The Kansas City Fed's research staff members produce working papers covering a wide range of economic topics, including monetary policy, payment methods, banking and more.
Distributional Effects of Payment Card Pricing and Merchant Cost Pass-through in the United States and CanadaBy Fumiko Hayashi, Marie-Hélène Felt, Joanna Stavins and Angelika Welte Low-income consumers in the United States and Canada pay the highest net transaction costs as a percentage of their purchases.
Did the Federal Reserve Break the Phillips Curve? Theory and Evidence of Anchoring Inflation ExpectationsBy Brent Bundick and A. Lee Smith Communicating a longer-run inflation objective better anchored inflation expectations in the United States, which may explain the weaker relationship between inflation and unemployment in recent years.
The Effect of the Conservation Reserve Program on Rural Economies: Deriving a Statistical Verdict from a Null FindingBy Jason P. Brown, Dayton M. Lambert and Timothy R. Wojan New technique allows researchers to determine when “statistically insignificant” means “no substantive effect.”
Does Communicating a Numerical Inflation Target Anchor Inflation Expectations? Evidence & Bond Market ImplicationsBy Brent Bundick and A. Lee Smith Communicating a longer-run inflation objective helped anchor inflation expectations in the United States but not in Japan.
The Labor Market Effects of Offshoring by U.S. Multinational Firms: Evidence from Changes in Global Tax PoliciesBy Nicholas Sly , Brian K. Kovak and Lindsay Oldenski Changes in global tax policy that lower the effective tax rate on foreign income raise employment at U.S. multinational firms.
Do Bank Bailouts Reduce or Increase Systemic Risk? The Effects of TARP on Financial System StabilityBy Raluca A. Roman, Allen N. Berger and John Sedunov The TARP bailout significantly reduced contributions to systemic risk, particularly for large banks, safe banks, and banks located in strong local economies. These reductions occurred primarily through a capital cushion channel.
Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation: Comment Based on System EstimationBy Willem Van Zandweghe, Yasuo Hirose and Takushi Kurozumi This paper re-examines the role of trend inflation in the U.S. economy's shift from the Great Inflation era to the Great Moderation era.
Did Saving Wall Street Really Save Main Street? The Real Effects of TARP on Local Economic ConditionsBy Raluca A. Roman and Allen N. Berger We investigate whether saving Wall Street through the Troubled Assets Relief Program (TARP) really saved Main Street during the recent financial crisis. Our difference-in-difference analysis suggests that TARP statistically and economically significantly increased net job creation and net hiring establishments and decreased business and personal bankruptcies. The results are robust, including accounting for endogeneity. The main mechanisms driving the results appear to be increases in commercial real estate lending and off-balance sheet real estate guarantees. These results suggest that saving Wall Street via TARP may have helped save Main Street, complementing the TARP literature and contributing to the cost-benefit debate.
Cash Flow and Risk Premium Dynamics in an Equilibrium Asset-Pricing Model with Recursive PreferencesBy Taeyoung Doh and Shu Wu Under linear approximations for asset prices and the assumption of independence between expected consumption growth and time-varying volatility, long-run risks models imply constant market prices of risks and often generate counterfactual results about asset return and cash ﬂow predictability. We develop and estimate a nonlinear equilibrium asset pricing model with recursive preferences and a ﬂexible econometric speciﬁcation of cash ﬂow processes. While in many long-run risks models time-varying volatility inﬂuences only risk premium but not expected cash ﬂows, in our model a common set of risk factors drive both expected cash ﬂow and risk premium dynamics. This feature helps the model to overcome two main criticisms against long-run risk models following Bansal and Yaron (2004): the over-predictability of cash ﬂows by asset prices and the tight relation between time-varying risk premia and growth volatility. Our model extends the approach in Le and Singleton (2010) to a setting with multiple cash ﬂows. We estimate the model using the long-run historical data in the U.S. and ﬁnd that the model with generalized market prices of risks produces cash ﬂow and return predictability that are more consistent with the data.
In a sticky-price model where firms finance their production inputs, there is both a lower and an upper bound on the central bank's inflation response necessary to rule out the possibility of self-fulfilling inflation expectations. This paper shows that real wage rigidities decrease this upper bound, but coefficients in the range of those on the Taylor rule place the economy well within the determinacy region. However, when there is time-variation in the share of firms who finance their inputs (i.e. Markov-Switching) then inflation targeting interest rate rules frequently result in indeterminacy, even if the central bank also targets output. Adding a nominal growth target to the policy rule can often alleviate this indeterminacy and therefore anchor inflation expectations.
Capturing Rents from Natural Resource Abundance: Private Royalties from U.S. Onshore Oil & Gas ProductionBy Jason P. Brown, Timothy Fitzgerald and Jeremy G. Weber We study how much private mineral owners capture geologically-driven advantages in well productivity through a higher royalty rate. Using proprietary data from nearly 1.8 million leases, we estimate that the six major shale plays generated $39 billion in private royalties in 2014. There is limited pass-through of resource abundance into royalty rates. A doubling of the ultimate recovery of the average well in a county increases the average royalty rate by 1 to 2 percentage points (a 6 to 11 percent increase). Thus, mineral owners benefit from resource abundance primarily through a quantity effect, not through negotiating better lease terms from extraction firms. The low pass-through likely reflects a combination of firms exercising market power in private leasing markets and uncertainty over the value of resource endowments.
Deteriorating economic conditions in late 2008 led the Federal Reserve to lower the target federal funds rate to near zero, inject liquidity into the financial system through novel facilities, and engage in large scale asset purchases. The combination of conventional and unconventional policy measures prevents using the effective federal funds rate to assess the effects of monetary policy beyond 2008. This paper develops an approach to identify the effects of monetary policy shocks in such instances. We employ a newly created broad monetary aggregate to elicit the effects of monetary policy shocks both prior to and after 2008. Our model produces plausible responses to monetary policy shocks free from price, output, and liquidity puzzles that plague other approaches. It also produces a series of monetary policy shocks which aligns well with major changes in the Fed’s asset purchase programs.
