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 2021-036
The Internal Capital Markets of Global Dealer Banks

Abstract:

This study uncovers the existence of a trillion-dollar internal capital market that played a central role in the financing of dealer banks during the 2008 Global Financial Crisis. Hand-collecting a novel set of dealer microdata at the subsidiary level, I present the first set of facts on the evolution of interaffiliate loans between U.S. primary dealers and their (primarily foreign) siblings. First, the aggregate size of these dealer internal capital markets quadrupled from $335 billion in 2001 to $1.2 trillion by 2007. Second, 25 percent of total repurchase agreements and 61 percent of total securities lending reported on U.S. primary dealer balance sheets were sourced internally from sibling dealers by year-end 2007. Third, internal securities lending collapsed by 55 percent during the 2008 crisis. These facts suggest that incorporating internal capital market dynamics may be fruitful for future research on dealer behavior and market liquidity.

Keywords: Global financial institutions, Broker-dealers, Internal capital markets, Shadow banking, Securities Lending

DOI: https://doi.org/10.17016/FEDS.2021.036

FEDS 2021-035
The COVID-19 Crisis and the Federal Reserve's Policy Response

Abstract:

The COVID-19 pandemic and the mitigation efforts put in place to contain it delivered the most severe blow to the U.S. economy since the Great Depression. In this paper, we argue that the Federal Reserve acted decisively and with dispatch to deploy all the tools in its conventional kit and to design, develop, and launch within weeks a series of innovative facilities to support the flow of credit to households and businesses. These measures, taken together, provided crucial support to the economy in 2020 and are continuing to contribute to what is expected to be a robust economic recovery in 2021.

Keywords: monetary policy, forward guidance, asset purchases, section 13(3) facilities

DOI: https://doi.org/10.17016/FEDS.2021.035

FEDS 2021-034
High-Frequency Estimates of the Natural Real Rate and Inflation Expectations

Alex Aronovich and Andrew Meldrum

Abstract:

We propose a new method of estimating the natural real rate and long-horizon inflation expectations, using nonlinear regressions of survey-based measures of short-term nominal interest rates and inflation expectations on U.S. Treasury yields. We find that the natural real rate was relatively stable during the 1990s and early 2000s, but declined steadily after the global financial crisis, before dropping more sharply to around 0 percent during the recent COVID-19 pandemic. Long-horizon inflation expectations declined steadily during the 1990s and have since been relatively stable at close to 2 percent. According to our method, the declines in both the natural real rate and long-horizon inflation expectations are clearly statistically significant. Our estimates are available at whatever frequency we observe bond yields, making them ideal for intraday event-study analysis--for example, we show that the natural real rate and long-horizon inflation expectations are not affected by temporary shocks to the stance of monetary policy.

Keywords: Natural real rate, nonlinear regression, term structure model

DOI: https://doi.org/10.17016/FEDS.2021.034

FEDS 2021-033
The Emergence of Forward Guidance As a Monetary Policy Tool

Abstract:

Forward guidance—the issuance by a central bank of public statements concerning the likely future settings of its policy instruments—is widely regarded as a new tool of monetary policy. The analysis in this paper shows that Federal Reserve policymakers from the 1950s onward actually accepted the premises of forward guidance: the notion that longer-term interest rates are key yields in aggregate spending decisions; and the proposition that indications of intentions regarding future short-term interest rate policy can affect longer-term rates. Over the same period, they were nevertheless wary about providing forward guidance regarding short-term interest rates, fearing that this could generate untoward market reactions or lock the Federal Open Market Committee into inappropriate rate settings. They concentrated on describing future policy in terms of achievement of economic objectives, with their commentary on interest-rate prospects usually confined to consideration of the longer-term factors affecting rates. Even in these years, however, there were infrequent occasions—notably in 1974 and 1982—when policymakers provided more explicit guidance regarding the path of short-term rates. In the 1990s, a consensus developed in U.S. policy circles that was more receptive toward the notion of guiding longer-term interest rates by providing indications of future FOMC actions. This consensus developed even before concerns about the lower bound on short-term rates became prevalent in U.S. policymaking. The new mindset, which stressed the stabilizing effects on the economy of communication of policy intentions, set the stage for the emergence of forward guidance as a monetary policy tool.

