FEDS 2020-103
What Drives U.S. Treasury Re-use?

Sebastian Infante and Zack Saravay


We study what drives the re-use of U.S. Treasury securities in the financial system. Using confidential supervisory data, we estimate the degree of collateral re-use at the dealer level through their collateral multiplier : the ratio between a dealer's secured funding and their outright holdings. We find that Treasury re-use increases as the supply of available securities decreases, especially when supply declines due to Federal Reserve asset purchases. We also find that non-U.S. dealers' re-use increases when profits from intermediating cash are high, U.S. dealers' re-use increases when demand to source on-the-run Treasuries is high, and both types of dealers' re-use can alleviate safe asset scarcity. Finally, we document a sharp drop in Treasury re-use at the onset of the COVID-19 pandemic, with a subsequent reversal after the Federal Reserve's intervention to support market functioning.

Keywords: re-use, repo, Treasury, collateral, rehypothecation

DOI: https://doi.org/10.17016/FEDS.2020.103

FEDS 2020-102
Which Output Gap Estimates Are Stable in Real Time and Why?


Output gaps that are estimated in real time can differ substantially from those estimated after the fact. We aim to understand the real-time instability of output gap estimates by comparing a suite of reduced-form models. We propose a new statistical decomposition and find that including a Okun’s law relationship improves real-time stability by alleviating the end-point problem. Models that include the unemployment rate also produce output gaps with relevant economic content. However, we find that no model of the output gap is clearly superior to the others along each metric we consider.

Keywords: Output gap; real-time data; trend-cycle decomposition; unobserved components model

DOI: https://doi.org/10.17016/FEDS.2020.102

FEDS 2020-101
Monetary Policy and Financial Stability


The 2008 Global Financial Crisis called into question the narrow focus on price stability of inflation targeting regimes. This paper studies the relationship between price stability and financial stability by analyzing alternative monetary policy regimes for an economy that experiences endogenous financial crises due to excessive household sector leverage. We reach four conclusions. First, a central bank can improve both price stability and financial stability by adopting an aggressive inflation targeting regime, in the absence of the zero lower bound (ZLB) constraint on nominal interest rates. Second, in the presence of the ZLB constraint, an aggressive inflation targeting regime may undermine both price stability and financial stability. Third, an aggressive price-level targeting regime can improve both price stability and financial stability, regardless of the presence of the ZLB constraint. Finally, a leaning against the wind policy can be detrimental to both price stability and financial stability when the credit cycle is driven by countercyclical household sector leverage. In this environment, leaning with credit spreads can be more effective.

Keywords: Inflation targeting, financial crises, zero lower bound

DOI: https://doi.org/10.17016/FEDS.2020.101

FEDS 2020-100
Latent Variables Analysis in Structural Models: A New Decomposition of the Kalman Smoother


This paper advocates chaining the decomposition of shocks into contributions from forecast errors to the shock decomposition of the latent vector to better understand model inference about latent variables. Such a double decomposition allows us to gauge the inuence of data on latent variables, like the data decomposition. However, by taking into account the transmission mechanisms of each type of shock, we can highlight the economic structure underlying the relationship between the data and the latent variables. We demonstrate the usefulness of this approach by detailing the role of observable variables in estimating the output gap in two models.

Keywords: Kalman smoother, latent variables, shock decomposition, data decomposition, double decomposition

DOI: https://doi.org/10.17016/FEDS.2020.100

FEDS 2020-099
Across the Universe: Policy Support for Employment and Revenue in the Pandemic Recession


Using data from 14 government sources, we develop comprehensive estimates of U.S. economic activity by sector, legal form of organization, and firm size to characterize how four government direct lending programs—the Paycheck Protection Program, the Main Street Lending Program, the Corporate Credit Facilities, and the Municipal Lending Facilities—relate to these classes of economic activity in the United States. The classes targeted by these programs are vast—accounting for 97 percent of total U.S. employment—though entity-specific financial criteria limit coverage within specific programs. These programs notionally cover a far larger universe than what was targeted by analogous Great Recession-era lending policies. We relate our estimates to those from timely alternative data sources, which do not typically cover the majority of the economic universe.

DOI: https://doi.org/10.17016/FEDS.2020.099

FEDS 2020-098
Collective Moral Hazard and the Interbank Market

Levent Altinoglu and Joseph E. Stiglitz


The concentration of risk within financial system is considered to be a source of systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions. We build a model of portfolio choice and endogenous contracts in which the government optimally intervenes during crises. By issuing financial claims to other institutions, relatively risky institutions endogenously become large and interconnected. This structure enables institutions to share the risk of systemic crisis in a privately optimal way, but channels funds to relatively risky investments and creates incentives even for smaller institutions to take excessive risks. Constrained efficiency can be implemented with macroprudential regulation designed to limit the interconnectedness of risky institutions.

DOI: https://doi.org/10.17016/FEDS.2020.098

FEDS 2020-097
Arbitrage and Liquidity: Evidence from a Panel of Exchange Traded Funds


Market liquidity is expected to facilitate arbitrage, which in turn should affect the liquidity of the assets traded by arbitrageurs. We study this relationship using a unique dataset of equity and bond ETFs compiled from big trade-level data. We find that liquidity is an important determinant of the efficacy of the ETF arbitrage. For less liquid bond ETFs, Granger-causality tests and impulse responses suggest that this relationship is stronger and more persistent, and liquidity spillovers are observed from portfolio constituents to ETF shares. Our results inform the design of synthetic securities, especially when derived from less liquid instruments.

Keywords: Exchange traded funds, ETF, market liquidity, law of one-price, arbitrage, ETF premium.

DOI: https://doi.org/10.17016/FEDS.2020.097

FEDS 2020-096
Price Discovery in the U.S. Treasury Cash Market: On Principal Trading Firms and Dealers

James Collin Harkrader and Michael Puglia


We explore the following question: does the trading activity of registered dealers on Treasury interdealer broker (IDB) platforms differ from that of principal trading firms (PTF), and if so, how and to what effect on market liquidity? To do so, we use a novel dataset that combines Treasury cash transaction reports from FINRA’s Trade Reporting and Compliance Engine (TRACE) and publicly available limit order book data from BrokerTec. We find that trades conducted in a limit order book setting have high permanent price impact when a PTF is the passive party, playing the role of liquidity provider. Conversely, we find that dealer trades have higher price impact when the dealer is the aggressive party, playing the role of liquidity taker. Trades in which multiple firms (whether dealers or PTFs) participate on one or both sides, however, have relatively low price impact. We interpret these results in light of theoretical models suggesting that traders with only a “small” informational advantage prefer to use (passive) limit orders, while traders with a comparatively large informational advantage prefer to use (aggressive) market orders. We also analyze the events that occurred in Treasury markets in March 2020, during the onset of the COVID-19 pandemic.

Keywords: Treasury markets, high frequency trading, market microstructure, price discovery, price impact, PTFs, dealers, TRACE, BrokerTec

DOI: https://doi.org/10.17016/FEDS.2020.096

FEDS 2020-095
Financial Conditions and Economic Activity: Insights from Machine Learning


Machine learning (ML) techniques are used to construct a financial conditions index (FCI). The components of the ML‐FCI are selected based on their ability to predict the unemployment rate one‐year ahead. Three lessons for macroeconomics and variable selection/dimension reduction with large datasets emerge. First, variable transformations can drive results, emphasizing the need for transparency in selection of transformations and robustness to a range of reasonable choices. Second, there is strong evidence of nonlinearity in the relationship between financial variables and economic activity—tight financial conditions are associated with sharp deteriorations in economic activity and accommodative conditions are associated with only modest improvements in activity. Finally, the ML‐FCI places sizable weight on equity prices and term spreads, in contrast to other measures. These lessons yield an ML‐FCI showing tightening in financial conditions before the early 1990s and early 2000s recessions, in contrast to the National Financial Conditions Index (NFCI).

Keywords: Big Data; Recession Prediction; Variable Selection

DOI: https://doi.org/10.17016/FEDS.2020.095

FEDS 2020-094
Price Level Risk and Some Long-Run Implications of Alternative Monetary Policy Strategies


This note focuses on the longer-run implications of alternative monetary policy strategies for the evolution of the price level. The analysis compares the properties of optimal policy in regimes ranging from pure inflation targeting (IT), to a form of weighted-average inflation targeting (WAIT), to pure price level targeting (PLT). Strategies such as WAIT and PLT tend to limit the downward drift in the path of the price level and also mitigate the uncertainty surrounding the expected path of the price level. The influence of alternative monetary policy strategies on the evolution of the price level may have some important long-run implications for entities or groups that rely heavily on long-term nominal debt. Some simple empirical estimates suggest the real value of existing Treasury debt could be boosted significantly in moving from a world in which the ZLB constraint rarely binds to one in which it regularly binds. Similarly, data from the Survey of Consumer Finances indicate that households at lower income levels, and particularly those with mortgage or educational loans outstanding, are exposed to significant price level risk. As a result, such households can experience a significant reduction in their real wealth, on average, in the transition to a world with frequently binding ZLB constraints. The WAIT and PLT regimes significantly mitigate these potential costs for these groups.

DOI: https://doi.org/10.17016/FEDS.2020.094

FEDS 2020-093
Financial Profiles of Workers Most Vulnerable to Coronavirus-Related Earnings Loss in the Spring of 2020

Brooke Helppie-McFall and Joanne W. Hsu


In spring 2020, the COVID-19 pandemic and related shutdowns had huge effects on unemployment. Using data from the Survey of Consumer Finances, we describe the financial profiles of US families whose workers were most vulnerable to coronavirus-related earnings losses in the spring of 2020, based on whether a particular worker was deemed "essential" and whether a worker's job could be conducted remotely. We use descriptive analytic techniques to examine how families' baseline financial situations would allow them to weather COVID-shutdown-related earnings losses. We find that families with non-teleworkable workers who were most vulnerable to layoff also had both demographic and financial profiles that are associated with greater vulnerability to income shocks: non-teleworkable families were more likely to be people of color and single wage-earners, and also to have less savings. The median non-teleworkable family, whether in non-essential or essential occupations, held only three weeks of income in savings, underscoring the importance of policy measures to blunt the financial effect of the COVID crisis.

Keywords: Savings, COVID-19, coronavirus, essential workers

DOI: https://doi.org/10.17016/FEDS.2020.093

FEDS 2020-092
Let's close the gap: Revising teaching materials to reflect how the Federal Reserve implements monetary policy

Jane Ihrig and Scott Wolla


The topic of the Federal Reserve’s (the Fed’s) implementation of monetary policy has a significant presence in economics textbooks as well as standards and guidelines for economics instruction. This presence likely reflects the fact that it is the implementation framework that helps ensure that the Fed’s desired level of its policy interest rate is transmitted to financial markets, which helps it steer the economy toward the Congressional dual mandate of maximum employment and price stability. Over the past decade or so, the Fed has purposefully shifted the way it implements monetary policy to an environment with ample reserves in the banking system, and it has introduced new policy tools along the way. This paper shows that, unfortunately, many teaching resources are not in sync with the Fed’s current framework. We review six, 2020 or 2021 edition, principles of economics textbooks, and we find they vary greatly in their coverage of the concepts associated with the way the Fed implements policy today and in the longer run. We provide recommendations on how the authors can improve the next editions of their textbooks. We also review standards and guidelines used by secondaryschool educators. All of these are out of date, and we provide proposals for how these materials can be updated.