Location Decisions of Natural Gas Extraction Establishments: A Smooth Transition Count Model ApproachBy Jason P. Brown and Dayton M. Lambert The economic geography of the United States' energy landscape changed rapidly with domestic expansion of the natural gas sector. Recent work with smooth transition parameter models is extended to an establishment location model estimated using Poisson regression to test whether expansion of this sector, as evidenced by firm location decisions from 2005 to 2010, is characterized by different growth regimes. Results suggest business establishment growth of firms engaged in natural gas extraction was faster when the average area of shale and tight gas transition coverage in neighboring counties exceeded 17%. Local agglomeration externalities, access to skilled labor and transportation infrastructure were of more economic importance to location decisions in the high growth regime. Accordingly, growth rates were heterogeneous across the lower 48 States, suggesting potentially different outcomes with respect to local investment decisions supporting this sector.
By Jun Nie and Lei Fang (RWP 13-10, January 2014)
The high U.S. unemployment rate after the Great Recession is usually considered as a result of changes in factors influencing either the demand side or the supply side of the labor market. However, no matter what factors have caused the changes in the unemployment rate, these factors should have influenced workers' and firms' decisions. Therefore, it is important to take into account workers' endogenous responses to changes in various factors when seeking to understand how these factors a ect the unemployment rate. To address this issue, we estimate a Mortensen-Pissarides style labor-market matching model with endogenous separation decisions and stochastic changes in workers' human capital. We study how agents' endogenous choices vary with changes in the exogenous shocks and changes in labor-market policy in the context of human capital dynamics. There are four main findings. First, once workers have accounted for and are able to optimally respond to possible human capital loss, the unemployment rate in an economy with human capital loss during unemployment will not be higher than in an economy with no human capital loss. The reason is that the increase in the unemployment rate led by human capital loss is more than o set by workers' endogenous responses to prevent them from being unemployed. Second, human capital accumulation on the job is more important than human capital loss during unemployment for both the unemployment rate and output. Third, workers' endogenous separation rates will decline when job finding rates fall. Fourth, taking into account the endogenous responses, UI extensions contributed 0.5 percentage point to the increase in the aggregate unemployment rate in the 2008-2012 period.
By Rong-Wei Chu, Jun Nie and Bei Zhang (RWP 13-09, January 2014)
A growing body of literature has suggested that agents' risk attitudes may not be constant and are correlated with factors such as wealth. We introduce state-dependent risk aversion into Aiyagari's (1994) heterogenous-agent version of standard neoclassical growth model with uninsurable idiosyncratic shocks to earning. We first quantitatively show the relationships among risk aversion, saving rate, equilibrium interest rate and wealth distribution. In particular, we show that if agent's risk aversion increases with wealth, the model predicts a larger wealth inequality, while assuming risk decreases with wealth leads to a smaller wealth inequality. We then use experimental data to estimate how risk aversion is correlated with an individual's wealth. We found that the relationship between risk aversion and wealth is hump-shaped. That is, risk aversion first increases with an individual's wealth and then decreases with it. Using the same model, we quantify the implication of this relationship between risk aversion and wealth on wealth inequality. The results show that the overall wealth inequality changes very little compared to the case with constant risk aversion. This is because, though the poorest agents save less, which increases wealth inequality, the richest agents also save less, which reduces the wealth inequality. Putting these two together, it leaves the overall wealth inequality implied by the model similar to that of the case of constant risk aversion.
By Takushi Kurozumi and Willem Van Zandweghe (RWP 13-08, June 2013; Revised February 2015)
In the presence of staggered price setting, high trend inflation induces a large deviation of steady-state output from its natural rate and indeterminacy of equilibrium under the Taylor rule. This paper examines the implications of a ''smoothed-off'' kink in demand curves for the natural rate hypothesis and macroeconomic stability using a canonical model with staggered price setting, and sheds light on the relationship between the hypothesis and the Taylor principle. An empirically plausible calibration of the model shows that the kink in demand curves mitigates the influence of price dispersion on aggregate output, thereby ensuring that the violation of the natural rate hypothesis is minor and preventing fluctuations driven by self-fulfilling expectations under the Taylor rule.
Rural Wealth Creation and Emerging Energy Industries: Lease and Royalty Payments to Farm Households and Businesses
By Jeremy G. Weber, Jason P. Brown, and John Pender (RWP 13-07, June 2013)
New technologies for accessing energy resources, changes in global energy markets, and government policies have encouraged growth in the natural gas and wind industries in the 2000s. The growth has offered new opportunities for wealth creation in many rural areas. At a local level, households who own land or mineral rights can benefit from energy development through lease and royalty payments. Using nationally-representative data on U.S. farms from 2011, we assess the consumption, investment, and wealth implications of the $2.3 billion in lease and royalty payments that energy companies paid to farm businesses. We estimate that the savings of current energy payments combined with the effect of payments on land values added $104,000 in wealth for the average recipient farm.
By Nada Mora (RWP 13-06, June 2013; Revised December 2014)
This paper reconciles industry conditions with the state of the economy in driving asset liquidation values and, therefore, recovery rates on defaulted debt securities. Macroeconomic effects matter but they operate differentially at the industry level. I find that industries whose sales growth is more correlated with GDP growth recover less during recessions. And industries that are more dependent on external finance recover more when the stock market rises. Direct measures of industry distress and industry fundamental value, in addition to measures of bond market illiquidity, enter with reduced economic and statistical significance once the constraint that the macroeconomy should have a uniform effect is relaxed. The results of this paper are not incompatible with the industry-equilibrium view put forward by Shleifer and Vishny (1992) and others, but it unmasks a channel of transmission from the macroeconomy.
Predicting Recessions with Leading Indicators: Model Averaging and Selection Over the Business Cycle
By Travis Berge (RWP 13-05, April 2013)
This paper evaluates the ability of several commonly followed economic indicators to predict business cycle turning points. As a baseline, forecasts from univariate models are combined by taking averages or by weighting forecasts with model-implied posterior probabilities. These combined forecasts are compared to those from a sophisticated model selection algorithm that allows for nonlinear model specifications. The preferred forecasting model is one that allows for nonlinear behavior across the business cycle and combines information from the yield curve with other indicators, especially at very short and very long horizons.