DOI: https://doi.org/10.17016/FEDS.2021.033

FEDS 2021-032
Arbitrage Capital of Global Banks

Abstract:

We show that the role of unsecured, short-term wholesale funding for global banks has changed significantly in the post-financial-crisis regulatory environment. Global banks mainly use such funding to finance liquid, near risk-free arbitrage positions—in particular, the interest on excess reserves arbitrage and the covered interest rate parity arbitrage. In this environment, we examine the response of global banks to a large negative wholesale funding shock as a result of the U.S. money market mutual fund reform implemented in 2016. In contrast to past episodes of wholesale funding dry-ups, we find that the primary response of global banks to the reform was a cutback in arbitrage positions that relied on unsecured funding, rather than a reduction in loan provision.

DOI: https://doi.org/10.17016/FEDS.2021.032

FEDS 2021-031
Cheapest-to-Deliver Pricing, Optimal MBS Securitization, and Market Quality

Abstract:

We study optimal securitization and its impact on market quality when the secondary market structure leads to cheapest-to-deliver pricing in the context of agency mortgage-backed securities (MBS). A majority of MBS are traded in the to-be-announced (TBA) market, which concentrates trading of heterogeneous MBS into a few liquid TBA contracts but induces adverse selection. We find that lenders segregate loans of like values into separate pools and tend to trade low-value MBS in the TBA market and high-value MBS outside the TBA market. We then present a model of optimal securitization for agency MBS. Lenders do not internalize the negative impact of such pooling and trading strategies on TBA market quality and thus create too many high-value MBS, which leads to more heterogeneity in MBS values, more adverse selection, and lower TBA liquidity. Lastly, we provide empirical evidence consistent with model predictions on how MBS pooling changes with trading costs and underlying loan value dispersion and how pooling practices affect MBS heterogeneity and TBA market adverse selection.

DOI: https://doi.org/10.17016/FEDS.2021.031

FEDS 2021-030
The Effect of the PPPLF on PPP Lending by Commercial Banks

Sriya Anbil, Mark Carlson, and Mary-Frances Styczynski

Abstract:

We analyze whether the Federal Reserve’s Paycheck Protection Program Liquidity Facility (PPPLF) was successful in bolstering the ability of commercial banks to provide credit to small businesses under the Small Business Administration’s Paycheck Protection Program (PPP). Using an instrumental variables approach, we find a causal effect of the facility boosting PPP lending. On average, commercial banks that used the PPPLF extended over twice as many PPP loans, relative to their total assets, as banks that did not use the PPPLF. Our instrument is a measure of banks’ familiarity with the operation of the Federal Reserve’s discount window; this measure is strongly related to both the propensity to sign up for and to utilize the PPPLF. Further, using a similar instrumental variables approach, we find evidence that the availability of the facility as a backstop source of funds may also have supported bank PPP lending, especially for larger banks.

Keywords: COVID-19, PPP, PPPLF, Federal Reserve, central bank lending

DOI: https://doi.org/10.17016/FEDS.2021.030

FEDS 2021-029
Dynamic Factor Copula Models with Estimated Cluster Assignments

Dong Hwan Oh and Andrew J. Patton

Abstract:

This paper proposes a dynamic multi-factor copula for use in high dimensional time series applications. A novel feature of our model is that the assignment of individual variables to groups is estimated from the data, rather than being pre-assigned using SIC industry codes, market capitalization ranks, or other ad hoc methods. We adapt the k-means clustering algorithm for use in our application and show that it has excellent finite-sample properties. Applying the new model to returns on 110 US equities, we find around 20 clusters to be optimal. In out-of-sample forecasts, we find that a model with as few as five estimated clusters significantly outperforms an otherwise identical model with 21 clusters formed using two-digit SIC codes.

