FEDS 2024-045
The 2023 Banking Turmoil and the Bank Term Funding Program

Abstract:

We use high-frequency data to examine the effectiveness of the Bank Term Funding Program (BTFP) in supporting the liquidity positions of vulnerable banks during the March 2023 banking turmoil. We uncover three key findings. First, our high-frequency data confirm that banks with high reliance on uninsured deposits and large unrealized losses on securities holdings suffered larger deposit outflows at the onset of the episode. Second, the BTFP played an outsized role in meeting these outflows at banks with larger securities losses, reflecting the at-par valuation of securities collateral at the BTFP (banks at the 90th percentile in securities losses replaced 26 cents of every dollar of outflows with BTFP borrowing, compared to only 7 cents on average). Third, in addition to funding loan growth and deposit outflows, banks used the BTFP to build cash holdings, indicating that the program enabled banks to position themselves against potential future funding needs. Overall, we demonstrate that the BTFP enabled banks to meet funding needs and preserve liquidity during the period of stress.

Keywords: 2023 banking turmoil, Bank Term Funding Program (BTFP), deposit outflows, emergency liquidity facilities, securities losses, uninsured deposits

DOI: https://doi.org/10.17016/FEDS.2024.045

FEDS 2024-044
Trademarks in Banking

Ryuichiro Izumi, Antonis Kotidis, and Paul E. Soto

Abstract:

One in five banks in the United States share a similar name. This can increase the likelihood of confusion among customers in the event of an idiosyncratic shock to a similarly named bank. We find that banks that share their name with a failed bank experience a half percent drop in transaction deposits relative to banks with similar characteristics but different name. This effect doubles for failures that are covered in media. We rationalize our findings via a model of financial contagion without fundamental linkages. Our model explains that when distinguishing banks is more costly due to similar trademarks, depositors are more likely to confuse their banks' condition resulting in financial contagion.

Keywords: Bank Failures, Bank Runs, Banking, Trademarks

DOI: https://doi.org/10.17016/FEDS.2024.044

FEDS 2024-043
The Slope of the Phillips Curve

Francesco Furlanetto and Antoine Lepetit

Abstract:

We review recent developments in the estimation and identification of the Phillips curve and its slope. We have three main objectives. First, we describe the econometric challenges faced by traditional approaches of estimating the Phillips curve, explain how new approaches address those challenges, and assess which limitations still remain. Second, we review the findings of those new approaches and examine the evidence regarding a potential flattening of the Phillips curve in the pre-pandemic period. Third, we provide an account of inflation dynamics in the post-pandemic period with a particular emphasis on the role of nonlinearities.

Keywords: Inflation dynamics, Phillips curve flattening, Phillips curve nonlinearities, Phillips curve slope

DOI: https://doi.org/10.17016/FEDS.2024.043

FEDS 2024-042
Demand Uncertainty, Selection, and Trade

Erick Sager and Olga A. Timoshenko

Abstract:

This paper examines the role of uncertainty on elasticities of trade flows with respect to variable trade costs in a canonical model of trade with monopolistic competition and heterogeneous firms. We identify two channels through which uncertainty impacts trade: through export participation thresholds (the selection effect) and the distribution of shocks governing export selection (the dispersion effect). While the selection effect dampens trade elasticities under uncertainty, the dispersion effect is ambiguous. We develop a methodology for using customs firm-level data to quantify trade elasticities under uncertainty, and the magnitude of each of the two channels through which uncertainty impacts trade. We find that uncertainty amplifies trade elasticities, on average, indicating that the dispersion effect of idiosyncratic firm-level shocks dominates -- though the effect is heterogeneous across industries. The overall magnitude of the endogenous selection mechanism on trade elasticities is small, indicating that the main drivers of trade in this class of trade models are overwhelmingly incumbent firms.

Keywords: Demand uncertainty, Extensive margin, Firm size distribution, Selection, Trade elasticities, Welfare

DOI: https://doi.org/10.17016/FEDS.2024.042

FEDS 2024-041
Continuity and Change in the Federal Reserve’s Perspective on Price Stability

David López-Salido, Emily J. Markowitz, and Edward Nelson

Abstract:

By examining statements made by the Federal Reserve leadership since the early 1950s, we establish that there has been considerable continuity in policymakers’ perceptions of the benefits of price stability. Policymakers have consistently contended that deviations from price stability give rise to greater cyclical instability, and they have also frequently suggested that potential output is significantly lowered by inflation. The recurrent support for price stability that comes through in these statements implies that it is invalid to take periods in the U.S. record of deviations from price stability as indicating a policymaker belief in the desirability of inflation.

Keywords: Dual mandate, Federal Reserve, Phillips curve, Price stability, Costs of inflation, Monetary policy objectives, Superneutrality

DOI: https://doi.org/10.17016/FEDS.2024.041

FEDS 2024-040
Information Friction in OTC Interdealer Markets

Benjamin Gardner and Yesol Huh

Abstract:

In over-the-counter (OTC) securities markets, interdealer markets are an important venue through which dealers can offload positions and share risk amongst themselves. Contrary to the popular conception that search frictions matter the most in OTC markets, we find that in the interdealer market for U.S. corporate bonds, information frictions are most relevant. Large dealers face large and informed customers and pay more than small dealers to transact in the interdealer market, despite on average providing liquidity to other dealers. Large dealers tend to trade through interdealer brokers (IDBs) to mitigate information leakage, but interdealer markets are still far from efficient.