By Andrew Foerster (RWP 13-04, June 2013; Revised November 2014)
This paper investigates how different monetary policy regime switching types impact macroeconomic dynamics. Policy switches that either affect the inflation target or the response to inflation deviations from target lead to different determinacy regions and different output, inflation, and interest rate distributions. With regime switching, the standard Taylor Principle breaks down in multiple ways; satisfying the Principle period-by-period is neither necessary nor sufficient for determinacy. Switching inflation targets primarily affects the economy's level, whereas switching inflation responses affects the variance. Even in periods with a fixed monetary policy rule, expectations of future policy switches produce different outcomes depending upon the switching type. Monetary authorities with given inflation objectives need to adjust their policy parameters to counteract expectations of future policy switches.
By John Carter Braxton (RWP 13-03, May 2013; Revised March 2014)
Initial jobless claims provide a weekly snapshot of the labor market. While known for being volatile, when put into the appropriate context initial jobless claims provide valuable information on the state of the labor market. This paper introduces a threshold of initial jobless claims that serves as a basis of comparison for the weekly reading of initial jobless claims. Observed initial jobless claims above the threshold are associated with a rising unemployment rate, and vice versa. The results of an out of sample forecasting experiment show that considering the deviation of initial jobless claims from the threshold of initial claims can improve forecasting accuracy of one month ahead unemployment rate forecasts by three times more than using a conventional rule of thumb for initial jobless claims as well as outperform several time series models. The improvements in forecasting accuracy are strongest during recessions. The results of this paper suggest that there could be benefits to producing nowcasting models of the unemployment rate that incorporate initial jobless claims. Finally, as initial jobless claims are a measure of separations and are shown to aid in forecasting the unemployment rate, it appears that separations do play some role in influencing the unemployment rate.
By Klaus Desmet and Jordan Rappaport (RWP 13-02, February 2013; Revised August 2014 - Online Appendix)
This paper studies the long run development of U.S. counties and metro areas from 1800 to 2000. In earlier periods smaller counties converge whereas larger counties diverge. Over time, due to changes in the age composition of locations and net congestion, convergence dissipates and divergence weakens. Gibrat's law emerges gradually without fully attaining it. Our findings suggest that orthogonal growth is a consequence of reaching a steady state population distribution, rather than an explanation of that distribution. A simple one-sector model, with entry of new locations, a growth friction, and decreasing net congestion closely matches these and related dynamics.
By Andrew Foerster, Juan Rubio-Ramirez, Dan Waggoner, and Tao Zha (RWP 13-01, February 2013; Revised November 2015)
This paper develops a general perturbation methodology for constructing high-order approximations to the solutions of Markov-switching DSGE models. We introduce an important and practical idea of partitioning the Markov-switching parameter space so that a steady state is well defined. With this definition, we show that the problem of finding an approximation of any order can be reduced to solving a system of quadratic equations. We propose using the theory of Gröbner bases in searching all the solutions to the quadratic system. This approach allows us to obtain all the approximations and ascertain how many of them are stable. Our methodology is applied to three models to illustrate its feasibility and practicality.
By Yulei Luo, Jun Nie, and Eric R. Young (RWP 12-11, March 2013; Revised March 2014)
This paper studies the aggregate dynamics of durable and nondurable consumption under sticky information diffusion (SID) due to noisy observations and slow learning within the permanent income framework. We show that SID can significantly improve the model's predictions on the joint behavior of income, durable, and nondurable consumption at the aggregate level. Specifically, we find that SID can help generate (i) realistic smoothness in durable and nondurable consumption, (ii) the autocorrelation of durable consumption, and (iii) the contemporaneous correlation between durable and nondurable consumption. Furthermore, we show that incorporating a fixed cost into our SID model does a better job of reproducing the infrequent adjustments of durable consumption at the individual level and the slow adjustments at the aggregate level.
By Edward S. Knotek II and Shujaat Khan (RWP 12-10, November 2012)
This paper revisits the phenomenon of stagflation. Using a standard New Keynesian dynamic, stochastic general equilibrium model, we show that stagflation from monetary policy alone is a very common occurrence when the economy is subject to both deviations from the policy rule and a drifting inflation target. Once the inflation target is fixed, the incidence of stagflation in the baseline model is essentially eliminated. In contrast with several other recent papers that have focused on the connection between monetary policy and stagflation, we show that while high uncertainty about monetary policy actions can be conducive to the occurrence of stagflation, imperfect information more generally is not a requisite channel to generate stagflation.
By Takushi Kurozumi and Willem Van Zandweghe (RWP 12-09, December 2012; Revised August 2015)
In sticky price models based on micro evidence that each period a fraction of prices is kept unchanged, recent studies reach the qualitatively same conclusion that higher trend inﬂation is a more serious source of indeterminacy of rational expectations equilibrium, regardless of whether labor is ﬁrm-speciﬁc or homogeneous. This paper shows that the model with ﬁrm-speciﬁc labor is more susceptible to indeterminacy induced by high trend inﬂation than the model with homogeneous labor, because these two different speciﬁcations of labor lead to distinct representations of inﬂation dynamics. In addition, the model with ﬁrm-speciﬁc labor is more susceptible to expectational instability of the equilibrium caused by high trend inﬂation.
By Jose Mustre-del-Rio (RWP 12-08, November 2012; Revised August 2018)
Evidence from the National Longitudinal Survey of Youth (NLSY) suggests the cyclicality of job duration depends on the worker's prior and future employment status. For example, among matches formed with previously nonemployed workers, those that end with the worker returning to nonemployment have pro-cyclical duration. In contrast, matches that end because the worker switches to another job have counter-cyclical duration. Moreover, dierences in starting wages do not account for these observed patterns.
By Didem Tuzemen (RWP 12-07, October 2012)
Studies that incorporate endogenous labor force participation, and search and matching frictions in a real business cycle model find that this three-state model generates counterfactual results: labor force participation is very volatile, unemployment is acyclical and highly positively correlated with vacancies. Based on the evidence that job-to-job flows are large in the U.S. labor market, this paper enriches the three-state model with an on-the-job search mechanism which leads to job-to-job flows. The modified model successfully generates countercyclical unemployment and the Beveridge Curve relationship. Quantitatively, business cycle statistics reproduced by the modified model are more in line with their empirical counterparts.
