Staff working papers in the Finance and Economics Discussion Series (FEDS) investigate a broad range of issues in economics and finance, with a focus on the U.S. economy and domestic financial markets.

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

Nathan R. Babb and Alan K. Detmeister

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

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


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

Vikram Nanda, Wei Wu, and Xing Zhou

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

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


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

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

Keywords: Extended and Emergency Unemployment Benefits, Unemployment rate


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

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

Keywords: Advertising, Mistakes, Mortgage, Refinancing


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

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

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

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


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

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

Keywords: Banking, Crisis, Interbank


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

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

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


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

Federic Holm-Hadulla and Kirstin Hubrich

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

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


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

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

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

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


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

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

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


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

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

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


FEDS 2017-059
Measuring the Natural Rate of Interest: Alternative Specifications (PDF)

Abstract: We build on the work of Laubach and Williams (2003) and subsequent studies by analyzing the effect on the estimates of the natural rate of interest (r*) of accounting for full parameter uncertainty and alternative specifications for the underlying components of the natural rate. Our estimation technique delivers richer time-series dynamics for the median estimate of r* within the Laubach and Williams model. Additionally, we find that models with transitory shocks to the non-growth component of the natural rate have a higher marginal likelihood and produce an upward-sloping post-crisis trajectory of the r* path and thus a higher recent median point estimate (1.8% in 2016:Q3).

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


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

Geert Bekaert, Eric Engstrom, and Andrey Ermolov

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

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


FEDS 2017-057
A Collateral Theory of Endogenous Debt Maturity (PDF)

R. Matthew Darst and Ehraz Refayet

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

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


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

Lamont Black, John Krainer, and Joseph Nichols

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

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


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

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

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


FEDS 2017-054
Bank Fees, Aftermarkets, and Consumer Behavior (PDF)

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

Keywords: Aftermarkets, banking, competition, overdraft fees


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

Nina Biljanovska and Alexandros P. Vardoulakis

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

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


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

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

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


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

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

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


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

Alex Hsu, Francisco Palomino, and Charles Qian

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

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


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

Inessa Liskovich and Maya Shaton

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

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


FEDS 2017-048
Pipeline Risk in Leveraged Loan Syndication (PDF)

Max Bruche, Frederic Malherbe, and Ralf R. Meisenzahl

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

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


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

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

Keywords: Information Frictions, Unemployment, Wages and compensation


FEDS 2017-046
Understanding survey based inflation expectations (PDF)

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

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


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

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

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


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

Abstract: We model hysteresis in the labor market as resulting from a strategic complementarity in firms' wage setting and workers' job search strategies. Strategic complementarity results in a continuum of possible equilibria with higher-wage equilibria welfare dominating lower-wage equilibria. Further, we specify a protocol for revelation of the new equilibria following shocks such that the model exhibits (1) periods of endogenous rigidity in wages and participation, (2) persistent changes in wages, participation, and output in response to transitory movements in labor productivity, (3) sluggish recoveries including both a "jobless" phase and a "wageless" phase. Furthermore, regardless of the history, expansions are insufficiently robust in the sense that misallocation remains during expansions.

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


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

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

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


FEDS 2017-042
Divest, Disregard, or Double Down? (PDF)

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

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


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

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

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


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

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

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


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

Martin Bodenstein, Gunes Kamber, and Christoph Thoenissen

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

Keywords: commodity prices, search and matching, unemployment


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

Luisa Carpinelli and Matteo Crosignani

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

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


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

Martin Eichenbaum, Benjamin K. Johannsen, and Sergio Rebelo

Abstract: This paper documents two facts about the behavior of floating exchange rates in countries where monetary policy follows a Taylor-type rule. First, the current real exchange rate is highly negatively correlated with future changes in the nominal exchange rate at horizons greater than two years. This negative correlation is stronger the longer is the horizon. Second, for most countries, the real exchange rate is virtually uncorrelated with future inflation rates both in the short and in the long run. We develop a class of models that can account for these and other key observations about real and nominal exchange rates.

Keywords: Exchange rates and foreign exchange, Monetary policy


FEDS 2017-036
Reputation and Investor Activism (PDF)

Travis L. Johnson and Nathan Swem

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

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


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

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

Keywords: Consumption, Fiscal policy, Intertemporal substitution, VAT


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

Simon Firestone, Amy Lorenc and Ben Ranish

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

Keywords: banking, capital, cost benefit


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

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

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


FEDS 2017-032
Where Credit is Due: The Relationship between Family Background and Credit Health (PDF)

Abstract: Using a novel dataset that links an individual's background, education, and federal financial aid participation to her future credit records, we document that, even though it is not, and cannot be, used by credit agencies in assigning risk, family background is a strong predictor of early-career credit health (that is, an individual's credit score when she is around 30 years old). This relationship persists even after controlling for achievement, a range of postsecondary schooling variables (e.g., educational attainment, institutional quality, undergraduate borrowing), and key elements of early credit histories (e.g., default on educational loans). Interestingly, undergraduate borrowing, which is not underwritten, correlates with background and appears to explain some of the difference in scores. In light of the many important contexts in which credit scores are relied upon to evaluate consumers (e.g., lending, insurance, employment), our study offers a new dimensio n in understanding the transmission of socioeconomic status across generations.