Keywords: OTC markets, Information asymmetry, Interdealer markets

DOI: https://doi.org/10.17016/FEDS.2024.040

FEDS 2024-039
Reaching for Duration and Leverage in the Treasury Market

Abstract:

We show substantial variation in mutual funds’ use of Treasury futures, both over time and across funds. This variation from mutual funds drives much of the time series variation in aggregate Treasury futures open interest, including over 60% of the recent rise in Treasury futures positions. We provide evidence these Treasury futures positions are largely attributable to mutual funds “reaching for duration” in order to track the duration of a benchmark index with high cash Treasury exposure. Specifically, we show mutual funds use futures to fill the gap between their portfolio and the index that results when they tilt their cash positions toward higher return but lower duration assets, such as mortgage-backed securities and equities, and away from cash Treasuries. Treasury futures positions are more common in mutual funds which indicate a focus on dual objectives of duration management and total return whose style has a higher allocation to Treasuries. Reaching for duration allows funds to track their index better at lower cost, but increases leverage in the Treasury market both through mutual funds long Treasury futures positions and through the leverage of hedge funds who take the corresponding short positions in Treasury futures.

Keywords: Treasury markets, mutual funds, duration, indexing, futures, mortgage-backed securities

DOI: https://doi.org/10.17016/FEDS.2024.039

FEDS 2024-038
Income Shocks and Their Transmission into Consumption

Edmund Crawley and Alexandros Theloudis

Abstract:

This paper reviews the economics literature of, primarily, the past 20 years that studies the link between income shocks and consumption fluctuations at the household level. We identify three broad approaches through which researchers estimate the consumption response to income shocks: (1) structural methods in which a fully or partially specified model helps identify the consumption response to income shocks from the data, (2) natural experiments in which the consumption response of one group that receives an income shock is compared with another group that does not, and (3) elicitation surveys in which consumers are asked how they expect to react to various hypothetical events.

Keywords: Consumption, Income, MPC

DOI: https://doi.org/10.17016/FEDS.2024.038

FEDS 2024-037
Factor Selection and Structural Breaks

Siddhartha Chib and Simon C. Smith

Abstract:

We develop a new approach to select risk factors in an asset pricing model that allows the set to change at multiple unknown break dates. Using the six factors displayed in Table 1 since 1963, we document a marked shift towards parsimonious models in the last two decades. Prior to 2005, five or six factors are selected, but just two are selected thereafter. This finding offers a simple implication for the factor zoo literature: ignoring breaks detects additional factors that are no longer relevant. Moreover, all omitted factors are priced by the selected factors in every regime. Finally, the selected factors outperform popular factor models as an investment strategy.

Keywords: Model comparison, Factor models, Structural breaks, Anomaly, Bayesian analysis, Discount factor, Portfolio analysis, Sparsity.

DOI: https://doi.org/10.17016/FEDS.2024.037

FEDS 2024-036
Households' Preferences Over Inflation and Monetary Policy Tradeoffs

Abstract:

We document novel facts about U.S. household preferences over inflation and monetary policy. Many households are highly attentive to news about monetary policy and to interest rates. The median household perceives the Federal Reserve's inflation target to be three percent, but would prefer it to be lower. Quantifying the tradeoff between inflation and unemployment, we find an average acceptable sacrifice ratio of 0.6, implying that households are likely to find disinflation costly. Average preferences are well represented by a non-linear loss function with near equal weights on inflation and unemployment. These preferences also exhibit sizable demographic heterogeneity.

Keywords: Household Survey, Attention, Inflation Target, Sacrifice Ratio, Dual Mandate

DOI: https://doi.org/10.17016/FEDS.2024.036

FEDS 2024-035
Central Banking Post Crises

Michael T. Kiley and Frederic S. Mishkin

Abstract:

The world economy has experienced the largest financial crisis in generations, a global pandemic, and a resurgence in inflation during the first quarter of the 21st century, yielding important insights for central banking. Price stability has important benefits and is the responsibility of a central bank. Achieving price stability in a complex and uncertain environment involves a credible commitment to a nominal anchor with a strong response to inflation and pre-emptive leaning against an overheating economy. Associated challenges imply that central bank communication and transparency are key elements of monetary policy strategies and tactics. Crises have emphasized the role of central banks in promoting financial stability, as financial stability is key to achieving price and economic stability, but this role increases risks to independence. Goals for central banks other than price and economic stability, complemented by financial stability, can make it more difficult for them to stabilize both inflation and economic activity.

Keywords: central bank governance, central banking, financial stability, monetary policy, science of central banking

DOI: https://doi.org/10.17016/FEDS.2024.035

FEDS 2024-034
Constructing high-frequency monetary policy surprises from SOFR futures

Miguel Acosta, Connor M. Brennan, and Margaret M. Jacobson

Abstract:

Eurodollar futures were the bedrock for constructing high-frequency series of monetary policy surprises, so their discontinuation poses a challenge for the continued empirical study of monetary policy. We propose an approach for updating the series of Gürkaynak et al. (2005) and Nakamura and Steinsson (2018) with SOFR futures in place of Eurodollar futures that is conceptually and materially consistent. We recommend using SOFR futures from January 2022 onward based on regulatory developments and trading volumes. The updated series suggest that surprises over the recent tightening cycle are larger in magnitude than those seen over the decade prior and restrictive on average.

