Abstract: Public debt can be optimal in standard incomplete market models with infinitely lived agents, since the associated capital crowd-out induces a higher interest rate. The higher interest rate encourages individuals to save and, hence, better self-insure against idiosyncratic labor earnings risk. Even though individual savings behavior is a crucial determinant of the optimality of public debt, this class of economies abstracts from empirically observed life cycle savings patterns. Thus, this paper studies how incorporating a life cycle affects optimal public debt. We find that while the infinitely lived agent model's optimal policy is public debt equal to 24% of output, the life cycle model's optimal policy is public savings equal to 61% of output. Although public debt also encourages life cycle agents to hold more savings during their lifetimes, the act of accumulating this savings mitigates the potential welfare benefit. Moreover, public savings improves life cycle agents' welfare by encouraging a flatter allocation of consumption and leisure over their lifetimes. Accordingly, abstracting from the life cycle yields an optimal policy that reduces average welfare by more than 0.6% of expected lifetime consumption. Furthermore, ignoring the life cycle overstates the influence of wealth inequality on optimal policy, since optimal policy is far less sensitive to wealth inequality in the life cycle model than in the infinitely lived agent model. These results demonstrate that studying optimal debt policy in an infinitely lived agent model, which abstracts from the realism of a life cycle in order to render models more computationally tractable, is not without loss of generality.
Keywords: Government Debt, Heterogeneous Agents, Incomplete Markets, Life Cycle
Abstract: We examine the interaction of regulatory reforms and changes in monetary policy in the U.S. repo market. Using a proprietary data set of repo transactions, we find that differences in regional implementation of Basel III capital reforms intensified European dealers' window-dressing by 80%. Money funds eligible to use the Fed's reverse repo (RRP) facility cut their private lending almost by half and instead lent to the Fed when European dealers withdraw, contributing to smooth implementation of Basel III. In a difference-in-differences setting, we show that ineligible funds lent 15% less to European dealers as they find their withdrawal for reporting purposes inconvenient. We find that intermediation through the RRP led to quantity and not pricing adjustments in the market, which is consistent with the RRP facility anchoring market rates.
Keywords: Basel III regulations, Federal Reserve Board and Federal Reserve System, Monetary policy, repo, reverse repo facility
Abstract: I show that the probability that the Board of Governors of the Federal Reserve System staff's forecasts (the "Greenbooks") overpredicted quarterly real gross domestic product (GDP) growth depends on both the forecast horizon and also whether the forecasted quarter was above or below trend real GDP growth. For forecasted quarters that grew below trend, Greenbooks were much more likely to overpredict real GDP growth, with one-quarter ahead forecasts overpredicting real GDP growth more than 75% of the time, and this rate of overprediction was higher for further ahead forecasts. For forecasted quarters that grew above trend, Greenbooks were slightly more likely to underpredict real GDP growth, with one-quarter ahead forecasts underpredicting growth about 60% of the time. Unconditionally, on average, Greenbooks overpredicted real GDP growth.
Keywords: Asymmetric Forecast Errors, Federal Open Market Committee, Forecast Accuracy, Greenbook, Monetary policy, Real-Time Data
Abstract: The federal government encourages human capital investment through lending and grant programs, but resources from these programs may also finance non-education activities for students whose liquidity is otherwise restricted. This paper explores this possibility, using administrative data for the universe of federal student loan borrowers linked to tax records. We examine the effects of a sharp discontinuity in program limits—generated by the timing of a student borrower's 24th birthday—on household formation early in the lifecycle. After demonstrating that this discontinuity induces a jump in federal support, we estimate an immediate and persistent increase in homeownership, with larger effects among those most financially constrained. In the first year, borrowers with higher limits also earn less but are more likely to save; however, there are no differences in subsequent years. Finally, effects on marriage and fertility lag homeownership. Altogether, the results appea r to be driven by liquidity rather than human capital or wealth effects.
