada.
Inventories, Lumpy Trade, and Large Devaluations
–January 1, 2008
George Alessandria, Joseph P. Kaboski, Virgiliu MidriganFixed transaction costs and delivery lags are important costs of international trade. These costs lead firms to import infrequently and hold substantially larger inventories of imported goods than domestic goods. Using multiple sources of data, we document these facts. We then show that a parsimoniously parameterized model economy with importers facing an (S, s)-type inventory management problem successfully accounts for these features of the data. Moreover, the model can account for import and import price dynamics in the aftermath of large devaluations. In particular, desired inventory adjustment in response to a sudden, large increase in the relative price of imported goods creates a short-term trade implosion, an immediate, temporary drop in the value and number of distinct varieties imported, as well as a slow increase in the retail price of imported goods. Our study of six current account reversals following large devaluation episodes in the last decade provide strong support for the model’s predictions.
How Much of South Korea’s Growth Miracle Can Be Explained by Trade Policy?
–November 1, 2008
Michelle P. Connolly, Kei-Mu YiSouth Korea’s growth miracle has been well documented. A large set of institutional and policy reforms in the early 1960s is thought to have contributed to the country’s extraordinary performance. In this paper, we assess the importance of one key set of policies, the trade policy reforms in Korea, as well as the concurrent GATT tariff reductions. We develop a model of neoclassical growth and trade that highlights two forces by which lower trade barriers can lead to increased per worker GDP: comparative advantage and specialization, and capital accumulation. We calibrate the model and simulate the effects of three sets of tariff reductions that occurred between the early 1962 and 1995. Our main finding is that the model can explain up to 32 percent of South Korea’s catch-up to the G7 countries in output per worker in the manufacturing sector. We find that the effects of the tariff reductions taken together are about twice as large as the sum of each reduction applied individually.
Asymmetric Expectation Effects of Regime Shifts in Monetary Policy
–September 1, 2008
Zheng Liu, Daniel F. Waggoner, Tao ZhaThis paper addresses two substantive issues: (1) Does the magnitude of the expectation effect of regime switching in monetary policy depend on a particular policy regime? (2) Under which regime is the expectation effect quantitatively important? Using two canonical DSGE models, we show that there exists asymmetry in the expectation effect across regimes. The expectation effect under the dovish policy regime is quantitatively more important than that under the hawkish regime. These results suggest that the possibility of regime shifts in monetary policy can have important effects on rational agents’ expectation formation and on equilibrium dynamics. They offer a theoretical explanation for the empirical possibility that a policy shift from the dovish regime to the hawkish regime may not be the main source of substantial reductions in the volatilities of inflation and output.
When is Discretion Superior to Timeless Perspective Policymaking?
–January 1, 2010
Richard DennisThe monetary policy literature assumes increasingly that policies are formulated according to the timeless perspective (Woodford, 1999a). However, treating the auxiliary state variables that characterize the timeless perspective equilibrium appropriately when evaluating policy performance, this paper shows that discretionary policymaking can be superior to timeless perspective policymaking and identifies model features that make this outcome more likely. Using standard New Keynesian DSGE models, discretion is found to dominate timeless perspective policymaking when the price/wage Phillips curves are relatively flat, due, perhaps, to firm-specific capital (or labor) and/or Kimball (1995) aggregation in combination with nominal rigidities. These results suggest that studies applying the timeless perspective might also usefully compare its performance to discretion, paying careful attention to how policy performance is evaluated.
Who Drove the Boom in Euro-Denominated Bond Issues?
–March 1, 2009
Galina Hale, Mark M. SpiegelWe make use of micro-level data for over 45,000 private bond issues by over 5000 firms from 22 countries in 1990-2006 to analyze the impact that the launch of the EMU had on their currency denomination. The use of the micro data allows us to isolate the "euro effect" on new and seasoned bond issuers while conditioning on individual issue characteristics. To our knowledge, ours is the first systematic analysis of this topic at the micro level. We find that the impact on new issuers is larger than on seasoned issuers and that most of the increase in the euro-denominated bond issuance by seasoned borrowers was along the "extensive" margin, i.e. borrowers switching currency denomination of their issues. Insofar as new entrants to the bond market will define the overall currency composition in the long run, these results imply that aggregate studies might be underestimating the euro effect. We also find that to a large extent the increase in euro issuance was "at the expense" of U.S. dollar issuance, suggesting that euro competes with the U.S. dollar as a currency of choice for international financial transactions.
Happiness, Unhappiness, and Suicide: An Empirical Assessment
–August 1, 2008
Mary C. Daly, Daniel WilsonThe use of subjective well-being (SWB) data for investigating the nature of individual preferences has increased tremendously in recent years. There has been much debate about the cross-sectional and time series patterns found in these data, particularly with respect to the relationship between SWB and relative status. Part of this debate concerns how well SWB data measures true utility or preferences. In a recent paper, Daly, Wilson, and Johnson (2007) propose using data on suicide as a revealed preference (outcome-based) measure of well-being and find strong evidence that reference-group income negatively affects suicide risk. In this paper, we compare and contrast the empirical patterns of SWB and suicide data. We find that the two have very little in common in aggregate data (time series and cross-sectional), but have a strikingly strong relationship in terms of their determinants in individual-level, multivariate regressions. This latter result cross-validates suicide and SWB micro data as useful and complementary indicators of latent utility.
Learning, Adaptive Expectations, and Technology Shocks
–September 1, 2008
Kevin X.D. Huang, Zheng Liu, Tao ZhaThis study explores the macroeconomic implications of adaptive expectations in a standard growth model. We show that the self-confirming equilibrium under adaptive expectations is the same as the steady state rational expectations equilibrium for all admissible parameter values, but that dynamics around the steady state are substantially different between the two equilibria. The differences are driven mainly by the dampened wealth effect and the strengthened intertemporal substitution effect, not by escapes emphasized by Williams (2003). Consequently, adaptive expectations can be an important source of frictions that amplify and propagate technology shocks and seem promising for generating plausible labor market dynamics.
Loan Officers and Relationship Lending to SMEs
–July 1, 2008
Hirofumi Uchida, Gregory F. Udell, Nobuyoshi YamoriPrevious research suggests that loan officers play a critical role in relationship lending by producing soft information about SMEs. For the first time, we empirically confirm this hypothesis. We also examine whether the role of loan officers differs from small to large banks as predicted by Stein (2002). While we find that small banks produce more soft information, the capacity and manner in which loan officers produce soft information does not seem to differ between large and small banks. This suggests that, although large banks may produce more soft information, they likely tend to concentrate their resources on transactions lending.
The Adjustment of Global External Balances: Does Partial Exchange Rate Pass-Through to Trade Prices Matter?
–June 1, 2008
Christopher J. Gust, Sylvain Leduc, Nathan SheetsThis paper assesses whether partial exchange rate pass-through to trade prices has important implications for the prospective adjustment of global external imbalances. To address this question, we develop and estimate an open-economy DGE model in which pass-through is incomplete due to the presence of local currency pricing, distribution services, and a variable demand elasticity that leads to fluctuations in optimal markups. We find that the overall magnitude of trade adjustment is similar in a low and high pass-through world with more adjustment in a low pass-through world occurring through a larger response of the exchange rate and terms of trade rather than real trade flows.
Sterilization, Monetary Policy, and Global Financial Integration
–August 1, 2008
Joshua Aizenman, Reuven GlickThis paper investigates the changing pattern and efficacy of sterilization within emerging market countries as they liberalize markets and integrate with the world economy. We estimate the marginal propensity to sterilize foreign asset accumulation associated with net balance of payments inflows, across countries and over time. We find that the extent of sterilization of foreign reserve inflows has risen in recent years to varying degrees in Asia as well as in Latin America, consistent with greater concerns about the potential inflationary impact of reserve inflows. We also find that sterilization depends on the composition of balance of payments inflows.
Do Banks Price their Informational Monopoly?
–February 1, 2008
Galina Hale, João A. C. SantosModern corporate finance theory argues that although bank monitoring is beneficial to borrowers, it also allows banks to use the private information they gain through monitoring to "hold-up" borrowers for higher interest rates. In this paper, we seek empirical evidence for this information hold-up cost. Since new information about a firm’s credit-worthiness is revealed at the time of its first issue in the public bond market, it follows that after firms undertake their bond IPO, banks with an exploitable information advantage will be forced to adjust their loan interest rates downwards, particularly for firms that are revealed to be safe. Our findings show that firms are able to borrow from banks at lower interest rates after they issue for the first time in the public bond market and that the magnitude of these savings is larger for safer firms. We further find that among safe firms, those that get their first credit rating at the time of their bond IPO benefit from larger interest rate savings than those that already had a credit rating when they entered the bond market. Since more information is revealed at the time of the bond IPO on the former firms and since this information will increase competition from uninformed banks, these findings provide support for the hypothesis that banks price their informational monopoly. Finally, we find that while entering the public bond market may reduce these informational rents, it is costly to firms because they have to pay higher underwriting costs on their IPO bonds. Moreover, IPO bonds are subject to more underpricing than subsequent bonds when they first trade in the secondary bond market.
Understanding Changes in Exchange Rate Pass-Through
–February 1, 2008
Yelena TakhtamanovaRecent research suggests that there has been a decline in the extent to which firms "pass through" changes in exchange rates to prices. Beyond providing further evidence in support of this claim, this paper proposes an explanation for the phenomenon. It then presents empirical evidence of a structural break during the 1990s in the relationship between the real exchange rate and CPI inflation for a set of 14 OECD countries. It is suggested that the recent reduction in the real exchange rate pass-through can be attributed in part to the low-inflation environment of the 1990s.
Climate Change and Housing Prices: Hedonic Estimates for North American Ski Resorts
–November 1, 2009
Van Butsic, Ellen Hanak, Robert G. VallettaWe use a hedonic framework to estimate and simulate the impact of global warming on real estate prices at North American ski resorts. To do so, we combine data on resort-area housing values from two sources–data on average values for U.S. Census tracts across a broad swath of the western U.S. and data on individual home sales for four markets in the western U.S. and Canada, each available over multiple decades–with detailed weather data and characteristics of ski resorts in those areas. Our OLS and fixed-effects models of changes in home values with respect to medium-run changes in the share of snowfall in winter precipitation yield precise and consistent estimates of positive snowfall effects on housing values in both data sources. We use our estimates to simulate the impact of likely climate shifts on home values in coming decades and find substantial variation across resort areas based on climatic characteristics such as longitude, elevation, and proximity to the Pacific Ocean. Resorts that are unfavorably located face likely large negative effects on home prices due to warming, unless adaptive measures are able to compensate for the deterioration of conditions in the ski industry.
Monetary and Financial Integration in the EMU: Push or Pull?
–July 1, 2008
Mark M. SpiegelA number of studies have recently noted that monetary integration in the European Monetary Union (EMU) has been accompanied by increased financial integration. This paper examines the channels through which monetary union increased financial integration, using international panel data on bilateral international commercial bank claims from 1998-2006. I decompose the relative increase in bilateral commercial bank claims among union members following monetary integration into three possible channels: A "borrower effect," as a country’s EMU membership may leave its borrowers more creditworthy in the eyes of foreign lenders; a "creditor effect," as membership in a monetary union may increase the attractiveness of a nation’s commercial banks as intermediaries, perhaps through increased scale economies enjoyed by commercial banks themselves or through an improved regulatory environment after the advent of monetary union; and a "pairwise effect," as joint membership in a monetary union increases the quality of intermediation between borrowers and creditors when both are in the same union. This pairwise effect could be attributed to mitigated currency risk stemming from monetary integration, but may also indicate that monetary union integration increases borrowing capacity. I decompose the data into a series of difference-in-differences specifications to isolate these three channels and find that the pairwise effect is the primary source of increased financial integration. This result is robust to a number of sensitivity exercises used to address concerns frequently associated with difference-in-differences specifications, such as serial correlation and issues associated with the timing of the intervention.
Financial Globalization and Monetary Policy Discipline
–July 1, 2008
Mark M. SpiegelThe literature appears to have reached a consensus that financial globalization has had a "disciplining effect" on monetary policy, as it has reduced the returns from–and hence the temptation for–using monetary policy to stabilize output. As a result, monetary policy over recent years has placed more emphasis on stabilizing inflation, resulting in reduced inflation and greater output stability. However, this consensus has not been accompanied by convincing empirical evidence that such a relationship exists. One reason is likely to be that de facto measures of financial globalization are endogenous, and that instruments for financial globalization are elusive. In this paper, I introduce a new instrument, financial remoteness, as a plausibly exogenous instrument for financial openness. I examine the relationship between financial globalization and median inflation levels over an 11 year cross-section from 1994 through 2004, as well as a panel of 5-year median inflation levels between 1980 and 2004. The results confirm a negative relationship between median inflation and financial globalization in the base specification, but this relationship is sensitive to the inclusion of conditioning variables or country fixed effects, precluding any strong inferences.
Imperfect Knowledge and the Pitfalls of Optimal Control Monetary Policy
–July 1, 2008
Athanasios Orphanides, John C. WilliamsThis paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations formation and uncertainty about the natural rates of interest and unemployment. We assume that agents have imperfect knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We also allow for central bank uncertainty regarding the natural rates of interest and unemployment. We find that the optimal control policy derived under the assumption of perfect knowledge about the structure of the economy can perform poorly when knowledge is imperfect. These problems are exacerbated by natural rate uncertainty, even when the central bank’s estimates of natural rates are efficient. We show that the optimal control approach can be made more robust to the presence of imperfect knowledge by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to the presence of imperfect knowledge about the economy provides an incentive to employ a "conservative" central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to the alternative models of learning that we study and natural rate uncertainty and outperform the optimal control policy and generally perform as well as the robust optimal control policy that places less weight on stabilizing economic activity and interest rates.
Speculative Growth, Overreaction, and the Welfare Cost of Technology-Driven Bubbles
–February 1, 2012
Kevin J. LansingThis paper develops a general equilibrium model to examine the quantitative effects of speculative bubbles on capital accumulation, growth, and welfare. A near-rational bubble component in the model equity price generates excess volatility in response to observed technology shocks. In simulations, intermittent equity price run-ups coincide with positive innovations in technology, investment and consumption booms, and faster trend growth, reminiscent of the U.S. economy during the late 1920s and late 1990s. The welfare cost of speculative bubbles depends crucially on parameter values. Bubbles can improve welfare if risk aversion is low and agents underinvest relative to the socially-optimal level. But for higher levels of risk aversion, the welfare cost of bubbles is large, typically exceeding one percent of annual consumption.
An Arbitrage-Free Generalized Nelson-Siegel Term Structure Model
–May 1, 2008
Jens H. E. Christensen, Francis X. Diebold, Glenn D. RudebuschThe Svensson generalization of the popular Nelson-Siegel term structure model is widely used by practitioners and central banks. Unfortunately, like the original Nelson-Siegel specification, this generalization, in its dynamic form, does not enforce arbitrage-free consistency over time. Indeed, we show that the factor loadings of the Svensson generalization cannot be obtained in a standard finance arbitrage-free affine term structure representation. Therefore, we introduce a closely related generalized Nelson-Siegel model on which the no-arbitrage condition can be imposed. We estimate this new arbitrage-free generalized Nelson-Siegel model and demonstrate its tractability and good in-sample fit.
Capital-Labor Substitution and Equilibrium Indeterminacy
–June 1, 2009
Jang-Ting Guo, Kevin J. LansingEmpirical evidence indicates that the elasticity of capital-labor substitution for the aggregate U.S. economy is below unity. In contrast, the existing indeterminacy literature has mostly restricted attention to a Cobb-Douglas production function which imposes a substitution elasticity exactly equal to unity. This paper examines the quantitative relationship between capital-labor substitution and the conditions needed for equilibrium indeterminacy (and belief-driven fluctuations) in a one-sector growth model. With variable capital utilization, the substitution elasticity has little quantitative impact on the minimum degree of increasing returns needed for indeterminacy. However, when capital utilization is constant, a below-unity substitution elasticity sharply raises the minimum degree of increasing returns. In this version of the model, lower substitution elasticities impose a higher adjustment cost on labor hours that cannot be mitigated by shifts in the capital utilization rate. Overall, our results show that empirically-plausible departures from the Cobb-Douglas specification can make indeterminacy more difficult to achieve.
Learning, Expectations Formation, and the Pitfalls of Optimal Control Monetary Policy
–April 1, 2008
Athanasios Orphanides, John C. WilliamsThis paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations. We assume that agents have imperfect knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We find that the optimal control policy derived under the assumption of rational expectations can perform poorly when expectations deviate modestly from rational expectations. We then show that the optimal control policy can be made more robust by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to learning provides an incentive to employ a "conservative" central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to empirically plausible parameterizations of the learning models and perform about as well or better than optimal control policies.
A Black Swan in the Money Market
–April 1, 2008
John B. Taylor, John C. WilliamsAt the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions–including the introduction of a new term auction facility (TAF)–to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.
Tax Competition among U.S. States: Racing to the Bottom or Riding on a Seesaw?
–March 1, 2017
Robert S. Chirinko, Daniel WilsonDramatic declines in capital tax rates among U.S. states and European countries have been linked by many commentators to tax competition, an inevitable “race to the bottom,” and underprovision of local public goods. This paper analyzes the reaction of capital tax policy in a given U.S. state to changes in capital tax policy by other states. Our study is undertaken with a novel panel data set covering the 48 contiguous U.S. states for the period 1965 to 2006 and is guided by the theory of strategic tax competition. The latter suggests that capital tax policy is a function of “foreign” (out-of-state) tax policy, preferences for government services, home state and foreign state economic and demographic conditions. The slope of the reaction function – the equilibrium response of home state to foreign state tax policy – is negative, contrary to casual evidence and many prior empirical studies of fiscal reaction functions. This result, which stands in contrast to most published findings, is due to two critical elements – allowing for delayed responses to foreign tax changes and for heterogeneous responses to aggregate shocks. Omitting either of these elements leads to a misspecified model and a positively sloped reaction function. Our results suggest that the secular decline in capital tax rates, at least among U.S. states, reflects synchronous responses among states to common shocks rather than competitive responses to foreign state tax policy. While striking given prior empirical findings, these results are fully consistent with the qualitative and quantitative implications of the theoretical model developed in this paper and presented elsewhere in the literature. Rather than “racing to the bottom,” our findings suggest that states are “riding on a seesaw.” Consequently, tax competition may lead to an increase in the provision of local public goods, and policies aimed at restricting tax competition to stem the tide of declining capital taxation are likely to be ineffective.
Takeoffs
–April 1, 2007
Joshua Aizenman, Mark M. SpiegelThis paper identifies factors associated with takeoff–a sustained period of high growth following a period of stagnation. We examine a panel of 241 "stagnation episodes" from 146 countries, 54% of these episodes are followed by takeoffs. Countries that experience takeoffs average 2.3% annual growth following their stagnation episodes, while those that do not average 0% growth; 46% of the takeoffs are "sustained," i.e. lasting 8 years or longer. Using probit estimation, we find that de jure trade openness is positively and significantly associated with takeoffs. A one standard deviation increase in de jure trade openness is associated with a 55% increase in the probability of a takeoff in our default specification. We also find evidence that capital account openness encourages takeoff responses, although this channel is less robust. Measures of de facto trade openness, as well as a variety of other potential conditioning variables, are found to be poor predictors of takeoffs. We also examine the determinants of nations achieving sustained takeoffs. While we fail to find a significant role for openness in determining whether or not takeoffs are sustained, we do find a role for output composition: Takeoffs in countries with more commodity-intensive output bundles are less likely to be sustained, while takeoffs in countries that are more service-intensive are more likely to be sustained. This suggests that adverse terms of trade shocks prevalent among commodity exports may play a role in ending long-term high growth episodes.
International Financial Remoteness and Macroeconomic Volatility
–November 1, 2007
Andrew K. Rose, Mark M. SpiegelThis paper shows that proximity to major international financial centers seems to reduce business cycle volatility. In particular, we show that countries that are further from major locations of international financial activity systematically experience more volatile growth rates in both output and consumption, even after accounting for domestic financial depth, political institutions, and other controls. Our results are relatively robust in the sense that more financially remote countries are more volatile, though the results are not always statistically significant. The comparative strength of this finding is in contrast to the more ambiguous evidence found in the literature.
Subprime Mortgage Delinquency Rates
–November 1, 2007
Mark Doms, Frederick T. Furlong, John KrainerWe evaluate the importance of three different channels for explaining the recent performance of subprime mortgages. First, the riskiness of the subprime borrowing pool may have increased. Second, pockets of regional economic weakness may have helped push a larger proportion of subprime borrowers into delinquency. Third, for a variety of reasons, the recent history of local house price appreciation and the degree of house price deceleration may have affected delinquency rates on subprime mortgages. While we find a role for all three candidate explanations, patterns in recent house price appreciation are far and away the best single predictor of delinquency levels and changes in delinquencies. Importantly, after controlling for the current level of house price appreciation, measures of house price deceleration remain significant predictors of changes in subprime delinquencies. The results point to a possible role for changes in house price expectations for explaining changes in delinquencies.
Capital Account Liberalization: Theory, Evidence, and Speculation
–January 1, 2007
Peter Blair HenryWritings on the macroeconomic impact of capital account liberalization find few, if any, robust effects of liberalization on real variables. In contrast to the prevailing wisdom, I argue that the textbook theory of liberalization holds up quite well to a critical reading of this literature. The lion’s share of papers that find no effect of liberalization on real variables tell us nothing about the empirical validity of the theory, because they do not really test it. This paper explains why it is that most studies do not really address the theory they set out to test. It also discusses what is necessary to test the theory and examines papers that have done so. Studies that actually test the theory show that liberalization has significant effects on the cost of capital, investment, and economic growth.
Capital Controls: Myth and Reality, A Portfolio Balance Approach to Capital Controls
–November 1, 2007
Nicolas E. Magud, Carmen Reinhart, Kenneth RogoffThe literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is no unified theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a "success" and (iv) the empirical studies lack a common methodology–furthermore these are significantly "overweighted" by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to "standardize" the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Control Effectiveness Index (WCCE Index). The difference between them lies in that the WCCE controls for the differentiated degree of methodological rigor applied to draw conclusions in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well known episodes than those of Chile and Malaysia. Then, using a portfolio balance approach we model the effects of imposing short-term capital controls. We find that there should exist country-specific characteristics for capital controls to be effective. From these simple perspective, this rationalizes why some capital controls were effective and some were not. We also show that the equivalence in effects of price- vs. quantity-capital control are conditional on the level of short-term capital flows.
Financial Integration in East Asia
–April 1, 2007
Hiroshi Fujiki, Akiko Terada-HagiwaraThis paper examines the degree of integration into world financial markets and the impacts on several key macroeconomic variables of selected East Asian economies, and draws policy implications. According to our analysis, the degrees of integration into world financial markets in those economies are increasing. Regarding the impacts of increasing integration into world financial markets on several macroeconomic variables, we find three results. First, casual two-way plots among macroeconomic variables do not support the theoretical prediction of reduction in relative consumption volatility. Second, the saving-investment correlation is higher than those of in Euro area economies. Third, the degrees of smoothing of idiosyncratic shock by cross-holding of financial assets are lower than Euro area economies. Those results suggest two policy implications. First, there’s some room for improvement in welfare gains in those economies by further risk sharing. Second, holding all other conditions given, the increasing integration into world financial markets alone is unlikely to provide a sound ground for a currency union in East Asia at this stage.
Optimal Reserve Management and Sovereign Debt
–November 1, 2007
Laura Alfaro, Fabio KanczukMost models currently used to determine optimal foreign reserve holdings take the level of international debt as given. However, given the sovereign’s willingness-to-pay incentive problems, reserve accumulation may reduce sustainable debt levels. In addition, assuming constant debt levels does not allow addressing one of the puzzles behind using reserves as a means to avoid the negative effects of crisis: why do not sovereign countries reduce their sovereign debt instead? To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model calibrated to a sample of emerging markets. We obtain that the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs.
The Determinants of Household Saving in China: A Dynamic Panel Analysis of Provincial Data
–January 1, 2007
Charles Yuji Horioka, Junmin WanIn this paper, we conduct a dynamic panel analysis of the determinants of the household saving rate in China using a life cycle model and panel data on Chinese provinces for the 1995-2004 period from China’s household survey. We find that China’s household saving rate has been high and rising and that the main determinants of variations over time and over space therein are the lagged saving rate, the income growth rate, and (in some cases) the real interest rate and the inflation rate. However, we find that the variables relating to the age structure of the population usually do not have a significant impact on the household saving rate. These results provide mixed support for the life cycle hypothesis as well as the permanent income hypothesis, are consistent with the existence of inertia or persistence, and imply that China’s household saving rate will remain high for some time to come.
The International Dimension of U.S. Expansions: A Structural VAR Analysis
–October 1, 2008
Giancarlo Corsetti, Luca Dedola, Sylvain LeducThis paper investigates the international dimension of productivity and demand shocks in the U.S. using sign restrictions based on standard theory predictions. Identifying shocks to U.S. manufacturing–our measure of tradables–we find that productivity gains have substantial aggregate demand effects, boosting U.S. consumption and investment, relative to the rest of the world, thus raising real imports; net exports and U.S. net foreign assets correspondingly decrease. At the same time, however, these shocks appreciate the U.S. real exchange rate, improve the terms of trade and raise stock prices. Shocks to the demand for U.S. manufacturing appear to have less pronounced aggregate effects, with little impact on trade and capital accounts; they lead to a (delayed) dollar appreciation, however. Our findings provide novel evidence on key channels of the international transmission of shocks, pointing to a low degree of consumption risk sharing as an essential feature of the transmission mechanism, and suggesting that strong wealth effects play an important role in generating aggregate demand fluctuations across countries.
Pricing-to-Market, Trade Costs, and International Relative Prices
–May 1, 2007
Andrew Atkeson, Ariel BursteinData on international relative prices from industrialized countries show large and systematic deviations from relative purchasing power parity. We embed a model of imperfect competition and variable markups in some of the recently developed quantitative models of international trade to examine whether such models can reproduce the main features of the fluctuations in international relative prices. We find that when our model is parameterized to match salient features of the data on international trade and market structure in the U.S., it reproduces deviations from relative purchasing power parity similar to those observed in the data because firms choose to price-to-market. We then examine how pricing-to-market depends on the presence of international trade costs and various features of market structure.
