FEDS 2017-125
Quantitative easing and bank risk taking: evidence from lending

Abstract: We empirically assess the effect of reserve accumulation as a result of quantitative easing (QE) on bank-level lending and risk taking activity. To overcome the endogeneity of bank-level reserve holdings to banks' other portfolio decisions, we employ instruments made available by a regulatory change that strongly influenced the distribution of reserves in the banking system. Consistent with theories of the portfolio substitution channel in which the transmission of QE depends in part on reserve creation itself, we document that reserves created in two distinct QE programs led to higher total loan growth and an increase in the share of riskier loans, such as commercial real estate, construction, C&I, and consumer loans, within banks' loan portfolios.
Accessible materials (.zip)

Keywords: Monetary policy, QE, bank lending, reserve balances

DOI: https://doi.org/10.17016/FEDS.2017.125

FEDS 2017-124
Interest on Reserves and Arbitrage in Post-Crisis Money Markets

Thomas Keating and Marco Macchiavelli

Abstract: Currently, Eurodollars and fed funds markets combined trade about $220 billion in funds daily, the vast majority of which with overnight tenor. In this paper, we document several features of these wholesale unsecured dollar funding markets. Using daily confidential data on wholesale unsecured borrowing and reserve balances, we show that foreign banks, which make up most of the trading volumes in these markets, keep around 99% of each additional Eurodollar and 80% of each fed fund borrowed as reserve balances. With these risk-free trades, banks earn the spread between interest on reserves and the borrowing rate. Relative to foreign banks, large domestic institutions borrow less often, but when they do, they keep around 99% of each additional Eurodollar or fed fund raised as reserves. Small domestic banks do not display any correlation between net borrowing and their reserves accumulation. We also discuss how regulatory costs affect trading patterns and interest rate differentials in wholesale dollar funding markets.
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Keywords: Arbitrage, Eurodollars, Fed funds, Interest on reserves, Monetary policy

DOI: https://doi.org/10.17016/FEDS.2017.124

FEDS 2017-123
Can macroprudential measures make cross-border lending more resilient? Lessons from the taper tantrum

Előd Takáts and Judit Temesvary

Abstract: We study the effect of macroprudential measures on cross-border lending during the taper tantrum, which saw a strong slowdown of cross-border bank lending to some jurisdictions. We use a novel dataset combining the BIS Stage 1 enhanced banking statistics on bilateral cross-border lending flows with the IBRN's macroprudential database. Our results suggest that macroprudential measures implemented in borrowers' host countries prior to the taper tantrum significantly reduced the negative effect of the tantrum on cross-border lending growth. The shock-mitigating effect of host country macroprudential rules are present both in lending to banks and non-banks, and are strongest for lending flows to borrowers in advanced economies and to the non-bank sector in general. Source (lending) banking system measures do not affect bilateral lending flows, nor do they enhance the effect of host country macroprudential measures. Our results imply that policymakers may consider applying macroprudential tools to mitigate international shock transmission through cross-border bank lending.
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Keywords: Taper tantrum, cross-border claims, diff-in-diff analysis, macroprudential policy

DOI: https://doi.org/10.17016/FEDS.2017.123

FEDS 2017-122
New Evidence on an Old Unanswered Question: Why Some Borrowers Purchase Credit Insurance and Other Debt Protection and Some Do Not

Thomas A. Durkin and Gregory Elliehausen

Abstract: Credit related insurance and other debt protection are products sold in conjunction with credit that extinguish a consumer's debt or suspends its periodic payments if events like death, disability, or involuntary unemployment occur. High penetration rates observed in the 1950s and 1960s raised concerns about coercion in the sale of credit insurance. This study presents evidence on credit insurance purchase and debt protection decisions from a new survey. The findings provide little evidence of widespread or systematic coercion in purchases. Instead, findings suggest that risk aversion and health or financial concerns motivate consumers to purchase credit insurance and debt protection, just as these concerns also motivate purchases of other types of insurance.
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Keywords: Consumer Protection, Credit Insurance, Insurance, Personal Finance

DOI: https://doi.org/10.17016/FEDS.2017.122

FEDS 2017-121
Investor Concentration, Flows, and Cash Holdings: Evidence from Hedge Funds

Mathias S. Kruttli, Phillip J. Monin, and Sumudu W. Watugala

Abstract: We show that when only a few investors own a substantial portion of a hedge fund's net asset value, flow volatility increases because investors' exogenous, idiosyncratic liquidity shocks are not diversified away. Using confidential regulatory filings, we confirm that high investor concentration hedge funds experience more volatile flows. These hedge funds hold more cash and liquid assets, which help absorb large, unexpected outflows. Such funds have to pay a liquidity premium and generate lower risk-adjusted returns. Investor concentration does not affect flow-performance sensitivity. These results are robust to including lock-up and redemption periods, strategy, manager ownership, and other controls.
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Keywords: Hedge funds, flows, investor concentration, portfolio liquidity, precautionary cash

DOI: https://doi.org/10.17016/FEDS.2017.121

FEDS 2017-120
Investment Responses to Trade Liberalization: Evidence from U.S. Industries and Establishments

Justin R. Pierce and Peter K. Schott

Abstract: This paper examines the effect of a change in U.S. trade policy on the domestic investment of U.S. manufacturers. Using a difference-in-differences identification strategy, we find that industries more exposed to reductions in import tariff uncertainty exhibit relative declines in investment after the change in trade policy. Within industries, we find that this relationship is concentrated among establishments with low initial levels of labor productivity, capital intensity and skill intensity. For plants with high initial levels of skill intensity, we find that increased exposure is associated with a relative increase in investment. We also find evidence that establishments' investment activity is smoother following the policy change.

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Keywords: China, Investment, Manufacturing, Most Favored Nation, Normal Trade Relations, Trade Policy

DOI: https://doi.org/10.17016/FEDS.2017.120

FEDS 2017-119
Dealers' Insurance, Market Structure, And Liquidity

Francesca Carapella and Cyril Monnet

Abstract: We develop a parsimonious model to study the equilibrium structure of financial markets and its efficiency properties. We find that regulations aimed at improving market outcomes can cause inefficiencies. The welfare benefit of such regulation stems from endogenously improving market access for some participants, thus boosting competition and lowering prices to the ultimate consumers. Higher competition, however, erodes profits from market activities. This has two effects: it disproportionately hurts more efficient market participants, who earn larger profits, and it reduces the incentives of all market participants to invest ex-ante in efficient technologies. The general equilibrium effect can therefore result in a welfare cost to society. Additionally, this economic mechanism can explain the resistance by some market participants to the introduction of specific regulation which could appear to be unambiguously beneficial.

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Keywords: Insurance, central counterparties, dealers, liquidity

DOI: https://doi.org/10.17016/FEDS.2017.119

FEDS 2017-118
Housing Bust, Bank Lending and Employment: Evidence from Multimarket Banks

Abstract: I use geographic variation in bank lending to study how bank real estate losses impacted the supply of credit and employment during the Great Recession. Banks exposed to distressed housing markets cut mortgage and small business lending relative to other banks in the same county. This lending contraction had real effects, as counties whose banks were exposed to adverse shocks in other markets suffered employment declines, especially in young firms. This finding is robust to instrumenting for bank exposure to housing shocks using shocks in distant markets, exposure based on historical lending, or exposure to markets with inelastic housing supply.

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Keywords: Bank lending, Employment, Financial crisis, Residential real estate

DOI: https://doi.org/10.17016/FEDS.2017.118

FEDS 2017-117
Liquidity from Two Lending Facilities

Sriya L. Anbil and Angela Vossmeyer

Abstract: During financial crises, the lender of last resort (LOLR) uses lending facilities to inject critical funding into the banking sector. The facilities need to be designed in such a way that banks are not reluctant to seek assistance due to stigma and that banks with liquidity concerns are attracted rather than those prone to risk-taking and moral hazard incentives. We use an unexpected disclosure that introduced stigma at one of two similar LOLRs during the Great Depression to evaluate whether banks used LOLR assistance to improve their liquidity needs using a novel trivariate model with recursive endogeneity. We find evidence that banks that approached the facility with stigma were less liquid and reduced their position of safe assets in comparison with banks that approached the facility with no stigma. Thus, stigma forced the pool of LOLR borrowers to separate into different groups of banks that ex-post revealed their liquidity preferences. This finding sheds light on why and when banks approach their LOLR.

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Keywords: Banks, credit unions, and other financial institutions, Great Depression, lender of last resort, liquidity, stigma

DOI: https://doi.org/10.17016/FEDS.2017.117

FEDS 2017-116
Customer Liquidity Provision: Implications for Corporate Bond Transaction Costs

Jaewon Choi and Yesol Huh

Abstract: The convention in calculating trading costs in corporate bond markets is to assume that dealers provide liquidity to non-dealers (customers) and calculate average bid-ask spreads that customers pay dealers. We show that customers often provide liquidity in corporate bond markets, and thus, average bid-ask spreads underestimate trading costs that customers demanding liquidity pay. Compared with periods before the 2008 financial crisis, substantial amounts of liquidity provision have moved from the dealer sector to the non-dealer sector, consistent with decreased dealer risk capacity. Among trades where customers are demanding liquidity, we find that these trades pay 35 to 50 percent higher spreads than before the crisis. Our results indicate that liquidity decreased in corporate bond markets and can help explain why despite the decrease in dealers' risk capacity, average bid-ask spread estimates remain low.

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Keywords: Bank Regulation, Corporate Bond, Financial Intermediation, Liquidity, Volcker Rule

DOI: https://doi.org/10.17016/FEDS.2017.116

FEDS 2017-115
Bank Failures, Capital Buffers, and Exposure to the Housing Market Bubble

Abstract: We empirically document that banks with greater exposure to high home price-to-income ratio regions in 2005 and 2006 have higher mortgage delinquency and charge-off rates and significantly higher probabilities of failure during the last financial crisis even after controlling for capital, liquidity, and other standard bank performance measures. While high price-to-income ratios present a greater likelihood of house price correction, we find no evidence that banks managed this risk by building stronger capital buffers. Our results suggest that there is scope for improved measures of mortgage loan risk that could be considered for regulatory and risk management applications.

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Keywords: Bank failure, credit risk, mortgage risk, residential real estate

DOI: https://doi.org/10.17016/FEDS.2017.115

FEDS 2017-114
Updates to the Sampling of Wealthy Families in the Survey of Consumer Finances

Abstract: Participation in household surveys has fallen over time, making it harder to produce a household survey--like the Survey of Consumer Finances (SCF)--in a timely manner. To address these challenges, the reference year of the sampling frame data for the 2016 SCF wealthy oversample was shifted back one year, allowing the oversample to be selected earlier than the past. In implementing this change, though, we risk identifying an outdated set of families and introducing variability in the sampling process. However, we show that the set of families selected in the new frame are observationally equivalent to those that would have been selected from a past frame, and that the increased variability of wealth estimates is compensated-for with the use of more comprehensive data than in the past. Other aspects of the SCF sampling process are revisited, too. We continue to find support for using permanent income in the sampling process, rather than annual income. We also estimate the geographic distribution of wealthy families and show that the current distribution is similar to the past. We propose adding one geographic area to the oversample, though, and supplementing by 100 the set of sampled families.

Accessible materials (.zip)

Keywords: Distribution, household surveys, sampling, wealth

DOI: https://doi.org/10.17016/FEDS.2017.114

FEDS 2017-113
Identification of Monetary Policy Shocks with External Instrument SVAR

Abstract: We explore the use of external instrument SVAR to identify monetary policy shocks. We identify a forward guidance shock as the monetary shock component having zero instant impact on the policy rate. A contractionary forward guidance shock raises both future output and price level, stressing the relative importance of revealing policymakers' view on future output and price level over committing to a policy stance. We also decompose non-monetary structural shocks, and find that positive shocks to output and price level lead to monetary contraction. Since information on output and price level is revealed through both monetary and non-monetary channels, some monetary and non-monetary shocks can look alike, leading to linear dependence and violating usual instrument SVAR assumptions. We show that some of the main findings are robust to such dependence.

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Keywords: Forward Guidance, Instrument VAR, Monetary policy

DOI: https://doi.org/10.17016/FEDS.2017.113

FEDS 2017-112
The Continuing Validity of Monetary Policy Autonomy Under Floating Exchange Rates

Abstract: Economic research in recent years has given considerable prominence to the issue of whether a floating exchange rate provides autonomy with regard to monetary policy to a central bank whose economy is highly open. In particular, Rey (2016) has argued that inflation-targeting advanced economies lack monetary policy autonomy by pointing to results suggesting that U.S. monetary policy shocks matter for the behavior of key financial variables in these economies. In contrast, it is argued in this paper that monetary autonomy does prevail in inflation-targeting advanced economies, notwithstanding the reaction of these economies' asset prices to U.S. monetary policy developments. The reason is that the monetary-autonomy argument, as advanced by Milton Friedman and as embedded in new open-economy models, rests on the fact that the monetary base is insulated from foreign influences under floating rates. This fact allows the home monetary authority to pursue a stabilization policy in which it has a decisive influence on nominal variables in the long run, as well as a short-run influence on real variables. The result that rest-of-world monetary policy is among the other factors affecting the short-run behavior of real variables (including real asset prices) in a small, floating-rate open economy turns out to be consistent with the traditional and appropriate concept of monetary policy autonomy under floating exchange rates. It follows that such effects of rest-of-world monetary policy on the home economy are consistent with the celebrated open-economy trilemma.

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Keywords: Monetary policy autonomy, floating exchange rates, inflation targeting, trilemma

DOI: https://doi.org/10.17016/FEDS.2017.112

FEDS 2017-111
Common Factors, Trends, and Cycles in Large Datasets

Matteo Barigozzi and Matteo Luciani

Abstract: This paper considers a non-stationary dynamic factor model for large datasets to disentangle long-run from short-run co-movements. We first propose a new Quasi Maximum Likelihood estimator of the model based on the Kalman Smoother and the Expectation Maximisation algorithm. The asymptotic properties of the estimator are discussed. Then, we show how to separate trends and cycles in the factors by mean of eigenanalysis of the estimated non-stationary factors. Finally, we employ our methodology on a panel of US quarterly macroeconomic indicators to estimate aggregate real output, or Gross Domestic Output, and the output gap.

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Keywords: EM Algorithm, Gross Domestic Output, Kalman Smoother, Non-stationary Approximate Dynamic Factor Model, Output Gap, Quasi Maximum Likelihood, Trend-Cycle Decomposition

DOI: https://doi.org/10.17016/FEDS.2017.111

FEDS 2017-110
An Assessment of the National Establishment Time Series (NETS) Database

Keith Barnatchez, Leland D. Crane, and Ryan A. Decker

Abstract: The National Establishment Time Series (NETS) is a private sector source of U.S. business microdata. Researchers have used state-specific NETS extracts for many years, but relatively little is known about the accuracy and representativeness of the nationwide NETS sample. We explore the properties of NETS as compared to official U.S. data on business activity: The Census Bureau's County Business Patterns (CBP) and Nonemployer Statistics (NES) and the Bureau of Labor Statistics' Quarterly Census of Employment and Wages (QCEW). We find that the NETS universe does not cover the entirety of the Census-based employer and nonemployer universes, but given certain restrictions NETS can be made to mimic official employer datasets with reasonable precision. The largest differences between NETS employer data and official sources are among small establishments, where imputation is prevalent in NETS. The most stringent of our proposed sample restrictions still allows scope that covers about three quarters of U.S. private sector employment. We conclude that NETS microdata can be useful and convenient for studying static business activity in high detail.