By William B. Hawkins and Jose Mustre-del-Rio (RWP 12-06, October 2012; Revised June 2016)
We study the eﬀects of ﬁnancial market incompleteness on occupational mobility. Incomplete insurance reduces occupational mobility and, as a result, the correlation of labor supply with occupational productivity is lower than under complete markets. Low-asset workers remain in low-productivity occupations even when the expected value of switching is positive. Negative occupational productivity shocks therefore have larger eﬀects on such workers' future earnings than they would for better insured workers. In a model calibrated to match observations from the Survey of Income and Program Participation (SIPP), we ﬁnd welfare costs of market in-completeness averaging 2.4 percent of lifetime consumption. We examine policies to increase occupational mobility. A subsidy to retraining costs increases mobility signiﬁcantly and is welfare improving for agents stuck in low-productivity occupations. Meanwhile, a proportional tax on labor income decreases mobility, but naturally improves welfare through redistribution.
By Kelly Edmiston, Lara Brooks, and Steven Shepelwich (RWP 12-05, August 2012; Revised April 2013)
This paper provides a detailed overview of the student loan market, presents new statistics that highlight student loan debt burdens and delinquency rates, and discusses current concerns among many Americans about student loans, including their fiscal impact. The report is intended to enhance awareness of the state of student loan debt and delinquency and highlight issues facing borrowers, creditors, the federal government, and society at large. The clear message is that student loans present problems for some borrowers that are well worth addressing. At the same time, the analysis suggests that student loans do not yet impose a significant burden on society from their fiscal impact.
By Taeyoung Doh and Michael Connolly (RWP 12-04, July 2012)
To capture the evolving relationship between multiple economic variables, time variation in either coefficients or volatility is often incorporated into vector autoregressions (VARs). The state space representation that links the transition of possibly unobserved state variables with observed variables is a useful tool to estimate VARs with time-varying coefficients or stochastic volatility. In this paper, we discuss how to estimate VARs with time-varying coefficients or stochastic volatility using the state space representation. We focus on Bayesian estimation methods which have become popular in the literature. As an illustration of the estimation methodology, we estimate a time-varying parameter VAR with stochastic volatility with the three U.S. macroeconomic variables including inflation, unemployment, and the long-term interest rate. Our empirical analysis suggests that the recession of 2007-2009 was driven by a particularly bad shock to the unemployment rate which increased its trend and volatility substantially. In contrast, the impacts of the recession on the trend and volatility of nominal variables such as the core PCE inflation rate and the ten-year Treasury bond yield are less noticeable.
By Fumiko Hayashi and Joanna Stavins (RWP 12-03, February 2012)
This paper investigates the effects of credit scores on consumer payment behavior, especially on debit and credit card use. Anecdotally, a negative relationship between debit card use and credit score has been reported; however, it is not clear whether that relationship is related to other factors, such as education or income, or whether it is a mere correlation. We use a new consumer survey dataset to examine whether this negative relationship holds after controlling for various consumer characteristics, including demographic and financial characteristics, consumers' perceptions toward payment methods, and card reward status. The results based on a single-year survey as well as on panel data suggest that there is a significant negative relationship between debit card use and credit score even after controlling for various characteristics. We supplement the analysis with evidence from Equifax data. The results indicate that an increase in consumers' cost of debit cards—in response to regulatory changes, for example—would have an adverse effect on low-credit-score consumers (typically those with lower incomes and less education).
We then investigate what credit score implies. If credit score significantly influences consumer access to credit cards, credit limits, or the cost of credit cards, then the negative relationship likely results from supply-side constraints. If a lower credit score is associated with differences in underlying preferences, then the negative relationship is likely due to demand-side effects. Preliminary evidence strongly suggests that supply-side factors play an important role in the cost of credit and in access to credit.
By Yulei Luo, Jun Nie and Eric R. Young (RWP 12-02, January 2012; Revised February 2012)
State-space models have been increasingly used to study macroeconomic and financial problems. A state space representation consists of two equations, a measurement equation which links the observed variables to unobserved state variables and a transition equation describing the dynamics of the state variables. In this paper, we show that a classic linear-quadratic macroeconomic framework which incorporates two new assumptions can be analytically solved and explicitly mapped to a state-space representation. The two assumptions we consider are the model uncertainty due to concerns for model misspecification (robustness) and the state uncertainty due to limited information constraints (rational inattention). We show that the state-space representation of the observable and unobservable can be used to quantify the key parameters on the degree of model uncertainty. We provide examples on how this framework can be used to study a range of interesting questions in macroeconomics and international economics.
By Yulei Luo, Jun Nie and Eric R. Young (RWP 12-01, January 2012; Revised June 2014)
In this paper we examine how model uncertainty due to the preference for robustness (RB) affects optimal taxation and the evolution of debt in the Barro tax-smoothing model (1979). We first study how the government spending shocks are absorbed in the short run by varying taxes or through debt under RB. Furthermore, we show that introducing RB improves the model’s predictions by generating (i) the observed relative volatility of the changes in tax rates to government spending, (ii) the observed comovement between government deficits and spending, and (iii) more consistent behavior of government budget deficits in the US economy.
By Todd E. Clark and Taeyoung Doh (RWP 11-16, November 2011)
The concept of trend inflation is important in making accurate inflation forecasts. However, there is little consensus on how the trend in inflation should be modeled. While some studies suggest a survey-based measure of long-run inflation expectations as a good empirical proxy for trend inflation, others have argued for a statistical exercise of decomposing inflation data into trend and cycle components.
In this paper, we assess alternative models of trend inflation based on the accuracy of medium-term inflation forecasts. To incorporate recent evidence on the time-varying macroeconomic volatility, we consider models with both constant volatility and time-varying volatility. For all the models, we compare not only point predictions but also density forecasts, such as deflation probability.
Our analysis yields two broad results. First, models with time-varying volatility consistently dominate those with constant volatility. Second, once time-varying volatility is incorporated, it is difficult to say that one model of trend inflation is better. Simply averaging forecasts with time-varying volatility is as good as forecasts from the best-fitting model. In addition, the relative performance of each model varies greatly over time. Overall, our results suggest that it is important to consider predictions from a range of models with time-varying volatility.