Examining the Bond Premium Puzzle with a DSGE Model
–July 1, 2008
Glenn D. Rudebusch, Eric T. SwansonThe basic inability of standard theoretical models to generate a sufficiently large and variable nominal bond risk premium has been termed the "bond premium puzzle." We show that the term premium on long-term bonds in the canonical dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is too small and stable relative to the data. We find that introducing long-memory habits in consumption as well as labor market frictions can help fit the term premium, but only by seriously distorting the DSGE model’s ability to fit other macroeconomic variables, such as the real wage; therefore, the bond premium puzzle remains.
Convergence and Anchoring of Yield Curves in the Euro Area
–November 1, 2008
Michael Ehrmann, Marcel Fratzscher, Refet S. Gürkaynak, Eric T. SwansonWe study the convergence of European bond markets and the anchoring of inflation expectations in the euro area using high-frequency bond yield data for France, Germany, Italy, and Spain as well as smaller euro area countries and a control group comprising the UK, Denmark, and Sweden. We find that Economic and Monetary Union (EMU) has led to substantial convergence in euro area sovereign bond markets in terms of interest rate levels, unconditional daily fluctuations, and conditional responses to major macroeconomic announcements. Our findings also suggest a substantial increase in the anchoring of long-term inflation expectations since EMU, particularly for Italy and Spain, which have seen their long-term interest rates become much lower, much less volatile, and much better anchored in response to news. Finally, we present evidence that the elimination of exchange rate risk and the adoption of a common monetary policy were the primary drivers of bond market convergence in the euro area, as opposed to fiscal policy restraint and the loose exchange rate peg of the 1990s.
How Does Competition Impact Bank Risk-Taking?
–September 1, 2007
Gabriel Jiménez, Jose A. Lopez, Jesús SaurinaA common assumption in the academic literature and in the actual supervision of banking systems worldwide is that franchise value plays a key role in limiting bank risk-taking. As the underlying source of franchise value is assumed to be market power, reduced competition has been considered to promote banking stability. Boyd and De Nicolo (2005) propose an alternative view where concentration in the loan market could lead to increased borrower debt loads and a corresponding increase in loan defaults that undermine bank stability. Martinez-Miera and Repullo (2007) encompass both approaches by proposing a nonlinear relationship between competition and bank risk-taking. Using unique datasets for the Spanish banking system, we examine the empirical nature of that relationship. After controlling for macroeconomic conditions and bank characteristics, we find that standard measures of market concentration do not affect the ratio of non-performing commercial loans (NPL), our measure of bank risk. However, using Lerner indexes based on bank-specific interest rates, we find a negative relationship between loan market power and bank risk. This result provides evidence in favor of the franchise value paradigm.
Determinants of Access to External Finance: Evidence from Spanish Firms
–September 1, 2007
Raquel Lago González, Jose A. Lopez, Jesús SaurinaAccess to external finance is a key determinant of a firm’s ability to develop, operate and expand. To date, the literature has examined a variety of macroeconomic and microeconomic factors that influence firm financing. In this paper, we examine access by Spanish firms to external financing, both from bank and non-bank sources. We use dynamic panel data estimation techniques to estimate our models over a sample of 60,000 firms during the period from 1992 to 2002. We find that Spanish firms are quite dependent on short-term non-bank financing (such as trade credit), which makes up about 65 percent of total firm debt. Our results indicate that this type of financing is less sensitive to firm characteristics than short-term bank financing. However, we also find that short-term bank debt seems to be accessed more during economic expansions, which may suggest a substitution away from non-bank financing as firm conditions improve. Short-term bank debt also seems to be accessed more as funding rates rise, possibly again suggesting a substitution away from higher-priced non-bank alternatives. Using data from the Spanish Credit Register maintained by the Banco de Espana, we find that the impact of funding costs on access to external financing, whether from banks or non-banks, is affected by the nature of borrowing firms’ bank relationships and collateral. In particular, we provide evidence of a potential hold-up problem in loan markets. Moreover, collateral plays a key role in making long-term finance available to firms.
Regional Economic Conditions and the Variability of Rates of Return in Commercial Banking
–September 1, 2007
Frederick T. Furlong, John KrainerWe develop new techniques to assess the relationship between commercial bank performance and the economic conditions in the markets in which they operate. In the analysis, we allow for heterogeneity in the responses of banks to regional economic conditions. We find a statistically significant relationship between bank performance and shocks to the regional markets in which they operate. We find that region-specific shocks have a significant and persistent effect on the cross-sectional variance of bank performance in the market. That is, shocks affecting average performance of banks in a region also tend to increase the dispersion of their performance. We demonstrate that this effect is due to heterogeneity in the banks’ exposures to their regional economies. Moreover, by allowing for this heterogeneity, we find that systematic responses to regional economic effects are notably more important in explaining the variation in bank performance than suggested by analysis in which responses are constrain to be the same for all banks.
The Affine Arbitrage-Free Class of Nelson-Siegel Term Structure Models
–March 1, 2010
Jens H. E. Christensen, Francis X. Diebold, Glenn D. RudebuschWe derive the class of affine arbitrage-free dynamic term structure models that approximate the widely-used Nelson-Siegel yield curve specification. These arbitrage-free Nelson-Siegel (AFNS) models can be expressed as slightly restricted versions of the canonical representation of the three-factor affine arbitrage-free model. Imposing the Nelson-Siegel structure on the canonical model greatly facilitates estimation and can improve predictive performance. In the future, AFNS models appear likely to be a useful workhorse representation for term structure research.
Learning and Optimal Monetary Policy
–July 1, 2007
Richard Dennis, Federico RavennaTo conduct policy efficiently, central banks must use available data to infer, or learn, the relevant structural relationships in the economy. However, because a central bank’s policy affects economic outcomes, the chosen policy may help or hinder its efforts to learn. This paper examines whether real-time learning allows a central bank to learn the economy’s underlying structure and studies the impact that learning has on the performance of optimal policies under a variety of learning environments. Our main results are as follows. First, when monetary policy is formulated as an optimal discretionary targeting rule, we find that the rational expectations equilibrium and the optimal policy are real-time learnable. This result is robust to a range of assumptions concerning private sector learning behavior. Second, when policy is set with discretion, learning can lead to outcomes that are better than if the model parameters are known. Finally, if the private sector is learning, then unannounced changes to the policy regime, particularly changes to the inflation target, can raise policy loss considerably.
Imperfect Information, Self-Selection, and the Market for Higher Education
–August 1, 2007
Tali RegevThis paper explores how the steady trends in increasing tuition costs, college enrollment, and the college wage gap might be related to the quality of college graduates. The model shows that the signaling role of education might be an important yet largely neglected ingredient in these recent changes. I develop a special signaling model in which workers of heterogeneous abilities face the same costs, yet a larger proportion of able individuals self-select to attend college since they are more likely to get higher returns. With imperfect information, the skill premium is an outcome which depends on the equilibrium quality of college attendees and nonattendees. Incorporating a production function of college education, I discuss the properties of the college market equilibrium. A skill-biased technical change directly decreases self-selection into college, but the general equilibrium effect may overturn the direct decline, since increased enrollment and rising tuition costs increase self-selection. Higher initial human capital has an external effect on subsequent investment in school: All agents increase their education, and the higher equilibrium tuition costs increase self-selection and the college premium.
Do Countries Default in “Bad Times”?
–May 1, 2007
Michael Tomz, Mark L. J. WrightThis paper uses a new dataset to study the relationship between economic output and sovereign default for the period 1820-2004. We find a negative but surprisingly weak relationship between output and default. Throughout history, countries have indeed defaulted during bad times (when output was relatively low), but they have also maintained debt service in the face of severe adverse shocks, and they have defaulted when domestic economic conditions were favorable. We show that this constitutes a puzzle for standard theories, which predict a much tighter negative relationship as default provides partial insurance against declines in output.
Forecasting Recessions: The Puzzle of the Enduring Power of the Yield Curve
–July 1, 2008
Glenn D. Rudebusch, John C. WilliamsFor over two decades, researchers have provided evidence that the yield curve, specifically the spread between long- and short-term interest rates, contains useful information for signaling future recessions. Despite these findings, forecasters appear to have generally placed too little weight on the yield spread when projecting declines in the aggregate economy. Indeed, we show that professional forecasters appear worse at predicting recessions a few quarters ahead than a simple real-time forecasting model that is based on the yield spread. This relative forecast power of the yield curve remains a puzzle.
Real Wage Cyclicality in the PSID
–July 1, 2007
Eric T. SwansonPrevious studies of real wage cyclicality have made only sparing use of the microdata detail that is available in the Panel Study of Income Dynamics (PSID). The present paper brings to bear this additional detail to investigate the robustness of previous results and to examine whether there are important cross-sectional and demographic differences in wage cyclicality. Although real wages were procyclical across the entire distribution of workers from 1967 to 1991, the wages of lower-income, younger, and less-educated workers exhibited greater procyclicality. However, workers’ straight-time hourly pay rates have been acyclical, suggesting that more variable pay margins such as bonuses, overtime, late shift premia, and commissions have played a substantial if not primary role in generating procyclicality.
Empirical Analysis of Corporate Credit Lines
–June 1, 2007
Gabriel Jiménez, Jose A. Lopez, Jesús SaurinaSince bank credit lines are a major source of corporate funding and liquidity, we examine the determinants of credit line usage with a database of Spanish corporate credit lines. A line’s default status is the primary factor driving its usage, which increases as a firm approaches default. Several lender characteristics suggest an important role for bank monitoring in firms’ usage decisions. Credit line usage is found to be inversely related to macroeconomic conditions. Overall, while several factors influence corporate credit line usage, our analysis suggests that default and supply-side variables are the most important.
The Composition of Capital Inflows when Emerging Market Firms Face Financing Constraints
–May 1, 2008
Katherine A. Smith, Diego ValderramaThe composition of capital inflows to emerging market economies tends to follow a predictable dynamic pattern across the business cycle. In most emerging market economies, total inflows are procyclical, with debt and portfolio equity flowing in first, followed later in the expansion by foreign direct investment (FDI). To understand the dynamic composition of these flows, we use a small open economy (SOE) framework to model the composition of capital inflows as the equilibrium outcome of emerging market firms’ financing decisions. We show how costly external financing and FDI search costs generate a state-contingent cost of financing such that the cheapest source of financing depends on the phase of the business cycle. In this manner, the financial frictions are able to explain the interaction between the types of flows and deliver a time-varying composition of flows, as well as other standard features of emerging market business cycles. If, as this work suggests, flows are an equilibrium outcome of firms’ financing decisions, then volatility of capital inflows is not necessarily bad for an economy. Furthermore, using capital controls to shut down one type of flow and encourage another is certain to have both short- and long-run welfare implications.
Relative Status and Well-Being: Evidence from U.S. Suicide Deaths
–July 1, 2010
Mary C. Daly, Norman J. Johnson, Daniel WilsonThis paper assesses the importance of interpersonal income comparisons using individual level data on suicide deaths. Our analysis considers whether suicide risk is systematically related to the income of others, holding own income and other individual and environmental factors fixed. We estimate proportional hazards and probit models of the suicide hazard using two separate and independent data sets: (1) the National Longitudinal Mortality Study and (2) the National Center for Health Statistics’ Mortality Detail Files combined with the 5 percent Public Use Micro Sample of the 1990 decennial census. Results from both data sources show that, controlling for own income and individual characteristics, individual suicide risk rises with reference group income. This result holds for reference groups defined either by county or more narrowly by county and one demographic marker (e.g., age, sex, race). These findings are robust to alternative specifications and cannot be explained by geographic variation in cost of living, access to emergency medical care, or suicide misclassification. Our results support findings using self-reported happiness data and are consistent with models of utility featuring “external habit” or “Keeping Up with the Joneses” preferences.
Welfare-Maximizing Monetary Policy under Parameter Uncertainty
–May 1, 2008
Rochelle M. Edge, Thomas Laubach, John C. WilliamsThis paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the U.S. economy where the policymaker faces uncertainty about model parameters. Uncertainty about parameters describing preferences and technology implies uncertainty about the model’s dynamics, utility-based welfare criterion, and the "natural" rates of output and interest that would prevail absent nominal rigidities. We estimate the degree of uncertainty regarding natural rates due to parameter uncertainty. We find that optimal Taylor rules under parameter uncertainty respond less to the output gap and more to price inflation than would be optimal absent parameter uncertainty. We also show that policy rules that focus solely on stabilizing wages and prices yield welfare outcomes very close to the first-best.
Rational and Near-Rational Bubbles without Drift
–October 1, 2009
Kevin J. LansingThis paper derives a general class of intrinsic rational bubble solutions in a Lucas-type asset pricing model. I show that the rational bubble component of the price-dividend ratio can evolve as a geometric random walk without drift, such that the mean of the bubble growth rate is zero. Driftless bubbles are part of a continuum of equilibrium solutions that satisfy a period-by-period no-arbitrage condition. I also derive a near-rational solution in which the agents forecast rule is under-parameterized. The near-rational solution generates intermittent bubbles and other behavior that is quantitatively similar to that observed in long-run U.S. stock market data.
How Robustness Can Lower the Cost of Discretion
–June 1, 2010
Richard DennisModel uncertainty has the potential to change importantly how monetary policy is conducted, making it an issue that central banks cannot ignore. Using a standard new Keynesian business cycle model, this paper analyzes the behavior of a central bank that conducts policy under discretion while fearing that its model is misspecified. The main results are as follows. First, policy performance can be improved if the discretionary central bank implements a robust policy. This important result is obtained because the central bank’s desire for robustness directs it to assertively stabilize inflation, thereby mitigating the stabilization bias associated with discretionary policymaking. Second, the central bank’s fear of model misspecification leads it to forecast future outcomes under the belief that inflation (in particular) will be persistent and have large unconditional variance, raising the probability of extreme outcomes. Private agents, however, anticipating the policy response, make decisions under the belief that inflation will be more closely stabilized, that is, more tightly distributed, than under rational expectations. Finally, as a technical contribution, the paper shows how to solve with robustness an important class of linear-quadratic decision problems.
Robust Monetary Policy with Imperfect Knowledge
–April 1, 2007
Athanasios Orphanides, John C. WilliamsWe examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess imperfect knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy’s natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models of expectations formation: rational expectations and learning. We show that in this environment the ability to stabilize the real side of the economy is significantly reduced relative to an economy under rational expectations with perfect knowledge. Furthermore, policies that would be optimal under perfect knowledge can perform very poorly if knowledge is imperfect. Efficient policies that take account of private learning and misperceptions of natural rates call for greater policy inertia, a more aggressive response to inflation, and a smaller response to the perceived unemployment gap than would be optimal if everyone had perfect knowledge of the economy. We show that such policies are quite robust to potential misspecification of private sector learning and the magnitude of variation in natural rates.
Market Power and Relationships in Small Business Lending
–January 1, 2007
Elizabeth LadermanThe empirical research literature regarding the effects of market structure on small business lending has yielded ambiguous results. This paper empirically tests for the presence of countervailing effects of increases in market concentration on small business loan volume. Countervailing effects would be expected if both the traditional Structure, Conduct, Performance (SCP) paradigm of industrial organization and a paradigm whereby market power benefits the formation of lending relationships (the relationship hypothesis), are at work. Using Community Reinvestment Act (CRA) data on small loans to small businesses, it is found that, on average, across MSAs, SCP effects dominate. But, as predicted by the relationship hypothesis, the negative effects of increases in concentration on small business loan volume are weaker, the greater the presence of young firms and the higher the business failure rate. Relationship effects due to business failure appear to come from highly concentrated MSAs. Endogeneity concerns are further addressed with the estimation of a regression that separates out the effects of changes in the number of lenders from the effects of changes in the sum of squared deviations of market shares.
Productivity Shocks in a Model with Vintage Capital and Heterogeneous Labor
–January 1, 2007
Milton H. Marquis, Bharat TrehanWe construct a vintage capital model in which worker skills lie along a continuum and workers can be paired with different vintages (as technology evolves) under a matching rule of "best worker with the best machine." Labor reallocation in response to technology shocks has two key implications for the wage premium. First, it limits both the magnitude and duration of change in the wage premium following a (permanent) embodied technology shock, so empirically plausible shocks do not lead to the kind of increases in the wage premium observed in the U.S. during the 1980s and early 1990s (though an increase in labor force heterogeneity does). Second, positive disembodied technology shocks tend to push up the wage premium as well, and while this effect is small, it does mean that a higher premium does not provide unambiguous information about the underlying shock. Labor reallocation also means that if embodied technology comes to play a larger role in long-run growth, investment and savings tend to fall in steady state, with little effect on output and employment, enabling the household to increase consumption without sacrificing leisure. The short run effects are more conventional: permanent shocks to disembodied technology induce a strong wealth effect that reduces savings and induces a consumption boom while permanent shocks to embodied technology induce dominant substitution effects and an expansion characterized by an investment boom.
Innovations in Mortgage Markets and Increased Spending on Housing
–July 1, 2007
Mark Doms, John KrainerInnovations in the mortgage market since the mid-1990s have effectively reduced a number of financing constraints. Coinciding with these innovations, we document a significant change in the propensity for households to own their homes, as well as substantial increases in the share of household income devoted to housing. These changes in housing expenditures are especially large for those groups that faced the greatest financial constraints, and are robust across the changing composition of households and their geographic location. We present evidence that young, constrained households may have used newly designed mortgages to finance their increased expenditures on housing.
Monetary Policy in a Small Open Economy with a Preference for Robustness
–April 1, 2009
Richard Dennis, Kai Leitemo, Ulf SöderströmWe use robust control techniques to study the effects of model uncertainty on monetary policy in a small-open-economy model estimated on Australian data. Compared to the closed economy, the presence of open-economy transmission channels and shocks not only produces new trade-offs for monetary policy, but also introduces additional sources of specification errors. We find that price markup shocks in the domestic and import sector are important contributors to volatility in the model, and that the domestic and import sector Phillips curves are particularly vulnerable to model misspecification. On the other hand, deviations from the interest rate parity condition do not contribute much to overall volatility, nor is the parity condition especially vulnerable to misspecification. Our results suggest that it may be more important for central banks in small open economies to understand the nature of price setting and the effects of exchange rate movements on the economy than the determination of the exchange rate itself.
Marriage and Divorce: Changes and Their Driving Forces
–February 1, 2007
Betsey Stevenson, Justin WolfersWe document key facts about marriage and divorce, comparing trends through the past 150 years and outcomes across demographic groups and countries. While divorce rates have risen over the past 150 years, they have been falling for the past quarter century. Marriage rates have also been falling, but more strikingly, the importance of marriage at different points in the life cycle has changed, reflecting rising age at first marriage, rising divorce followed by high remarriage rates, and a combination of increased longevity with a declining age gap between husbands and wives. Cohabitation has also become increasingly important, emerging as a widely used step on the path to marriage. Out-of-wedlock fertility has also risen, consistent with declining "shotgun marriages." Compared with other countries, marriage maintains a central role in American life. We present evidence on some of the driving forces causing these changes in the marriage market: the rise of the birth control pill and women’s control over their own fertility; sharp changes in wage structure, including a rise in inequality and partial closing of the gender wage gap; dramatic changes in home production technologies; and the emergence of the internet as a new matching technology. We note that recent changes in family forms demand a reassessment of theories of the family and argue that consumption complementarities may be an increasingly important component of marriage. Finally, we discuss how these facts should inform family policy debates.
Currency Crises and Foreign Credit in Emerging Markets: Credit Crunch or Demand Effect?
–January 1, 2007
Carlos O. Arteta, Galina HaleCurrency crises of the past decade highlighted the importance of balance-sheet effects of currency crises. In credit-constrained markets such effects may lead to further declines in credit. Controlling for a host of fundamentals, we find a systematic decline in foreign credit to emerging market private firms of about 25% in the first year following currency crises, which we define as large changes in real value of the currency. This decline is especially large in the first five months, lessens in the second year and disappears entirely by the third year. We identify the effects of currency crises on the demand and supply of credit and find that the decline in the supply of credit is persistent and contributes to about 8% decline in credit for the first two years, while the 35% decline in demand lasts only five months.
Wealth Effects out of Financial and Housing Wealth: Cross Country and Age Group Comparisons
–January 1, 2007
Eva Sierminska, Yelena TakhtamanovaTo explore the link between household consumption and wealth, we use a new source of harmonized microdata (Luxembourg Wealth Study). We investigate whether there are differences in wealth effects from different types of wealth and across age groups. We consider three countries: Canada, Italy and Finland. We find that the overall wealth effect from housing is stronger than the effect from financial wealth for the three countries in the sample. Additionally, in accordance with the life-cycle theory of consumption, we find the housing wealth effect to be significantly lower for younger households. We also find between-country differences in the wealth effect.
Global Price Dispersion: Are Prices Converging or Diverging?
–December 1, 2006
Paul R. Bergin, Reuven GlickThis paper documents significant time-variation in the degree of global price convergence over the last two decades. In particular, there appears to be a general U-shaped pattern with price dispersion first falling and then rising in recent years, a pattern which is remarkably robust across country groupings and commodity groups. This time-variation is difficult to explain in terms of the standard gravity equation variables common in the literature, as these tend not to vary much over time or have not risen in recent years. However, regression analysis indicates that this time-varying pattern coincides well with oil price fluctuations, which are clearly time-varying and have risen substantially since the late 1990s. As a result, this paper offers new evidence on the role of transportation costs in driving international price dispersion.
State Investment Tax Incentives: What Are the Facts?
–November 1, 2006
Robert S. Chirinko, Daniel WilsonThere is an ongoing debate in the U.S. among policymakers and the courts concerning the practical effects of state investment tax incentives. However, this debate often suffers from a lack of clear information on the extent of such incentives among states and how these incentives have evolved over time. This paper takes a first step toward addressing this shortcoming. Compiling information from all 50 states and the District of Columbia over the past 40 years, we are able to paint a picture of the variation in state investment tax incentives across states and over time. In particular, we document three stylized facts: (1) Over the last 40 years, state investment tax incentives have become increasingly large and increasingly common among states; (2) these incentives, as well as the level of the overall after-tax price of capital, are to a large extent clustered in certain regions of the country; and (3) states that enact investment tax credits tend to do so around the same time as their neighboring states.
Unemployment Insurance and the Uninsured
–December 1, 2006
Tali RegevUnder federal-state law workers who quit a job are not entitled to receive unemployment insurance benefits. To show how the existence of the uninsured affects wages and employment, I extend an equilibrium search model to account for two types of unemployed workers: those who are currently receiving unemployment benefits and for whom an increase in unemployment benefits reduces the incentive to work, and those who are currently not insured. For these, work provides an added value in the form of future eligibility, and an increase in unemployment benefits increases their willingness to work. Incorporating both types into a search model permits me to solve analytically for the endogenous wage dispersion and insurance rate in the economy. I show that, in general equilibrium when firms adjust their job creation margin, the wage dispersion is reduced and the overall effect of benefits can be signed: higher unemployment benefits increase average wages and decrease the vacancy-to-unemployment ratio.
State Investment Tax Incentives: A Zero-Sum Game?
–July 1, 2008
Robert S. Chirinko, Daniel WilsonOver the past four decades, state investment tax incentives have proliferated. This emergence of state investment tax credits (ITC) and other investment tax incentives raises two important questions: 1) Are these tax incentives effective in achieving their stated objective, to increase investment within the state?; 2) To the extent these incentives raise investment within the state, how much of this increase is due to investment drawn away from other states? To begin to answer these questions, we construct a detailed panel dataset for 48 states for 20+ years. The dataset contains series on output and capital, their relative prices, and establishment counts. The effects of tax variables on capital formation and establishments are measured by the Jorgensonian user cost of capital that depends in a nonlinear manner on federal and state tax variables. Cross-jurisdictional differences in state investment tax credits and state corporate tax rates entering the user cost, combined with a panel that is long in the time dimension, are key to identifying the effectiveness of state investment incentives. Two models are estimated. The Capital Demand Model is motivated by the first-order condition for a profit-maximizing firm and relates at the state level the capital/output ratio to the relative user cost of capital. The Twin-Counties Model exploits both the spatial breaks (“discontinuities”) in tax policy at state borders and our panel dataset to relate at the county level the relative user cost to the location of manufacturing establishments. Using the Capital Demand Model, we find that own-state capital formation is substantially increased by tax-induced reductions in the own-state price of capital and, more interestingly, substantially decreased by tax-induced reductions in the price of capital in competitive-states. Similarly, using our Twin-Counties Model, we find that county manufacturing establishment counts around state borders are higher on the side of the border with the lower price of capital, but the difference is economically small, suggesting that establishments are much less mobile than overall capital. Extensions of the Capital Demand Model also reveal that state capital tax policy appears to be a zero-sum game among the states in that an equiproportionate increase in own-state and competitive-states user costs tends to have no effect on own-state capital formation.
Macroeconomic Implications of Changes in the Term Premium
–November 1, 2006
Glenn D. Rudebusch, Brian P. Sack, Eric T. SwansonLinearized New Keynesian models and empirical no-arbitrage macro-finance models offer little insight regarding the implications of changes in bond term premiums for economic activity. We investigate these implications using both a structural model and a reduced-form framework. We show that there is no structural relationship running from the term premium to economic activity, but a reduced-form empirical analysis does suggest that a decline in the term premium has typically been associated with stimulus to real economic activity, which contradicts earlier results in the literature.
Foreign Bank Lending and Bond Underwriting in Japan During the Lost Decade
–November 1, 2006
Jose A. Lopez, Mark M. SpiegelWe examine foreign intermediation activity in Japan during the so-called "lost decade" of the 1990s, contrasting the behavior of lending by foreign commercial banks and underwriting activity by foreign investment banks over that period. Foreign bank lending is shown to be sensitive to domestic Japanese conditions, particularly Japanese interest rates, more so than their domestic Japanese bank counterparts. During the 1990s, foreign bank lending in Japan fell, both in overall numbers and as a share of total lending. However, there was marked growth in foreign underwriting activity in the international yen-denominated bond sector. A key factor in the disparity between these activities is their different clienteles: While foreign banks in Japan lent primarily to domestic borrowers, international yen-denominated bond issuers were primarily foreign entities with yen funding needs or opportunities for profitable swaps. Indeed, low interest rates that discouraged lending activity in Japan by foreign banks directly encouraged foreign underwriting activity tied to the so-called "carry trades." Regulatory reforms, particularly the "Big Bang" reforms of the 1990s, also play a large role in the growth of foreign underwriting activity over our sample period.
