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 2018-070
Reliably Computing Nonlinear Dynamic Stochastic Model Solutions: An Algorithm with Error Formulas (PDF)

Abstract: This paper provides a new technique for representing discrete time nonlinear dynamic stochastic time invariant maps. Using this new series representation, the paper augments the usual solution strategy with an additional set of constraints thereby enhancing algorithm reliability. The paper also provides general formulas for evaluating the accuracy of proposed solutions. The technique can readily accommodate models with occasionally binding constraints and regime switching. The algorithm uses Smolyak polynomial function approximation in a way which makes it possible to exploit a high degree of parallelism.

Keywords: Econometric modeling, mathematical and quantitative methods

DOI: https://doi.org/10.17016/FEDS.2018.070

FEDS 2018-069
The Effect of Common Ownership on Profits: Evidence From the U.S. Banking Industry (PDF)

Abstract: Theory predicts that "common ownership" (ownership of rivals by a common shareholder) can be anticompetitive because it reduces the weight firms place on their own profits and shifts weight toward rival firms held by common shareholders. In this paper we use accounting data from the banking industry to examine empirically whether shifts in the profit weights are associated with shifts in profits. We present the distribution of a wide range of estimates that vary the specification, sample restrictions, and assumptions used to calculate the profit weights. The distribution of estimates is roughly centered around zero, but we find statistically significant estimates in either direction in some cases. Economically, most estimates are fairly small. Our interpretation of these findings is that there is little evidence for economically important effects of common ownership on profits in the banking industry.

Keywords: Banking, Common Ownership, Competition, Profits

DOI: https://doi.org/10.17016/FEDS.2018.069

FEDS 2018-068
The Long and Short of It: Do Public and Private Firms Invest Differently? (PDF)

Naomi Feldman, Laura Kawano, Elena Patel, Nirupama Rao, Michael Stevens, and Jesse Edgerton

Abstract: Using data from U.S. corporate tax returns, which provide a sample representative of the universe of U.S. corporations, we investigate the differential investment propensities of public and private firms. Re-weighting the data to generate observationally comparable sets of public and private firms, we find robust evidence that public firms invest more overall, particularly in R&D. Exploiting within-firm variation in public status, we find that firms dedicate more of their investment to R&D following IPO, and reduce these investments upon going private. Our findings suggest that public stock markets facilitate greater investment, on average, particularly in risky, uncollateralized investments.

Keywords: Investment, Public firms, corporate governance

DOI: https://doi.org/10.17016/FEDS.2018.068

FEDS 2018-067
Unemployment Risk (PDF)

Abstract: Fluctuations in upside risks to unemployment over the medium term are examined using quantile regressions. U.S. experience reveals an elevated risk of large increases in unemployment when inflation or credit growth is high and when the unemployment rate is low. Inflation was a significant contributor to unemployment risk in the 1970s and early 1980s, and fluctuations in credit have contributed importantly to unemployment risk since the 1980s. Fluctuations in upside risk to unemployment are larger than fluctuations in the median outlook or downside risk to unemployment. Accounting for inflation and the state of the business cycle is important for understanding the role of financial conditions in shaping unemployment risk. The analysis suggests that fluctuations in near-term risks to unemployment decreased after 1984 because inflation stabilized, but fluctuations in medium-term risks increased owing to the large swings in credit in recent decades.

Keywords: Credit, GDP at Risk, Risk management

DOI: https://doi.org/10.17016/FEDS.2018.067

FEDS 2018-066
The Differential Impact of Bank Size on Systemic Risk (PDF)

Amy G. Lorenc and Jeffery Y. Zhang

Abstract: We examine whether financial stress at larger banks has a different impact on the real economy than financial stress at smaller banks. Our empirical results show that stress experienced by banks in the top 1 percent of the size distribution leads to a statistically significant and negative impact on the real economy. This impact increases with the size of the bank. The negative impact on quarterly real GDP growth caused by stress at banks in the top 0.15 percent of the size distribution is more than twice as large as the impact caused by stress at banks in the top 0.75 percent, and more than three times as large as the impact caused by stress at banks in the top 1 percent. These results are broadly informative as to how the stringency of regulatory standards should vary with bank size, and support the idea that the largest banks should be subject to the most stringent requirements while smaller banks should be subject to successively less stringent requirements.

Keywords: Bank Failures, Bank Size, Financial Regulation, Systemic Risk, Tailoring

DOI: https://doi.org/10.17016/FEDS.2018.066

FEDS 2018-065
Price Pressure and Price Discovery in the Term Structure of Interest Rates (PDF)

Scott Mixon and Tugkan Tuzun

Abstract: We study the price pressure and price discovery effects in the U.S. Treasury market by using a term structure model. Our model decomposes yield curve shifts into two components: a virtually permanent change related to order flow and a transitory, price pressure effect due to dealer inventories. We find strong evidence that net dealer Treasury inventories has impact on the yield curve. Cash Treasury instruments in inventory have a larger impact on yields than futures contracts, suggesting that cash and futures inventories are not perfect substitutes. Price discovery in the level of interest rates is most strongly linked to non-dealer order flow in the 10-year futures contract, while price discovery in the slope of the curve is linked to order flow in the 10-year futures and the 5-year cash market.

Keywords: Dealers, Liquidity, Price Discovery, Price Pressure , Treasury Market

DOI: https://doi.org/10.17016/FEDS.2018.065

FEDS 2018-064
Measuring Aggregate Housing Wealth: New Insights from an Automated Valuation Model (PDF)

Abstract: We construct a new measure of aggregate U.S. housing wealth based on Zillow's Automated Valuation Model (AVM). AVMs offer advantages over other methods because they are based on recent market transaction prices, utilize large datasets which include property characteristics and local geographic variables, and are updated frequently with little lag. However, using Zillow's AVM to measure aggregate housing wealth requires overcoming several challenges related to the representativeness of the Zillow sample. We propose methods that address these challenges and generate a new estimate of aggregate U.S. housing wealth from 2001 to 2016. This new measure provides insights into some of the disadvantages of other approaches to measuring housing wealth. Specifically, with respect to the owner valuations typically used in survey data, it appears that homeowners were slow to recognize the drop in housing wealth during the financial crisis and that their estimates of this drop were unrealistically small. At the same time, repeat-sales price indexes appear to overstate the extent of the drop in value between 2006 and 2011 and overstate the recovery thereafter.

Keywords: Consumer economics and finance, Data collection and estimation, Flow of funds, Residential real estate

DOI: https://doi.org/10.17016/FEDS.2018.064

FEDS 2018-063
Bank Holdings and Systemic Risk (PDF)

Celso Brunetti, Jeffrey H. Harris, and Shawn Mankad

Abstract: The recent financial crisis has focused attention on identifying and measuring systemic risk. In this paper, we propose a novel approach to estimate the portfolio composition of banks as function of daily interbank trades and stock returns. While banks' assets are reported to regulators and/or the public at relatively low frequencies (e.g. quarterly or annually), our approach estimates bank asset holdings at higher frequencies which allows us to derive precise estimates of (i) portfolio concentration within each bank--a measure of diversification--and (ii) common holdings across banks--a measure of market susceptibility to propagating shocks. We find evidence that systemic risk measures derived from our approach lead, in a forecasting sense, several commonly used systemic risk indicators.

Keywords: Bank holdings, concentration index, similarity index, systemic risk

DOI: https://doi.org/10.17016/FEDS.2018.063

FEDS 2018-062
The Role of Expectations in Changed Inflation Dynamics (PDF)

Abstract: The Phillips curve has been much flatter in the past twenty years than in the preceding decades. We consider two hypotheses. One is that prices at the microeconomic level are stickier than they used to be---in the context of the canonical Calvo model, firms are adjusting prices less often. The other is that the expectations of firms and households about future inflation are now less well informed by macroeconomic conditions; because expectations are important in the setting of current-period prices, inflation is therefore less sensitive to macroeconomic conditions. To distinguish between our two hypotheses, we bring to bear information on inflation expectations from surveys, which allow us to distinguish changes in the sensitivity of inflation to economic conditions conditioning on expectations from changes in the sensitivity of expectations themselves to economic conditions. We find that, with some measures, expectations are less tied to economic conditions than i n the past, and thus that this reduced attentiveness can account for a significant portion of the reduction in the sensitivity of inflation to economic conditions in recent decades.

Keywords: Inflation dynamics, Phillips curve, Survey Inflation Expectations

DOI: https://doi.org/10.17016/FEDS.2018.062

FEDS 2018-061
Information and Liquidity of OTC Securities: Evidence from Public Registration of Rule 144A Bonds (PDF)

Song Han, Alan G. Huang, Madhu Kalimipalli, and Ke Wang

Abstract: The Rule 144A private debt represents a significant and growing segment of the U.S. bond market. This paper examines the market liquidity effects of enhanced information disclosure induced by the public registration of 144A bonds. Using the regulatory version of TRACE data for the period 2002-2013, we find that following public registration of 144A bonds, dealer-specific effective bid-ask spreads narrow, especially for issues with higher ex-ante information asymmetry. Our results are consistent with existing theories that disclosure reduces information risk and thus improves market liquidity.