Keywords: correlation, tail risk, multivariate density forecast

DOI: https://doi.org/10.17016/FEDS.2021.029

FEDS 2021-028
Are Repo Markets Fragile? Evidence from September 2019

Abstract:

We show that the segmented structure of the U.S. Treasury repo market, in which some participants have limited access across the segments, leads to rate dispersion, even in this essentially riskless market. Using confidential data on repo trading, we demonstrate how the rate dispersion between the centrally cleared and over-the-counter (OTC) segments of the Treasury repo market was exacerbated during the stress episode of September 2019. Our results highlight that, while segmentation can increase fragility in the repo market, the presence of strong trading relationships in the OTC segment helps mitigate it by reducing rate dispersion.

Keywords: repo market, OTC market, CCP, segmentation, nancial stability

DOI: https://doi.org/10.17016/FEDS.2021.028

FEDS 2021-027
Unintended Consequences of Unemployment Insurance Benefits: The Role of Banks

Yavuz Arslan, Ahmet Degerli, Gazi Kabaş

Abstract:

We use disaggregated U.S. data and a border discontinuity design to show that more generous unemployment insurance (UI) policies lower bank deposits. We test several channels that could explain this decline and find evidence consistent with households lowering their precautionary savings. Since deposits are the largest and most stable source of funding for banks, the decrease in deposits affects bank lending. Banks that raise deposits in states with generous UI policies squeeze their small business lending. Furthermore, counties that are served by these banks experience a higher unemployment rate and lower wage growth.

DOI: https://doi.org/10.17016/FEDS.2021.027

FEDS 2021-026
Limited Participation in Equity Markets and Business Cycles

Abstract:

This paper studies how the rise in US households' participation in equity markets affects the transmission of macroeconomic shocks to the economy. I embed limited participation into a New Keynesian framework for the US economy to analyze the individual and aggregate effects of higher participation. I derive three main results. First, participants are relatively more responsive to shocks than nonparticipants. Second, higher participation reduces the effectiveness of monetary policy. Third, with higher participation the economy becomes less volatile. I contrast key predictions of my model with new micro-level empirical evidence on the response of consumption to monetary policy shocks.

Keywords: Limited Participation; Monetary Policy; Stock Market; Investment; Business Cycle

DOI: https://doi.org/10.17016/FEDS.2021.026

FEDS 2021-025
Labor Market Effects of the Oxycodone-Heroin Epidemic

David Cho, Daniel I. Garcia, Joshua Montes, and Alison Weingarden

Abstract:

We estimate the causal effects of heroin use on labor market outcomes by proxying for heroin use with prior exposure to oxycodone, the largest of the prescription opioids with a well-documented history of abuse. After a nationwide tightening in the supply of oxycodone in 2010, states with greater prior exposure to oxycodone experienced much larger increases in heroin use and mortality. We find increases in heroin use led to declines in employment and labor force participation rates, particularly for white, young, and less educated groups, consistent with the profile of oxycodone misusers. The results show the importance of extending beyond prescriptions when accounting for the labor market effects of the opioid crisis.

DOI: https://doi.org/10.17016/FEDS.2021.025

FEDS 2021-024
COVID-19 as a Stress Test: Assessing the Bank Regulatory Framework

Alice Abboud, Elizabeth Duncan, Akos Horvath, Diana Iercosan, Bert Loudis, Francis Martinez, Timothy Mooney, Ben Ranish, Ke Wang, Missaka Warusawitharana, Carlo Wix

Abstract:

The widespread economic damage caused by the ongoing COVID-19 pandemic poses the first major test of the bank regulatory reforms put in place following the global financial crisis. This study assesses this framework, with an emphasis on capital and liquidity requirements. Leading up to the COVID-19 crisis, banks were well-capitalized and held ample liquid assets, reflecting in part heightened requirements. Capital requirements were comparable across major jurisdictions, despite differences in the implementation of the international Basel standards. The overall robust capital and liquidity levels resulted in a resilient banking system, which maintained lending through the early stages of the pandemic. Furthermore, trading activity was a source of strength for banks, reflecting in part a prudent regulatory approach. Areas for potential improvement include addressing the cyclicality of requirements.