Beyond the Classroom: Using Title IX to Measure the Return to High School Sports
–March 1, 2006
Betsey StevensonPrevious research has found that male high school athletes experience better outcomes than non-athletes, including higher educational attainment, more employment, and higher wages. Students self-select into athletics, however, so these may be selection effects rather than causal effects. To address this issue, I examine Title IX which provides a unique quasiexperiment in female athletic participation. Between 1972 and 1978, U.S. high schools rapidly increased their female athletic participation rates (to approximately the same level as their male athletic participation rates) in order to comply with Title IX. This paper uses variation in the level of boys’ athletic participation across states before Title IX as an instrument for the change in girls’ athletic participation over the 1970s. Analyzing differences in outcomes for both the pre- and post-Title IX cohorts across states, I find that a 10 percentage point rise in state-level female sports participation generates a 1 percentage point increase in female college attendance and a 1 to 2 percentage point rise in female labor force participation. Furthermore, greater opportunities to play sports leads to greater female participation in previously male-dominated occupations, particularly for high-skill occupations.
The Impact of Divorce Laws on Marriage-Specific Capital
–July 1, 2006
Betsey StevensonThis paper considers how divorce law alters the incentives for couples to invest in their marriage, focusing on the impact of unilateral divorce laws on investments in new marriages. Differences across states between 1970 and 1980 provide useful quasi-experimental variation with which to consider incentives to invest in several types of marriage-specific capital: spouse’s education, children, household specialization, and home ownership. I find that adoption of unilateral divorce–regardless of the prevailing property-division laws–reduces investment in all types of marriage-specific capital considered except home ownership. In contrast, results for home ownership depend on the underlying property division laws.
Evidence on the Costs and Benefits of Bond IPOs
–September 1, 2006
Galina Hale, João A. C. SantosThis paper investigates whether it is costly for nonfinancial firms to enter the public bond market, and whether firms benefit from their bond IPOs. We find that both gross spreads and ex ante credit spreads are higher for IPO bonds, suggesting that firms pay higher underwriting costs on their first public bond. We also find that underpricing in the secondary market is higher for IPO bonds, further suggesting that it is costly to enter the public bond market. The costs of entering the public bond market are economically meaningful and are higher for risky firms. We investigate the benefits from entering the public bond market, by looking at the costs firms pay to raise external funding subsequently to their bond IPOs. Our results show that these benefits exist, but they accrue only to safe firms. These firms benefit from a reduction both in the interest rates they pay on bank loans and the costs they incur to issue private bonds after they enter the public bond market. Together with our the previous findings, these results lend support to the thesis that bond IPOs are unique.
Exchange-Rate Effects on China’s Trade: An Interim Report
–May 1, 2006
Jaime Marquez, John W. SchindlerThough China’s share of world trade is comparable to that of Japan, little is known about the response of China’s trade to changes in exchange rates. The few estimates available suffer from two limitations. First, the data for trade prices are based on proxies for prices from other countries. Second, the estimation sample includes the period of China’s transformation from a centrally planned economy to a market-oriented system. To address these limitations, this paper develops an empirical model explaining the shares of China’s exports and imports in world trade in terms of the real effective value of the renminbi. The specifications control for foreign direct investment and for the role of imports of parts to assemble merchandise exports. Parameter estimation uses disaggregated monthly trade data and excludes the period during which most of China’s decentralization occurred. The estimation results suggest that a ten-percent real appreciation of the renminbi lowers the share of aggregate Chinese exports by a half of a percentage point. The same appreciation lowers the share of aggregate imports by about a tenth of a percentage point.
Global Current Account Adjustment: A Decomposition
–May 1, 2006
Michael Devereux, Amartya Lahiri, Ke PangThe rising current account deficit in the USA has attracted considerable attention in recent years. We use the "business cycle accounting" methodology to identify the principal distortions that have affected the external accounts of the US. In particular, we measure distortions in the optimality conditions of a simple two-country general equilibrium model using data from the US and the other G7 countries. We then feed these measured distortions into the model individually and use the simulated counterfactual paths of the current account to determine the contribution of each of these "wedges" to the overall external imbalance of the USA. We find that no single wedge in isolation can account closely for the observed current account. However, a combination of productivity differences and deviations from risk-sharing between the US and the rest of the G7 does the best job in accounting for most of the measured movement of the US current account.
Saving and Interest Rates in Japan: Why They Have Fallen and Why They Will Remain Low
–May 1, 2006
R.Anton Braun, Daisuke Ikeda, Douglas H. JoinesThis paper quantifies the role of alternative shocks in accounting for the recent declines in Japanese saving rates and interest rates and provides some projections about their future course. We consider three distinct sources of variation in saving rates and real interest rates: changes in fertility rates, changes in survival rates, and changes in technology. The empirical relevance of these factors is explored using a computable dynamic OLG model. We find that the combined effects of demographics and slower total factor productivity growth successfully explain both the levels and the magnitudes of the declines in the saving rate and the after-tax real interest rate during the 1990s. Model simulations indicate that the Japanese savings puzzle is over.
The U.S. Current Account Deficit and the Expected Share of World Output
–March 1, 2006
Charles Engel, John H. RogersWe investigate the possibility that the large current account deficits of the U.S. are the outcome of optimizing behavior. We develop a simple long-run world equilibrium model in which the current account is determined by the expected discounted present value of its future share of world GDP relative to its current share of world GDP. The model suggests that under some reasonable assumptions about future U.S. GDP growth relative to the rest of the advanced countries–more modest than the growth over the past 20 years–the current account deficit is near optimal levels. We then explore the implications for the real exchange rate. Under some plausible assumptions, the model implies little change in the real exchange rate over the adjustment path, though the conclusion is sensitive to assumptions about tastes and technology. Then we turn to empirical evidence. A test of current account sustainability suggests that the U.S. is not keeping on a long-run sustainable path. A direct test of our model finds that the dynamics of the U.S. current account–the increasing deficits over the past decade–are difficult to explain under a particular statistical model (Markov-switching) of expectations of future U.S. growth. But, if we use survey data on forecasted GDP growth in the G7, our very simple model appears to explain the evolution of the U.S. current account remarkably well. We conclude that expectations of robust performance of the U.S. economy relative to the rest of the advanced countries is a contender–though not the only legitimate contender–for explaining the U.S. current account deficit.
A Quantitative Analysis of China’s Structural Transformation
–May 1, 2006
Robert Dekle, Guillaume VandenbrouckeBetween 1978 and 2003 the Chinese economy experienced a remarkable 5.7 percent annual growth of GDP per labor. At the same time, there has been a noticeable transformation of the economy: the share of workers in agriculture decreased from over 70 percent to less than 50 percent. We distinguish three sectors: private agriculture and nonagriculture and public nonagriculture. A growth accounting exercise reveals that the main source of growth was TFP in the private nonagricultural sector. The reallocation of labor from agriculture to nonagriculture accounted for 1.9 percent out of the 5.7 percent growth in output per labor. The reallocation of labor from the public to the private sector also accounted for a significant part of growth in the 1996-2003 period. We calibrate a general equilibrium model where the driving forces are public investment and employment, as well as sectorial TFP derived from our growth accounting exercise. The model tracks the historical employment share of agriculture and the labor productivities of all three sectors quite well.
Dual Labor Markets and Business Cycles
–September 1, 2005
David Cook, Hiromi NosakaIn this paper, we model a dynamic general equilibrium model of a small open developing economy. We model labor markets as including both formal and informal urban employment as well as rural employment. We find that modelling dual labor markets helps explain why output in developing economies may fall even as labor inputs remain constant during financial crises. An external financial shock may lead to a reallocation of labor from productive formal sectors of the economy to less productive informal sectors.
Incomplete Information Processing: A Solution to the Forward Discount Puzzle
–June 1, 2006
Philippe Bacchetta, Eric van WincoopThe uncovered interest rate parity equation is the cornerstone of most models in international macro. However, this equation does not hold empirically since the forward discount, or interest rate differential, is negatively related to the subsequent change in the exchange rate. This forward discount puzzle implies that excess returns on foreign currency investments are predictable. In this paper we investigate to what extent incomplete information processing can explain this puzzle. We consider two types of incompleteness: infrequent and partial information processing. We calibrate a two-country general equilibrium model to the data and show that incomplete information processing can fully match the empirical evidence. It can also account for several related empirical phenomena, including that of "delayed overshooting." We show that incomplete information processing is consistent both with evidence that little capital is devoted to actively managing short-term currency positions and with a small welfare gain from active portfolio management. The gain is small because exchange rate changes are very hard to predict. The welfare gain is easily outweighed by a small cost of active portfolio management.
Computer Use and the U.S. Wage Distribution, 1984-2003
–October 1, 2006
Robert G. VallettaGiven past estimates of wage increases associated with workplace computer use and higher usage rates among more skilled workers, the diffusion of computers has been interpreted as a mechanism for skill-biased technological change and consequent widening of the earnings distribution. I investigate this link by testing for direct effects of rising computer use on the distribution of wages in the United States. Analysis of data from the periodic CPS computer use supplements over the years 1984-2003 reveals that the positive association between workplace computer use and wages declines at higher skill levels, with the notable exception of a higher return to computer use for highly educated workers that emerged after 1997. Over my complete sample frame, however, the net association between rising computer use and the distribution of wages was quite limited. For broad groups defined by educational attainment, rising computer use was associated with rising between-group inequality that was offset by falling within-group inequality, suggesting that computers have exerted a "leveling" rather than a "polarizing" effect on wages.
Non-Economic Engagement and International Exchange: The Case of Environmental Treaties
–October 1, 2006
Andrew K. Rose, Mark M. SpiegelWe examine the role of non-economic partnerships in promoting international economic exchange. Since far-sighted countries are more willing to join costly international partnerships such as environmental treaties, environmental engagement tends to encourage international lending. Countries with such non-economic partnerships also find it easier to engage in economic exchanges since they face the possibility that debt default might also spill over to hinder their non-economic relationships. We present a theoretical model of these ideas, and then verify their empirical importance using a bilateral cross-section of data on international crossholdings of assets and environmental treaties. Our results support the notion that international environmental cooperation facilitates economic exchange.
Moderate Inflation and the Deflation-Depression Link
–October 1, 2006
Jess Benhabib, Mark M. SpiegelIn a recent paper, Atkeson and Kehoe (2004) demonstrated the lack of a robust empirical relationship between inflation and growth for a cross-section of countries with 19th and 20th century data, concluding that the historical evidence only provides weak support for the contention that deflation episodes are harmful to economic growth. In this paper, we revisit this relationship by allowing for inflation and growth to have a nonlinear specification dependent on inflation levels. In particular, we allow for the possibility that high inflation is negatively correlated with growth, while a positive relationship exists over the range of negative-to-moderate inflation. Our results confirm a positive relationship between inflation and growth at moderate inflation levels, and support the contention that the relationship between inflation and growth is non-linear over the entire sample range.
Revealing the Secrets of the Temple: The Value of Publishing Central Bank Interest Rate Projections
–October 1, 2006
Glenn D. Rudebusch, John C. WilliamsThe modern view of monetary policy stresses its role in shaping the entire yield curve of interest rates in order to achieve various macroeconomic objectives. A crucial element of this process involves guiding financial market expectations of future central bank actions. Recently, a few central banks have started to explicitly signal their future policy intentions to the public, and two of these banks have even begun publishing their internal interest rate projections. We examine the macroeconomic effects of direct revelation of a central bank’s expectations about the future path of the policy rate. We show that, in an economy where private agents have imperfect information about the determination of monetary policy, central bank communication of interest rate projections can help shape financial market expectations and may improve macroeconomic performance.
Monetary Policy in a Low Inflation Economy with Learning
–September 1, 2006
John C. WilliamsIn theory, monetary policies that target the price level, as opposed to the inflation rate, should be highly effective at stabilizing the economy and avoiding deflation in the presence of the zero lower bound on nominal interest rates. With such a policy, if the short-term interest rate is constrained at zero and the inflation rate declines below its trend, the public expects that policy will eventually engineer a period of above-trend inflation that restores the price level to its target level. Expectations of future monetary accommodation stimulate output and inflation today, mitigating the effects of the zero bound. The effectiveness of such a policy strategy depends crucially on the alignment of the public’s and the central bank’s expectations of future policy actions. In this paper, we consider an environment where private agents have imperfect knowledge of the economy and therefore continuously reestimate the forecasting model that they use to form expectations. We find that imperfect knowledge on the part of the public, especially regarding monetary policy, can undermine the effectiveness of price-level-targeting strategies that would work well if the public had complete knowledge. For low inflation targets, the zero lower bound can cause a dramatic deterioration in macroeconomic performance with severe recessions occurring with alarming frequency. However, effective communication of the policy strategy that reduces the public’s confusion about the future course of monetary policy significantly reduces the stabilization costs associated with the zero bound. Finally, the combination of learning and the zero bound implies the need for a stronger policy response to movements in the price level than would otherwise be optimal and such a rule is effective at stabilizing both inflation and output in the presence of learning and the zero bound even with a low inflation target.
Information and Communications Technology as a General-Purpose Technology: Evidence from U.S Industry Data
–December 1, 2006
Susanto Basu, John G. FernaldMany people point to information and communications technology (ICT) as the key for understanding the acceleration in productivity in the United States since the mid-1990s. Stories of ICT as a ‘general purpose technology’ suggest that measured TFP should rise in ICT-using sectors (reflecting either unobserved accumulation of intangible organizational capital; spillovers; or both), but with a long lag. Contemporaneously, however, investments in ICT may be associated with lower TFP as resources are diverted to reorganization and learning. We find that U.S. industry results are consistent with GPT stories: the acceleration after the mid-1990s was broadbased–located primarily in ICT-using industries rather than ICT-producing industries. Furthermore, industry TFP accelerations in the 2000s are positively correlated with (appropriately weighted) industry ICT capital growth in the 1990s. Indeed, as GPT stories would suggest, after controlling for past ICT investment, industry TFP accelerations are negatively correlated with increases in ICT usage in the 2000s.
Measuring Oil-Price Shocks Using Market-Based Information
–September 1, 2006
Michele Cavallo, Tao WuWe develop two measures of exogenous oil-price shocks for the period 1984 to 2006 based on market commentaries on daily oil-price fluctuations. Our measures are based on exogenous events that trigger substantial fluctuations in spot oil prices and are constructed to be free of endogenous and anticipatory movements. We find that the dynamic responses of output and prices implied by these measures are "well behaved." We also find that the response of output is larger than the one implied by a conventional measure of oil-price shocks proposed in the literature.
Safe and Sound Banking, 20 Years Later: What Was Proposed and What Has Been Adopted
–August 1, 2006
Frederick T. Furlong, Simon H. KwanIn 1986, a task force of banking academics organized and sponsored by the American Bankers Association convened to examine the banking industry and the efficacy of its regulatory system. The group was charged with reviewing the problems of ensuring the safety and soundness of the banking system and evaluating a number of policy options to improve the efficiency, performance, and safety of the system by changing the structure of the deposit insurance system and the bank regulatory and supervisory process. The results of the work of the task force were published by the MIT Press as the book, Perspectives on Safe and Sound Banking (Benston et al., 1986, the Report), which includes a set of principal options and recommendations. The purpose of this article is to assess the extent to which changes in public policy regarding depository institutions have been aligned with the recommendations of the Report. We find that, over the past 20 years, several legislative initiatives and changes in regulations and the bank supervisory process have been in keeping with the specific recommendations of the Report or with the analytic framework underlying the recommendations. At the same time, other recommendations in the Report have not been taken up and some proposals rejected in the Report have been put in place by legislative and regulatory initiatives. Overall, public policy and private sector initiatives appear to have contributed to safer and sounder banking and thrift sectors over the past 20 years. Consistent with what we see as the main theme of the Report, a likely contributing factor is the more appropriate alignment of incentive for risk-taking among larger depository institutions. Developments affecting risk-taking by depository institutions likely include higher capitalizations, greater risk exposure of private sector stakeholders more generally, improvements in risk management, and supervision and regulation that is focused on overall risk.
Aggregate Shocks or Aggregate Information? Costly Information and Business Cycle Comovement
–September 1, 2006
Laura Veldkamp, Justin WolfersWhen similar patterns of expansion and contraction are observed across sectors, we call this a business cycle. Yet explaining the similarity and synchronization of these cycles across industries remains a puzzle. Whereas output growth across industries is highly correlated, identifiable shocks, like shocks to productivity, are far less correlated. While previous work has examined complementarities in production, we propose that sectors make similar input decisions because of complementarities in information acquisition. Because information about driving forces has a high fixed cost of production and a low marginal cost of replication, it can be more efficient for firms to share the cost of discovering common shocks than to invest in uncovering detailed sectoral information. Firms basing their decisions on this common information make highly correlated production choices. This mechanism amplifies the effects of common shocks, relative to sectoral shocks.
Did Foreign Direct Investment Put an Upward Pressure on Wages in China?
–May 1, 2008
Galina Hale, Cheryl LongIn this paper we study the extent to which foreign direct investment (FDI) could have contributed to recent increase in wages in China. Using a World Bank survey data set of 1500 Chinese enterprises conducted in 2002, we find that the presence of FDI has both direct and indirect effects on wages of skilled workers, while it does not appear to affect wages of production workers. Moreover, we find that the indirect effect of the FDI presence on wages of skilled workers is limited to private firms. We further find that observed quality of skilled workers in state owned enterprises (SOEs) declines in the presence of FDI in the same industry and region. We discuss potential reasons for such discrepancy in the FDI effects on private firms’ and SOEs’ labor practices. These findings highlight the relevance of labor market institutions in determining FDI spillovers.
Endogenous Skill Bias in Technology Adoption: City-Level Evidence from the IT Revolution
–August 1, 2006
Paul Beaudry, Mark Doms, Ethan LewisThis paper focuses on the bi-directional interaction between technology adoption and labor market conditions. We examine cross-city differences in PC adoption, relative wages, and changes in relative wages over the period 1980-2000 to evaluate whether the patterns conform to the predictions of a neoclassical model of endogenous technology adoption. Our approach melds the literature on the effect of the relative supply of skilled labor on technology adoption to the often distinct literature on how technological change influences the relative demand for skilled labor. Our results support the idea that differences in technology use across cities and its effects on wages reflect an equilibrium response to local factor supply conditions. The model and data suggest that cities initially endowed with relatively abundant and cheap skilled labor adopted PCs more aggressively than cities with relatively expensive skilled labor, causing returns to skill to increase most in cities that adopted PCs most intensively. Our findings indicate that neoclassical models of endogenous technology adoption can be very useful for understanding where technological change arises and how it affects markets.
Futures Prices as Risk-Adjusted Forecasts of Monetary Policy
–September 1, 2006
Monika Piazzesi, Eric T. SwansonMany researchers have used federal funds futures rates as measures of financial markets’ expectations of future monetary policy. However, to the extent that federal funds futures reflect risk premia, these measures require some adjustment. In this paper, we document that excess returns on federal funds futures have been positive on average and strongly countercyclical. In particular, excess returns are surprisingly well predicted by macroeconomic indicators such as employment growth and financial business-cycle indicators such as Treasury yield spreads and corporate bond spreads. Excess returns on eurodollar futures display similar patterns. We document that simply ignoring these risk premia significantly biases forecasts of the future path of monetary policy. We also show that risk premia matter for some futures-based measures of monetary policy shocks used in the literature.
The Frequency of Price Adjustment Viewed Through the Lens of Aggregate Data
–November 1, 2009
Richard DennisThe Calvo pricing model that lies at the heart of many New Keynesian business cycle models has been roundly criticized for being inconsistent both with time series data on inflation and with micro-data on the frequency of price changes. In this paper I develop a new pricing model whose structure can be interpreted in terms of menu costs and information gathering/processing costs, that usefully recognizes both criticisms. The resulting Phillips curve encompasses the partial-indexation model, the full-indexation model, and the Calvo model, and can speak to micro-data in ways that these models cannot. Taking the Phillips curve to the data, I find that the share of firms that change prices each quarter is about 60 percent and, perhaps reflecting the importance of information gathering/processing costs, that price indexation is important for inflation dynamics.
Sovereign Debt Crises and Credit to the Private Sector
–December 1, 2006
Carlos O. Arteta, Galina HaleWe use micro-level data to analyze emerging markets’ private sector access to international debt markets during sovereign debt crises. Using fixed effect analysis, we find that these crises are systematically accompanied by a decline in foreign credit domestic private firms, both during debt renegotiations and for over two years after the restructuring agreements are reached. This decline is large (over 20 percent), statistically significant, and robust when we control for a host of fundamentals. We find that this effect is concentrated in the nonfinancial sector and is different for exporters and for firms in the non-exporting sector. We also find that the magnitude of the effect depends on the type of debt restructuring agreement.
The Relative Price and Relative Productivity Channels for Aggregate Fluctuations
–June 1, 2006
Eric T. SwansonThis paper demonstrates that sectoral heterogeneity itself–without any additional bells or whistles–has first-order implications for the transmission of aggregate shocks to aggregate variables in an otherwise standard DSGE model. The effects of sectoral heterogeneity on this transmission are decomposed into two channels: a "relative price" channel and a "relative productivity" channel. The relative price channel results from changes in the relative prices of aggregates, such as investment vis-a-vis consumption goods, which occurs in a sectoral model in response to even standard aggregate shocks. The relative productivity channel arises from changes in the distribution of inputs across sectors. We show that, for standard sectoral models, this latter channel is second-order, but becomes first-order if we consider a nontraded input such as capital utilization or introduce a wedge that thwarts the steady-state equalization of marginal products of a traded input across sectors. For reasonable parameterizations, the relative productivity channel causes aggregate productivity to vary procyclically in response to non-technological shocks such as changes in government purchases.
Quantitative Easing and Japanese Bank Equity Values
–July 1, 2006
Takeshi Kobayashi, Mark M. Spiegel, Nobuyoshi YamoriOne of the primary motivations offered by the Bank of Japan (BOJ) for its quantitative easing program–whereby it maintained a current account balance target in excess of required reserves, effectively pegging short-term interest rates at zero–was to maintain credit extension by the troubled Japanese financial sector. We conduct an event study concerning the anticipated impact of quantitative easing on the Japanese banking sector by examining the impact of the introduction and expansion of the policy on Japanese bank equity values. We find that excess returns of Japanese banks were greater when increases in the BOJ current account balance target were accompanied by "nonstandard" expansionary policies, such as raising the ceiling on BOJ purchases of long-term Japanese government bonds. We also provide cross-sectional evidence that suggests that the market perceived that the quantitative easing program would disproportionately benefit financially weaker Japanese banks.
Labor Supply and Personal Computer Adoption
–June 1, 2006
Mark Doms, Ethan LewisThe positive correlations found between computer use and human capital are often interpreted as evidence that the adoption of computers have raised the relative demand for skilled labor, the widely touted skill-biased technological change hypothesis. However, several models argue the skill-intensity of technology is endogenously determined by the relative supply of skilled labor. We use instruments for the supply of human capital coupled with a rich dataset on computer usage by businesses to show that the supply of human capital is an important determinant of the adoption of personal computers. Our results suggest that great caution must be exercised in placing economic interpretations on the correlations often found between technology and human capital.
Measuring the Miracle: Market Imperfections and Asia’s Growth Experience
–May 1, 2006
John G. Fernald, Brent NeimanThe newly industrialized economies (NIEs) of Asia are the fastest-growing economies in the world since 1960. A clear understanding of their rapid development remains elusive, with continuing disputes over the roles of technology growth, capital accumulation, and international trade and investment. We reconcile seemingly contradictory explanations by accounting for imperfections in output and capital markets. For instance, in Singapore, growth-accounting studies using quantities (the primal approach) find rising capital-output ratios and a constant labor share; but studies using real factor prices (the dual approach) find a constant user cost. We provide evidence that "favored" firms reaped economic profits and received preferential tax treatment, subsidies, and access to capital–market imperfections that are difficult to capture when implementing the dual approach. Further, declining pure profits can reconcile the constant or rising labor shares in revenue in the NIEs with theories of international trade that predict falling labor shares in cost. We provide empirical support for the quantitative importance of profits and heterogeneous user costs, describe the two-sector dynamics, and derive measures of technology growth, corrected for the imperfections that we quantify. We then discuss implications for broader disputes about Asian development.
The Bond Yield “Conundrum” from a Macro-Finance Perspective
–May 1, 2006
Glenn D. Rudebusch, Eric T. Swanson, Tao WuIn 2004 and 2005, long-term interest rates remained remarkably low despite improving economic conditions and rising short-term interest rates, a situation that former Fed Chairman Alan Greenspan dubbed a "conundrum." We document the extent and timing of this conundrum using two empirical no-arbitrage macro-finance models of the term structure of interest rates. These models confirm that the recent behavior of long-term yields has been unusual–that is, it cannot be explained within the framework of the models. Therefore, we consider other macroeconomic factors omitted from the models and find that some of these variables, particularly declines in long-term bond volatility, may explain a portion of the conundrum. Foreign official purchases of U.S Treasuries appear to have played little or no role.
Time-Varying U.S. Inflation Dynamics and the New Keynesian Phillips Curve
–August 1, 2008
Kevin J. LansingThis paper introduces a form of boundedly-rational inflation expectations in the New Keynesian Phillips curve. The representative agent is assumed to behave as an econometrician, employing a time series model for inflation that allows for both permanent and temporary shocks. The near-unity coefficient on expected inflation in the Phillips curve causes the agent’s perception of a unit root in inflation to become close to self-fulfilling. In a "consistent expectations equilibrium," the value of the Kalman gain parameter in the agent’s forecast rule is pinned down using the observed autocorrelation of inflation changes. The forecast errors observed by the agent are close to white noise, making it difficult for the agent to detect a misspecification of the forecast rule. I show that this simple model of inflation expectations can generate time-varying persistence and volatility that is broadly similar to that observed in long-run U.S. data. Model-based values for expected inflation track well with movements in survey-based measures of U.S. expected inflation. In numerical simulations, the model can generate pronounced low-frequency swings in the level of inflation that are driven solely by expectational feedback, not by changes in monetary policy.
Inflation Targeting under Imperfect Knowledge
–April 1, 2006
Athanasios Orphanides, John C. WilliamsA central tenet of inflation targeting is that establishing and maintaining well-anchored inflation expectations are essential. In this paper, we reexamine the role of key elements of the inflation targeting framework towards this end, in the context of an economy where economic agents have an imperfect understanding of the macroeconomic landscape within which the public forms expectations and policymakers must formulate and implement monetary policy. Using an estimated model of the U.S. economy, we show that monetary policy rules that would perform well under the assumption of rational expectations can perform very poorly when we introduce imperfect knowledge. We then examine the performance of an easily implemented policy rule that incorporates three key characteristics of inflation targeting: transparency, commitment to maintaining price stability, and close monitoring of inflation expectations, and find that all three play an important role in assuring its success. Our analysis suggests that simple difference rules in the spirit of Knut Wicksell excel at tethering inflation expectations to the central bank’s goal and in so doing achieve superior stabilization of inflation and economic activity in an environment of imperfect knowledge.
