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 2020-027
Dynamic Beveridge Curve Accounting

Abstract: We develop a dynamic decomposition of the empirical Beveridge curve, i.e., the level of vacancies conditional on unemployment. Using a standard model, we show that three factors can shift the Beveridge curve: reduced-form matching efficiency, changes in the job separation rate, and out-of-steady-state dynamics. We find that the shift in the Beveridge curve during and after the Great Recession was due to all three factors, and each factor taken separately had a large effect. Comparing the pre-2010 period to the post-2010 period, a fall in matching efficiency and out-of-steady-state dynamics both pushed the curve upward, while the changes in the separations rate pushed the curve downward. The net effect was the observed upward shift in vacancies given unemployment. In previous recessions changes in matching efficiency were relatively unimportant, while dynamics and the separations rate had more impact. Thus, the unusual feature of the Great Recession was the deterioration in matching efficiency, while separations and dynamics have played significant, partially offsetting roles in most downturns. The importance of these latter two margins contrasts with much of the literature, which abstracts from one or both of them. We show that these factors affect the slope of the empirical Beveridge curve, an important quantity in recent welfare analyses estimating the natural rate of unemployment.


FEDS 2020-026
When is the Fiscal Multiplier High? A Comparison of Four Business Cycle Phases

Travis Berge, Maarten De Ridder and Damjan Pfajfar

Abstract: We synthesize the recent, at times conflicting, empirical literature regarding whether fiscal policy is more effective during certain points in the business cycle. Evidence of state dependence in the multiplier depends critically on how the business cycle is defined. Estimates of the fiscal multiplier do not change when the unemployment rate is above or below its trend. However, we find that the multiplier is higher when the unemployment rate is increasing relative to when it is decreasing. This result holds using both a long time-series at the U.S. national level and for a panel of U.S. states.


FEDS 2020-025
Costly Commuting and the Job Ladder

Abstract: Even though workers in the UK spent just 1,000 pounds on commuting in 2017, the economic loss may be far higher because of the congestion externality arising from the way in which one worker's commute affects the commuting time of others. I provide empirical evidence that commuting time affects job acceptance, pointing to large indirect costs of congestion. To interpret the empirical facts and quantify the costs of congestion, I build a model featuring a frictional labor market within a metropolitan area. By endogenizing commuting congestion in a labor search model, the model connects labor market responses to urban policies. Workers evaluate job offers based on their productivity and commuting costs, taking congestion as given, but by accepting and commuting to distant jobs, affect other workers' labor market outcomes. Through this mechanism, equilibrium moving decisions, housing rent, and wages are tightly linked to congestion. Calibrating the model to the local la bor market around London, I show that the effect of the congestion externality is to significantly decrease welfare and increase wage inequality. I quantify the effects of a congestion tax on labor market outcomes, and show that the welfare-maximizing tax has substantial negative effects on inequality, but comes at a cost of higher unemployment.


FEDS 2020-024
Common and idiosyncratic inflation

Abstract: We use a dynamic factor model to disentangle changes in prices due to economy-wide (common) shocks, from changes in prices due to idiosyncratic shocks. Using 146 disaggregated individual price series from the U.S. PCE price index, we find that most of the fluctuations in core PCE prices observed since 2010 have been idiosyncratic in nature. Moreover, we find that common core inflation responds to economic slack, while the idiosyncratic component does not. That said, even after filtering out idiosyncratic factors, the estimated Phillips curve is extremely flat post-1995. Therefore, our results suggest that the flattening of the Phillips curve is the result of macroeconomic forces.


FEDS 2020-023
Online Estimation of DSGE Models

Michael Cai, Marco Del Negro, Edward Herbst, Ethan Matlin, Reca Sarfati, and Frank Schorfheide

Abstract: This paper illustrates the usefulness of sequential Monte Carlo (SMC) methods in approximating DSGE model posterior distributions. We show how the tempering schedule can be chosen adaptively, document the accuracy and runtime benefits of generalized data tempering for "online" estimation (that is, re-estimating a model asnew data become available), and provide examples of multimodal posteriors that are well captured by SMC methods. We then use the online estimation of the DSGE model to compute pseudo-out-of-sample density forecasts and study the sensitivity ofthe predictive performance to changes in the prior distribution. We find that making priors less informative (compared to the benchmark priors used in the literature) by increasing the prior variance does not lead to a deterioration of forecast accuracy.


