http://www.federalreserve.gov/pubs/ifdp/default.htm Staff working papers in the International Finance Discussion Paper (IFDP) series are preliminary matierials circulated to stimulate discussion and critical comment. The analyses and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors. References in publications to the International Finance Discussion Paper series (other than acknowledgment) should be cleared with the author(s) to protect the tentative character of these papers http://www.federalreserve.gov/pubs/ifdp/gifjpg/newbig.gif http://www.federalreserve.gov/pubs/ifdp/ http://www.federalreserve.gov/pubs/ifdp/2009/983/default.htm In a two-country DSGE model, the effects of foreign demand shocks on the home country are greatly amplified if the home economy is constrained by the zero lower bound for policy interest rates. This result applies even to countries that are relatively closed to trade such as the United States. The duration of the liquidity trap is determined endogenously. Adverse foreign shocks can extend the duration of the liquidity trap, implying more contractionary effects for the home country; conversely, large positive shocks can prompt an early exit, implying effects that are closer to those when the zero bound constraint is not binding. 2009-11-03T12:17:19-04:00 en The Effects of Foreign Shocks When Interest Rates are at Zero 2009-11-03T12:11:33-04:00 FRB Zero lower bound spillover effects DSGE models IFDP983: The Effects of Foreign Shocks When Interest Rates are at Zero http://www.federalreserve.gov/pubs/ifdp/2009/983/ifdp983.pdf PDF version Martin Bodenstein, Christopher J. Erceg, and Luca Guerrieri 2009-11-03T12:11:33-04:00 983 F32 F41 http://www.federalreserve.gov/pubs/ifdp/2009/982/default.htm We introduce a novel method for estimating a monetary policy rule using macroeconomic news. Market forecasts of both economic conditions and monetary policy are affected by news, and our estimation links the two effects. This enables us to estimate directly the policy rule agents use to form their expectations, and in so doing flexibly capture the particular dynamics of policy response. We find evidence that between 1994 and 2007 the market-perceived Federal Reserve policy rule changed: the output response vanished, and the inflation response path became more gradual but larger in long-run magnitude. In a standard model we show that output smoothing caused by a larger inflation response magnitude is offset by the more measured pace of response. Our response coefficient estimates are robust to measurement and theoretical issues with both potential output and the inflation target. 2009-11-03T12:17:19-04:00 en The Market-Perceived Monetary Policy Rule 2009-11-02T10:54:09-04:00 FRB Monetary policy rule market perceptions Taylor Rule Fed funds futures IFDP982: The Market-Perceived Monetary Policy Rule http://www.federalreserve.gov/pubs/ifdp/2009/982/ifdp982.pdf PDF version James D. Hamilton, Seth Pruitt, and Scott C. Borger 2009-11-02T10:54:09-04:00 982 E43 E52 E58 http://www.federalreserve.gov/pubs/ifdp/2009/981/default.htm We study empirical mean-variance optimization when the portfolio weights are restricted to be direct functions of underlying stock characteristics such as value and momentum. The closed-form solution to the portfolio weights estimator shows that the portfolio problem in this case reduces to a mean-variance analysis of assets with returns given by single-characteristic strategies (e.g., momentum or value). In an empirical application to international stock return indexes, we show that the direct approach to estimating portfolio weights clearly beats a naive regression-based approach that models the conditional mean. However, a portfolio based on equal weights of the single-characteristic strategies performs about as well, and sometimes better, than the direct estimation approach, highlighting again the difficulties in beating the equal-weighted case in mean-variance analysis. The empirical results also highlight the potential for `stock-picking' in international indexes, using characteristics such as value and momentum, with the characteristic-based portfolios obtaining Sharpe ratios approximately three times larger than the world market. 