Are There Productivity Spillovers from Foreign Direct Investment in China?
–February 1, 2008
Galina Hale, Cheryl LongWe review previous literature on productivity spillovers of foreign direct investment (FDI) in China and conduct our own analysis using a firm-level data set from a World Bank survey. We find that the evidence of FDI spillovers on the productivity of Chinese domestic firms is mixed, with many positive results largely due to aggregation bias or failure to control for endogeneity of FDI. Attempting over 2500 specifications which take into account forward and backward linkages, we fail to find evidence of systematic positive productivity spillovers from FDI. We do, however, find robust evidence that Chinese private firms tend to invest less in innovation in the presence of FDI. Combined with our previous findings that domestic private firms tend to be more involved in providing inputs and intermediary goods for foreign firms (Hale and Long, 2006), these results suggest a more passive role played by domestic firms in the global division of labor than envisioned by the Chinese government.
Keeping Up with the Joneses and Staying Ahead of the Smiths: Evidence from Suicide Data
–May 1, 2006
Mary C. Daly, Daniel WilsonThis paper empirically assesses the theory of interpersonal income comparison using a unique data set on suicide deaths in the United States. We treat suicide as a choice variable, conditional on exogenous risk factors, reflecting one’s assessment of current and expected future utility. Using this framework we examine whether differences in group-specific suicide rates are systematically related to income dispersion, controlling for socio-demographic characteristics and income level. The results strongly support the notion that individuals consider relative income in addition to absolute income when evaluating their own utility. Importantly, the findings suggest that relative income affects utility in a two-sided manner, meaning that individuals care about the incomes of those above them (the Joneses) and those below them (the Smiths). Our results complement and extend those from studies using subjective survey data or data from controlled experiments.
Interpreting Prediction Market Prices as Probabilities
–April 1, 2006
Justin Wolfers, Eric ZitzewitzWhile most empirical analysis of prediction markets treats prices of binary options as predictions of the probability of future events, Manski (2004) has recently argued that there is little existing theory supporting this practice. We provide relevant analytic foundations, describing sufficient conditions under which prediction markets prices correspond with mean beliefs. Beyond these specific sufficient conditions, we show that for a broad class of models prediction market prices are usually close to the mean beliefs of traders. The key parameters driving trading behavior in prediction markets are the degree of risk aversion and the distribution on beliefs, and we provide some novel data on the distribution of beliefs in a couple of interesting contexts. We find that prediction markets prices typically provide useful (albeit sometimes biased) estimates of average beliefs about the probability an event occurs.
Methods for Robust Control
–March 1, 2009
Richard Dennis, Kai Leitemo, Ulf SöderströmRobust control allows policymakers to formulate policies that guard against model misspecification. The principal tools used to solve robust control problems are state-space methods (see Hansen and Sargent 2008, and Giordani and Soderlind 2004). In this paper we show that the structural-form methods developed by Dennis (2007) to solve control problems with rational expectations can also be applied to robust control problems, with the advantage that they bypass the task, often onerous, of having to express the reference model in state-space form. In addition, we show how to implement two different timing assumptions with distinct implications for the robust policy and the economy. We apply our methods to a New Keynesian dynamic stochastic general equilibrium model and find that robustness has important effects on policy and the economy.
Does Inflation Targeting Anchor Long-Run Inflation Expectations? Evidence from Long-Term Bond Yields in the U.S., U.K., and Sweden
–March 1, 2006
Refet S. Gürkaynak, Andrew T. Levin, Eric T. SwansonWe investigate the extent to which inflation targeting helps anchor long-run inflation expectations by comparing the behavior of daily bond yield data in the United Kingdom and Sweden–both inflation targeters–to that in the United States, a non-inflation-targeter. Using the difference between far-ahead forward rates on nominal and inflation-indexed bonds as a measure of compensation for expected inflation and inflation risk at long horizons, we examine how much, if at all, far-ahead forward inflation compensation moves in response to macroeconomic data releases and monetary policy announcements. In the U.S., we find that forward inflation compensation exhibits highly significant responses to economic news. In the U.K., we find a level of sensitivity similar to that in the U.S. prior to the Bank of England gaining independence in 1997, but a striking absence of such sensitivity since the central bank became independent. In Sweden, we find that forward inflation compensation has been insensitive to economic news over the whole period for which we have data. Our findings support the view that a well-known and credible inflation target helps to anchor the private sector’s perceptions of the distribution of long-run inflation outcomes.
Partisan Impacts on the Economy: Evidence from Prediction Markets and Close Elections
–February 1, 2006
Erik Snowberg, Justin Wolfers, Eric ZitzewitzPolitical economists interested in discerning the effects of election outcomes on the economy have been hampered by the problem that economic outcomes also influence elections. We sidestep these problems by analyzing movements in economic indicators caused by clearly exogenous changes in expectations about the likely winner during election day. Analyzing high frequency financial fluctuations on November 2 and 3 in 2004, we find that markets anticipated higher equity prices, interest rates, and oil prices and a stronger dollar under a Bush presidency than under Kerry. A similar Republican-Democrat differential was also observed for the 2000 Bush-Gore contest. Prediction market based analyses of all presidential elections since 1880 also reveal a similar pattern of partisan impacts, suggesting that electing a Republican president raises equity valuations by 2-3 percent, and that since Reagan, Republican presidents have tended to raise bond yields.
Pegged Exchange Rate Regimes — A Trap?
–September 1, 2005
Joshua Aizenman, Reuven GlickThis paper studies the empirical and theoretical association between the duration of a pegged exchange rate and the cost experienced upon exiting the regime. We confirm empirically that exits from pegged exchange rate regimes during the past two decades have often been accompanied by crises, the cost of which increases with the duration of the peg before the crisis. We explain these observations in a framework in which the exchange rate peg is used as a commitment mechanism to achieve inflation stability, but multiple equilibria are possible. We show that there are ex ante large gains from choosing a more conservative not only in order to mitigate the inflation bias from the well-known time inconsistency problem, but also to steer the economy away from the high inflation equilibria. These gains, however, come at a cost in the form of the monetary authority’s lesser responsiveness to output shocks. In these circumstances, using a pegged exchange rate as an anti-inflation commitment device can create a "trap" whereby the regime initially confers gains in anti-inflation credibility, but ultimately results in an exit occasioned by a big enough adverse real shock that creates large welfare losses to the economy. We also show that the more conservative is the regime in place and the larger is the cost of regime change, the longer will be the average spell of the fixed exchange rate regime, and the greater the output contraction at the time of a regime change.
Five Open Questions about Prediction Markets
–January 1, 2006
Justin Wolfers, Eric ZitzewitzInterest in prediction markets has increased in the last decade, driven in part by the hope that these markets will prove to be valuable tools in forecasting, decisionmaking and risk management–in both the public and private sectors. This paper outlines five open questions in the literature, and we argue that resolving these questions is crucial to determining whether current optimism about prediction markets will be realized.
Sovereign Debt, Volatility, and Insurance
–February 1, 2005
Kenneth M. KletzerExternal debt increases the vulnerability of indebted emerging market economies to macroeconomic volatility and financial crises. Capital account reversals often lead sovereign debt repayment crises that are only resolved after prolonged and difficult debt restructuring. Foreign indebtedness exacerbates domestic financial distress in crisis, increasing both the incidence and severity of emerging market crises. These outcomes contrast with the presumption that access to international capital markets should help countries to smooth domestic consumption and investment against macroeconomic shocks. This paper uses models of sovereign to reconsider the role of sovereign debt renegotiation for international risk sharing and presents an approach for analyzing contractual innovations for implementing contingent debt repayments. The financial innovations that might allow risk-sharing rather than risk-inducing capital flows go beyond contractual changes that ease debt renegotiation by separating contingent payments from bonds.
Market-Based Measures of Monetary Policy Expectations
–January 1, 2006
Refet S. Gürkaynak, Brian P. Sack, Eric T. SwansonA number of recent papers have used different financial market instruments to measure near-term expectations of the federal funds rate and the high-frequency changes in these instruments around FOMC announcements to measure monetary policy shocks. This paper evaluates the empirical success of a variety of financial market instruments in predicting the future path of monetary policy. All of the instruments we consider provide forecasts that are clearly superior to those of standard time series models at all of the horizons considered. Among financial market instruments, we find that federal funds futures dominate all the other securities in forecasting monetary policy at horizons out to six months. For longer horizons, the predictive power of many of the instruments we consider is very similar. In addition, we present evidence that monetary policy shocks computed using the current-month federal funds futures contract are influenced by changes in the timing of policy actions that do not influence the expected course of policy beyond a horizon of about six weeks. We propose an alternative shock measure that captures changes in market expectations of policy over slightly longer horizons.
Could Capital Gains Smooth a Current Account Rebalancing?
–January 1, 2006
Michele Cavallo, Cédric TilleA narrowing of the U.S. current account deficit through exchange rate movements is likely to entail a substantial depreciation of the dollar, as stressed in the widely cited contribution by Obstfeld and Rogoff (2005). We assess how the adjustment is affected by the high degree of international financial integration in the world economy. A growing body of research stresses the increasing leverage in international financial positions, with industrialized economies holding substantial and growing financial claims on each other. Exchange rate movements then leads to valuations effects as the currency compositions of a country’s assets and liabilities are not matched. In particular, a dollar depreciation generates valuation gains for the U.S. by boosting the dollar value of the large amount of its foreign-currency denominated assets. We consider an adjustment scenario in which the U.S. net external debt is held constant. The key finding is that while the current account moves into balance, the pace of adjustment is smooth. Intuitively, the valuation gains stemming from the depreciation of the dollar allow the U.S. to finance ongoing, albeit shrinking, current account deficits. We find that the smooth pattern of adjustment is robust to alternative scenarios, although the ultimate movements in exchange rates are affected.
Monetary Policy Shocks, Inventory Dynamics, and Price-setting Behavior
–August 1, 2005
Yongseung Jung, Tack YunIn this paper, we estimate a VAR model to present an empirical finding that an unexpected rise in the federal funds rate decreases the ratio of sales to stocks available for sales, while it increases finished goods inventories. In addition, dynamic responses of these variables reach their peaks several quarters after a monetary shock. In order to understand the observed relationship between monetary policy and finished goods inventories, we allow for the accumulation of finished goods inventories in an optimizing sticky price model, where prices are set in a staggered fashion. In our model, holding finished inventories helps firms to generate more sales at given their prices. We then show that the model can generate the observed relationship between monetary shocks and finished goods inventories. Furthermore, we find that allowing for inventory holdings leads to a Phillips curve equation, which makes the inflation rate depend on the expected present-value of future marginal cost as well as the current periodicals marginal cost and the expected rate of future inflation.
Higher-Order Perturbation Solutions to Dynamic, Discrete-Time Rational Expectations Models
–January 1, 2006
Gary S. Anderson, Andrew T. Levin, Eric T. SwansonWe present an algorithm and software routines for computing nth order Taylor series approximate solutions to dynamic, discrete-time rational expectations models around a nonstochastic steady state. The primary advantage of higher-order (as opposed to first- or second-order) approximations is that they are valid not just locally, but often globally (i.e., over nonlocal, possibly very large compact sets) in a rigorous sense that we specify. We apply our routines to compute first- through seventh-order approximate solutions to two standard macroeconomic models, a stochastic growth model and a life-cycle consumption model, and discuss the quality and global properties of these solutions.
Macroeconomic Derivatives: An Initial Analysis of Market-Based Macro Forecasts, Uncertainty, and Risk
–September 1, 2005
Refet S. Gürkaynak, Justin WolfersIn September 2002, a new market in "Economic Derivatives" was launched allowing traders to take positions on future values of several macroeconomic data releases. We provide an initial analysis of the prices of these options. We find that market-based measures of expectations are similar to survey-based forecasts, although the market-based measures somewhat more accurately predict financial market responses to surprises in data. These markets also provide implied probabilities of the full range of specific outcomes, allowing us to measure uncertainty, assess its driving forces, and compare this measure of uncertainty with the dispersion of point-estimates among individual forecasters (a measure of disagreement). We also assess the accuracy of market-generated probability density forecasts. A consistent theme is that few of the behavioral anomalies present in surveys of professional forecasts survive in equilibrium, and that these markets are remarkably well calibrated. Finally we assess the role of risk, finding little evidence that risk-aversion drives a wedge between market prices and probabilities in this market.
Why Has the U.S. Beveridge Curve Shifted Back? New Evidence Using Regional Data
–December 1, 2005
Robert G. VallettaThe Beveridge curve depicts the empirical relationship between job vacancies and unemployment, which in turn reflects the underlying efficiency of the job matching process. Previous analyses of the Beveridge curve suggested deterioration in match efficiency during the 1970s and early 1980s, followed by improved match efficiency beginning in the late 1980s. This paper combines aggregate and regional data on job vacancies and unemployment to estimate the U.S. aggregate and regional Beveridge curves, focusing on the period 1976-2005. Using new data on job vacancies from the U.S. Bureau of Labor Statistics, the help-wanted advertising series that formed the basis of past work are modified to form synthetic job vacancy series at the national and regional level. The results suggest that a decline in the dispersion of employment growth across geographic areas contributed to a pronounced inward shift in the Beveridge curve since the late 1980s, reversing the earlier pattern identified by Abraham (1987) and reinforcing findings of favorable labor market trends in the 1990s (e.g., Katz and Krueger 1999).
Optimal Nonlinear Policy: Signal Extraction with a Non-Normal Prior
–December 1, 2005
Eric T. SwansonThe literature on optimal monetary policy typically makes three major assumptions: (1) policymakers’ preferences are quadratic, (2) the economy is linear, and (3) stochastic shocks and policymakers’ prior beliefs about unobserved variables are normally distributed. This paper relaxes the third assumption and explores its implications for optimal policy. The separation principle continues to hold in this framework, allowing for tractability and application to forward-looking models, but policymakers’ beliefs are no longer updated in a linear fashion, allowing for plausible nonlinearities in optimal policy. We consider in particular a class of models in which policymakers’ priors about the natural rate of unemployment are diffuse in a region around the mean. When this is the case, it is optimal for policy to respond cautiously to small surprises in the observed unemployment rate, but become increasingly aggressive at the margin. These features of optimal policy match statements by Federal Reserve officials and the behavior of the Fed in the 1990s.
Markov Perfect Industry Dynamics with Many Firms
–November 1, 2005
C. Lanier Benkard, Benjamin Van Roy, Gabriel Y. WeintraubWe propose an approximation method for analyzing Ericson and Pakes (1995)-style dynamic models of imperfect competition. We develop a simple algorithm for computing an "oblivious equilibrium," in which each firm is assumed to make decisions based only on its own state and knowledge of the long run average industry state, but where firms ignore current information about competitors’ states. We prove that, as the market becomes large, if the equilibrium distribution of firm states obeys a certain "light-tail" condition, then oblivious equilibria closely approximate Markov perfect equilibria. We develop bounds that can be computed to assess the accuracy of the approximation for any given applied problem. Through computational experiments, we find that the method often generates useful approximations for industries with hundreds of firms and in some cases even tens of firms.
Empirical Analysis of the Average Asset Correlation for Real Estate Investment Trusts
–October 1, 2005
Jose A. LopezThe credit risk capital requirements within the current Basel II Accord are based on the asymptotic single risk factor (ASRF) approach. The asset correlation parameter, defined as an obligor’s sensitivity to the ASRF, is a key driver within this approach, and its average values for different types of obligors are to be set by regulators. Specifically, for commercial real estate (CRE) lending, the average asset correlations are to be determined using formulas for either income-producing real estate or high-volatility commercial real estate. In this paper, the value of this parameter was empirically examined using portfolios of U.S. publicly traded real estate investment trusts (REITs) as a proxy for CRE lending more generally. CRE lending as a whole was found to have the same calibrated average asset correlation as corporate lending, providing support for the recent U.S. regulatory decision to treat these two lending categories similarly for regulatory capital purposes. However, the calibrated values for CRE categories, such as multifamily residential or office lending, varied in important ways. The comparison of calibrated and regulatory values of the average asset correlations for these categories suggest that the current regulatory formulas generate parameter values that may be too high in most cases.
Trend Breaks, Long-Run Restrictions, and the Contractionary Effects of Technology Improvements
–June 1, 2008
John G. FernaldStructural vector-autoregressions with long-run restrictions are extraordinarily sensitive to low-frequency correlations. This paper explores this sensitivity analytically and via simulations, focusing on the contentious issue of whether hours worked rise or fall when technology improves. Recent literature finds that when hours per person enter the VAR in levels, hours rise; when they enter in differences, hours fall. However, once we allow for (statistically and economically plausible) trend breaks in productivity, the treatment of hours is relatively unimportant: Hours fall sharply on impact following a technology improvement. The issue is the common high-low-high pattern of hours per capita and productivity growth since World War II. Such low-frequency correlation almost inevitably implies a positive estimated impulse response. The trend breaks control for this correlation. In addition, the specification with breaks can easily "explain" (or encompass) the positive estimated response when the breaks are omitted; in contrast, the no-breaks specification has more difficulty explaining the negative response when breaks are included. More generally, this example suggests a need for care in applying the long-run-restrictions approach.
Robust Control with Commitment: A Modification to Hansen-Sargent
–December 1, 2006
Richard DennisThis paper examines the Hansen and Sargent (2003) formulation of the robust Stackelberg problem and shows that their method of constructing the approximating equilibrium, which is central to any robust control exercise, is generally invalid. The paper then turns to the Hansen and Sargent (2007) treatment, which, responding to the problems raised in this paper, changes subtly, but importantly, how the robust Stackelberg problem is formulated. This paper proves, first, that their method for obtaining the approximating equilibrium is now equivalent to the one developed in this paper, and, second, that the worst-case specification errors are not subject to a time-inconsistency problem. Analyzing robust monetary policy in two New Keynesian business cycle models, the paper demonstrates that a robust central bank should primarily fear that the supply side of its approximating model is misspecified and that attenuation characterizes robust policymaking. Depending on how the robust Stackelberg problem is formulated, this paper shows that the Hansen-Sargent approximating equilibrium can be dynamically unstable and that robustness can be irrelevant, i.e., that the robust policy can coincide with the rational expectations policy.
Monetary Policy Inertia: Fact or Fiction?
–August 1, 2006
Glenn D. RudebuschMany interpret estimated monetary policy rules as suggesting that central banks conduct very sluggish partial adjustment of short-term policy interest rates. In contrast, others argue that this appearance of policy inertia is an illusion and simply reflects the spurious omission of important persistent influences on the actual setting of policy. Similarly, the real-world implications of the theoretical arguments for policy inertia are debatable. However, empirical evidence on policy gradualism obtained by examining expectations of future monetary policy embedded in the term structure of interest rates is definitive and indicates that the actual amount of policy inertia is quite low.
Accounting for the Secular “Decline” of U.S. Manufacturing
–September 1, 2006
Milton H. Marquis, Bharat TrehanThere has been considerable debate about the causes of the "decline" of U.S. manufacturing over the post-war period. We show that the behavior of employment, prices and output in manufacturing relative to services over this period can be explained by a two-sector growth model in which productivity shocks are the only driving forces. The data also suggest that households are unwilling to substitute goods for services (the estimated elasticity of substitution is statistically indistinguishable from zero), so the economy adjusts to differential productivity growth entirely by reallocating labor across sectors.
Monetary Policy with Imperfect Knowledge
–October 1, 2005
Athanasios Orphanides, John C. WilliamsWe examine the performance and robustness of monetary policy rules when the central bank and the public have imperfect knowledge of the economy and continuously update their estimates of model parameters. We find that versions of the Taylor rule calibrated to perform well under rational expectations with perfect knowledge perform very poorly when agents are learning and the central bank faces uncertainty regarding natural rates. In contrast, difference rules, in which the change in the interest rate is determined by the inflation rate and the change in the unemployment rate, perform well when knowledge is both perfect and imperfect.
Government Employment Expenditure and the Effects of Fiscal Policy Shocks
–September 1, 2005
Michele CavalloSince World War II, about 75 percent of consumption expenditure by the U.S. government has consisted of wages and salaries for government employees. I distinguish between the goods and the employment expenditure components of government consumption in assessing the effects of fiscal shocks on the macroeconomy. Identifying exogenous fiscal shocks with the onset of military buildups, I show that they lead to a substantial increase in both the number of hours worked and output for the government. I also show that allowing for the distinction between the two main components of government consumption improves the quantitative performance of the neoclassical growth model. In particular, a neoclassical model economy with government employment does a good job of accounting for the dynamic response of private consumption to a fiscal policy shock. Government employment expenditure acts as a transfer payment for households, thereby dampening substantially the wealth effect on consumption and labor supply associated with fiscal shocks.
Monetary Policy under Uncertainty in Micro-Founded Macroeconometric Models
–July 1, 2005
Andrew T. Levin, Alexei Onatski, John C. Williams, Noah WilliamsWe use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.
The Value of Knowledge Spillovers
–June 1, 2005
Yi DengThis paper aims at quantifying the economic value of knowledge spillovers by exploring information contained in patent citations. We estimate a market valuation equation for semiconductor firms during the 1980s and 1990s, and find an average value in the amount of $0.6 to 1.2 million "R&D-equivalent" dollars for the knowledge spillovers as embodied in one patent citation. For an average semiconductor firm, such an estimate implies that the total value of knowledge spillovers the firm received during the sample period could be as high as half of its actual total R&D expenditures in the same period. This provides a direct measure of the economic values of the social returns or externalities of relevant technological innovations. We also find that the value of knowledge spillovers declines as the size of the firm’s patent portfolio increases, and that self citations are more valuable than external citations, indicating a significant amount of tacit knowledge or know-how spillovers that occur within the firm.
Tradability, Productivity, and Understanding International Economic Integration
–September 1, 2005
Paul R. Bergin, Reuven GlickThis paper develops a two-country macro model with endogenous tradability to study features of international economic integration. Recent episodes of integration in Europe and North America suggest some surprising observations: while quantities of trade have increased significantly, especially along the extensive margin of goods previously not traded, price dispersion has not decreased and may even have increased. These observations challenge the usual understanding of integration in the literature. We propose a way of reconciling these price and quantity observations in a macroeconomic model where the decision of heterogeneous firms to trade internationally is endogenous. Trade is shaped both by the nature of heterogeneity — trade costs versus productivity — and by the nature of trade policies — cuts in fixed costs versus cuts in per unit costs like tariffs. For example, in contrast to tariff cuts, trade policies that work mainly by lowering various fixed costs of trade may have large effects on entry decisions at the extensive margin without having direct effects on price-setting decisions. Whether this entry raises or lowers price dispersion depends on the type of heterogeneity that distinguishes the new entrants from incumbent traders.
The IMF in a World of Private Capital Markets
–February 21, 2005
Barry EichengreenThe IMF attempts to stabilize private capital flows to emerging markets by providing public monitoring and emergency finance. In analyzing its role we contrast cases where banks and bondholders do the lending. Banks have a natural advantage in monitoring and creditor coordination, while bonds have superior risk sharing characteristics. Consistent with this assumption, banks reduce spreads as they obtain more information through repeat transactions with borrowers. By comparison, repeat borrowing has little influence in bond markets, where publicly-available information dominates. But spreads on bonds are lower when they are issued in conjunction with IMF-supported programs, as if the existence of a program conveyed positive information to bondholders. The influence of IMF monitoring in bond markets is especially pronounced for countries vulnerable to liquidity crises.
Collateral Damage: Trade Disruption and the Economic Impact of War
–August 1, 2005
Reuven Glick, Alan M. TaylorConventional wisdom in economic history suggests that conflict between countries can be enormously disruptive of economic activity, especially international trade. Yet nothing is known empirically about these effects in large samples. We study the effects of war on bilateral trade for almost all countries with available data extending back to 1870. Using the gravity model, we estimate the contemporaneous and lagged effects of wars on the trade of belligerent nations and neutrals, controlling for other determinants of trade. We find large and persistent impacts of wars on trade, and hence on national and global economic welfare. A rough accounting indicates that such costs might be of the same order of magnitude as the "direct" costs of war, such as lost human capital, as illustrated by case studies of World War I and World War II.
Maintenance Expenditures and Indeterminacy under Increasing Returns to Scale
–July 1, 2006
Jang-Ting Guo, Kevin J. LansingThis paper develops a one-sector real business cycle model in which competitive firms allocate resources for the production of goods, investment in new capital, and maintenance of existing capital. Firms also choose the utilization rate of existing capital. A higher utilization rate leads to faster capital depreciation, while an increase in maintenance activity has the opposite effect. We show that as the equilibrium ratio of maintenance expenditures to GDP rises, the required degree of increasing returns for local indeterminacy declines over a wide range of parameter combinations. When the model is calibrated to match empirical evidence on the relative size of maintenance and repair activity, we find that local indeterminacy (and belief-driven fluctuations) can occur with a mild and empirically plausible degree of increasing returns–around 1.08.
How Have Borrowers Fared in Banking Mega-mergers?
–March 1, 2005
Kenneth A. Carow, Edward J. Kane, Rajesh P. NarayananPrevious studies of event returns surrounding bank mergers show that banks gain value in megamergers and additional value when they absorb in-market competitors. A portion of these gains has been traced to the increased bargaining power of banks vis-a-vis regulators and other competitors. We demonstrate that increased bargaining power of megabanks adversely affects loan customers of the acquired institution. Wealth losses are greater when loan customers are credit-constrained, the loan customer is smaller, or the acquisition is an in-market deal. These findings reinforce complaints that the ongoing consolidation in banking has unfavorably affected the availability of credit for smaller firms and especially capital-constrained firms.
Beggar Thy Neighbor? The In-State, Out-of-State, and Aggregate Effects of R&D Tax Credits
–August 1, 2008
Daniel WilsonThe proliferation of R&D tax incentives among U.S. states in recent decades raises two important questions: (1) Are these tax incentives effective in achieving their stated objective, to increase R&D spending within the state? (2) To the extent the incentives do increase R&D within the state, how much of this increase is due to drawing R&D away from other states? In short, this paper answers (1) "yes" and (2) "nearly all," with the implication that the net national effect of R&D tax incentives on R&D spending is near zero. The paper addresses these questions by exploiting the cross-sectional and time-series variation in R&D tax credits, and in turn the user cost of R&D, among U.S. states from 1981-2004 to estimate an augmented version of the standard R&D factor demand model. I estimate an in-state user cost elasticity (UCE) around -2.5 (in the long-run), consistent with previous studies of the R&D cost elasticity. However, the R&D elasticity with respect to costs in neighboring states, which has not previously been investigated, is estimated to be around +2.7, suggesting a zero-sum game among states and raising concerns about the efficiency of state R&D credits from the standpoint of national social welfare.