By Jon Christensson, Kenneth Spong, and Jim Wilkinson (RWP 11-15, December 2011)
Many countries have suggested macroprudential supervision as a means for earlier identification and better control of the risks that might lead to a financial crisis. Since macroprudential supervision would focus on the financial system in its entirety and on major risks that could threaten financial stability, it shares many of the same goals as the financial stability reports written by most central banks. This article examines the financial stability reports of five central banks to assess how effective they were in identifying the problems that led to the recent financial crisis and what implications they might have for macroprudential supervision.
The financial stability reports in these five countries were generally successful in foreseeing the risks that contributed to the crisis, but the reports underestimated the severity of the crisis and did not fully anticipate the timing and pattern of important events. While the stress tests in these reports provided insights into the resiliency and capital needs of the banks in these countries, the stresses and scenarios tested often differed from what actually occurred and some of the reports did not consider them to be likely events. One other major challenge for the central banks was in taking the concerns expressed in financial stability reports and linking them to effective and timely supervisory policy. Overall, the reports were a worthwhile exercise in identifying and monitoring key financial trends and emerging risks, but they also indicate the significant challenges macroprudential supervision will have in anticipating and addressing financial market disruptions.
By Travis J. Berge and Òscar Jordà (RWP 11-14, November 2011)
This 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.
By Hsieh Fushing, Shu-Chun Chen, Travis J. Berge, and Òscar Jordà (RWP 11-13, October 2010)
This paper introduces a new empirical strategy for the characterization of business cycles. It combines non-parametric decoding methods that classify a series into expansions and recessions but does not require specification of the underlying stochastic process generating the data. It then uses network analysis to combine the signals obtained from different economic indicators to generate a unique chronology. These methods generate a record of peak and trough dates comparable, and in one sense superior, to the NBER's own chronology. The methods are then applied to 22 OECD countries to obtain a global business cycle chronology.
By Travis J. Berge (RWP 11-12, November 2011)
Catalyzed by the work of Meese and Rogoff (1983), a large literature has documented the inability of empirical models to accurately forecast exchange rates out-of-sample. This paper extends the literature by introducing an empirical strategy that endogenously builds forecast models from a broad set of conventional exchange rate signals. The method is extremely flexible, allowing for potentially nonlinear models for each currency and forecast horizon that evolve over time. Analysis of the models selected by the procedure sheds light on the erratic behavior of exchange rates and their apparent disconnect from macroeconomic fundamentals. In terms of forecast ability, the Meese-Rogoff result remains intact. At short horizons, the method cannot outperform a random walk, although at longer horizons the method does outperform the random walk null. These findings are found consistently across currencies and forecast evaluation methods.
By Ching Wai (Jeremy) Chiu, Bjørn Eraker, Andrew T. Foerster, Tae Bong Kim, and Hernán D. Seoane
(RWP 11-11 December 2011)
Economic data are collected at various frequencies but econometric estimation typically uses the coarsest frequency. This paper develops a Gibbs sampler for estimating VAR models with mixed and irregularly sampled data. The approach allows efficient likelihood inference even with irregular and mixed frequency data. The Gibbs sampler uses simple conjugate posteriors even in high dimensional parameter spaces, avoiding a non-Gaussian likelihood surface even when the Kalman filter applies. Two applications illustrate the methodology and demonstrate efficiency gains from the mixed frequency estimator: one constructs quarterly GDP estimates from monthly data, the second uses weekly financial data to inform monthly output.
By Kelly D. Edmiston (RWP 11-10 December 2011; Revised March 2018)
Public housing has long been a contentious issue for cities and regions. On one hand, there is an acute need for affordable housing in low- and moderate-income communities. But the massing of public or otherwise subsidized housing in disadvantaged neighborhoods has given rise to concerns that “public housing” has led to decay in these communities. The purpose of this paper is to use analytical tools to evaluate the “conventional wisdom” that lower-income housing developments lead to decay the lower-income communities in which they generally are placed. I use a highly unique dataset on property conditions for tens of thousands of individual land parcels and an approach for estimating count data models based on the Conway-Maxwell-Poisson (CMP) distribution. The CMP is useful for estimating models with underdispersed data, which is uncommon. Results suggest that while large rehab developments tend to enhance property conditions nearby, the effects of other types of developments generally are negative.
By José Mustre-del-Río (RWP 11-09 December 2011)
This paper examines the Frisch elasticity at the extensive margin of labor supply in an economy consistent with the observed dispersion in average employment rates across individuals. An incomplete markets economy with indivisible labor is presented where agents differ in their disutility of labor and market skills. The model's key parameters are estimated using indirect inference with panel data from the National Longitudinal Survey of the Youth-NLSY. The estimated model implies an elasticity of aggregate employment of 0.71. A simple decomposition reveals that labor disutility dierences, which capture the dispersion in employment rates, are crucial for this quantitative result. These differences alone generate an elasticity of 0.69. Meanwhile, skill differences alone imply an elasticity of 1.1. These results suggest that the literature generates large employment elasticities by ignoring individual labor supply differences.
By Mauricio Cárdenas, Santiago Ramírez, and Didem Tuzemen (RWP 11-08 December 2011)
This paper shows that higher commodity dependence reduces the government's incentive to invest in fiscal capacity. After developing a model that makes this prediction, evidence is provided supporting the view that countries more dependent on commodities (whose rents can be easily appropriated by the government, such as oil) have weaker fiscal capacity. Also, fiscal capacity is found to improve less over time in commodity dependent countries relative to countries where commodity exports play a less relevant role. These empirical results are obtained in a panel dataset with estimators that address endogeneity issues.
By Mauricio Cárdenas and Didem Tuzemen (RWP 11-07 December 2011)
Existing studies have shown that the state's ability to tax, also known as fiscal capacity, is positively related to economic development. In this paper, we analyze the determinants of the government's decision to invest in state capacity, which involves a trade-off between present consumption and the ability to collect more taxes in the future. Using a model, we highlight some political and economic dimensions of this decision and conclude that political stability, democracy, income inequality, as well as the valuation of public goods relative to private goods, are important variables to consider. We then test the main predictions of the model using cross-country data and find that state capacity is higher in more stable and equal societies, both in economic and political terms, and in countries where the chances of fighting an external war are high, which is a proxy for the value of public goods.