2009-11-03T12:17:19-04:00 en Characteristic-Based Mean-Variance Portfolio Choice 2009-11-02T10:51:55-04:00 FRB Mean-variance analysis momentum strategies portfolio choice stock characteristics value strategies IFDP981: Characteristic-Based Mean-Variance Portfolio Choice http://www.federalreserve.gov/pubs/ifdp/2009/981/ifdp981.pdf PDF version Erik Hjalmarsson and Peter Manchev 2009-11-02T10:51:55-04:00 981 C22 C23 G11 G15 http://www.federalreserve.gov/pubs/ifdp/2009/980/default.htm We study the impact that algorithmic trading, computers directly interfacing at high frequency with trading platforms, has had on price discovery and volatility in the foreign exchange market. Our dataset represents a majority of global interdealer trading in three major currency pairs in 2006 and 2007. Importantly, it contains precise observations of the size and the direction of the computer-generated and human-generated trades each minute. The empirical analysis provides several important insights. First, we find evidence that algorithmic trades tend to be correlated, suggesting that the algorithmic strategies used in the market are not as diverse as those used by non-algorithmic traders. Second, we find that, despite the apparent correlation of algorithmic trades, there is no evident causal relationship between algorithmic trading and increased exchange rate volatility. If anything, the presence of more algorithmic trading is associated with lower volatility. Third, we show that even though some algorithmic traders appear to restrict their activity in the minute following macroeconomic data releases, algorithmic traders increase their provision of liquidity over the hour following each release. Fourth, we find that non-algorithmic order flow accounts for a larger share of the variance in exchange rate returns than does algorithmic order flow. Fifth, we find evidence that supports the recent literature that proposes to depart from the prevalent assumption that liquidity providers in limit order books are passive. 2009-11-03T12:17:19-04:00 en Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market 2009-11-02T10:49:12-04:00 FRB Algorithmic trading volatility liquidity provision private information IFDP980: Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market http://www.federalreserve.gov/pubs/ifdp/2009/980/ifdp980.pdf PDF version Alain Chaboud, Benjamin Chiquoine, Erik Hjalmarsson, and Clara Vega 2009-11-02T10:49:12-04:00 980 F3 G12 G14 G15 http://www.federalreserve.gov/pubs/ifdp/2009/979/default.htm Among the various explanations for the runup in oil and commodity prices of recent years, one story focuses on the role of monetary policy in the United States and in developing economies. In this view, developing countries that peg their currencies to the dollar were forced to ease their monetary policies after reductions in U.S. interest rates, leading to economic overheating, excess demand for oil and other commodities, and rising commodity prices. We assess that hypothesis using the Federal Reserve staffs forward-looking, multicountry, dynamic general equilibrium model, SIGMA. We find that even if many developing country currencies were pegged to the dollar, an easing of U.S. monetary policy would lead to only a transitory runup in oil prices. Instead, strong economic growth in many developing economies, as well as shortfalls in oil production, better explain the sustained runup in oil prices observed until earlier this year. Moreover, a closer look at exchange rates and interest rates around the world suggests that the monetary policies of many developing economies, including in East Asia, are less closely influenced by U.S. policies than is frequently assumed. 2009-11-03T12:17:19-04:00 en Did Easy Money in the Dollar Bloc Fuel the Global Commodity Boom? 2009-10-09T9:31:50-04:00 FRB Oil prices SDGE models monetary policy IFDP979: Did Easy Money in the Dollar Bloc Fuel the Global Commodity Boom? http://www.federalreserve.gov/pubs/ifdp/2009/979/ifdp979.pdf PDF version Christopher Erceg, Luca Guerrieri, and Steven B. Kamin 2009-10-09T9:31:50-04:00 979 F41 F42 http://www.federalreserve.gov/pubs/ifdp/2009/978/default.htm Are structural vector autoregressions (VARs) useful for discriminating between macro models? Recent assessments of VARs have shown that these statistical methods have adequate size properties. In other words, in simulation exercises, VARs will only infrequently reject the true data generating process. However, in assessing a statistical test, we often also care about power: the ability of the test to reject a false hypothesis. Much less is known about the power of structural VARs. This paper attempts to fill in this gap by exploring the power of long-run structural VARs against a set of DSGE models that vary in degree from the true data generating process. We report results for two tests: the standard test of checking the sign on impact and a test of the shape of the response. For the models studied here, testing the shape is a more powerful test than simply looking at the sign of the response. In addition, relative to an alternative statistical test based on sample correlations, we find that the shape-based tests have greater power. Given the results on the power and size properties of long-run VARs, we conclude that these VARs are useful for discriminating between macro models. 