Keywords: Federal Reserve, monetary policy, economic education, introductory economics, macroeconomics

DOI: https://doi.org/10.17016/FEDS.2020.092

FEDS 2020-091
Economics and Epidemics: Evidence from an Estimated Spatial Econ-SIR Model

Mark Bognanni, Doug Hanley, Daniel Kolliner, Kurt Mitman


Economic analysis of effective policies for managing epidemics requires an integrated economic and epidemiological approach. We develop and estimate a spatial, micro-founded model of the joint evolution of economic variables and the spread of an epidemic. We empirically discipline the model using new U.S. county-level data on health, mobility, employment outcomes, and non-pharmaceutical interventions (NPIs) at a daily frequency. Absent policy or medical interventions, the model predicts an initial period of exponential growth in new cases, followed by a protracted period of roughly constant case levels and reduced economic activity. Nevertheless, if vaccine development proved impossible, and suppression cannot entirely eradicate the disease, a utilitarian policymaker cannot improve significantly over the laissez-faire equilibrium by using lockdowns. Conversely, if a vaccine will arrive within two years, NPIs can improve upon the laissez-faire outcome by dramatically decreasing the number of infectious agents and keeping infections low until vaccine arrival. Mitigation measures that reduce viral transmission (e.g., mask-wearing) both reduce the virus’s spread and increase economic activity.

DOI: https://doi.org/10.17016/FEDS.2020.091

FEDS 2020-090
Raiders of the Lost High-Frequency Forecasts: New Data and Evidence on the Efficiency of the Fed's Forecasting

Andrew C. Chang and Trace J. Levinson


We introduce a new dataset of real gross domestic product (GDP) growth and core personal consumption expenditures (PCE) inflation forecasts produced by the staff of the Board of Governors of the Federal Reserve System. In contrast to the eight Greenbook forecasts a year the staff produces for Federal Open Market Committee (FOMC) meetings, our dataset has roughly weekly forecasts. We use these new data to study whether the staff forecasts efficiently and whether efficiency, or lack thereof, is time-varying. Prespecified regressions of forecast errors on forecast revisions show that the staff's GDP forecast errors correlate with its GDP forecast revisions, particularly for forecasts made more than two weeks from the start of a FOMC meeting, implying GDP forecasts exhibit time-varying inefficiency between FOMC meetings. We find some weaker evidence for inefficient inflation forecasts.

High frequency forecasts replication (.zip)

Keywords: Federal Reserve; Forecast efficiency; Information Rigidities; Highfrequency forecasts; Preanalysis plan; Preregistration plan; Real-time data.

DOI: https://doi.org/10.17016/FEDS.2020.090

FEDS 2020-089
Business Exit During the COVID-19 Pandemic: Non-Traditional Measures in Historical Context


Given lags in official data releases, economists have studied "alternative data" measures of business exit resulting from the COVID-19 pandemic. Such measures are difficult to understand without historical context, so we review official data on business exit in recent decades. Business exit is common in the U.S., with about 7.5 percent of firms exiting annually in recent years, and is countercyclical (particularly recently). Both the high level and the cyclicality of exit are driven by very small firms. We explore a range of alternative measures and indicators of business exit, including novel measures based on payroll events and phone-tracking data, and find tentative evidence that exit has been elevated during 2020. Evidence is somewhat mixed, however, and exiting businesses do not appear to represent a large share of U.S. employment.

DOI: https://doi.org/10.17016/FEDS.2020.089

FEDS 2020-088
Adverse Selection Dynamics in Privately-Produced Safe Debt Markets


Privately-produced safe debt is designed so that there is no adverse selection in trade. This is because no agent finds it profitable to produce private information about the debt’s backing and all agents know this (i.e., it is information-insensitive). But in some macro states, it becomes profitable for some agents to produce private information, and then the debt faces adverse selection when traded (i.e., it becomes information-sensitive). We empirically study these adverse selection dynamics in a very important asset class, collateralized loan obligations, a large symbiotic appendage of the regulated banking system, which finances loans to below investmentgrade firms.

Original paper: PDF

Keywords: Safe debt, adverse selection, information sensitivity, collateralized loan obligations

DOI: https://doi.org/10.17016/FEDS.2020.088r1

FEDS 2020-087
Central Bank Communication with a Financial Stability Objective


An endogenous financial crisis is introduced into the canonical model used to study central bank transparency. The central bank is endowed with private information about the real economy and credit conditions which jointly determine financial vulnerabilities. An optimal choice is made regarding whether to communicate this information to the public. A key finding is that the optimal communication strategy depends on the state of the credit cycle and the composition of shocks driving the cycle. From a policy perspective, this raises the possibility that central bank communication in the presence of a financial stability objective faces a time inconsistency problem.

Keywords: Financial stability report, Information disclosure, Survey of economic projections, Time inconsistency problem, Transparency

DOI: https://doi.org/10.17016/FEDS.2020.087

FEDS 2020-086
Banks, Non Banks, and Lending Standards


We study how competition between banks and non-banks affects lending standards. Banks have private information about some borrowers and are subject to capital requirements to mitigate risk-taking incentives from deposit insurance. Non-banks are uninformed and market forces determine their capital structure. We show that lending standards monotonically increase in bank capital requirements. Intuitively, higher capital requirements raise banks’ skin in the game and screening out bad projects assures positive expected lending returns. Non-banks enter the market when capital requirements are sufficiently high, but do not cause a deterioration in lending standards. Optimal capital requirements trade-off inefficient lending to bad projects under loose standards with inefficient collateral liquidation under tight standards.
Accessible materials (.zip)

Keywords: Lending standards, credit cycles, asymmetric information, non-banks, regulation

DOI: https://doi.org/10.17016/FEDS.2020.086

FEDS 2020-085
Estimates of r* Consistent with a Supply-Side Structure and a Monetary Policy Rule for the U.S. Economy


We estimate the natural rate of interest (r*) using a semi-structural model of the U.S. economy that jointly characterizes the trend and cyclical factors of key macroeconomic variables such as output, the unemployment rate, in ation, and short- and long-term interest rates. We specify a monetary policy rule and an equation that characterizes the 10-year Treasury yield to exploit the information provided by both interest rates to infer r*. However, the use of a monetary policy rule with a sample that spans the Great Recession and its aftermath poses a challenge because of the effective lower bound. We devise a Bayesian estimation technique that incorporates a Tobit-like specification to deal with the censoring problem. We compare and validate our model specifications using pseudo out-of-sample forecasting exercises and Bayes factors. Our results show that the smoothed value of r* declined sharply around the Great Recession, eventually falling below zero, and has remained negative since then. Our results also indicate that obviating the censoring would imply higher estimates of r* than otherwise.
Accessible materials (.zip)

Keywords: natural rate of interest, natural unemployment rate, output gap, shadow interest rate

DOI: https://doi.org/10.17016/FEDS.2020.085

FEDS 2020-084
Income in the Off-Season: Household Adaptation to Yearly Work Interruptions


Joblessness is highly seasonal. To analyze how households adapt to seasonal joblessness, we introduce a measure of seasonal work interruptions premised on the idea that a seasonal worker will tend to exit employment around the same time each year. We show that an excess share of prime-age US workers experience recurrent separations spaced exactly 12 months apart. These separations coincide with aggregate seasonal downturns and are concentrated in seasonally volatile industries. Examining workers most prone to seasonal work interruptions, we find that these workers incur large earnings losses during the off-season. Lost earnings are (i) driven mainly by repeated separations from the same employer; (ii) not recouped at other firms; (iii) partly offset by unemployment benefits; and (iv) amplified by concurrent drops in partners' earnings. On net, household income falls by about 80 cents for each $1 lost in own earnings.
Accessible materials (.zip)

Keywords: seasonality, seasonal employment, job loss, household income, household labor dynamics, unemployment, unemployment insurance

DOI: https://doi.org/10.17016/FEDS.2020.084

FEDS 2020-083
Pandemic Recession Dynamics: The Role of Monetary Policy in Shifting a U-Shaped Recession to a V-Shaped Rebound


COVID-19 has depressed economic activity around the world. The initial contraction may be amplified by the limited space for conventional monetary policy actions to support recovery implied by the low level of nominal interest rates recently. Model simulations assuming an initial contraction in output of 10 percent suggest several policy lessons. Adverse effects of constrained monetary policy space are large, changing a V-shaped rebound into a deep U-shaped recession absent large-scale Quantitative Easing (QE). Additionally, the medium-term scarring on economic potential can be large, and mitigation of such effects involves persistently accommodative monetary policy to support investment and long-run productive capacity. The simulations also illustrate the importance of coordinating QE and interest rate policy. Finally, the simulations, conducted within a model developed prior to the pandemic, illustrate limitations in economists’ understanding of QE and the channels through which shocks like a pandemic affect medium-term economic performance.
Accessible materials (.zip)

Keywords: Quantitative Easing, Effective Lower Bound, Unconventional Monetary Policy

DOI: https://doi.org/10.17016/FEDS.2020.083

FEDS 2020-082
Revealing Cluster Structures Based on Mixed Sampling Frequencies

Yeonwoo Rho, Yun Liu, and Hie Joo Ahn


This paper proposes a new nonparametric mixed data sampling (MIDAS) model and develops a framework to infer clusters in a panel regression with mixed frequency data. The nonparametric MIDAS estimation method is more flexible and substantially simpler to implement than competing approaches. We show that the proposed clustering algorithm successfully recovers true membership in the cross-section, both in theory and in simulations, without requiring prior knowledge of the number of clusters. This methodology is applied to a mixed-frequency Okun’s law model for state-level data in the U.S. and uncovers four meaningful clusters based on the dynamic features of state-level labor markets.

Accessible materials (.zip)

Keywords: Clustering; forecasting; mixed data sampling regression model; panel data; penal- ized regression.

DOI: https://doi.org/10.17016/FEDS.2020.082

FEDS 2020-081
Boom Town Business Dynamics

Ryan A. Decker, Meagan McCollum, and Gregory B. Upton Jr.


The shale oil and gas boom in the U.S. provides a unique opportunity to study economic growth in a "boom town" environment, to derive insights about economic expansions more generally, and to obtain clean identification of the causal effects of economic growth on specific margins of business adjustment. The creation of new business establishments--separate from the expansion of existing establishments--accounts for a disproportionate share of the multi-industry employment growth sparked by the shale boom, an intuitive but not inevitable empirical result that is broadly consistent with canonical models of firm dynamics. New firms, in particular, contribute nearly half of the cumulative economic growth resulting from the shale boom.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.081

FEDS 2020-080
Correcting for Endogeneity in Models with Bunching

Carolina Caetano, Gregorio Caetano, and Eric Nielsen


We show that in models with endogeneity, bunching at the lower or upper boundary of the distribution of the treatment variable may be used to build a correction for endogeneity. We derive the asymptotic distribution of the parameters of the corrected model, provide an estimator of the standard errors, and prove the consistency of the bootstrap. An empirical application reveals that time spent watching television, corrected for endogeneity, has roughly no net effect on cognitive skills and a significant negative net effect on non-cognitive skills in children.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.080

FEDS 2020-079
Investor Demands for Safety, Bank Capital, and Liquidity Measurement


We construct a model of a bank's optimal funding choice, where the bank negotiates with both safety-driven short-term bondholders and (mostly) risk-taking long-term bondholders. We establish that investor demands for safety create a negative relationship between the bank's capital choices and short-term funding, as well as negative relationships between capital and common measures of bank liquidity. Consistent with our model, our bank-level empirical analysis of these capital-liquidity tradeoffs show (1) that bank liquidity measures have a strong and negative relationship to its capital ratio for both large and small banks, and (2) that this relationship has weakened with the advent of stronger liquidity regulation. Our results suggest that the safety concerns of bank debt investors may underlie capital-liquidity tradeoffs and that a bank's share of collateralized short-term debt may be a more robust measure of bank liquidity.