DOI: https://doi.org/10.17016/FEDS.2024.034

FEDS 2024-033
Monetary Policy Strategies to Foster Price Stability and a Strong Labor Market

Abstract:

I assess monetary policy strategies to foster price stability and labor market strength. The assessment incorporates a range of challenges, including uncertainty regarding the equilibrium real interest rate, mismeasurement of economic potential, and balancing the costs and benefits associated with employment shortfalls and labor market strength. I find that the ELB remains a significant constraint, hindering achievement of the inflation objective and worsening employment shortfalls. Symmetric policy reaction functions mitigate the most adverse effects of employment shortfalls by contributing to economic stability. Make-up strategies address ELB risks. These strategies call for policy to accommodate some period of inflation above its long-run objective following an ELB episode. I also consider an asymmetric shortfalls approach to policy. This approach provides accommodation in response to weak activity while foregoing tightening in response to strong activity. While the approach can, in principle, address ELB risks by raising inflation, it performs poorly. The shortfalls approach exacerbates economic volatility, worsens employment shortfalls, and creates excess inflationary pressures. Mismeasurement is not sufficient to limit the importance of strong responses to measured slack. Overall, monetary policy can promote price stability and labor market strength by focusing on economic stability, with a strategy targeted to address ELB risks.

Keywords: Monetary policy, Rules and discretion, effective lower bound, symmetric loss function, asymmetric loss function

DOI: https://doi.org/10.17016/FEDS.2024.033

FEDS 2024-032
Monetary Policy, Employment Shortfalls, and the Natural Rate Hypothesis

Abstract:

Activity shortfalls are more costly than strong activity. I consider optimal monetary policy under discretion with an asymmetric (activity shortfalls) loss function. The model satisfies the natural rate hypothesis. The asymmetric loss function and resulting optimal monetary policy exacerbates shortfalls in activity. The additional frequency of activity shortfalls arises from the adjustment of expectations implied by the natural rate hypothesis. The shortfalls asymmetry leads to an inflationary bias, similar to results in the time-consistency literature. Mandating a central bank objective with greater symmetry than the social loss function improves outcomes. Greater symmetry lowers the magnitude of activity shortfalls. Greater symmetry also reduces inflation bias. The model also implies that an optimal monetary policy does not accommodate fluctuations from aggregate demand shocks, as is standard in such models. As a result, the analysis implies that monetary accommodation of strength in economic activity likely requires justifications other than asymmetric costs of shortfalls.

Keywords: Monetary Policy, Rules, discretion, symmetric loss function, asymmetric loss function

DOI: https://doi.org/10.17016/FEDS.2024.032

FEDS 2024-031
Are Supply Networks Efficiently Resilient?

Agostino Capponi, Chuan Du, Joseph E. Stiglitz

Abstract:

We show that supply networks are inefficiently, and insufficiently, resilient. Upstream firms can expand their production capacity to hedge against supply and demand shocks. The social benefits of such investments are not internalized, however, because of market power and market incompleteness. Upstream firms underinvest in capacity and resilience, passing on the costs to downstream firms, and drive trade excessively toward the spot markets. There is a wedge between the market solution and a constrained optimal benchmark, which persists even without rare and large shocks. Policies designed to incentivize capacity investment, reduce reliance on spot markets, and enhance competition ameliorate the externality.

DOI: https://doi.org/10.17016/FEDS.2024.031

FEDS 2024-030
Evaluating the Effects of Geographic Adjustments on Poverty Measures Using Self-Reported Financial Well-Being Scores

Abstract:

A central aspect of poverty measurement is how well the measure can identify the people and places that are experiencing financial hardships. This paper explores the relationship between poverty and financial hardship by using the CFPB’s financial well-being scale, which reflects individuals’ self-assessments of their financial challenges. Using this measure, for every 1 percentage point increase in a state’s official poverty rate for working-age adults, there is a 0.59 percentage point increase in the share of working-age adults with very low financial well-being. In contrast, the state’s supplemental poverty rate is negatively correlated with the rate of financial hardship using the CFPB measure. This finding is due to the supplemental poverty measure’s geographic adjustment shifting poverty towards areas that have lower rates of self-reported financial hardship.

Keywords: Cost of living adjustments, Poverty, Well-being

DOI: https://doi.org/10.17016/FEDS.2024.030

FEDS 2024-029
Personal Tax Changes and Financial Well-being: Evidence from the Tax Cuts and Jobs Act

Abstract:

We estimate the effects of personal income tax decreases on financial well-being, including qualitative subjective assessments and quantitative measures. A plausibly causal design shows that tax decreases in the Tax Cuts and Jobs Act made survey respondents more likely to say they were “living comfortably” financially, with null effects at lower levels of subjective financial well-being. Estimates from a similar design using credit bureau data show that people who had larger tax decreases were modestly more likely to open new accounts, and more likely to have higher consumer credit balances. Tax decreases had effects on credit scores that are indistinguishable from zero. Results suggest that larger tax decreases improve financial wellbeing in ways not fully proxied by typical administrative data.