2009-11-03T12:17:19-04:00 en The Power of Long-Run Structural VARs 2009-09-10T12:45:38-04:00 FRB Vector autoregression dynamic stochastic general equilibrium model confidence intervals impulse responpd functions identifications long run restrictions specification error sampling IFDP978: The Power of Long-Run Structural VARs http://www.federalreserve.gov/pubs/ifdp/2009/978/ifdp978.pdf PDF version Christopher Gust and Robert Vigfusson 2009-09-10T12:45:38-04:00 978 C1 http://www.federalreserve.gov/pubs/ifdp/2009/977/default.htm We decompose the returns differential between U.S. portfolio claims and liabilities into the composition, return, and timing effects. Our most striking and robust finding is that foreigners exhibit poor timing when reallocating between bonds and equities within their U.S. portfolios. The poor timing of foreign investors--caused primarily by deliberate trading, not a lack of portfolio rebalancing--contributes positively to the U.S. external returns differential. We find no evidence that the poor timing is driven by mechanical reserve accumulation by emerging market countries; rather, it is driven almost entirely by the poor timing of rich, developed (mainly European) countries. Finally, while poor foreign timing appears to be persistent across subsamples, other terms in our decomposition (the composition and return effects and U.S. timing abroad), as well as the overall differential, are sometimes negative, sometimes positive, and usually indistinguishable from zero. 2009-11-03T12:17:19-04:00 en Decomposing the U.S. External Returns Differential 2009-09-10T9:42:46-04:00 FRB Returns differential timing effect IFDP977: Decomposing the U.S. External Returns Differential http://www.federalreserve.gov/pubs/ifdp/2009/977/ifdp977.pdf PDF version Stephanie Curcuru, Tomas Dvorak, and Francis E. Warnock 2009-09-10T9:42:46-04:00 977 F21 F3 http://www.federalreserve.gov/pubs/ifdp/2009/976/default.htm In the past decade, some observers have noted an unusual aspect of the Mexican peso's behavior: During periods when the U.S. dollar has risen (fallen) against other major currencies such as the euro, the peso has risen (fallen) against the dollar. Very few other currencies display this behavior. In this paper, we attempt to explain the unusual pattern of the peso's correlation with the dollar by developing some general empirical models of exchange rate correlations. Based on a study of 29 currencies, we find that most of the cross-country variation in exchange rate correlations with the dollar and the euro can be explained by just a few variables. First, a country's currency is more likely to rise against the dollar as the dollar rises against the euro, the closer it is to the United States and the farther it is from the euro area. In this result, distance likely proxies for the role of economic integration in affecting exchange rate correlations. Second, and perhaps more surprisingly, a country's currency is more likely to exhibit this unusual pattern when its sovereign credit rating is more risky. This may reflect that currencies of riskier countries are less substitutable in investor portfolios than those of better-rated countries. All told, these factors well explain the peso's unusual behavior, as Mexico both is very close to the United States and has a lower credit rating than most industrial economies. 2009-11-03T12:17:19-04:00 en The Puzzling Peso 2009-09-09T10:18:44-04:00 FRB Mexico peso dollar exchange rates interest rate differentials inflation output gap output growth differentials IFDP976: The Puzzling Peso http://www.federalreserve.gov/pubs/ifdp/2009/976/ifdp976.pdf PDF version Carlos Arteta, Steven B. Kamin, and Justin Vitanza 2009-09-09T10:18:44-04:00 976 F30 F31 http://www.federalreserve.gov/pubs/ifdp/2009/975/default.htm Theory predicts that a nation's stochastic intertemporal budget constraint is satisfied if net foreign assets (NFA) are integrated of any finite order, or if net exports (NX) and NFA satisfy an error-correction specification with a residual integrated of any finite order. We test these conditions using data for 21 industrial and 29 emerging economies for the 1970-2004 period. The results show that, despite the large global imbalances of recent years, NFA and NX positions are consistent with external solvency. Country-specific unit root tests on NFA-GDP ratios suggest that nearly all of them are integrated of order 1. Pooled Mean Group error-correction estimation yields evidence of a statistically significant, negative response of the NX-GDP ratio to the NFA-GDP ratio that is largely homogeneous across countries. 