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Keywords: CBP, NAICS, NETS, QCEW, business microdata, employment, establishment size

DOI: https://doi.org/10.17016/FEDS.2017.110

FEDS 2017-109
Mechanics of linear quadratic Gaussian rational inattention tracking problems

Abstract: This paper presents a general framework for constructing and solving the multivariate static linear quadratic Gaussian (LQG) rational inattention tracking problem. We interpret the nature of the solution and the implied action of the agent, and we construct representations that formalize how the agent processes data. We apply this infrastructure to the rational inattention price-setting problem, confirming the result that a conditional response to economics shocks is possible, but casting doubt on a common assumption made in the literature. We show that multiple equilibria and a social cost of increased attention can arise in these models. We consider the extension to the dynamic problem and provide an approximate solution method that achieves low approximation error for many applications found in the LQG rational inattention literature.

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Keywords: Rational inattention, information acquisition, signal extraction

DOI: https://doi.org/10.17016/FEDS.2017.109

FEDS 2017-108
The Great Recession and a Missing Generation of Exporters

William F. Lincoln, Andrew H. McCallum, and Michael Siemer

Abstract: The collapse of international trade surrounding the Great Recession has garnered significant attention. This paper studies firm entry and exit in foreign markets and their role in the post-recession recovery of U.S. exports using confidential microdata from the U.S. Census Bureau. We find that incumbent exporters account for the vast majority of the decline in export volumes during the crisis. The recession also induced a missing generation of exporters, with large increases in exits and a substantial decline in entries into foreign markets. New exporters during these years tended to have larger export volumes, however, compensating for the decline in the number of exporting firms. Thus, while entry and exit were important for determining the variety of U.S. goods that were exported, they were less important for the trajectory of aggregate foreign sales.

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Keywords: Business cycles, entry , exit, exports, financial crisis, firm dynamics, great recession

DOI: https://doi.org/10.17016/FEDS.2017.108

FEDS 2017-107
What's the Story? A New Perspective on the Value of Economic Forecasts

Steven A. Sharpe, Nitish R. Sinha, and Christopher A. Hollrah

Abstract: We apply textual analysis tools to measure the degree of optimism versus pessimism of the text that describes Federal Reserve Board forecasts published in the Greenbook. The resulting measure of Greenbook text sentiment, "Tonality," is found to be strongly correlated, in the intuitive direction, with the Greenbook point forecast for key economic variables such as unemployment and inflation. We then examine whether Tonality has incremental power for predicting unemployment, GDP growth, and inflation up to four quarters ahead. We find it to have significant and substantive predictive power for both GDP growth and unemployment, particularly since 1991: higher (more optimistic) Tonality presages higher GDP growth and lower unemployment, relative to the Greenbook point forecasts. We then test whether Tonality helps predict monetary policy and stock returns. Higher Tonality has some power to predict tighter than forecasted monetary policy, while it has substantial power fo r predicting higher 3-month, 6-month, and 12-month stock market returns.

Accessible materials (.zip)
Original paper: PDF | Accessible materials (.zip)

Keywords: Text Analysis, Economic Forecasts, Monetary policy, Stock Returns

DOI: https://doi.org/10.17016/FEDS.2017.107r1

FEDS 2017-106
Inferring the Shadow Rate from Real Activity

Benjamin Garcia and Arsenios Skaperdas

Abstract: We estimate a shadow rate consistent with the paths of time series capturing real activity. This allows us to quantify the real effects of unconventional monetary policy in terms of equivalent short-term interest rate movements. We find that large-scale asset purchases and forward guidance had significant real effects equivalent of up to a four percent reduction in the federal funds rate.

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Keywords: Kalman filter, effective lower bound, external instrument VAR, shadow rate, unconventional monetary policy

DOI: https://doi.org/10.17016/FEDS.2017.106

FEDS 2017-105
The Unequal Distribution of Economic Education: A Report on the Race, Ethnicity, and Gender of Economics Majors at US Colleges and Universities

Amanda Bayer and David Wilcox

Abstract: The distribution of economic education among US college graduates is quite unequal: female and underrepresented minority undergraduates, collectively, major in economics at 0.36 the rate that white, non-Hispanic male students do. This paper makes a four-part contribution to address this imbalance. First and foremost, we provide detailed comparative data at the institution level to provoke and inform the attention of economists and senior administrators at colleges and universities, among others. Second, we establish a definition of full inclusion in economic education on college and university campuses and use that definition to evaluate the status quo and to compare institutions. Third, we illuminate the reasons why the need to improve the distribution of economic education is urgent, including the imperative to support economic policymaking. Lastly, we point the way forward, identifying both currently available resources and reasonable next steps for all involved parties to take.

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Keywords: Education, Ethnicity, Race

DOI: https://doi.org/10.17016/FEDS.2017.105

FEDS 2017-104
Taxes and the Fed: Theory and Evidence from Equities

Anthony M. Diercks and William Waller

Abstract: We provide a critical theoretical and empirical analysis that suggests a key driver of fiscal effects on equity markets is the Federal Reserve. For the Post-1980 era, tax cuts lead to higher cash flow news and higher discount rates. The discount rate news tends to dominate such that tax cuts are associated with lower equity returns. This result is flipped for the Pre-1980 era. Our results are confirmed across multiple measures of tax shocks (narrative, SVAR, municipal bonds, etc.) at different frequencies (daily, quarterly, annual). We motivate our empirical findings with a standard New Keynesian model (in addition to the FRB/US model) that exhibits a shift in the aggressiveness of monetary policy. Moreover in our theoretical framework, downward nominal wage rigidities account for observed asymmetries in the response to tax cuts versus tax increases.

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Keywords: fiscal policy, stock market, news decomposition

DOI: https://doi.org/10.17016/FEDS.2017.104

FEDS 2017-103
Trader Positions and Marketwide Liquidity Demand

Esen Onur, John S. Roberts, and Tugkan Tuzun

Abstract: In electronic, liquid markets, traders frequently change their positions. The distribution of these trader position changes carries important information about liquidity demand in the market. From this distribution of trader position-changes, we construct a marketwide measure for intraday liquidity demand that does not necessarily depend on aggressive trading. Using a rich regulatory dataset on S&P 500 E-mini futures and 10-year Treasury futures markets, we show that this liquidity demand measure has a positive impact on prices. We then decompose our measure of liquidity demand into three components: aggressive, passive and mixed liquidity demand. Passive liquidity demand also has an impact on prices; a one standard deviation increase in passive liquidity demand is associated with 0.5 tick rise in prices for S&P 500 E-mini futures. In addition, we find that new information is incorporated into the prices when passive liquidity demanders take positions. By providing direct evidence, we contribute to the growing literature on the impact of passive limit orders.
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Keywords: Liquidity, Passive Trading, Price Impact

DOI: https://doi.org/10.17016/FEDS.2017.103

FEDS 2017-102
Measuring Inflation Anchoring and Uncertainty: A US and Euro Area Comparison

Olesya Grishchenko, Sarah Mouabbi, and Jean-Paul Renne

Abstract: We use several US and euro-area surveys of professional forecasters to estimate a dynamic factor model of inflation featuring time-varying uncertainty. We obtain survey-consistent distributions of future inflation at any horizon, both in the US and the euro area. Equipped with this model, we propose a novel measure of the anchoring of inflation expectations that accounts for inflation uncertainty. Our results suggest that following the Great Recession, inflation anchoring improved in the US, while mild de-anchoring occurred in the euro-area. As of our sample end, both areas appear to be equally anchored.
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Keywords: anchoring of inflation expectations, dynamic factor model, inflation, stochastic volatility, surveys of professional forecasters, term structure of inflation expectations and inflation uncertainty

DOI: https://doi.org/10.17016/FEDS.2017.102

FEDS 2017-101
Measuring Mortgage Credit Availability: A Frontier Estimation Approach

Abstract: We construct a new measure of mortgage credit availability that describes the maximum amount obtainable by a borrower of given characteristics. We estimate this "loan frontier" using mortgage originations data from 2001 to 2014 and show that it reflects a binding borrowing constraint. Our estimates reveal that the expansion of mortgage credit during the housing boom was substantial for all borrowers, not only for low-score or low-income borrowers. The contraction was most pronounced for low-score borrowers. Using variation in the frontier across metropolitan areas over time, we show that borrowing constraints played an important role in the recent housing cycle.
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Keywords: Constraints, Construction, Credit Availability, Frontier, House prices, Mortgages

DOI: https://doi.org/10.17016/FEDS.2017.101

FEDS 2017-100
Faster Payments: Market Structure and Policy Considerations

Aaron Rosenbaum, Garth Baughman, Mark Manuszak, Kylie Stewart, Fumiko Hayashi, and Joanna Stavins

Abstract: The U.S. payments industry is in the process of developing ubiquitous, safe, faster electronic solutions for making a broad variety of business and personal payments. How this market for faster payments will evolve will be shaped by a range of economic forces, such as economies of scale and scope, network effects, switching costs, and product differentiation. Emerging technologies could alter these forces and lead to new organizational arrangements or market structures that are different from those in legacy payment markets to date. In light of this uncertainty, this paper examines three hypothetical market structures that may emerge: a dominant-operator environment, a multi-operator environment, and a decentralized environment. Each of these market structures has different implications for the public policy objectives of efficiency, safety, and ubiquity. The paper also considers tools to promote positive outcomes in each market structure.
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Keywords: Faster payments, market structure and competition, payment system improvement, public policy, retail payments

DOI: https://doi.org/10.17016/FEDS.2017.100

FEDS 2017-099
How does the Fed adjust its Securities Holdings and Who is Affected?

Jane Ihrig, Lawrence Mize, and Gretchen C. Weinbach

Abstract: The Federal Open Market Committee indicated in its September 2017 post-meeting statement that it will initiate in October a balance sheet normalization program to gradually reduce its securities holdings. This action will put in place a policy of reinvesting and redeeming portions of the principal payments received by the Federal Reserve from its holdings of Treasury and agency securities. How are these adjustments to the Federal Reserve's securities holdings transacted and who is affected? This paper provides a primer regarding how the Federal Reserve accounts for these securities transactions. It also illustrates the numerous ways that the Federal Reserve's actions can play out across other sectors of the economy, including those that engage directly with the Federal Reserve and those that are involved indirectly as funds change hands.
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Keywords: FOMC, Federal Reserve Board and Federal Reserve System, balance sheet management, balance sheet policy, monetary policy normalization, securities redemption, securities reinvestment

DOI: https://doi.org/10.17016/FEDS.2017.099

FEDS 2017-098
On Targeting Frameworks and Optimal Monetary Policy

Martin Bodenstein and Junzhu Zhao

Abstract: Speed limit policy, a monetary policy strategy that focuses on stabilizing inflation and the change in the output gap, consistently delivers better welfare outcomes than flexible inflation targeting or flexible price level targeting in empirical New Keynesian models when policymakers lack the ability to commit to future policies. Even if the policymaker can commit under an inflation targeting strategy, the discretionary speed limit policy performs better for most empirically plausible model parameterizations from a normative perspective.

Keywords: delegation, inflation targeting, optimal monetary policy, price level targeting, speed limit policy

DOI: https://doi.org/10.17016/FEDS.2017.098

FEDS 2017-097
Optimal Bank Regulation in the Presence of Credit and Run Risk

Anil K. Kashyap, Dimitrios P. Tsomocos, and Alexandros P. Vardoulakis

Abstract: We modify the Diamond and Dybvig (1983) model of banking to jointly study various regulations in the presence of credit and run risk. Banks choose between liquid and illiquid assets on the asset side, and between deposits and equity on the liability side. The endogenously determined asset portfolio and capital structure interact to support credit extension, as well as to provide liquidity and risk-sharing services to the real economy. Our modifications create wedges in the asset and liability mix between the private equilibrium and a social planner's equilibrium. Correcting these distortions requires the joint implementation of a capital and a liquidity regulation.

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Keywords: bank runs, capital, credit risk, limited liability, liquidity, regulation

DOI: https://doi.org/10.17016/FEDS.2017.097

FEDS 2017-096
Reaffirming the Influence of Milton Friedman on U.K. Economic Policy

Abstract: This paper finds a significant influence of Milton Friedman on U.K. economic policy from the 1970s onward, and especially during the period of the Thatcher Government. The finding is based on a consideration of statements by policymakers and key economic advisers, as well as an analysis of Friedman's commentary in the 1970s, 1980s, and 1990s on U.K. economic developments. Explicit, public acknowledgments of Friedman's influence were given by Margaret Thatcher, Chancellor of the Exchequer Geoffrey Howe, Bank of England officials, and others in policy circles. Examples of Friedman's influence include the absorption into U.K. policy doctrine of the permanent income hypothesis and the natural rate hypothesis, the rejection from 1979 onward of incomes policy as a weapon against inflation, and U.K. officials' repeated appeals to monetary sovereignty when arguing against monetary union or a sterling peg. Evidence of influence by Friedman on privatization policy and on the official perspective on the current account deficit can also be discerned. Although he had only limited interaction with U.K. policymakers, Friedman had a major influence, reflected in the adoption into actual U.K. policymaking of recommendations made in his writings and in the fact that those writings--which were studied closely by a number of senior U.K. economic advisers--helped alter U.K. economists' conceptual framework and thereby fostered doctrinal changes in U.K. economic policy. This paper's analysis also shows that two prominent critics of the Thatcher economic policy--Labour's Harold Wilson and the Conservatives' Edward Heath--saw this policy as partly due to the influence of Friedman, whom each of them had met before the Thatcher era.

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Keywords: Incomes policy, Milton Friedman, Monetarism, U.K. economic policy

DOI: https://doi.org/10.17016/FEDS.2017.096

FEDS 2017-095
Regular Variation of Popular GARCH Processes Allowing for Distributional Asymmetry

Abstract: Linear GARCH(1,1) and threshold GARCH(1,1) processes are established as regularly varying, meaning their heavy tails are Pareto like, under conditions that allow the innovations from the, respective, processes to be skewed. Skewness is considered a stylized fact for many financial returns assumed to follow GARCH-type processes. The result in this note aids in establishing the asymptotic properties of certain GARCH estimators proposed in the literature.

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Keywords: GARCH, Pareto tail, heavy tail, regular variation, threshold GARCH

DOI: https://doi.org/10.17016/FEDS.2017.095

FEDS 2017-094
Why Rent When You Can Buy?

Cyril Monnet and Borghan N. Narajabad

Abstract: Using a model with bilateral trades, we explain why agents prefer to rent the goods they can afford to buy. Absent bilateral trading frictions, renting has no role even with uncertainty about future valuations. With pairwise meetings, agents prefer to sell (or buy) durable goods whenever they have little doubt on the future value of the good. As uncertainty grows, renting becomes more prevalent. Pairwise matching alone is sufficient to explain why agents prefer to rent, and there is no need to introduce random matching, information asymmetries, or other market frictions.