Keywords: Credit limits, homeownership, household formation, human capital, liquidity, saving, student loans
How much has wealth concentration grown in the United States? A re-examination of data from 2001-2013 (PDF)
Abstract: Well known research based on capitalized income tax data shows robust growth in wealth concentration in the late 2000s. We show that these robust growth estimates rely on an assumption---homogeneous rates of return across the wealth distribution---that is not supported by data. When the capitalization model incorporates heterogeneous rates of return (on just interest-bearing assets), wealth concentration estimates in 2011 fall from 40.5% to 33.9%. These estimates are consistent in levels and trend with other micro wealth data and show that wealth concentration increases until the Great Recession, then declines before increasing again.
Keywords: Household wealth, wealth concentration
Abstract: We use relatively unexplored dimensions of US microdata to examine how US manufacturing employment has evolved across industries, firms, establishments, and regions from 1977 to 2012. We show that these data provide support for both trade- and technology-based explanations of the overall decline of employment over this period, while also highlighting the difficulties of estimating an overall contribution for each mechanism. Toward that end, we discuss how further analysis of these trends might yield sharper insights.
Keywords: Employment, Manufacturing, Output, Technology, Trade
Abstract: This paper models an unexplored source of liquidity risk faced by large broker-dealers: collateral runs. By setting different contracting terms on repurchase agreements with cash borrowers and lenders, dealers can source funds for their own activities. Cash borrowers internalize the risk of losing their collateral in case their dealer defaults, prompting them to withdraw it. This incentive creates strategic complementarities for counterparties to withdraw their collateral, reducing a dealer's liquidity position and compromising her solvency. Collateral runs are markedly different than traditional wholesale funding runs because they are triggered by a contraction in dealers' assets, rather than their liabilities.
Keywords: Collateral, dealer, default, liquidity, rehypothecation, repo, runs
Abstract: We study a class of backtests for forecast distributions in which the test statistic is a spectral transformation that weights exceedance events by a function of the modeled probability level. The choice of the kernel function makes explicit the user's priorities for model performance. The class of spectral backtests includes tests of unconditional coverage and tests of conditional coverage. We show how the class embeds a wide variety of backtests in the existing literature, and propose novel variants as well. In an empirical application, we backtest forecast distributions for the overnight P&L of ten bank trading portfolios. For some portfolios, test results depend materially on the choice of kernel.
Keywords: Backtesting, Risk management, Volatility
The Impact of the Current Expected Credit Loss Standard (CECL) on the Timing and Comparability of Reserves (PDF)
Abstract: The new forward-looking credit loss provisioning standard, CECL, is intended to promote proactive provisioning as loan loss reserves can be conditioned on expectations of the economic cycle. We study the degree to which one modeling decision--expectations about the path of future house prices--affects the size and timing of provisions for first-lien residential mortgage portfolios. While we find that provisions are generally less pro-cyclical compared to the current incurred loss standard, CECL may complicate the comparability of provisions across banks and time. Market participants will need to disentangle the degree to which variation in provisions across firms is driven by underlying risk versus differences in modeling assumptions.
Keywords: CECL, accounting rule change, model risk, mortgage loans
"Unconventional" Monetary Policy as Conventional Monetary Policy: A Perspective from the U.S. in the 1920s (PDF)
Abstract: To implement monetary policy in the 1920s, the Federal Reserve utilized administered interest rates and conducted open market operations in both government securities and private money market securities, sometimes in fairly considerable amounts. We show how the Fed was able to effectively use these tools to influence conditions in money markets, even those in which it was not an active participant. Moreover, our results suggest that the transmission of monetary policy to money markets occurred not just through changing the supply of reserves but importantly through financial market arbitrage and the rebalancing of investor portfolios. The tools used in the 1920s by the Federal Reserve resemble the extraordinary monetary policy tools used by central banks recently and provide further evidence on their effectiveness even in ordinary times.