Keywords: Rule 144A bond, broker-dealers, information disclosure, liquidity, public registration

DOI: https://doi.org/10.17016/FEDS.2018.061

FEDS 2018-060
The Shift from Active to Passive Investing: Potential Risks to Financial Stability? (PDF)

Abstract: The past couple of decades have seen a significant shift in assets from active to passive investment strategies. We examine the potential effects of this shift on financial stability through four different channels: (1) effects on investment funds' liquidity transformation and redemption risks; (2) passive strategies that amplify market volatility; (3) increases in asset-management industry concentration; and (4) the effects on valuations, volatility, and comovement of assets that are included in indexes. Overall, the shift from active to passive investment strategies appears to be increasing some types of risk while diminishing others: The shift has probably reduced liquidity transformation risks, although some passive strategies amplify market volatility, and passive-fund growth is increasing asset-management industry concentration. We find mixed evidence that passive investing is contributing to the comovement of assets. Finally, we use our framework to assess how financial stability risks are likely to evolve if the shift to passive investing continues, noting that some of the repercussions of passive investing ultimately may slow its growth.

Keywords: asset management; passive investing; index investing; indexing; mutual fund; exchange-traded fund; leveraged and inverse exchange-traded products; financial stability; systemic risk; market volatility; inclusion effects; daily rebalancing.

DOI: https://doi.org/10.17016/FEDS.2018.060

FEDS 2018-059
Some Implications of Uncertainty and Misperception for Monetary Policy (PDF)

Abstract: When choosing a strategy for monetary policy, policymakers must grapple with mismeasurement of labor market slack, and of the responsiveness of price inflation to that slack. Using stochastic simulations of a small-scale version of the Federal Reserve Board’s principal New Keynesian macroeconomic model, we evaluate representative rule-based policy strategies, paying particular attention to how those strategies interact with initial conditions in the U.S. as they are seen today and with the current outlook. To do this, we construct a current relevant baseline forecast, one that is constructed loosely based on a recent FOMC forecast, and conduct our experiments around that baseline. We find the initial conditions and forecast that policymakers face affect decisions in a material way. The standard advice from the literature, that in the presence of mismeasurement of resource slack policymakers should substantially reduce the weight attached to those measures in setting the policy rate, and substitute toward a more forceful response to inflation, is overstated. We find that a notable response to the unemployment gap is typically beneficial, even if that gap is mismeasured. Even when the dynamics of inflation are governed by a 1970s-style Phillips curve, meaningful response to resource utilization is likely to turn out to be worthwhile, particularly in environments where resource utilization is thought to be tight to begin with and inflation is close to its target level.

Keywords: Monetary policy, uncertainty, stochastic simulation, policy analysis

DOI: https://doi.org/10.17016/FEDS.2018.059

FEDS 2018-058
Oil, Equities, and the Zero Lower Bound (PDF)

Abstract: From late 2008 to 2017, oil and equity returns were more positively correlated than in other periods. In addition, we show that both oil and equity returns became more responsive to macroeconomic news. We provide empirical evidence and theoretical justification that these changes resulted from nominal interest rates being constrained by the zero lower bound (ZLB). Although the ZLB alters the economic environment in theory, supportive empirical evidence has been lacking. Our paper provides clear evidence of the ZLB altering the economic environment, with implications for the effectiveness of fiscal and monetary policy.

Keywords: Equities, Macroeconomic Surprises, New-Keynesian Model, Oil, Zero Lower Bound

DOI: https://doi.org/10.17016/FEDS.2018.058

FEDS 2018-057
Hidden Baggage: Behavioral Responses to Changes in Airline Ticket Tax Disclosure (PDF)

Sebastien Bradley and Naomi E. Feldman

Abstract: We examine the impact on air travelers of an enforcement action issued by the U.S. Department of Transportation in January 2012 that required U.S. air carriers and online travel agents to incorporate all mandatory taxes and fees into their advertised fares. Exploiting cross-itinerary ticket tax variation within international city market pairs, we provide evidence that the more prominent display of tax-inclusive prices is associated with a significant reduction in tax incidence on consumers and a decline in passenger volume along more heavily-taxed itineraries. Ticket revenues are commensurately reduced. These results suggest a pronounced degree of inattention to ticket taxes prior to the introduction of full-fare advertising and reinforces the theoretical predictions and experimental findings of the literature on tax salience in a quasi-experimental context where taxes average more than $100 per ticket and where firms may engage in price-setting behavior.

Keywords: Tax incidence, tax salience

DOI: https://doi.org/10.17016/FEDS.2018.057

FEDS 2018-056
A Shadow Rate or a Quadratic Policy Rule? The Best Way to Enforce the Zero Lower Bound in the United States (PDF)

Martin M. Andreasen and Andrew Meldrum

Abstract: We study whether it is better to enforce the zero lower bound (ZLB) in models of U.S. Treasury yields using a shadow rate model or a quadratic term structure model. We show that the models achieve a similar in-sample fit and perform comparably in matching conditional expectations of future yields. However, when the recent ZLB period is included in the sample, the models'' ability to match conditional expectations away from the ZLB deteriorates because the time-series dynamics of the pricing factors change. In addition, neither model provides a reasonable description of conditional volatilities when yields are away from the ZLB.

Keywords: Quadratic term structure models, Sequential regression approach, Shadow rate models, Zero lower bound

DOI: https://doi.org/10.17016/FEDS.2018.056

FEDS 2018-055
The Near-Term Forward Yield Spread as a Leading Indicator: A Less Distorted Mirror (PDF)

Abstract: The spread between the yield on a 10-year Treasury bond and the yield on a shorter maturity bond, such as a 2-year Treasury, is commonly used as an indicator for predicting U.S. recessions. We show that such "long-term spreads" are statistically dominated in recession prediction models by an economically more intuitive alternative, a "near-term forward spread." This latter spread can be interpreted as a measure of the market's expectations for the near-term trajectory of conventional monetary policy rates. The predictive power of our near-term forward spread indicates that, when market participants expected--and priced in--a monetary policy easing over the next 12-18 months, this indicated that a recession was quite likely in the offing. Yields on bonds beyond 18 months in maturity are shown to have no added value for forecasting either recessions or the growth rate of GDP.

Keywords: Yield Spread, Recession Forecast, Monetary Policy, Policy Path

DOI: https://doi.org/10.17016/FEDS.2018.055

FEDS 2018-054
Financial Frictions, Financial Shocks, and Aggregate Volatility (PDF)

Abstract: The Great Moderation in the U.S. economy was accompanied by a widespread increase in the volatility of financial variables. We explore the sources of the divergent patterns in volatilities by estimating a model with time-varying nancial rigidities subject to structural breaks in the size of the exogenous processes and two institutional characteristics: the coefficients in the monetary policy rule and the severity of the financial rigidity at the steady state. To do so, we generalize the estimation methodology developed by Cúrdia and Finocchiaro (2013). Institutional changes are key in accounting for the volatility slowdown in real and nominal variables and in shaping the transmission mechanism of financial shocks. Our model accounts for the increase in the volatility of financial variables through larger nancial shocks, but the vulnerability of the economy to these shocks is significantly alleviated by the estimated changes in institutions.

Keywords: Changes in cyclical volatilities, financial frictions, financial shocks, structural breaks, Bayesian methods

DOI: https://doi.org/10.17016/FEDS.2018.054

FEDS 2018-053
Tapping into Financial Synergies: Alleviating Financial Constraints Through Acquisitions (PDF)

Rohan Williamson and Jie Yang

Abstract: The paper examines whether financially constrained firms are able to use acquisitions to ease their constraints. The results show that acquisitions do ease financing constraints for constrained acquirers. Relative to unconstrained acquires, financially constrained firms are more likely to use undervalued equity to fund acquisitions and to target unconstrained and more liquid firms. Using a propensity score matched sample in a difference-in-difference framework, the results show that constrained acquirers become less constrained post-acquisition and relative to matched non-acquiring firms. This improvement is more pronounced for diversifying acquisitions and constrained firms that acquire rather than issue equity and retain the proceeds. Following acquisition, constrained acquirers raise more debt and increase investments, consistent with experiencing reductions in financing constraints relative to matched non-acquirers. These improvements are not seen for unconstrained acquirers. Finally, the familiar diversification discount is non- existent for financially constrained acquirers.