By Viral V. Acharya and Nada Mora (RWP 11-06 December 2011)
Can banks maintain their advantage as liquidity providers when they are heavily exposed to a financial crisis? The standard argument - that banks can - hinges on deposit inflows that are seeking a safe haven and provide banks with a natural hedge to fund drawn credit lines and other commitments. We shed new light on this issue by studying the behavior of bank deposit rates and inflows during the 2007-09 crisis. Our results indicate that the role of the banking system as a stabilizing liquidity insurer is not one of the passive recipient, but of an active seeker, of deposits. We find that banks facing a funding squeeze sought to attract deposits by offering higher rates. Banks offering higher rates were also those most exposed to liquidity demand shocks (as measured by their unused commitments, wholesale funding dependence, and limited liquid assets), as well as with fundamentally weak balance-sheets (as measured by their non-performing loans or by subsequent failure). Such rate increases have a competitive effect in that they lead other banks to offer higher rates as well. Overall, the results present a nuanced view of deposit rates and flows to banks in a crisis, one that reflects banks not just as safety havens but also as stressed entities scrambling for deposits.
By Alison Felix and James R. Hines Jr. (RWP 11-05 November 2011)
Many American communities seek to attract or retain businesses with tax abatements, tax credits, or tax increment financing of infrastructure projects (TIFs). The evidence for 1999 indicates that communities are most likely to offer one or more of these business development incentives if their residents have low incomes, if they are located close to state borders, and if their states have troubled political cultures. Ten percent greater median household income is associated with a 3.2 percent lower probability of offering incentives; ten percent greater distance from a state border is associated with a 1.0 percent lower probability of offering incentives; and a 10 percent higher rate at which government officials are convicted of federal corruption crimes is associated with a 1.2 percent greater probability of offering business incentives. TIFs are the preferred incentive of communities whose residents have household incomes between $25,000 and $75,000; whereas TIFs are much less commonly offered by communities whose residents have household incomes below $25,000. The need to finance TIFs out of incremental tax revenues may make it infeasible for many of the poorest of communities to use TIFs for local business development.
By Andrew T. Foerster (RWP 11-04 August 2011; Revised May 2015)
This paper considers a model with financial frictions and studies the role of expectations and unconventional monetary policy response to financial crises. During a financial crisis, the financial sector has reduced ability to provide credit to productive firms, and the central bank may help lessen the magnitude of the downturn by using unconventional monetary policy to inject liquidity into credit markets. The model allows parameters to change according to a Markov process, which gives agents in the economy expectations about the probability of the central bank intervening in response to a crisis, as well as expectations about the central bank's exit strategy post-crisis. Using this Markov regime switching specification, the paper addresses three issues. First, it considers the effects of different exit strategies, and shows that, after a crisis, if the central bank sells off its accumulated assets too quickly, the economy can experience a double-dip recession. Second, it analyzes the effects of expectations of intervention policy on pre-crisis behavior. In particular, if the central bank increases the probability of intervening during crises, this increase leads to a loss of output in pre-crisis times. Finally, the paper considers the welfare implications of guaranteeing intervention during crises, and shows that providing a guarantee can raise or lower welfare depending upon the exit strategy used, and that committing before a crisis can be welfare decreasing but then welfare increasing once a crisis occurs.
By Martin Fukac and Vladimir Havlena (RWP 11-03 August 2011)
This paper is written by authors from technical and economic fields, motivated to find a common language and views on the problem of the optimal use of information in model estimation. The center of our interest is the natural condition of control -- a common assumption in the Bayesian estimation in technical sciences, which may be violated in economic applications. In estimating dynamic stochastic general equilibrium (DSGE) models, typically only a subset of endogenous variables are treated as measured even if additional data sets are available. The natural condition of control dictates the exploitation of all available information, which improves model adaptability and estimates efficiency. We illustrate our points on a basic RBC model.
By Michal Kowalik (RWP 11-02 March 2011; Revised October 2012)
The paper derives optimal capital requirements, when the bank’s quality is private information. The supervisor can inspect the bank and punish the undercapitalized one with recapitalization and downsizing. The cost of bank’s capital and its ability to sell its assets are crucial for the bank’s incentive to reveal its quality truthfully. The paper provides following policy implications. First, sensitivity of capital requirements to the bank’s quality should be low in good times and high in bad times. Second, a leverage ratio should be accompanied by a requirement that the bank selling its assets retains part of them. Third, using results from supervisory inspection on the secondary market for the bank’s assets increases the bank’s incentive to misreport its quality. Fourth, implementation of the sensitive capital requirements cannot rely solely on information revealed on the market for the bank’s assets.
By Takushi Kurozumi and Willem Van Zandweghe (RWP 11-01 October 2010)
In a sticky-price model with labor market search and matching frictions, forecast-based interest rate policy almost always induces indeterminacy when it is strictly inflation targeting and satisfies the Taylor principle. Indeterminacy is due to a vacancy channel of monetary policy that makes inflation expectations self-fulfilling. The effect of this channel strengthens as the sluggishness of the adjustment of employment relative to that of consumption increases. When this relative sluggishness is high, the Taylor principle fails to ensure determinacy, regardless of whether the policy is forecast-based or outcome-based, whether it is strictly or flexibly inflation targeting, or contains policy rate smoothing.
By Edward S. Knotek II (RWP 10-18 December 2010)
Macroeconomic models often generate nominal price rigidity via menu costs. This paper provides empirical evidence that treating menu costs as a structural explanation for sticky prices may be spurious. Using supermarket scanner data, I note two empirical facts: (1) price points, embodied in nine-ending prices, account for more than 60 percent of prices; (2) at the conclusion of sales, post-sale prices return to their pre-sale levels nearly 90 percent of the time. I construct a model that nests roles for menu costs and price points and estimate model variants via simulated method of moments. Excluding the two facts yields a statistically and economically significant role for menu costs in generating price rigidity. Incorporating the two facts yields an incentive to set nine-ending prices two orders of magnitude larger than the menu costs in this model. In this setting, the price point model can match the two stylized facts, but menu costs are effectively irrelevant as a source of price rigidity. The choice of a mechanism for price rigidity matters for aggregate dynamics.