Keywords: Monetary policy, administered rates, central banking, money markets, quantitative easing, unconventional monetary policy
Liquidity Requirements, Free-Riding, and the Implications for Financial Stability Evidence from the early 1900s (PDF)
Abstract: Maintaining sufficient liquidity in the financial system is vital for financial stability. However, since returns on liquid assets are typically low, individual financial institutions may seek to hold fewer such assets, especially if they believe they can rely on other institutions for liquidity support. We examine whether state banks in the early 1900s took advantage of relatively high cash balances maintained by national banks, due to reserve requirements, to hold less cash themselves. We find that state banks did hold less cash in places where both state legal requirements were lower and national banks were more prevalent
Keywords: Financial stability, free-riding, liquidity requirements, reserve requirements
Abstract: Bilateral financial contracts typically require an assessment of counterparty risk. Central clearing of these financial contracts allows market participants to mutualize their counterparty risk, but this insurance may weaken incentives to acquire and to reveal information about such risk. When considering this trade-off, participants would choose central clearing if information acquisition is incentive compatible. If it is not, they may prefer bilateral clearing, when this choice prevents strategic default while economizing on costly collateral. In either case, participants independently choose the efficient clearing arrangement. Consequently, central clearing can be socially inefficient under certain circumstances. These results stand in contrast to those in Achary and Bisin (2014), who find that central clearing is always the optimal clearing arrangement.
Keywords: Central counterparties, Collateral, Liimited Commitment
Abstract: Nonbanks originated about half of all mortgages in 2016, and 75% of mortgages insured by the FHA or VA. Both shares are much higher than those observed at any point in the 2000s. We describe in this paper how nonbank mortgage companies are vulnerable to liquidity pressures in both their loan origination and servicing activities, and we document that this sector in the aggregate appears to have minimal resources to bring to bear in a stress scenario. We show how these exact same liquidity issues unfolded during the financial crisis, leading to the failure of many nonbank companies, requests for government assistance, and harm to consumers. The extremely high share of nonbank lenders in FHA and VA lending suggests that nonbank failures could be quite costly to the government, but this issue has received very little attention in the housing-reform debate.
Keywords: FHA, Ginnie Mae, Mortgages and credit, financial crisis, mortgage servicing, nonbank institutions
Early-Stage Business Formation: An Analysis of Applications for Employer Identification Numbers (PDF)
Abstract: This paper reports on the development and analysis of a newly constructed dataset on the early stages of business formation. The data are based on applications for Employer Identification Numbers (EINs) submitted in the United States, known as IRS Form SS-4 filings. The goal of the research is to develop high-frequency indicators of business formation at the national, state, and local levels. The analysis indicates that EIN applications provide forward-looking and very timely information on business formation. The signal of business formation provided by counts of applications is improved by using the characteristics of the applications to model the likelihood that applicants become employer businesses. The results also suggest that EIN applications are related to economic activity at the local level. For example, application activity is higher in counties that experienced higher employment growth since the end of the Great Recession, and application counts grew more rapidly in counties engaged in shale oil and gas extraction. Finally, the paper provides a description of new public use dataset, the "Business Formation Statistics (BFS)," that contains new data series on business applications and formation. The initial release of the BFS shows that the number of business applications in the 3rd quarter of 2017 that have relatively high likelihood of becoming job creators is still far below pre-Great Recession levels.
Keywords: Business fluctuations and cycles, Urban, rural, and regional economics
Abstract: This paper uses high-frequency data to analyze the effects of US monetary policy--during the conventional and unconventional policy regimes--on foreign government bonds markets in advanced and emerging market economies. The results indicate that an expansionary US monetary policy steepens the foreign yield curve--denominated in local currency--during a conventional US monetary policy regime and flattens the foreign yield curve during an unconventional policy regime. The passthrough of unconventional US monetary policy to foreign bond yields is, on balance, comparable to that of conventional policy. In addition a conventional US monetary easing leads to a significant narrowing of the credit spreads on dollar-denominated sovereign bonds that are issued by countries with a speculative-grade sovereign credit rating. However, during the unconventional policy regime, yields on speculative-grade sovereign debt denominated in dollars move one-to-one with yields on comparable-m aturity US Treasury securities.