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Keywords: Bargaining, Bilateral matching, Over-the-counter market, Rent, Repo, Security lending, directed search

DOI: https://doi.org/10.17016/FEDS.2017.094

FEDS 2017-093
Did QE lead banks to relax their lending standards? Evidence from the Federal Reserve's LSAPs

Robert Kurtzman, Stephan Luck, and Tom Zimmermann

Abstract: Using confidential loan officer survey data on lending standards and internal risk ratings on loans, we document an effect of large-scale asset purchase programs (LSAPs) on lending standards and risk-taking. We exploit cross-sectional variation in banks' holdings of mortgage-backed securities to show that the first and third round of quantitative easing (QE1 and QE3) significantly lowered lending standards and increased loan risk characteristics. The magnitude of the effects is about the same in QE1 and QE3, and is comparable to the effect of a one percentage point decrease in the Fed funds target rate.

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Keywords: Banks, QE, Risk, SLOOS, STBL

DOI: https://doi.org/10.17016/FEDS.2017.093

FEDS 2017-092
How have banks been managing the composition of high-quality liquid assets?

Jane Ihrig, Edward Kim, Ashish Kumbhat, Cindy Vojtech, and Gretchen C. Weinbach

Abstract: We study banks' post-crisis liquidity management. We construct time series of U.S. banks' holdings of high-quality liquid assets (HQLA) and examine how these assets have been managed in recent years to comply with the Liquidity Coverage Ratio (LCR) requirement. We find that, in becoming LCR compliant, banks initially ramped up their stock of reserve balances. However, once the requirement was met, some banks subsequently shifted the compositions of their liquid portfolios significantly. This raises the question: What drives the compositions of banks' HQLA? We show that a risk-return framework can account for a range of potential portfolio compositions depending on banks' tolerance for interest rate risk. And, our data indicate that banks have indeed adopted a range of portfolio compositions, with some components exhibiting a high degree of daily variance. These findings lead us to conclude that about half of large banks are largely focused on risk-return conside rations in managing the compositions of their HQLA pools while the other half appear bound by other factors. We highlight the importance of our findings for both the transmission and implementation of monetary policy.

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Keywords: HQLA, LCR, bank balance sheets, liquid assets, liquidity management, reserve balances

DOI: https://doi.org/10.17016/FEDS.2017.092r1

FEDS 2017-091
Employment, Wages and Optimal Monetary Policy

Martin Bodenstein and Junzhu Zhao

Appendix (PDF)

Abstract: We study optimal monetary policy when the empirical evidence leaves the policymaker uncertain whether the true data-generating process is given by a model with sticky wages or a model with search and matching frictions in the labor market. Unless the policymaker is almost certain about the search and matching model being the correct data-generating process, the policymaker chooses to stabilize wage inflation at the expense of price inflation, a policy resembling the policy that is optimal in the sticky wage model, regardless of the true model. This finding reflects the greater sensitivity of welfare losses to deviations from the model-specific optimal policy in the sticky wage model. Thus, uncertainty about important aspects of the structure of the economy does not necessarily translate into uncertainty about the features of good monetary policy.

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Keywords: model uncertainty, optimal monetary policy, optimal targeting rules, search and matching, sticky wages

DOI: https://doi.org/10.17016/FEDS.2017.091

FEDS 2017-090
Improving the 30-Year Fixed-Rate Mortgage

Wayne Passmore and Alexander H. von Hafften

Abstract: The 30-year fixed-rate fully amortizing mortgage (or "traditional fixed-rate mortgage") was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With so little equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowner might have better uses for this money. Third, refinancing mortgages is often very costly. We propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or "Fixed-COFI mortgage"), that resolves these three flaws. This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and no down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk wedge between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. Committing to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin, the homeowner uses this wedge to accumulate home equity quickly. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. Fixed-COFI mortgages may help some renters gain access to homeownership. These renters may be, for example, paying rents as high as comparable mortgage payments in high-cost metropolitan areas but do not have enough savings for a down payment. The Fixed-COFI mortgage may help such renters, among others, purchase homes.

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Keywords: COFI, Cost of funds, Financial institutions, Fixed-rate mortgage, Homeownership, Interest rates, Mortgages and credit

DOI: https://doi.org/10.17016/FEDS.2017.090

FEDS 2017-089
Whose Child Is This? Shifting of Dependents Among EITC Claimants Within the Same Household

David Splinter, Jeff Larrimore, and Jacob Mortenson

Abstract: Using a panel of household level tax data, we estimate the degree to which dependents are “reassigned” between tax units within households, and how these reassignments affect combined tax liabilities. Reassigning dependents reduces combined tax liabilities on average, suggesting some household level coordination. Additionally, when EITC benefits expanded in 2009, reassignments increasingly involved adding a third child to tax returns to claim these new benefits. However, the subgroup reassigning towards three child tax units actually increased total household tax liabilities, suggesting that some taxpayers may prioritize minimizing their own tax burden or focus on particularly salient aspects of tax policy.

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Keywords: earned income tax credit, household level tax coordination, tax avoidance

DOI: https://doi.org/10.17016/FEDS.2017.089

FEDS 2017-088
The Timing of Mass Layoff Episodes: Evidence from U.S. Microdata

Abstract: This paper studies employment decisions at U.S. companies over the 2007–2012 period, during and after the Great Recession. To this end, I build a panel dataset that matches publicly-listed companies' financial reports to their announced layoff episodes. Using limited dependent variable regressions, I find that layoffs respond to accumulated changes in a company's financial conditions. While recent financial changes have the largest impacts on layoff propensities, financial changes over at least four previous quarters appear to have additional marginal effects.

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Keywords: Downsizing, Employment adjustment costs

DOI: https://doi.org/10.17016/FEDS.2017.088

FEDS 2017-087
Forward-looking and Incentive-compatible Operational Risk Capital Framework

Abstract: This paper proposes an alternative framework to set banks' operational risk capital, which allows for forward-looking assessments and limits gaming opportunities by relying on an incentive-compatible mechanism. This approach would improve upon the vulnerability to gaming of the AMA and the lack of risk-sensitivity of BCBS's new standardized approach for operational risk.

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Keywords: Banking Regulation, Operational Risk, Regulatory Capital, Incentive Compatibility

DOI: https://doi.org/10.17016/FEDS.2017.087r1

FEDS 2017-086
The Effect of Interest Rates on Home Buying: Evidence from a Discontinuity in Mortgage Insurance Premiums

Abstract: We study the effect of interest rates on the housing market by taking advantage of a sudden and unexpected price change in a large government mortgage program. The Federal Housing Administration (FHA) insures most mortgages to lower-downpayment, lower-credit score borrowers, including a majority of first-time homebuyers. The FHA charges borrowers an annual mortgage insurance premium (MIP), and in January, 2015 the FHA abruptly reduced the MIP, and thus FHA borrowers' effective interest rate, by 50 basis points. Using a regression discontinuity design, we find that the MIP reduction increased the number of home purchase originations among the FHA-reliant population by nearly 14 percent. The response to the premium cut was negatively correlated with borrower income, with no observable response among relatively high income borrowers. We trace part of the jump in home buying to the MIP reduction helping ease binding debt payment-to-income ratio limits thus allowing more applications to be approved. Finally, we find no evidence that the MIP reduction increased house prices.

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Keywords: Interest rates, Mortgages and credit, Residential real estate

DOI: https://doi.org/10.17016/FEDS.2017.086

FEDS 2017-085
Oil price pass-through into core inflation

Cristina Conflitti and Matteo Luciani

Abstract: We estimate the oil price pass-through into consumer prices both in the US and in the euro area. In particular, we disentangle the specific effect that an oil price change might have on each disaggregate price, from the effect on all prices that an oil price change might have since it affects the whole economy. To do so, we first estimate a Dynamic Factor Model on a panel of disaggregate price indicators, and then we use VAR techniques to estimate the pass-through. Our results show that the oil price passes through core inflation only via its effect on the whole economy. This pass-through is estimated to be small, but statistically different from zero and long lasting.

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Keywords: Core inflation, oil price, dynamic factor model, pass-through, disaggregate consumer prices

DOI: https://doi.org/10.17016/FEDS.2017.085

FEDS 2017-084
Why Are Banks Not Recapitalized During Crises?

Abstract: I develop a model where the sovereign debt capacity depends on the capitalization of domestic banks. Low-capital banks optimally tilt their government bond portfolio toward domestic securities, linking their destiny to that of the sovereign. If the sovereign risk is sufficiently high, low-capital banks reduce private lending to further increase their holdings of domestic government bonds, lowering sovereign yields and supporting the home sovereign debt capacity. The model rationalizes, in the context of the eurozone periphery, the increase in domestic government bond holdings, the reduction of bank credit supply, and the prolonged fragility of the financial sector.

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Keywords: Bank Capital, Sovereign Crises, Risk-Shifting, Government Bonds, Bank Credit

DOI: https://doi.org/10.17016/FEDS.2017.084

FEDS 2017-083
Managing Counterparty Risk in OTC Markets

Christoph Frei, Agostino Capponi, and Celso Brunetti

Abstract: We study how banks manage their default risk to optimally negotiate quantities and prices of contracts in over-the-counter markets. We show that costly actions exerted by banks to reduce their default probabilities are inefficient. Negative externalities due to counterparty concentration may lead banks to reduce their default probabilities even below the social optimum. The model provides new implications which are supported by empirical evidence: (i) intermediation is done by low-risk banks with medium initial exposure; (ii) the risk-sharing capacity of the market is impaired, even when the trade size limit is not binding; and (iii) intermediaries play the fundamental role of diversifying the idiosyncratic risk in CDS contracts, besides increasing the risk-sharing capacity of the market.

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Keywords: Over-the-counter markets, conterparty concentration, counterparty risk, negative externalities

DOI: https://doi.org/10.17016/FEDS.2017.083r1

FEDS 2017-082
Identifying Contagion in a Banking Network

Alan Morrison, Michalis Vasios, Mungo Wilson, and Filip Zikes

Abstract: We present the first micro-level evidence of the transmission of shocks through financial networks. Using the network of credit default swap (CDS) transactions between banks, we identify bank CDS returns attributable to counterparty losses. A bank's own CDS spread increases whenever counterparties from whom it has purchased default protection themselves experience losses. We find no such effect from losses of non-counterparties, nor from counterparties to whom the bank has sold protection. The effect on bank CDS returns through this counterparty loss channel is large relative to the direct effect on a bank's CDS returns from its own trading losses.

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Keywords: Contagion, counterparty risk, credit default swaps, networks

DOI: https://doi.org/10.17016/FEDS.2017.082

FEDS 2017-081
FinTech and Financial Innovation: Drivers and Depth

Abstract: This paper answers two questions that help those analyzing FinTech understand its origins, growth, and potential to affect financial stability. First, it answers the question of why "FinTech" is happening right now. Many of the technologies that support FinTech innovations are not new, but financial institutions and entrepreneurs are only now applying them to financial products and services. Analysis of the supply and demand factors that drive "traditional" financial innovation reveals a confluence of factors driving a large quantity of innovation. Second, this paper answers the question of why FinTech is getting so much more attention than traditional innovation normally does. The answer to this question has to do with the 'depth' of innovation, a concept introduced in this paper. The deeper an innovation, the greater the ability of that innovation to transform financial services. The paper shows that many FinTech innovations are deep innovations and hence have a greater potential to change financial services. A greater potential to transform can also lead to a greater chance of affecting financial stability.

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Keywords: FinTech, financial innovation

DOI: https://doi.org/10.17016/FEDS.2017.081

FEDS 2017-080
Monetary Policy in a Low Interest Rate World

Abstract: Nominal interest rates may remain substantially below the averages of the last half-century, as central bank's inflation objectives lie below the average level of inflation and estimates of the real interest rate likely to prevail over the long run fall notably short of the average real interest rate experienced over this period. Persistently low nominal interest rates may lead to more frequent and costly episodes at the effective lower bound (ELB) on nominal interest rates. We revisit the frequency and potential costs of such episodes in a low-interest-rate world in a dynamic-stochastic-general-equilibrium (DSGE) model and large-scale econometric model, the FRB/US model. Several conclusions emerge. First, monetary policy strategies based on traditional policy rules lead to poor economic performance when the equilibrium interest rate is low, with economic activity and inflation more volatile and systematically falling short of desirable levels. Moreover, the freque ncy and length of ELB episodes under such policy approaches is significantly higher than in previous studies. Second, a risk-adjustment to a simple rule in which monetary policymakers are more accommodative, on average, than prescribed by the rule ensures that inflation achieves its 2 percent objective and requires that policymakers aim at inflation near 3 percent when the ELB is not binding. Third, commitment strategies in which monetary accommodation is not removed until either inflation or economic activity overshoot their long-run objectives are very effective in both the DSGE and FRB/US model. Finally, our results suggest that the adverse effects associated with the ELB may be substantial at inflation targets near 2 percent if r* is low and monetary policy follows a traditional policy approach. Whether such adverse effects could justify a higher inflation target depends on whether monetary policy strategies substantially different from traditional approaches are feasible and an assessment of the effects of the inflation target on economic welfare.

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Keywords: Interest rates, Model comparison, Monetary policy

DOI: https://doi.org/10.17016/FEDS.2017.080

FEDS 2017-079
The Effect of Bank Supervision on Risk Taking: Evidence from a Natural Experiment

Abstract: In this paper, we exploit a natural experiment in which thrifts in several states witnessed an exogenous reduction in supervisory attention to assess the effect of supervision on financial institutions' willingness to take risk. We show that the affected institutions took on much more risk than their unaffected counterparts in other districts that were subject to identical regulations. Subsequent to the emergency enlistment of examiners and supervisors from other parts of the country two years later, additional risk taking by the affected thrifts ceased. We find that the expansion in risk taking resulted in a higher incidence of failure as well as more costly failures. None of these patterns are present in commercial banks subject to a different primary supervisory agent but otherwise similar to the thrifts in our sample.

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Keywords: S&L crisis, bank supervision, lending, resolution costs, risk taking

DOI: https://doi.org/10.17016/FEDS.2017.079

FEDS 2017-078
Firm Leverage, Labor Market Size, and Employee Pay

Abstract: We provide estimates of the wage costs of firms' debt exploiting within-firm variation in workers' expected unemployment costs due to variation in local labor market size. We find that, following an increase in firm leverage, workers with higher unemployment costs experience higher wage growth relative to workers at the same firm with lower unemployment costs. Our estimates suggest wage costs are an important component in the cost of debt; a 10 percentage point increase in firm leverage increases wages for the median worker by 1.9% and increases total firm wage costs by 17 basis points of firm value.

