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 2018-014
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-m aturity US Treasury securities.

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 d iscussion 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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

Keywords: Consumption, Inequality, Wealth

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

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Last Update: January 02, 2018