Keywords: Diversification, Financing Constraints, Firm Structure, Mergers & Acquisitions

DOI: https://doi.org/10.17016/FEDS.2018.053

FEDS 2018-052
Preventing Controversial Catastrophes (PDF)

Steven D. Baker, Burton Hollifield, and Emilio Osambela

Abstract: In a market-based democracy, we model different constituencies that disagree regarding the likelihood of economic disasters. Costly public policy initiatives to reduce or eliminate disasters are assessed relative to private alternatives presented by financial markets. Demand for such public policies falls as much as 40% with disagreement, and crowding out by private insurance drives most of the reduction. As support for disaster-reducing policy jumps in periods of disasters, costly policies may be adopted only after disasters occur. In some scenarios constituencies may even demand policies oriented to increase disaster risk if these policies introduce speculative opportunities.

Keywords: Crowding out, Disagreement, Disaster risk, Government policy, Willingness to pay

DOI: https://doi.org/10.17016/FEDS.2018.052

FEDS 2018-051
From Taylor's Rule to Bernanke's Temporary Price Level Targeting (PDF)

James Hebden and David Lopez-Salido

Abstract: Bernanke's strategies for integrating forward guidance into conventional instrument rules anticipate that effective lower bound (ELB) episodes may become part a regular occurrence and that monetary policy should recognize this likelihood (Bernanke (2017a); Bernanke (2017b)). Bernanke's first proposal is a form of flexible temporary price level targeting (TPLT), in which a lower-for-longer policy path is prescribed through a "shadow rate". This shadow rate accounts for cumulative shortfalls in inflation and output relative to exogenous trends, and the policy rate is kept at the ELB until the joint shortfall is made up. Bernanke's second proposal adds only the cumulative inflation shortfall since the beginning of an ELB episode directly to an otherwise standard Taylor rule. This cumulative shortfall in inflation from the 2 percent objective can be restated in terms of deviations of the price level from a price level target that increases at 2 percent annually. We evaluate the performance of these strategies, which we call Bernanke's TPLT rules, using a small version of the FRB/US model. We then optimize these rules, computing efficient policy frontiers that trace out the best (minimum) obtainable combinations of output and inflation volatility given the effective lower bound constraint on the policy rate. The results suggest that Bernanke's rules give better macroeconomic outcomes than most of the other rules considered in the literature (including Taylor (1993) and Taylor (1999)) by stabilizing inflation and unemployment during severe recessions. Under these TPLT strategies, when the policy rate is made more responsive to shortfalls in inflation, the the likelihood of below-target inflation occurring alongside high unemployment rates decreases. However, the probability of an overheated economy, with temporarily above-target inflation and low unemployment rate, increases.

Keywords: Taylor rule, history-dependent policy, price level targeting, zero lower bound

DOI: https://doi.org/10.17016/FEDS.2018.051

FEDS 2018-050
Speed Limit Policy and Liquidity Traps (PDF)

Taisuke Nakata, Sebastian Schmidt, and Paul Yoo

Abstract: The zero lower bound (ZLB) constraint on interest rates makes speed limit policies (SLPs)--policies aimed at stabilizing the output growth--less effective. Away from the ZLB, the history dependence induced by a concern for output growth stabilization improves the inflation-output tradeoff for a discretionary central bank. However, in the aftermath of a deep recession with a binding ZLB, a central bank with an objective for output growth stabilization aims to engineer a more gradual increase in output than under the standard discretionary policy. The anticipation of a more restrained recovery exacerbates the declines in inflation and output when the lower bound is binding.

Keywords: Liquidity Traps, Markov-Perfect Equilibrium, Speed Limit Policy, Zero Lower Bound.

DOI: https://doi.org/10.17016/FEDS.2018.050

FEDS 2018-049
Attenuating the Forward Guidance Puzzle: Implications for Optimal Monetary Policy (PDF)

Taisuke Nakata, Ryota Ogaki, Sebastian Schmidt, and Paul Yoo

Abstract: We examine the implications of less powerful forward guidance for optimal policy using a sticky-price model with an effective lower bound (ELB) on nominal interest rates as well as a discounted Euler equation and Phillips curve. When the private-sector agents discount future economic conditions more in making their decisions today, an announced cut in future interest rates becomes less effective in stimulating current economic activity. While the implication of such discounting for optimal policy depends on its degree, we find that, under a wide range of plausible degrees of discounting, it is optimal for the central bank to compensate for the reduced effect of a future rate cut by keeping the policy rate at the ELB for longer.

Keywords: Discounted Euler Equation, Discounted Phillips Curve, Effective Lower Bound, Forward Guidance, Optimal Policy

DOI: https://doi.org/10.17016/FEDS.2018.049

FEDS 2018-048
Income Inequality, Financial Crises, and Monetary Policy (PDF)

Abstract: We construct a general equilibrium model in which income inequality results in insufficient aggregate demand, deflation pressure, and excessive credit growth by allocating income to agents featuring low marginal propensity to consume, and if excessive, can lead to an endogenous financial crisis. This economy generates distributions for equilibrium prices and quantities that are highly skewed to the downside due to financial crises and the liquidity trap. Consequently, symmetric monetary policy rules designed to minimize fluctuations around fixed means become inefficient. A simultaneous reduction in inflation volatility and mean unemployment rate is feasible when an asymmetric policy rule is adopted.

Keywords: Monetary policy, credit, financial crises, income inequality

DOI: https://doi.org/10.17016/FEDS.2018.048

FEDS 2018-047
Half-full or Half-empty? Financial Institutions, CDS Use, and Corporate Credit Risk (PDF)

Cecilia Caglio, R. Matt Darst, and Eric Parolin

Abstract: We construct a novel U.S. data set that matches bank holding company credit default swap (CDS) positions to detailed U.S. credit registry data containing both loan and corporate bond holdings to study the effects of banks' CDS use on corporate credit quality. Banks may use CDS to mitigate agency frictions and not renegotiate loans with solvent but illiquid borrowers resulting in poorer measures of credit risk. Alternatively, banks may lay off the credit risk of high quality borrowers through the CDS market to comply with risk-based capital requirements, which does not impact corporate credit risk. We find new evidence that corporate default probabilities and downgrade likelihoods, if anything, are slightly lower when banks purchase CDS against their borrowers. The results are consistent with banks using CDS to efficiently lay off credit risk rather than inefficiently liquidate firms.

Keywords: Bank lending, credit default swaps, risk management

DOI: https://doi.org/10.17016/FEDS.2018.047

FEDS 2018-046
Self-confirming Price Dispersion in Monetary Economies (PDF)

Garth Baughman and Stanislav Rabinovich

Abstract: In a monetary economy, we show that price dispersion arises as an equilibrium outcome without the need for costly simultaneous search or any heterogeneity in preferences, production costs, or search technologies. A distribution of money holdings among buyers makes sellers indifferent across a set of posted prices, leading to a non-degenerate price distribution. This price distribution, in turn, makes buyers indifferent across a range of money balances, rationalizing the non-degenerate distribution of money holdings. We completely characterize the distribution of posted prices and money holdings in any equilibrium. Equilibria with price dispersion admit higher maximum prices than observed in any single-price equilibrium. Also, price dispersion reduces welfare by creating mismatch between posted prices and money balances. Inflation exacerbates this welfare loss by shifting the distribution towards higher prices.

Keywords: Seach, price dispersion, money, inflation

DOI: https://doi.org/10.17016/FEDS.2018.046

FEDS 2018-045
The Local Impact of Containerization (PDF)

Leah Brooks, Nicolas Gendron-Carrier, and Gisela Rua

Abstract: We investigate how containerization impacts local economic activity. Containerization is premised on a simple insight: packaging goods for waterborne trade into a standardized container makes them dramatically cheaper to move. We use a novel costshifter instrument--port depth pre-containerization--to contend with the non-random adoption of containerization by ports. Container ships sit much deeper in the water than their predecessors, making initially deep ports cheaper to containerize. Consistent with New Economic Geography models, we find that counties near container ports grow an additional 70 percent from 1950 to 2010. Gains predominate in counties with initially low population density and manufacturing.

DOI: https://doi.org/10.17016/FEDS.2018.045

FEDS 2018-044
A Nowcasting Model for the Growth Rate of Real GDP of Ecuador: Implementing a Time-Varying Intercept (PDF)

Manuel P. Gonzalez-Astudillo and Daniel Baquero

Abstract: This paper proposes a model to nowcast the annual growth rate of real GDP for Ecuador. The specification combines monthly information of 28 macroeconomic variables with quarterly information of real GDP in a mixed-frequency approach. Additionally, our setup includes a time-varying mean coefficient on the annual growth rate of real GDP to allow the model to incorporate prolonged periods of low growth, such as those experienced during secular stagnation episodes. The model produces reasonably good nowcasts of real GDP growth in pseudo out-of-sample exercises and is marginally more precise than a simple ARMA model.