Accessible materials (.zip)

Keywords: Safe assets, Bank Liquidity, Liquidity regulation, capitalization, bank balance sheet management

DOI: https://doi.org/10.17016/FEDS.2020.079

FEDS 2020-078
Out of Sight No More? The Effect of Fee Disclosures on 401(k) Investment Allocations

Mathias Kronlund, Veronika K. Pool, Clemens Sialm, and Irina Stefanescu


We examine the effects of a 2012 regulatory reform that mandated fee and performance disclosures for the investment options in 401(k) plans. We show that participants became significantly more attentive to expense ratios and short-term performance after the reform. The disclosure effects are stronger among plans with large average contributions per participant and weaker for plans with many investment options. Additionally, these results are not driven by secular changes in investor behavior or sponsor-initiated changes to the investment menus. Our findings suggest that providing salient fee and performance information can mitigate participants' inertia in retirement plans.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.078

FEDS 2020-077
Modeling the Consumption Response to the CARES Act

Christopher D. Carroll, Edmund Crawley, Jiri Slacalek, Matthew N. White


To predict the effects of the 2020 U.S. CARES Act on consumption, we extend a model that matches responses of households to past consumption stimulus packages. The extension allows us to account for two novel features of the coronavirus crisis. First, during the lockdown, many types of spending are undesirable or impossible. Second, some of the jobs that disappear during the lockdown will not reappear when it is lifted. We estimate that, if the lockdown is short-lived, the combination of expanded unemployment insurance benefits and stimulus payments should be sufficient to allow a swift recovery in consumer spending to its pre-crisis levels. If the lockdown lasts longer, an extension of enhanced unemployment benefits will likely be necessary if consumption spending is to recover.

Accessible materials (.zip)

Keywords: Consumption, Coronavirus, Stimulus

DOI: https://doi.org/10.17016/FEDS.2020.077

FEDS 2020-076
Intermeeting Rate Cuts as a Response to Rare Disasters


This paper measures the probability of rare disasters by measuring the probability of the intermeeting federal funds rate cuts they provoke. Differentiating between months with Federal Open Market Committee (FOMC) meetings and months without identifies excess returns on federal funds futures averaging -1.5 bps per horizon month-ahead at short horizons, corresponding to a 3-5% per month risk-neutral probability of an intermeeting rate cut. The excess returns differ between months with and without meetings, suggesting a positive risk premium associated with meetings. The federal funds excess returns explain a significant portion of equity excess returns, and hence the equity premium puzzle.

Accessible materials (.zip)

Keywords: Rare Disasters, Equity Premium, Risk Premium, Federal Funds Futures

DOI: https://doi.org/10.17016/FEDS.2020.076

FEDS 2020-075
Considerations Regarding Inflation Ranges


We consider three ways that a monetary policy framework may employ a range for inflation outcomes: (1) ranges that acknowledge uncertainty about inflation outcomes (uncertainty ranges), (2) ranges that define the scope for intentional deviations of inflation from its target (operational ranges), and (3) ranges over which monetary policy will not react to inflation deviations (indifference ranges). After defining these three ranges, we highlight a number of costs and benefits associated with each. Our discussion of the indifference range is accompanied by simulations from the FRB/US model, illustrating the potential for long-term inflation expectations to drift within the range.

Accessible materials (.zip)

Keywords: forward guidance, monetary policy.

DOI: https://doi.org/10.17016/FEDS.2020.075

FEDS 2020-074
Monetary Policy Strategies and Tools: Financial Stability Considerations

Jonathan Goldberg, Elizabeth Klee, Edward Simpson Prescott, and Paul Wood


This paper examines potential interactions between financial stability and the monetary policy strategies and tools considered in the Federal Reserve’s review of monetary policy strategy, tools, and communication practices. Achieving the Federal Reserve’s goals of full employment and price stability promotes financial stability. A key concern, however, is that with a low equilibrium real interest rate, a low policy rate will be necessary, and in turn, these low rates may contribute to an increase in financial system vulnerabilities. Our analysis suggests that there are typically significant macroeconomic and financial stability benefits of using these tools and strategies, but there are plausible situations in which financial vulnerabilities are such that it would be desirable to limit their use. A clear communications strategy can help minimize financial vulnerabilities. Should vulnerabilities arise, they are often best addressed with macroprudential tools.

Accessible materials (.zip)

Keywords: U.S. monetary policy, financial stability, macroprudential policy.

DOI: https://doi.org/10.17016/FEDS.2020.074

FEDS 2020-073
Distributional Considerations for Monetary Policy Strategy

Laura Feiveson, Nils Goernemann, Julie Hotchkiss, Karel Mertens, and Jae Sim


We show that makeup strategies, such as average inflation targeting and price-level targeting, can be more effective than a flexible inflationtargeting strategy in overcoming the obstacles created by the effective lower bound in a heterogeneous agent New Keynesian (HANK) model. We also show that the macroeconomic stabilization benefits from such alternative strategies can be substantially larger in a HANK environment than in a representative agent New Keynesian model. We argue that gains in employment outcomes from switching to an alternative strategy would generate disproportionate improvements for historically disadvantaged households and thus have potentially long-lasting effects on the economic well-being of these groups.

Accessible materials (.zip)

Keywords: heterogeneous agent New Keynesian model, representative agent New Keynesian model, effective lower bound, inequality, hand to mouth, average inflation targeting, price-level targeting.

DOI: https://doi.org/10.17016/FEDS.2020.073

FEDS 2020-072
Unemployment Rate Benchmarks

Richard K. Crump, Christopher J. Nekarda, and Nicolas Petrosky-Nadeau


This paper discusses various concepts of unemployment rate benchmarks that are frequently used by policymakers for assessing the current state of the economy as it relates to the pursuit of both price stability and maximum employment. In particular, we propose two broad categories of unemployment rate benchmarks: (1) a longer-run unemployment rate expected to prevail after adjusting to business cycle shocks and (2) a stable-price unemployment rate tied to inflationary pressures. We describes how various existing measures used as benchmark rates fit within this taxonomy with the goal of facilitating the use of a common set of terms for assessments of the current state of the economy and deliberations among policymakers.

Accessible materials (.zip)

Keywords: labor market, monetary policy, unemployment, business cycles.

DOI: https://doi.org/10.17016/FEDS.2020.072

FEDS 2020-071
Issues in the Use of the Balance Sheet Tool


This paper considers various ways of using balance sheet policy (BSP) to provide monetary policy stimulus, including the BSPs put in place by the Federal Reserve in the wake of the Global Financial Crisis, the choice between fixed-size and flow-based asset purchase programs, policies targeting interest rate levels rather than the quantity of asset purchases, and programs aimed at increasing more direct lending to households and firms. For each of these BSP options, we evaluate benefits and costs. We conclude by observing that BSPs’ relative effectiveness and thus optimal configuration will depend on the shocks affecting the economy. Consequently, it would be valuable for the Federal Reserve to keep a variety of tools at its disposal and employ the ones that best fit the situation that it faces.

Accessible materials (.zip)

Keywords: balance sheet policy, quantitative easing, yield curve control, credit easing, central bank lending authority.

DOI: https://doi.org/10.17016/FEDS.2020.071

FEDS 2020-070
Issues regarding the Use of the Policy Rate Tool

Jeffrey Campbell, Thomas B. King, Anna Orlik, and Rebecca Zarutskie


We review two nonstandard uses of the policy rate tool, which provide additional stimulus when interest rates are close to or at the effective lower bound—forward guidance and negative interest rate policy. In particular, we survey the use of these tools since the start of the Great Recession, review evidence of their effectiveness, and discuss key considerations that confront monetary policymakers while using them.

Accessible materials (.zip)

Keywords: monetary policy, effective lower bound, forward guidance, central bank communication, negative interest rate policy.

DOI: https://doi.org/10.17016/FEDS.2020.070

FEDS 2020-069
How Robust Are Makeup Strategies to Key Alternative Assumptions?

James Hebden, Edward P. Herbst, Jenny Tang, Giorgio Topa, and Fabian Winkler


We analyze the robustness of makeup strategies—policies that aim to offset, at least in part, past misses of inflation from its objective—to alternative modeling assumptions, with an emphasis on the role of inflation expectations. We survey empirical evidence on the behavior of shorter-run and long-run inflation expectations. Using simulations from the FRB/US macroeconomic model, we find that makeup strategies can moderately offset the real effects of adverse economic shocks, even when much of the public is uninformed about the monetary strategy. We also discuss the robustness of makeup strategies to alternative assumptions about the slope of the Phillips curve and the (mis)perception of economic slack.

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Keywords: monetary policy, effective lower bound, expectations.

DOI: https://doi.org/10.17016/FEDS.2020.069

FEDS 2020-068
Alternative Strategies: How Do They Work? How Might They Help?

Jonas Arias, Martin Bodenstein, Hess Chung, Thorsten Drautzburg, and Andrea Raffo


Several structural developments in the U.S. economy—including lower neutral interest rates and a flatter Phillips curve—have challenged the ability of the current monetary policy framework to deliver on the Federal Open Market Committee’s (FOMC) dual-mandate goals. This paper explores whether makeup strategies, in which policymakers seek to stabilize average inflation around the inflation target over some horizon, could strengthen the FOMC’s ability to fulfill its dual mandate. The quantitative analysis discussed here suggests that credible makeup strategies may provide some moderate stabilization gains. The practical implementation of these strategies, however, faces a number of challenges that would have to be surmounted for the full benefit of these strategies to be realized.

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Keywords: Inflation stabilization, effective lower bound, Taylor rule, alternative monetary policy strategies, monetary policy communication.

DOI: https://doi.org/10.17016/FEDS.2020.068

FEDS 2020-067
Strengthening the FOMC’s Framework in View of the Effective Lower Bound and Some Considerations Related to Time-Inconsistent Strategies

Fernando Duarte, Benjamin K. Johannsen, Leonardo Melosi, and Taisuke Nakata


We analyze the framework for monetary policy in view of the effective lower bound (ELB). We find that the ELB is likely to bind in most future recessions and propose some ways that theoretical models imply that the framework could be strengthened. We also discuss ways that commitment strategies, which are not part of the framework, may improve economic outcomes. These policies can suffer from a time-inconsistency problem, which we analyze.

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Keywords: Monetary policy, effective lower bound, forward guidance, balance sheet policies, commitment policies, time inconsistency.

DOI: https://doi.org/10.17016/FEDS.2020.067

FEDS 2020-066
Monetary Policy Tradeoffs and the Federal Reserve’s Dual Mandate

Andrea Ajello, Isabel Cairó, Vasco Cúrdia, Thomas A. Lubik, and Albert Queralto


Some key structural features of the U.S. economy appear to have changed in the recent decades, making the conduct of monetary policy more challenging. In particular, there is high uncertainty about the levels of the natural rate of interest and unemployment as well as about the effect of economic activity on inflation. At the same time, a prolonged period of below-target inflation has raised concerns about the unanchoring of inflation expectations at levels below the Federal Open Market Committee’s inflation target. In addition, a low natural rate of interest increases the probability of hitting the effective lower bound during a downturn. This paper studies how these factors complicate the attainment of the objectives specified in the Federal Reserve’s dual mandate in the context of a DSGE (dynamic stochastic general equilibrium) model, taking into account risk-management considerations. We find that these challenges may warrant pursuing more accommodative policy than would be desirable otherwise. However, such accommodative policy could be associated with concerns about risks to financial markets.
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Keywords: U.S. monetary policy, optimal policy, discretion.

DOI: https://doi.org/10.17016/FEDS.2020.066

FEDS 2020-065
Monetary Policy and Economic Performance since the Financial Crisis

Dario Caldara, Etienne Gagnon, Enrique Martínez-García, and Christopher J. Neely


We review macroeconomic performance over the period since the Global Financial Crisis and the challenges in the pursuit of the Federal Reserve’s dual mandate. We characterize the use of forward guidance and balance sheet policies after the federal funds rate reached the effective lower bound. We also review the evidence on the efficacy of these tools and consider whether policymakers might have used them more forcefully. Finally, we examine the post-crisis experience of other major central banks with these policy tools.
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Keywords: Global Financial Crisis 2007–09, monetary policy, effective lower bound, structural changes, forward guidance, balance sheet policies.