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Original paper: PDF | Accessible materials (.zip)

Keywords: Capital structure, Costs of financial distress, Wages and compensation

DOI: https://doi.org/10.17016/FEDS.2017.078r1

FEDS 2017-077
Exporting and Frictions in Input Markets: Evidence from Chinese Data

Maria D. Tito and Ruoying Wang

Abstract: This paper investigates the impact of international trade on input market distortions. We focus on a specific friction, binding borrowing constraints in capital markets. We propose a theoretical model where a firm's demand for capital is constrained by an initial asset allocation and past sales. While the initial distribution of assets induces misallocation if the asset endowment at more productive firms does not fully cover their demand for capital, the dependence of the borrowing constraint from past sales proxies for cross-firm differences in the cost of default, which is empirically higher at larger firms. Overtime, an increase in sales relaxes the borrowing constraint; similarly, shocks to market access{such as opening to trade{contribute to easing the financial constraints, thus accelerating the convergence toward the frictionless allocation. To analyze the empirical relationship between market access and credit frictions, we draw on the annual surveys conducted by the Chinese National Bureau of Statistics (NBS) for 1998 to 2007, and we construct firm-level measures of distortions that control for firm heterogeneity. We find smaller labor and capital distortions across exporting firms; such distortions are even smaller in sectors where firms face lower tariffs or are more dependent on external financing, a proxy for the presence of binding financial constraints. Our empirical analysis also shows that export shocks significantly reduce the dispersion across input returns over time, with the effect mostly occurring at constrained firms. Our findings point to within-sector input reallocation as an important channel to overcome misallocation in open economies.

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Keywords: heterogeneous firms, financial frictions, misallocation, and international trade

DOI: https://doi.org/10.17016/FEDS.2017.077

FEDS 2017-076
Misallocation Costs of Digging Deeper into the Central Bank Toolkit

Robert Kurtzman and David Zeke

Abstract: Central bank large-scale asset purchases, particularly the purchase of corporate bonds of nonfinancial firms, can induce a misallocation of resources through their heterogeneous effect on firms cost of capital. First, we analytically demonstrate the mechanism in a static model. We then evaluate the misallocation of resources induced by corporate bond buys and the associated output losses in a calibrated heterogeneous firm New Keynesian DSGE model. The calibrated model suggests misallocation effects from corporate bond buys can be large enough to make them less effective than government bond buys, which is not the case without accounting for misallocation effects.

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Keywords: QE, LSAPs, and Misallocation

DOI: https://doi.org/10.17016/FEDS.2017.076

FEDS 2017-075
The Federal Reserve's Portfolio and its Effect on Interest Rates

Abstract: We explore the historical composition of the Federal Reserve's Treasury portfolio and its effect on Treasury yields. Using data from 1985 to 2016, we show that the divergence of the composition of the Federal Reserve's portfolio from overall Treasury securities outstanding is associated with a statistically significant effect on interest rates. In aggregate, when the Federal Reserve's portfolio has shorter maturity than overall Treasury debt outstanding, measures of the term premium are higher at all horizons; likewise, when the Federal Reserve's portfolio has longer maturity, term premiums are lower. In addition, at the individual security level, differences in Federal Reserve holdings from overall Treasury debt outstanding are correlated with measures of pricing errors and liquidity premiums. We discuss the mechanism for this effect, which could include elements of preferred-habitat theory as well as the fiscal theory of the price level.

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Keywords: Federal Reserve, SOMA portfolio, Treasury securities, portfolio composition

DOI: https://doi.org/10.17016/FEDS.2017.075

FEDS 2017-074
The Impact of Price Controls in Two-sided Markets: Evidence from US Debit Card Interchange Fee Regulation

Abstract: We study the pricing of deposit accounts following a regulation that capped debit card interchange fees in the United States and provide the first empirical investigation of the link between interchange fees and granular deposit account prices. This link is broadly predicted by the theoretical literature on two-sided markets, but the nature and magnitude of price changes are key empirical issues. To examine the ways that banks adjusted their account prices in response to the regulatory cap on interchange fees, we exploit the cap's differential applicability across banks and account types, while accounting for equilibrium spillover effects on banks exempt from the cap. Our results show that banks subject to the cap raised checking account prices by decreasing the availability of free accounts, raising monthly fees, and increasing minimum balance requirements, with different adjustment across account types. We also find that banks exempt from the cap adjusted prices as a competitive response to price changes made by regulated banks. Not accounting for such competitive responses underestimates the policy's impact on the market, for both banks subject to the cap and those exempt from it.

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Keywords: Equilibrium effects, Financial supervision and regulation, Interchange fees, Retail banking and debit cards, Two-sided markets

DOI: https://doi.org/10.17016/FEDS.2017.074

FEDS 2017-073
How Effective is Monetary Policy at the Zero Lower Bound? Identification Through Industry Heterogeneity

Abstract: US monetary policy was constrained from 2008 to 2015 by the zero lower bound, during which the Federal Reserve would likely have lowered the federal funds rate further if it were able to. This paper uses industry-level data to examine how growth was affected. Despite the zero bound constraint, industries historically more sensitive to interest rates, such as construction, performed relatively well in comparison to industries not typically affected by monetary policy. Further evidence suggests that unconventional policy lowered the effective stance of policy below zero.

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Keywords: industry heterogeneity, unconventional monetary policy, zero lower bound

DOI: https://doi.org/10.17016/FEDS.2017.073

FEDS 2017-072
The Credit Card Act and Consumer Finance Company Lending

Gregory Elliehausen and Simona M. Hannon

Abstract: The Credit Card Accountability and Disclosure Act (CARD Act) of 2009 restricted several risk management practices of credit card issuers. Using a quasi-experimental design with credit bureau data on consumer lending, we find evidence consistent with the hypothesis that the act's restrictions on risk management practices contributed to a large decline in bank card holding by higher risk, nonprime consumers but had little effect on prime consumers. Looking at consumer finance loans, historically a source of credit for higher risk consumers, we find greater reliance on such loans by nonprime consumers in states with high consumer finance rate ceilings following the CARD Act than by nonprime consumers in states with low rate ceilings or by prime consumers. That nonprime consumers in states with high consumer finance rate ceilings relied more heavily on consumer finance loans suggests that consumer finance loans were a substitute for subprime credit cards for risky consum ers when rate ceilings permit such loans to be profitable. Consumer finance loans would not be available to many higher risk, nonprime consumers in low rate states because such loans would be unprofitable, and prime consumers would not need consumer finance loans because other, less expensive types of credit would generally be available to them.

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Keywords: CARD Act, consumer credit , credit cards, credit supply, household finance , personal loans, subprime credit

DOI: https://doi.org/10.17016/FEDS.2017.072

FEDS 2017-071
Racial Gaps in Labor Market Outcomes in the Last Four Decades and over the Business Cycle

Tomaz Cajner, Tyler Radler, David Ratner, and Ivan Vidangos

Abstract: We examine racial disparities in key labor market outcomes for men and women over the past four decades, with a special emphasis on their evolution over the business cycle. Blacks have substantially higher and more cyclical unemployment rates than whites, and observable characteristics can explain very little of this differential, which is importantly driven by a comparatively higher risk of job loss. In contrast, the Hispanic-white unemployment rate gap is comparatively small and is largely explained by lower educational attainment of (mostly foreign-born) Hispanics. Regarding labor force participation, the remarkably low participation rate of black men is largely unexplained by observables, is mostly driven by high labor force exit rates from employment, and has shown little improvement over the last 40 years. Furthermore, even among those who work, blacks and Hispanics are more likely than whites to work part-time schedules despite wanting to work additional hour s, and the racial gaps in this involuntary part-time employment are large even after controlling for observable characteristics. Our findings also suggest that the robust recovery of the labor market in the last few years has contributed significantly to reducing the gaps that had widened dramatically as a result of the Great Recession; however, the disparities remain substantial.

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Keywords: Business Cycle, Discrimination, Inequality, Labor Force Participation, Racial Disparities, Unemployment

DOI: https://doi.org/10.17016/FEDS.2017.071

FEDS 2017-070
Nonlinearities in the Phillips Curve for the United States: Evidence Using Metropolitan Data

Nathan R. Babb and Alan K. Detmeister

Abstract: With the unemployment rate in the United States currently below estimates of its natural rate we examine if the relationship between inflation and unemployment is nonlinear. Using aggregate data we are unable to reject a linear relationship. However, using metropolitan-level data we find the slope of the Phillips curve is roughly twice as large when unemployment is low compared to when it is high. Nevertheless the simple nonlinear Phillips curves used here suggest a core CPI inflation rate that is only slightly different than the linear version over the next couple of years.

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Keywords: Core CPI Prices, Grid Searching, Metropolitan Statistical Area data, Phillips Curve

DOI: https://doi.org/10.17016/FEDS.2017.070

FEDS 2017-069
Investment Commonality across Insurance Companies: Fire Sale Risk and Corporate Yield Spreads

Vikram Nanda, Wei Wu, and Xing Zhou

Abstract: Insurance companies often follow highly correlated investment strategies. As major investors in corporate bonds, their investment commonalities subject investors to fire-sale risk when regulatory restrictions prompt widespread divestment of a bond following a rating downgrade. Reflective of fire-sale risk, clustering of insurance companies in a bond has significant explanatory power for yield spreads, controlling for liquidity, credit risk and other factors. The effect of fire-sale risk on bond yield spreads is more evident for bonds held to a greater extent by capital-constrained insurance companies, those with ratings closer to NAIC risk-categories with larger capital requirements, and during the financial crisis.

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Keywords: capital constraints, corporate bonds, credit rating, fire sales, insurance companies, regulation, yield spread

DOI: https://doi.org/10.17016/FEDS.2017.069

FEDS 2017-068
How Large were the Effects of Emergency and Extended Benefits on Unemployment during the Great Recession and its Aftermath?

Abstract: This paper presents estimates of the effect of unemployment benefit extensions during the Great Recession on unemployment and labor force participation. Unlike many recent studies of this subject, our estimates, following the work of Hagedorn, Karahan, Manovskii, and Mitman (2016), are inclusive of the effects of benefit extensions on employer, as well as, worker behavior. To identify the effect of benefit extensions, we use plausibly exogenous changes in the rules governing benefit extensions and their differential effects on the maximum duration of benefits across states. We find that the effect of benefit extensions is likely modest, with a 90 percent confidence interval of the effect on the unemployment rate ranging from 0 to 1/2 percentage point.

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Keywords: Extended and Emergency Unemployment Benefits, Unemployment rate

DOI: https://doi.org/10.17016/FEDS.2017.068

FEDS 2017-067
Consumer Mistakes and Advertising: The Case of Mortgage Refinancing

Abstract: Does advertising help consumers to find the products they need or push them to buy products they don't need? In this paper, we study the effects of advertising on consumer mistakes and quantify the resulting effect on consumer welfare in the market for mortgage refinancing. Mortgage borrowers frequently make costly refinancing mistakes by either refinancing when they should wait, or by waiting when they should refinance. We assemble a novel data set that combines a borrower's exposure to direct mail refinance advertising and their subsequent refinancing decisions. Even though on average borrowers would lose approximately $500 by refinancing, the average monthly exposure of 0.23 refinancing advertisements reduces the expected net present value of mortgage payments on average by $13, because borrowers who should refinance are targeted by advertisers and more responsive to advertising. A counterfactual advertising policy that redirects all advertising to borrowers who shou ld refinance would increase the gain in borrower welfare to $45.

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Keywords: Advertising, Mistakes, Mortgage, Refinancing

DOI: https://doi.org/10.17016/FEDS.2017.067

FEDS 2017-066
Measuring International Uncertainty: the Case of Korea

Minchul Shin, Boyuan Zhang, Molin Zhong, and Dong Jin Lee

Abstract: We leverage a data rich environment to construct and study a measure of macroeconomic uncertainty for the Korean economy. We provide several stylized facts about uncertainty in Korea from 1991M10-2016M5. We compare and contrast this measure of uncertainty with two other popular uncertainty proxies, financial and policy uncertainty proxies, as well as the U.S. measure constructed by Jurado et. al. (2015).

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Keywords: Business cycle, Data rich environment, Korean economy, Stochastic volatility, Uncertainty

DOI: https://doi.org/10.17016/FEDS.2017.066

FEDS 2017-065
A Price-Differentiation Model of the Interbank Market and Its Application to a Financial Crisis

Abstract: Rate curves for overnight loans between bank pairs, as functions of loan values, can be used to infer valuation of reserves by banks. The inferred valuation can be used to interpret shifts in rate curves between bank pairs, for example, in response to a financial crisis. This paper proposes a model of lending by a small bank to a large monopolistic bank to generate a tractable rate curve. An explicit calibration procedure for model parameters is developed and applied to a dataset from Mexico around the 2008 financial crisis. During the crisis, relatively small banks were lending to large banks at lower rates than usual, and the calibration suggests that a broad decline in valuation of reserves is responsible for this outcome, rather than a general increase in the supply of lending or compositional effects.

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Keywords: Banking, Crisis, Interbank

DOI: https://doi.org/10.17016/FEDS.2017.065

FEDS 2017-064
Is the Rent Too High? Aggregate Implications of Local Land-Use Regulation

Abstract: Highly productive U.S. cities are characterized by high housing prices, low housing stock growth, and restrictive land-use regulations (e.g., San Francisco). While new residents would benefit from housing stock growth in cities with highly productive firms, existing residents justify strict local land-use regulations on the grounds of congestion and other costs of further development. This paper assesses the welfare implications of these local regulations for income, congestion, and urban sprawl within a general-equilibrium model with endogenous regulation. In the model, households choose from locations that vary exogenously by productivity and endogenously according to local externalities of congestion and sharing. Existing residents address these externalities by voting for regulations that limit local housing density. In equilibrium, these regulations bind and house prices compensate for differences across locations. Relative to the planner's optimum, the decentraliz ed model generates spatial misallocation whereby high-productivity locations are settled at too-low densities. The model admits a straightforward calibration based on observed population density, expenditure shares on consumption and local services, and local incomes. Welfare and output would be 1.4% and 2.1% higher, respectively, under the planner's allocation. Abolishing zoning regulations entirely would increase GDP by 6%, but lower welfare by 5.9% because of greater congestion.

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Keywords: General Equilibrium, House Prices, Housing Supply, Regulation, Urban, Rural, & Regional Economics

DOI: https://doi.org/10.17016/FEDS.2017.064

FEDS 2017-063
Macroeconomic implications of oil price fluctuations: a regime-switching framework for the euro area

Federic Holm-Hadulla and Kirstin Hubrich

Abstract: We investigate whether the response of the macro-economy to oil price shocks undergoes episodic changes. Employing a regime-switching vector autoregressive model we identify two regimes that are characterized by qualitatively different patterns in economic activity and inflation following oil price shocks in the euro area. In the 'normal regime', oil price shocks trigger only limited and short-lived adjustments in these variables. In the 'adverse regime', by contrast, oil price shocks are followed by sizeable and sustained macroeconomic fluctuations, with inflation and economic activity moving in the same direction as the oil price. The responses of inflation expectations and wage growth point to second-round effects as a potential driver of the dynamics characterizing the adverse regime. The systematic response of monetary policy works against such second-round effects in the 'adverse regime' but is insufficient to fully offset them. The model also delivers (conditiona l) probabilities for being (staying) in either regime, which may help interpret oil price fluctuations -- and inform deliberations on the adequate policy response -- in real-time.

Keywords: Regime Switching models, inflation, inflation expectations, oil prices, time-varying transition probabilities

DOI: https://doi.org/10.17016/FEDS.2017.063

FEDS 2017-062
Comparing Cross-Country Estimates of Lorenz Curves Using a Dirichlet Distribution Across Estimators and Datasets

Andrew C. Chang, Phillip Li, and Shawn M. Martin

Abstract: Chotikapanich and Griffiths (2002) introduced the Dirichlet distribution to the estimation of Lorenz curves. This distribution naturally accommodates the proportional nature of income share data and the dependence structure between the shares. Chotikapanich and Griffiths (2002) fit a family of five Lorenz curves to one year of Swedish and Brazilian income share data using unconstrained maximum likelihood and unconstrained non-linear least squares. We attempt to replicate the authors' results and extend their analyses using both constrained estimation techniques and five additional years of data. We successfully replicate a majority of the authors' results and find that some of their main qualitative conclusions also hold using our constrained estimators and additional data.