2009-11-03T12:17:19-04:00 en On the Solvency of Nations: Are Global Imbalances Consistent with Intertemporal Budget Constraints? 2009-07-08T11:36:20-04:00 FRB Global imbalances external solvency debt sustainability Pooled Mean Group estimation IFDP975: On the Solvency of Nations: Are Global Imbalances Consistent with Intertemporal Budget Constraints? http://www.federalreserve.gov/pubs/ifdp/2009/975/ifdp975.pdf PDF version Ceyhun Bora Durdu, Enrique G. Mendoza, and Marco E. Terrones 2009-07-08T11:36:20-04:00 975 F41 F32 E66 http://www.federalreserve.gov/pubs/ifdp/2009/974/default.htm During Apartheid, there was little need for redistributional policies or to borrow for public works since the vast majority of the population was underserved. With the arrival of a representative democracy in 1994, however, South Africa faced a unique problem- providing new and improved public services for the majority of its citizens while at the same time ensuring that filling this void would not undermine macroeconomic stability. Over the past fifteen years, policy makers have achieved macrostability, but progress on social needs has been below expectations and South Africa continues to lag behind its peers. This paper reviews the progress made so far and examines the challenges ahead for the upcoming administration. Our analysis suggest an increase in skill formation as a possible solution to the policy dilemma of fulfilling the outsized social demands while maintaining macrostability. 2009-11-03T12:17:19-04:00 en South Africa's Post-Apartheid Two-Step: Social Demands versus Macro Stability 2009-06-11T15:46:59-04:00 FRB Apartheid social needs stability welfare macroeconomy IFDP974: South Africa's Post-Apartheid Two-Step: Social Demands versus Macro Stability http://www.federalreserve.gov/pubs/ifdp/2009/974/ifdp974.pdf PDF version Brahima Coulibaly and Trevon D. Logan 2009-06-11T15:46:59-04:00 974 D6 E6 H1 I0 O2 http://www.federalreserve.gov/pubs/ifdp/2009/973/default.htm This paper utilizes a unique high-frequency database to measure how exchange rates in nine emerging markets react to macroeconomic news in the U.S. and domestic economies from 2000 to 2006. We find that major U.S. macroeconomic news have a strong impact on the returns and volatilities of emerging market exchange rates, but many domestic news do not. Emerging market currencies have become more sensitive to U.S. news in recent years. We also find that market sentiment could sway the impact of news on these currencies systematically, as good (bad) news seems to matter more when optimism (pessimism) prevails. Market uncertainty also interacts with macroeconomic news in a statistically significant way, but its role varies across currencies and news. 2009-11-03T12:17:19-04:00 en The Impact of Macroeconomic Announcements on Real Time Foreign Exchange Rates in Emerging Markets 2009-06-09T9:49:38-04:00 FRB Exchange rate emerging market macroeconomic news high-frequency data IFDP973: The Impact of Macroeconomic Announcements on Real Time Foreign Exchange Rates in Emerging Markets http://www.federalreserve.gov/pubs/ifdp/2009/973/ifdp973.pdf PDF version Fang Cai, Hyunsoo Joo, and Zhiwei Zhang 2009-06-09T9:49:38-04:00 973 F31 G14 G15 http://www.federalreserve.gov/pubs/ifdp/2009/972/default.htm We analyze retail prices and at-the-dock (import) prices of specific items in the Bureau of Labor Statistics' (BLS) CPI and IPP databases, using both databases simultaneously to identify items that are identical in description at the dock and when sold at retail. This identification allows us to measure the distribution wedge associated with bringing traded goods from the point of entry into the United States to their retail outlet. We find that overall U.S. distribution wedges are 50-70%, around 10 to 20 percentage points higher than that reported in the literature. We discuss the implications of this for measuring the size of the "pure" tradeables sector, exchange rate pass-through, and real exchange rate determination. We find that distribution wedges are very stable over time but there is considerable variation across items. There is some variation across the country of origin for the imported item, for our major trading partners, but not as much as the cross-item variation. We also investigate the determinants of distribution wedges, finding that wedges do not vary systematically with exchange rates, but are related to other features of the micro data. 2009-11-03T12:17:19-04:00 en Border Prices and Retail Prices 2009-06-09T9:16:32-04:00 FRB Prices distribution exchange rates IFDP972: Border Prices and Retail Prices http://www.federalreserve.gov/pubs/ifdp/2009/972/ifdp972.pdf