DOI: https://doi.org/10.17016/FEDS.2021.024

FEDS 2021-023
Recycling Carbon Tax Revenue to Maximize Welfare

Stephie Fried, Kevin Novan, William B. Peterman

Abstract:

This paper explores how to recycle carbon tax revenue back to households to maximize welfare. Using a general equilibrium lifecycle model calibrated to reflect the heterogeneity in the U.S. economy, we find the optimal policy uses two thirds of carbon-tax revenue to reduce the distortionary tax on capital income while the remaining one third is used to increase the progressivity of the labor-income tax. The optimal policy attains higher welfare and more equality than the lump-sum rebate approach preferred by policymakers as well as the approach originally prescribed by economists--which called exclusively for reductions in distortionary taxes.

Keywords: Carbon tax; overlapping generations; revenue recycling

DOI: https://doi.org/10.17016/FEDS.2021.023

FEDS 2021-022
Fundamental Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data

Bastian von Beschwitz, Sandro Lunghi, Daniel Schmidt

Abstract:

We exploit detailed transaction and position data for a sample of long-short equity hedge funds to study the trading activity of fundamental investors. We find that hedge funds exhibit skill in opening positions, but that they close their positions too early, thereby forgoing about a third of the trades' potential profitability. We explain this behavior with the limits of arbitrage: hedge funds close positions early in order to reallocate their capital to more profitable investments and/or to accommodate tightened financial constraints. Consistent with this view, we document that hedge funds leave more money on the table after opening new positions, negative returns, or increases in funding constraints and volatility.

Keywords: Hedge funds, Short selling, Profitability, Fundamental Trading

DOI: https://doi.org/10.17016/FEDS.2021.022

FEDS 2021-021
Gender and Social Networks on Bank Boards

Ann L. Owen, Judit Temesvary and Andrew Wei

Abstract:

We examine the effect of the social networks of bank directors on board gender diversity and compensation using a unique, newly compiled dataset over the 1999-2018 period. We find that within-board social networks are extensive, but there are significant differences in the size and gender composition of social networks of male vs female bank directors. We also find that samegender networks play an important role in determining the gender composition of bank boards. Finally, we show that those connected to male directors receive higher compensation, but we find no evidence that connections to female directors are influential in determining pay and bonuses.

DOI: https://doi.org/10.17016/FEDS.2021.021

FEDS 2021-020
Global Stablecoins: Monetary Policy Implementation Considerations from the U.S. Perspective

Matthew Malloy and David Lowe

Abstract:

This note explores the potential effects of the widespread adoption of a global stablecoin (GSC) on key aggregate financial sector balance sheets in the United States. To do this, we map out cash flows of GSC transactions among financial sector entities using a stylized set of 't-accounts'. By analyzing these individual transactions, we infer aggregate and compositional effects on U.S. commercial banking sector and Federal Reserve balance sheets. Through this lens, we also consider how these balance sheet changes could affect monetary policy implementation, the demand for central bank reserves, and the market for U.S. dollar safe assets.

DOI: https://doi.org/10.17016/FEDS.2021.020

FEDS 2021-019
The Ways the Cookie Crumbles: Education and the Margins of Cyclical Adjustment in the Labor Market

Abstract:

I document that less educated workers experience higher and more cyclically sensitive job separation rates. Meanwhile, workers with a bachelor's degree or more exhibit pro-cyclical wages while workers without a high school degree exhibit no statistically discernible cyclical pattern. Differences in the sensitivity are most stark when measurement of labor costs accounts for the value of the persistent effects of current macroeconomic conditions on future remitted wages. These findings suggest optimally differential implementation of self-enforcing implicit wage contracts in which educated workers and their employers leverage relative employment stability to smooth the effects of cyclical fluctuations over longer horizons. This margin of adjustment is less available to the less well educated, who have shorter expected employment durations. Furthermore, failure to account for the heterogeneities documented here leads to substantial underestimation of the welfare costs of business cycles.