DOI: https://doi.org/10.17016/FEDS.2020.065

FEDS 2020-064
When it Rains it Pours: Cascading Uncertainty Shocks

Anthony M. Diercks, Alex Hsu, and Andrea Tamoni


We empirically document that serial uncertainty shocks are (1) common in the data and (2) have an increasingly stronger impact on the macroeconomy. In other words, a series of bad (positive) uncertainty shocks exacerbates the economic decline significantly. From a theoretical perspective, these findings are puzzling: existing benchmark models do not deliver the observed amplification. We show analytically that a state dependent precautionary motive with respect to uncertainty shocks is required. Our derivations suggest that the state dependent precautionary motive only shows up at fourth order approximations or higher. Fundamentally, in DSGE models solved with perturbations, agents have always possessed a state dependent precautionary motive but typical solu-tion methods were hiding this fact. Future studies need to consider solving the model via fourth (or higher) order perturbation in order to avoid understating the effect of uncertainty shocks that occur in succession.
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Keywords: Dynamic Equilibrium Economies; Stochastic Volatility; Perturbation.

DOI: https://doi.org/10.17016/FEDS.2020.064

FEDS 2020-063
The Consequences of Medicare Pricing: An Explanation of Treatment Choice


Primary care physicians (PCPs) provide more specialty procedures in less-urban areas, where specialists are fewer. Using a structural random-coefficient model and the demographic and time variation in the data, this paper shows that changes in policy-set reimbursements lead to a reallocation of the suddenly-more-remunerative procedures away from specialists and toward PCPs, and this effect is stronger, the more rural an area is. A reimbursement-unit increase for a given procedure leads to outside-metro PCPs gaining 7-15% market share more than metro PCPs in that procedure, at the expense of specialists. Small metropolitan areas and very rural areas are the most affected.
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Keywords: Primary care physicians; Specialists; Specialty procedures; Rural; Reallocation; Medicare; Fee-for-service.

DOI: https://doi.org/10.17016/FEDS.2020.063

FEDS 2020-062
Paying Too Much? Price Dispersion in the U.S. Mortgage Market

Neil Bhutta, Andreas Fuster, and Aurel Hizmo


We document wide dispersion in the mortgage rates that households pay on identical loans, and show that borrowers' financial sophistication is an important determinant of the rates obtained. We estimate a gap between the 10th and 90th percentile mortgage rate that borrowers with the same characteristics obtain for identical loans, in the same market, on the same day, of 54 basis points|equivalent to about $6,500 in upfront costs (points) for the average loan. Time-invariant lender attributes explain little of this rate dispersion, and considerable dispersion remains even within loan officer. Comparing the rates borrowers obtain to the real-time distribution of rates that lenders could offer for the same loan and borrower type, we find that borrowers who are likely to be the least financially savvy tend to substantially overpay relative to the rates available in the market. In the time series, the average overpayment decreases when overall market interest rates rise, suggesting that a rising level of borrowing costs encourages more search and negotiation. Furthermore, new survey data provide direct evidence that financial knowledge and shopping both affect the mortgage rates borrowers get, and that shopping activity increases with the level of market rates.
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DOI: https://doi.org/10.17016/FEDS.2020.062

FEDS 2020-061
Are Shadow Rate Models of the Treasury Yield Curve Structurally Stable?


We examine the structural stability of Gaussian shadow rate term structure models of Treasury yields over a sample that includes the period from 2008 onwards during which the U.S. policy rate was at its effective lower bound. After a conceptual discussion of several potential sources of a structural break in the context of the shadow rate model, we document various pieces of evidence for structural instability based on predictive tests and Lagrange multiplier tests, as well as with separate estimations of the pre-ELB and post-ELB subsamples. In order to overcome the diffculties associated with the latent-factor nature of the model in testing for a structural break, we focus on objects that can be given intuitive interpretation, such as principal components, or that are constructed to be invariant to factor rotations.

Keywords: Shadow rate term structure models, Treasury yields, ELB, structural break, structural instability, factor rotations, principal components

DOI: https://doi.org/10.17016/FEDS.2020.061

FEDS 2020-060
Supply-Side Effects of Pandemic Mortality: Insights from an Overlapping-Generations Model


We use an overlapping-generations model to explore the implications of mortality during pandemics for the economy's productive capacity. Under current epidemiological projections for the progression of COVID-19, our model suggests that mortality will have, in itself, at most small effects on output and factor prices. The reason is that projected mortality is small in proportion to the population and skewed toward individuals who are retired from the labor force. That said, we show that if the spread of COVID-19 is not contained, or if the ongoing pandemic were to follow a mortality pattern similar to the 1918–1920 Great Influenza pandemic, then the effects on the productive capacity would be economically significant and persist for decades.

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Keywords: Pandemics, potential output, real wage, equilibrium real interest rate, demographics

DOI: https://doi.org/10.17016/FEDS.2020.060

FEDS 2020-059
A New Daily Federal Funds Rate Series and History of the Federal Funds Market, 1928-1954

Sriya Anbil, Mark Carlson, Christopher Hanes, and David C. Wheelock


This article describes the origins and development of the federal funds market from its inception in the 1920s to the early 1950s. We present a newly digitized daily data series on the federal funds rate from April 1928 through June 1954. We compare the behavior of the funds rate with other money market interest rates and the Federal Reserve discount rate. Our federal funds rate series will enhance the ability of researchers to study an eventful period in U.S. financial history and to better understand how monetary policy was transmitted to banking and financial markets. For the 1920s and 1930s, our series is the best available measure of the overnight risk-free interest rate, better than the call money rate which many studies have used for that purpose. For the 1940s-1950s, our series provides new information about the transition away from wartime interest-rate pegs culminating in the 1951 Treasury-Federal Reserve Accord.

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Keywords: Federal funds rate, call loan rate, money market, Federal Reserve System

DOI: https://doi.org/10.17016/FEDS.2020.059

FEDS 2020-058
The Multiplier Effect of Education Expenditure

Maarten De Ridder, Simona M. Hannon, Damjan Pfajfar


This paper examines the short-run effects of federal education expenditures on local income. We exploit city-level variation in exposure to national changes in the $30-billion Federal Pell Grant Program, which is the largest program to help low-income students attend college in the U.S., to calculate fiscal multipliers of education expenditures. An increase in Pell grants by 1 percent of a city's income raises local income by 2.4 percent over the next two years. This multiplier effect is larger than estimates for military spending (1.5 on average). Multipliers are higher when grants are awarded to students at non-profit colleges, as for-profit colleges absorb most of the grant increases with raises in tuition. Multipliers are also higher during recessions than in expansions: Pell grants can be an effective tool for countercyclical policy that adds to already established benefits, such as, increasing the affordability of college and fostering longrun economic growth.

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DOI: https://doi.org/10.17016/FEDS.2020.058

FEDS 2020-057
Market Power, Inequality, and Financial Instability


Over the last four decades, the U.S. economy has experienced a few secular trends, each of which may be considered undesirable in some aspects: declining labor share; rising profit share; rising income and wealth inequalities; and rising household sector leverage, and associated financial instability. We develop a real business cycle model and show that the rise of market power of the firms in both product and labor markets over the last four decades can generate all of these secular trends. We derive macroprudential policy implications for financial stability.

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DOI: https://doi.org/10.17016/FEDS.2020.057

FEDS 2020-056
Optimal Dynamic Capital Requirements and Implementable Capital Buffer Rules

Matthew Canzoneri, Behzad Diba, Luca Guerrieri, Arsenii Mishin


We build a quantitatively relevant macroeconomic model with endogenous risk-taking. In our model, deposit insurance and limited liability can lead banks to make risky loans that are socially ineficient. This excessive risk-taking can be triggered by aggregate or sectoral shocks that reduce the return on safer loans. Excessive risk-taking can be avoided by raising bank capital requirements, but unnecessarily tight requirements lower welfare by limiting liquidity producing bank deposits. Consequently, optimal capital requirements are dynamic (or state contingent). We provide examples in which a Ramsey planner would raise capital requirements: (1) during a downturn caused by a TFP shock; (2) during an expansion caused by an investment specific shock; and (3) during an increase in market volatility that has little effect on the business cycle. In practice, the economy is driven by a constellation of shocks, and the Ramsey policy is probably beyond the policymaker's ken; so, we also consider implementable policy rules. Some rules can mimic the optimal policy rather well but are not robust to all the calibrations we consider. Basel III guidance calls for increasing capital requirements when the credit to GDP ratio rises, and relaxing them when it falls; this rule does not perform well. In fact, slightly elevated static capital requirements generally do about as well as any implementable rule.

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DOI: https://doi.org/10.17016/FEDS.2020.056

FEDS 2020-055
Reconciling Unemployment Claims with Job Losses in the First Months of the COVID-19 Crisis


In the spring of 2020, many observers relied heavily on weekly initial claims for unemployment insurance benefits (UI) to estimate contemporaneous reductions in US employment induced by the COVID-19 pandemic. Though UI claims provided a timely, high-frequency window into mounting layoffs, the cumulative volume of initial claims filed through the May reference week substantially exceeded realized reductions in payroll employment and likely contributed to the historically large discrepancy between consensus expectations of further April-to-May job losses and the strong job gains reflected in the May employment report. Analyzing the relationship between UI claims and underlying employment, we argue that insured unemployment—an alternative high-frequency indicator that responds to gross job gains as well as gross job losses—offers important advantages as a barometer of labor market conditions. Adjusting for reporting artifacts and for time lags between employment flows and associated claims, we show that insured unemployment comoved strongly with payroll employment throughout the first months of the pandemic, as it did during the Great Recession.

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DOI: https://doi.org/10.17016/FEDS.2020.055

FEDS 2020-054
The Hidden Heterogeneity of Inflation Expectations and its Implications

Lena Dräger, Michael J. Lamla, and Damjan Pfajfar


Using a new consumer survey dataset, we document a new dimension of heterogeneity in inflation expectations that has implications for consumption and saving decisions as well as monetary policy transmission. We show that German households with the same inflation expectations differently assess whether the level of expected inflation and of nominal interest rates is appropriate or too high/too low. The `hidden heterogeneity' in expectations stemming from these opinions is related to demographic characteristics and affects current and planned spending in addition to the Euler equation effect of the perceived real interest rate. Furthermore, these differences in opinions affect German households differently depending on whether they are renters or homeowners.

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DOI: https://doi.org/10.17016/FEDS.2020.054

FEDS 2020-053
A Crisis of Missed Opportunities? Foreclosure Costs and Mortgage Modification During the Great Recession

Stuart Gabriel, Matteo Iacoviello, and Chandler Lutz


We investigate the impact of Great Recession policies in California that substantially increased lender pecuniary and time costs of foreclosure. We estimate that the California Foreclosure Prevention Laws (CFPLs) prevented 250,000 California foreclosures (a 20% reduction) and created $300 billion in housing wealth. The CFPLs boosted mortgage modifications and reduced borrower transitions into default. They also mitigated foreclosure externalities via increased maintenance spending on homes that entered foreclosure. The CFPLs had minimal adverse side effects on the availability of mortgage credit for new borrowers. Altogether, findings suggest that policy interventions that keep borrowers in their homes may be broadly beneficial during times of widespread housing distress.