Keywords: Taxes, subjective well-being, household finances, credit, financial well-being

DOI: https://doi.org/10.17016/FEDS.2024.029

FEDS 2024-028
Tale About Inflation Tails

Olesya V. Grishchenko and Laura Wilcox

Abstract:

We study probabilities of extreme inflation events in the United States and the euro area. Using a state-space model that incorporates information from a large set of professional forecasters, we generate the term structure of inflation forecasts as well as probabilities of future inflation for any range of inflation outcomes in closed form at any horizon. Since the onset of the COVID-19 pandemic, inflation expectations increased materially amid heightened uncertainty about future inflation. Likelihood of significant departures of inflation targets in the longer term reached about 15 percent in the middle of 2022, increasing from near zero levels in 2020. Such an increase in the right tail of the probability distribution over future inflation outcomes drives an increase in inflation expectations and inflation risk premiums. Several popular external uncertainty measures are associated with variation in tail probabilities.

Keywords: inflation anchoring, inflation forecasts, inflation state-space model, probability of rare inflation events

DOI: https://doi.org/10.17016/FEDS.2024.028

FEDS 2024-027
Government Debt, Limited Foresight, and Longer-term Interest Rates

Abstract:

We study the relationship between government debt and interest rates in an environment where financial market participants have limited foresight about the future path of government debt. We show that limited foresight substantially attenuates estimates of the effect of government debt on longer-term yields relative to the benchmark of rational expectations often used in empirical analysis.

Keywords: government debt, longer-term interest rates, term premiums, limited foresight

DOI: https://doi.org/10.17016/FEDS.2024.027

FEDS 2024-026
Manufacturing Sentiment: Forecasting Industrial Production with Text Analysis

Abstract:

This paper examines the link between industrial production and the sentiment expressed in natural language survey responses from U.S. manufacturing firms. We compare several natural language processing (NLP) techniques for classifying sentiment, ranging from dictionary-based methods to modern deep learning methods. Using a manually labeled sample as ground truth, we find that deep learning models--partially trained on a human-labeled sample of our data--outperform other methods for classifying the sentiment of survey responses. Further, we capitalize on the panel nature of the data to train models which predict firm-level production using lagged firm-level text. This allows us to leverage a large sample of "naturally occurring" labels with no manual input. We then assess the extent to which each sentiment measure, aggregated to monthly time series, can serve as a useful statistical indicator and forecast industrial production. Our results suggest that the text responses provide information beyond the available numerical data from the same survey and improve out-of-sample forecasting; deep learning methods and the use of naturally occurring labels seem especially useful for forecasting. We also explore what drives the predictions made by the deep learning models, and find that a relatively small number of words--associated with very positive/negative sentiment--account for much of the variation in the aggregate sentiment index.

Keywords: Industrial Production, Natural Language Processing, Machine Learning, Forecasting

DOI: https://doi.org/10.17016/FEDS.2024.026

FEDS 2024-025
Corporate Mergers and Acquisitions Under Lender Scrutiny

Buhui QIu, Teng Wang

Abstract:

This paper examines corporate mergers and acquisitions (M&A) outcomes under lender scrutiny. Using the unique shocks of U.S. supervisory stress testing, we find that firms under increased lender scrutiny after their relationship banks fail stress tests engage in fewer but higher-quality M&A deals. Evidence from comprehensive supervisory data reveals improved credit quality for newly originated M&A-related loans under enhanced lender scrutiny. This improvement is further evident in positive stock return reactions to M&A deals financed by loans subject to enhanced lender scrutiny. As companies engage in fewer but higher-quality deals, they also experience higher returns on assets. Our findings highlight the importance of lender scrutiny in corporate M&A activities.

Keywords: Mergers and Acquisitions, Lender Scrutiny, Stress Tests

DOI: https://doi.org/10.17016/FEDS.2024.025

FEDS 2024-024
Navigating Higher Education Insurance: An Experimental Study on Demand and Adverse Selection

Sidhya Balakrishnan, Eric Bettinger, Michael S. Kofoed, Dubravka Ritter, Douglas A. Webber, Ege Aksu, and Jonathan S. Hartley

Abstract:

We conduct a survey-based experiment with 2,776 students at a non-profit university to analyze income insurance demand in education financing. We offered students a hypothetical choice: either a federal loan with income-driven repayment or an income-share agreement (ISA), with randomized framing of downside protections. Emphasizing income insurance increased ISA uptake by 43%. We observe that students are responsive to changes in contract terms and possible student loan cancellation, which is evidence of preference adjustment or adverse selection. Our results indicate that framing specific terms can increase demand for higher education insurance to potentially address risk for students with varying outcomes.

Keywords: Adverse Selection, Education Finance, Higher Education, Income Share Agreements, Student Loans

DOI: https://doi.org/10.17016/FEDS.2024.024

FEDS 2024-023
Does it Pay to Send Multiple Pre-Paid Incentives? Evidence from a Randomized Experiment

Andrew C. Chang, Joanne W. Hsu, Eva Ma, Kate Bachtell, and Micah Sjoblom

Abstract:

To encourage survey participation and improve sample representativeness, the Survey of Consumer Finances (SCF) offers an unconditional pre-paid monetary incentive and separate post-paid incentive upon survey completion. We conducted a pre-registered between-subject randomized control experiment within the 2022 SCF, with at least 1,200 households per experimental group, to examine whether changing the pre-paid incentive structure affects survey outcomes. We assess the effects of: (1) altering the total dollar value of the pre-paid incentive (“incentive effect”), (2) giving two identical pre-paid incentives holding the total dollar value fixed (“reminder effect”), and (3) offering multiple pre-paid incentives of different amounts holding the total dollar value fixed (“slope effect”) on survey response rates, interviewer burden, and data quality. Our evidence indicates that a single $15 pre-paid incentive increases response rates and maintains similar levels of interviewer burden and data quality, relative to a single $5 pre-paid incentive. Splitting the $15 into two pre-paid incentives of different amounts increases interviewer burden though lengthening time in the field without improving response rates, reducing the number of contact attempts needed for a response, or improving data quality, regardless of whether the first pre-paid is larger or smaller than the second.