DOI: https://doi.org/10.17016/FEDS.2021.019

FEDS 2021-018
The Macro Effects of Climate Policy Uncertainty

Stephie Fried, Kevin Novan, William B. Peterman

Abstract:

Uncertainty surrounding if and when the U.S. government will implement a federal climate policy introduces risk into the decision to invest in capital used in conjunction with fossil fuels. To quantify the macroeconomic impacts of this climate policy risk, we develop a dynamic, general equilibrium model that incorporates beliefs about future climate policy. We find that climate policy risk reduces carbon emissions by causing the capital stock to shrink and become relatively cleaner. Our results reveal, however, that a carbon tax could achieve the same reduction in emissions at less than half the cost.

DOI: https://doi.org/10.17016/FEDS.2021.018

FEDS 2021-017
Liquidity Networks, Interconnectedness, and Interbank Information Asymmetry

Celso Brunetti, Jeffrey H. Harris, and Shawn Mankad

Abstract:

Network analysis has demonstrated that interconnectedness among market participants results in spillovers, amplifies or absorbs shocks, and creates other nonlinear effects that ultimately affect market health. In this paper, we propose a new directed network construct, the liquidity network, to capture the urgency to trade by connecting the initiating party in a trade to the passive party. Alongside the conventional trading network connecting sellers to buyers, we show both network types complement each other: Liquidity networks reveal valuable information, particularly when information asymmetry in the market is high, and provide a more comprehensive characterization of interconnectivity in the overnight-lending market.

DOI: https://doi.org/10.17016/FEDS.2021.017

FEDS 2021-016
The Fed's Discount Window in "Normal" Times

Huberto M. Ennis and Elizabeth Klee

Abstract:

We study new transaction-level data of discount window borrowing in the U.S. between 2010 and 2017, merged with quarterly data on bank financial con- ditions (balance sheet and revenue). The objective is to improve our under- standing of the reasons for why banks use the discount window during periods outside financial crises. We also provide a model of the decision of banks to borrow at the window, which is helpful for interpreting the data. We find that decisions to gain access and to borrow at the discount window are meaning- fully correlated with some relevant banks' characteristics and the composition of banks' balance sheets. Banks choose simultaneously to obtain access to the discount window and hold more cash-like liquidity as a proportion of assets. Yet, conditional on access, larger and less liquid banks tend to borrow more from the discount window. In general, our findings suggest that banks could, in principle, adapt their operations to modulate, and possibly reduce, their use of the discount window in "normal" times.

DOI: https://doi.org/10.17016/FEDS.2021.016

FEDS 2021-015
Consumption-Based Asset Pricing When Consumers Make Mistakes

Abstract:

I analyze the implications of allowing consumers to make mistakes on the risk-return relationships predicted by consumption-based asset pricing models. I allow for consumption mistakes using a model in which a portfolio manager selects investments on a consumer's behalf. The consumer has an arbitrary consumption policy that could reflect a wide range of mistakes. For power utility, expected returns do not generally depend on exposure to single-period consumption shocks, but robustly depend on exposure to both long-run consumption and expected return shocks. I empirically show that separately accounting for both types of shocks helps explain the equity premium and cross section of stock returns.

DOI: https://doi.org/10.17016/FEDS.2021.015

FEDS 2021-014
Forecasting US inflation in real time

Abstract:

We perform a real-time forecasting exercise for US inflation, investigating whether and how additional information--additional macroeconomic variables, expert judgment, or forecast combination--can improve forecast accuracy and robustness. In our analysis we consider the pre-pandemic period including the Global Financial Crisis and the following expansion--the longest on record--featuring unemployment that fell to a rate not seen for nearly sixty years. Distinguishing features of our study include the use of published Federal Reserve Board staff forecasts contained in Tealbooks and a focus on forecasting performance before, during, and after the Global Financial Crisis, with relevance also for the current crisis and beyond. We find that while simple models remain hard to beat, the additional information that we consider can improve forecasts, especially in the post-crisis period. Our results show that (1) forecast combination approaches improve forecast accuracy over simpler models and robustify against bad forecasts, a particularly relevant feature in the current environment; (2) aggregating forecasts of inflation components can improve performance compared to forecasting the aggregate directly; (3) judgmental forecasts, which likely incorporate larger and more timely datasets, provide improved forecasts at short horizons.