Keywords: Conventional and unconventional US monetary policy, financial spillovers, sovereign yields and credit spreads
Abstract: This paper analyzes Milton Friedman's (1968) article "The Role of Monetary Policy," via a discussion of seven fallacies concerning the article. These fallacies are: (1) "The Role of Monetary Policy" was Friedman's first public statement of the natural rate hypothesis. (2) The Friedman-Phelps Phillips curve was already presented in Samuelson and Solow's (1960) analysis. (3) Friedman's specification of the Phillips curve was based on perfect competition and no nominal rigidities. (4) Friedman's (1968) account of monetary policy in the Great Depression contradicted the Monetary History's version. (5) Friedman (1968) stated that a monetary expansion will keep the unemployment rate and the real interest rate below their natural rates for two decades. (6) The zero lower bound on nominal interest rates invalidates the natural rate hypothesis. (7) Friedman's (1968) treatment of an interest-rate peg was refuted by the rational expectations revolution. The d iscussion lays out the reasons why each of these seven items is a fallacy and infers key aspects of the framework underlying Friedman's (1968) analysis.
Keywords: Fisher effect, Milton Friedman, Phillips curve, liquidity effect, natural rate hypothesis, price stickiness, zero lower bound
Abstract: Using the Panel Survey of Income Dynamics, we identify six household types as a function of their balance sheet composition. Since 1999, there has been a decline in the share of patient households and an increase in the share of impatient households with negative wealth. Using a DSGE model with search and matching frictions, we explore how changes in the distribution of households affect the transmission of government spending shocks. We show that the relative share of households in the left tail of the wealth distribution plays a key role in the aggregate marginal propensity to consume, the magnitude of the fiscal multipliers, and the distributional consequences of fiscal shocks. While the output and consumption multipliers are positively correlated with the share of households with negative wealth, the size of the employment multiplier is negatively correlated. For calibrations based on the empirical household weights after the Great Recession, our model delivers jobless fiscal expansions.
Keywords: Fiscal policy, Panel Survey of Income Dynamics, heterogeneity, household balance sheet, search and matching
Abstract: Using loan-level municipal bank lending data, we examine the debt structure of municipalities and its response to exogenous income shocks. We show that small, more indebted, low-income, and medium credit quality counties are particularly reliant on private bank financing. Low income counties are more likely to increase bank debt share after an adverse permanent income shock while high income counties do not shift their debt structure in response. In contrast, only high income counties draw on their credit lines after adverse transitory income shocks. Overall, our paper raises concerns about claim dilution of bondholders and highlights the importance of municipal disclosure of private debt.
Keywords: bank lending, claim dilution, disclosure, municipal finance
Abstract: Measures of income concentration--such as the share of income received by the highest income families--may be biased by pro-cyclical volatility in annual income. Permanent income, though, can smooth away such volatility and sort families by their usual economic resources. Here, we demonstrate this bias using rolling 3-year panels of IRS tax records from 1997 to 2013 as a proxy for permanent income. For example, one measure of 2012 income concentration--the share of income received by the top 0.1 percent--falls from 11.3 percent to 8.9 percent when families are organized by permanent income instead of annual income. However, the growth in income concentration cannot be explained by this volatility, as growth rates are comparable in the permanent income and annual income groupings during our sample period. Further, the probability of remaining in the highest income groups, while relatively low at the very top of the distribution, increased slightly during our sample period, s uggesting that top incomes have become less volatile in this dimension. These results are confirmed using household income data measured in the Survey of Consumer Finances (SCF)--a household survey with a large oversample of high-income households and a unique measure of permanent income.