Keywords: Pre-paid incentives, unconditional incentives, sequential incentives, response rates, surveys, data quality, household finance

DOI: https://doi.org/10.17016/FEDS.2024.023

FEDS 2024-022
Assessing the Common Ownership Hypothesis in the US Banking Industry

Abstract:

The U.S. banking industry is well suited to assess the common ownership hypothesis (COH), because thousands of private banks without common ownership (CO) compete with hundreds of public banks with high and increasing levels of CO. This paper assesses the COH in the banking industry using more comprehensive ownership data than previous studies. In simple comparisons of raw deposit rate averages we document that (i) private banks do offer substantially more attractive deposit rates than public banks, but (ii) the deposit rates of public banks are similar in markets without CO where a single public bank competes only with private rivals, and in markets with CO where multiple public banks compete with each other. Panel regressions of deposit rates on the profit weights implied by the COH are generally consistent with the COH if only quarter FEs (without other controls) are included but not if bank-quarter FEs are included. Estimates with bank-quarter FEs are “precise zeros” with 95% CIs suggesting that the threefold rise in CO among public banks between 2005 and 2022 moved their deposit rates by less than a quarter of a basis point in either direction. To assess the COH along non-price dimensions we also estimate the effect of CO on deposit quantities, and find that the estimates are also not consistent with the COH.

Keywords: Bank Competition, Common Ownership

DOI: https://doi.org/10.17016/FEDS.2024.022

FEDS 2024-021
Financial Stability Implications of CBDC

Abstract:

A Central Bank Digital Currency (CBDC) is a form of digital money that is denominated in the national unit of account and constitutes a direct liability of the central bank. We examine the financial stability risks and benefits of issuing a CBDC under different design options. Our analysis is based on lessons derived from historical case studies as well as on an analytical framework that allows us to characterize the mechanisms through which a CBDC can affect financial stability. We further discuss various policy tools that can be employed to mitigate financial stability risks.

Keywords: CBDC, financial stability, runs, stablecoins, central bank liabilities, regulation

DOI: https://doi.org/10.17016/FEDS.2024.021

FEDS 2024-020
Tracking Real Time Layoffs with SEC Filings: A Preliminary Investigation

Leland D. Crane, Emily Green, Molly Harnish, Will McClennan, Paul E. Soto, Betsy Vrankovich, and Jacob Williams

Abstract:

We explore a new source of data on layoffs: timely 8-K filings with the Securities and and Exchange Commission. We develop measures of both the number of reported layoff events and the number of affected workers. These series are highly correlated with the business cycle and other layoff indicators. Linking firm-level reported layoff events with WARN notices suggests that 8-K filings are sometimes available before WARN notices, and preliminary regression results suggest our layoff series are useful for forecasting. We also document the industry composition of the data and specific areas where the industry shares diverge.

Keywords: Alternative Data, Forecasting, Labor Markets, Large Language Models, Layoffs, Natural Language Processing

DOI: https://doi.org/10.17016/FEDS.2024.020

FEDS 2024-019
Risk Perception and Loan Underwriting in Securitized Commercial Mortgages

Simon Firestone, Nathan Godin, Akos Horvath, Jacob Sagi

Abstract:

We use model-implied volatility to proxy for property risk perceptions in the commercial real estate lending market. Although loan-to-value ratios (LTVs) unconditionally decreased following the Global Financial Crisis, LTVs conditioned on implied volatility and other theoretically motivated fundamental determinants of optimal leverage show no conclusive trend before or after the crisis. Taking reported property and loan attributes at face value, we find no clear pattern of unwarranted credit being extended to commercial real estate assets. We conclude that systematically higher LTV decisions pre-crisis would have primarily stemmed from risk misperceptions rather than imprudent practices. Our findings suggest that the aggregate LTV level should be interpreted as a proxy for lending standards only after controlling for aggregate risk perceptions, among a host of asset and lending market factors. Our findings also highlight the importance of measuring and tracking aggregate risk perceptions in informing regulators and policymakers.

Keywords: Global Financial Crisis, Implied volatility, Lending standards, Loan underwriting, Mortgages, Real estate finance

DOI: https://doi.org/10.17016/FEDS.2024.019

FEDS 2024-018
Institution, Major, and Firm-Specific Premia: Evidence from Administrative Data

Ben Ost, Weixiang Pan, and Douglas Webber

Abstract:

We examine how a student’s field of degree and institution attended contribute to the labor market outcomes of young graduates. Administrative panel data that combines student transcripts with matched employer-employee records allow us to provide the first decomposition of premia into individual and firm-specific components. We find that both major and institutional premia are more strongly related to the firm-specific component of wages than the individual-specific component of wages. On average, a student’s major is a more important predictor of future wages than the selectivity of the institution attended, but major premia (and their relative ranking) can differ substantially across institutions, suggesting the importance of program-level data for prospective students and their parents.