Keywords: Ecuador, Nowcasting model, secular stagnation, time-varying coefficients

DOI: https://doi.org/10.17016/FEDS.2018.044

FEDS 2018-043
Financial Heterogeneity and Monetary Union (PDF)

Simon Gilchrist, Raphael Schoenle, Jae W. Sim, and Egon Zakrajsek

Abstract: We analyze the economic consequences of forming a monetary union among countries with varying degrees of financial distortions, which interact with the firms' pricing decisions because of customer-market considerations. In response to a financial shock, firms in financially weak countries (the periphery) maintain cashflows by raising markups--in both domestic and export markets--while firms in financially strong countries (the core) reduce markups, undercutting their financially constrained competitors to gain market share. When the two regions are experiencing different shocks, common monetary policy results in a substantially higher macroeconomic volatility in the periphery, compared with a flexible exchange rate regime; this translates into a welfare loss for the union as a whole, with the loss borne entirely by the periphery. By helping firms from the core internalize the pecuniary externality engendered by the interaction of financial frictions and customer markets, a unilateral fiscal devaluation by the periphery can improve the union's overall welfare.
Technical Appendix (PDF)

Keywords: Eurozone; financial crisis; monetary union; inflation dynamics; markups; fiscal devaluation

DOI: https://doi.org/10.17016/FEDS.2018.043

FEDS 2018-042
The Money View Versus the Credit View (PDF)

Sarah S. Baker, David López-Salido, and Edward Nelson

Abstract: We argue that Schularick and Taylor's (2012) comparison of credit growth and monetary growth as financial-crisis predictors does not necessarily provide a valid basis for achieving one of their stated intentions: evaluating the relative merits of the "money view" and "credit view" as accounts of macroeconomic outcomes. Our own analysis of the postwar evidence suggests that money outperforms credit in predicting economic downturns in the 14 countries in Schularick and Taylor's dataset. This contrasts with Schularick and Taylor's (2012) highly negative verdict on the money view. In accounting for the difference in findings, we first explain that Schularick and Taylor's characterization of the money view is defective, both because their criterion for its validity (that rapid monetary growth predicts financial crises) is misplaced, and because they incorrectly take the money view's proponents as relying on the notion that monetary aggregates are a good proxy for credit a ggregates. In fact, the money view of Friedman and Schwartz does not predict an automatic relationship between rapid monetary growth and (financial or economic) downturns, nor does it rest on money being a good proxy for credit. We further show that Schularick and Taylor's data on money have systematic faults. For our reexamination of the evidence, we have constructed new, and more reliable, annual data on money for the countries studied by Schularick and Taylor.

Keywords: credit view, financial crises, money view, recessions

DOI: https://doi.org/10.17016/FEDS.2018.042

FEDS 2018-041
Nothing is Certain Except Death and Taxes: The Lack of Policy Uncertainty from Expiring "Temporary" Taxes (PDF)

Abstract: What is the policy uncertainty surrounding expiring taxes? How uncertain are the approvals of routine extensions of temporary tax policies? To answer these questions, I use event studies to measure cumulative abnormal returns (CARs) for firms that claimed the U.S. research and development (R&D) tax credit from 1996-2015. In 1996, the U.S. R&D tax credit was statutorily temporary but was routinely extended ten times until 2015, when it was made permanent. I take the event dates as both when these ten extensions of the R&D tax credit were introduced into committee and when significant CARs on these dates, which suggests that the market anticipated these extensions to become law. My results support the fact that a routine extension of a temporary tax policy is not a generator of policy uncertainty and, therefore, that a routine extension of temporary tax policy is not a fiscal shock.

Keywords: Cumulative Abnormal Returns; Excess Returns; Event Study; Fiscal Policy; R&D; Research and Development; Sunset Provision; Tax Extension; Temporary Tax; Uncertainty Shocks; User Cost of Capital

DOI: https://doi.org/10.17016/FEDS.2018.041

FEDS 2018-040
An Output Gap Measure for the Euro Area: Exploiting Country-Level and Cross-Sectional Data Heterogeneity (PDF)

Abstract: This paper proposes a methodology to estimate the euro-area output gap by taking advantage of two types of data heterogeneity. On the one hand, the method uses information on real GDP, inflation, and the unemployment rate for each member state; on the other hand, it jointly considers this information for all the euro-area countries to extract an area-wide output gap measure. The setup is an unobserved components model that theorizes a common cycle across euro-area economies in addition to country- specific cyclical components. I estimate the model with Bayesian methods using data for the 19 countries of the euro area from 2000:Q1 through 2017:Q2 and perform model comparisons across different specifications of the output trend. The estimation of the model preferred by the data indicates that, because of negative shocks to trend output during the global financial crisis, output remained slightly above potential in that period, but an output gap of about negative 3-1⁄2 percent emerged during the European debt crisis. At the end of the sample period, output is estimated to be about 1 percent above potential.

Keywords: Unobserved components model, euro area, Okun's law, Phillips curve, output gap

DOI: https://doi.org/10.17016/FEDS.2018.040

FEDS 2018-039
The Rise of Shadow Banking: Evidence from Capital Regulation (PDF)

Rustom M. Irani, Rajkamal Iyer, Ralf R. Meisenzahl, and José-Luis Peydró

Abstract: We investigate the connections between bank capital regulation and the prevalence of lightly regulated nonbanks (shadow banks) in the U.S. corporate loan market. For identification, we exploit a supervisory credit register of syndicated loans, loan-time fixed-effects, and shocks to capital requirements arising from surprise features of the U.S. implementation of Basel III. We find that less-capitalized banks reduce loan retention and nonbanks step in, particularly among loans with higher capital requirements and at times when capital is scarce. This reallocation has important spillovers: loans funded by nonbanks with fragile liabilities experience greater sales and price volatility during the 2008 crisis.

Keywords: Shadow banks; risk-based capital regulation; Basel III; interactions between banks and nonbanks; trading by banks; distressed debt

DOI: https://doi.org/10.17016/FEDS.2018.039

FEDS 2018-038
What Macroeconomic Conditions Lead Financial Crises? (PDF)

Abstract: Research has suggested that a rapid pace of nonfinancial borrowing reliably precedes financial crises, placing the pace of debt growth at the center of frameworks for the deployment of macroprudential policies. I reconsider the role of asset-prices and current account deficits as leading indicators of financial crises. Run-ups in equity and house prices and a widening of the current account deficit have substantially larger (and more statistically-significant) effects than debt growth on the probability of a financial crisis in standard crisis-prediction models. The analysis highlights the value of graphs of predicted crisis probabilities in an assessment of predictors.
Accessible materials (.zip)

Keywords: Current account, Debt, Equity prices, Financial crisis, House prices

DOI: https://doi.org/10.17016/FEDS.2018.038

FEDS 2018-037
Efficient Mismatch (PDF)

David M. Arseneau and Brendan Epstein

Abstract: This paper presents a model in which mismatch employment arises in a constrained efficient equilibrium. In the decentralized economy, however, mismatch gives rise to a congestion externality whereby heterogeneous job seekers fail to internalize how their individual actions affect the labor market outcomes of competitors in a common unemployment pool. We provide an analytic characterization of this distortion, assess the distributional nature of the associated welfare effects, and relate it to the relative productivity of low- and high-skilled workers competing for similar jobs.
Accessible materials (.zip)

Keywords: Labor market frictions, competitive search equilibrium, crowding in/out, skill-mismatch

DOI: https://doi.org/10.17016/FEDS.2018.037

FEDS 2018-036
Density Forecasts in Panel Data Models: A Semiparametric Bayesian Perspective (PDF)

Abstract: This paper constructs individual-specific density forecasts for a panel of firms or households using a dynamic linear model with common and heterogeneous coefficients and cross-sectional heteroskedasticity. The panel considered in this paper features a large cross-sectional dimension N but short time series T. Due to the short T, traditional methods have difficulty in disentangling the heterogeneous parameters from the shocks, which contaminates the estimates of the heterogeneous parameters. To tackle this problem, I assume that there is an underlying distribution of heterogeneous parameters, model this distribution nonparametrically allowing for correlation between heterogeneous parameters and initial conditions as well as individual-specific regressors, and then estimate this distribution by pooling the information from the whole cross-section together. Theoretically, I prove that both the estimated common parameters and the estimated distribution of the heterogeneous parameters achieve posterior consistency, and that the density forecasts asymptotically converge to the oracle forecast. Methodologically, I develop a simulation-based posterior sampling algorithm specifically addressing the nonparametric density estimation of unobserved heterogeneous parameters. Monte Carlo simulations and an application to young firm dynamics demonstrate improvements in density forecasts relative to alternative approaches.
Accessible materials (.zip)

Keywords: Bayesian Nonparametric Methods, Density Forecasts, Panel Data, Posterior Consistency, Young Firm Dynamics

DOI: https://doi.org/10.17016/FEDS.2018.036

FEDS 2018-035
Can More Housing Supply Solve the Affordability Crisis? Evidence from a Neighborhood Choice Model (PDF)