By Yulei Luo, Jun Nie, and Eric R. Young (RWP10-17 December 2010)
We examine the effects of two types of informational frictions, robustness (RB) and ﬁnite information-processing capacity (called rational inattention or RI) on the current account, in an otherwise standard intertemporal current account (ICA) model. We show that the interaction of RB and RI has the potential to improve the model’s predictions on the joint dynamics of the current account and income: (i) the contemporaneous correlation between the current account and income, (ii) the volatility and persistence of the current account in small open emerging and developed economies. In addition, we show that the two informational frictions could also better explain consumption dynamics in small open economies: the impulse responses of consumption to income shocks and the relative volatility of consumption growth to income growth. Calibrated versions using detection probabilities ﬁt the data better along these dimensions than the standard model does.
By Yulei Luo, Jun Nie, and Eric R. Young (RWP10-16 December 2010; Revised September 2013)
In this paper we examine the effects of two types of information imperfections, robustness (RB) and ﬁnite information-processing capacity (called rational inattention or RI), on international consumption correlations in an otherwise standard small open economy model. We show that in the presence of capital mobility in ﬁnancial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to income shocks across countries facing different macroeconomic uncertainty. However, the calibrated RB model cannot explain the observed consumption correlations quantitatively. We then show that introducing RI is capable of matching the behavior of international consumption quantitatively via two channels: (1) the gradual response to income shocks that increases the correlations and (2) the presence of the common noise shocks that reduce the correlations.
By Takushi Kurozumi and Willem Van Zandweghe (RWP10-15 December 2010)
In a sticky price model with investment spending, recent research shows that inflation-forecast targeting interest rate policy makes determinacy of equilibrium essentially impossible. We examine a necessary and sufficient condition for determinacy under interest rate policy that responds to a weighted average of an inflation forecast and current inflation. This condition demonstrates that the average-inflation targeting policy ensures determinacy as long as both the response to average inflation and the relative weight of current inflation are large enough. We also find that interest rate policy which responds solely to past inflation guarantees determinacy when its response satisfies the Taylor principle and is not large. These results still hold even when wages and hours worked are determined by Nash bargaining.
By Takushi Kurozumi and Willem Van Zandweghe (RWP10-14 December 2010)
This paper examines implications of incorporating labor market search and matching frictions into a sticky price model for determinacy and E-stability of rational expectations equilibrium (REE) under interest rate policy. When labor adjustment takes place solely at the extensive margin, forecast-based policy that meets the Taylor principle is likely to induce indeterminacy and E-instability, regardless of whether it is strictly or flexibly inflation targeting. When labor adjustment takes place at both the extensive and intensive margins, the strictly inflation-forecast targeting policy remains likely to induce indeterminacy, but it generates a unique E-stable fundamental REE as long as the Taylor principle is satisfied. These results suggest that introducing the search and matching frictions alter determinacy properties of the strictly inflation-forecast targeting policy, but not its E-stability properties in the presence of the intensive margin of labor.
By Kerstin Gerling, Michal Kowalik and Heiner Schumacher (RWP10-13 July 2010)
We analyze under what condiitons credit markets are efficient in providing loans to entrepreneurs who can start a new project after previous failure. An entrepreneur of uncertain talent chooses the riskiness of her project. If banks cannot perfectly observe the risk of previous projects, two equilibria may coexist: (1) an inefficient equilibrium in which the entrepreneur undertakes a low-risk project and has no access to finance after failure; and (2) a more efficient equilibrium in which the entrepreneur undertakes high-risk projects and gets financed even after an endogenously determined number of failures.
By Nada Mora (RWP10-12 September 2010; Revised February 2013)
This paper tests for agency problems between the lead arranger and syndicate participants in the syndicated loan market. One problem comes from adverse selection, whereby the lead arranger has a private informational advantage over participants. A second problem comes from moral hazard, whereby the lead arranger puts less effort in monitoring when it retains a smaller loan portion. Applying an instrumental variables strategy, I find that borrowers' performance is influenced by the lead's share. Dynamic tests extract active contributions made by the lead, supporting a monitoring interpretation. Loan covenants serve as a mechanism to induce the lead arranger to monitor.
By Michal Kowalik and David Martinez-Miera (RWP10-11 April 2010)
This paper analyzes the role of expected income in entrepreneurial borrowing. We claim that poorer individuals are safer borrowers because they place more value on the relationship with the bank. We study the dynamics of a monopolistic bank granting loans and taking deposits from overlapping generations of entrepreneurs with different levels of expected income. Matching the evidence of the Grameen Bank we show that a bank will focus on individuals with lower expected income, and will not disburse dividends until it reaches all the potential borrowers. We find empirical support for our theoretical results using data from a household survey from Bangladesh. We show that various measures of expected income are positively and signficantly correlated with default probabilities.
By Klaus Adam and Roberto M. Billi (RWP10-10 March 2010; Revised January 2011)
We study interactions between monetary policy, which sets nominal interest rates, and fiscal policy, which levies distortionary income taxes to finance public goods, in a standard, sticky-price economy with monopolistic competition. Policymakers? inability to commit in advance to future policies gives rise to excessive inflation and excessive public spending, resulting in welfare losses equivalent to several percent of consumption each period. We show how appointing a conservative monetary authority, which dislikes inflation more than society does, can considerably reduce these welfare losses and that optimally the monetary authority is predominantly concerned about inflation. Full conservatism, i.e., exclusive concern about inflation, entirely eliminates the welfare losses from discretionary monetary and fiscal policymaking, provided monetary policy is determined after fiscal policy each period. Full conservatism, however, is severely suboptimal when monetary policy is determined simultaneously with fiscal policy or before fiscal policy each period.
By Troy Davig, Eric M. Leeper and Todd B. Walker (RWP10-09 March 2010)
A rational expectations framework is developed to study the consequences of alternative means to resolve the "unfunded liabilities" problem--unsustainable exponential growth in federal Social Security, Medicare, and Medicaid spending with no plan to finance it. Resolution requires specifying a probability distribution for how and when monetary and fiscal policies will change as the economy evolves through the 21st century. Beliefs based on that distribution determine the existence of and the nature of equilibrium. We consider policies that in expectation combine reaching a fiscal limit, some distorting taxation, modest inflation, and some reneging on the government's promised transfers. In the equilibrium, inflation-targeting monetary policy cannot successfully anchor expected inflation. Expectational effects are always present, but need not have large impacts on inflation and interest rates in the short and medium runs.