Exchange Rate Overshooting and the Costs of Floating
–May 1, 2005
Michele Cavallo, Kate Kisselev, Fabrizio Perri, Nouriel RoubiniCurrency crises are usually associated with large nominal and real depreciations. In some countries depreciations are perceived to be very costly ("fear of floating"). In this paper we try to understand the reasons behind this fear. We first look at episodes of currency crises in the 1990s and establish that countries entering a crisis with high levels of foreign debt tend to experience large real exchange rate overshooting (devaluation in excess of the long-run equilibrium level) and large output contractions. We then develop a model of a small open economy that helps to explain this evidence. The key element of the model is the presence of a margin constraint on the domestic country. Real devaluations, by reducing the value of domestic assets relative to international liabilities, make countries with high foreign debt more likely to hit the constraint. When countries hit the constraint they are forced to sell domestic assets, and this causes a further devaluation of the currency (overshooting) and a reduction of their stock prices (overreaction). This fire sale can have a significant negative wealth effect. The model highlights a key tradeoff when considering fixed versus flexible exchange rate regimes; a fixed exchange regime can, by avoiding exchange rate overshooting, mitigate the negative wealth effect but at the cost of additional distortions and output drops in the short run. There are plausible parameter values under which fixed exchange rates dominate flexible exchange rates from a welfare perspective.
Alternative Measures of the Federal Reserve Banks’ Cost of Equity Capital
–October 1, 2005
Michelle L. Barnes, Jose A. LopezThe Monetary Control Act of 1980 requires the Federal Reserve System to provide payment services to depository institutions through the twelve Federal Reserve Banks at prices that fully reflect the costs a private-sector provider would incur, including a cost of equity capital (COE). Although Fama and French (1997) conclude that COE estimates are "woefully" and "unavoidably" imprecise, the Reserve Banks require such an estimate every year. We examine several COE estimates based on the CAPM model and compare them using econometric and materiality criteria. Our results suggests that the benchmark CAPM model applied to a large peer group of competing firms provides a COE estimate that is not clearly improved upon by using a narrow peer group, introducing additional factors into the model, or taking account of additional firm-level data, such as leverage and line-of-business concentration. Thus, a standard implementation of the benchmark CAPM model provides a reasonable COE estimate, which is needed to impute costs and set prices for the Reserve Banks’ payments business.
Offshore Financial Centers: Parasites or Symbionts?
–May 1, 2005
Andrew K. RoseThis paper analyzes the causes and consequences of offshore financial centers (OFCs). Since OFCs are likely to be tax havens and money launderers, they encourage bad behavior in source countries. Nevertheless, OFCs may also have unintended positive consequences for their neighbors, since they act as a competitive fringe for the domestic banking sector. We derive and simulate a model of a home country monopoly bank facing a representative competitive OFC which offers tax advantages attained by moving assets offshore at a cost that is increasing in distance between the OFC and the source. Our model predicts that proximity to an OFC is likely to have pro-competitive implications for the domestic banking sector, although the overall effect on welfare is ambiguous. We test and confirm the predictions empirically. Proximity to an OFC is associated with a more competitive domestic banking system and greater overall financial depth.
Modeling Bond Yields in Finance and Macroeconomics
–January 1, 2005
Francis X. Diebold, Monika Piazzesi, Glenn D. RudebuschFrom a macroeconomic perspective, the short-term interest rate is a policy instrument under the direct control of the central bank. From a finance perspective, long rates are risk-adjusted averages of expected future short rates. Thus, as illustrated by much recent research, a joint macro-finance modeling strategy will provide the most comprehensive understanding of the term structure of interest rates. We discuss various questions that arise in this research, and we also present a new examination of the relationship between two prominent dynamic, latent factor models in this literature: the Nelson-Siegel and affine no-arbitrage term structure models.
Government Consumption Expenditures and the Current Account
–February 1, 2005
Michele CavalloThis paper distinguishes between two components of government consumption, expenditure on final goods and expenditure on hours, and compares the effects of changes in these two on the current account. I find that changes in government expenditure on hours do not directly affect the current account and that their impact is considerably smaller than the impact produced by changes in government expenditure on final goods. These findings indicate that considering government consumption as entirely expenditure on final goods leads to overestimating its role in accounting for movements in the current account balance.
On Using Relative Prices to Measure Capital Specific Technological Progress
–March 1, 2005
Milton H. Marquis, Bharat TrehanRecently, Greenwood, Hercowitz and Krusell (GHK) have identified the relative price of (new) capital with capital-specific technological progress. In a two-sector growth model, however, the relative price of capital equals the ratio of the productivity processes in the two sectors. Restrictions from this model are used with data on wages and prices to construct measures of productivity growth and test the GHK identification, which is easily rejected by the data. This raises questions about various measures of the contribution that capital-specific technological progress might make to the economy. This identification also induces a negative correlation between the resulting measures of capital-specific and economy-wide technological change, which potentially explains why papers employing this identification find that capital-specific technological change accelerated in the mid-1970s. We impose structure on the productivity measures based on their long-run behavior and find evidence of a slowdown in productivity in the 1970s that is common to both sectors and an acceleration in the mid-1990s that is exclusive to the capital sector.
The Welfare Consequences of ATM Surcharges: Evidence from a Structural Entry Model
–October 1, 2005
Gautam Gowrisankaran, John KrainerWe estimate a structural model of the market for automatic teller machines (ATMs) in order to evaluate the implications of regulating ATM surcharges on ATM entry and consumer and producer surplus. We estimate the model using data on firm and consumer locations, and identify the parameters of the model by exploiting a source of local quasi-experimental variation, that the state of Iowa banned ATM surcharges during our sample period while the state of Minnesota did not. We develop new econometric methods that allow us to estimate the parameters of equilibrium models without computing equilibria. Monte Carlo evidence shows that the estimator performs well. We find that a ban on ATM surcharges reduces ATM entry by about 12 percent, increases consumer welfare by about 10 percent and lowers producer profits by about 10 percent. Total welfare remains about the same under regimes that permit or prohibit ATM surcharges and is about 17 percent lower than the surplus maximizing level. This paper can help shed light on the theoretically ambiguous implications of free entry on consumer and producer welfare for differentiated products industries in general and ATMs in particular.
Dollar Bloc or Dollar Block: External Currency Pricing and the East Asian Crisis
–May 1, 2004
David Cook, Michael DevereuxThis paper provides a quantitative investigation of the East Asian crisis of 1997-1999. The two essential features of the crisis that we focus on are (a) the crisis was a regional phenomenon; the depth and severity of the crisis were exacerbated by a large decline in regional demand, and (b) the practice of setting export goods prices in dollars (which we document empirically) led to a powerful internal propagation effect of the crisis within the region, contributing greatly to the decline in regional trade flows. We construct a model with these two features and show that it can do a reasonable job of accounting for the response of the main macroeconomic aggregates in Korea, Malaysia, and Thailand during the crisis.
Private Capital Flows, Capital Controls, and Default Risk
–August 1, 2004
Mark L. J. WrightWhat has been the effect of the shift in emerging market capital flows toward private sector borrowers? Are emerging market capital flows more efficient? If not, can controls on capital flows improve welfare? This paper shows that the answers depend on the form of default risk. When private loans are enforceable, but there is the risk that the government will default on behalf of all residents, private lending is inefficient and capital controls are potentially Pareto-improving. However, when private agents may individually default, capital flow subsidies are potentially Pareto-improving.
Putting the Brakes on Sudden Stops: The Financial Frictions-Moral Hazard Tradeoff of Asset Price Guarantees
–September 1, 2004
Enrique MendozaThe hypothesis that "sudden stops" to capital inflows in emerging economies may be caused by global capital market frictions, such as collateral constraints and trading costs, suggests that sudden stops could be prevented by offering price guarantees on the emerging market asset class. Providing these guarantees is a risky endeavor, however, because they introduce a moral hazard-like incentive similar to those that are also viewed as a cause of emerging markets crises. This paper studies this financial frictions-moral hazard tradeoff using an equilibrium asset-pricing model in which margin constraints, trading costs, and ex ante price guarantees interact in the determination of asset prices and macroeconomic dynamics. In the absence of guarantees, margin calls and trading costs create distortions that produce sudden stops driven by occasionally binding credit constraints and Irving Fisher’s debt-deflation mechanism. Price guarantees contain the asset deflation by creating another distortion that props up the foreign investors’ demand for emerging market assets. Quantitative simulation analysis shows the strong interaction of these two distortions in driving the dynamics of asset prices, consumption, and the current account. Price guarantees are found to be effective for containing sudden stops but at the cost of introducing potentially large distortions that could lead to "overvaluation" of emerging market assets.
Country Spreads and Emerging Countries: Who Drives Whom?
–October 1, 2003
Martin Uribe, Z. Vivian YueA number of studies have stressed the role of movements in U.S. interest rates and country spreads in driving business cycles in emerging market economies. At the same time, country spreads have been found to respond to changes in both the U.S. interest rate and domestic conditions in emerging markets. These intricate interrelationships leave open a number of fundamental questions: Do country spreads drive business cycles in emerging countries or vice versa or both? Do U.S. interest rates affect emerging countries directly or primarily through their effect on country spreads? This paper addresses these and other related questions using a methodology that combines empirical and theoretical elements. The main findings are as follows: (1) U.S. interest rate shocks explain about 20 percent of movements in aggregate activity in emerging market economies at business-cycle frequency. (2) Country spread shocks explain about 12 percent of business-cycle movements in emerging economies. (3) About 60 percent of movements in country spreads are explained by country spread shocks. (4) In response to an increase in U.S. interest rates, country spreads first fall and then display a large delayed overshooting. (5) U.S. interest rate shocks affect domestic variables mostly through their effects on country spreads. (6) The fact that country spreads respond to business conditions in emerging economies significantly exacerbates aggregate volatility in these countries. (7) The U.S. interest rate shocks and country spread shocks identified in this paper are plausible in the sense that they imply similar business cycles in the context of an empirical VAR model as they do in the context of a theoretical dynamic general equilibrium model of an emerging market economy.
Defaultable Debt, Interest Rates, and the Current Account
–May 1, 2004
Mark Aguiar, Gita GopinathWorld capital markets have experienced large-scale sovereign defaults on a number of occasions, the most recent being Argentina’s default in 2002. In this paper we develop a quantitative model of debt and default in a small open economy. We use this model to match four empirical regularities regarding emerging markets: defaults occur in equilibrium, interest rates are countercyclical, net exports are countercyclical, and interest rates and the current account are positively correlated. That is, emerging markets on average borrow more in good times and at lower interest rates than they do in slumps. Our ability to match these facts within the framework of an otherwise standard business cycle model with endogenous default relies on the importance of a stochastic trend in emerging markets.
Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria
–August 1, 2004
Roberto Chang, Andres VelascoExchange rate policies depend on portfolio choices, and portfolio choices depend on anticipated exchange rate policies. This opens the door to multiple equilibria in policy regimes. We construct a model in which agents optimally choose to denominate their assets and liabilities either in domestic or in foreign currency. The monetary authority optimally chooses to float or to fix the currency, after portfolios have been chosen. We identify conditions under which both fixing and floating are equilibrium policies: if agents expect fixing and arrange their portfolios accordingly, the monetary authority validates that expectation; the same happens if agents initially expect floating. We also show that a flexible exchange rate Pareto-dominates a fixed one. It follows that social welfare would rise if the monetary authority could precommit to floating.
How Do Trade and Financial Integration Affect the Relationship between Growth and Volatility?
–May 1, 2004
M. Ayban Kose, Eswar S. Prasad, Marco E. TerronesThe influential work of Ramey and Ramey (1995) highlighted an empirical relationship that has now come to be regarded as conventional wisdom–that output volatility and growth are negatively correlated. We reexamine this relationship in the context of globalization–a term typically used to describe the phenomenon of growing international trade and financial integration that has intensified since the mid-1980s. We employ various econometric techniques and a comprehensive new data set to analyze the link between growth and volatility. Our findings suggest that, while the basic negative association between growth and volatility has been preserved during the 1990s, both trade and financial integration attenuate this negative relationship. Specifically, countries that are more open to trade appear to face a less severe tradeoff between growth and volatility. We find a similar, although slightly less robust, result for the interaction of financial integration with volatility. We also investigate some of the channels, including investment and credit, through which different aspects of global integration could affect the growth-volatility relationship.
When in Peril, Retrench: Testing the Portfolio Channel of Contagion
–July 1, 2004
Fernando A. BronerOne plausible mechanism through which financial market shocks may propagate across countries is through the effect of past gains and losses on investors’ risk aversion. The paper first presents a simple model examining how heterogeneous changes in investors’ risk aversion affects portfolio decisions and stock prices. Second, the paper shows empirically that, when funds’ returns are below average, they adjust their holdings toward the average (or benchmark) portfolio. In other words, they tend to sell the assets of countries in which they were "overweight," increasing their exposure to countries in which they were "underweight." Based on this insight, the paper discusses a matrix of financial interdependence reflecting the extent to which countries share overexposed funds. Comparing this measure to indexes of trade or bank linkages indicates that our index can improve predictions about which countries are likely to be affected by contagion from crisis centers.
Market Price Accounting and Depositor Discipline in Japanese Regional Banks
–May 1, 2004
Mark M. Spiegel, Nobuyoshi YamoriWe examine the determinants of Japanese regional bank decisions concerning pricing unrealized losses or gains to market. We also examine the impact of these decisions on the intensity of depositor discipline, in the form of the sensitivity of deposit growth to bank financial conditions. To obtain consistent estimates of depositor discipline, we first model and estimate the bank pricing-to-market decision and then estimate the intensity of depositor discipline after conditioning for that decision. We find that banks were less likely to price to market the larger were their unrealized securities losses. We also find statistically significant evidence of depositor discipline among banks that elected to price their assets to market. Our results indicate that depositor discipline was more intense for the subset of banks that priced-to-market, suggesting that increased transparency may enhance depositor discipline.
Deposit Insurance, Regulatory Forbearance and Economic Growth: Implications for the Japanese Banking Crisis
–January 1, 2004
Robert Dekle, Kenneth M. KletzerAn endogenous growth model with financial intermediation is used to show how public deposit insurance and weak prudential regulation can lead to banking crises and permanent declines in economic growth. The impact of regulatory forbearance on investment, saving, and asset price dynamics under perfect foresight are derived in the model. The assumptions of the theoretical model are based on essential features of the Japanese financial system and its regulation. The model demonstrates how banking and growth crises can evolve under perfect foresight. The dynamics for economic aggregates and asset prices predicted by the model are shown to be generally consistent with the experience of the Japanese economy and financial system through the 1990s. We also test our maintained hypothesis of rational expectations using asset price data for Japan over the 1980s and 1990s. An implication of our analysis is that delaying the resolution of banking crises adversely affects future economic growth.
Accounting for a Shift in Term Structure Behavior with No-Arbitrage and Macro-Finance Models
–November 1, 2005
Glenn D. Rudebusch, Tao WuThis paper examines a shift in the dynamics of the term structure of interest rates in the U.S. during the mid-1980s. We document this shift using standard interest rate regressions and using dynamic, affine, no-arbitrage models estimated for the pre- and post-shift subsamples. The term structure shift largely appears to be the result of changes in the pricing of risk associated with a "level" factor. Using a macro-finance model, we suggest a link between this shift in term structure behavior and changes in the dynamics and risk pricing of the Federal Reserve’s inflation target as perceived by investors.
North-South Technological Diffusion and Dynamic Gains from Trade
–July 1, 2005
Michelle P. Connolly, Diego ValderramaThis paper studies the transitional dynamics in a quality ladder model of endogenous growth in which North-South trade leads to technological diffusion through reverse engineering of intermediate goods. The concept of learning-to-learn is incorporated into both imitative and innovative processes, which in turn drive domestic technological progress. International trade with imitation leads to feedback effects between Southern imitators and Northern innovators who compete for the world market. Consequently, both regions face transition paths dependent on their relative technologies. We solve the model numerically to illustrate the transition paths and welfare effects of Southern trade liberalization. While particular welfare results depend on parameter choices, we demonstrate that focusing solely on steady-state results can lead to incorrect welfare interpretations.
Implications of Intellectual Property Rights for Dynamic Gains from Trade
–July 1, 2005
Michelle P. Connolly, Diego ValderramaA simple intellectual property rights (IPRs) framework is introduced into a dynamic quality ladder model of technological diffusion between innovating firms in one country and imitating firms in another country. The presence of technological spillovers and feedback effects between firms in the two countries demonstrates that, even when steady state growth increases, transition costs sometimes dominate steady state welfare gains. Most existing models of international IPRs find that high intellectual property enforcement in the imitating country leads to welfare gains in the innovating country at the expense of the imitating country. In contrast, we find IPR regimes that, even after accounting for transition costs, positively affect welfare in both countries. Preferred IPR regimes maintain competition from imitative activity but enforce some remuneration to innovators for the spillovers they generate. Well-designed IPR regimes imposed at the time of trade liberalization will be welfare enhancing for both regions relative to trade liberalization without IPR enforcement.
Using a Long-Term Interest Rate as the Monetary Policy Instrument
–December 1, 2004
Bruce McGough, Glenn D. Rudebusch, John C. WilliamsUsing a short-term interest rate as the monetary policy instrument can be problematic near its zero bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find, when Taylor type policy rules are used to set the long rate in a standard New Keynesian model, indeterminacy–that is, multiple rational expectations equilibria–may often result. However, a policy rule with a long rate policy instrument that responds in a "forward-looking" fashion to inflation expectations can avoid the problem of indeterminacy.
Investment Behavior of U.S. Firms over Heterogeneous Capital Goods: A Snapshot
–March 1, 2006
Daniel WilsonRecent research has indicated that investment in certain capital types, such as computers, has fostered accelerated productivity growth and enabled a fundamental reorganization of the workplace. However, remarkably little is known about the composition of investment at the micro level. This short paper takes an important first step in filling this knowledge gap by looking at the newly available micro data from the 1998 Annual Capital Expenditure Survey (ACES), a sample of roughly 30,000 firms drawn from the private, nonfarm economy. The paper establishes a number of stylized facts. Among other things, I find that in contrast to aggregate data the typical firm tends to concentrate its capital expenditures in a very limited number of capital types, though which types are chosen varies greatly from firm to firm. In addition, computers account for a significantly larger share of firms’ incremental investment than they do of lumpy investment. [Keywords: Capital Heterogeneity, Investment; JEL Codes D21, D24, D29.]
Financial Contracting and the Choice between Private Placement and Publicly Offered Bonds
–November 1, 2004
Willard T. Carleton, Simon H. KwanPrivate placement bonds have unique financial contracting in controlling borrower-lender agency conflicts due to direct monitoring and the relative ease of future renegotiation. Our data show that private placements are more likely to have restrictive covenants and are more likely to be issued by smaller and riskier borrowers. We find the determinants of bond yield spreads to be quite different between private placements and public issues, reflecting the different institutional arrangements between the two markets. Finally, in issuing bonds, we find that firms self-select the bond type to minimize both the financing costs and the transaction costs.
Testing the Strong Form of Market Discipline: The Effects of Public Market Signals on Bank Risk
–November 1, 2004
Simon H. KwanUnder the strong form of market discipline, publicly traded banks that have constantly available public market signals from their stock (and bond) prices would take less risk than non-publicly traded banks because counterparties, borrowers, and regulators could react to adverse public market signals against publicly traded banks. In comparing the credit risk, earnings risk, capitalization, and failure risk between publicly traded and non-publicly traded banks, the evidence in this paper rejects the strong-form of market discipline. In fact, the findings indicate that banking organizations tend to take more risk when they were publicly traded than when they were privately owned.
The Ins and Outs of Poverty in Advanced Economies: Poverty Dynamics in Canada, Germany, Great Britain, and the United States
–November 1, 2004
Robert G. VallettaComparative analysis of poverty dynamics–incidence, transitions, and persistence–can yield important insights about the nature of poverty and the effectiveness of alternative policy responses. This manuscript compares poverty dynamics in four advanced industrial countries (Canada, unified Germany, Great Britain, and the United States) for overlapping six-year periods in the 1990s. The data indicate that poverty persistence is higher in North America than in Europe; for example, despite high incidence, poverty in Great Britain is relatively transitory. Most poverty transitions, and the prevalence of chronic poverty, are associated with employment instability and family dissolution in all four countries. The results also suggest that differences in social policy are crucial for the observed differences in poverty incidence and persistence between Europe and North America.
Specifying and Estimating New Keynesian Models with Instrument Rules and Optimal Monetary Policies
–January 1, 2005
Richard DennisThis paper looks at whether sticky-price New Keynesian models with microfounded inertia can usefully describe U.S. data. I estimate a range of models, considering specifications with either internal or external consumption habits, specifications containing Taylor-type rules or an optimal discretionary rule, and specifications where inflation is driven by movements in the gap or real marginal costs. Among other results, I find that models with external habits produce very similar aggregate behavior to models with internal habits. I also find that modeling monetary policy in terms of an optimal discretionary rule describes U.S. data as well as a forward-looking Taylor-type rule does, and that the data favor the traditional gap-based Phillips curve over specifications containing real marginal costs.
Asset Price Declines and Real Estate Market Illiquidity: Evidence from Japanese Land Values
–January 1, 2005
John KrainerWe examine the pattern of price depreciation in Japanese land values subsequent to the 1990 stock market crash. While all land values fell heavily, the data indicate that Japanese commercial land values fell much more quickly than residential land values. Using an error-correction specification, we confirm that Japanese commercial land prices exhibited faster convergence to steady state values than residential land prices. We then develop an overlapping-generations model with two-sided matching and search to explain this disparity. In the model, old agents own real estate and are matched each period with a young agent endowed with an unverifiable idiosyncratic service value for the old agent’s real estate. When fundamentals decline, the old agents optimally "fish" for high service flow young agents by pricing above average valuation levels. This leads to higher illiquidity and default in times of price decline, as well as price persistence which is increasing in the variance of average service flows. As we would posit that the variance of service flows would be higher for residential real estate than for the commercial real estate market, this model matches the Japanese experience.
Currency Crises, Capital Account Liberalization, and Selection Bias
–June 1, 2005
Reuven Glick, Xueyan Guo, Michael HutchisonAre countries with unregulated capital flows more vulnerable to currency crises? Efforts to answer this question properly must control for "self selection" bias since countries with liberalized capital accounts may also have more sound economic policies and institutions that make them less likely to experience crises. We employ a matching and propensity score methodology to address this issue in a panel analysis of developing countries. Our results suggest that, after controlling for sample selection bias, countries with liberalized capital accounts experience a lower likelihood of currency crises. That is, when two countries have the same likelihood of allowing free movement of capital (based on historical evidence and a very similar set of economic and political characteristics)–and one country imposes controls and the other does not–the country without controls has a lower likelihood of experiencing a currency crisis.
Transition Dynamics in Vintage Capital Models: Explaining the Postwar Catch-Up of Germany and Japan
–July 1, 2004
Simon Gilchrist, John C. WilliamsWe consider a neoclassical interpretation of Germany and Japan’s rapid postwar growth that relies on a catch-up mechanism through capital accumulation where technology is embodied in new capital goods. Using a putty-clay model of production and investment, we are able to capture many of the key empirical properties of Germany and Japan’s postwar transitions, including persistently high but declining rates of labor and total factor productivity growth, a U-shaped response of the capital-output ratio, rising rates of investment and employment, and moderate rates of return to capital.
IT and Beyond: The Contribution of Heterogeneous Capital to Productivity
–May 1, 2008
Daniel WilsonThis paper explores the relationship between capital composition and productivity using a unique and highly detailed data set on firm-level investment in the U.S. We develop a succinct methodology for modeling the separate effects of a large number of capital types in a production function framework. We then use this methodology, combined with recently developed techniques for accounting for unobserved productivity, to identify these effects and back out the implied marginal products of each capital type. The results indicate that information and communications technology (ICT) capital–specifically, computers, software, and communications equipment–are positively and statistically significantly associated with output, even after conditioning on total capital, labor, and various proxies for unobserved productivity. We compare the implied marginal products for different capital types to official data on rental prices and find that the marginal products of the ICT capital types are substantially above their measured rental prices. Lastly, we provide evidence of complementarities and substitutabilities, both among capital types–a rejection of the common assumption of perfect substitutability–and between certain capital types and labor.
Why the Apple Doesn’t Fall Far: Understanding Intergenerational Transmission of Human Capital
–July 1, 2004
Sandra E. Black, Paul Devereux, Kjell SalvanesParents with higher education levels have children with higher education levels. However, is this because parental education actually changes the outcomes of children, suggesting an important spillover of education policies, or is it merely that more able individuals who have higher education also have more able children? This paper proposes to answer this question with a unique data set from Norway. Using the reform of the education system that was implemented in different municipalities at different times in the 1960s as an instrument for parental education, we find little evidence of a causal relationship between parents’ education and children’s education, despite significant OLS relationships. We find 2SLS estimates that are consistently lower than the OLS estimates, with the only statistically significant effect being a positive relationship between mother’s education and son’s education. These findings suggest that the high correlations between parents’ and children’s education are due primarily to family characteristics and inherited ability and not education spillovers.
Robust Estimation and Monetary Policy with Unobserved Structural Change
–July 1, 2004
John C. WilliamsThis paper considers the joint problem of model estimation and implementation of monetary policy in the face of uncertainty regarding the process of structural change in the economy. I model unobserved structural change through time variation in the natural rates of interest and unemployment. I show that certainty equivalent optimal policies perform poorly when there is model uncertainty about the natural rate processes. I then examine the properties of combined estimation methods and policy rules that are robust to this type of model uncertainty. I find that weighted averages of sample means perform well as estimators of natural rates. The optimal policy under uncertainty responds more aggressively to inflation and less so to the perceived unemployment gap than the certainty equivalent policy. This robust estimation/policy combination is highly effective at mitigating the effects of natural rate mismeasurement.
Time-Varying Equilibrium Real Rates and Monetary Policy Analysis
–June 1, 2004
Bharat Trehan, Tao WuAlthough it is generally recognized that the equilibrium real interest rate (ERR) varies over time, most recent work on policy analysis has been carried out under the assumption that this rate is constant. We show how this assumption can affect inferences about the conduct of policy in two different areas. First, if the ERR moves in the same direction as the trend growth rate (as is suggested by theory), the probability that an unperceived change in trend growth will lead to a substantial change in inflation is noticeably lower than is suggested by recent analyses (of inflation in the 1970s, for example) that assume a constant ERR. Second, if the monetary authority targets a time varying ERR but the econometrician assumes otherwise, estimated policy rules will tend to exaggerate the degree of interest rate smoothing as well as the weight that the monetary authority places upon inflation.