PDF version David Berger, Jon Faust, John H. Rogers, and Kai Steverson 2009-06-09T9:16:32-04:00 972 F30 http://www.federalreserve.gov/pubs/ifdp/2009/971/default.htm This paper shows empirical evidence in favor of forward-looking household consumption--that consumption today depends directly on household-specific ex-ante expectations of future income. This analysis is unique in using a direct consumption measure combined with an ex-ante household-specific measure of expected future income, constructed from detailed survey and administrative data on Social Security, pensions, and retirement plans. Households with high expected future income spend more today than households that have lower future income but identical current income and net worth. Omitting household-specific future income can cause mis-estimation of key consumption questions. Furthermore, when all three resources for consumption (current income, net worth, and future income) are accounted for, the average propensity to spend out of current income is similar to predictions of optimal consumption under uncertainty in a dynamic stochastic model, although the propensities to spend out of accumulated net worth and expected future income are notably lower in the data than the optimal model. Finally, these data also provide evidence on the effect of risk on consumption while controlling for all three resources. Households with high measured risk aversion consume less out of future income. All households, on average, consume more out of the more predictable sources of future income, such as future Social Security benefits. 2009-11-03T12:17:20-04:00 en Consumption Response to Expected Future Income 2009-05-28T15:50:00-04:00 FRB Consumption permanent income hypothesis IFDP971: Consumption Response to Expected Future Income http://www.federalreserve.gov/pubs/ifdp/2009/971/ifdp971.pdf PDF version Laurie Pounder 2009-05-28T15:50:00-04:00 971 D12 D13 D91 http://www.federalreserve.gov/pubs/ifdp/2009/970/default.htm A common view in the literature is that the effect of energy price shocks on macroeconomic aggregates is asymmetric in energy price increases and decreases. We show that widely used asymmetric vector autoregressive models of the transmission of energy price shocks are misspecified, resulting in inconsistent parameter estimates, and that the implied impulse responses have been routinely computed incorrectly. As a result, the quantitative importance of unanticipated energy price increases for the U.S. economy has been exaggerated. In response to this problem, we develop alternative regression models and methods of computing responses to energy price shocks that yield consistent estimates regardless of the degree of asymmetry. We also introduce improved tests of the null hypothesis of symmetry in the responses to energy price increases and decreases. An empirical study reveals little evidence against the null hypothesis of symmetry in the responses to energy price shocks. Our analysis also has direct implications for the theoretical literature on the transmission of energy price shocks and for the debate about policy responses to energy price shocks. 2009-11-03T12:17:20-04:00 en Pitfalls in Estimating Asymmetric Effects of Energy Price Shocks 2009-05-28T15:37:40-04:00 FRB Asymmetry oil price energy prices net increase shocks propagation transmission vector autoregression IFDP970: Pitfalls in Estimating Asymmetric Effects of Energy Price Shocks http://www.federalreserve.gov/pubs/ifdp/2009/970/ifdp970.pdf PDF version Lutz Kilian and Robert Vigfusson 2009-05-28T15:37:40-04:00 970 C32 E37 Q43 http://www.federalreserve.gov/pubs/ifdp/2009/969/default.htm Exchange rate movements are difficult to predict but there appear to be discernible patterns in how currencies jointly appreciate or depreciate against the dollar. In this paper, we study the dependence structure of a number of exchange rate pairs against the dollar. We employ a conditional copula approach to recover the joint distributions for pairs of exchange rates and study both the correlation and the upper and lower tail dependence of these distributions. We analyze changes in dependence measures over time, and we investigate whether these measures are affected by the business cycle or interest rate differentials. Our results show that dependencies are indeed time-varying. We find that foreign and U.S. recessions affect the joint dependence structure and that currencies with higher interest rate differentials tend to move less closely together, not only on average (correlation), but also when extreme events occur (tails). 