Accessible materials (.zip)

Keywords: Constrained Estimation, Dirichlet Distribution, Gini Coefficient, Income Distribution, Lorenz Curve, Replication, Share Data

DOI: https://doi.org/10.17016/FEDS.2017.062

FEDS 2017-061
Fiscal Policy and Aggregate Demand in the U.S. Before, During and Following the Great Recession

Abstract: We examine the effect of federal and subnational fiscal policy on aggregate demand in the U.S. by introducing the fiscal effect (FE) measure. FE can be decomposed into three components. Discretionary FE quantifies the effect of discretionary or legislated policy changes on aggregate demand. Cyclical FE captures the effect of the automatic stabilizers--changes in government taxes and spending arising from the business cycle. Residual FE measures the effect of all changes in government revenues and outlays which cannot be categorized as either discretionary or cyclical; for example, it captures the effect of the secular increase in entitlement program spending due to the aging of the population. We use FE to examine the contribution of fiscal policy to growth in real GDP over the course of the Great Recession and current expansion. We compare this contribution to the contributions to growth in aggregate demand made by fiscal policy over past business cycles. In doin g so, we highlight that the relatively strong support of government policy to GDP growth during the Great Recession was followed by a historically weak contribution over the course of the current expansion.

Accessible materials (.zip)

Keywords: Fiscal policy, Great Recession, Multipliers, Public debt and national budget, Public economics, Taxation, automatic stabilizers

DOI: https://doi.org/10.17016/FEDS.2017.061

FEDS 2017-060
Money-Financed Fiscal Programs: A Cautionary Tale

Abstract: A number of prominent economists and policymakers have argued that money-financed fiscal programs (helicopter drops) could be efficacious in boosting output and inflation in economies facing persistent economic weakness, very low inflation, and significant fiscal strains. We em-ploy a fairly conventional macroeconomic model to explore the possible effects of such policies. While we do find that money-financed fiscal programs, if communicated successfully and seen as credible by the public, could provide significant stimulus, we underscore the risks that would be associated with such a program. These risks include persistently high inflation if the central bank fully adhered to the program; or alternatively, that such a program would be ineffective in providing stimulus if the public doubted the central bank’s commitment to such an extreme strategy. We also highlight how more limited forms of monetary and fiscal cooperation -- such as a promise by the central ba nk to be more accommodative than usual in response to fiscal stimulus -- may be more credible and easier to communicate, and ultimately more effective in providing economic stimulus.

Keywords: DSGE Model, Fiscal policy, Liquidity Trap, Monetary policy

DOI: https://doi.org/10.17016/FEDS.2017.060

FEDS 2017-059
Measuring the Natural Rate of Interest: A Note on Transitory Shocks

Abstract: We present evidence that the natural rate of interest is buffeted by both permanent and transitory shocks. We establish this result by estimating a benchmark model with Bayesian methods and loose priors on the unobserved drivers of the natural rate. When subject to transitory shocks, the median estimate for the U.S. economy is more procyclical, displays a less marked secular decline, and is therefore higher following the Great Recession than most estimates in the literature.

Accessible materials (.zip)
Original paper: PDF | Accessible materials (.zip)

Keywords: natural rate of interest, monetary policy, Kalman filter, pileup, trend growth

DOI: https://doi.org/10.17016/FEDS.2017.059r1

FEDS 2017-058
Macro Risks and the Term Structure of Interest Rates

Geert Bekaert, Eric Engstrom, and Andrey Ermolov

Abstract: We use non-Gaussian features in U.S. macroeconomic data to identify aggregate supply and demand shocks while imposing minimal economic assumptions. Recessions in the 1970s and 1980s were driven primarily by supply shocks, later recessions were driven primarily by demand shocks, and the Great Recession exhibited large negative shocks to both demand and supply. We estimate "macro risk factors" that drive "bad" (negatively skewed) and "good" (positively skewed) variation for supply and demand shocks. The Great Moderation is mostly accounted for by a reduction in good variance. In contrast, bad variances for both supply and demand shocks, which account for most recessions, shows no secular decline. We document that macro risks significantly contribute to the variation yields, risk premiums and return variances for nominal bonds. While overall bond risk premiums are counter-cyclical, an increase in demand variance lowers risk premiums.

Accessible materials (.zip)

Keywords: bond return predictability, business cycle, great moderation, macroeconomic volatility, term premium

DOI: https://doi.org/10.17016/FEDS.2017.058

FEDS 2017-057
A Collateral Theory of Endogenous Debt Maturity

R. Matthew Darst and Ehraz Refayet

Abstract: This paper studies optimal debt maturity when firms cannot issue state contingent claims and must back promises with collateral. We establish a trade-off between long-term borrowing costs and short-term rollover costs. Issuing both long- and short-term debt balances financing costs because different debt maturities allow firms to cater risky promises across time to investors most willing to hold risk. Contrary to existing theories predicated on information frictions or liquidity risk, we show that collateral is sufficient to explain the joint issuance of different types of debt: safe "money-like" debt, risky short- and long-term debt. The model predicts that borrowing costs are lowest, leading to more leverage and production, when firms issue multiple debt maturities. Lastly, we show that "hard" secured debt covenants are redundant when collateral is scarce because they act as perfect substitutes for short-term debt.

Revised Paper: Accessible materials (.zip)

Original Paper: PDFAccessible materials (.zip)

Keywords: collateral, debt maturity, investment, cost of capital, debt covenants

DOI: https://doi.org/10.17016/FEDS.2017.057r1

FEDS 2017-056
Safe Collateral, Arm's-Length Credit: Evidence from the Commercial Real Estate Mortgage Market

Lamont Black, John Krainer, and Joseph Nichols

Abstract: When collateral is safe, there are fewer opportunities for lenders to suffer economic losses. We develop a model to show how risky and safe collateral naturally pair with different types of lenders according to how informed the lenders are in states where borrowers are in financial distress. Our application is to the commercial real estate mortgage market where we compare loans funded by commercial mortgage-backed securities (CMBS) to bank loans. We model CMBS investors as lower cost providers of funding, but less informed, and vice-versa for banks. This leads to a separating equilibrium where only safe collateral is funded by CMBS and risky collateral is funded by bank lenders. This prediction is tested using the 2007-2009 shutdown of the CMBS market as a natural experiment, where suddenly collateral usually funded with CMBS were instead financed with bank loans. Our results show that loans with CMBS-like qualities that were "counterfactually" funded by banks were less likely to default or be renegotiated. We conclude that the securitization channel in this market, when available, funds safer collateral.

Accessible materials (.zip)

Keywords: collateral, securitization, commercial banking, commercial real estate

DOI: https://doi.org/10.17016/FEDS.2017.056

FEDS 2017-055
The Role of Transfer Prices in Profit-Shifting by U.S. Multinational Firms: Evidence from the 2004 Homeland Investment Act

Abstract: Using unique transaction-level microdata, this paper documents profit-shifting behavior by U.S. multinational firms via the strategic transfer pricing of intra-firm trade. A simple model reveals how differences in tax rates, both the corporate tax rates across countries and the dividend repatriation tax rate over time, affect the worldwide profit-maximizing transfer-prices set by firms for intra-firm exports and imports. I test the predictions of the model in the context of the 2004 Homeland Investment Act (HIA), a one-time tax repatriation holiday which generated a discreet change in the incentives for U.S. firms to shift profits to low-tax jurisdictions. Matching individual trade transactions by firm, product, country, mode-of-transport, and month across arms-length and related-party transactions (following Bernard, Jensen, and Schott (2006)) yields a measure of the transfer-price wedge at a point in time. A difference-in-difference strategy reveals that this wedge responds as predicted by the model: In the period following passage of the HIA, the export transfer price wedge increased in low-tax relative to high-tax countries, while the import transfer price wedge exhibited the opposite behavior. Consistent with the form of tax avoidance known as "round-tripping, the results imply $6 billion USD of under-reported U.S. exports, nearly $7 billion USD of over-reported U.S. imports, and roughly $2 billion USD in foregone U.S. corporate tax receipts.

Accessible materials (.zip)

Keywords: Corporate Taxes, Intra-firm Trade, Multinational firms, Profit-Shifting, Transfer Prices

DOI: https://doi.org/10.17016/FEDS.2017.055

FEDS 2017-054
Bank Fees, Aftermarkets, and Consumer Behavior

Abstract: Fees for banking services have been a policy concern for over 20 years and the subject of several government agencies studies, which focused on the magnitude, incidence, or disclosure of such fees. Using a sample of single market banks, I study the relationship between market-level consumer characteristics and bank fee revenue, fees, and bank return on assets (ROA) to infer consumer and firm behavior. Of particular interest, I use county-level IRS tax records as a measure of the consumer income distribution, but my analysis also includes measures of age and education distributions. I find very little evidence that banks are systematically charging higher aftermarket fees in counties with greater proportions of younger, less educated, or poorer households. Standard measures of competition such as the Herfindahl-Hirschmann Index of deposit concentration are correlated with fees for base checking accounts, but not correlated with aftermarket product fees. Finally, state-wide restrictions on payday lending are correlated with higher bank fees, but not with increased bank revenue or ROA.

Accessible materials (.zip)

Keywords: Aftermarkets, banking, competition, overdraft fees

DOI: https://doi.org/10.17016/FEDS.2017.054

FEDS 2017-053
Capital taxation with heterogeneous discounting and collateralized borrowing

Nina Biljanovska and Alexandros P. Vardoulakis

Abstract: We study optimal long-run capital taxation in a closed economy with heterogeneity in agents' time-discount factors where borrowing is allowed but restricted by a collateral constraint. Financial frictions distort intertemporal optimization margins and the tax system serves a dual role: first, it is used to finance government consumption; second, it serves to alleviate the distortions arising from the binding collateral constraint. The discrepancy between the private and the social discount factors pushes for a subsidy on capital, while the discrepancy introduced by the collateral constraint pushes for a tax in the long-run. When consumption smoothing motives are muted, the two effects counter-balance each other and the tax is zero. With finite elasticity of intertemporal substitution, the second discrepancy dominates and the tax on capital income is positive in the long-run.

Accessible materials (.zip)

Keywords: Ramsey taxation, collateral constraint, heterogeneous discount factors, tax on capital

DOI: https://doi.org/10.17016/FEDS.2017.053

FEDS 2017-052
Take it to the Limit: The Debt Ceiling and Treasury Yields

Abstract: We use the 2011 and 2013 U.S. debt limit impasses to examine the extent to which investors react to a heightened possibility of financial contagion. To do so, we first model the response of yields on government debt to a potential debt limit "breach." We then demonstrate empirically that yields on all Treasuries rose by 4 to 8 basis points during both impasses, while excess yields on bills at risk of delayed principal payments were significantly larger in 2013. Perhaps counterintuitively, our model suggests market participants placed a lower probability on financial contagion resulting from a breach in 2013.

Accessible materials (.zip)

Keywords: Debt Limit, Financial contagion, Political uncertainty, Treasury Yields

DOI: https://doi.org/10.17016/FEDS.2017.052

FEDS 2017-051
GDP Trend-cycle Decompositions Using State-level Data

Abstract: This paper develops a method for decomposing GDP into trend and cycle exploiting the cross-sectional variation of state-level real GDP and unemployment rate data. The model assumes that there are common output and unemployment rate trend and cycle components, and that each state's output and unemployment rate are subject to idiosyncratic trend and cycle perturbations. The model is estimated with Bayesian methods using quarterly data from 2005:Q1 to 2016:Q1 for the 50 states and the District of Columbia. Results show that the U.S. output gap reached about -8% during the Great Recession and is about 0.6% in 2016:Q1.

Accessible materials (.zip)

Keywords: Unobserved components model, state-level GDP data, trend-cycle decomposition

DOI: https://doi.org/10.17016/FEDS.2017.051

FEDS 2017-050
The Decline in Asset return Predictability and Macroeconomic Volatility

Alex Hsu, Francisco Palomino, and Charles Qian

Abstract: We document strong U.S. stock and bond return predictability from several macroeconomic volatility series before 1982, and a significant decline in this predictability during the Great Moderation. These findings are robust to alternative empirical specifications and out-of-sample tests. We explore the predictability decline using a model that incorporates monetary policy and shocks with time-varying volatility. The decline is consistent with changes in both policy and shock dynamics. While an increase in the response to inflation in the interest-rate policy rule decreases volatility, more persistent and less volatile shocks explain the lower predictability.

Accessible materials (.zip)

Keywords: Asset return predictability, Great Moderation, Monetary policy, Time-varying macroeconomic volatility

DOI: https://doi.org/10.17016/FEDS.2017.050

FEDS 2017-049
Borrowers in Search of Feedback: Evidence from Consumer Credit Markets

Inessa Liskovich and Maya Shaton

Abstract: We study recent technological innovation in credit markets and document their role in providing information to households. We show that households value the ability to learn detailed information about their cost of credit. This function is most valued by less creditworthy households with less experience in credit markets. To measure the demand for information provision we exploit a quasi-natural experiment in an online consumer credit market. A large lending platform unexpectedly switched from pricing loans through an auction mechanism to centralized pricing determined by broad credit grade. This change resulted in an instant decrease in the amount of tailored feedback available to market participants. We find that less experienced households immediately and disproportionately exit the market and the response is concentrated among higher risk households. We rule out alternative explanations such as changes in access to credit, borrower risk profiles, and interest rate l evels. Our findings point to a potentially important role for financial innovation: enabling less experienced households to more easily learn about their credit market options.

Accessible materials (.zip)

Keywords: Consumer finance, Fintech, Household Finance, Online lending markets

DOI: https://doi.org/10.17016/FEDS.2017.049

FEDS 2017-048
Pipeline Risk in Leveraged Loan Syndication

Max Bruche, Frederic Malherbe, and Ralf R. Meisenzahl

Abstract: Leveraged term loans are typically arranged by banks but distributed to institutional investors. Using novel data, we find that to elicit investors' willingness to pay, arrangers expose themselves to pipeline risk: They have to retain larger shares when investors are willing to pay less than expected. We argue that the retention of such problematic loans creates a debt overhang problem. Consistent with this, we find that the materialization of pipeline risk for an arranger reduces its subsequent arranging and lending activity. Aggregate time series exhibit a similar pattern, which suggests that the informational friction we identify could amplify the credit cycle.

Accessible materials (.zip)

Keywords: Debt Overhang, Lead Arranger Share, Leveraged Loans, Pipeline Risk, Syndicated Loans

DOI: https://doi.org/10.17016/FEDS.2017.048

FEDS 2017-047
The Cyclical Behavior of Unemployment and Wages under Information Frictions

Abstract: I propose a new mechanism for sluggish wages based on workers' noisy information about the state of the economy. Wages do not respond immediately to a positive aggregate shock because workers do not (yet) have enough information to demand higher wages. This increases firms' incentives to post more vacancies, which makes unemployment volatile and sensitive to aggregate shocks. The model is robust to two major criticisms of existing theories of sluggish wages and volatile unemployment: flexibility of wages for new hires and pro-cyclicality of the opportunity cost of employment. Calibrated to U.S. data, the model explains 70% of unemployment volatility.