Elliot Anenberg and Edward Kung

Abstract: We estimate a neighborhood choice model using 2014 American Community Survey data to investigate the degree to which new housing supply can improve housing affordability. In the model, equilibrium rental rates are determined so that the number of households choosing each neighborhood is equal to the number of housing units in each neighborhood. We use the estimated model to simulate how rental rates would respond to an exogenous increase in the number of housing units in a neighborhood. We find that the rent elasticity is low, and thus marginal reductions in supply constraints alone are unlikely to meaningfully reduce rent burdens. The reason for this result appears to be that rental rates are more closely determined by the level of amenities in a neighborhood--as in a Rosen-Roback spatial equilibrium framework--than by the supply of housing.
Accessible materials (.zip)

Keywords: Housing affordability, housing supply, neighborhood choice

DOI: https://doi.org/10.17016/FEDS.2018.035

FEDS 2018-034
The Nature of Household Labor Income Risk (PDF)

Seth Pruitt and Nicholas Turner

Abstract: What is the nature of labor income risk facing households? We answer this question using detailed administrative data on household earnings from the U.S. Internal Revenue Service. By analyzing total household labor earnings as well as each member's earnings, we offer several new findings. One, households face substantially less risk than males in isolation. Second, households face roughly half the countercyclical increase in risk that males face. Third, spousal labor income ameliorates household earnings risk through both extensive and intensive margins.
Accessible materials (.zip)

Keywords: Earnings risk, household labor dynamics

DOI: https://doi.org/10.17016/FEDS.2018.034

FEDS 2018-033
Publication Bias and the Cross-Section of Stock Returns (PDF)

Andrew Y. Chen and Tom Zimmermann

Abstract: We develop an estimator for publication bias and apply it to 156 hedge portfolios based on published cross-sectional return predictors. Publication bias adjusted returns are only 12% smaller than in-sample returns. The small bias comes from the dispersion of returns across predictors, which is too large to be accounted for by data-mined noise. Among predictors that can survive journal review, a low t-stat hurdle of 1.8 controls for multiple testing using statistics recommended by Harvey, Liu, and Zhu (2015). The estimated bias is too small to account for the deterioration in returns after publication, suggesting an important role for mispricing.
Accessible materials (.zip)

Keywords: data mining, mispricing, publication bias, stock return anomalies

DOI: https://doi.org/10.17016/FEDS.2018.033

FEDS 2018-032
Voluntary Reserve Targets (PDF)

Abstract: This paper updates the standard workhorse model of banks' reserve management to include frictions inherent to money markets. We apply the model to study monetary policy implementation through an operating regime involving voluntary reserve targets (VRT). When reserves are abundant, as is the case following the unconventional policies adopted during the recent financial crisis, operating regimes based on reserve requirements may lead to a collapse in interbank trade. We show that, no matter the relative abundance of reserves, VRT encourage market activity and support the central bank's control over interest rates. In addition to this characterization, we consider (i) the impact of routine and non-routine liquidity injections by the central bank on market outcomes and (ii) a comparison with the implementation framework currently adopted by the Federal Reserve. Overall, we show that a VRT framework may provide several advantages over other frameworks.
Accessible materials (.zip)

Keywords: Monetary policy, Money Markets, Reserve Targets

DOI: https://doi.org/10.17016/FEDS.2018.032

FEDS 2018-031
The Origins of Aggregate Fluctuations in a Credit Network Economy (PDF)

Abstract: I show that inter-firm lending plays an important role in business cycle fluctuations. I first build a tractable network model of the economy in which trade in intermediate goods is financed by supplier credit. In the model, a financial shock to one firm affects its ability to make payments to its suppliers. The credit linkages between firms propagate financial shocks, amplifying their aggregate effects by about 30 percent. To calibrate the model, I construct a proxy of inter-industry credit flows from firm- and industry-level data. I then estimate aggregate and idiosyncratic shocks to industries in the US and find that financial shocks are a prominent driver of cyclical fluctuations, accounting for two-thirds of the drop in industrial production during the Great Recession. Furthermore, idiosyncratic financial shocks to a few key industries can explain a considerable portion of these effects. In contrast, productivity shocks had a negligible impact during the recession.
Accessible materials (.zip)

Keywords: Great Recession, business cycles, credit network, financial frictions, input-output network, trade credit

DOI: https://doi.org/10.17016/FEDS.2018.031

FEDS 2018-030
How much does health insurance cost? Comparison of premiums in administrative and survey data (PDF)

Jeff Larrimore and David Splinter

Abstract: Using newly available administrative data from the Internal Revenue Service, this paper studies the distribution of employer-sponsored health insurance premiums. Previous estimates, in contrast, were almost exclusively from household surveys. After correcting for coverage limitations of the IRS data, we find that average premiums for employer-sponsored plans are roughly $1000 higher in IRS records than in the Current Population Survey. The downward bias in the CPS is largely driven by underestimating of premiums among married workers and topcoding of high premiums.
Accessible materials (.zip)

Keywords: CPS, Employer Sponsored Health Insurance, IRS data, Topcoding

DOI: https://doi.org/10.17016/FEDS.2018.030

FEDS 2018-029
Reconsidering the Consequences of Worker Displacements: Firm versus Worker Perspective (PDF)

Aaron Flaaen, Matthew D. Shapiro, and Isaac Sorkin

Abstract: Prior literature has established that displaced workers suffer persistent earnings losses by following workers in administrative data after mass layoffs. This literature assumes that these are involuntary separations owing to economic distress. This paper examines this assumption by matching survey data on worker-supplied reasons for separations with administrative data. Workers exhibit substantially different earnings dynamics in mass layoffs depending on the reason for separation. Using a new methodology to account for the increased separation rates across all survey responses during a mass layoff, the paper finds earnings loss estimates that are surprisingly close to those using only administrative data.
Accessible materials (.zip)

Keywords: Earnings Losses, Job Loss, Unemployment

DOI: https://doi.org/10.17016/FEDS.2018.029

FEDS 2018-028
Optimal Public Debt with Life Cycle Motives (PDF)

William B. Peterman and Erick Sager

Abstract: Public debt can be optimal in standard incomplete market models with infinitely lived agents, since the associated capital crowd-out induces a higher interest rate. The higher interest rate encourages individuals to save and, hence, better self-insure against idiosyncratic labor earnings risk. Even though individual savings behavior is a crucial determinant of the optimality of public debt, this class of economies abstracts from empirically observed life cycle savings patterns. Thus, this paper studies how incorporating a life cycle affects optimal public debt. We find that while the infinitely lived agent model's optimal policy is public debt equal to 24% of output, the life cycle model's optimal policy is public savings equal to 61% of output. Although public debt also encourages life cycle agents to hold more savings during their lifetimes, the act of accumulating this savings mitigates the potential welfare benefit. Moreover, public savings improves life cycle agents' welfare by encouraging a flatter allocation of consumption and leisure over their lifetimes. Accordingly, abstracting from the life cycle yields an optimal policy that reduces average welfare by more than 0.6% of expected lifetime consumption. Furthermore, ignoring the life cycle overstates the influence of wealth inequality on optimal policy, since optimal policy is far less sensitive to wealth inequality in the life cycle model than in the infinitely lived agent model. These results demonstrate that studying optimal debt policy in an infinitely lived agent model, which abstracts from the realism of a life cycle in order to render models more computationally tractable, is not without loss of generality.
Accessible materials (.zip)

Keywords: Government Debt, Heterogeneous Agents, Incomplete Markets, Life Cycle

DOI: https://doi.org/10.17016/FEDS.2018.028

FEDS 2018-027
The Regulatory and Monetary Policy Nexus in the Repo Market (PDF)

Abstract: We examine the interaction of regulatory reforms and changes in monetary policy in the U.S. repo market. Using a proprietary data set of repo transactions, we find that differences in regional implementation of Basel III capital reforms intensified European dealers' window-dressing by 80%. Money funds eligible to use the Fed's reverse repo (RRP) facility cut their private lending almost by half and instead lent to the Fed when European dealers withdraw, contributing to smooth implementation of Basel III. In a difference-in-differences setting, we show that ineligible funds lent 15% less to European dealers as they find their withdrawal for reporting purposes inconvenient. We find that intermediation through the RRP led to quantity and not pricing adjustments in the market, which is consistent with the RRP facility anchoring market rates.
Accessible materials (.zip)

Keywords: Basel III regulations, Federal Reserve Board and Federal Reserve System, Monetary policy, repo, reverse repo facility

DOI: https://doi.org/10.17016/FEDS.2018.027

FEDS 2018-026
The Fed's Asymmetric Forecast Errors (PDF)