Keywords: Inequality, Top Incomes, Volatility
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 this sluggish 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 homeowners might have better uses for this money. Third, refinancing mortgages is often very costly. Expensive refinancing may prevent homeowners from taking advantage of falling rates. To resolve these three flaws, we propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or "Fixed-COFI mortgage"). This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and does not require a 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 lower monthly payments or toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk "wedges" between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. We discuss two variations of the Fixed-COFI mortgage. Homeowners with "affordable" Fixed-COFI mortgages are rebated the "wedges" between the traditional fixed-rate mortgage payments and the COFI mortgage payment. After the "wedges" are rebated, these homeowners may pay substantially less to purchase their homes in 30 years than homeowners with traditional fixed-rate mortgages. This mortgage design may help alleviate housing affordability pressures in many areas of the United States. The other variation of Fixed-COFI mortgage is the "homeownership" Fixed-COFI mortgage. With the "homeownership" Fixed-COFI mortgage, the homeowner commits to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin.
Keywords: COFI, Fixed-rate Mortgage, cost of funds, downpayment, homeownership, interest rates, mortgage
A Global Lending Channel Unplugged? Does U.S. Monetary Policy Affect Cross-border and Affiliate Lending by Global U.S. Banks? (PDF)
Abstract: We examine how U.S. monetary policy affects the international activities of U.S. Banks. We access a rarely studied U.S. bank-level regulatory dataset to assess at a quarterly frequency how changes in the U.S. Federal funds rate (before the crisis) and quantitative easing (after the onset of the crisis) affects changes in cross-border claims by U.S. banks across countries, maturities and sectors, and also affects changes in claims by their foreign affiliates. We find robust evidence consistent with the existence of a potent global bank lending channel. In response to changes in U.S. monetary conditions, U.S. banks strongly adjust their cross-border claims in both the pre and post-crisis period. However, we also find that U.S. bank affiliate claims respond mainly to host country monetary conditions.
Keywords: bank lending channel, cross-country analysis, global banking, monetary transmission
Abstract: The pace of job reallocation has declined in all U.S. sectors since 2000. In standard models, aggregate job reallocation depends on (a) the dispersion of idiosyncratic productivity shocks faced by businesses and (b) the marginal responsiveness of businesses to those shocks. Using several novel empirical facts from business microdata, we infer that the pervasive post-2000 decline in reallocation reflects weaker responsiveness in a manner consistent with rising adjustment frictions and not lower dispersion of shocks. The within-industry dispersion of TFP and output per worker has risen, while the marginal responsiveness of employment growth to business-level productivity has weakened. The responsiveness in the post-2000 period for young firms in the high-tech sector is only about half (in manufacturing) to two thirds (economy wide) of the peak in the 1990s. Counterfactuals show that weakening productivity responsiveness since 2000 accounts for a significant drag on aggregate productivity.
Keywords: Dynamism, Entrepreneurship, Job reallocation, Labor supply and demand, Productivity
Abstract: This paper investigates the risk channel of monetary policy through banks' lending standards. We modify the classic costly state verification (CSV) problem by introducing a risk-neutral monopolistic bank, which maximizes profits subject to borrower participation. While the bank can diversify idiosyncratic default risk, it bears the aggregate risk. We show that, in partial equilibrium, the bank prefers a higher leverage ratio of borrowers, when the profitability of lending increases, e.g. after a monetary expansion. This risk channel persists when we embed our contract in a standard New Keynesian DSGE model. Using a factor-augmented vector autoregression (FAVAR) approach, we find that the model-implied impulse responses to a monetary policy shock replicate their empirical counterparts.