FEDS 2020-022
The Fed's "Ample-Reserves" Approach to Implementing Monetary Policy

Abstract: We describe the Federal Reserve's (the Fed's) approach to implementing monetary policy in an ample-reserves regime. We use a stylized model to explain the factors the Fed considers and the tools it uses to ensure interest rate control when the quantity of reserves is ample. Then, we take a close look at the Fed's experience operating in this regime in the post-crisis period, both as it has raised and lowered its policy rate. Looking ahead, we highlight some considerations relevant for maintaining a level of reserves consistent with the efficient and effective implementation of monetary policy, and conclude with an overview of the benefits of an ample-reserves regime. This primer is intended to enhance discussions and understanding of the Fed's actions and communications regarding monetary policy implementation, as many resources on this topic may be out of date given the recent evolution of the policy environment.


FEDS 2020-021
The Increasing Deflationary Influence of Consumer Digital Access Services

David M. Byrne and Carol A. Corrado

Abstract: Consumer digital access services—internet, mobile phone, cable TV, and streaming—accounted for over 2 percent of U.S. household consumption in 2018. We construct prices for these services using direct measures of volume (data transmitted, talk time, and hours of programming). Our price index fell 12 percent per year from 1988 to 2018 while official prices moved up modestly. Using our digital services index, we estimate total personal consumption expenditure (PCE) prices have risen nearly 1/2 percentage point slower than the official index since 2008. Importantly, the spread between alternative and official PCE price inflation has increased noticeably over time.

Original paper: PDF


FEDS 2020-020
Monetary Policy Implementation with an Ample Supply of Reserves

Gara Afonso, Kyungmin Kim, Antoine Martin, Ed Nosal, Simon Potter, and Sam Schulhofer-Wohl

Abstract: Methods of monetary policy implementation continue to change. The level of reserve supply—scarce, abundant, or somewhere in between—has implications for the efficiency and effectiveness of an implementation regime. The money market events of September 2019 highlight the need for an analytical framework to better understand implementation regimes. We discuss major issues relevant to the choice of an implementation regime, using a parsimonious framework and drawing from the experience in the United States since the 2007-09 financial crisis. We find that the optimal level of reserve supply likely lies somewhere between scarce and abundant reserves, thus highlighting the benefits of implementation with what could be called "ample" reserves. The Federal Reserve's announcement in October 2019 that it would maintain a level of reserve supply greater than the one that prevailed in early September is consistent with the implications of our framework.


FEDS 2020-019
Capacity Choice, Monetary Trade, and the Cost of Inflation

Garth Baughman and Stanislav Rabinovich

Abstract: Firms often make production decisions before meeting a buyer. We incorporate this often-overlooked fact into an otherwise standard monetary search model and show that it has important implications for the set of equilibria, efficiency, and the cost of inflation. Our model features a strategic complementarity between the buyers' ex ante choice of money balances and sellers' ex ante choice of productive capacity. When resale value of unsold inventories is high, sellers carry excess capacity and the equilibrium is unique. But, when resale value is low, there is a continuum of equilibria, all of which are inefficient and welfare-ranked. Effects of inflation are highly nonlinear. When inflation is high, the buyer's money holdings bind, and inflation therefore reduces trade through a standard real-balance channel. When inflation is low, the seller's capacity constraint binds, real balances have no effect at the margin, and inflation has no effect on output or welfare.


FEDS 2020-018
Technological Innovation and Discrimination in Household Finance

Adair Morse and Karen Pence

Abstract: Technology has changed how discrimination manifests itself in financial services. Replacing human discretion with algorithms in decision-making roles reduces taste-based discrimination, and new modeling techniques have expanded access to financial services to households who were previously excluded from these markets. However, algorithms can exhibit bias from human involvement in the development process, and their opacity and complexity can facilitate statistical discrimination inconsistent with antidiscrimination laws in several aspects of financial services provision, including advertising, pricing, and credit-risk assessment. In this chapter, we provide a new amalgamation and analysis of these developments, identifying five gateways whereby technology induces discrimination to creep into financial services. We also consider how these technological changes in finance intersect with existing discrimination and data privacy laws, leading to our contribution of four fron tlines of regulation. Our analysis concludes that the net effect of innovation in technological finance on discrimination is ambiguous and depends on the future choices made by policymakers, the courts, and firms.