Abstract: I show that the probability that the Board of Governors of the Federal Reserve System staff's forecasts (the "Greenbooks") overpredicted quarterly real gross domestic product (GDP) growth depends on both the forecast horizon and also whether the forecasted quarter was above or below trend real GDP growth. For forecasted quarters that grew below trend, Greenbooks were much more likely to overpredict real GDP growth, with one-quarter ahead forecasts overpredicting real GDP growth more than 75% of the time, and this rate of overprediction was higher for further ahead forecasts. For forecasted quarters that grew above trend, Greenbooks were slightly more likely to underpredict real GDP growth, with one-quarter ahead forecasts underpredicting growth about 60% of the time. Unconditionally, on average, Greenbooks overpredicted real GDP growth.
Accessible materials (.zip)

Keywords: Asymmetric Forecast Errors, Federal Open Market Committee, Forecast Accuracy, Greenbook, Monetary policy, Real-Time Data

DOI: https://doi.org/10.17016/FEDS.2018.026

FEDS 2018-025
A Day Late and a Dollar Short: Liquidity and Household Formation among Student Borrowers (PDF)

Sarena Goodman, Adam Isen, and Constantine Yannelis

Abstract: The federal government encourages human capital investment through lending and grant programs, but resources from these programs may also finance non-education activities for students whose liquidity is otherwise restricted. This paper explores this possibility, using administrative data for the universe of federal student loan borrowers linked to tax records. We examine the effects of a sharp discontinuity in program limits--generated by the timing of a student borrower's 24th birthday--on household formation early in the lifecycle. After demonstrating that this discontinuity induces a jump in federal support, we estimate an immediate and persistent increase in homeownership, with larger effects among those most financially constrained. In the first year, borrowers with higher limits also earn less but are more likely to save; however, there are no differences in subsequent years. Finally, effects on marriage and fertility lag homeownership. Altogether, the results appear to be driven by liquidity rather than human capital or wealth effects.
Accessible materials (.zip)

Keywords: Credit limits, homeownership, household formation, human capital, liquidity, saving, student loans

DOI: https://doi.org/10.17016/FEDS.2018.025

FEDS 2018-024
How much has wealth concentration grown in the United States? A re-examination of data from 2001-2013 (PDF)

Jesse Bricker, Alice Henriques, and Peter Hansen

Abstract: Well known research based on capitalized income tax data shows robust growth in wealth concentration in the late 2000s. We show that these robust growth estimates rely on an assumption---homogeneous rates of return across the wealth distribution---that is not supported by data. When the capitalization model incorporates heterogeneous rates of return (on just interest-bearing assets), wealth concentration estimates in 2011 fall from 40.5% to 33.9%. These estimates are consistent in levels and trend with other micro wealth data and show that wealth concentration increases until the Great Recession, then declines before increasing again.
Accessible materials (.zip)

Keywords: Household wealth, wealth concentration

DOI: https://doi.org/10.17016/FEDS.2018.024

FEDS 2018-023
New Perspectives on the Decline of U.S. Manufacturing Employment (PDF)

Teresa C. Fort, Justin R. Pierce, and Peter K. Schott

Abstract: We use relatively unexplored dimensions of US microdata to examine how US manufacturing employment has evolved across industries, firms, establishments, and regions from 1977 to 2012. We show that these data provide support for both trade- and technology-based explanations of the overall decline of employment over this period, while also highlighting the difficulties of estimating an overall contribution for each mechanism. Toward that end, we discuss how further analysis of these trends might yield sharper insights.
Accessible materials (.zip)

Keywords: Employment, Manufacturing, Output, Technology, Trade

DOI: https://doi.org/10.17016/FEDS.2018.023

FEDS 2018-022
Collateral Runs (PDF)

Abstract: This paper models an unexplored source of liquidity risk faced by large broker-dealers: collateral runs. By setting different contracting terms on repurchase agreements with cash borrowers and lenders, dealers can source funds for their own activities. Cash borrowers internalize the risk of losing their collateral in case their dealer defaults, prompting them to withdraw it. This incentive creates strategic complementarities for counterparties to withdraw their collateral, reducing a dealer's liquidity position and compromising her solvency. Collateral runs are markedly different than traditional wholesale funding runs because they are triggered by a contraction in dealers' assets, rather than their liabilities.
Accessible materials (.zip)

Keywords: Collateral, dealer, default, liquidity, rehypothecation, repo, runs

DOI: https://doi.org/10.17016/FEDS.2018.022

FEDS 2018-021
Spectral backtests of forecast distributions with application to risk management (PDF)

Michael B. Gordy and Alexander J. McNeil

Abstract: We study a class of backtests for forecast distributions in which the test statistic is a spectral transformation that weights exceedance events by a function of the modeled probability level. The choice of the kernel function makes explicit the user's priorities for model performance. The class of spectral backtests includes tests of unconditional coverage and tests of conditional coverage. We show how the class embeds a wide variety of backtests in the existing literature, and propose novel variants as well. In an empirical application, we backtest forecast distributions for the overnight P&L of ten bank trading portfolios. For some portfolios, test results depend materially on the choice of kernel.
Accessible materials (.zip)

Keywords: Backtesting, Risk management, Volatility

DOI: https://doi.org/10.17016/FEDS.2018.021

FEDS 2018-020
The Impact of the Current Expected Credit Loss Standard (CECL) on the Timing and Comparability of Reserves (PDF)

Abstract: The new forward-looking credit loss provisioning standard, CECL, is intended to promote proactive provisioning as loan loss reserves can be conditioned on expectations of the economic cycle. We study the degree to which one modeling decision--expectations about the path of future house prices--affects the size and timing of provisions for first-lien residential mortgage portfolios. While we find that provisions are generally less pro-cyclical compared to the current incurred loss standard, CECL may complicate the comparability of provisions across banks and time. Market participants will need to disentangle the degree to which variation in provisions across firms is driven by underlying risk versus differences in modeling assumptions.
Accessible materials (.zip)

Keywords: CECL, accounting rule change, model risk, mortgage loans

DOI: https://doi.org/10.17016/FEDS.2018.020

FEDS 2018-019
"Unconventional" Monetary Policy as Conventional Monetary Policy: A Perspective from the U.S. in the 1920s (PDF)

Abstract: To implement monetary policy in the 1920s, the Federal Reserve utilized administered interest rates and conducted open market operations in both government securities and private money market securities, sometimes in fairly considerable amounts. We show how the Fed was able to effectively use these tools to influence conditions in money markets, even those in which it was not an active participant. Moreover, our results suggest that the transmission of monetary policy to money markets occurred not just through changing the supply of reserves but importantly through financial market arbitrage and the rebalancing of investor portfolios. The tools used in the 1920s by the Federal Reserve resemble the extraordinary monetary policy tools used by central banks recently and provide further evidence on their effectiveness even in ordinary times.
Accessible materials (.zip)

Keywords: Monetary policy, administered rates, central banking, money markets, quantitative easing, unconventional monetary policy

DOI: https://doi.org/10.17016/FEDS.2018.019

FEDS 2018-018
Liquidity Requirements, Free-Riding, and the Implications for Financial Stability Evidence from the early 1900s (PDF)

Mark Carlson and Matthew Jaremski

Abstract: Maintaining sufficient liquidity in the financial system is vital for financial stability. However, since returns on liquid assets are typically low, individual financial institutions may seek to hold fewer such assets, especially if they believe they can rely on other institutions for liquidity support. We examine whether state banks in the early 1900s took advantage of relatively high cash balances maintained by national banks, due to reserve requirements, to hold less cash themselves. We find that state banks did hold less cash in places where both state legal requirements were lower and national banks were more prevalent.
Accessible materials (.zip)

Keywords: Financial stability, free-riding, liquidity requirements, reserve requirements

DOI: https://doi.org/10.17016/FEDS.2018.018

FEDS 2018-017
Transparency and collateral: central versus bilateral clearing (PDF)

Gaetano Antinolfi, Francesca Carapella, and Francesco Carli

Abstract: Bilateral financial contracts typically require an assessment of counterparty risk. Central clearing of these financial contracts allows market participants to mutualize their counterparty risk, but this insurance may weaken incentives to acquire and to reveal information about such risk. When considering this trade-off, participants would choose central clearing if information acquisition is incentive compatible. If it is not, they may prefer bilateral clearing, when this choice prevents strategic default while economizing on costly collateral. In either case, participants independently choose the efficient clearing arrangement. Consequently, central clearing can be socially inefficient under certain circumstances. These results stand in contrast to those in Achary and Bisin (2014), who find that central clearing is always the optimal clearing arrangement.
Accessible materials (.zip)

Keywords: Central counterparties, Collateral, Liimited Commitment

DOI: https://doi.org/10.17016/FEDS.2018.017

FEDS 2018-016
Liquidity Crises in the Mortgage Market (PDF)