2009-11-03T12:17:20-04:00 en Exchange Rates Dependence: What Drives It? 2009-05-13T14:11:44-04:00 FRB Copula bivariate distributions t-GARCH models correlation upper/lower tail IFDP969: Exchange Rates Dependence: What Drives It? http://www.federalreserve.gov/pubs/ifdp/2009/969/ifdp969.pdf PDF version Sigridur Benediktsdottir and Chiara Scotti 2009-05-13T14:11:44-04:00 969 C1 G15 http://www.federalreserve.gov/pubs/ifdp/2009/968/default.htm The two sector model presented in this note suggests a simple structural decomposition of movements in the price of investment goods into exogenous and endogenous sources. The endogenous fluctuations arise in the presence of countercyclical markups which vary differently across the consumption and investment sectors. In turn, the movements in the markups are due to endogenous procyclical net business formation. The model, while being consistent with the countercyclicality of the price of investment goods, suggests that about a quarter of the movement in the price series can be attributed to this endogenous mechanism. 2009-11-03T12:17:20-04:00 en Markup Variation and Endogenous Fluctuations in the Price of Investment Goods 2009-03-26T15:33:33-04:00 FRB Price of investment business cycle firm dynamics markup IFDP968: Markup Variation and Endogenous Fluctuations in the Price of Investment Goods http://www.federalreserve.gov/pubs/ifdp/2009/968/ifdp968.pdf PDF version Max Floetotto, Nir Jaimovich, and Seth Pruitt 2009-03-26T15:33:33-04:00 968 E32 L11 L16 http://www.federalreserve.gov/pubs/ifdp/2009/967/default.htm This paper examines the effect that biofuels production has had on commodity and global food prices. The innovative contribution of this paper is the interactive spreadsheet that allows the reader to choose the assumptions behind the estimates. By allowing the reader to choose the country, time period, supply and demand elasticities, and the size of indirect effects we explicitly illustrate the sensitivity of the estimated effect of biofuels production on prices. Our best estimates suggest that the increase in biofuels production over the past two years has had a sizeable impact on corn, sugar, barley and soybean prices, but a much smaller impact on global food prices. Over the past two years (ending June 2008), we estimate that the increase in worldwide biofuels production pushed up corn, soybean and sugar prices by 27, 21 and 12 percentage points respectively. The countries that account for most of the upward pressure on these prices are the United States and Brazil. Our best estimates suggest that the increase in U.S. biofuels production (ethanol and biodiesel) pushed up corn prices by more than 22 percentage points and soybean prices (soybeans and soybean oil) by more than 15 percentage points, while the increase in EU biofuels production pushed corn and soybean prices up around 3 percentage points. Brazil's increase in sugar-based ethanol production accounts for the entire rise in the price of sugar. Although biofuels had a noticeable impact on individual crop prices, they had a much smaller impact on global food prices. Our best estimate suggests that the increase in worldwide biofuels production over the past two years accounts for just over 12 percent of the rise in the IMF's food price index. The increase in U.S. biofuels production accounts for roughly 60 percent of this effect, while Brazil accounts for 14 percent and the EU accounts for 15 percent. The key take-away point is that nearly 90 percent of the rise in global food prices comes from factors other than biofuels. 2009-11-03T12:17:20-04:00 en Biofuels Impact on Crop and Food Prices: Using an Interactive Spreadsheet 2009-03-24T11:52:55-04:00 FRB Biofuels ethanol commodity prices food prices IFDP967: Biofuels Impact on Crop and Food Prices: Using an Interactive Spreadsheet http://www.federalreserve.gov/pubs/ifdp/2009/967/ifdp967.pdf PDF version Scott Baier, Mark Clements, Charles Griffiths, and Jane Ihrig 2009-03-24T11:52:55-04:00 967 E31 Q42 Q11 http://www.federalreserve.gov/pubs/ifdp/2009/966/default.htm Sharp exchange rate depreciations, or currency crashes, are associated with poor economic outcomes in industrial countries only when they are caused by inflationary macroeconomic policies. Moreover, the poor outcomes are attributable to inflationary policies in general and not the currency crashes in particular. On the other hand, crashes caused by rising unemployment or external deficits have always had good economic consequences with stable or falling inflation rates. 2009-11-03T12:17:20-04:00 en Currency Crashes in Industrial Countries: Much Ado About Nothing? 