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DOI: https://doi.org/10.17016/FEDS.2020.053

FEDS 2020-052
Designing a Main Street Lending Facility


Banks add value by monitoring borrowers. High funding costs make banks reluctant to lend. A central bank can ease funding by purchasing loans, but cannot distinguish which loans require more or less monitoring, exposing it to adverse selection. A multi-tier loan pricing facility arises as the optimal institutional design setting both the purchase price and banks' risk retention for given loan characteristics. This design dominates uniform (flat) structure for loan purchases, provides the right incentives to banks and achieves maximum lending at lower rates to businesses. Both the multi-tier and flat structures deliver welfare gains compared to no intervention, but the relative gain between the two depends on three sufficient statistics: the share of loans requiring monitoring, the risk-retention ratio, and the liquidity premium.
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DOI: https://doi.org/10.17016/FEDS.2020.052

FEDS 2020-051
The Evolution of Price Discovery in an Electronic Market

Alain Chaboud, Erik Hjalmarsson, and Filip Zikes


We study the evolution of the price discovery process in the euro-dollar and dollar-yen currency pairs over a ten-year period on the EBS platform, a global trading venue used by both manual and automated traders. We find that the importance of market orders decreases sharply over that period, owing mainly to a decline in the information share from manual trading, while the information share of market orders from algorithmic and high-frequency traders remains fairly constant. At the same time, there is a substantial, but gradual, increase in the information share of limit orders. Price discovery also becomes faster, suggesting improvements in market efficiency. The results are consistent with theoretical predictions that in more efficient markets, informed traders tend to use more limit orders.
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Keywords: High-frequency trading, Limit orders, Price discovery

DOI: https://doi.org/10.17016/FEDS.2020.051

FEDS 2020-050
The Effect of the Central Bank Liquidity Support during Pandemics: Evidence from the 1918 Spanish Influenza Pandemic

Haelim Anderson, Jin-Wook Chang, and Adam Copeland


The coronavirus outbreak raises the question of how central bank liquidity support affects financial stability and promotes economic recovery. Using newly assembled data on cross-county flu mortality rates and state-charter bank balance sheets in New York, we investigate the effects of the 1918 Influenza Pandemic on the banking system and the role of the Federal Reserve during the pandemic. We find that banks located in more severely affected areas experienced deposit withdrawals. Banks which were members of the Federal Reserve were able to access central bank liquidity and so continue or even expand lending. Banks which were not members, however, did not borrow on the interbank market but rather curtailed lending, suggesting there was little-to-no pass-through of central bank liquidity. Further, in the counties most affected by the 1918 Influenza, even banks with direct access to the discount window liquidated assets so as to meet large deposit withdrawals, suggesting limits to the effectiveness of the liquidity provision by the Federal Reserve. Finally, we show that the pandemic caused only a short-term disruption on the financial sector. Over the long-term, deposits returned and banks restored their asset portfolios.
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Keywords: 1918 influenza, pandemics, financial stability, bank lending, economic recovery

DOI: https://doi.org/10.17016/FEDS.2020.050

FEDS 2020-049
Aggregate Demand and Aggregate Supply Effects of COVID-19: A Real-time Analysis

Geert Bekaert, Eric Engstrom, and Andrey Ermolov


We extract aggregate demand and supply shocks for the US economy from real-time survey data on inflation and real GDP growth using a novel identification scheme. Our approach exploits non-Gaussian features of macroeconomic forecast revisions and imposes minimal theoretical assumptions. After verifying that our results for U.S. post-World War II business cycle fluctuations are largely in line with the prevailing consensus, we proceed to study output and price fluctuations during the COVID-19 pandemic. We attribute two thirds of the decline in 2020:Q1 GDP to a negative shock to aggregate demand. In contrast, regarding the staggeringly large decline in GDP in 2020:Q2, we estimate two thirds of this shock was due to a reduction in aggregate supply. Statistical analysis suggests a slow recovery due to a persistent effects of the supply shock, but surveys suggest a somewhat faster rebound with a recovery in aggregate supply leading the way.
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DOI: https://doi.org/10.17016/FEDS.2020.049

FEDS 2020-048
Global Demand for Basket-Backed Stablecoins


We develop a model where persistent trade shocks create demand for a basket- backed stablecoin, such as Mark Carney's "synthetic hegemonic currency" or Facebook's recent proposal for Libra. In numerical simulations, we find four main results. First, because of general equilibrium effects of the basket currency on the volatility of currency values, overall demand for that currency is small. Second, despite scant holdings of the basket, its global reach may contribute to substantial increases in welfare if the basket is widely accepted, allowing it to complement holdings of sovereign currencies. Third, we calculate the welfare maximizing composition of the basket, finding that optimal weights depend on the pattern of international acceptance, but that basket composition does not significantly affect welfare. Fourth, despite potential welfare improvements, low demand for the basket currency from buyers limits sellers' incentives to invest in accepting it, suggesting that fears of a so-called global stablecoin replacing domestic sovereign currencies may be overstated.
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DOI: https://doi.org/10.17016/FEDS.2020.048

FEDS 2020-047
Macroeconomic Effects of Large-Scale Asset Purchases: New Evidence

Kyungmin Kim, Thomas Laubach, and Min Wei


We examine the macroeconomic effect of large-scale asset purchases (LSAPs) and forward guidance (FG) using a proxy structural VAR estimated on data through 2015, where the stance of the LSAP policy is measured using primary dealer expectations of the Federal Reserve's asset holdings. Monetary policy shocks are identified using instruments constructed from event study yield changes, and additional assumptions are employed to separately identify LSAP and FG shocks. We find that unexpected expansions in the Federal Reserve's asset holdings during the ZLB period between 2008 and 2015 had significant expansionary effects on the macroeconomy, with real activity and inflation rising and unemployment declining notably following the shock. The policy accommodation appears to be transmitted to the economy both through financial markets—including Treasury yields, credit spreads and equity prices—and through bank lending. The effects on Treasury yields and term premiums appear to be longer-lived than previously documented, while the effects on credit spreads and especially bank lending also appear persistent. These results appear fairly robust to alternative identification and econometric methodologies, alternative policy indicators and instruments, and controlling for any possible Federal Reserve information effect. A counterfactual analysis shows that absent the LSAP3 program implemented between late 2012 and 2014, CPI inflation would have been about 1 percentage point lower, while the unemployment rate would have been about 4 percentage points higher, by the end of 2015.
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DOI: https://doi.org/10.17016/FEDS.2020.047

FEDS 2020-046
ivcrc: An Instrumental Variables Estimator for the Correlated Random Coefficients Model

David Benson, Matthew A. Masten, Alexander Torgovitsky


We present the ivcrc command, which implements an instrumental variables (IV) estimator for the linear correlated random coefficients (CRC) model. This model is a natural generalization of the standard linear IV model that allows for endogenous, multivalued treatments and unobserved heterogeneity in treatment effects. The proposed estimator uses recent semiparametric identification results that allow for flexible functional forms and permit instruments that may be binary, discrete, or continuous. The command also allows for the estimation of varying coefficients regressions, which are closely related in structure to the proposed IV estimator. We illustrate this IV estimator and the ivcrc command by estimating the returns to education in the National Longitudinal Survey of Young Men.
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DOI: https://doi.org/10.17016/FEDS.2020.046

FEDS 2020-045
Can Forecast Errors Predict Financial Crises? Exploring the Properties of a New Multivariate Credit Gap


Yes, they can. I propose a new method to detect credit booms and busts from multivariate systems -- monetary Bayesian vector autoregressions. When observed credit is systematically higher than credit forecasts justified by real economic activity variables, a positive credit gap emerges. The methodology is tested for 31 advanced and emerging market economies. The resulting credit gaps fit historical evidence well and detect turning points earlier, outperforming the credit-to-GDP gaps in signaling financial crises, especially at longer horizons. The results survive in real time and can shed light on the drivers of credit booms.
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DOI: https://doi.org/10.17016/FEDS.2020.045

FEDS 2020-044
Housing Supply and Affordability: Evidence from Rents, Housing Consumption and Household Location

Raven Molloy, Charles G. Nathanson and Andrew Paciorek


We examine how housing supply constraints affect housing affordability, which we define as the quality-adjusted price of housing services. In our dynamic model, supply constraints increase the price of housing services by only half has much as the purchase price of a home, since the purchase price responds to expected future increases in rent as well as contemporaneous rent increases. Households respond to changes in the price of housing services by altering their housing consumption and location choices, but only by a small amount. We evaluate these predictions using common measures of housing supply constraints and data from US metropolitan areas from 1980 to 2016. We find sizeable effects of supply constraints on house prices, but modest-to-negligible effects on rent, lot size, structure consumption, location choice within metropolitan areas, sorting across metropolitan areas, and housing expenditures. We conclude that housing supply constraints distort housing affor dability, and therefore housing consumption and location decisions, by less than their estimated effects on house prices suggest.
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DOI: https://doi.org/10.17016/FEDS.2020.044

FEDS 2020-043
Wealth Distribution and Retirement Preparation Among Early Savers

Lindsay Jacobs, Elizabeth Llanes, Kevin Moore, Jeffrey Thompson, Alice Henriques Volz


This paper develops a new combined wealth measure using data from the Survey of Consumer Finances, by augmenting data on net worth with estimates of defined benefit (DB) pension wealth and expected Social Security wealth. We use this combined wealth concept to explore retirement preparation among groups of households in their pre-retirement years (40-49 and 50-59) and also to explore the concentration of wealth. We find evidence of moderate, but rising, shortfalls in retirement preparation. We also show that including DB pension and Social Security wealth results in markedly lower measures of wealth concentration. Trends toward higher concentration over time are also somewhat moderated.
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DOI: https://doi.org/10.17016/FEDS.2020.043

FEDS 2020-042
Post-crisis Signals in Securitization: Evidence from Auto ABS


We find significant evidence of asymmetric information and signaling in post-crisis offerings in the auto asset-backed securities (ABS) market. Using granular regulatory reporting data, we are able to directly measure private information and quantify its effect on signaling and pricing. We show that lenders "self-finance'' unobservably higher-quality loans by holding these loans for longer periods to signal private information. This signal is priced in initial offerings of auto ABS and accurately predicts ex-post loan performance. We also demonstrate that our results are robust to exogenous shifts in the demand and supply of auto loans. Despite an environment of post-crisis enhanced transparency and securitization standards, signaling may be motivated by inattentive investors and regulations enforcing "no adverse selection'' in constructing ABS.
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DOI: https://doi.org/10.17016/FEDS.2020.042

FEDS 2020-041
A Comparison of Living Standards Across the States of America

Elena Falcettoni and Vegard M. Nygaard


We use an expected utility framework to examine how living standards vary across the United States and how each state's living standards have evolved over time. Our welfare measure accounts for cross-state variations in mortality, consumption, education, inequality, and cost of living. We find that per capita income is a good indicator of living standards, with a correlation of 0.80 across states. Living standards in most states, however, appear closer to those in the richest states than their difference in per capita income would suggest. Whereas high-income states benefit from higher life expectancy, consumption, and college attainment, low-income states benefit from lower cost of living. All states experienced positive welfare growth, and hence rising living standards, between 1999 and 2015. The annual welfare growth rate, however, varied from 1.38 to 3.76 percent across states due to varying gains in life expectancy, consumption, and college attainment, with life ex pectancy accounting for 50.3 percent of the variation. Finally, the growth rate of per capita income is a poor proxy for how fast living standards are rising in a particular state since the correlation between welfare growth and per capita income growth is only 0.38, and deviations are often large.
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DOI: https://doi.org/10.17016/FEDS.2020.041