Keywords: College Major, College Premium, Firm Effect, Higher Education, Returns to Institution, Wage Decomposition

DOI: https://doi.org/10.17016/FEDS.2024.018

FEDS 2024-017
A New Measure of Climate Transition Risk Based on Distance to a Global Emission Factor Frontier

Benjamin N. Dennis, Talan B. İşcan

Abstract:

Targeted financing of transition to a "net zero" global economy entails climate transition risk. We propose a measure of transition risk at the country-sector dyad level composed of five tiers of transition risk based on two factors: i) the gap between a dyad's existing emission factor (EF) – a measure of the greenhouse gas intensity of output – and the global 'frontier' sectoral EF, and ii) a dyad's recent convergence towards the frontier EF. Dyads that are either close to the frontier or converging towards the frontier carry lower transition risk. Our measure, using 45 sectors across 66 countries, accounts for both direct greenhouse gas emissions as well as those that enter into production through complex supply chains as captured by intercountry, input-output tables, and can be applied at different levels of stringency to high-, middle-, and low-income economies. Our measure thus accounts for, and sheds light on, EF reductions through investment in lower emissions production techniques in own facilities as well as sourcing intermediate inputs with lower embodied emissions.

Keywords: convergence, direct emissions, greenhouse gas emissions, production emissions, transition risk

DOI: https://doi.org/10.17016/FEDS.2024.017

FEDS 2024-016
On Commercial Construction Activity's Long and Variable Lags

David Glancy, Robert J. Kurtzman, and Lara Loewenstein

Abstract:

We use microdata on the phases of commercial construction projects to document three facts regarding time-to-plan lags: (1) plan times are long—about 1.5 years on average—and highly variable, (2) roughly one-third of projects are abandoned in planning, (3) property price appreciation reduces the likelihood of abandonment. We construct a model with endogenous planning starts and abandonment that matches these facts. Endogenous abandonment make short-term building supply more elastic, as price shocks immediately affect the exercise of construction options rather than just planning starts. The model has the testable implication that supply is more elastic when there are more “shovel ready” projects available to advance to construction. We use local projections to validate that this prediction holds in the cross-section for U.S. cities.

Keywords: Commercial real estate, Construction, Time to plan

DOI: https://doi.org/10.17016/FEDS.2024.016

FEDS 2024-015
How Private Equity Fuels Non-Bank Lending

Sharjil Haque, Simon Mayer, and Teng Wang

Abstract:

We show how private equity (PE) buyouts fuel loan sales and non-bank participation in the U.S. syndicated loan market. Combining loan-level data from the Shared National Credit register with buyout deals from Pitchbook, we find that PE-backed loans feature lower bank monitoring, lower loan shares retained by the lead bank, and more loan sales to non-bank financial intermediaries. For PE-backed loans, the sponsor’s reputation and the strength of its relationship with the lead bank further reduce the lead bank’s retained share and monitoring. Our results suggest that PE sponsor engagement substitutes for bank monitoring, allowing banks to retain less skin-in-the game in the loans they originate and to sell greater loan shares to non-banks.

Keywords: Syndicated Loans, Private Equity, LBO, Bank Monitoring, CLO, Securitization, Loan Sales

DOI: https://doi.org/10.17016/FEDS.2024.015

FEDS 2024-014
Linear Factor Models and the Estimation of Expected Returns

Cisil Sarisoy, Peter de Goeij, and Bas J.M. Werker

Abstract:

This paper analyzes the properties of expected return estimators on individual assets implied by the linear factor models of asset pricing, i.e., the product of β and λ. We provide the asymptotic properties of factor-model-based expected return estimators, which yield the standard errors for risk premium estimators for individual assets. We show that using factor-model-based risk premium estimates leads to sizable precision gains compared to using historical averages. Finally, inference about expected returns does not suffer from a small-beta bias when factors are traded. The more precise factor-model-based estimates of expected returns translate into sizable improvements in out-of-sample performance of optimal portfolios.

Keywords: Cross Section of Expected Returns, Risk Premium, Small β's

DOI: https://doi.org/10.17016/FEDS.2024.014

FEDS 2024-013
In the Driver's Seat: Pandemic Fiscal Stimulus and Light Vehicles

Abstract:

This paper explores the impact of two fiscal programs, the Economic Impact Payments and the Paycheck Protection Program, on vehicle purchases and relates our findings to post-pandemic price pressures. We find that receiving a stimulus check increased the probability of purchasing new vehicles. In addition, the disbursement of funds from the Paycheck Protection Program was associated with a rise in local new car registrations. Our estimates indicate that these two programs account for a boost of 1 3/4 million units—or 12 percent—to new car sales in 2020. Furthermore, the induced boost in sales coincided with the presence of significant production constraints and exacerbated an inventory drawdown, thereby contributing to the rapid increase in new vehicle prices that prevailed in the subsequent years.