You Suk Kim, Steven M. Laufer, Karen Pence, Richard Stanton, and Nancy Wallace

Abstract: Nonbanks originated about half of all mortgages in 2016, and 75% of mortgages insured by the FHA or VA. Both shares are much higher than those observed at any point in the 2000s. We describe in this paper how nonbank mortgage companies are vulnerable to liquidity pressures in both their loan origination and servicing activities, and we document that this sector in the aggregate appears to have minimal resources to bring to bear in a stress scenario. We show how these exact same liquidity issues unfolded during the financial crisis, leading to the failure of many nonbank companies, requests for government assistance, and harm to consumers. The extremely high share of nonbank lenders in FHA and VA lending suggests that nonbank failures could be quite costly to the government, but this issue has received very little attention in the housing-reform debate

Accessible materials (.zip)

Original paper (PDF) | Accessible materials (.zip)

Keywords: FHA, Ginnie Mae, Mortgages and credit, financial crisis, mortgage servicing, nonbank institutions

DOI: https://doi.org/10.17016/FEDS.2018.016r1

FEDS 2018-015
Early-Stage Business Formation: An Analysis of Applications for Employer Identification Numbers (PDF)

Kimberly Bayard, Emin Dinlersoz, Timothy Dunne, John Haltiwanger, Javier Miranda, and John Stevens

Abstract: This paper reports on the development and analysis of a newly constructed dataset on the early stages of business formation. The data are based on applications for Employer Identification Numbers (EINs) submitted in the United States, known as IRS Form SS-4 filings. The goal of the research is to develop high-frequency indicators of business formation at the national, state, and local levels. The analysis indicates that EIN applications provide forward-looking and very timely information on business formation. The signal of business formation provided by counts of applications is improved by using the characteristics of the applications to model the likelihood that applicants become employer businesses. The results also suggest that EIN applications are related to economic activity at the local level. For example, application activity is higher in counties that experienced higher employment growth since the end of the Great Recession, and application counts grew more rapidly in counties engaged in shale oil and gas extraction. Finally, the paper provides a description of new public use dataset, the "Business Formation Statistics (BFS)," that contains new data series on business applications and formation. The initial release of the BFS shows that the number of business applications in the 3rd quarter of 2017 that have relatively high likelihood of becoming job creators is still far below pre-Great Recession levels.

Accessible materials (.zip)

Keywords: Business fluctuations and cycles, Urban, rural, and regional economics

DOI: https://doi.org/10.17016/FEDS.2018.015

FEDS 2018-014
US Monetary Policy and International Bond Markets (PDF)

Simon Gilchrist, Vivian Yue, and Egon Zakrajsek

Abstract: This paper uses high-frequency data to analyze the effects of US monetary policy--during the conventional and unconventional policy regimes--on foreign government bonds markets in advanced and emerging market economies. The results indicate that an expansionary US monetary policy steepens the foreign yield curve--denominated in local currency--during a conventional US monetary policy regime and flattens the foreign yield curve during an unconventional policy regime. The passthrough of unconventional US monetary policy to foreign bond yields is, on balance, comparable to that of conventional policy. In addition a conventional US monetary easing leads to a significant narrowing of the credit spreads on dollar-denominated sovereign bonds that are issued by countries with a speculative-grade sovereign credit rating. However, during the unconventional policy regime, yields on speculative-grade sovereign debt denominated in dollars move one-to-one with yields on comparable-maturity US Treasury securities.

Accessible materials (.zip)

Keywords: Conventional and unconventional US monetary policy, financial spillovers, sovereign yields and credit spreads

DOI: https://doi.org/10.17016/FEDS.2018.014

FEDS 2018-013
Seven Fallacies Concerning Milton Friedman's "The Role of Monetary Policy" (PDF)

Abstract: This paper analyzes Milton Friedman's (1968) article "The Role of Monetary Policy," via a discussion of seven fallacies concerning the article. These fallacies are: (1) "The Role of Monetary Policy" was Friedman's first public statement of the natural rate hypothesis. (2) The Friedman-Phelps Phillips curve was already presented in Samuelson and Solow's (1960) analysis. (3) Friedman's specification of the Phillips curve was based on perfect competition and no nominal rigidities. (4) Friedman's (1968) account of monetary policy in the Great Depression contradicted the Monetary History's version. (5) Friedman (1968) stated that a monetary expansion will keep the unemployment rate and the real interest rate below their natural rates for two decades. (6) The zero lower bound on nominal interest rates invalidates the natural rate hypothesis. (7) Friedman's (1968) treatment of an interest-rate peg was refuted by the rational expectations revolution. The discussion lays out the reasons why each of these seven items is a fallacy and infers key aspects of the framework underlying Friedman's (1968) analysis.

Accessible materials (.zip)

Keywords: Fisher effect, Milton Friedman, Phillips curve, liquidity effect, natural rate hypothesis, price stickiness, zero lower bound

DOI: https://doi.org/10.17016/FEDS.2018.013

FEDS 2018-012
Household's Balance Sheets and the Effect of Fiscal Policy (PDF)

Javier Andrés, José E. Boscá, Javier Ferri, and Cristina Fuentes-Albero

Abstract: Using the Panel Survey of Income Dynamics, we identify six household types as a function of their balance sheet composition. Since 1999, there has been a decline in the share of patient households and an increase in the share of impatient households with negative wealth. Using a DSGE model with search and matching frictions, we explore how changes in the distribution of households affect the transmission of government spending shocks. We show that the relative share of households in the left tail of the wealth distribution plays a key role in the aggregate marginal propensity to consume, the magnitude of the fiscal multipliers, and the distributional consequences of fiscal shocks. While the output and consumption multipliers are positively correlated with the share of households with negative wealth, the size of the employment multiplier is negatively correlated. For calibrations based on the empirical household weights after the Great Recession, our model delivers jobless fiscal expansions.

Accessible materials (.zip)

Keywords: Fiscal policy, Panel Survey of Income Dynamics, heterogeneity, household balance sheet, search and matching

DOI: https://doi.org/10.17016/FEDS.2018.012

FEDS 2018-011
Claim Dilution in the Municipal Debt Market (PDF)

Ivan T. Ivanov and Tom Zimmermann

Abstract: Using loan-level municipal bank lending data, we examine the debt structure of municipalities and its response to exogenous income shocks. We show that small, more indebted, low-income, and medium credit quality counties are particularly reliant on private bank financing. Low income counties are more likely to increase bank debt share after an adverse permanent income shock while high income counties do not shift their debt structure in response. In contrast, only high income counties draw on their credit lines after adverse transitory income shocks. Overall, our paper raises concerns about claim dilution of bondholders and highlights the importance of municipal disclosure of private debt.

Accessible materials (.zip)

Keywords: bank lending, claim dilution, disclosure, municipal finance

DOI: https://doi.org/10.17016/FEDS.2018.011

FEDS 2018-010
Top Income Concentration and Volatility (PDF)

Jeffrey Thompson, Michael Parisi, and Jesse Bricker

Abstract: Measures of income concentration--such as the share of income received by the highest income families--may be biased by pro-cyclical volatility in annual income. Permanent income, though, can smooth away such volatility and sort families by their usual economic resources. Here, we demonstrate this bias using rolling 3-year panels of IRS tax records from 1997 to 2013 as a proxy for permanent income. For example, one measure of 2012 income concentration--the share of income received by the top 0.1 percent--falls from 11.3 percent to 8.9 percent when families are organized by permanent income instead of annual income. However, the growth in income concentration cannot be explained by this volatility, as growth rates are comparable in the permanent income and annual income groupings during our sample period. Further, the probability of remaining in the highest income groups, while relatively low at the very top of the distribution, increased slightly during our sample period, s uggesting that top incomes have become less volatile in this dimension. These results are confirmed using household income data measured in the Survey of Consumer Finances (SCF)--a household survey with a large oversample of high-income households and a unique measure of permanent income.

Accessible materials (.zip)

Keywords: Inequality, Top Incomes, Volatility

DOI: https://doi.org/10.17016/FEDS.2018.010

FEDS 2018-009
Financing Affordable and Sustainable Homeownership with Fixed-COFI Mortgages (PDF)

Wayne Passmore and Alexander H. von Hafften

Abstract: The 30-year fixed-rate fully amortizing mortgage (or "traditional fixed-rate mortgage") was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With this sluggish equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowners might have better uses for this money. Third, refinancing mortgages is often very costly. Expensive refinancing may prevent homeowners from taking advantage of falling rates. To resolve these three flaws, we propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or "Fixed-COFI mortgage"). This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and does not require a down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward lower monthly payments or toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk "wedges" between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. We discuss two variations of the Fixed-COFI mortgage. Homeowners with "affordable" Fixed-COFI mortgages are rebated the "wedges" between the traditional fixed-rate mortgage payments and the COFI mortgage payment. After the "wedges" are rebated, these homeowners may pay substantially less to purchase their homes in 30 years than homeowners with traditional fixed-rate mortgages. This mortgage design may help alleviate housing affordability pressures in many areas of the United States. The other variation of Fixed-COFI mortgage is the "homeownership" Fixed-COFI mortgage. With the "homeownership" Fixed-COFI mortgage, the homeowner commits to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin.