FEDS 2020-040
Bank Lending in the Knowledge Economy

Giovanni Dell'Ariccia, Dalida Kadyrzhanova, Camelia Minoiu, and Lev Ratnovski


We study the composition of bank loan portfolios during the transition of the real sector to a knowledge economy where firms increasingly use intangible capital. Exploiting heterogeneity in bank exposure to the compositional shift from tangible to intangible capital, we show that exposed banks curtail commercial lending and reallocate lending to other assets, such as mortgages. We estimate that the substantial growth in intangible capital since the mid-1980s explains around 30% of the secular decline in the share of commercial lending in banks' loan portfolios. We provide suggestive evidence that this reallocation increased the riskiness of banks' mortgage lending.
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DOI: https://doi.org/10.17016/FEDS.2020.040

FEDS 2020-039
Zeroing in on the Expected Returns of Anomalies

Andrew Y. Chen and Mihail Velikov


We zero in on the expected returns of long-short portfolios based on 120 stock market anomalies by accounting for (1) effective bid-ask spreads, (2) post-publication effects, and (3) the modern era of trading technology that began in the early 2000s. Net of these effects, the average anomaly's expected return is a measly 8 bps per month. The strongest anomalies return only 10-20 bps after accounting for data-mining with either out-of-sample tests or empirical Bayesian methods. Expected returns are negligible despite cost optimizations that produce impressive net returns in-sample and the omission of additional trading costs like price impact.
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DOI: https://doi.org/10.17016/FEDS.2020.039

FEDS 2020-038
Machine Learning, the Treasury Yield Curve and Recession Forecasting

Michael Puglia and Adam Tucker


We use machine learning methods to examine the power of Treasury term spreads and other financial market and macroeconomic variables to forecast US recessions, vis-à-vis probit regression. In particular we propose a novel strategy for conducting cross-validation on classifiers trained with macro/financial panel data of low frequency and compare the results to those obtained from standard k-folds cross-validation. Consistent with the existing literature we find that, in the time series setting, forecast accuracy estimates derived from k-folds are biased optimistically, and cross-validation strategies which eliminate data "peeking" produce lower, and perhaps more realistic, estimates of forecast accuracy. More strikingly, we also document rank reversal of probit, Random Forest, XGBoost, LightGBM, neural network and support-vector machine classifier forecast performance over the two cross-validation methodologies. That is, while a k-folds cross-validation indicates tha t the forecast accuracy of tree methods dominates that of neural networks, which in turn dominates that of probit regression, the more conservative cross-validation strategy we propose indicates the exact opposite, and that probit regression should be preferred over machine learning methods, at least in the context of the present problem. This latter result stands in contrast to a growing body of literature demonstrating that machine learning methods outperform many alternative classification algorithms and we discuss some possible reasons for our result. We also discuss techniques for conducting statistical inference on machine learning classifiers using Cochrane's Q and McNemar's tests; and use the SHapley Additive exPlanations (SHAP) framework to decompose US recession forecasts and analyze feature importance across business cycles.
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DOI: https://doi.org/10.17016/FEDS.2020.038

FEDS 2020-037
Equity Financing Risk

Mamdouh Medhat and Berardino Palazzo


A risk factor linked to aggregate equity issuance conditions explains the empirical performance of investment factors based on the asset growth anomaly of Cooper, Gulen, and Schill (2008). This new risk factor, dubbed equity financing risk (EFR) factor, subsumes investment factors in leading linear factor models. Most importantly, when substituted for investment factors, the EFR factor improves the overall pricing performance of linear factor models, delivering a significant reduction in absolute pricing errors and their associated t-statistics for several anomalies, including the ones related to R&D expenditures and cash-based operating profitability.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.037

FEDS 2020-036
Should Children Do More Enrichment Activities? Leveraging Bunching to Correct for Endogeneity

Carolina Caetano, Gregorio Caetano, and Eric Nielsen


We study the effects of enrichment activities such as reading, homework, and extracurricular lessons on children's cognitive and non-cognitive skills. We take into consideration that children forgo alternative activities, such as play and socializing, in order to spend time on enrichment. Our study controls for selection on unobservables using a novel approach which leverages the fact that many children spend zero hours per week on enrichment activities. At zero enrichment, confounders vary but enrichment does not, which gives us direct information about the effect of confounders on skills. Using time diary data available in the Panel Study of Income Dynamics (PSID), we find that the net effect of enrichment is zero for cognitive skills and negative for non-cognitive skills, which suggests that enrichment may be crowding out more productive activities on the margin. The negative effects on non-cognitive skills are concentrated in higher-income students in high school, consistent with elevated academic competition related to college admissions.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.036

FEDS 2020-035
Monetary Policy, Self-Fulfilling Expectations and the U.S. Business Cycle


I estimate a medium-scale New-Keynesian model and relax the conventional assumption that the central bank adopted an active monetary policy by pursuing inflation and output stability over the entire post-war period. Even after accounting for a rich structure, I find that monetary policy was passive prior to the Volcker disinflation. Sunspot shocks did not represent quantitatively relevant sources of volatility. By contrast, such passive interest rate policy accommodated fundamental productivity and cost shocks that de-anchored inflation expectations, propagated via self-fulfilling inflation expectations and constituted the primary sources of the run-up in inflation from the 1960s through the late 1970s.
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Keywords: Monetary policy, business cycle, expectations, indeterminacy, Bayesian methods

DOI: https://doi.org/10.17016/FEDS.2020.035

FEDS 2020-034
Branching Networks and Geographic Contagion of Commodity Price Shocks


This paper studies the role of banks' branching networks in propagating the oil shocks. Banks that were exposed to the oil shocks through their operations in oil-concentrated counties experienced a liquidity drainage in the form of a declining amount of demand deposit inflow as well as an increasing percentage of troubled loans. Banks were forced to sell liquid assets, and contracted lending to small businesses and mortgage borrowers in counties that were not directly affected by the oil shocks. The effect is magnified when banks do not have strong community ties, but is mitigated if banks' branching network is sufficiently dispersed. I also find the decline in local credit supply cannot be completely offset by healthy competing banks' increased lending, providing fresh evidence from the perspective of bank competition.
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DOI: https://doi.org/10.17016/FEDS.2020.034

FEDS 2020-033
Health Insurance and Hospital Supply: Evidence from 1950s Coal Country

Theodore F. Figinski and Erin Troland


The United States government spends billions on public health insurance and has funded a number of programs to build health care facilities. However, the government runs these two types of programs separately: in different places, at different times, and for different populations. We explore whether access to both health insurance and hospitals can improve health outcomes and access to health care. We analyze a coal mining union health insurance program in 1950s Appalachia with and without a complementary hospital construction program. Our results show that the union insurance alone increased hospital births and reduced infant mortality. Once the union hospitals opened, however, the insurance and the hospitals together substantially increased the net amount of hospital beds and health care employees, with limited crowd-out of existing private hospitals. Our results suggest that hospitals can complement health insurance in underserved areas.
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DOI: https://doi.org/10.17016/FEDS.2020.033

FEDS 2020-032
Monetary Policy Uncertainty and Monetary Policy Surprises


Monetary policy uncertainty affects the transmission of monetary policy shocks to longer-term nominal and real yields. For a given monetary policy shock, the reaction of yields is more pronounced when the level of monetary policy uncertainty is low. Primary dealers and other investors adjust their interest rate positions more when monetary policy uncertainty is low than when uncertainty is high. These portfolio adjustments likely explain the larger pass-through of a monetary policy shock to bond yields when uncertainty is low. These findings shed new light on the role that monetary policy uncertainty plays in the transmission of monetary policy to financial markets.
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Keywords: Monetary policy surprises, monetary policy uncertainty, interest rates, primary dealers

DOI: https://doi.org/10.17016/FEDS.2020.032

FEDS 2020-031
Social Distancing and Supply Disruptions in a Pandemic

Martin Bodenstein, Giancarlo Corsetti, and Luca Guerrieri


Drastic public health measures such as social distancing or lockdowns can reduce the loss of human life by keeping the number of infected individuals from exceeding the capacity of the health care system but are often criticized because of the social and the economic cost they entail. We question this view by combining an epidemiological model, calibrated to capture the spread of the COVID-19 virus, with a multisector model, designed to capture key characteristics of the U.S. Input Output Tables. Our two-sector model features a core sector that produces intermediate inputs not easily replaced by inputs from the other sector, subject to minimum-scale requirements. We show that, by affecting workers in this core sector, the high peak of an infection not mitigated by social distancing may cause very large upfront economic costs in terms of output, consumption and investment. Social distancing measures can reduce these costs, especially if skewed towards non-core industries and occupations with tasks that can be performed from home, helping to smooth the surge in infections among workers in the core sector.
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Keywords: Infectious disease, epidemic, recession, COVID-19.

DOI: https://doi.org/10.17016/FEDS.2020.031

FEDS 2020-030
Tracking Labor Market Developments during the COVID-19 Pandemic: A Preliminary Assessment


Many traditional official statistics are not suitable for measuring high-frequency developments that evolve over the course of weeks, not months. In this paper, we track the labor market effects of the COVID-19 pandemic with weekly payroll employment series based on microdata from ADP. These data are available essentially in real-time, and allow us to track both aggregate and industry effects. Cumulative losses in paid employment through April 4 are currently estimated at 18 million; just during the two weeks between March 14 and March 28 the U.S. economy lost about 13 million paid jobs. For comparison, during the entire Great Recession less than 9 million private payroll employment jobs were lost. In the current crisis, the most affected sector is leisure and hospitality, which has so far lost or furloughed about 30 percent of employment, or roughly 4 million jobs.
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DOI: https://doi.org/10.17016/FEDS.2020.030

FEDS 2020-029
"Revitalize or Stabilize": Does Community Development Financing Work?


Banks in the United States originate $100 billion in community development loans every year and hold a similar amount of community development investments on their balance sheets. A number of federal place-based policies encourage the provision of these loans and investments to promote growth, employment and the availability of affordable housing to disadvantaged communities. Research into the effectiveness of privately supplied community development financing has been hampered, however, by the lack of comprehensive data on banks' community development activities at a local level. Hand collected data from thousands of Community Reinvestment Act performance evaluations fill this gap. Using these data, the effect of the supply of community development funding on local economic outcomes is estimated. Endogeneity of community development financing to local demand factors is addressed, exploiting the fact that banks exhibit fixed tendencies to engage in community developme nt financing across markets. Shifts in the share of local deposit markets toward banks with a greater tendency to supply community development loans are associated with subsequent expansion in total employment and wages paid. Estimates suggest $56,000 in community development lending is required to create one job, on net. There is no measurable effect on the supply of affordable housing or the growth of house prices. Counties experiencing a shift in local deposit market shares toward community development intensive banks were on similar pre-trends as the rest of the country in the years prior to the shift, as measured across a range of economic and credit market outcomes.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.029

FEDS 2020-028
Sowing the Seeds of Financial Imbalances: The Role of Macroeconomic Performance


The seeds of financial imbalances are sown in times of buoyant economic growth. We study the link between macroeconomic performance and financial imbalances, focusing on the experience of the United States since the 1960s. We first follow a narrative approach to review historical episodes of significant financial imbalances and find that the onset of financial disturbances typically occurs when the economy is running hot. We then look for evidence of a statistical link between measures of macroeconomic conditions and financial imbalances. In our in-sample analysis, we find that strong economic growth is followed by a build-up of financial imbalances across all dimensions of the National Financial Conditions Index. In our out-of-sample analysis, we find that the link between strong economic performance and increases in nonfinancial leverage is particularly strong and robust. Using a structural VAR identified with narrative sign restrictions, we also demonstrate that business cycle shocks are important drivers of non financial leverage.
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Keywords: Economic Performance; Nonfinancial Leverage; Financial Imbalances; Financial Stability; Forecasting; VARs; Sign Restrictions; Narrative.