Accessible materials (.zip)

Keywords: Information Frictions, Unemployment, Wages and compensation

DOI: https://doi.org/10.17016/FEDS.2017.047

FEDS 2017-046
Understanding survey based inflation expectations

Abstract: Survey based measures of inflation expectations are not informationally efficient yet carry important information about future inflation. This paper explores the economic significance of informational inefficiencies of survey expectations. A model selection algorithm is applied to the inflation expectations of households and professionals using a large panel of macroeconomic data. The expectations of professionals are best described by different indicators than the expectations of households. A forecast experiment finds that it is difficult to exploit informational inefficiencies to improve inflation forecasts, suggesting that the economic cost of the surveys' deviation from rationality is not large.

Accessible materials (.zip)

Keywords: Informational efficiency, Phillips curve, Survey based inflation expectations, boosting, inflation forecasting, machine learning

DOI: https://doi.org/10.17016/FEDS.2017.046

FEDS 2017-045
Measuring Transaction Costs in the Absence of Timestamps

Abstract: This paper develops measures of transaction costs in the absence of transaction timestamps and information about who initiates transactions, which are data limitations that often arise in studies of over-the-counter markets. I propose new measures of the effective spread and study the performance of all estimators analytically, in simulations, and present an empirical illustration with small-cap stocks for the 2005-2014 period. My theoretical, simulation, and empirical results provide new insights into measuring transaction costs and may help guide future empirical work.

Accessible materials (.zip)

Keywords: Effective spread, simulated method of moments, time-varying estimation, transaction costs

DOI: https://doi.org/10.17016/FEDS.2017.045

FEDS 2017-044
Hysteresis via Endogenous Rigidity in Wages and Participation

Abstract: We document that the past three "jobless" recoveries also featured asymmetries in labor force participation and labor compensation, with each falling to new lows during each cycle. We model these asymmetries as resulting from a strategic complementarity in firms' wage setting and workers' job search strategies. Strategic complementarity results in a continuum of possible equilibria with higher-wage equilibria welfare dominating lower-wage equilibria. Assuming that no economic agent deviates from an existing strategy unless deviation is a unilateral best response, the model exhibits (1) periods of endogenous rigidity in wages and participation, (2) persistent changes in wages, participation, and output in response to transitory movements in labor productivity, (3) sluggish recoveries including both a ``jobless'' phase, in which productivity recovers while unemployment remains elevated, and a "wageless" phase, in which employment recovers but wages remain depressed. Calibrating the model suggests that the U.S. unemployment rate may need to fall to as low as 2.8 percent before labor compensation recovers to pre-Financial Crisis levels.

Accessible materials (.zip)
Original paper: PDF | Accessible materials (.zip)

Keywords: Hysteresis, Jobless Recovery, Kinked Labor Supply, Real Rigidity, Strategic Complementarity , Wageless Recovery

DOI: https://doi.org/10.17016/FEDS.2017.044r1

FEDS 2017-043
The Display of Information and Household Investment Behavior

Abstract: I exploit a natural experiment to show that household investment decisions depend on the manner in which information is displayed. Israeli retirement funds were prohibited from displaying returns for periods shorter than twelve months. In this setting, the information displayed was altered but the accessible information remained the same. Using differences-in-differences design, I find that this change caused reduction in fund flow sensitivity to past returns, decline in trade volume, and increased asset allocation toward riskier funds. These results are consistent with models of limited attention and myopic loss aversion, and have important implications for households accumulated wealth at retirement.

Accessible materials (.zip)

Keywords: Attention, Household Finance, Information Display, Myopic Loss Aversion, Salience

DOI: https://doi.org/10.17016/FEDS.2017.043

FEDS 2017-042
Divest, Disregard, or Double Down?

Abstract: How much, if at all, should an endowment invest in a firm whose activities run counter to the charitable missions the endowment funds? Endowments typically disregard the objectionable nature of or divest from such firms. However, if firm returns increase with activities the endowment combats, doubling down on the investment increases expected utility by aligning funding availability with need. I call this "mission hedging." This paper offers the first model that characterizes the endowment's investment decision on the objectionable firm, defines investment trade-offs, and examines related evidence. Bad actors provide good opportunities to hedge mission-specific risks.

Accessible Materials (.zip)

Keywords: Socially responsible investing, divestment, endowment, foundation, philanthropy, portfolio, universities and colleges

DOI: https://doi.org/10.17016/FEDS.2017.042

FEDS 2017-041
Private Money Creation with Safe Assets and Term Premia

Abstract: It has been documented that an increase in the demand for safe assets induces the private sector to create more money-like claims. Focusing on private repos backed by U.S. Treasury securities, I show that an increase in the demand for safe assets leads to a decreases in the issuance of Treasury repos. The intuition is that Treasury securities already function as a safe asset, thus in terms of safe asset creation, private Treasury repos are neutral. In the model, Treasury repos are beneficial because they shift risk (i.e. term premia) from relatively risk averse households to a more risk tolerant financial sector, which issues repos to finance its portfolio. When the demand for safe assets increases, Treasury securities are reallocated to households, reducing the amount of Treasury repo issued by the financial sector. By contrast, Treasury repos created by the Federal Reserve's RRP program--a safe asset created by the public sector--increase with the demand for safe as sets. I show the data supports the model's main predictions.

Accessible materials (.zip)

Keywords: Federal Reserve Board and Federal Reserve System, Monetary policy, Private money, Repo, Safe assets

DOI: https://doi.org/10.17016/FEDS.2017.041

FEDS 2017-040
Employment Dynamics in a Signaling Model with Workers' Incentives

Abstract: Many firms adjust employment in a "lumpy'' manner -- infrequently and in large bursts. In this paper, I show that lumpy adjustments can arise from concerns about the incentives of remaining workers. Specifically, I develop a model in which a firm's productivity depends on its workers' effort and workers' income prospects depend on the firm's profitability. I use this model to analyze the consequences of demand shocks that are observed by the firm but not by its workers, who can only try to infer the firm's profitability from its employment decisions. I show that the resulting signaling model has pooling equilibria in which, for small negative shocks, the firm bears the costs of some labor hoarding in order to conceal negative information from workers and thus maintain their incentives for effort. However, if negative shocks accumulate then labor hoarding becomes too costly; at that point the firm drastically reduces employment.

Accessible materials (.zip)

Keywords: Asymmetric information, Displacement, Downsizing, Labor demand, Layoffs, Moral hazard, Signaling

DOI: https://doi.org/10.17016/FEDS.2017.040

FEDS 2017-039
Commodity prices and labour market dynamics in small open economies

Martin Bodenstein, Gunes Kamber, and Christoph Thoenissen

Abstract: We investigate the connection between commodity price shocks and unemployment in advanced resource-rich small open economies from an empirical and theoretical perspective. Shocks to commodity prices are shown to influence labour market conditions primarily through the real exchange rate. The empirical impact of commodity price shocks is obtained from estimating a panel vector autoregression; a positive price shock is found to expand the components of GDP, to cause the real exchange rate to appreciate, and to improve labour market conditions. For every one percent increase in commodity prices, our estimates suggest a one basis point decline in the unemployment rate and at its peak a 0.3% increase in unfilled vacancies. We then match the impulse responses to a commodity price shock from a small open economy model with net commodity exports and search and matching frictions in the labour market to these empirical responses. As in the data, an increase in commodity prices raises consumption demand in the small open economy and induces a real appreciation. Facing higher relative prices for their goods, non-commodity producing firms post additional job vacancies, causing the number of matches between firms and workers to rise. As a result, unemployment falls, even if employment in the commodity-producing sector is negligible. For commodity price shocks, there is little difference between the standard Diamond (1982), Mortensen (1982), and Pissarides (1985) approach of modelling search and matching frictions and the alternating offer bargaining model suggested by Hall (2008).

Accessible materials (.zip)

Keywords: commodity prices, search and matching, unemployment

DOI: https://doi.org/10.17016/FEDS.2017.039

FEDS 2017-038
The Effect of Central Bank Liquidity Injections on Bank Credit Supply

Luisa Carpinelli and Matteo Crosignani

Abstract: We study the effectiveness of central bank liquidity injections in restoring bank credit supply following a wholesale funding dry-up. We combine borrower-level data from the Italian credit registry with bank security-level holdings and analyze the transmission of the European Central Bank three-year Long Term Refinancing Operation. Exploiting a regulatory change that expands eligible collateral, we show that banks more affected by the dry-up use this facility to restore their credit supply, while less affected banks use it to increase their holdings of high-yield government bonds. Unable to switch from affected banks during the dry-up, firms benefit from the intervention.

Accessible materials (.zip)

Keywords: Bank Credit Supply, Bank Wholesale Funding, Lender of Last Resort, Unconventional Monetary Policy

DOI: https://doi.org/10.17016/FEDS.2017.038

FEDS 2017-037
Monetary Policy and the Predictability of Nominal Exchange Rates

Martin Eichenbaum, Benjamin K. Johannsen, and Sergio Rebelo

Abstract: This paper documents two facts about countries with floating exchange rates where monetary policy controls inflation using a short-term interest rate. First, the current real exchange rate predicts future changes in the nominal exchange rate at horizons greater than two years both in sample and out of sample. This predictability improves with the length of the horizon. Second, the real exchange rate is virtually uncorrelated with future inflation rates both in the short run and in the long run. We show that a large class of open-economy models is consistent with these findings and that, empirically and theoretically, the ability of the real exchange rate to forecast changes in the nominal exchange rate depends critically on the nature of the monetary regime.

Accessible materials (.zip)

Original paper: PDF | Accessible materials (.zip)

Keywords: Exchange rates and foreign exchange, Monetary policy

DOI: https://doi.org/10.17016/FEDS.2017.037r1

FEDS 2017-036
Reputation and Investor Activism

Travis L. Johnson and Nathan Swem

Abstract: We show that an activist's reputation is a critical determinant of the success of their campaigns. We model reputation as target managers' belief about the activist's willingness to initiate a proxy fight. Our model indicates reputation, rather than stake size, induces managers to settle without a proxy fight. We present empirical evidence supporting our model's predictions: target companies more-frequently increase payouts, change management or board composition, engage in a merger or acquisition, or otherwise reorganize in response to high reputation activist campaigns, while target actions are not sensitive to the activist's stake size.

Accessible materials (.zip)

Keywords: Corporate Governance, Hedge Funds, Investor Activism, Reputation

DOI: https://doi.org/10.17016/FEDS.2017.036

FEDS 2017-035
The Household Expenditure Response to a Consumption Tax Rate Increase

Abstract: This study measures the effect of an increase in Japan's Value Added Tax rate on the timing of household expenditures and consumption, which do not necessarily coincide. The analysis finds that durable and storable expenditures surged in the month prior to the tax rate increase, fell sharply upon implementation, but quickly returned to their previous long-run levels. Non-storable non-durable expenditures increased slightly in the month prior to the tax rate increase, but were otherwise unresponsive. A dynamic structural model of household consumption reveals that the observed expenditure responses were driven by stockpiling behavior, the insensitivity of durable and non-durable consumption to a change in the real interest rate, and strong complementarities between durables and non-durables. The results suggest that salient intertemporal price variation may have a large, though highly transitory impact on household expenditures.

Accessible materials (.zip)

Keywords: Consumption, Fiscal policy, Intertemporal substitution, VAT

DOI: https://doi.org/10.17016/FEDS.2017.035

FEDS 2017-034
An Empirical Economic Assessment of the Costs and Benefits of Bank Capital in the US

Simon Firestone, Amy Lorenc and Ben Ranish

Abstract: We show that trade frictions in OTC markets result in inefficient private liquidity provision. We develop a dynamic model of market-based financial intermediation with a two-way interaction between primary credit markets and secondary OTC markets. Private allocations are generically inefficient because investors and firms fail to internalize how their actions affect liquidity in secondary markets. This inefficiency can lead to liquidity that is suboptimally low or high compared to the second best. Our analysis provides a rationale for the regulation and public provision of liquidity and the effect of quantitative easing or tightening on capital markets and investment.

Accessible materials (.zip)

Keywords: banking, capital, cost benefit

DOI: https://doi.org/10.17016/FEDS.2017.034

FEDS 2017-033
Private and Public Liquidity Provision in Over-the-Counter Markets

Abstract: We show that trade frictions in OTC markets result in inefficient private liquidity provision. We develop a dynamic model of market-based financial intermediation with a two-way interaction between primary credit markets and secondary OTC markets. Private allocations are generically inefficient because investors and firms fail to internalize how their actions affect liquidity in secondary markets. This inefficiency can lead to liquidity that is suboptimally low or high compared to the second best. Our analysis provides a rationale for the regulation and public provision of liquidity and the effect of quantitative easing or tightening on capital markets and investment.

Accessible materials (.zip)

Keywords: Liquidity provision, OTC, market liquidity, monetary policy normalization, over-the-counter markets, quantitative easing, quantitative tightening

DOI: https://doi.org/10.17016/FEDS.2017.033

FEDS 2017-032
On Intergenerational Immobility: Evidence that Adult Credit Health Reflects the Childhood Environment

Abstract: Using a novel dataset that links socioeconomic background to future credit, postsecondary education, and federal student loan and grant records, we document that, even though it is not and cannot be used by credit agencies in assigning risk, background is a strong predictor of adult credit health. A relationship remains upon inclusion of achievement, attainment, and debt management metrics. These findings reveal a new dimension along which childhood circumstances persist into adulthood and imply that the many important contexts in which credit scores are relied upon to evaluate individuals (e.g., lending, insurance, employment) may be helping to preserve inherited inequities.

Accessible materials (.zip)

Original paper: PDF | Accessible materials (.zip)

Keywords: Credit Health, Credit Scores, Intergenerational Immobility, Socioeconomic Status, Student Loans

DOI: https://doi.org/10.17016/FEDS.2017.032r1

FEDS 2017-031
Are Central Cities Poor and Non-White?

Abstract: For much of the 20th century, America's central cities were viewed as synonymous with economic and social hardship, often used as proxy for low-income communities of color. Since the 1990s, however, many metropolitan areas have seen a resurgence of interest in central city neighborhoods. Theoretical models of income sorting lead to ambiguous predictions about where households of different income levels will live within metropolitan areas. In this paper, we explore intra-city spatial patterns of income and race for U.S. metropolitan areas, focusing particularly on the locations of low-income and minority neighborhoods. Results indicate that, on average, income and white population shares increase with distance to city centers. However, many centrally located neighborhoods are neither low-income nor majority non-white, while low-income and minority neighborhoods are spatially dispersed across most metropolitan areas.

Accessible materials (.zip)

Keywords: Community development, Demographic economics, Income sorting, Neighborhood choice, Racial segregation, Urban spatial structure, Urban, rural and regional economics

DOI: https://doi.org/10.17016/FEDS.2017.031

FEDS 2017-030
How Would US Banks Fare in a Negative Interest Rate Environment?