Keywords: Discretionary Fiscal Policy, Light Vehicle Purchases, Inflation

DOI: https://doi.org/10.17016/FEDS.2024.013

FEDS 2024-012
Parental Employment at the Onset of the Pandemic: Effects of Lockdowns and Government Policies

Kabir Dasgupta, Linda Kirkpatrick, and Alexander Plum

Abstract:

The COVID-19 pandemic had disproportionate impacts on women’s employment, especially for mothers with school-age and younger children. However, the impacts likely varied depending on the type of policy response adopted by various governments. New Zealand presents a unique policy setting in which one of the strictest lockdown restrictions was combined with a generous wage subsidy scheme to secure employment. We utilize tax records to compare employment patterns of parents from the pandemic period (treatment group) to similar parents from a recent pre-pandemic period (control group). For mothers whose youngest child is aged between one and 12, we find a 1-2-percentage point decline in the likelihood of being employed in the first six months of the pandemic; for fathers, we hardly see any significant changes in employment. Additionally, the decline in mothers’ employment rates is mainly driven by those not employed in the month before the lockdown. We also find similar employment patterns for future parents who had no children during the evaluation period. This indicates that the adverse labour market impacts are not uniquely experienced by mothers, but by women in general.

Keywords: Pandemic, Employment. Parental gap, Administrative data

DOI: https://doi.org/10.17016/FEDS.2024.012

FEDS 2024-011
Monetary Policy Shocks: Data or Methods?

Connor M. Brennan, Margaret M. Jacobson, Christian Matthes, Todd B. Walker

Abstract:

Different series of high-frequency monetary shocks can have a correlation coefficient as low as 0.5 and the same sign in only two-thirds of observations. Both data and methods drive these differences, which are starkest when the federal funds rate is at its effective lower bound. Methods that exploit the differential responsiveness of short- and long-term asset prices can incorporate additional information. After documenting differences in monetary shocks, we explore their consequence for inference. We find that empirical estimates of monetary policy transmission from local projections and VARs are less affected by shock choice than forecast revision specifications.

Keywords: High-frequency monetary policy shocks, Monetary policy transmission, Empirical monetary economics.

DOI: https://doi.org/10.17016/FEDS.2024.011

FEDS 2024-010
Land development and frictions to housing supply over the business cycle

Abstract:

Using a novel data set of U.S. residential land developments, we document that the average time to develop residential properties—which includes both the time spent preparing land infrastructures and construction—is about three years, consistent with sizable lags in housing investment projects. We show that the time to develop is highly dispersed across locations, a finding that helps quantify the housing supply elasticity that is relevant for assessing local housing variations over the business cycle. We also show that incorporating long and dispersed time to develop into an otherwise standard housing investment model helps rationalize some empirical facts on the housing market. Our model implies that policies to boost housing supply are less effective in immediately stabilizing house prices for regions where land development takes a long time.

Keywords: house price dynamics, housing supply, residential investment

DOI: https://doi.org/10.17016/FEDS.2024.010

FEDS 2024-009
Reexamining the 'Role of the Community Reinvestment Act in Mortgage Supply and the U.S. Housing Boom'

Abstract:

Concerns have lingered since the 2007 subprime crisis that government housing policies promote risky mortgage lending. The first peer-reviewed evidence of a causal effect was published by the Review of Financial Studies in a paper (Saadi, 2020) linking the crisis to changes in the Community Reinvestment Act (CRA) in 1995. A review of that paper, however, shows that it misrepresents the policy changes as having taken effect in mid-1998, 2.5 years after they were implemented. When the correct timing is used, a similar analysis yields no evidence of a relationship between CRA and riskier mortgage lending. Instead, the results are shown to reflect an unrelated confounding event, the first collapse of the U.S. subprime mortgage market following Russia’s debt default in August 1998.

Keywords: Community Reinvestment Act (CRA), house prices, mortgage lending, subprime crisis

DOI: https://doi.org/10.17016/FEDS.2024.009

FEDS 2024-008
Difference-in-Differences in the Marketplace

Robert Minton and Casey B. Mulligan

Abstract:

Price theory says that the most important effects of policy and technological change are often found beyond their first point of contact. This appears opposed to econometric methods that rule out spillovers of one person's treatment on another's outcomes. This paper uses the industry model from price theory to represent the statistical concepts of treatments and controls. When treated and control observations are in the same market, the controls are indirectly affected by the treatment. Moreover, even the effect of the treatment on the treated reveals only part of the consequence for the treated of treating the entire market, which is often the parameter of interest. Marshall's Laws of Derived Demand provide a guide for empirical work: precise price-theoretic interpretations of the direct and spillover effects of a treatment, the quantitative relationships between them, and how they correspond to the scale and substitution effects emphasized in price theory.

DOI: https://doi.org/10.17016/FEDS.2024.008

FEDS 2024-007
Has Intergenerational Progress Stalled? Income Growth Over Five Generations of Americans

Kevin Corinth and Jeff Larrimore

Abstract:

We find that each of the past four generations of Americans was better off than the previous one, using a post-tax, post-transfer income measure constructed annually from 1963-2022 based on the Current Population Survey Annual Social and Economic Supplement. At age 36–40, Millennials had a real median household income that was 18 percent higher than that of the previous generation at the same age. This rate of intergenerational progress was slower than that experienced by the Silent Generation (34 percent) and Baby Boomers (27 percent), but similar to that experienced by Generation X (16 percent). Slower progress for Generation X and Millennials is due to their stalled growth in work hours—holding work hours constant, they experienced a greater intergenerational increase in real market income than Baby Boomers. Intergenerational progress for Millennials under age 30 has remained robust as well, although their income growth largely results from higher reliance on their parents. We also find that the higher educational costs incurred by younger generations is far outweighed by their lifetime income gains.