DOI: https://doi.org/10.17016/FEDS.2020.028

FEDS 2020-027
Dynamic Beveridge Curve Accounting


We develop a dynamic decomposition of the empirical Beveridge curve, i.e., the level of vacancies conditional on unemployment. Using a standard model, we show that three factors can shift the Beveridge curve: reduced-form matching efficiency, changes in the job separation rate, and out-of-steady-state dynamics. We find that the shift in the Beveridge curve during and after the Great Recession was due to all three factors, and each factor taken separately had a large effect. Comparing the pre-2010 period to the post-2010 period, a fall in matching efficiency and out-of-steady-state dynamics both pushed the curve upward, while the changes in the separations rate pushed the curve downward. The net effect was the observed upward shift in vacancies given unemployment. In previous recessions changes in matching efficiency were relatively unimportant, while dynamics and the separations rate had more impact. Thus, the unusual feature of the Great Recession was the deterioration in matching efficiency, while separations and dynamics have played significant, partially offsetting roles in most downturns. The importance of these latter two margins contrasts with much of the literature, which abstracts from one or both of them. We show that these factors affect the slope of the empirical Beveridge curve, an important quantity in recent welfare analyses estimating the natural rate of unemployment.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.027

FEDS 2020-026
When is the Fiscal Multiplier High? A Comparison of Four Business Cycle Phases

Travis Berge, Maarten De Ridder and Damjan Pfajfar


We synthesize the recent, at times conflicting, empirical literature regarding whether fiscal policy is more effective during certain points in the business cycle. Evidence of state dependence in the multiplier depends critically on how the business cycle is defined. Estimates of the fiscal multiplier do not change when the unemployment rate is above or below its trend. However, we find that the multiplier is higher when the unemployment rate is increasing relative to when it is decreasing. This result holds using both a long time-series at the U.S. national level and for a panel of U.S. states.
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DOI: https://doi.org/10.17016/FEDS.2020.026

FEDS 2020-025
Costly Commuting and the Job Ladder


Even though workers in the UK spent just 1,000 pounds on commuting in 2017, the economic loss may be far higher because of the congestion externality arising from the way in which one worker's commute affects the commuting time of others. I provide empirical evidence that commuting time affects job acceptance, pointing to large indirect costs of congestion. To interpret the empirical facts and quantify the costs of congestion, I build a model featuring a frictional labor market within a metropolitan area. By endogenizing commuting congestion in a labor search model, the model connects labor market responses to urban policies. Workers evaluate job offers based on their productivity and commuting costs, taking congestion as given, but by accepting and commuting to distant jobs, affect other workers' labor market outcomes. Through this mechanism, equilibrium moving decisions, housing rent, and wages are tightly linked to congestion. Calibrating the model to the local la bor market around London, I show that the effect of the congestion externality is to significantly decrease welfare and increase wage inequality. I quantify the effects of a congestion tax on labor market outcomes, and show that the welfare-maximizing tax has substantial negative effects on inequality, but comes at a cost of higher unemployment.
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DOI: https://doi.org/10.17016/FEDS.2020.025

FEDS 2020-024
Common and idiosyncratic inflation


We use a dynamic factor model to disentangle changes in prices due to economy-wide (common) shocks, from changes in prices due to idiosyncratic shocks. Using 146 disaggregated individual price series from the U.S. PCE price index, we find that most of the fluctuations in core PCE prices observed since 2010 have been idiosyncratic in nature. Moreover, we find that common core inflation responds to economic slack, while the idiosyncratic component does not. That said, even after filtering out idiosyncratic factors, the estimated Phillips curve is extremely flat post-1995. Therefore, our results suggest that the flattening of the Phillips curve is the result of macroeconomic forces.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.024

FEDS 2020-023
Online Estimation of DSGE Models

Michael Cai, Marco Del Negro, Edward Herbst, Ethan Matlin, Reca Sarfati, and Frank Schorfheide


This paper illustrates the usefulness of sequential Monte Carlo (SMC) methods in approximating DSGE model posterior distributions. We show how the tempering schedule can be chosen adaptively, document the accuracy and runtime benefits of generalized data tempering for "online" estimation (that is, re-estimating a model asnew data become available), and provide examples of multimodal posteriors that are well captured by SMC methods. We then use the online estimation of the DSGE model to compute pseudo-out-of-sample density forecasts and study the sensitivity ofthe predictive performance to changes in the prior distribution. We find that making priors less informative (compared to the benchmark priors used in the literature) by increasing the prior variance does not lead to a deterioration of forecast accuracy.
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DOI: https://doi.org/10.17016/FEDS.2020.023

FEDS 2020-022
The Fed's "Ample-Reserves" Approach to Implementing Monetary Policy


We describe the Federal Reserve's (the Fed's) approach to implementing monetary policy in an ample-reserves regime. We use a stylized model to explain the factors the Fed considers and the tools it uses to ensure interest rate control when the quantity of reserves is ample. Then, we take a close look at the Fed's experience operating in this regime in the post-crisis period, both as it has raised and lowered its policy rate. Looking ahead, we highlight some considerations relevant for maintaining a level of reserves consistent with the efficient and effective implementation of monetary policy, and conclude with an overview of the benefits of an ample-reserves regime. This primer is intended to enhance discussions and understanding of the Fed's actions and communications regarding monetary policy implementation, as many resources on this topic may be out of date given the recent evolution of the policy environment.
Accessible materials (.zip)

Note: This paper was reposted on March 6, 2020, to correct typos on pages 22 and 30.

DOI: https://doi.org/10.17016/FEDS.2020.022

FEDS 2020-021
The Increasing Deflationary Influence of Consumer Digital Access Services

David M. Byrne and Carol A. Corrado


Consumer digital access services—internet, mobile phone, cable TV, and streaming—accounted for over 2 percent of U.S. household consumption in 2018. We construct prices for these services using direct measures of volume (data transmitted, talk time, and hours of programming). Our price index fell 12 percent per year from 1988 to 2018 while official prices moved up modestly. Using our digital services index, we estimate total personal consumption expenditure (PCE) prices have risen nearly 1/2 percentage point slower than the official index since 2008. Importantly, the spread between alternative and official PCE price inflation has increased noticeably over time.
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Original paper: PDF | Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.021r1

FEDS 2020-020
Monetary Policy Implementation with an Ample Supply of Reserves

Gara Afonso, Kyungmin Kim, Antoine Martin, Ed Nosal, Simon Potter, and Sam Schulhofer-Wohl


Methods of monetary policy implementation continue to change. The level of reserve supply—scarce, abundant, or somewhere in between—has implications for the efficiency and effectiveness of an implementation regime. The money market events of September 2019 highlight the need for an analytical framework to better understand implementation regimes. We discuss major issues relevant to the choice of an implementation regime, using a parsimonious framework and drawing from the experience in the United States since the 2007-09 financial crisis. We find that the optimal level of reserve supply likely lies somewhere between scarce and abundant reserves, thus highlighting the benefits of implementation with what could be called "ample" reserves. The Federal Reserve's announcement in October 2019 that it would maintain a level of reserve supply greater than the one that prevailed in early September is consistent with the implications of our framework.
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DOI: https://doi.org/10.17016/FEDS.2020.020

FEDS 2020-019
Capacity Choice, Monetary Trade, and the Cost of Inflation

Garth Baughman and Stanislav Rabinovich


Firms often make production decisions before meeting a buyer. We incorporate this often-overlooked fact into an otherwise standard monetary search model and show that it has important implications for the set of equilibria, efficiency, and the cost of inflation. Our model features a strategic complementarity between the buyers' ex ante choice of money balances and sellers' ex ante choice of productive capacity. When resale value of unsold inventories is high, sellers carry excess capacity and the equilibrium is unique. But, when resale value is low, there is a continuum of equilibria, all of which are inefficient and welfare-ranked. Effects of inflation are highly nonlinear. When inflation is high, the buyer's money holdings bind, and inflation therefore reduces trade through a standard real-balance channel. When inflation is low, the seller's capacity constraint binds, real balances have no effect at the margin, and inflation has no effect on output or welfare.
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DOI: https://doi.org/10.17016/FEDS.2020.019

FEDS 2020-018
Technological Innovation and Discrimination in Household Finance

Adair Morse and Karen Pence


Technology has changed how discrimination manifests itself in financial services. Replacing human discretion with algorithms in decision-making roles reduces taste-based discrimination, and new modeling techniques have expanded access to financial services to households who were previously excluded from these markets. However, algorithms can exhibit bias from human involvement in the development process, and their opacity and complexity can facilitate statistical discrimination inconsistent with antidiscrimination laws in several aspects of financial services provision, including advertising, pricing, and credit-risk assessment. In this chapter, we provide a new amalgamation and analysis of these developments, identifying five gateways whereby technology induces discrimination to creep into financial services. We also consider how these technological changes in finance intersect with existing discrimination and data privacy laws, leading to our contribution of four fron tlines of regulation. Our analysis concludes that the net effect of innovation in technological finance on discrimination is ambiguous and depends on the future choices made by policymakers, the courts, and firms.
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Keywords: Discrimination, fair lending, statistical discrimination, FinTech, taste-based preferences, algorithmic decision-making, proxy variables, big data

DOI: https://doi.org/10.17016/FEDS.2020.018

FEDS 2020-017
Changing Stability in U.S. Employment Relationships: A Tale of Two Tails

Raven Molloy, Christopher L. Smith, and Abigail Wozniak


We confront two seemingly-contradictory observations about the US labor market: the rate at which workers change employers has declined since the 1980s, yet there is a commonly expressed view that long-term employment relationships are more difficult to attain. We reconcile these observations by examining how the distribution of employment tenure has changed in aggregate and for various demographic groups. We show that the fraction of workers with short tenure (less than a year) has been falling since the 1980s, consistent with the decline in job changing. Meanwhile, the fraction of workers with long tenure (20 years or more) has been rising modestly owing to an increase in long tenure for women and the ageing of the population. Long tenure has declined markedly among older men; this trend may have spurred popular perceptions that long-term employment is less common than in the past. The decline in long-tenure for men appears due to an increase in mid-career separa tions that reduce the likelihood of reaching long-tenure, rather than an increase in late-career separations. Nevertheless, survey evidence indicates that these changes in employment relationships are not associated with heightened concerns about job insecurity or decreases in job satisfaction as reported by workers. The decline in short-tenure is widespread, associated with fewer workers cycling among briefly-held jobs, and coincides with an increase in perceived job security among short tenure workers.

DOI: https://doi.org/10.17016/FEDS.2020.017

FEDS 2020-016
Financial Stability Committees and Basel III Macroprudential Capital Buffers

Rochelle M. Edge and J. Nellie Liang


We evaluate how a country’s governance structure for macroprudential policy affects its implementation of Basel III macroprudential capital buffers. We find that the probabilities of using the countercyclical capital buffer (CCyB) are higher in countries that have financial stability committees (FSCs) with stronger governance mechanisms and fewer agencies, which reduces coordination problems. These higher probabilities are more sensitive to credit growth, consistent with the CCyB being used to mitigate systemic risk. A country’s probability of using the CCyB is even higher when the FSC or ministry of finance has direct authority to set the CCyB, perhaps because setting the CCyB involves establishing a new macro-financial analytical process to regularly assess systemic risks and allows these new entities to influence the process. These results are consistent with elected officials creating the FSCs with the strongest governance and fewer agencies for functional delegati on reasons, but most FSCs are created for symbolic political reasons.

Accessible version (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.016

FEDS 2020-015
Primer on the Forward-Looking Analysis of Risk Events (FLARE) Model: A Top-Down Stress Test Model

Sergio Correia, Kevin F. Kiernan, Matthew P. Seay and Cindy M. Vojtech


This technical note describes the Forward-Looking Analysis of Risk Events (FLARE) model, which is a top-down model that helps assess how well the banking system is positioned to weather exogenous macroeconomic shocks. FLARE estimates banking system capital under varying macroeconomic scenarios, time horizons, and other systemic shocks.