Abstract: This paper uses a unique new data set to empirically examine bank-level expectations regarding the impact of negative short-term interest rates on bank profitability through net interest margins. The results show that banks differ significantly in their views regarding how profits might be affected in a negative interest rate environment and that much of this heterogeneity can be explained by cross-bank differences in the provision of liquidity services. We find that those banks that are more active in providing liquidity to borrowers anticipate suffering reduced profitability through declines in interest income on short-duration assets. The opposite is true of banks that are more active in providing liquidity to depositors as these banks expect to benefit form lower short-term funding costs. However, we find that these distributional effects wash out at the aggregate level, as liquidity provision is sufficiently well diversified across all banks.

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Keywords: Banking conditions, net interest margins, unconventional monetary policy

DOI: https://doi.org/10.17016/FEDS.2017.030

FEDS 2017-029
Estimating the Competitive Effects of Common Ownership

Abstract: If managers maximize the payoffs of their shareholders rather than firm profits, then it may be anticompetitive for a shareholder to own competing firms. This is because a manager's objective function may place weight on profits of competitors who are held by the same shareholder. Recent research found evidence that common ownership by diversified institutional investors is anticompetitive by showing that prices in the airline and banking industries are related to generalized versions of the Herfindahl-Hirschman Index (HHI) that account for common ownership. In this paper we propose an alternative approach to estimating the competitive effects of common ownership that relates prices and quantities directly to the weights that such managers may be placing on the profits of their rivals. We argue that this approach has several advantages. First, the approach does not inherit the endogeneity problems of HHI regressions, which arise because HHI measures are functions of quantities. Second, because we treat quantities as outcomes we can look for competitive effects of common ownership on both prices and quantities. Third, while concentration measures vary only at the market-time level, the profit weights also vary at the firm level, which allows us to control for a richer set of unobservables. We apply this approach to data from the banking industry. Our empirical findings are mixed, though they're preliminary as we investigate irregularities in ownership data (Anderson and Brockman (2016)). The sign of the estimated effect is sensitive to the specification. Economically, estimated effects on prices and quantities are fairly small.

Accessible materials (.zip)

Original Paper: Full paper (PDF) | Accessible materials (.zip)

Original Paper DOI: https://doi.org/10.17016/FEDS.2017.029

Keywords: Common Ownership, Bank Competition

DOI: https://doi.org/10.17016/FEDS.2017.029r1

FEDS 2017-028
The Skewness of the Price Change Distribution: A New Touchstone for Sticky Price Models

Shaowen Luo and Daniel Villar

Abstract: We present a new way of empirically evaluating various sticky price models used to assess the degree of monetary non-neutrality. While menu cost models uniformly predict that price change skewness and dispersion fall with inflation, in the Calvo model both rise. However, CPI price data from the late 1970's onwards shows that skewness does not fall with inflation, while dispersion does. We develop a random menu cost model that, with a menu cost distribution that has a strong Calvo feature, can match the empirical patterns found. The model therefore exhibits much more monetary non-neutrality than existing menu cost models.

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Keywords: Inflation, Monetary policy, Prices, business fluctuations, and cycles

DOI: https://doi.org/10.17016/FEDS.2017.028

FEDS 2017-027
Looking Inside the Magic 8 Ball: An Analysis of Sales Forecasts using Italian Firm-Level Data

Abstract: This paper explores firm forecasting strategies. Using Italian data, we focus on two aspects of the forecasting process: how firms forecast sales and how accurate their predictions are. We relate both outcomes to current conditions, firm experience, global factors, and other firm characteristics. We find that current conditions tend to explain most of the variability in the sales forecast. While past projection errors tend to account for cross-firm differences in models of expectation formation, they are a key explanatory variable in models of forecast accuracy. Among other controls, firm size, experience, and global conditions--through the effect of price changes that the firm anticipates--shape firm expectations and influence the projection errors. Our findings suggest that models of sales expectations should take firm characteristics and market heterogeneity into account.

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Keywords: Exporting, Forecast Accuracy, Sales Forecasting

DOI: https://doi.org/10.17016/FEDS.2017.027

FEDS 2017-026
The Transmission of Monetary Policy through Bank Lending: The Floating Rate Channel

Filippo Ippolito, Ali K. Ozdagliy, and Ander Perez-Orive

Abstract: We examine both theoretically and empirically a mechanism through which outstanding bank loans affect the firm balance sheet channel of monetary policy transmission. Unlike other debt, most bank loans have floating rates mechanically tied to monetary policy rates. Hence, monetary policy-induced changes to floating rates affect the liquidity, balance sheet strength, and investment of financially constrained firms that use bank debt. We show that firms-especially financially constrained firms-with more unhedged bank debt display a stronger sensitivity of their stock price, cash holdings, sales, inventory, and fixed capital investment to monetary policy. This effect disappears when policy rates are at the zero lower bound, which further supports the floating rate mechanism and reveals a new limitation of unconventional monetary policy. We argue that the floating rate channel can have a significant macroeconomic effect due to the large size of the aggregate stock of unhedged floating-rate business debt, an effect that is at least as important as the bank lending channel that operates through new loans.

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Keywords: monetary policy transmission, firm balance sheet channel, bank debt, floating inter- est rates, financial constraints, hedging

DOI: https://doi.org/10.17016/FEDS.2017.026

FEDS 2017-025
Precautionary On-the-Job Search over the Business Cycle

Hie Joo Ahn and Ling Shao

Abstract: This paper provides new evidence for cyclicality in the job-search effort of employed workers, on-the-job search (OJS) intensity, in the United States using American Time Use Survey and various cyclical indicators. We find that OJS intensity is countercyclical along both the extensive and intensive margins, with the countercyclicality of extensive margin stronger than the other. An increase in the layoffs rate and the deterioration in expectations about future personal financial situation are the primary factors that raise OJS intensity. Our findings suggest that the precautionary motive in the job search is a crucial driver of the countercyclicality in OJS intensity.

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Keywords: On-the-job search, business cycles, labor flows, time use

DOI: https://doi.org/10.17016/FEDS.2017.025

FEDS 2017-024
A Likelihood-Based Comparison of Macro Asset Pricing Models

Andrew Y. Chen, Rebecca Wasyk, and Fabian Winkler

Abstract: We estimate asset pricing models with multiple risks: long-run growth, long-run volatility, habit, and a residual. The Bayesian estimation accounts for the entire likelihood of consumption, dividends, and the price-dividend ratio. We find that the residual represents at least 80% of the variance of the price-dividend ratio. Moreover, the residual tracks most recognizable features of stock market history such as the 1990's boom and bust. Long run risks and habit contribute primarily in crises. The dominance of the residual comes from the low correlation between asset prices and consumption growth moments. We discuss theories which are consistent with our results.

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Keywords: Bayesian Estimation, Equity Premium Puzzle, Excess Volatility, Habit, Long run risks, Particle Filter, Rare Disasters

DOI: https://doi.org/10.17016/FEDS.2017.024

FEDS 2017-023
Information in Financial Markets: Who Gets It First?

Abstract: I compare the timing of information acquisition among institutional investors and sell-side analysts, and I show that hedge fund trades predict the direction of subsequent analyst ratings change reports while other investors' trades do not. In addition, hedge funds reverse trades after analyst reports, while other investors follow the analysts. Finally, I show that hedge funds perform best among stocks with high analyst coverage. These results suggest that hedge funds have superior information acquisition skills, and that analysts assist hedge funds in exploiting information acquisition advantages. These dynamics illustrate how hedge funds play an important role in information generation.

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Keywords: Analysts, Hedge Funds, Information, Mutual Funds

DOI: https://doi.org/10.17016/FEDS.2017.023

FEDS 2017-022
Going Entrepreneurial? IPOs and New Firm Creation

Tania Babina, Paige Ouimet, and Rebecca Zarutskie

Abstract: Using matched employee-employer US Census data, we examine the effect of a successful initial public offering (IPO) on employee departures to startups. Accounting for the endogeneity of a firm's choice to go public, we find strong evidence that going public induces employees to leave for start-ups. Moreover, we document that the increase in turnover following an IPO is driven by employees departing to start-ups; we find no change in the rate of employee departures for established firms. We present evidence that, following an IPO, many employees who received stock grants experience a positive shock to their wealth which allows them to better tolerate the risks associated with joining a startup or to obtain funding. Our results suggest that the recent declines in IPO activity and new firm creation in the US may be causally linked. The recent decline in IPOs means fewer workers may move to startups, decreasing overall new firm creation in the economy.

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Keywords: Entrepreneurship, Initial Public Offerings, New Firms, Wealth

DOI: https://doi.org/10.17016/FEDS.2017.022

FEDS 2017-021
Are Basel's Capital Surcharges for Global Systemically Important Banks Too Small?

Wayne Passmore and Alexander H. von Hafften

Abstract: The Basel Committee promulgates bank regulatory standards that many major economies enact to a significant extent. One element of the Basel III capital standards is a system of capital surcharges for global systemically important banks (G-SIBs). If the purpose of the surcharges is to ensure the survival of G-SIBs through serious crises (like the 2007-09 financial crisis) without extraordinary public assistance, our analysis suggests that current surcharges are too low because of three shortcomings: (1) the Basel system underestimates the probability that a GSIB can fail, (2) the Basel system fails to account for short-term funding, and (3) the Basel system excludes too many banks from current surcharges. Our best estimate suggests that the current surcharges should be between 225 and 525 basis points higher for G-SIBs that are not reliant on short-term funding; G-SIBs that are reliant on short-term funding should have even higher surcharges. Furthermore, we find that, even with significant confidence in the effectiveness of other Basel III reforms, modest increases in surcharges appear needed.

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Keywords: Basel III, G-SIBs, G-SIFIs, bank capital, bank equity, bank regulation, banks

DOI: https://doi.org/10.17016/FEDS.2017.021

FEDS 2017-020
Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve's Approach

David Reifschneider and Peter Tulip

Data - HTML

Abstract: Since November 2007, the Federal Open Market Committee (FOMC) of the U.S. Federal Reserve has regularly published participants' qualitative assessments of the uncertainty attending their individual forecasts of real activity and inflation, expressed relative to that seen on average in the past. The benchmarks used for these historical comparisons are the average root mean squared forecast errors (RMSEs) made by various private and government forecasters over the past twenty years. This paper documents how these benchmarks are constructed and discusses some of their properties. We draw several conclusions. First, if past performance is a reasonable guide to future accuracy, considerable uncertainty surrounds all macroeconomic projections, including those of FOMC participants. Second, different forecasters have similar accuracy. Third, estimates of uncertainty about future real activity and interest rates are now considerably greater than prior to the financial crisis; in contrast, estimates of inflation accuracy have changed little. Finally, fan charts--constructed as plus-or-minus one RMSE intervals about the median FOMC forecast, under the expectation that future projection errors will be unbiased and symmetrically distributed, and that the intervals cover about 70 percent of possible outcomes--provide a reasonable approximation to future uncertainty, especially when viewed in conjunction with the FOMC's qualitative assessments. That said, an assumption of symmetry about the interest rate outlook is problematic if the expected path of the federal funds rate is expected to remain low.

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Keywords: FOMC, Fan Charts, Forecasting, Uncertainty

DOI: https://doi.org/10.17016/FEDS.2017.020

FEDS 2017-019
Declining Dynamism, Allocative Efficiency, and the Productivity Slowdown

Ryan A. Decker, John Haltiwanger, Ron S. Jarmin, and Javier Miranda

Abstract: A large literature documents declining measures of business dynamism including high-growth young firm activity and job reallocation. A distinct literature describes a slowdown in the pace of aggregate labor productivity growth. We relate these patterns by studying changes in productivity growth from the late 1990s to the mid 2000s using firm-level data. We find that diminished allocative efficiency gains can account for the productivity slowdown in a manner that interacts with the within-firm productivity growth distribution. The evidence suggests that the decline in dynamism is reason for concern and sheds light on debates about the causes of slowing productivity growth.

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Keywords: Job reallocation, Labor supply and demand, Productivity

DOI: https://doi.org/10.17016/FEDS.2017.019

FEDS 2017-018
Macroeconomic Forecasting in Times of Crises

Pablo Guerrón-Quintana and Molin Zhong

Abstract: We propose a parsimonious semiparametric method for macroeconomic forecasting during episodes of sudden changes. Based on the notion of clustering and similarity, we partition the time series into blocks, search for the closest blocks to the most recent block of observations, and with the matched blocks we proceed to forecast. One possibility is to compare local means across blocks, which captures the idea of matching directional movements of a series. We show that our approach does particularly well during the Great Recession and for variables such as inflation, unemployment, and real personal income. When supplemented with information from housing prices, our method consistently outperforms parametric linear, nonlinear, univariate, and multivariate alternatives for the period 1990 - 2015.

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Keywords: Forecasting, Great Recession, Nearest neighbor, Semiparametric methods

DOI: https://doi.org/10.17016/FEDS.2017.018

FEDS 2017-017
Lining Up: Survey and Administrative Data Estimates of Wealth Concentration

Arthur B. Kennickell

Abstract: The Survey of Consumer Finances (SCF) has a dual-frame sample design that supplements a standard area-probability frame with a sample of observations drawn from statistical records derived from tax returns. The tax-based frame is stratified on the basis of a "wealth index" constructed largely from observed income flows, with the intent of heavily oversampling wealthy households. Although the SCF is not specifically designed to estimate wealth concentration, the design arguably provides sufficient support to enable such analysis with a reasonable level of credibility. Similar estimates may also be made by using tax-based data directly, as in [1], by using a construct very close to a key part of the SCF wealth index. Such an approach has appeal as a way of tapping a much larger set of information to improve SCF estimates. Not surprisingly, there are differences in the two approaches, largely as a result of conceptual differences or complications in the survey imp leme ntation. This paper focuses on the top 1 percent of the wealth distribution, the group most intensively covered by the SCF list sample and it explores the stability of the relationship between the patterns of concentration in the survey data and parallel patterns in tax-based estimates and considers how those patterns differ across survey participants, the full sample and the entire survey frame. In addition, the paper makes as series of recommendation for further research on the technical support of the survey.

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Keywords: Nonresponse, Oversampling, Sampling, Skewed distributions, Wealth measurement

DOI: https://doi.org/10.17016/FEDS.2017.017

FEDS 2017-016
ICT Asset Prices: Marshaling Evidence into New Measures

David Byrne and Carol Corrado

Abstract: This paper is a companion to our recent paper, "ICT Prices and ICT Services: What do they tell us about Productivity and Technology?" It provides the sources and methods used to construct national accounts-style price deflators for the major components of ICT investment--communications equipment, computer equipment, and software--that were presented and analyzed in that paper. The ICT equipment measures described herein were also used in Byrne, Fernald, and Reinsdorf (2016). This paper is a companion to our recent paper, "ICT Services and their Prices: What do they tell us about Productivity and Technology?" It provides the sources and methods used to construct national accounts-style price deflators for the major components of ICT investment--communications equipment, computer equipment, and software--that were analyzed and used in that paper. The ICT equipment measures described herein were also used in Byrne, Fernald, and Reinsdorf (2016).

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Original paper: PDF | Accessible materials (.zip)

Keywords: ICT asset prices, Information and communication technology (ICT), Prices

DOI: https://doi.org/10.17016/FEDS.2017.016r1

FEDS 2017-015
ICT Services and their Prices: What do they tell us about Productivity and Technology?