Keywords: Discrimination, fair lending, statistical discrimination, FinTech, taste-based preferences, algorithmic decision-making, proxy variables, big data


FEDS 2020-017
Changing Stability in U.S. Employment Relationships: A Tale of Two Tails

Raven Molloy, Christopher L. Smith, and Abigail Wozniak

Abstract: We confront two seemingly-contradictory observations about the US labor market: the rate at which workers change employers has declined since the 1980s, yet there is a commonly expressed view that long-term employment relationships are more difficult to attain. We reconcile these observations by examining how the distribution of employment tenure has changed in aggregate and for various demographic groups. We show that the fraction of workers with short tenure (less than a year) has been falling since the 1980s, consistent with the decline in job changing. Meanwhile, the fraction of workers with long tenure (20 years or more) has been rising modestly owing to an increase in long tenure for women and the ageing of the population. Long tenure has declined markedly among older men; this trend may have spurred popular perceptions that long-term employment is less common than in the past. The decline in long-tenure for men appears due to an increase in mid-career separa tions that reduce the likelihood of reaching long-tenure, rather than an increase in late-career separations. Nevertheless, survey evidence indicates that these changes in employment relationships are not associated with heightened concerns about job insecurity or decreases in job satisfaction as reported by workers. The decline in short-tenure is widespread, associated with fewer workers cycling among briefly-held jobs, and coincides with an increase in perceived job security among short tenure workers.


FEDS 2020-016
Financial Stability Committees and Basel III Macroprudential Capital Buffers

Rochelle M. Edge and J. Nellie Liang

Abstract: We evaluate how a country’s governance structure for macroprudential policy affects its implementation of Basel III macroprudential capital buffers. We find that the probabilities of using the countercyclical capital buffer (CCyB) are higher in countries that have financial stability committees (FSCs) with stronger governance mechanisms and fewer agencies, which reduces coordination problems. These higher probabilities are more sensitive to credit growth, consistent with the CCyB being used to mitigate systemic risk. A country’s probability of using the CCyB is even higher when the FSC or ministry of finance has direct authority to set the CCyB, perhaps because setting the CCyB involves establishing a new macro-financial analytical process to regularly assess systemic risks and allows these new entities to influence the process. These results are consistent with elected officials creating the FSCs with the strongest governance and fewer agencies for functional delegati on reasons, but most FSCs are created for symbolic political reasons.


FEDS 2020-015
Primer on the Forward-Looking Analysis of Risk Events (FLARE) Model: A Top-Down Stress Test Model

Sergio Correia, Kevin F. Kiernan, Matthew P. Seay and Cindy M. Vojtech

Abstract: This technical note describes the Forward-Looking Analysis of Risk Events (FLARE) model, which is a top-down model that helps assess how well the banking system is positioned to weather exogenous macroeconomic shocks. FLARE estimates banking system capital under varying macroeconomic scenarios, time horizons, and other systemic shocks.


FEDS 2020-014
Forward-Looking Monetary Policy and the Transmission of Conventional Monetary Policy Shocks

Chunya Bu, John Rogers, and Wenbin Wu

Abstract: Standard structural VAR models and estimation using Romer and Romer (2004) monetary policy shocks show that, in samples after the 1980s, a contractionary conventional monetary policy shock generates smaller and sometimes perversely-signed impulse responses compared to earlier samples. Using insights from the central bank information effects literature, we show that the analyses producing these results suffer from an omitted variables problem related to forward-looking information emanating from Federal Reserve forecasts. Transmission of conventional monetary policy shocks takes on the standard signs, and is typically significant, once Fed forward-looking information is taken into account. This reconciliation does not follow from adding private sector forecasts to the estimation frameworks.


FEDS 2020-013
Inflation at Risk

Abstract: We investigate how macroeconomic drivers affect the predictive inflation distribution as well as the probability that inflation will run above or below certain thresholds over the near term. This is what we refer to as Inflation-at-Risk–a measure of the tail risks to the inflation outlook. We find that the recent muted response of the conditional mean of inflation to economic conditions does not convey an adequate representation of the overall pattern of inflation dynamics. Analyzing data from the 1970s reveals ample variability in the conditional predictive distribution of inflation that remains even when focusing on the post-2000 period of stable and low mean inflation. We also document that in the United States and in the Euro Area tight financial conditions carry substantial downside inflation risks, a feature overlooked by much of the literature. Our paper offers a new empirical perspective to existing macroeconomic models, showing that changes in credit conditions are also key to understand the dynamics of the inflation tails.

Keywords: Quantile Regression, Inflation Risks.