Note: On February 14, 2020, this paper was updated to include additional acknowledgements.

Accessible version (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.015

FEDS 2020-014
Forward-Looking Monetary Policy and the Transmission of Conventional Monetary Policy Shocks

Chunya Bu, John Rogers, and Wenbin Wu


Standard structural VAR models and estimation using Romer and Romer (2004) monetary policy shocks show that, in samples after the 1980s, a contractionary conventional monetary policy shock generates smaller and sometimes perversely-signed impulse responses compared to earlier samples. Using insights from the central bank information effects literature, we show that the analyses producing these results suffer from an omitted variables problem related to forward-looking information emanating from Federal Reserve forecasts. Transmission of conventional monetary policy shocks takes on the standard signs, and is typically significant, once Fed forward-looking information is taken into account. This reconciliation does not follow from adding private sector forecasts to the estimation frameworks.

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DOI: https://doi.org/10.17016/FEDS.2020.014

FEDS 2020-013
Inflation at Risk


We investigate how macroeconomic drivers affect the predictive inflation distribution as well as the probability that inflation will run above or below certain thresholds over the near term. This is what we refer to as Inflation-at-Risk–a measure of the tail risks to the inflation outlook. We find that the recent muted response of the conditional mean of inflation to economic conditions does not convey an adequate representation of the overall pattern of inflation dynamics. Analyzing data from the 1970s reveals ample variability in the conditional predictive distribution of inflation that remains even when focusing on the post-2000 period of stable and low mean inflation. We also document that in the United States and in the Euro Area tight financial conditions carry substantial downside inflation risks, a feature overlooked by much of the literature. Our paper offers a new empirical perspective to existing macroeconomic models, showing that changes in credit conditions are also key to understand the dynamics of the inflation tails.

Accessible version (.zip)

Keywords: Quantile Regression, Inflation Risks.

DOI: https://doi.org/10.17016/FEDS.2020.013

FEDS 2020-012
Time-varying uncertainty of the Federal Reserve's output gap estimate


What is the output gap and when do we know it? A factor stochastic volatility model estimates the common component to forecasts of the output gap produced by the staff of the Federal Reserve, its time-varying volatility, and time-varying, horizon-specific forecast uncertainty. The common factor to these forecasts is highly procyclical, and unexpected increases to the common factor are associated with persistent responses in other macroeconomic variables. However, output gap estimates are very uncertain, even well after the fact. Output gap uncertainty increases around business cycle turning points. Lastly, increased macroeconomic uncertainty, as measured by the output gap's time-varying volatility, produces pronounced negative responses to other macroeconomic variables.

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DOI: https://doi.org/10.17016/FEDS.2020.012

FEDS 2020-011
Evaluating the Success of President Johnson's War on Poverty: Revisiting the Historical Record Using a Full-Income Poverty Measure

Richard V. Burkhauser, Kevin Corinth, James Elwell, and Jeff Larrimore


We evaluate progress in President's Johnson's War on Poverty. We do so relative to the scientifically arbitrary but policy relevant 20 percent baseline poverty rate he established for 1963. No existing poverty measure fully captures poverty reductions based on the standard that President Johnson set. To fill this gap, we develop a Full-income Poverty Measure with thresholds set to match the 1963 Official Poverty Rate. We include cash income, taxes, and major in-kind transfers and update poverty thresholds for inflation annually. While the Official Poverty Rate fell from 19.5 percent in 1963 to 12.3 percent in 2017, our Full-income Poverty Rate based on President Johnson's standards fell from 19.5 percent to 2.3 percent over that period. Today, almost all Americans have income above the inflation-adjusted thresholds established in the 1960s. Although expectations for minimum living standards evolve, this suggests substantial progress combatting absolute poverty since the War on Poverty began.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.011

FEDS 2020-010
Bias in Local Projections

Edward P. Herbst and Benjamin K. Johannsen


Local projections (LPs) are a popular tool in macroeconomic research. We show that LPs are often used with very small samples in the time dimension. Consequently, LP point estimates can be severely biased. We derive simple expressions for this bias and propose a way to bias-correct LPs. Small sample bias can also lead autocorrelation-robust standard errors to dramatically understate sampling uncertainty. We argue they should be avoided in LPs like the ones we study. Using identified monetary policy shocks, we demonstrate that the bias in point estimates can be economically meaningful and the bias in standard errors can affect inference.

Original paper: PDF | Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.010r1

FEDS 2020-009
Central Clearing and Systemic Liquidity Risk

Thomas King, Travis D. Nesmith, Anna Paulson, and Todd Prono


By stepping between bilateral counterparties, a central counterparty (CCP) transforms credit exposure. CCPs generally improve financial stability. Nevertheless, large CCPs are by nature concentrated and interconnected with major global banks. Moreover, although they mitigate credit risk, CCPs create liquidity risks, because they rely on participants to provide cash. Such requirements increase with both market volatility and default; consequently, CCP liquidity needs are inherently procyclical. This procyclicality makes it more challenging to assess CCP resilience in the rare event that one or more large financial institutions default. Liquidity-focused macroprudential stress tests could help to assess and manage this systemic liquidity risk.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.009

FEDS 2020-008
Treasury safety, liquidity, and money premium dynamics: Evidence from recent debt limit impasses


Treasury securities normally possess unparalleled safety and liquidity and, consequently, carry a money premium. We use recent debt limit impasses, which temporarily increased the riskiness of Treasuries, to investigate the relationship between the money premium, safety, and liquidity. Our results shed light on Treasury market dynamics specifically, and debt more generally. We first establish that a decline in the perceived safety of Treasuries erodes the money premium at all times. Meanwhile, changes in liquidity only affected the money premium during the impasses. Next, we show that Treasury safety and liquidity dynamics are generally consistent with the theory of the information sensitivity of debt.

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DOI: https://doi.org/10.17016/FEDS.2020.008

FEDS 2020-007
Do Minorities Pay More for Mortgages?


We test for racial discrimination in the prices charged by mortgage lenders. We construct a unique dataset where we observe all three dimensions of a mortgage's price: the interest rate, discount points, and fees. While we find statistically significant gaps by race and ethnicity in interest rates, these gaps are offset by differences in discount points. We trace out point-rate schedules and show that minorities and whites face identical schedules, but sort to different locations on the schedule. Such sorting may reflect systematic differences in liquidity or preferences. Finally, we find no differences in total fees by race or ethnicity.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.007

FEDS 2020-006
Approximately Right?: Global v. Local Methods for Open-Economy Models with Incomplete Markets

Oliver de Groot, C. Bora Durdu and Enrique G. Mendoza


Global and local methods are widely used in international macroeconomics to analyze incomplete-markets models. We study solutions for an endowment economy, an RBC model and a Sudden Stops model with an occasionally binding credit constraint. First-order, second-order, risky steady state and DynareOBC solutions are compared v. fixed-point-iteration global solutions in the time and frequency domains. The solutions differ in key respects, including measures of precautionary savings, cyclical moments, impulse response functions, financial premia and macro responses to credit constraints, and periodograms of consumption, foreign assets and net exports. The global method is easy to implement and faster than local methods for the endowment model. Local methods are faster for the RBC model and the global and DynareOBC solutions are of comparable speed. These findings favor global methods except when prevented by the curse of dimensionality and urge caution when using local methods. Of the latter, first-order solutions are preferable because results are very similar to second-order methods.
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DOI: https://doi.org/10.17016/FEDS.2020.006

FEDS 2020-005
Consumption Heterogeneity: Micro Drivers and Macro Implications

Edmund Crawley and Andreas Kuchler


This paper explores the microfoundations of consumption models and quantifies the macro implications of consumption heterogeneity. We propose a new empirical method to estimate the response of consumption to permanent and transitory income shocks for different groups of households. We then apply this method to administrative data from Denmark. The large sample size, along with detailed household balance sheet information, allows us to finely divide the population along relevant dimensions. We find that households that stand to lose from an interest rate hike are significantly more responsive to income shocks than those that stand to gain. Following a 1-percentage-point interest rate increase, we estimate that consumption growth decreases by a 1/4 percentage point through this interest rate exposure channel alone, making this channel substantially larger than the intertemporal substitution channel that is at the core of representative agent New Keynesian models.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.005

FEDS 2020-004
Confidence, financial literacy and investment in risky assets: Evidence from the Survey of Consumer Finances

Andrej Cupák, Pirmin Fessler, Joanne W. Hsu, Piotr R. Paradowski


We employ recent Survey of Consumer Finances (SCF) microdata from the US to analyze the impacts of confidence in one's own financial knowledge, confidence in the economy, and objective financial literacy on investment in risky financial assets (equity and bonds) on both the extensive and intensive margins. Controlling for a rich set of covariates including risk aversion, we find that objective financial literacy is positively related to investment in risky assets as well as debt securities. Moreover, confidence in own financial skills additionally increases the probability of holding risky assets and bonds. While these relationships are rather robust for the extensive margin, they break down with regard to the conditional share of financial wealth in risky assets of those who actually hold them. The relevance of financial literacy as well as confidence varies considerably with the distribution of wealth as well as across several socio-economic dimensions such as age, education and race.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.004

FEDS 2020-003
Short-term Planning, Monetary Policy, and Macroeconomic Persistence


This paper uses aggregate data to estimate and evaluate a behavioral New Keynesian (NK) model in which households and firms plan over a finite horizon. The finite-horizon (FH) model outperforms rational expectations versions of the NK model commonly used in empirical applications as well as other behavioral NK models. The better fit of the FH model reflects that it can induce slow-moving trends in key endogenous variables which deliver substantial persistence in output and inflation dynamics. In the FH model, households and firms are forward-looking in thinking about events over their planning horizon but are backward looking regarding events beyond that point. This gives rise to persistence without resorting to additional features such as habit persistence and price contracts indexed to lagged inflation. The parameter estimates imply that the planning horizons of most households and firms are less than two years which considerably dampens the effects of expected fut ure changes of monetary policy on the macroeconomy.

Accessible materials (.zip)

Keywords: Finite-horizon planning, learning, monetary policy, New Keynesian model, Bayesian estimation.

DOI: https://doi.org/10.17016/FEDS.2020.003

FEDS 2020-002
Monetary Policy and Birth Rates: The Effect of Mortgage Rate Pass-Through on Fertility

Fergus Cumming and Lisa Dettling


This paper examines whether monetary policy pass-through to mortgage interest rates affects household fertility decisions. Using administrative data on mortgages and births in the UK, our empirical strategy exploits variation in the timing of when families were eligible for a rate adjustment, coupled with the large reductions in the monetary policy rate that occurred during the Great Recession. We estimate that each 1 percentage point drop in the policy rate increased birth rates by 2 percent. In aggregate, this pass-through of accommodative monetary policy to mortgage rates was sufficiently large to outweigh the headwinds of the Great Recession and prevent a "baby bust" in the UK, in contrast to the US. Our results provide new evidence on the nature of monetary policy transmission to households and suggest a new mechanism via which mortgage contract structures can affect both aggregate demand and supply.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.002

FEDS 2020-001
The Power of Narratives in Economic Forecasts

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


The sentiment, or “Tonality”, extracted from the narratives that accompany Federal Reserve economic forecasts is strongly correlated with future economic performance, positively with GDP and negatively with unemployment and inflation. Moreover, Tonality conveys incremental information in that it predicts errors in both Federal Reserve and private-sector forecasts of GDP, unemployment, and monetary policy up to four quarters out. Tonality similarly predicts stock returns. Tonality is most informative when uncertainty is high and point forecasts predict subpar growth. Quantile regressions indicate that much of Tonality’s forecasting power arises from its signal of downside risks to economic performance and stock returns.

Original Paper: PDF | Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2020.001r1

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Last Update: January 12, 2021