Accessible materials (.zip)

Keywords: COFI, Fixed-rate Mortgage, cost of funds, downpayment, homeownership, interest rates, mortgage

DOI: https://doi.org/10.17016/FEDS.2018.009

FEDS 2018-008
A Global Lending Channel Unplugged? Does U.S. Monetary Policy Affect Cross-border and Affiliate Lending by Global U.S. Banks? (PDF)

Judit Temesvary, Steven Ongena, and Ann L. Owen

Abstract: We examine how U.S. monetary policy affects the international activities of U.S. Banks. We access a rarely studied U.S. bank-level regulatory dataset to assess at a quarterly frequency how changes in the U.S. Federal funds rate (before the crisis) and quantitative easing (after the onset of the crisis) affects changes in cross-border claims by U.S. banks across countries, maturities and sectors, and also affects changes in claims by their foreign affiliates. We find robust evidence consistent with the existence of a potent global bank lending channel. In response to changes in U.S. monetary conditions, U.S. banks strongly adjust their cross-border claims in both the pre and post-crisis period. However, we also find that U.S. bank affiliate claims respond mainly to host country monetary conditions.

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Keywords: bank lending channel, cross-country analysis, global banking, monetary transmission

DOI: https://doi.org/10.17016/FEDS.2018.008

FEDS 2018-007
Changing Business Dynamism and Productivity: Shocks vs. Responsiveness (PDF)

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

Abstract: The pace of job reallocation has declined in all U.S. sectors since 2000. In standard models, aggregate job reallocation depends on (a) the dispersion of idiosyncratic productivity shocks faced by businesses and (b) the marginal responsiveness of businesses to those shocks. Using several novel empirical facts from business microdata, we infer that the pervasive post-2000 decline in reallocation reflects weaker responsiveness in a manner consistent with rising adjustment frictions and not lower dispersion of shocks. The within-industry dispersion of TFP and output per worker has risen, while the marginal responsiveness of employment growth to business-level productivity has weakened. The responsiveness in the post-2000 period for young firms in the high-tech sector is only about half (in manufacturing) to two thirds (economy wide) of the peak in the 1990s. Counterfactuals show that weakening productivity responsiveness since 2000 accounts for a significant drag on aggregate productivity.

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Keywords: Dynamism, Entrepreneurship, Job reallocation, Labor supply and demand, Productivity

DOI: https://doi.org/10.17016/FEDS.2018.007

FEDS 2018-006
Bank Market Power and the Risk Channel of Monetary Policy (PDF)

Elena Afanasyeva and Jochen Güntner

Abstract: This paper investigates the risk channel of monetary policy through banks' lending standards. We modify the classic costly state verification (CSV) problem by introducing a risk-neutral monopolistic bank, which maximizes profits subject to borrower participation. While the bank can diversify idiosyncratic default risk, it bears the aggregate risk. We show that, in partial equilibrium, the bank prefers a higher leverage ratio of borrowers, when the profitability of lending increases, e.g. after a monetary expansion. This risk channel persists when we embed our contract in a standard New Keynesian DSGE model. Using a factor-augmented vector autoregression (FAVAR) approach, we find that the model-implied impulse responses to a monetary policy shock replicate their empirical counterparts.

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Keywords: Costly state verification, Credit supply, Lending standards, Monetary policy, Risk Channel

DOI: https://doi.org/10.17016/FEDS.2018.006

FEDS 2018-005
Using Payroll Processor Microdata to Measure Aggregate Labor Market Activity (PDF)

Tomaz Cajner, Leland Crane, Ryan Decker, Adrian Hamins-Puertolas, Christopher Kurz, and Tyler Radler

Abstract: We show that high-frequency private payroll microdata can help forecast labor market conditions. Payroll employment is perhaps the most reliable real-time indicator of the business cycle and is therefore closely followed by policymakers, academia, and financial markets. Government statistical agencies have long served as the primary suppliers of information on the labor market and will continue to do so for the foreseeable future. That said, sources of "big data" are becoming increasingly available through collaborations with private businesses engaged in commercial activities that record economic activity on a granular, frequent, and timely basis. One such data source is generated by the firm ADP, which processes payrolls for about one fifth of the U.S. private sector workforce. We evaluate the efficacy of these data to create new statistics that complement existing measures. In particular, we develop a set of weekly aggregate employment indexes from 2000 to 2017, which allows us to measure employment at a higher frequency than is currently possible. The extensive coverage of the ADP data--similar in terms of private employment to the BLS CES sample--implies potentially high information value of these data, and our results confirm this conjecture. Indeed, the timeliness and frequency of the ADP payroll microdata substantially improves forecast accuracy for both current-month employment and revisions to the BLS CES data.

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Keywords: Consumption, saving, production, employment, and investment, Labor supply and demand, forecasting

DOI: https://doi.org/10.17016/FEDS.2018.005

FEDS 2018-004
Quantitative Easing and the "New Normal" in Monetary Policy (PDF)

Abstract: Interest rates may remain low and fall to their effective lower bound (ELB) often. As a result, quantitative easing (QE), in which central banks expand their balance sheet to lower long-term interest rates, may complement policy approaches focused on adjustments in short-term interest rates. Simulation results using a large-scale model (FRB/US) suggest that QE does not improve economic performance if the steady-state interest rate is high, confirming that such policies were not advantageous from 1960 to 2007. However, QE can offset a significant portion of the adverse effects of the ELB when the equilibrium real interest rate is low. These improvements in economic performance exceed those associated with moderate increases in the inflation target. Active QE is primarily required when nominal interest rates are near the ELB, pointing to benefits within the model from QE as a secondary tool while relying on short-term interest rates as the primary tool.

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Keywords: Interest rates, Macroeconomic models, Monetary policy

DOI: https://doi.org/10.17016/FEDS.2018.004

FEDS 2018-003
Entrepreneurship and State Taxation (PDF)

E. Mark Curtis and Ryan A. Decker

Abstract: Entrepreneurship plays a vital role in the economy, yet there exists little well-identified research into the effects of taxes on startup activity. Using recently developed county-level data on startups, we examine the effect of states' corporate, personal and sales tax rates on new firm activity and test for cross-border spillovers in response to these policies. We find that new firm employment is negatively--and disproportionately--affected by corporate tax rates. We find little evidence of an effect of personal and sales taxes on entrepreneurial outcomes. Our results are robust to changes in the tax base and other state-level policies.

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Keywords: Labor supply and demand, Taxation, entrepreneurship, firm dynamics

DOI: https://doi.org/10.17016/FEDS.2018.003

FEDS 2018-002
Fiscal Implications of the Federal Reserve's Balance Sheet Normalization (PDF)

Michele Cavallo, Marco Del Negro, W. Scott Frame, Jamie Grasing, Benjamin A. Malin, and Carlo Rosa

Abstract: The paper surveys the recent literature on the fiscal implications of central bank balance sheets, with a special focus on political economy issues. It then presents the results of simulations that describe the effects of different scenarios for the Federal Reserve's longer-run balance sheet on its earnings remittances to the U.S. Treasury and, more broadly, on the government's overall fiscal position. We find that reducing longer-run reserve balances from $2.3 trillion (roughly the current amount) to $1 trillion reduces the likelihood of posting a quarterly net loss in the future from 30 percent to under 5 percent. Further reducing longer-run reserve balances from $1 trillion to pre-crisis levels has little effect on the likelihood of net losses.

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Keywords: Central bank balance sheets, Monetary policy, Remittances

DOI: https://doi.org/10.17016/FEDS.2018.002

FEDS 2018-001
Inequality in 3-D: Income, Consumption, and Wealth (PDF)

Jonathan Fisher, David Johnson, Timothy Smeeding, and Jeffrey Thompson

Abstract: We do not need to and should not have to choose amongst income, consumption, or wealth as the superior measure of well-being. All three individually and jointly determine well-being. We are the first to study inequality in three conjoint dimensions for the same households, using income, consumption, and wealth from the 1989-2016 Surveys of Consumer Finances (SCF). The paper focuses on two questions. What does inequality in two and three dimensions look like? Has inequality in multiple dimensions increased by less, by more, or by about the same as inequality in any one dimension? We find an increase in inequality in two dimensions and in three dimensions, with a faster increase in multi-dimensional inequality than in one-dimensional inequality. Viewing inequality through one dimension greatly understates the level and the growth in inequality in two and three dimensions. The U.S. is becoming more economically unequal than is generally understood.

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Keywords: Consumption, Inequality, Wealth

DOI: https://doi.org/10.17016/FEDS.2018.001

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Last Update: October 19, 2018