Keywords: Full income, Growth, Generations, Mobility, Millennials

DOI: https://doi.org/10.17016/FEDS.2024.007

FEDS 2024-006
The Informational Centrality of Banks

Abstract:

The equity and debt prices of large nonbank firms contain information about the future state of the banking system. In this sense, banks are informationally central. The amount of this information varies over time and over equity and debt. During a financial crisis banks are, by definition of a crisis, at risk of failure. Debt prices became about 50 percent more informative than equity prices about the future state of the banking system during the financial crisis of 2007-2009. This was partly due to investors' fears that banks might not be able to refinance the firms' debt.

Keywords: Price informativeness, Asset pricing, Banking system, Financial crises

DOI: https://doi.org/10.17016/FEDS.2024.006

FEDS 2024-005
Nonlinear Inflation Dynamics in Menu Cost Economies

Andres Blanco, Corina Boar, Callum Jones, Virgiliu Midrigan

Abstract:

Canonical menu cost models, when parameterized to match the micro-price data, cannot reproduce the extent to which the fraction of price changes increases with inflation. They also predict implausibly large menu costs and misallocation in the presence of strategic complementarities. We resolve these shortcomings by extending the multiproduct menu cost model along two dimensions. First, the products sold by a firm are imperfect substitutes. Second, strategic complementarities are at the firm, not product level. In contrast to standard models, the fraction of price changes increases rapidly with the size of monetary shocks, so our model implies a non-linear Phillips curve.

Keywords: Menu costs, Inflation, Phillips curve

DOI: https://doi.org/10.17016/FEDS.2024.005

FEDS 2024-004
What makes a job better? Survey evidence from job changers

Katherine Lim and Mike Zabek

Abstract:

Changes in pay and benefits alone incorrectly predict self-assessed changes in overall job quality 30 percent of the time, according to survey evidence from job changers. Job changers also place more emphasis on their interest in their work than they do on pay and benefits in evaluating whether their new job is better. Parents particularly emphasize work-life balance, and we find some indications that mothers value it more than fathers. Improvements in pay are highly correlated with improvements in other amenities for workers with less education but not for workers with a bachelor's degree or more. The higher positive correlation implies that differences in pay and benefits understate differences in total job quality to a greater degree among workers with less education.

Keywords: Job quality, Amenities, Surveys, Employment

DOI: https://doi.org/10.17016/FEDS.2024.004

FEDS 2024-003
Reasons Behind Words: OPEC Narratives and the Oil Market

Celso Brunetti, Marc Joëts, Valérie Mignon

Abstract:

We analyze the content of the Organization of the Petroleum Exporting Countries (OPEC) communications and whether it provides information to the crude oil market. To this end, we derive an empirical strategy which allows us to measure OPEC's public signal and test whether market participants find it credible. Using Structural Topic Models, we analyze OPEC narratives and identify several topics related to fundamental factors, such as demand, supply, and speculative activity in the crude oil market. Importantly, we find that OPEC communication reduces oil price volatility and prompts market participants to rebalance their positions. Our analysis indicates that market participants assess OPEC communications as providing an important signal to the crude oil market.

Keywords: OPEC Announcements, Structural Topic Models, Volatility, Traders' Positions

DOI: https://doi.org/10.17016/FEDS.2024.003

FEDS 2024-002
Government-Sponsored Mortgage Securitization and Financial Crises

Wayne Passmore and Roger Sparks

Abstract:

This paper analyzes a model of the mortgage market, considering scenarios with and without government-sponsored mortgage securitization. Conventional wisdom says that securitization, by fostering diversification and creating a “safe” asset in the form of mortgage-backed security (MBS), will reduce risk and enhance liquidity, thereby mitigating financial crises. We construct a strategic-game framework to model the interaction between the securitizer and banks. In this framework, the securitizer initiates the process by setting the MBS contract terms, which includes the guaranteed rate and the criterion that qualifies a mortgage for securitization. The bank then selects which qualifying mortgages to exchange for the MBS. Our investigation leads to a key result: government-sponsored securitization, somewhat counterintuitively, is more likely to exacerbate the severity and frequency of financial crises.

Keywords: Financial Crises, Government Sponsored, Mortgage Market, Mortgage-backed securities (MBS), Securitization

DOI: https://doi.org/10.17016/FEDS.2024.002

FEDS 2024-001
A Field Guide to Monetary Policy Implementation Issues in a New World with CBDC, Stablecoin, and Narrow Banks

Abstract:

This paper develops an analytical framework aimed at shedding light on the implications of the evolution of financial market structure for monetary policy implementation and transmission. The basic model builds on that developed in Chen et. al. (2014) which, in turn, draws inspiration from the pioneering work of Tobin (1969) and Gurley and Shaw (1960). The paper focuses, in particular, on the implications of introducing new types of fixed-rate financial assets in the financial system including retail and wholesale central bank digital currency (CBDC), stablecoins issued by narrow nonbanks, and deposits issued by narrow banks. The analysis also provides a crude way of capturing some of the effects of bank capital and liquidity regulation on financial intermediation and monetary policy implementation. Perhaps the most important conclusion is that the introduction of new fixed-rate assets by the Federal Reserve or by other financial intermediaries can have significant effects on equilibrium interest rates and patterns of financial intermediation and may also affect the potency of monetary policy tools. These effects are most pronounced when new financial assets are close substitutes for existing financial assets.

Keywords: Bank Regulation, Financial Innovation, Monetary Policy Implementation, Monetary policy

DOI: https://doi.org/10.17016/FEDS.2024.001

Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.

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Last Update: June 14, 2024