Research Working Papers

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.

Monetary Policy Regime Switches and Macroeconomic Dynamics

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.

Revisiting Initial Jobless Claims as a Labor Market Indicator

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.

The Settlement of the United States, 1800 to 2000: The Long Transition Toward Gibrat's Law

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.

Perturbation Methods for Markov-Switching DSGE Models

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.

Financial Frictions and Occupational Mobility

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.

Student Loans: Overview and Issues (Update)

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.

The State Space Representation and Estimation of a Time-Varying Parameter VAR with Stochastic...

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.

Effects of Credit Scores on Consumer Payment Choice

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.

Model Uncertainty, State Uncertainty, and State-space Models

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.

Model Uncertainty and Intertemporal Tax Smoothing

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.

Estimating VAR's Sampled at Mixed or Irregular Spaced Frequencies: A Bayesian Approach

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.

Low-Income Housing Tax Credit Developments and Neighborhood Property Conditions

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.

The Aggregate Implications of Individual Labor Supply Heterogeneity

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.

Commodity Dependence and Fiscal Capacity

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.

Under-Investment in State Capacity: The Role of Inequality and Political Instability

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.

Are Banks Passive Liquidity Backstops? Deposit Rates and Flows during the 2007-2009 Crisis

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.

Who Offers Tax-Based Business Development Incentives?

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.

Financial Crises, Unconventional Monetary Policy Exit Strategies, and Agents' Expectations

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.

Note on the Role of Natural Condition of Control in the Estimation of DSGE Models

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.

Bank Capital Regulation and Secondary Markets for Bank Assets

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.

Labor Market Search, the Taylor Principle, and Indeterminacy

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.

Entrepreneurial Risk Choice and Credit Market Equilibria

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.

Lender Exposure and Effort in the Syndicated Loan Market

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.

The Creditworthiness of the Poor: A Model of the Grameen Bank

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.

Distortionary Fiscal Policy and Monetary Policy Goals

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.

"Unfunded Liabilities" and Uncertain Fiscal Financing

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.

Structural Macro-Econometric Modelling in a Policy Environment

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.

Impulse Response Identification in DSGE Models

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.

Discretionary Monetary Policy in the Calvo 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.

The Taylor Rule and the Practice of Central Banking

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.

Euler-Equation Estimation for Discrete Choice Models: A Capital Accumulation Application

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.

Training or Search? Evidence and an Equilibrium Model

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.

Executive Compensation and Business Policy Choices at U.S. Commercial Banks

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.

Inflation Targeting and Private Sector Forecasts

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.