Keywords: Costly state verification, Credit supply, Lending standards, Monetary policy, Risk Channel
Abstract: We show that high-frequency private payroll microdata can help forecast labor market conditions. Payroll employment is perhaps the most reliable real-time indicator of the business cycle and is therefore closely followed by policymakers, academia, and financial markets. Government statistical agencies have long served as the primary suppliers of information on the labor market and will continue to do so for the foreseeable future. That said, sources of "big data" are becoming increasingly available through collaborations with private businesses engaged in commercial activities that record economic activity on a granular, frequent, and timely basis. One such data source is generated by the firm ADP, which processes payrolls for about one fifth of the U.S. private sector workforce. We evaluate the efficacy of these data to create new statistics that complement existing measures. In particular, we develop a set of weekly aggregate employment indexes from 2000 to 2017 , which allows us to measure employment at a higher frequency than is currently possible. The extensive coverage of the ADP data—similar in terms of private employment to the BLS CES sample—implies potentially high information value of these data, and our results confirm this conjecture. Indeed, the timeliness and frequency of the ADP payroll microdata substantially improves forecast accuracy for both current-month employment and revisions to the BLS CES data.
Keywords: Consumption, saving, production, employment, and investment, Labor supply and demand, forecasting
Abstract: Interest rates may remain low and fall to their effective lower bound (ELB) often. As a result, quantitative easing (QE), in which central banks expand their balance sheet to lower long-term interest rates, may complement policy approaches focused on adjustments in short-term interest rates. Simulation results using a large-scale model (FRB/US) suggest that QE does not improve economic performance if the steady-state interest rate is high, confirming that such policies were not advantageous from 1960 to 2007. However, QE can offset a significant portion of the adverse effects of the ELB when the equilibrium real interest rate is low. These improvements in economic performance exceed those associated with moderate increases in the inflation target. Active QE is primarily required when nominal interest rates are near the ELB, pointing to benefits within the model from QE as a secondary tool while relying on short-term interest rates as the primary tool.
Keywords: Interest rates, Macroeconomic models, Monetary policy
Abstract: Entrepreneurship plays a vital role in the economy, yet there exists little well-identified research into the effects of taxes on startup activity. Using recently developed county-level data on startups, we examine the effect of states' corporate, personal and sales tax rates on new firm activity and test for cross-border spillovers in response to these policies. We find that new firm employment is negatively--and disproportionately--affected by corporate tax rates. We find little evidence of an effect of personal and sales taxes on entrepreneurial outcomes. Our results are robust to changes in the tax base and other state-level policies.
Keywords: Labor supply and demand, Taxation, entrepreneurship, firm dynamics
Abstract: The paper surveys the recent literature on the fiscal implications of central bank balance sheets, with a special focus on political economy issues. It then presents the results of simulations that describe the effects of different scenarios for the Federal Reserve's longer-run balance sheet on its earnings remittances to the U.S. Treasury and, more broadly, on the government's overall fiscal position. We find that reducing longer-run reserve balances from $2.3 trillion (roughly the current amount) to $1 trillion reduces the likelihood of posting a quarterly net loss in the future from 30 percent to under 5 percent. Further reducing longer-run reserve balances from $1 trillion to pre-crisis levels has little effect on the likelihood of net losses.
Keywords: Central bank balance sheets, Monetary policy, Remittances
Abstract: We do not need to and should not have to choose amongst income, consumption, or wealth as the superior measure of well-being. All three individually and jointly determine well-being. We are the first to study inequality in three conjoint dimensions for the same households, using income, consumption, and wealth from the 1989-2016 Surveys of Consumer Finances (SCF). The paper focuses on two questions. What does inequality in two and three dimensions look like? Has inequality in multiple dimensions increased by less, by more, or by about the same as inequality in any one dimension? We find an increase in inequality in two dimensions and in three dimensions, with a faster increase in multi-dimensional inequality than in one-dimensional inequality. Viewing inequality through one dimension greatly understates the level and the growth in inequality in two and three dimensions. The U.S. is becoming more economically unequal than is generally understood.
Keywords: Consumption, Inequality, Wealth