Consumer Sentiment, the Economy, and the News Media
–July 1, 2004
Mark Doms, Norman J. MorinThe news media affects consumers’ perceptions of the economy through three channels. First, the news media conveys the latest economic data and the opinions of professionals to consumers. Second, consumers receive a signal about the economy through the tone and volume of economic reporting. Last, the greater the volume of news about the economy, the greater the likelihood that consumers will update their expectations about the economy. We find evidence that all three of these channels affect consumer sentiment. We derive measures of the tone and volume of economic reporting, building upon the R-word index of The Economist. We find that there are periods when reporting on the economy has not been consistent with actual economic events, especially during the early 1990s. As a consequence, there are times during which consumer sentiment is driven away from what economic fundamentals would suggest. We also find evidence supporting that consumers update their expectations about the economy much more frequently during periods of high news coverage than in periods of low news coverage; high news coverage of the economy is concentrated during recessions and immediately after recessions, implying that "stickiness" in expectations is countercyclical. Finally, because the model of consumer sentiment is highly nonlinear, month-to-month changes in sentiment are difficult to interpret. For instance, although an increase in the number of articles that mention "recession" typically is associated with a decline in sentiment, under certain conditions it can actually result in an increase in various sentiment indexes.
Productivity, Tradability, and the Long-Run Price Puzzle
–June 1, 2004
Paul R. Bergin, Reuven Glick, Alan M. TaylorLong-run cross-country price data exhibit a puzzle. Today, richer countries exhibit higher price levels than poorer countries, a stylized fact usually attributed to the "Balassa-Samuelson" effect. But looking back fifty years, or more, this effect virtually disappears from the data. What is often assumed to be a universal property is actually quite specific to recent times. What might explain this historical pattern? We adopt a framework where goods are differentiated by tradability and productivity. A model with monopolistic competition, a continuum-of-goods, and endogenous tradability allows for theory and history to be consistent for a wide range of underlying productivity shocks.
Monetary and Financial Integration: Evidence from Portuguese Borrowing Patterns
–June 1, 2004
Mark M. SpiegelThis paper examines the impact of European Monetary Union (EMU) accession on bilateral Portuguese international borrowing patterns. Using a difference-indifferences methodology, I demonstrate that Portugal’s accession to the EMU was accompanied by a change in its borrowing pattern in favor of borrowing from its EMU partner nations. This extends the evidence in the literature that overall international borrowing is facilitated by the creation of a monetary union, and raises the issue of financial diversion. The results are shown to survive a wide variety of robustness checks and are corroborated by preliminary evidence concerning Greece’s accession to EMU in 2001.
Lock-in of Extrapolative Expectations in an Asset Pricing Model
–October 1, 2005
Kevin J. LansingThis paper examines an agent’s choice of forecast method within a standard asset pricing model. To make a conditional forecast, a representative agent may choose one of the following: (1) a rational (or fundamentals-based) forecast that employs knowledge of the stochastic process governing dividends, (2) a constant forecast based on a simple long-run average of the forecast variable, or (3) a time-varying forecast that extrapolates from the last observation of the forecast variable. I show that a representative agent who is concerned about minimizing forecast errors may inadvertently become "locked in" to an extrapolative forecast. In particular, the initial use of extrapolation alters the law of motion of the forecast variable so that the agent perceives no accuracy gain from switching to one of the alternative forecast methods. Under extrapolative expectations, the model can generate excess volatility of stock prices, time-varying volatility of returns, long-horizon predictability of returns, bubbles driven by optimism about the future, and sharp downward movements in stock prices that resemble market crashes. All of these features appear to be present in long-run U.S. stock market data.
Using Securities Market Information for Bank Supervisory Monitoring
–May 1, 2004
John Krainer, Jose A. LopezBank supervisors in the United States conduct comprehensive on-site inspections of bank holding companies (BHCs) and assign them a supervisory rating meant to summarize their overall condition. We develop an empirical forecasting model of these ratings that combines supervisory and securities market data. We find that securities market variables, such as BHC stock returns and bond yield spreads, improve the model’s in-sample fit. We also find that debt market variables provide more information on supervisory ratings for BHCs closer to default, while equity market variables provide more information for those further from default. In out-of sample forecasting, we find that the accuracy of the model with both equity and debt variables is little different from the accuracy of a model based on supervisory information alone. However, the model with securities market data identifies additional ratings downgrades, which supervisors would probably value enough to warrant the use of this extended model for off-site monitoring purposes.
Learning and Shifts in Long-Run Productivity Growth
–March 1, 2004
Rochelle M. Edge, Thomas Laubach, John C. WilliamsShifts in the long-run rate of productivity growth–such as those experienced by the U.S. economy in the 1970s and 1990s–are difficult, in real time, to distinguish from transitory fluctuations. In this paper, we analyze the evolution of forecasts of long-run productivity growth during the 1970s and 1990s and examine in the context of a dynamic general equilibrium model the consequences of gradual real-time learning on the responses to shifts in the long-run productivity growth rate. We find that a simple updating rule based on an estimated Kalman filter model using real-time data describes economists’ long-run productivity growth forecasts during these periods extremely well. We then show that incorporating this process of learning has profound implications for the effects of shifts in trend productivity growth and can dramatically improve the model’s ability to generate responses that resemble historical experience. If immediately recognized, an increase in the long-run growth rate causes long-term interest rates to rise and produces a sharp decline in employment and investment, contrary to the experiences of the 1970s and 1990s. In contrast, with learning, a rise in the long-run rate of productivity growth sets off a sustained boom in employment and investment, with long-term interest rates rising only gradually. We find the characterization of learning to be crucial regardless of whether shifts in long-run productivity growth owe to movements in TFP growth concentrated in the investment goods sector or economy-wide TFP.
Evaluating Interest Rate Covariance Models within a Value-at-Risk Framework
–March 1, 2004
Miguel A. Ferreira, Jose A. LopezWe find that covariance matrix forecasts for an international interest rate portfolio generated by a model that incorporates interest-rate level volatility effects perform best with respect to statistical loss functions. However, within a value-at-risk (VaR) framework, the relative performance of the covariance matrix forecasts depends greatly on the VaR distributional assumption. Simple forecasts based just on weighted averages of past observations perform best using a VaR framework. In fact, we find that portfolio variance forecasts that ignore the individual assets in the portfolio generate the lowest regulatory capital charge, a key economic decision variable for commercial banks. Our results provide empirical support for the commonly-used VaR models based on simple covariance matrix forecasts and distributional assumptions.
The Improving Relative Status of Black Men
–January 1, 2004
Kenneth A. Couch, Mary C. DalyUsing data from the Current Population Survey, we examine recent trends in the relative economic status of black men. Our findings point to gains in the relative wages of black men (compared to whites) during the 1990s, especially among younger workers. In 1989, the average black male worker (experienced or not) earned about 69 percent as much per week as the average white male worker. In 2001, the average younger black worker was earning about 86 percent as much as an equally experienced white male; black males at all experience levels earned 72 percent as much as the average white in 2001. Greater occupational diversity and a reduction in unobserved skill differences and/or labor market discrimination explain much of the trend. For both younger and older workers, general wage inequality tempered the rate of wage convergence between blacks and whites during the 1990s, although the effects were less pronounced than during the 1980s.
Does Regional Economic Performance Affect Bank Conditions? New Analysis of an Old Question
–November 1, 2003
Mary C. Daly, John Krainer, Jose A. LopezThe idea that regional economic performance affects bank health is intuitive and broadly consistent with the aggregate banking data. That said, micro-level research on this relationship provides a mixed picture of the importance, size, and timing of regional variables for bank performance. This paper helps reconcile the heterogeneous findings of previous research by: (1) employing a unique "composite measure" of regional economic performance that combines several regional indicators into a single index; (2) constructing bank-specific measures of regional economic conditions, based on bank deposit shares, that account for banks’ presence in several states; and (3) estimating models for all banks and intra- and interstate banks separately. Empirical results based on this bank-specific composite regional measure point to a tractable link between regional economic performance and bank health. The importance of regional variables holds for both intra- and inter-state banks. Out-of sample forecasts indicate that the composite index also helps tie down the relative riskiness of bank portfolios across states. Finally, although interstate banks do seem to diversify away some of their portfolio risk, our analysis suggests it is too soon to conclude that interstate banks are immune from regional influences.
The Decline of Activist Stabilization Policy: Natural Rate Misperceptions, Learning, and Expectations
–December 1, 2003
Athanasios Orphanides, John C. WilliamsWe develop an estimated model of the U.S. economy in which agents form expectations by continually updating their beliefs regarding the behavior of the economy and monetary policy. We explore the effects of policymakers’ misperceptions of the natural rate of unemployment during the late 1960s and 1970s on the formation of expectations and macroeconomic outcomes. We find that the combination of monetary policy directed at tight stabilization of unemployment near its perceived natural rate and large real-time errors in estimates of the natural rate uprooted heretofore quiescent inflation expectations and destabilized the economy. Had monetary policy reacted less aggressively to perceived unemployment gaps, inflation expectations would have remained anchored and the stagnation of the 1970s would have been avoided. Indeed, we find that less activist policies would have been more effective at stabilizing both inflation and unemployment. We argue that policymakers, learning from the experience of the 1970s, eschewed activist policies in favor of policies that concentrated on the achievement of price stability, contributing to the subsequent improvements in macroeconomic performance of the U.S. economy.
What’s Driving the New Economy?: The Benefits of Workplace Innovation
–October 1, 2003
Sandra E. Black, Lisa M. LynchThis paper argues that changes in workplace organization, including the usage of self-managed teams, incentive pay, and employee voice, have been a significant component of the turnaround in productivity growth in the United States during the 1990s. Our work goes beyond measuring the impact of computers on productivity and finds that these types of workplace innovation appear to explain a large part of the movement in multi-factor productivity in the United States over the period 1993-1996. These results suggest additional dimensions to the recent productivity growth in the US that may well have implications for productivity growth potential in Europe.
How Workers Fare When Employers Innovate
–February 1, 2003
Sandra E. Black, Anya Krivelyova, Lisa M. LynchComplementing existing work on firm organizational structure and productivity, this paper examines the impact of organizational change on workers. We find evidence that employers do appear to compensate at least some of their workers for engaging in high performance workplace practices. We also find a significant association between high performance workplace practices and increased wage inequality. Finally, we examine the relationship between organizational structure and employment changes and find that some practices, such as self-managed teams, are associated with greater employment reductions, while other practices, such as the percentage of workers involved in job rotation, are associated with lower employment reductions.
The Responses of Wages and Prices to Technology Shocks
–December 1, 2003
Rochelle M. Edge, Thomas Laubach, John C. WilliamsThis paper reexamines wage and price dynamics in response to permanent shocks to productivity. We estimate a micro-founded dynamic general equilibrium (DGE) model of the U.S. economy with sticky wages and sticky prices using impulse responses to technology and monetary policy shocks. We utilize a flexible specification for wage- and price-setting that allows for the sluggish adjustment of both the levels of these variables as in standard contracting models as well as intrinsic inertia in wage and price inflation. On the price front, we find that in our VAR inflation jumps in response to an identified permanent technology shock, implying that, on average, prices adjust quickly and that there is little evidence for any intrinsic inflation inertia like that commonly found in models used for monetary policy evaluation. On the wage front, we find evidence for significant inertia in wages and some intrinsic inertia in nominal wage inflation. Our results provide support for the standard sticky-price specification of the New Keynesian model; however, the evidence on the high degree of wage inertia presents a challenge for standard models of wage setting.
How Fast Do Personal Computers Depreciate? Concepts and New Estimates
–November 1, 2003
Mark Doms, Wendy E. Dunn, Stephen D. Oliner, Daniel E. SichelThis paper provides new estimates of depreciation rates for personal computers (PCs) using an extensive database on prices of used PCs. Our results show that PCs lose roughly half their remaining value, on average, with each additional year of use. We decompose that decline into age-related depreciation and a revaluation effect, where the latter effect is driven by the steep ongoing drop in the constant-quality prices of newly introduced PCs. Our results are directly applicable for measuring the depreciation of PCs in the National Income and Product Accounts (NIPA) and were incorporated into the December 2003 comprehensive NIPA revision. Regarding tax policy, our estimates suggest that the current tax depreciation schedule for PCs is about right in a zero-inflation environment. However, because the tax code is not indexed for inflation, the tax allowances would be too small in present value for inflation rates above the very low level now prevailing.
IT Investment and Firm Performance in U.S. Retail Trade
–November 1, 2003
Mark Doms, Ron S. Jarmin, Shawn D. KlimekWe examine the relationship between investments in information technology (IT) and two measures of retail firm performance: labor productivity and productivity growth over the 1992 to 1997 period. We use untapped firm and establishment micro data from the Censuses of Retail Trade and the Assets and Expenditures Survey. We show that large firms account for most retail IT investment, employment and establishment growth. We find evidence of a significant relationship between IT investment intensity and productivity growth. We found no evidence of a similar link between IT and growth in the number of establishments operated by retail firms.
The Macroeconomy and the Yield Curve: A Nonstructural Analysis
–October 1, 2003
S. Boragan Aruoba, Francis X. Diebold, Glenn D. RudebuschWe estimate a model with latent factors that summarize the yield curve (namely, level, slope, and curvature) as well as observable macroeconomic variables (real activity, inflation, and the stance of monetary policy). Our goal is to provide a characterization of the dynamic interactions between the macroeconomy and the yield curve. We find strong evidence of the effects of macro variables on future movements in the yield curve and much weaker evidence for a reverse influence. We also relate our results to a traditional macroeconomic approach based on the expectations hypothesis.
A Macro-Finance Model of the Term Structure, Monetary Policy, and the Economy
–December 1, 2004
Glenn D. Rudebusch, Tao WuThis paper develops and estimates a macro-finance model that combines a canonical affine no-arbitrage finance specification of the term structure with standard macroeconomic aggregate relationships for output and inflation. From this new empirical formulation, we obtain several interesting results: (1) the latent term structure factors from finance no-arbitrage models appear to have important macroeconomic and monetary policy underpinnings, (2) there is no evidence of monetary policy inertia or a slow partial adjustment of the policy interest rate by the Federal Reserve, and (3) both forward-looking and backward-looking elements play important roles in macroeconomic dynamics.
New Keynesian Optimal Policy Models: An Empirical Assessment
–November 1, 2004
Richard DennisThis paper estimates two optimization-based sticky-price New Keynesian models and assesses how well they describe U.S. output, inflation, and interest rate dynamics. We consider models in which either internal habit formation influence consumption behavior, and in which Calvo-pricing and inflation indexation generate price and inflation inertia. Subject to constraints dictated by household and firm behavior, monetary policy is set under discretion and the model’s time-consistent equilibrium is employed to estimate key behavioral parameters. We find that specifications estimated on consumption data perform better than specifications estimated on output data and that models with external habit formation out-perform models with internal habit formation. Nevertheless, even the best fitting specification displays characteristics that are inconsistent with the data.
Communications Equipment: What Has Happened to Prices?
–June 1, 2003
Mark DomsThis paper examines the prices for communications equipment, an important component of information technology. Unlike prices for computers which officially fall sharply every year, the official prices for communications equipment have barely budged over the past decade. This paper combines earlier work on prices for several segments of communications equipment with new results for public exchanges, fiber optic equipment, and modems. The results suggest that prices for communications equipment fall much faster than official statistics would indicate, but not as fast as computers. The results presented in this paper, if incorporated into the NIPAs, would decrease MFP growth by about 0.1 percentage point per year and increase the contribution of capital deepening by a likewise amount. Also, GDP growth would be boosted marginally."
When Do Matched-Model and Hedonic Techniques Yield Similar Measures?
–June 1, 2003
Ana M. Aizcorbe, Carol Corrado, Mark DomsHedonic techniques were developed to control for quality differences across goods and over time in order to construct constant-quality aggregate price measures. When the available data are a panel of high-frequency data on models whose characteristics are constant over time, matched-model price indexes can also be used to obtain constant quality price measures. We show this by demonstrating that, given data of this type, certain matched-model indexes yield price measures that are numerically close to those obtained using hedonic techniques. ; * This paper is a condensed version of a paper that was presented at the CRIW workshop on Price Measurement at the NBER Summer Institute, July 31-August 1, 2000 and is available at http://www.nber.org.
Prices for Local Area Network Equipment
–June 1, 2003
Mark Doms, Chris FormanIn this paper we examine quality-adjusted prices for local area network (LAN) equipment. Hedonic regressions are used to estimate price changes for the two largest classes of LAN equipment, routers and switches. A matched model was used for LAN cards and the prices for hubs were inferred by using an economic relationship to switches. Overall, we find that prices for the four groups of LAN equipment fell at a 17 percent annual rate between 1995 and 2000. These results stand in sharp contrast to the PPI for communications equipment that is nearly flat over the 1990s.
Left Behind: SSI in the Era of Welfare Reform
–May 1, 2003
Richard V. Burkhauser, Mary C. DalySSI was established in 1972, born out of a compromise at the time between those wanting to provide a guaranteed income floor and those wishing to limit it to individuals not expected to work: the aged, blind, and disabled. SSI is now the largest federal means-tested program in the United States, serving a population dominated by low-income adults and children with disabilities. With other forms of federal support devolving to state programs (e.g., welfare), policymakers pressing to redefine social expectations about who should and should not work, and the Americans with Disabilities Act guaranteeing people with disabilities the right to employment, the goals and design of SSI have come under scrutiny. In this article we review the role that SSI has played to this point and consider the directions SSI might take in a work-dominated welfare environment where people with disabilities increasingly wish to be included in the labor market.
Inflation Scares and Forecast-Based Monetary Policy
–July 1, 2003
Athanasios Orphanides, John C. WilliamsCentral banks pay close attention to inflation expectations. In standard models, however, inflation expectations are tied down by the assumption of rational expectations and should be of little independent interest to policy makers. In this paper, we relax the assumption of rational expectations with perfect knowledge and reexamine the role of inflation expectations in the economy and in the conduct of monetary policy. Agents are assumed to have imperfect knowledge of the precise structure of the economy and the policymakers’ preferences. Expectations are governed by a perpetual learning technology. With learning, disturbances can give rise to endogenous inflation scares, that is, significant and persistent deviations of inflation expectations from those implied by rational expectations. The presence of learning increases the sensitivity of inflation expectations and the term structure of interest rates to economic shocks, in line with the empirical evidence. We also explore the role of private inflation expectations for the conduct of efficient monetary policy. Under rational expectations, inflation expectations equal a linear combination of macroeconomic variables and as such provide no additional information to the policy maker. In contrast, under learning, private inflation expectations follow a time-varying process and provide useful information for the conduct of monetary policy.
Robust Monetary Policy with Competing Reference Models
–July 1, 2003
Andrew T. Levin, John C. WilliamsThe literature on robust monetary policy rules has largely focused on the case in which the policymaker has a single reference model while the true economy lies within a specified neighborhood of the reference model. In this paper, we show that such rules may perform very poorly in the more general case in which non-nested models represent competing perspectives about controversial issues such as expectations formation and inflation persistence. Using Bayesian and minimax strategies, we then consider whether any simple rule can provide robust performance across such divergent representations of the economy. We find that a robust outcome is attainable only in cases where the objective function places substantial weight on stabilizing both output and inflation; in contrast, we are unable to find a robust policy rule when the sole policy objective is to stabilize inflation. We analyze these results using a new diagnostic approach, namely, by quantifying the fault tolerance of each model economy with respect to deviations from optimal policy.
Endogenous Tradability and Macroeconomic Implications
–June 1, 2005
Paul R. Bergin, Reuven GlickThis paper advocates a new way of thinking about goods trade in an open economy macro model. It develops a simple method for analyzing trade costs that are heterogeneous among a continuum of goods, and it explores how these costs determine the endogenous decision by a seller of whether to trade a good internationally. This way of thinking offers new insights into international market integration and the behavior of international relative prices. As one example, it provides a natural explanation for a prominent and controversial puzzle in international macroeconomics regarding the surprisingly low degree of volatility in the relative price of nontraded goods. Because tradedness is an endogenous decision, the good on the margin forms a link holding together the prices of traded and nontraded goods. The paper goes on to find that endogenizing trade has implications for other basic macroeconomic issues.
Military Expenditure, Threats, and Growth
–March 1, 2003
Joshua Aizenman, Reuven GlickThis paper clarifies one of the puzzling results of the economic growth literature: the impact of military expenditure is frequently found to be non-significant or negative, yet most countries spend a large fraction of their GDP on defense and the military. We start by empirical evaluation of the non- linear interactions between military expenditure, external threats, corruption, and other relevant controls. While growth falls with higher levels of military spending, given the values of the other independent variables, we show that military expenditure in the presence of threats increases growth. We explain the presence of these non-linearities in an extended version of Barro and Sala-i-Martin (1995), allowing the dependence of growth on the severity of external threats, and on the effective military expenditure associated with these threats.
Currency Boards, Dollarized Liabilities, and Monetary Policy Credibility
–May 1, 2003
Mark M. Spiegel, Diego ValderramaThe recent collapse of the Argentine currency board raises new questions about the desirability of formal fixed exchange rate regimes in modern developing economies. This paper examines the impact of dollarized liabilities with potential default for a currency board with costly abandonment. We compare the performance of a currency board to a central bank with full discretion in two environments: One with only idiosyncratic firm shocks, and one with both idiosyncratic shocks and shocks to the dollar-euro rate. We show that the possibility of default with peso-valued exports generates a risk premium on borrowing tied to expected future monetary policy. In addition, the presence of dollarized liabilities mitigates the time-inconsistency problem faced by the monetary authority. Finally, our numerical results demonstrate that the relative performance of the central bank under discretion compared to a currency board is ambiguous with only firm shocks, but that discretion unambiguously dominates when we also introduce shocks to the dollar-euro rate.
Institutional Efficiency, Monitoring Costs, and the Investment Share of FDI
–March 1, 2003
Joshua Aizenman, Mark M. SpiegelThis paper models and tests the implications of institutional efficiency on the pattern of foreign direct investment (FDI). We posit that domestic agents have a comparative advantage over foreign agents in overcoming some of the obstacles associated with corruption and weak institutions. We model these circumstances in a principal-agent framework with costly ex-post monitoring and enforcement of an ex-ante labor contract. Ex-post monitoring and enforcement costs are assumed to be lower for domestic entrepreneurs than for foreign ones, but foreign producers enjoy a countervailing productivity advantage. Under these asymmetries, multinationals pay higher wages than domestic producers, in line with the insight of efficiency wages and with the evidence about the ‘multinationals wage premium.’ FDI is also more sensitive to increases in enforcement costs. We then test this prediction for a cross section of developing countries. We use Mauro’s (1995) index of institutional efficiency as an indicator of the strength of property rights enforcement within a given country. We compare institutional efficiency levels for a large cross section of countries in 1989 to subsequent FDI flows from 1990 to 1999. We find that institutional efficiency is positively associated with the ratio of subsequent foreign direct investment flows to both gross fixed capital formation and to private investment. This finding is true for both simple cross-sections and for cross-sections weighted by country size.
Inferring Policy Objectives from Economic Outcomes
–June 1, 2003
Richard DennisThis paper stresses that estimated policy rules are reduced form equations that are silent on many important policy questions. To obtain a structural understanding of monetary policy it is necessary to estimate the policymaker’s objective function, rather than its policy reaction function. With these issues in mind, this paper proposes a system-based estimation approach that uses the solution to the policymaker’s optimization problem to infer the underlying policy regime from the economy’s evolution over time. The paper derives conditions under which the parameters in a policymaker’s policy objective function can be identified and estimated. These identification conditions apply to forward-looking rational-expectations models as well as to backward-looking models, extending existing results. We apply these conditions to a New Keynesian sticky-price model of the US economy, estimating jointly all of the model’s behavioral parameters and the policy regime parameters. The results show that the implicit inflation target and the relative weight placed on interest rate smoothing both declined with Volcker’s appointment to Federal Reserve chairman. However, the estimates reveal that other – non-monetary-policy – parameters have changed over time also.
Importing Technology
–March 1, 2003
Francesco Caselli, Daniel WilsonWe look at disaggregated imports of various types of equipment to make inferences on cross-country differences in the composition of equipment investment. We make three contributions. First, we document large differences in investment composition. Second, we explain these differences as being based on each equipment type’s intrinsic efficiency, as well as on its degree of complementarity with other factors whose abundance differ across countries. Third, we examine the implications of investment composition for development accounting, i.e., for explaining the cross-country variation in income per capita.
Mortgages as Recursive Contracts
–September 1, 2004
John Krainer, Milton H. MarquisMortgages are one-sided contracts under which the borrower may terminate the contract at any time, while the lender must commit to honoring the terms of the contract throughout its life. There are two aspects to this feature of the contract that are modeled in this paper. The first is that the borrower may choose between buying a house or renting. Given these alternatives, a contract between a household and a lender makes home ownership feasible, and provides insurance to the household against fluctuating rental payments. The second is that once in a contract, the household may terminate the contract by refinancing the future mortgage, and thus enter into a new contract. This option will be exercised whenever a combination of house price appreciation and declines in the mortgage rate is sufficient to increase the ex ante expected lifetime utility from the new versus the old contract.
Human Capital and Technology Diffusion
–December 1, 2003
Jess Benhabib, Mark M. SpiegelThis paper generalizes the Nelson-Phelps catch-up model of technology diffusion. We allow for the possibility that the pattern of technology diffusion can be exponential, which would predict that nations would exhibit positive catch-up with the leader nation, or logistic, in which a country with a sufficiently small capital stock may exhibit slower total factor productivity growth than the leader nation. ; We derive a nonlinear specification for total factor productivity growth that nests these two specifications. We estimate this specification for across-section of nations from 1960 through 1995. Our results support the logistic specification, and are robust to a number of sensitivity checks. ; Our model also appears to predict slow total factor productivity growth well. 22 of the 27 nations that we identify as lacking the critical human capital levels needed to achieve faster total factor productivity growth than the leader nation in 1960 did achieve lower growth over the next 35 years.