2009-03-05T8:46:36-04:00 FRB Exchange rate depreciation inflation unemployment current account IFDP966: Currency Crashes in Industrial Countries: Much Ado About Nothing? http://www.federalreserve.gov/pubs/ifdp/2009/966/ifdp966.pdf PDF version Joseph E. Gagnon 2009-03-05T8:46:36-04:00 966 F31 F32 F41 http://www.federalreserve.gov/pubs/ifdp/2009/965/default.htm We re-examine the optimality of tax smoothing from the point of view of frictional labor markets. Our central result is that whether or not this cornerstone optimal fiscal policy prescription carries over to an environment with labor market frictions depends crucially on the cyclical nature of labor force participation. If the participation rate is exogenous at business-cycle frequencies -- as is typically assumed in the literature -- we show it is not optimal to smooth tax rates on labor income in the face of business-cycle shocks. However, if households do optimize at the participation margin, then tax-smoothing is optimal despite the presence of matching frictions. To understand these results, we develop a concept of general-equilibrium efficiency in search-based environments, which builds on existing (partial-equilibrium) search-efficiency conditions. Using this concept, we develop a notion of search-based labor-market wedges that allows us to trace the source of the sharply-contrasting fiscal policy prescriptions to the value of adjusting participation rates. Our results demonstrate that policy prescriptions can be very sensitive to the cyclical nature of labor-force participation in search-based environments. 2009-11-03T12:17:20-04:00 en Tax Smoothing in Frictional Labor Markets 2009-03-05T8:42:15-04:00 FRB Labor market frictions optimal taxation IFDP965: Tax Smoothing in Frictional Labor Markets http://www.federalreserve.gov/pubs/ifdp/2009/965/ifdp965.pdf PDF version David M. Arseneau and Sanjay K. Chugh 2009-03-05T8:42:15-04:00 965 E24 E50 E62 E63 http://www.federalreserve.gov/pubs/ifdp/2009/964/default.htm The employment and hours worked of young individuals fluctuate much more over the business cycle than those of prime-aged individuals. Understanding the mechanism underlying this observation is key to explaining the volatility of aggregate hours over the cycle. We argue that the joint behavior of age-specific hours and wages in the U.S. data point to differences in the cyclical characteristics of labor demand. To articulate this view, we consider a production technology displaying capital-experience complementarity. We estimate the key parameters governing the degree of complementarity and show that the model can account for the behavior of age-specific hours and wages while generating a series of aggregate hours that is nearly as volatile as output. 2009-11-03T12:17:20-04:00 en The Demand for Youth: Implications for the Hours Volatility Puzzle 2009-01-28T14:29:37-04:00 FRB Business cycle demographics capital-experience complementarity labor demand IFDP964: The Demand for Youth: Implications for the Hours Volatility Puzzle http://www.federalreserve.gov/pubs/ifdp/2009/964/ifdp964.pdf PDF version Nir Jaimovich, Seth Pruitt, and Henry E. Siu 2009-01-28T14:29:37-04:00 964 E00 E32 http://www.federalreserve.gov/pubs/ifdp/2009/963/default.htm This paper attacks the Meese-Rogoff puzzle from a different perspective: out-of-sample interval forecasting. Most studies in the literature focus on point forecasts. In this paper, we apply Robust Semiparametric (RS) interval forecasting to a group of Taylor rule models. Forecast intervals for twelve OECD exchange rates are generated and modified tests of Giacomini and White (2006) are conducted to compare the performance of Taylor rule models and the random walk. Our contribution is twofold. First, we find that in general, Taylor rule models generate tighter forecast intervals than the random walk, given that their intervals cover out-of-sample exchange rate realizations equally well. This result is more pronounced at longer horizons. Our results suggest a connection between exchange rates and economic fundamentals: economic variables contain information useful in forecasting the distributions of exchange rates. The benchmark Taylor rule model is also found to perform better than the monetary and PPP models. Second, the inference framework proposed in this paper for forecast-interval evaluation can be applied in a broader context, such as inflation forecasting, not just to the models and interval forecasting methods used in this paper. 2009-11-03T12:17:20-04:00 en The Taylor Rule and Forecast Intervals for Exchange Rates 2009-01-14T8:42:59-04:00 FRB The exchange rate disconnect puzzle exchange rate forecast interval forecasting IFDP963: The Taylor Rule and Forecast Intervals for Exchange Rates http://www.federalreserve.gov/pubs/ifdp/2009/963/ifdp963.pdf PDF version Jian Wang and Jason J. Wu 2009-01-14T8:42:59-04:00 963 F31 C14 C53