David Byrne and Carol Corrado

Abstract: This paper reassesses the link between ICT prices, technology, and productivity. To understand how the ICT sector could come to the rescue of a whole economy, we extend a multi-sector model due to Oulton (2012) to include ICT services (e.g., cloud services) and use it to calibrate the steady-state contribution of the ICT sector to growth in aggregate U.S. labor productivity. Because ICT technologies diffuse through the economy increasingly via purchases of cloud and data analytic services that are not fully accounted for in the standard narrative on ICT's contribution to economic growth, the contribution of ICT to growth in output per hour going forward is found to be substantially larger than generally thought--1.4 percentage points per year. One reason why the estimated contribution is so large is that official ICT asset prices are found to substantially understate the productivity of the sector. The model developed in this paper also has implications for the relation ship between prices for ICT services and prices for the capital stocks (i.e., ICT assets) used to supply them. In particular, ICT service prices may diverge from asset prices and capture productivity gains from ICT asset management by the sector.

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Original paper: PDF | Accessible materials (.zip)

Keywords: Productivity, computer software and internet services, high-performance computing, information and communications technology (ICT), prices, technology

DOI: https://doi.org/10.17016/FEDS.2017.015r1

FEDS 2017-014
Firm Networks and Asset Returns

Abstract: This paper argues that changes in the propagation of idiosyncratic shocks along firm networks are important to understanding variations in asset returns. When calibrated to match key features of supplier-customer networks in the United States, an equilibrium model in which investors have recursive preferences and firms are interlinked via enduring relationships generates long-run consumption risks. Additionally, the model matches cross-sectional patterns of portfolio returns sorted by network centrality, a feature unaccounted for by standard asset pricing models.

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Original paper: PDF | Accessible materials (.zip)

Keywords: Equilibrium asset prices, Inter-firm relationships, Networks, Shock propagation

DOI: https://doi.org/10.17016/FEDS.2017.014r1

FEDS 2017-013
To Build or to Buy? The Role of Local Information in Credit Market Development

Abstract: Exploiting the heterogeneity in legal constraints on local bank employees' mobility, I show that access to local information influences banks' modes of expansion. Banks entering a new market typically establish new branches directly when interbank labor mobility is less restrictive but acquire incumbent branches otherwise. The treatment effect is strengthened when information asymmetries between local and entrants are severe. Furthermore, I find a surge in the total amount of local small business and mortgage loans granted, a higher mortgage approval rate, and a reduction of mortgage rates by surrounding incumbent branches, precisely around the period of entrants establishing new branches, which indicate intensified competition among banks.

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Keywords: Credit market development, Labor mobility, Local information

DOI: https://doi.org/10.17016/FEDS.2017.013

FEDS 2017-012
Does Knowledge Protection Benefit Shareholders? Evidence from Stock Market Reaction and Firm Investment in Knowledge Assets

Buhui Qiu and Teng Wang

Abstract: This paper studies whether knowledge protection affects shareholder value and firms' investment in knowledge assets using the staggered adoptions and rejections of the inevitable disclosure doctrine (IDD) by U.S. state courts as exogenous changes in the level of knowledge protection. We find positive (negative) abnormal stock returns around the IDD adoption (rejection) day for firms headquartered in the state and uncover a positive IDD treatment effect on firms' investment in knowledge assets. Moreover, the effects on stock returns and knowledge assets investment are stronger in more knowledge-oriented industries and firms. Finally, enhancing knowledge protection does not discourage local entrepreneurial activity.

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Keywords: Inevitable Disclosure Doctrine, Investment in Knowledge Assets, Knowledge Protection, Shareholder Value

DOI: https://doi.org/10.17016/FEDS.2017.012

FEDS 2017-011
The (Unintended?) Consequences of the Largest Liquidity Injection Ever

Matteo Crosignani, Miguel Faria-e-Castro, and Luis Fonseca

Abstract: We study the design of lender of last resort interventions and show that the provision of long-term liquidity incentivizes purchases of high-yield short-term securities by banks. Using a unique security-level data set, we find that the European Central Bank's three-year Long-Term Refinancing Operation incentivized Portuguese banks to purchase short-term domestic government bonds that could be pledged to obtain central bank liquidity. This "collateral trade" effect is large, as banks purchased short-term bonds equivalent to 8.4% of amount outstanding. The resumption of public debt issuance is consistent with a strategic reaction of the debt agency to the observed yield curve steepening.

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Keywords: Lender of Last Resort, Sovereign Debt, Unconventional Monetary Policy

DOI: https://doi.org/10.17016/FEDS.2017.011

FEDS 2017-010
Minimum Wages and Consumer Credit: Impacts on Access to Credit and Traditional and High-Cost Borrowing

Abstract: Proponents of minimum wage legislation point to its potential to raise earnings and reduce poverty, while opponents argue that disemployment effects lead to net welfare losses. But these arguments typically ignore the possibility of spillover effects on other aspects of households' financial circumstances. This paper examines how state-level minimum wages affect the decisions of lenders and low-income borrowers. Using data derived from direct mailings of credit offers, survey-reported usage of high-cost alternative credit products, and debt recorded in credit reports, we find that higher minimum wages increase the supply of unsecured credit to lower-income adults, who in turn, use more traditional credit and less high-cost alternative credit like payday loans. Further, delinquency rates fall and credit scores rise in both the short run and one year later. Overall, our results suggest that minimum wage policy has positive spillover effects by relaxing borrowing constra ints among lower-income households, thereby reducing borrowing costs. This reduction in borrowing costs can increase disposable income by 20-110 percent more than the direct effect on earnings alone.

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Original paper: PDF | Accessible materials (.zip)

Keywords: Consumer debt, credit cards, credit constraints, credit supply, delinquency, minimum wages, payday loans

DOI: https://doi.org/10.17016/FEDS.2017.010r1

FEDS 2017-009
Capital Misallocation and Secular Stagnation

Andrea Caggese and Ander Perez-Orive

Abstract: The widespread emergence of intangible technologies in recent decades may have significantly hurt output growth--even when these technologies replaced considerably less productive tangible technologies--because of structurally low interest rates caused by demographic forces. This insight is obtained in a model in which intangible capital cannot attract external finance, firms are credit constrained, and there is substantial dispersion in productivity. In a tangibles-intense economy with highly leveraged firms, low rates enable more borrowing and faster debt repayment, reduce misallocation, and increase aggregate output. An increase in the share of intangible capital in production reduces the borrowing capacity and increases the cash holdings of the corporate sector, which switches from being a net borrower to a net saver. In this intangibles-intense economy, the ability of firms to purchase intangible capital using retained earnings is impaired by low interest rates, be cause low rates increase the price of capital and slow down the accumulation of corporate savings.

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Keywords: Borrowing Constraints, Capital Reallocation, Intangible Capital, Secular Stagnation

DOI: https://doi.org/10.17016/FEDS.2017.009

FEDS 2017-008
Credit Scores, Social Capital, and Stock Market Participation

Data (.zip)

Abstract: While a rapidly growing body of research underscores the influence of social capital on financial decisions and economic developments, objective data-based measurements of social capital are lacking. We introduce average credit scores as an indicator of a community's social capital and present evidence that this measure is consistent with, but richer and more robust than, those used in the existing literature, such as electoral participation, blood donations, and survey-based measures. Merging unique proprietary credit score data with two nationwide representative household surveys, we show that households residing in communities with higher social capital are more likely to invest in stocks, even after controlling for a rich set of socioeconomic, preferential, neighborhood, and demographic characteristics. Notably, such a relationship is robustly observed only when social capital is measured using community average credit scores. Consistent with the notion that social capital and trust promote stock investment, we find the following: first, the association between average credit score and stock ownership is more pronounced among the lower educated; second, social capital levels of the county where one grew up appear to have a lasting influence on future stock investment; and third, investors who did not own stocks before have a greater chance of entering the stock market a few years after they relocate to higher-score communities.

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Keywords: Credit scores, Social Capital, Stock market participation, Trust

DOI: https://doi.org/10.17016/FEDS.2017.008

FEDS 2017-007
Managing Stigma during a Financial Crisis

Abstract: How should regulators design effective emergency lending facilities to mitigate stigma during a financial crisis? I explore this question using data from an unexpected disclosure of partial lists of banks that secretly borrowed from the lender of last resort during the Great Depression. I find evidence of stigma in that depositors withdrew more deposits from banks included on the lists in comparison with banks left off the lists. However, stigma dissipated for banks that were revealed earlier after subsequent banks were revealed. Overall, the results suggest that an emergency lending facility that never reveals bank identities would mitigate stigma.

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Keywords: Great Depression, central bank, financial crisis, stigma

DOI: https://doi.org/10.17016/FEDS.2017.007

FEDS 2017-006
Heaping at Round Numbers on Financial Questions: The Role of Satisficing

Michael Gideon, Brooke Helppie-McFall, and Joanne W. Hsu

Abstract: Survey responses to quantitative financial questions frequently display strong patterns of heaping at round numbers. This paper uses two studies to examine variation in rounding across questions and by individual characteristics. Rounding was more common for respondents low in ability, for respondents low in motivation, and for more difficult questions, all consistent with theories of satisficing. Questions that require more difficult information retrieval and integration of information exhibit more heaping. The use of records, which lowers task difficulty, reduces rounding as well. Higher episodic memory is associated with less rounding, and standard measures of motivation are negatively associated with rounding. These relationships, along with the fact that longer response latencies are associated with less rounding, all support the idea that rounding is a manifestation of satisficing on open-ended financial questions. Rounding patterns also appear remarkably similar across the two studies, despite being fielded in different modes and employing different question order and wording.

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Keywords: Consumer surveys, Data collection and estimation, Satisficing

DOI: https://doi.org/10.17016/FEDS.2017.006

FEDS 2017-005
How Fast are Semiconductor Prices Falling?

David M. Byrne, Stephen D. Oliner, and Daniel E. Sichel

Abstract: The Producer Price Index (PPI) for the United States suggests that semiconductor prices have barely been falling in recent years, a dramatic contrast to the rapid declines reported from the mid-1980s to the early 2000s. This slowdown in the rate of decline is puzzling in light of evidence that the performance of microprocessor units (MPUs) has continued to improve at a rapid pace. Over the course of the 2000s, the MPU prices posted by Intel, the dominant producer of MPUs, became much stickier over the chips' life cycle. As a result of this change, we argue that the matched-model methodology used in the PPI for MPUs likely started to be biased after the early 2000s and that hedonic indexes can provide a more accurate measure of price change since then. MPU prices fell rapidly through 2004 on every price measure we present, with the PPI declining at an even quicker pace than the hedonic indexes. However, from 2004 to 2009, our preferred hedonic index fell faster than the PPI, and from 2009 to 2013 the gap widened further, with our preferred index falling at an average annual rate of 42 percent, while the PPI declined at only a 6 percent rate. Given that MPUs currently represent about half of U.S. shipments of semiconductors, this difference has important implications for gauging the rate of innovation in the semiconductor sector.

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Keywords: measurement, hedonic price index, quality adjustment, technological change, microprocessor

DOI: https://doi.org/10.17016/FEDS.2017.005

FEDS 2017-004
A Unified Framework for Dimension Reduction in Forecasting

Alessandro Barbarino and Efstathia Bura

Abstract: Factor models are widely used in summarizing large datasets with few underlying latent factors and in building time series forecasting models for economic variables. In these models, the reduction of the predictors and the modeling and forecasting of the response y are carried out in two separate and independent phases. We introduce a potentially more attractive alternative, Sufficient Dimension Reduction (SDR), that summarizes x as it relates to y, so that all the information in the conditional distribution of y|x is preserved. We study the relationship between SDR and popular estimation methods, such as ordinary least squares (OLS), dynamic factor models (DFM), partial least squares (PLS) and RIDGE regression, and establish the connection and fundamental differences between the DFM and SDR frameworks. We show that SDR significantly reduces the dimension of widely used macroeconomic series data with one or two sufficient reductions delivering similar forecasting performance to that of competing methods in macro-forecasting.

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Keywords: Diffusion Index, Dimension Reduction, Factor Models, Forecasting, Partial Least Squares, Principal Components

DOI: https://doi.org/10.17016/FEDS.2017.004

FEDS 2017-003
Bond Market Intermediation and the Role of Repo

Abstract: We model the role that repurchase agreements (repos) play in bond market intermediation. Not only do repos allow dealers to finance their activities, but they also enable dealers to source assets without taking ownership. When the asset trades with repo specialness, i.e, when the associated repo rate is significantly below prevailing market rates, borrowing the asset is more expensive, resulting in higher bid-ask spreads. Limiting a single dealer's leverage decreases its market-making abilities, so the dealer charges a higher bid-ask spread. However, limiting all dealers' leverage reduces pressure on repo specialness, thus decreasing bid-ask spreads. More generally, this paper characterizes the importance of collateralized borrowing and lending for bond market intermediation, shows how frictions in repo markets can affect the underlying cash market liquidity, and underscores the importance of securities lending.

Original paper: PDF | Accessible materials (.zip)

Keywords: Market liquidity, Financial services and intermediation, Repo, Specialness, U.S. Treasury market

DOI: https://doi.org/10.17016/FEDS.2017.003r1

FEDS 2017-002
Household Incomes in Tax Data: Using Addresses to Move from Tax Unit to Household Income Distributions

Jeff Larrimore, Jacob Mortenson, and David Splinter

Abstract: Tax return data are increasingly the standard for tracking income statistics in the United States. However, these data have traditionally been limited by their inability to capture non-filers and to identify members of separate tax units living in the same household. We overcome these obstacles and create household records directly in the tax data using mailing address information included on tax forms. We then present the first set of tax-based household income and inequality measures for the entire income distribution. When comparing household income inequality results in the tax data to those using the March CPS, we confirm previous findings that the March CPS understates the inequality of household income. However, we also find that the previous approach of using tax units in the IRS data to proxy for households leads to an overstatement of household income inequality. Finally, using households in the IRS tax records, we illustrate how focusing on tax units rather than households alters the observed distribution of tax programs such as the Earned Income Tax Credit.

Accessible materials (.zip)

Keywords: EITC, Household Income, IRS Data, Income Inequality, Tax Unit Income

DOI: https://doi.org/10.17016/FEDS.2017.002

FEDS 2017-001
The currency dimension of the bank lending channel in international monetary transmission

Elod Takats and Judit Temesvary

Abstract: We investigate how the use of a currency transmits monetary policy shocks in the global banking system. We use newly available unique data on the bilateral cross-border lending flows of 27 BIS-reporting lending banking systems to over 50 borrowing countries, broken down by currency denomination (USD, EUR and JPY). We have three main findings. First, monetary shocks in a currency significantly affect cross-border lending flows in that currency, even when neither the lending banking system nor the borrowing country uses that currency as their own. Second, this transmission works mainly through lending to non-banks. Third, this currency dimension of the bank lending channel works similarly across the three currencies suggesting that the cross-border bank lending channel of liquidity shock transmission may not be unique to lending in USD.

Accessible materials (.zip)

Keywords: Bank lending channel, Cross-border bank lending, Currency denomination, Monetary transmission

DOI: https://doi.org/10.17016/FEDS.2017.001

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Last Update: November 29, 2017