Keywords: Inflation, Survey forecasts, Forecast combination

DOI: https://doi.org/10.17016/FEDS.2021.014

FEDS 2021-013
Redistribution and the Monetary-Fiscal Policy Mix

Saroj Bhattarai, Jae Won Lee, and Choongryul Yang

Abstract:

We show that the effectiveness of redistribution policy in stimulating the economy and improving welfare is directly tied to how much inflation it generates, which in turn hinges on monetary-fiscal adjustments that ultimately finance the transfers. We compare two distinct types of monetary-fiscal adjustments: In the monetary regime, the government eventually raises taxes to finance transfers, while in the fiscal regime, inflation rises, effectively imposing inflation taxes on public debt holders. We show analytically in a simple model how the fiscal regime generates larger and more persistent inflation than the monetary regime. In a quantitative application, we use a two-sector, two-agent New Keynesian model, situate the model economy in a COVID-19 recession, and quantify the effects of the transfer components of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. We find that the transfer multipliers are significantly larger under the fiscal regime—which results in a milder contraction—than under the monetary regime, primarily because inflationary pressures of this regime counteract the deflationary forces during the recession. Moreover, redistribution produces a Pareto improvement under the fiscal regime.

Keywords: Household heterogeneity, Redistribution, Monetary-fiscal policy mix, Transfer multiplier, Welfare evaluation, COVID-19, CARES Act

DOI: https://doi.org/10.17016/FEDS.2021.013

FEDS 2021-012
The Information Content of Stress Test Announcements

Abstract:

We exploit institutional features of the U.S. banking stress tests to disentangle different types of information garnered by market participants when the stress test results are released. By examining the reaction of different asset prices, we find evidence that market participants value the stress test announcements not only for the information on possible future capital distributions but also for the signals about bank resilience. These results back the use of stress tests by central banks to inform the broader public about the soundness of the banking system.

DOI: https://doi.org/10.17016/FEDS.2021.012

FEDS 2021-011
Is Lending Distance Really Changing? Distance Dynamics and Loan Composition in Small Business Lending

Abstract:

Has information technology improved small businesses' access to credit by hardening the information used in loan underwriting and reducing the importance of proximity to lenders? Previous research, pointing to increasing average lending distances, suggests that it has. But this conclusion can obscure differences across loans and lenders. Using over 20 years of Community Reinvestment Act data on small business lending, we find that while average distances have increased substantially, distances at individual banks remain unchanged. Instead, average distance has increased because a small group of lenders specializing in high-volume, small-loan lending nationwide have increased their share of small business lending by 10 percentage points. Our findings imply that small businesses continue to depend on local banks.

DOI: https://doi.org/10.17016/FEDS.2021.011

FEDS 2021-010
Monetary policy and the corporate bond market: How important is the Fed information effect?

Abstract:

Does expansionary monetary policy drive up prices of risky assets? Or, do investors interpret monetary policy easing as a signal that economic fundamentals are weaker than they previously believed, prompting riskier asset prices to fall? We test these competing hypotheses within the U.S. corporate bond market and find evidence strongly in favor of the second explanation—known as the "Fed information effect". Following an unanticipated monetary policy tightening (easing), returns on corporate bonds with higher credit risk outperform (underperform). We conclude that monetary policy surprises are predominantly interpreted by market participants as signaling information about the state of the economy.

DOI: https://doi.org/10.17016/FEDS.2021.010

FEDS 2021-009
What Drives Bank Peformance?

Luca Guerrieri and James Collin Harkrader

Abstract:

Focusing on some key metrics of bank performance, such as revenues and loan charge-off rates, we estimate the fraction of the observed variation in these metrics that can be attributed to changes in economic conditions. Macroeconomic factors can explain the preponderance of the fluctuations in charge-off rates. By contrast, bank-specific, idiosyncratic factors account for a sizable share of the variation in bank revenues. These results point to importance of bank-specific business models as a driver of performance.