Robust Monetary Policy Rules with Unknown Natural Rates
–December 1, 2003
Athanasios Orphanides, John C. WilliamsWe examine the performance and robustness properties of alternative monetary policy rules in the presence of structural change that renders the natural rates of interest and unemployment uncertain. Using a forward-looking quarterly model of the U.S. economy, estimated over the 1969-2002 period, we show that the cost of underestimating the extent of misperceptions regarding the natural rates significantly exceeds the costs of overestimating such errors. Naive adoption of policy rules optimized under the false presumption that misperceptions regarding the natural rates are likely to be small proves particularly costly. Our results suggest that a simple and effective approach for dealing with ignorance about the degree of uncertainty in estimates of the natural rates is to adopt difference rules for monetary policy, in which the short-term nominal interest rate is raised or lowered from its existing level in response to inflation and changes in economic activity. These rules do not require knowledge of the natural rates of interest or unemployment for setting policy and are consequently immune to the likely misperceptions in these concepts. To illustrate the differences in outcomes that could be attributed to the alternative policies we also examine the role of misperceptions for the stagflationary experience of the 1970s and the disinflationary boom of the 1990s.
Employment Declines Among People with Disabilities: Population Movements, Isolated Experience, or Broad Policy Concern?
–September 1, 2002
Mary C. Daly, Andrew J. HoutenvilleWe began by asking whether the decline in employment among those with disabilities was broad-based or narrowly focused, explained by population shifts or changes in behavior and/or opportunities among those with disabilities, or simply reflective of exogenous deteriorations in health, relatively immune from policy corrections. Our findings point strongly towards changes in behavior and/or opportunities as the key to understanding the recent decline. We show that employment declines were very broadbased across key population subgroups, that the largest contributions to the decline were among subgroups most connected to the labor market, and that shifts in population shares actually contributed positively, rather than negatively, to employment among those with disabilities during the 1990s. These findings tell us that there are no simple answers to the disturbing trend in employment. Instead the decline appears to owe to a complex combination of behavioral and policy changes that come together to dramatically alter the connection of people with disabilities to the labor market during the 1990s.
Nonlinearities in International Business Cycles
–December 1, 2002
Diego ValderramaThis paper documents the dynamic properties of national output, its components, and the current account for five OECD countries. There is strong evidence of conditional volatility for almost all time series as well as significant deviations from normality. The deviations are detected particularly in GDP, net exports, investment time series.
Self-Reported Work Limitation Data: What They Can and Cannot Tell Us
–May 1, 2002
Richard V. Burkhauser, Mary C. Daly, Andrew J. Houtenville, Nigar NargisData constraints make the long-term monitoring of the working-age population with disabilities a difficult task. Indeed, the Current Population Survey (CPS) is the only national data source that offers detailed work and income questions and consistently asked measures of disability over a 20-year period. Despite its widespread use in the literature, the CPS and surveys like it have come under attack of late, with critics discounting the results of any research obtained from such data. We put these criticisms in perspective by systematically examining what the CPS data can and cannot be used for in disability research. Based on comparisons with the National Health Interview Survey (NHIS), a data set with much more information on health than the CPS, we find that the work limitation-based definition of disability available in the CPS underestimates the size of the broader population with health impairments in the NHIS, but that the employment trends in these two populations in the NHIS are not significantly different from one another. We then show that the trends in employment observed for the NHIS population defined by self-reported work limitation are not statistically different from those found in the CPS. Based on these findings, we argue (1) that the CPS and other nationally representative employment-based data sets can be used to monitor trends in outcomes of those with disabilities and, (2) that the dramatic decline in the employment of people with disabilities we describe in the CPS during the 1990s is not an artifact of the data.
United States Disability Policy in a Changing Environment
–September 1, 2001
Richard V. Burkhauser, Mary C. DalyTwo factors are likely to cause the debate surrounding disability policy to intensify over the next decade. First, the protracted period of economic growth that the United States has experienced since 1992 cannot last forever. And, applications for DI and SSI are sensitive to the business cycle. A downturn in the economy will increase applications and heighten efforts to broaden the categorical definition of disability. This is even more likely since the welfare reforms of 1996 have made it more difficult for low-income people to be eligible for other programs. Second, the percentage of the population aged 50 and over is increasing. Given that the prevalence of disability rises sharply at these ages, applications for both DI and SSI are likely to rise. The effect of this demographic change is magnified by the fact that in 2000 the age of eligibility for full Social Security retirement benefits began to rise from 65 to 67. This increase in the normal retirement age will increase the relative value of DI and SSI benefits for workers considering exiting the labor market prior to age 67. All these factors suggest another major round of debate over disability policy and program expansion in the near future.
The Supplemental Security Income Program
–July 1, 2002
Richard V. Burkhauser, Mary C. DalyIn general, our examination suggests that in the absence of a universal guaranteed income program for all Americans, the operational flexibility of the categorical eligibility criteria for SSI has made the program sensitive to both downturns in the business cycle and to increases in the pool of vulnerable people. Moreover, when the dividing lines separating the working-age adult and child populations eligible for SSI from those eligible for other income-based benefits are imprecise, as with disability, policy changes in other welfare programs likely will affect SSI caseloads.
Exploring the Role of the Real Exchange Rate in Australian Monetary Policy
–June 1, 2002
Richard DennisAn important issue in small open-economies is whether policymakers should respond to exchange rate movements when they formulate monetary policy. Micro-founded models tend to suggest that there is little to be gained from responding to exchange rate movements, and the literature has largely concluded that such a response is unnecessary, or even undesirable (Taylor, 2001). This paper examines this issue using an estimated model of the Australian economy. In contrast to micro-founded models, according to this model policymakers should allow for movements in the real exchange rage and the terms-of-trade when they set interest rates. Further, taking real exchange rate movements into account appears even more important with price level targeting than with inflation targeting.
Bayesian Inference for Hospital Quality in a Selection Model
–July 1, 2002
John F. Geweke, Gautam Gowrisankaran, Robert J. TownThis paper develops new econometric methods to infer hospital quality in a model with discrete dependent variables and non-random selection. Mortality rates in patient discharge records are widely used to infer hospital quality. However, hospital admission is not random and some hospitals may attract patients with greater unobserved severity of illness than others. In this situation the assumption of random admission leads to spurious inference about hospital quality. This study controls for hospital selection using a model in which distance between the patient’s residence and alternative hospitals are key exogenous variables. Bayesian inference in this model is feasible using a Markov chain Monte Carlo posterior simulator, and attaches posterior probabilities to quality comparisons between individual hospitals and groups of hospitals. The study uses data on 74,848 Medicare patients admitted to 114 hospitals in Los Angeles County from 1989 through 1992 with a diagnosis of pneumonia. It finds the smallest and largest hospitals to be of the highest quality. There is strong evidence of dependence between the unobserved severity of illness and the assignment of patients to hospitals, whereby patients with a high unobserved severity of illness are disproportionately admitted to high quality hospitals. Consequently a conventional probit model leads to inferences about quality markedly different than those in this study’s selection model.
Learning and the Value of Information: The Case of Health Plan Report Cards
–June 1, 2002
Michael Chernew, Gautam Gowrisankaran, Dennis P. ScanlonWe estimate a Bayesian learning model in order to assess the value of health plan performance information and the extent to which the explicit provision of information about product quality alters consumer behavior. We take advantage of a natural experiment in which health plan performance information for HMOs was released to employees of a Fortune 50 company for the first time. Our empirical work indicates that the release of information had a small but statistically significant effect on health plan choices, causing 3.1% of employees to switch health plans. Although consumers were willing to pay an extra $267 per year per below average rating avoided, the average value of the information per employee was only $10 per year. The relatively small impact of the ratings arises because the ratings were estimated to be very imprecise measures of quality. More precise measures of quality could have been more valuable.
Network Externalities and Technology Adoption: Lessons from Electronic Payments
–May 1, 2002
Gautam Gowrisankaran, Joanna StavinsWe seek to analyze the extent and sources of network externalities for the automated clearinghouse (ACH) electronic payments system using a quarterly panel data set on individual bank adoption and usage of ACH. We provide three methods to identify network externalities using this panel data. The first method identifies network externalities from the clustering of ACH adoption. The second method identifies them by examining whether banks in areas with higher market concentration or larger competitors are more likely to adopt ACH. The third method identifies them by examining whether the ACH adoption by small branches of large banks affects the adoption by local competitors. Using fixed effects and panel data these methods separately identify network externalities from technological advancement, peer-group effects, economies of scale and market power. We find evidence that the network externalities are moderately large.
The Impact of Financial Frictions on a Small Open Economy: When Current Account Borrowing Hits a Limit
–November 1, 2002
Diego ValderramaThe evidence of the last 20 years of recurring output busts and rapid reversals of the current account in emerging markets indicates that domestic agents may not be able to borrow in international capital markets to fully insure themselves against internal and external shocks. This paper models this phenomenon as a form of excess volatility by introducing a financial friction into a stochastic model of a small open economy. The financial friction limits the current account deficit to a fixed fraction of gross domestic product. The paper shows that conditional volatility and asymmetry are significant statistical characteristics of the GDP and current account that reflect the excess volatility and the current account reversals. The economic model can explain the conditional volatility and asymmetry of Mexican GDP and the current account.
The X-Efficiency of Commercial Banks in Hong Kong
–December 1, 2001
Simon H. KwanThis paper uses the stochastic econometric cost frontier approach to investigate the cost efficiency of commercial banks in Hong Kong. On average, the X-efficiency of Hong Kong banks is found to be about 16 to 30 percent of observed total costs, which is comparable to the findings in the U.S. banking industry. X-efficiency is found to decline over time, indicating that banks in Hong Kong are now operating closer to the cost frontier than before. This is consistent with technological innovation that might have occurred in the Hong Kong banking industry. Furthermore, the average large bank in Hong Kong is found to be less efficient than the average small bank, particularly during the earlier time periods. Finally, X-efficiency is found to be related to certain bank characteristics. Specifically, X-efficiency is found to decline with bank size, deposit-to-asset ratio, loan-to-asset ratios, provision for loan loss, and loan growth, and to increase with off-balance sheet activities.
Statistical Nonlinearities in the Business Cycle: A Challenge for the Canonical RBC Model
–September 1, 2002
Diego ValderramaSignificant nonlinearities are found in several cyclical components macroeconomic time series across countries. Standard equilibrium models of business cycles successfully explain most first and second moments of these time series. Nevertheless, this paper shows that a model of this class cannot replicate nonlinear features of the data. Applying the Efficient Method of Moments (Gallant and Tauchen, 1996, 2000) methodology to build an algorithm that searches over the models parameter space establishes the parameterization that best allows replication of all statistical properties of the data. The results show that this parameterization captures nonlinearities in investment but fails to account for observed properties of consumption.
Estimating the Euler Equation for Output
–September 1, 2002
Jeffrey C. Fuhrer, Glenn D. RudebuschNew Keynesian macroeconomic models have generally emphasized that expectations of future output are a key factor in determining current output. The theoretical motivation for such forward-looking behavior relies on a straightforward generalization of the well-known Euler equation for consumption. In this paper, we use maximum likelihood and generalized method of moments (GMM) methods to explore the empirical importance of output expectations. We find little evidence that rational expectations of future output help determine current output, especially after taking into account the small-sample bias in GMM.
A Model of Endogenous Nontradability and its Implications for Current Account
–June 1, 2003
Paul R. Bergin, Reuven GlickThis paper analyzes how a model where goods are endogenously nontraded can help explain the relationship between the current account and real exchange rate fluctuations. We formulate a small open economy two-period model in which goods switch endogenously between being traded or nontraded. The model demonstrates how movements in the real exchange rate and real interest rate can impose significant costs on intertemporal trade. The model also shows that a variety of nonlinear relationships is possible between the current account and real exchange rate, depending on the relative transport costs and substitutability in preferences between goods. In contrast to recent work, our analysis implies that such costs of intertemporal trade may be a concern for many countries, not just those with large current account imbalances.
How Important Is Precommitment for Monetary Policy?
–September 1, 2002
Richard Dennis, Ulf SöderströmEconomic outcomes in dynamic economies with forward-looking agents depend crucially on whether or not the central bank can precommit, even in the absence of the traditional "inflation bias." This paper quantifies the welfare differential between precommitment and discretionary policy in both a stylized theoretical framework and in estimated data-consistent models. From the precommitment and discretionary solutions we calculate the permanent deviation of inflation from target that in welfare terms is equivalent to moving from discretion to precommitment, the "inflation equivalent." In the estimated models, using a range of reasonable central bank preference parameters, the "inflation equivalent" ranges from 0.05 to 3.6 percentage points, with a mid-point of either 0.15 or 1-1.5 percentage points, depending on the model. In addition to the degree of forward-looking behavior, we show that the existence of transmission lags and/or information lags is crucial for determining the welfare gain from precommitment.
A Gravity Model of Sovereign Lending: Trade, Default and Credit
–September 1, 2002
Andrew K. Rose, Mark M. SpiegelOne reason why countries service their external debts is the fear that default might lead to shrinkage of international trade. If so, then creditors should systematically lend more to countries with which they share closer trade links. We develop a simple theoretical model to capture this intuition, then test and corroborate this idea.
Stylized Facts on Nominal Term Structure and Business Cycles: An Empirical VAR Study
–August 1, 2001
Tao WuThis paper examines the importance of various macroeconomic shocks in explaining the movement of the term structure of nominal bond yields in the post-war U.S., as well as the channels through which such macro shocks influence the yield curve, using a structural Vector Autoregressive (VAR) model. The results show that the monetary-policy and the aggregate-supply shocks are important determinants of the nominal term structure. Moreover, the monetary-policy innovations have a large but transitory effect on the nominal bond yields, primarily by changing the slope of the yield curve, and the aggregate-supply shocks from private sector have a more persistent effect on the level of the yield curve, but have little effect on the slope of the yield curve.
Monetary Policy and the Slope Factors in Empirical Term Structure Estimations
–August 1, 2001
Tao WuThis paper examines the empirical relationship between the movement of the slope factor in term structure of nominal interest rates and exogenous monetary-policy shocks in the U.S. after 1982. Using first a six-variable VAR model and then a GMM estimation model of the "Taylor rule," I estimate the exogenous monetary-policy shocks implied by each of them in the U.S. during this period. Meanwhile, a two-factor model is used to extract the underlying slope factor of the term structure. Results from the correlation study suggest that there is strong correlation between the slope factor and the exogenous monetary-policy shocks. Moreover, monetary-policy shocks can explain a large part of variability of the slope factor. This study provides strong evidence in support of Knez, Litterman and Scheinkman (1994)’s conjecture on the relation between the slope factor and the Federal Reserve policy, and is also consistent with the results in Wu (2001a)’s general-equilibrium based simulation study.
Macro Factors and the Affine Term Structure of Interest Rates
–January 1, 2005
Tao WuI formulate an affine term structure model of bond yields from a general equilibrium business-cycle model, with observable macro state variables of the structural economy as the factors. The factor representing monetary policy is strongly mean-reverting, and its influence on the term structure is primarily through changing the slope of the yield curve. The factor representing technology is more persistent, and it affects the term structure by shifting the level of the yield curve. The dynamic implications of the model for the macro economy and the term structure are consistent with the broad empirical patterns. From simulation studies of the macro-factor model I can extract the "level" and "slope" factors, similar to the ones extracted from the empirical term structure estimations. Simulation studies also show that the movement of the "slope" factor is primarily driven by the monetary-policy innovations, and the changes of the "level" factor is more closely associated with the aggregate-supply shocks from the private sector.
The Empirical Relationship between Average Asset Correlation, Firm Probability of Default and Asset Size
–June 1, 2002
Jose A. LopezThe asymptotic single risk factor (ASRF) approach is a simplified framework for determining regulatory capital charges for credit risk and has become an integral part of how credit risk capital requirements are to be determined under the second Basel Accord. Within this approach, a key regulatory parameter is the average asset correlation. In this paper, we examine the empirical relationship between the average asset correlation, firm probability of default and firm asset size measured by the book value of assets by imposing the ASRF approach within the KMV methodology for determining credit risk capital requirements. Using data from year-end 2000, credit portfolios consisting of U.S., Japanese and European firms are analyzed. The empirical results suggest that average asset correlation is a decreasing function of probability of default and an increasing function of asset size. When compared with the average asset correlations proposed by the Basel Committee on Banking Supervision in November 2001, the empirical average asset correlations further suggest that accounting for firm asset size, especially for larger firms, may be important. In conclusion, the empirical results suggest that a variety of factors may impact average asset correlations within an ASRF framework, and these factors may need to be accounted for in the final calculation of regulatory capital requirements for credit risk.
Imperfect Knowledge, Inflation Expectations, and Monetary Policy
–May 1, 2002
Athanasios Orphanides, John C. WilliamsThis paper investigates the role that imperfect knowledge about the structure of the economy plays in the formation of expectations, macroeconomic dynamics, and the efficient formulation of monetary policy. Economic agents rely on an adaptive learning technology to form expectations and continuously update their beliefs regarding the dynamic structure of the economy based on incoming data. The process of perpetual learning introduces an additional layer of dynamic interactions between monetary policy and economic outcomes. We find that policies that would be efficient under rational expectations can perform poorly when knowledge is imperfect. In particular, policies that fail to maintain tight control over inflation are prone to episodes in which the public’s expectations of inflation become uncoupled from the policy objective and stagnation results, in a pattern similar to that experienced in the United States during the 1970s. More generally, we show that policy should respond more aggressively to inflation under imperfect knowledge than under perfect knowledge.
Investment, Capacity, and Uncertainty: A Putty-Clay Approach
–May 1, 2002
Simon Gilchrist, John C. WilliamsIn this paper, we embed the microeconomic decisions associated with investment under uncertainty, capacity utilization, and machine replacement in a general equilibrium model based on putty-clay technology. We show that the combination of log-normally distributed idiosyncratic productivity uncertainty and Leontief utilization choice yields an aggregate production function that is easily characterized in terms of hazard rates for the standard normal distribution. At low levels of idiosyncratic uncertainty, the short-run elasticity of supply is substantially lower than the elasticity of supply obtained from a fully-flexible Cobb-Douglas alternative. In the presence of irreversible factor proportions, an increase in idiosyncratic uncertainty about the productivity of an investment project typically reduces investment at the micro level, but it raises aggregate investment. Increases in uncertainty also have important dynamic implications, causing sustained increases in investment and hours and a medium-term expansion in the growth rate of labor productivity.
Assessing the Lucas Critique in Monetary Policy Models
–February 1, 2002
Glenn D. RudebuschEmpirical estimates of monetary policy rules suggest that the behavior of U.S. monetary policymakers changed during the past few decades. However, at the same time, statistical analyses of lagged representations of the economy, such as VARs, often have not rejected the null of structural stability. These two sets of empirical results appear to contradict the Lucas critique. This paper provides a reconciliation by showing that the apparent policy invariance of reduced forms is consistent with the magnitude of historical policy shifts and the relative insensitivity of the reduced forms of plausible forward-looking macroeconomic specifications to policy shifts.
Operating Performance of Banks Among Asian Economies: An International and Time Series Comparison
–February 1, 2002
Simon H. KwanAfter controlling for loan quality, liquidity, capitalization, and output mix, per unit bank operating costs are found to vary significantly across Asian countries and over time. Further analysis reveals that the country rankings of per unit labor and physical capital costs are highly correlated, suggesting that there exist systematic differences in bank operating efficiency across Asian countries. However, this measure of operating efficiency is found to be unrelated to the degree of openness of the banking sector. Asian bank operating costs were found to decline from 1992 to 1997, indicating that banks were improving their operating performance over time. Since 1997, the run-up in operating costs coincided with the Asian financial crisis, suggesting that banks were incurring additional costs in dealing with their problem loans while output was declining simultaneously. Moreover, the labor cost share is found to decline significantly between 1997 and 1999, indicating that banks were able to cut their labor force after the financial crisis but were less flexible to reduce physical capital input. Furthermore, significant differences in labor cost share are detected across countries, suggesting that different countries have different bank production functions. The variations in labor cost share are significantly positively related to the country’s financial services wage rate, suggesting that banks using relatively more labor in a particular country is due to the labor force productivity, rather than labor being cheap.
The Employment of Working-Age People with Disabilities in the 1980s and the 1990s: What Current Data Can and Cannot Tell Us
–November 1, 2001
Richard V. Burkhauser, Mary C. Daly, Andrew J. Houtenville, Nigar NargisA new and highly controversial literature argues that the employment of working-age people with disabilities fell dramatically relative to the rest of the working-age population in the 1990s. Some dismiss these results as fundamentally flawed because they come from a self-reported work limitation-based disability population that captures neither the actual population with disabilities nor its employment trends. In this paper, we examine the merits of these criticisms. We first consider some of the difficulties of defining and consistently measuring the population with disabilities. We then discuss how these measurement difficulties potentially bias empirical estimates of the prevalence of disability and of the employment behavior of those with disabilities. Having provided a context for our analysis, we use data from the National Health Interview Survey (NHIS) to compare the prevalence and employment rates across two empirical populations of those with disabilities: one defined by self-reported impairments and one defined by self-reported work limitations. We find that although traditional work limitation-based definitions underestimate the size of the broader population with health impairments, the employment trends in the populations defined by work limitations and impairments are not significantly different from one another over the 1980s and 1990s. We then show that the trends in employment observed for the NHIS population defined by self-reported work limitations are statistically similar to those found in the Current Population Survey (CPS). Based on this analysis, we argue that nationally representative employment-based data sets like the CPS can be used to monitor the employment trends of those with disabilities over the past two decades.
Precommitment, the Timeless Perspective, and Policymaking from Behind a Veil of Uncertainty
–August 1, 2001
Richard DennisWoodford (1999) develops the notion of a "timelessly optimal" pre-commitment policy. This paper uses a simple business cycle model to illustrate this notion. We show that timelessly optimal policies are not unique and that they are not necessarily better than the time-consistent solution. Further, we describe a method for constructing optimal pre-commitment rules in an environment where the policymaker does not know the initial state of the economy. This latter solution is useful for characterizing the benefits policymakers extract through exploiting initial conditions.
Embodying Embodiment in a Structural, Macroeconomic Input-Output Model
–October 1, 2001
Daniel WilsonThis paper describes an attempt to build a regression-based system of labor productivity equations that incorporate the effects of capital-embodied technological change into IDLIFT, a structural, macroeconomic input-output model of the U.S. economy. Builders of regression-based forecasting models have long had difficulty finding labor productivity equations that exhibit the Neoclassical or Solowian property that movements in investment should cause accompanying movements in labor productivity. Theory dictates that this causation is driven by the effect of traditional capital deepening as well as technological change embodied in capital. Lack of measurement of the latter has hampered the ability of researchers to properly estimate the productivity-investment relationship. Wilson (2001a), by estimating industry-level embodied technological change, has alleviated this difficulty. In this paper, I utilize those estimates to construct capital stocks that are adjusted for technological change which are then used to estimate Neoclassical-type labor productivity equations. It is shown that replacing IDLIFT’s former productivity equations, based on changes in output and time trends, with the new equations results in a convergence between the dynamic behavior of the model and that predicted by Neoclassical production theory.
Is Embodied Technology the Result of Upstream R&D? Industry-Level Evidence
–October 1, 2001
Daniel WilsonIn this paper, I develop an industry-level index of capital-embodied R&D by capturing the extent of research and development directed at the capital goods in which a given industry invests. Compiling and adjusting data from the National Science Foundation and Commerce Department, I construct industry-level, time-series measures of this index and investigate its properties. The data allow me to identify the R&D directed at the development of specific types of capital rather than incorrectly assuming industry R&D spending is equivalent to R&D directed at the industry’s product, an assumption typically made in the R&D literature. It is first shown that R&D directed at a type of capital is a good measure of its technological change. The constructed index of an industry’s capital-embodied R&D is then compared to rates of embodied technological change estimated using plant-level manufacturing data. The index of embodied R&D is found to be positively and significantly related to the estimated rates of embodied technological change. Likewise, embodied R&D is shown to have a positive and significant effect on conventionally-measured total factor productivity growth (i.e. the Solow Residual). This has two implications. First, the capital component of the Solow Residual is generally mismeasured as it does not adequately capture technological change. Second, the constructed index of embodied R&D is proportional to true embodied technological change. Rates of embodied technological change are thus imputed for non-manufacturing industries using the estimated relationship between embodied R&D and embodied technological change found in the manufacturing data.
Quantifying Embodied Technological Change
–October 1, 2001
Plutarchos Sakellaris, Daniel WilsonWe estimate the rate of embodied technological change directly from plant-level manufacturing data on current output and input choices along with histories on their vintages of equipment investment. Our estimates range between 8 and 17 percent for the typical U.S. manufacturing plant during the years 1972-1996. Any number in this range is substantially larger than is conventionally accepted with some important implications. First, the role of investment-specific technological change as an engine of growth is even larger than previously estimated. Second, existing producer durable price indices do not adequately account for quality change. As a result, measured capital stock growth is biased. Third, if accurate, the Hulten and Wykoff (1981) economic depreciation rates may primarily reflect obsolescence.
Small Business and Computers: Adoption and Performance
–October 1, 2001
Marianne BitlerUntil recently, little evidence suggested that the computer revolution of recent decades has had much impact on aggregate economic growth. Analysis at the worker level has found evidence that use of computers is associated with higher wages. Although some research questions whether this finding is solely due to unobserved heterogeneity in worker quality, others point to such results as evidence that the wage premia for skilled workers have increased over time. Adoption of new technologies is associated with higher productivity and higher productivity growth. As in the worker literature, firms adopting computers may simply be more productive firms. Using new data from the 1998 Survey of Small Business Finances, I examine the determinants of computer adoption by small, privately-held firms and analyze whether computer use affects profits, sales, labor productivity, or other measures of firm success. I am able to control for many firm characteristics not available in other data sets. I find that computer adoption is more likely by larger firms, by younger firms, by firms whose markets are national or international, and by limited liability firms. Adoption is also more likely by firms founded or inherited by a current owner and by firms whose primary owners are more educated. Firms with more than 50% of their ownership shares held by African Americans or Asians, and, in some specifications, firms with more than 50% of their shares held by Hispanics are less likely to have adopted computers, echoing results for households in the literature. Evidence concerning the link between computer use and firm performance is mixed. Current performance as measured by profits or sales is not associated with current computer use in the full sample. In some specifications, use of computers for specific tasks is associated with higher costs. Estimates of the effects of computer use on costs are larger (in absolute value) when the sample is restricted to manufacturing or wholesale trade firms or to larger small businesses. Estimates using the more parsimonious set of control variables widely available in other firm level data show large and positive effects of computer use on firm costs, sales, and profits, suggesting that controlling for managerial, firm, and owner characteristics is important.