By Martin Fukac (RWP10-08 February 2010)
In this paper we review the evolution of macroeconomic modelling in a policy environment that took place over the past sixty years. We identify and characterise four generations of macro models. Particular attention is paid to the fourth generation -- dynamic stochastic general equilibrium models. We discuss some of the problems in how these models are implemented and quantified.
By Martin Fukac (RWP10-07 February 2010)
Dynamic stochastic general equilibrium (DSGE) models have become a widely used tool for policymakers. This paper modifies the global identification theory used for structural vectorautoregressions, and applies it to DSGE models. We use this theory to check whether a DSGE model structure allows for unique estimates of structural shocks and their dynamic effects. The potential cost of a lack of identification for policy oriented models along that specific dimension is huge, as the same model can generate a number of contrasting yet theoretically and empirically justifiable recommendations. The problem and methodology are illustrated using a simple New Keynesian business cycle model.
By Willem Van Zandweghe and Alexander L. Wolman (RWP10-06 February 2010; Revised March 2017)
We study discretionary equilibrium in the Calvo pricing model for a monetary authority that chooses the money supply, producing three main contributions. First, the model delivers a unique private-sector equilibrium for a broad range of parameterizations, in contrast to earlier results for the Taylor pricing model. Second, a generalized Euler equation shows how the monetary authority affects future welfare through its influence on the future state of the economy. Third, we provide exact solutions, including welfare analysis, for the transitional dynamics that occur if the monetary authority loses or gains the ability to commit.
By Pier Francesco Asso, George A. Kahn and Robert Leeson (RWP10-05 February 2010)
The Taylor rule has revolutionized the way many policymakers at central banks think about monetary policy. It has framed policy actions as a systematic response to incoming information about economic conditions, as opposed to a period-by-period optimization problem. It has emphasized the importance of adjusting policy rates more than one-for-one in response to an increase in inflation. And, various versions of the Taylor rule have been incorporated into macroeconomic models that are used at central banks to understand and forecast the economy.
This paper examines how the Taylor rule is used as an input in monetary policy deliberations and decision-making at central banks. The paper characterizes the policy environment at the time of the development of the Taylor rule and describes how and why the Taylor rule became integrated into policy discussions and, in some cases, the policy framework itself. Speeches by policymakers and transcripts and minutes of policy meetings are examined to explore the practical uses of the Taylor rule by central bankers. While many issues remain unresolved and views still differ about how the Taylor rule can best be applied in practice, the paper shows that the rule has advanced the practice of central banking.
By Russell Cooper, John Haltiwanger and Jonathan L. Willis (RWP10-04 January 2010)
This paper studies capital adjustment at the establishment level. Our goal is to characterize capital adjustment costs, which are important for understanding both the dynamics of aggregate investment and the impact of various policies on capital accumulation. Our estimation strategy searches for parameters that minimize ex post errors in an Euler equation. This strategy is quite common in models for which adjustment occurs in each period. Here, we extend that logic to the estimation of parameters of dynamic optimization problems in which non-convexities lead to extended periods of investment inactivity. In doing so, we create a method to take into account censored observations stemming from intermittent investment. This methodology allows us to take the structural model directly to the data, avoiding time-consuming simulation-based methods. To study the effectiveness of this methodology, we ﬁrst undertake several Monte Carlo exercises using data generated by the structural model. We then estimate capital adjustment costs for U.S. manufacturing establishments in two sectors.
By Jun Nie (RWP10-03 January 2010)
Training programs are a major tool of labor market policies in OECD countries. I use a unique panel data set on the labor market experience of individual German workers between 2000 and 2002 to estimate a dynamic model of search and training, which allows me to quantify the impact of training programs and unemployment benefits on employment, unemployment, output, and the government expenditures.
The model extends Ljungqvist and Sargent (JPE, 1998) by incorporating a training decision and a broader menu of unemployment benefits. Government-sponsored training programs feature a key trade-off with respect to unemployment insurance programs: they offer more generous unemployment benefits but require more time and effort from workers to generate higher skills. As a result, unemployed workers with different human capital and benefits make different decisions about training, search, and job acceptance.
I use the model to quantitatively study the recent reforms implemented in Germany and run more counterfactual experiments. I simulate the transition path under back-to-back unexpected reforms in 2003-2006 and find the dynamics of the model's unemployment rates are close to the data. In a counterfactual experiment in which I model an economy with a German-like training system and a US-like unemployment benefit structure (roughly, benefits are lower), I find that employment and output rise substantially.
By Robert DeYoung, Emma Y. Peng and Meng Yan (RWP10-02 January 2010)
This study examines whether and how the terms of CEO compensation contracts at large commercial banks between 1994 and 2006 influenced, or were influenced by, the risky business policy decisions made by these firms. We find strong evidence that bank CEOs responded to contractual risk-taking incentives by taking more risk; bank boards altered CEO compensation to encourage executives to exploit new growth opportunities; and bank boards set CEO incentives in a manner designed to moderate excessive risk-taking. These relationships are strongest during the second half of our sample, after deregulation and technological change had expanded banks' capacities for risk-taking.
By Stephen G. Cecchetti and Craig S. Hakkio (RWP10-01 January 2010)
Transparency is one of the biggest innovations in central bank policy of the past quarter century. Modern central bankers believe that they should be as clear about their objectives and actions as possible. However, is greater transparency always beneficial? Recent work suggests that when private agents have diverse sources of information, public information can cause them to overreact to the signals from the central bank, leading the economy to be too sensitive to common forecast errors. Greater transparency could be destabilizing. While this theoretical result has clear intuitive appeal, it turns on a combination of assumptions and conditions, so it remains to be established that it is of empirical relevance.
In this paper we study the degree to which increased information about monetary policy might lead to individuals coordinating their forecasts. Specifically, we estimate a series of simple models to measure the impact of inflation targeting on the dispersion of private sector forecasts of inflation. Using a panel data set that includes 15 countries over 20 years we find no convincing evidence that adopting an inflation targeting regime leads to a reduction in the dispersion of private sector forecasts of inflation. While for some specifications adoption of inflation target does seem to reduce the standard deviation of inflation forecasts, the impact is rarely precise and always small.