DOI: https://doi.org/10.17016/FEDS.2021.009

FEDS 2021-008
The COVID-19 Shock and Consumer Credit: Evidence from Credit Card Data

Akos Horvath, Benjamin Kay, and Carlo Wix

Abstract:

We use credit card data from the Federal Reserve Board's FR Y-14M reports to study the impact of the COVID-19 shock on the use and availability of consumer credit across borrower types from March through August 2020. We document an initial sharp decrease in credit card transactions and outstanding balances in March and April. While spending starts to recover by May, especially for risky borrowers, balances remain depressed overall. We find a strong negative impact of local pandemic severity on credit use, which becomes smaller over time, consistent with pandemic fatigue. Restrictive public health interventions also negatively affect credit use, but the pandemic itself is the main driver. We further document a large reduction in credit card originations, especially to risky borrowers. Consistent with a tightening of credit supply and a flight-to-safety response of banks, we find an increase in interest rates of newly issued credit cards to less creditworthy borrowers.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2021.008

FEDS 2021-007
Misallocation in Open Economy

Maria D. Tito and Ruoying Wang

Abstract:

This paper estimates the impact of reducing export and import tariffs on firm input choices. In presence of borrowing constraints, lower export tariffs facilitate the reallocation of capital and labor inputs across firms, while a decline in import tariffs either tightens import competition or increases the availability of imported inputs; all three mechanisms suggest that a higher degree of openness should be associated with lower misallocation. To analyze the empirical relationship between openness and input misallocation, we draw on the annual surveys conducted by the Chinese National Bureau of Statistics (NBS) between 1998 and 2007. From the surveys, we con- struct firm-level measures of input misallocation that control for firm heterogeneity; we identify shocks to openness using industry tariff levels and firm trade shares. We find that firm facing higher tariffs in either import or export markets make less optimal input choices. We further decompose our analysis between input and output tariffs: our results suggest that the labor reallocation mainly occurs because of lower input tariffs, while the selection effect induced by changes in output tariffs does not necessarily cause more distorted firms to exit and, therefore, tends to have an insignificant effect on input allocation. Finally, we calculate the contribution of tariff changes towards aggregate misallocation and productivity: our results indicate that the impact of firm-level tariff reductions on aggregate misallocation and productivity was marginal in our sample period, but the presence of sizeable interactions between trade shocks and mis- allocation at the sector level suggests that our result should be interpreted as a lower bound of the overall effect.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2021.007

FEDS 2021-006
Bunching estimation of elasticities using Stata

Marinho Bertanha, Andrew H. McCallum, Alexis Payne, and Nathan Seegert

Abstract:

A continuous distribution of agents that face a piecewise-linear schedule of incentives results in a distribution of responses with mass points located where the slope (kink) or intercept (notch) of the schedule changes. Bunching methods use these mass points to estimate an elasticity parameter, which summarizes agents' responses to incentives. This article introduces the command bunching, which implements new non-parametric and semi-parametric identification methods for estimating elasticities developed by Bertanha et al. (2021). These methods rely on weaker assumptions than currently made in the literature and result in meaningfully different estimates of the elasticity in various contexts.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2021.006

FEDS 2021-005
Political Connections, Allocation of Stimulus Spending, and the Jobs Multiplier

Joonkyu Choi, Veronika Penciakova, Felipe Saffie

Abstract:

Using American Recovery and Reinvestment Act (ARRA) data, we show that firms lever their political connections to win stimulus grants and public expenditure channeled through politically connected firms hinders job creation. We build a unique database that links campaign contributions and state legislative election outcomes to ARRA grant allocation. Using exogenous variation in political connections based on ex-post close elections held before ARRA, we causally show that politically connected firms are 64 percent more likely to secure a grant. Based on an instrumental variable approach, we also establish that state-level employment creation associated with grants channeled through politically connected firms is nil. Therefore, the impact of fiscal stimulus is not only determined by how much is spent, but also by how the expenditure is allocated across recipients.

Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2021.005

FEDS 2021-004
Politicians Avoid Tax Increases Around Elections

Andrew C. Chang, Linda R. Cohen, Amihai Glazer, and Urbashee Paul

Abstract:

We use new annual data on gasoline taxes and corporate income taxes from U.S. states to analyze whether politicians avoid tax increases in election years. These data contain 3 useful attributes: (1) when state politicians enact tax laws, (2) when state politicians implement tax laws on consumers and firms, and (3) the size of tax changes. Using a pre-analysis research plan that includes regressions of tax rate changes and tax enactment years on time-to-gubernatorial election year indicators, we find that elections decrease the probability of politicians enacting increases in taxes and reduce the size of implemented tax changes relative to non-election years. We find some evidence that politicians are most likely to enact tax increases right after an election. These election effects are stronger for gasoline taxes than for corporate income taxes and depend on no other political, demographic, or macroeconomic conditions. Supplemental analysis supports political salience over legislative eort in generating this difference in electoral effects.
Accessible materials (.zip)

DOI: https://doi.org/10.17016/FEDS.2021.004

FEDS 2021-003
Ten Days Late and Billions of Dollars Short: The Employment Effects of Delays in Paycheck Protection Program Financing

Abstract:

Delay in the provision of Paycheck Protection Program (PPP) loans due to insufficient initial funding under the CARES Act substantially and persistently reduced employment. Delayed loans increased job losses in May and persistently reduced recalls throughout the summer. The magnitude and heterogeneity of effects suggest significant barriers to obtaining external financing, particularly among small firms. Effects are inequitably distributed: larger among the self-employed, less well paid, less well educated and--importantly for the design of future programs--in very small firms. Our estimates imply the PPP saved millions of jobs but larger initial funding could have saved millions more, particularly if it had been directed toward the smallest firms. About half of the jobs lost to insufficient PPP funding are lost in firms with fewer than 10 employees, despite such firms accounting for less than 20 percent of employment.
Accessible materials (.zip)

Keywords: Paycheck Protection Program, CARES Act, Countercyclical Fiscal Policy, Covid-19, Kurzarbeit, Income Support, Small Business Lending, Small and Medium Enterprises (SMEs), Financial Frictions

DOI: https://doi.org/10.17016/FEDS.2021.003

FEDS 2021-002
Better Bunching, Nicer Notching

Marinho Bertanha, Andrew H. McCallum, and Nathan Seegert

Abstract:

We study the bunching identification strategy for an elasticity parameter that summarizes agents' response to changes in slope (kink) or intercept (notch) of a schedule of incentives. A notch identifies the elasticity but a kink does not, when the distribution of agents is fully flexible. We propose new non-parametric and semi-parametric identification assumptions on the distribution of agents that are weaker than assumptions currently made in the literature. We revisit the original empirical application of the bunching estimator and find that our weaker identification assumptions result in meaningfully different estimates. We provide the Stata package bunching to implement our procedures.
Accessible materials (.zip)

Keywords: partial identification, censored regression, bunching, notching

DOI: https://doi.org/10.17016/FEDS.2021.002

FEDS 2021-001
International Yield Spillovers

Don H. Kim and Marcelo Ochoa

Abstract:

This paper investigates spillovers from foreign economies to the U.S. through changes in longterm Treasury yields. We document a decline in the contribution of U.S. domestic news to the variance of long-term Treasury yields and an increased importance of overnight yield changes—a rough proxy for the contribution of foreign shocks to U.S. yields—over the past decades. Using a model that identifies U.S., Euro area, and U.K. shocks that move global yields, we estimate that foreign (non-U.S.) shocks account for at least 20 percent of the daily variation in long-term U.S. yields in recent years. We argue that spillovers occur in large part through bond term premia by showing that a low level of foreign yields relative to U.S. yields predicts a decline in distant forward U.S. yields and higher returns on a strategy that is long on a long-term Treasury security and short on a long-term foreign bond.
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Keywords: Bond risk premia, foreign spillovers, event study, identification by heteroskedasticity, predictability.

DOI: https://doi.org/10.17016/FEDS.2021.001

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Last Update: June 03, 2021