Incorporating Equity Market Information into Supervisory Monitoring Models
–September 1, 2001
John Krainer, Jose A. LopezWe examine whether equity market variables, such as stock returns and equity-based default probabilities, are useful to bank supervisors for assessing the condition of bank holding companies. Using an event study framework, we find that equity market variables anticipate supervisory ratings changes by up to four quarters and that the improvements in forecast accuracy arising from conditioning on equity market information are statistically significant. We develop an off-site monitoring model that easily combines supervisory and equity market information, and we find that the model’s forecasts also anticipate supervisory ratings changes by several quarters. While the inclusion of equity market variables in the model does not improve forecast accuracy by much relative to simply using supervisory variables, we conclude that equity market information is useful for forecasting supervisory ratings and should be incorporated into supervisory monitoring models.
Does a Currency Union Affect Trade? The Time Series Evidence
–September 1, 2001
Reuven Glick, Andrew K. RoseDoes leaving a currency union reduce international trade? We answer this question using a large annual panel data set covering 217 countries from 1948 through 1997. During this sample a large number of countries left currency unions; they experienced economically and statistically significant declines in bilateral trade, after accounting for other factors. Assuming symmetry, we estimate that a pair of countries that starts to use a common currency experiences a near doubling in bilateral trade.
The Disposition of Failed Bank Assets: Put Guarantees or Loss-Sharing Arrangements
–September 1, 2001
Mark M. SpiegelTo mitigate the regulator losses associated with bank failures, efforts are usually made to dispose of failed bank assets quickly. However, this process usually precludes due diligence examination by acquiring banks, leading to problems of asymmetric information concerning asset quality. this paper examines two mechanisms that have been used for dealing with these problems, "put guarantees," under which acquiring banks are allowed to return assets to the regulatory authority for liquidation, and "loss-sharing arrangements," under which the acquiring banks keep all assets under their control to maturity and are then compensated by the regulatory authority for a portion of asset losses. The analysis is conducted in a Hart-Moore framework in which the removal of certain assets from the banking system can reduce their value. Changes in the relative desirability of the two guarantee mechanisms during economic downturns are shown to depend on the credibility of the regulatory authority. When the regulatory authority enjoys credibility, a downturn favors the loss-sharing arrangement, while when the regulatory authority lacks credibility, the impact of a downturn is ambiguous.
Impact of Deposit Rate Deregulation in Hong Kong on the Market Value of Commercial Banks
–August 1, 2001
Simon H. KwanThis paper examines the effects of deposit rate deregulation in Hong Kong on the market value of banks. The release of the Consumer Council’s Report in 1994 recommending interest rate deregulation is found to produce negative abnormal returns, while the announcement in 1995 terminating the deregulation program led to positive abnormal returns. Furthermore, news about resumption of interest rate deregulation in 1998 and the official announcement in 2000 to abolish the interest rate rules produced negative abnormal returns. The evidence suggests that Hong Kong banks earned rents from deposit rate restrictions and that relaxation of rate ceilings reduced these rents.
Some Implications of Using Prices to Measure Productivity in a Two-Sector Growth Model
–July 1, 2003
Milton H. Marquis, Bharat TrehanWe construct a 2 sector growth model with sector specific technology shocks where one sector produces intermediate goods while the other produces final goods. Theoretical restrictions from this model are used to compute the time series for sector-specific TFPs based solely on factor prices and the relative price of intermediate goods to final goods over the 1959-2000 period. An aggregate TFP measure based on these series appears quite similar to the multifactor productivity measure constructed by the BLS. We find statistical evidence of structural breaks in the growth rate of our productivity measures in 1973 and 1995. The first of these breaks appears to be due to an economy-wide productivity slowdown, while the second is attributed to a sharp pickup in the growth rate of productivity in the intermediate goods sector. Using only these TFP measures, the model’s predictions of output growth rates in the two sectors over the intervals defined by the estimated break dates compare favorably with the actual data on consumer nondurables and services (final goods) and consumer and producer durables (intermediate goods).
Optimal Policy Rules in Rational-Expectations Models: New Solution Algorithms
–September 7, 2005
Richard DennisThis paper develops methods to solve for optimal discretionary policies and optimal commitment policies in rational expectations models. These algorithms, which allow the optimization constraints to be conveniently expressed in second-order structural form, are more general than existing methods and are simple to apply. We use several New Keynesian business cycle models to illustrate their application. Simulations show that the procedures developed in this paper can quickly solve small-scale models and that they can be usefully and effectively applied to medium- and large-scale models.
The Policy Preferences of the U.S. Federal Reserve
–July 1, 2004
Richard DennisThis paper uses a small data-consistent model of the United States to identify and estimate the Federal Reserve’s policy preferences. We find critical differences between the policy regimes in operation during the Burns-Miller and Volcker-Greenspan periods. Over the Volcker-Greenspan period we estimate the inflation target to be 2.0% and find that policymakers were willing to allow the real interest rate to change in order to keep overall changes in the nominal interest rate relatively small. In contrast, for the Burns-Miller period the inflation target is estimated to be 5.9%, and we find that policy makers were much more prepared to tolerate changes in the nominal interest rate than they were changes in the real interest rate. Consequently, over this period policymakers tended to accommodate movements in inflation. We find statistical evidence that a policy regime shift occurred with Volcker’s appointment to Federal Reserve chairman.
Economic Outcomes of Working-Age People with Disabilities over the Business Cycle: An Examination of the 1980s and 1990s
–March 1, 2001
Richard V. Burkhauser, Mary C. Daly, Andrew J. Houtenville, Nigar NargisWe examine the rate of employment and the household income of the working-age population (aged 25-61) with and without disabilities over the business cycles of the 1980s and 1990s using data from the March Current Population Survey and the National Health Interview Survey. In general, we find that while the employment of working-age men and women with and without disabilities exhibited a procyclical trend during the 1980s business cycle, this was not the case during the 1990s expansion. During the 1990s, the employment of working-age men and women without disabilities continued to be procyclical, but the employment rates of their counterparts with disabilities declined over the entire 1990s business cycle. Although increases in disability transfer income replaced a significant fraction of their lost earnings, the household income of men and women with disabilities fell relative to the rest of the population over the decade.
The Supplemental Security Income Program
–September 1, 2000
Richard V. Burkhauser, Mary C. DalySolvency Runs, Sunspot Runs, and International Bailouts
–March 1, 2001
Mark M. SpiegelThis paper introduces a model of international lender of last resort (ILLR) activity under asymmetric information. The ILLR is unable to distinguish between runs due to debtor insolvency and those which are the result of pure sunspots. Nevertheless, the ILLR can elicit the underlying state of nature from informed creditors by offering terms consistent with generating a separating equilibrium. Achieving the separating equilibrium requires that the ILLR lends to the debtor at sufficiently high rates. This adverse electing problem provides an alternative rationale for Bagehot’s Principle of last-resort lending at high rates of interest to the moral hazard motivation commonly found in the literature.
Inflation Taxes, Financial Intermediation, and Home Production
–January 1, 2001
Milton H. MarquisThis paper examines the incidence and welfare costs of inflation in the presence of financial market frictions and home production. The results suggest that financing constraints on firms’ working capital expenditures significantly increase the welfare costs relative to the standard Cooley-Hansen (1989) cash-in-advance framework. These costs are reduced, but remain above those computed by Cooley and Hansen, when a financial intermediary is introduced that engages in asset transformation by creating liquid, interest-bearing deposit accounts and uses the proceeds to finance working capital loans to firms. Explicitly modeling home production activities tends to exacerbate the distortions that inflation induces in employment and market output to a considerable degree, and suggests that welfare costs of anticipated inflation may be substantially higher than previous estimates. Sensitivity analysis indicates that the magnitude of the market response to inflation and the attendant welfare costs of inflation depend strongly on the elasticity of substitution between capital and labor in home production, and to a much lesser degree on the elasticity of substitution between home and market consumption. When households must also finance their gross investment in home capital by borrowing from the financial intermediary, home production is indirectly taxed by inflation. As a result of this credit friction, resources thus tend to move back into the market, thereby mitigating the adverse effects of inflation on employment and output, while further increasing the welfare losses.
Forward-Looking Behavior and the Optimality of the Taylor Rule
–February 1, 2001
Kevin J. Lansing, Bharat TrehanThis paper derives a closed-form solution for the optimal discretionary monetary policy in a small macroeconomic model that allows for varying degrees of forward-looking behavior. We show that a more forward-looking aggregate demand equation serves to attenuate the response to inflation and the output gap in the optimal interest rate rule. In contrast, a more forward-looking real interest rate equation serves to magnify the response to both variables. A more forward-looking Phillips curve serves to attenuate the response to inflation but magnifies the response to the output gap. ; Original title: Forward-looking behavior and the optimality of the Taylor rule.
Term Structure Evidence on Interest Rate Smoothing and Monetary Policy Inertia
–January 1, 2001
Glenn D. RudebuschNumerous studies have used quarterly data to estimate monetary policy rules or reaction functions that appear to exhibit a very slow partial adjustment of the policy interest rate. The conventional wisdom asserts that this gradual adjustment reflects a policy inertia or interest rate smoothing behavior by central banks. However, such quarterly monetary policy inertia would imply a large amount of forecastable variation in interest rates at horizons of more than three months, which is contradicted by evidence from the term structure of interest rates. The illusion of monetary policy inertia evident in the estimated policy rules likely reflects the persistent shocks that central banks face.
The Federal Reserve Banks’ Imputed Cost of Equity Capital
–January 1, 2001
Edward J. Green, Jose A. Lopez, Zhenyu WangAccording to the Monetary Control Act of 1980, the Federal Reserve Banks must establish fees for their priced services to recover all operating costs as well as imputed costs of capital and taxes that would be incurred by a profit-making firm. The calculations required to establish these imputed costs are referred to collectively as the Private Sector Adjustment Factor (PSAF). In this paper, we propose a new approach for calculating the cost of equity capital used in the PSAF. The proposed approach is based on a simple average of three methods as applied to a peer group of bank holding companies. The three methods estimate the cost of equity capital from three different perspectives – the historical average of comparable accounting earnings, the discounted value of expected future cashflows, and the equilibrium price of investment risk as per the capital asset pricing model. We show that the proposed approach would have provided stable and sensible estimates of the cost of equity capital for the PSAF from 1981 through 1998.
Evaluating Covariance Matrix Forecasts in a Value-at-Risk Framework
–April 1, 2000
Jose A. Lopez, Christian WalterCovariance matrix forecasts of financial asset returns are an important component of current practice in financial risk management. A wide variety of models, ranging from matrices of simple summary measures to covariance matrices implied from option prices, are available for generating such forecasts. In this paper, we evaluate the relative accuracy of different covariance matrix forecasts using standard statistical loss functions and a value-at-risk (VaR) framework. This framework consists of hypothesis tests examining various properties of VaR models based on these forecasts as well as an evaluation using a regulatory loss function. ; Using a foreign exchange portfolio, we find that implied covariance matrix forecasts appear to perform best under standard statistical loss functions. However, within the economic context of a VaR framework, the performance of VaR models depends more on their distributional assumptions than on their covariance matrix specification. Of the forecasts examined, simple specifications, such as exponentially-weighted moving averages of past observations perform best with regard to the magnitude of VaR exceptions and regulatory capital requirements. These results provide empirical support for the commonly-used VaR models based on simple covariance matrix forecasts and distributional assumptions.
Optimal Simple Targeting Rules for Small Open Economies
–December 1, 2000
Richard DennisThis paper solves for optimal policy rules in a stylized small open economy model under a spectrum of targeting regimes. These policy reaction functions are presented as feedback rules highlighting the dominant state variables in each rule. Optimal simple rules – rules that exploit a reduced information set – are explored to assess how much is lost when information is excluded from the optimal state-contingent rule. For the model analyzed we find that some optimal simple rules can approximate reasonably well the optimal state-contingent rule, these simple rules contain the real exchange rate. Knowing which variables underpin the performance of the optimal state-contingent rule is important for developing simple, robust, rules with good stabilizing properties.
Term Premia and Interest Rate Forecasts in Affine Models
–December 31, 2000
Gregory R. DuffeeI find that the standard class of affine models produces poor forecasts of future changes in Treasury yields. Better forecasts are generated by assuming that yields follow random walks. The failure of these models is driven by one of their key features: the compensation that investors receive for facing risk is a multiple of the variance of the risk. This means that risk compensation cannot vary independently of interest rate volatility. I also describe and empirically estimate a class of models that is broader than the standard affine class. These ‘essentially affine’ models retain the tractability of the usual models, but allow the compensation for interest rate risk to vary independently of interest rate volatility. This additional flexibility proves useful in forming accurate forecasts of future yields.
Asymmetric Cross-sectional Dispersion in Stock Returns: Evidence and Implications
–January 1, 2001
Gregory R. DuffeeThis paper documents that daily stock returns of both firms and industries are more dispersed when the overall stock market rises than when it falls. This positive relation is conceptually distinct from – and appears unrelated to – asymmetric return correlations. I argue that the source of the relation is positive skewness in sector-specific return shocks. I use this asymmetric behavior to explain a previously-observed puzzle: aggregate trading volume tends to be higher on days when the stock market rises than when it falls. The idea proposed here is that trading is more active on days when the market rises because on those days there is more non-market news on which to trade. I find that empirically, the bulk of the relation between volume and the signed market return is explained by variations in non-market volatility.
Learning About a Shift in Trend Output: Implications for Monetary Policy and Inflation
–December 1, 2000
Kevin J. LansingThis paper develops a small forward-looking macroeconomic model where the Federal Reserve estimates the level of potential output in real time by running a regression on past output data. The Fed’s perceived output gap is used as an input to the monetary policy rule while the true output gap influences aggregate demand and inflation. I investigate the consequences of two postulated shifts in the growth rate of U.S. potential output: the first occurs in the early-1970s and the second in the mid-1990s. Initially, Fed policymakers interpret these shifts to be cyclical shocks but their regression algorithm allows them to gradually discover the truth as the economy evolves over time. Under a Taylor-type rule, the model can produce a hump-shaped pattern in trend inflation that peaks around 1979 and a downward movement in trend inflation since 1995. Under a nominal income growth rule, these low-frequency movements in inflation are substantially reduced but not eliminated. The business cycle stabilization properties of the two rules turn out to be quite similar. Finally, using stochastic simulations, I show that efforts to identify the Fed’s policy rule using a regression based on final data can create the illusion of strong interest rate smoothing behavior when in fact none exists.
Growth Effects of a Flat Tax
–December 1, 2000
Steven P. Cassou, Kevin J. LansingThis paper develops a quantitative general equilibrium model to assess the growth effects of adopting a flat tax plan similar to the one proposed by Hall and Rabushka (1995). Using parameters calibrated to match the progressivity of the U.S. tax schedule and other features of the U.S. economy, we compute the growth and level effects of adopting a revenue-neutral flat tax for both a human-capital based endogenous growth model and a standard neoclassical growth model. Growth effects are decomposed into the parts attributable to the flattening of the marginal tax schedule, the full expensing of physical-capital investment, and the elimination of double taxation of corporate dividends. We find that the most important element of the reform is the flattening of the marginal tax schedule. Without this element, the combined effects of the other parts of the reform can actually reduce long-run growth.
Solving for Optimal Simple Rules in Rational-Expectations Models
–December 1, 2000
Richard DennisThis paper presents techniques to solve for optimal simple monetary policy rules in rational expectations models, assuming discretion. The techniques described are notable for the flexibility they provide over the structure of the policy rule being solved for. Specifically, not all state variables need enter the policy rule allowing rules optimal conditional on a given information set to be easily constructed. The algorithms described are compared to related solution methods, and applied to the model in Clarida, Gali, and Gertler (1999).
Steps Toward Identifying Central Bank Policy Preferences
–December 1, 2000
Richard DennisThis paper takes the parameters in central bank loss functions as fundamental preferences to be estimated from the data. It is these preferences (along with target values) that define the policy regime in operation and that potentially change with senior central bank appointments. Optimizing central banks apply policy rules whose feedback coefficients are functions of its preferences. Consequently, under some conditions, it is possible to back out estimates of the preference parameters from estimated policy reaction functions. This paper establishes conditions under which a policy regime can be identified and illustrates these conditions using a number of popular models.
Testing Present Value Models of the Current Account: A Cautionary Note
–December 31, 2000
Kenneth KasaFollowing Campbell (1987) and Campbell and Shiller (1987), many papers have evaluated the intertemporal approach to the current account by testing restrictions on a Vector Autoregression (VAR). The attractiveness of the Campbell-Shiller methodology is that it is thought to be immune to omitted information. This paper uses results from Hansen and Sargent (1991a) and Quah (1990) to show that this is not true in certain (empirically plausible) situations. In particular, it is shown that if fundamentals are driven by unobserved (to the econometrician) permanent and transitory components, then the theoretical restrictions of a standard Present Value model of the current account might not be testable with a VAR. This is because the theoretical moving average representation can turn out to be noninvertible. This implies that observed data, including the current account, do not reveal the underlying shocks to agents’ information sets. ; These results are potentially relevant given the results of several recent papers which claim that current accounts are ‘excessively volatile’. I provide a simple example in which a researcher employing the Campbell-Shiller methodology is tricked into thinking the current account responds excessively to shocks when in fact the data are consistent with the theory.
A Robust Hansen-Sargent Prediction Formula
–December 31, 2000
Kenneth KasaThis paper derives a formula for the optimal forecast of a discounted sum of future values of a random variable. This problem reflects a preference for robustness in the presence of (unstructured) model uncertainty. The paper shows that revisions of a robust forecast are more sensitive to new information, and discusses the relevance of this result to previous findings of excess sensitivity of consumption and asset prices to new information.
Learning, Large Deviations, and Recurrent Currency Crises
–December 31, 2000
Kenneth KasaThis paper studies a version of Obstfeld’s (1997) "escape clause" model. The model is calibrated to produce three rational expectations equilibria. Two of these equilibria are E-stable in the sense of Evans (1985), and one is unstable. Dynamics are introduced by assuming that agents must learn about the government’s decision rule. It is assumed they do this using a stochastic approximation algorithm. It turns out that as a certain parameter describing the sensitivity of beliefs to new information gets small, the algorithm converges weakly to a small noise diffusion process. The dynamics of exchange rate changes are then characterized using large deviation techniques from Freidlin and Wentzell (1998). These methods describe the sense in which the limiting distribution of exchange rate changes is approximated by a two-state Markov-switching process, where the two states correspond to the two E-stable equilibria of the algorithm’s mean dynamics. The analysis relates the parameters of this process to assumptions about learning and the stochastic properties of the underlying shocks. ; The model is applied to the exchange rate histories of Argentina, Brazil, and Mexico. Although two-state Markov-switching models describe these countries’ exchange rate histories quite well, they have little ex ante predictive power. Of more interest to this paper, however, is the finding that observed currency crises look a lot like the predicted ‘escape routes’ of the calibrated escape clause model, augmented with an adaptive learning rule. A key feature of these escape routes is that expectations of a devaluation erupt suddenly, without any large contemporaneous shocks. This is consistent with evidence showing that crises are often poorly anticipated by financial markets.
Instability under Nominal GDP Targeting: The Role of Expectations
–January 1, 2000
Richard DennisBall (1997) shows using a small closed economy model that nominal GDP targeting can lead to instability. This paper extends Ball’s model to uncover the role inflation expectations play in generating this instability. By changing the process by which inflation expectations are formed in the short-run aggregate supply curve we show that nominal GDP targeting in either level or growth form does not generally result in instability. We further show that in Ball’s (1997) case where exact targeting causes instability that moving to inexact targeting restores stability.
Liquidity Effects and Financial Intermediation in a Model with a Frictionless Bond Market
–November 1, 2000
Tor Einarsson, Milton H. MarquisAn “expansionary” monetary policy that increases the growth rate of bank reserves is generally believed by policy makers to induce a “liquidity effect”, or a persistent decline in short-term nominal interest rates, that stimulates real activity. Christiano, et al. (1991,1995,1997) have incorporated this feature of the economy into equilibrium business cycle models by introducing a commercial bank that acquires deposits from households and channels those funds to firms, which use them to fund their working capital expenses. Bank deposits are the only interest-bearing financial asset available to households, and bank loans are the only source of working capital finance available to firms. To obtain a liquidity effect in response to an unanticipated reserves injection, those models rely on an information friction whereby households precommit to a liquid asset position prior to the monetary shock. In practice, the capital markets are a major source of working capital finance, and U.S. data indicate that bank financing as a share of total short-term working capital finance is countercyclical. This paper extends this literature by introducing a bond market that allows for nonintermediated loans directly from households to firms, and examines the information friction that could induce liquidity effects and countercyclicality in the degree of bank intermediation of working capital finance. The results indicate: (i) “sticky prices” are neither necessary nor sufficient to induce a liquidity effect; (ii) deposit precommitment by households along with a presetting of the deposit rate by banks does induce persistent liquidity effects, but results in excess volatility of consumption and investment; (iii) minimizing the deposit precommitment, while maintaining the preset deposit rate induces a weaker liquidity effect that is more in line with the data, without the excess volatility in consumption and investment; and (iv) the share of bank intermediation in working capital finance is countercyclical in all cases, including the absence of an information friction.
Black-White Wage Inequality in the 1990s: A Decade of Progress
–August 1, 2000
Kenneth A. Couch, Mary C. DalyUsing Current Population Survey data, we find that the gap between wages by black and white males declined during the 1990s at a rate of 0.59 percentage point per year. The reduction in occupational crowding appears to be most important in explaining this trend. Recent wage convergence was most rapid among younger workers with less than 10 years experience; for this group the black-white wage gap declined by 1.40 percentage points per year. Among younger workers greater occupational diversity and a reduction in unexplained or residual differences are important in explaining this trend. For both younger and older workers, general wage inequality tempered the rate of wage convergence between blacks and whites during the 1990s.
Inequality and Poverty in the United States: The Effects of Rising Male Wage Dispersion and Changing Family Behavior
–June 1, 2000
Mary C. Daly, Robert G. VallettaThe trend toward increasing inequality in family income in the United States since the late 1960s is well documented. Among key possible explanations for this increase are rising dispersion in individual earnings, changes in female labor supply decisions, and changes in family composition and living arrangements. We analyze the contribution of these factors to changes in family income inequality and poverty during the years 1969-1998, focusing on labor supply and family structure as behavioral changes but accounting also for changes in the distribution of male earnings. Our analyses rely on conditionally weighted density estimation, a semiparametric decomposition technique recently developed by DiNardo, Fortin, and Lemieux (1996). We also use a relatively novel rank-based distributional exchange to assess the effects of changes in the distribution of male earnings. ; In our empirical work, we first analyze changes between 1969 and 1989, which corresponds roughly to the period of rising inequality that has been the focus of previous work. Our results indicate that rising dispersion of male earnings and the decline of traditional forms of family structure respectively explain up to about three-fourths and about one-half of rising inequality in family income during this period. The impact of changing family structure was most pronounced in the lower half of the distribution. In contrast, the increase in female labor force participation offset rising inequality to some degree, mainly in the upper half of the distribution, although its impact has moved down the distribution over time. In extending the analyses to the 1990s, we find that the rate at which inequality grew slowed after 1989, but the explanatory factors continued to have substantial effects. In each decade, the effects of the explanatory factors on poverty were especially large and followed a pattern similar to that for inequality.
Common Shocks and Currency Crises
–April 1, 2000
Ramon Moreno, Bharat TrehanThis paper attempts to determine the extent to which common external shocks explain simultaneous currency crises. We define crises on a country by country basis using a new criterion that takes into account variations in the volatility of exchange rates over time and across countries. Using a Poisson regression model, we find that over the post-Bretton woods period, a small number of common external shocks can explain between sixty to eighty percent of the variation in the total number of crises over time, depending upon the set of countries one looks at. Our findings provide one explanation of why currency crises sometimes bunch together and sometimes do not.
Union Effects on Health Insurance Provision and Coverage in the United States
–April 1, 2000
Thomas C. Buchmueller, John DiNardo, Robert G. VallettaSince Freeman and Medoff’s (1984) comprehensive review of what unions do, union density in the U.S. has fallen substantially. During the same period, employer provision of health insurance has undergone substantial changes in extent and form. Using individual data from various supplements to the Current Population Survey and establishment data from the 1993 Robert Wood Johnson Foundation survey, we investigate the effects of unionization on employer provision of health benefits. We find that in addition to increasing coverage by employer-provided health benefits, unions reduce employee cost sharing and substantially increase the probability that employer-provided health plans extend to retirees. The union effects on coverage for current employees and for retirees have risen over time, and our estimates suggest that declining unionization explains about 17-20 percent of the decrease in employer-provided health insurance between 1983 and 1997.
Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty
–March 1, 2000
Glenn D. RudebuschNominal income rules for monetary policy have long been debated, but two issues are of particular recent interest. First, there are questions about the performance of such rules over a range of plausible empirical models-especially models with and without rational inflation expectations. Second, there are questions about the performance of these rules in real time using the type of data that is actually available contemporaneously to policymakers rather than final revised data. This paper determines optimal monetary policy rules in the presence of such model uncertainty and real-time data uncertainty and finds only a limited role for nominal output growth.
Is Implied Correlation Worth Calculating? Evidence from Foreign Exchange Options and Historical Data
–February 1, 2000
Jose A. Lopez, Christian WalterImplied volatilities, as derived from option prices, have been shown to be useful in forecasting the subsequently observed volatility of the underlying financial variables. In this paper, we address the question of whether implied correlations, derived from options on the exchange rates in a currency trio, are useful in forecasting the observed correlations. We compare the forecast performance of the implied correlations from two currency trios with markedly different characteristics against correlation forecasts based on historical, time-series data. For the correlations in the USD/DEM/JPY currency trio, we find that implied correlations are useful in forecasting observed correlations, but they do not fully incorporate all the information in the historical data. For the correlations in the USD/DEM/CHF currency trio, implied correlations are much less useful. In general, since the performance of implied correlations varies across currency trios, implied correlations may not be worth calculating in all instances.
The Potential Diversification and Failure Reduction Benefits of Bank Expansion into Nonbanking Activities
–January 1, 2000
Elizabeth LadermanBank holding company (BHC) expansion into nonbank financial activities may increase or decrease the standard deviation of BHC ROA and/or the probability of bankruptcy of the BHC. Using individual firm data and a new application of a simulated merger methodology, I find the standard-deviation minimizing and bankruptcy-probability minimizing nonbank weights for a variety of nonbanking activities for two time periods, 1979-1986 and 1987-1997, for all BHCs and for large BHCs. I find that relatively substantial levels of investment in life insurance underwriting are optimal for reducing the standard deviation of BHC ROA. Appreciable levels of investment in life insurance underwriting, casualty insurance underwriting, and securities brokerage are optimal for reducing the probability of bankruptcy of the BHC.