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


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

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

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


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

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

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


FEDS 2017-029
Estimating the Competitive Effects of Common Ownership (PDF)

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

Original Paper: Full paper (PDF)

Original Paper DOI:

Keywords: Common Ownership, Bank Competition


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

Shaowen Luo and Daniel Villar

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

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


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

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

Keywords: Exporting, Forecast Accuracy, Sales Forecasting


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

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

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

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


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

Hie Joo Ahn and Ling Shao

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

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


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

Andrew Y. Chen, Rebecca Wasyk, and Fabian Winkler

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

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


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

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

Keywords: Analysts, Hedge Funds, Information, Mutual Funds


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

Tania Babina, Paige Ouimet, and Rebecca Zarutskie

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

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


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

Wayne Passmore and Alexander H. von Hafften

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

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


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

David Reifschneider and Peter Tulip

Data - HTML

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

Keywords: FOMC, Fan Charts, Forecasting, Uncertainty


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

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

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

Keywords: Job reallocation, Labor supply and demand, Productivity


FEDS 2017-018
Macroeconomic Forecasting in Times of Crises (PDF)

Pablo Guerrón-Quintana and Molin Zhong

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

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


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

Arthur B. Kennickell

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

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


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

David Byrne and Carol Corrado

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

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


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

David Byrne and Carol Corrado

Abstract: This paper reassesses the link between ICT prices, technology, and productivity. To understand how the ICT sector could come to the rescue of a whole economy, we introduce a simple model that sets out the steady-state contribution of the sector to the growth in U.S. labor productivity. The model extends Oulton (2012) to include ICT services (e.g., cloud computing) which has implications for the relationship between prices for ICT services and prices for the capital stocks (i.e., ICT assets) used to supply them. ICT asset prices are then put under a microscope, and offcial prices are found to substantially understate ICT price declines. And because ICT use continues to diffuse through the economy increasingly via cloud and related services which are not fully accounted for in the standard narrative on ICT's contribution to economic growth the contribution of ICT to growth in output per hour going forward is calibrated to be substantially larger than thought in the past.

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


FEDS 2017-014
Inter-firm Relationships and Asset Prices (PDF)

Abstract: This paper proposes a novel link between the propagation of shocks within production networks and asset prices. It develops a dynamic network model in which the propagation of firm cash-flow shocks via inter-firm relationships affects the economy's equilibrium asset prices. When calibrated to match key features of customer-supplier networks in the United States, the model generates long-run risks, high and volatile risk premia, and a low and stable risk-free rate. Consistent with data from firms in manufacturing and service industries, the model predicts that central firms in the network command lower risk premiums than peripheral firms, and that firm-level return volatilities exhibit a high degree of co-movement.

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


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

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

Keywords: Credit market development, Labor mobility, Local information


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

Buhui Qiu and Teng Wang

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

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


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

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

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

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


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

Abstract: Proponents of minimum wage legislation point to its potential to raise earnings and lift families out of poverty, while opponents argue that disemployment effects lead to net welfare losses. But these arguments typically ignore the possibility that minimum wage policy has spillover effects on other aspects of households' financial circumstances. This paper examines how state-level minimum wage changes affect the decisions of lenders and low-income borrowers. Using data derived from direct mailings of credit offers, debt recorded in credit reports, and survey-reported usage of alternative credit products, we broadly find that when minimum wages rise, access to credit expands for lower-income households, who in turn, use more traditional credit and less high-cost alternatives. Specifically, for each $1 increase in the minimum wage, lower-income households receive 7 percent more credit card offers, with higher limits and improved terms. Further, there is a drop in usage o f high-cost borrowing: payday borrowing falls 40 percent. Finally, we find that borrowers are also better able to manage their debt: delinquency rates fall by 5 percent. Overall, our results suggest that minimum wage policy has positive spillover effects by relaxing borrowing constraints among lower income households.

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


FEDS 2017-009
Capital Misallocation and Secular Stagnation (PDF)

Andrea Caggese and Ander Perez-Orive

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

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


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

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

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


FEDS 2017-007
Managing Stigma during a Financial Crisis (PDF)

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

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


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

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

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

Keywords: Consumer surveys, Data collection and estimation, Satisficing


FEDS 2017-005
How Fast are Semiconductor Prices Falling? (PDF)

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

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

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


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

Alessandro Barbarino and Efstathia Bura

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

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


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

Abstract: This paper models the important role that repurchase agreements (repos) play in bond market intermediation. Not only do repos allow dealers to finance their activities, but they also increase dealers' ability to satisfy levered client demands without having to adjust their holdings of risky assets. In effect, the ability to borrow specific assets for delivery allows dealers to source large quantity of assets without taking ownership of them. Larger levered client orders imply larger asset borrowing demands, thus increasing the borrowing cost for the asset (i.e., repo specialness). Dealers pass on the higher intermediation cost to their clients in the form of higher bid-ask spreads. Although this method of intermediation is optimal, the use of repos significantly increases dealers' balance sheets. Limiting one dealer's balance sheet leverage, leaving all else equal, reduces the affected dealer's market making abilities and increases his bid-ask spreads. The equilibrium effect of limiting all dealers' balance sheet leverage on bid-ask spreads is unclear, and depends on the intensity of clients' demand and securities lenders' sensitivity to repo specialness.

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


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

Jeff Larrimore, Jacob Mortenson, and David Splinter

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

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


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

Elod Takats and Judit Temesvary

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

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


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Last Update: June 27, 2017