FEDS 2020-012
Time-varying uncertainty of the Federal Reserve's output gap estimate

Abstract: What is the output gap and when do we know it? A factor stochastic volatility model estimates the common component to forecasts of the output gap produced by the staff of the Federal Reserve, its time-varying volatility, and time-varying, horizon-specific forecast uncertainty. The common factor to these forecasts is highly procyclical, and unexpected increases to the common factor are associated with persistent responses in other macroeconomic variables. However, output gap estimates are very uncertain, even well after the fact. Output gap uncertainty increases around business cycle turning points. Lastly, increased macroeconomic uncertainty, as measured by the output gap's time-varying volatility, produces pronounced negative responses to other macroeconomic variables.


FEDS 2020-011
Evaluating the Success of President Johnson's War on Poverty: Revisiting the Historical Record Using a Full-Income Poverty Measure

Richard V. Burkhauser, Kevin Corinth, James Elwell, and Jeff Larrimore

Abstract: We evaluate progress in President's Johnson's War on Poverty. We do so relative to the scientifically arbitrary but policy relevant 20 percent baseline poverty rate he established for 1963. No existing poverty measure fully captures poverty reductions based on the standard that President Johnson set. To fill this gap, we develop a Full-income Poverty Measure with thresholds set to match the 1963 Official Poverty Rate. We include cash income, taxes, and major in-kind transfers and update poverty thresholds for inflation annually. While the Official Poverty Rate fell from 19.5 percent in 1963 to 12.3 percent in 2017, our Full-income Poverty Rate based on President Johnson's standards fell from 19.5 percent to 2.3 percent over that period. Today, almost all Americans have income above the inflation-adjusted thresholds established in the 1960s. Although expectations for minimum living standards evolve, this suggests substantial progress combatting absolute poverty since the War on Poverty began.


FEDS 2020-010
Bias in Local Projections

Edward P. Herbst and Benjamin K. Johannsen

Abstract: Local projections (LPs) are a popular tool in applied macroeconomic research. We survey the related literature and find that LPs are often used with very small samples in the time dimension. With small sample sizes, given the high degree of persistence in most macroeconomic data, impulse responses estimated by LPs can be severely biased. This is true even if the right-hand-side variable in the LP is iid, or if the data set includes a large cross-section (i.e., panel data). We derive a simple expression to elucidate the source of the bias. Our expression highlights the interdependence between coefficients of LPs at different horizons. As a byproduct, we propose a way to bias-correct LPs. Using U.S. macroeconomic data and identified monetary policy shocks, we demonstrate that the bias correction can be large.


FEDS 2020-009
Central Clearing and Systemic Liquidity Risk

Thomas King, Travis D. Nesmith, Anna Paulson, and Todd Prono

Abstract: By stepping between bilateral counterparties, a central counterparty (CCP) transforms credit exposure. CCPs generally improve financial stability. Nevertheless, large CCPs are by nature concentrated and interconnected with major global banks. Moreover, although they mitigate credit risk, CCPs create liquidity risks, because they rely on participants to provide cash. Such requirements increase with both market volatility and default; consequently, CCP liquidity needs are inherently procyclical. This procyclicality makes it more challenging to assess CCP resilience in the rare event that one or more large financial institutions default. Liquidity-focused macroprudential stress tests could help to assess and manage this systemic liquidity risk.


FEDS 2020-008
Treasury safety, liquidity, and money premium dynamics: Evidence from recent debt limit impasses

Abstract: Treasury securities normally possess unparalleled safety and liquidity and, consequently, carry a money premium. We use recent debt limit impasses, which temporarily increased the riskiness of Treasuries, to investigate the relationship between the money premium, safety, and liquidity. Our results shed light on Treasury market dynamics specifically, and debt more generally. We first establish that a decline in the perceived safety of Treasuries erodes the money premium at all times. Meanwhile, changes in liquidity only affected the money premium during the impasses. Next, we show that Treasury safety and liquidity dynamics are generally consistent with the theory of the information sensitivity of debt.


FEDS 2020-007
Do Minorities Pay More for Mortgages?

Abstract: We test for racial discrimination in the prices charged by mortgage lenders. We construct a unique dataset where we observe all three dimensions of a mortgage's price: the interest rate, discount points, and fees. While we find statistically significant gaps by race and ethnicity in interest rates, these gaps are offset by differences in discount points. We trace out point-rate schedules and show that minorities and whites face identical schedules, but sort to different locations on the schedule. Such sorting may reflect systematic differences in liquidity or preferences. Finally, we find no differences in total fees by race or ethnicity.


FEDS 2020-006
Approximately Right?: Global v. Local Methods for Open-Economy Models with Incomplete Markets

Oliver de Groot, C. Bora Durdu and Enrique G. Mendoza

Abstract: Global and local methods are widely used in international macroeconomics to analyze incomplete-markets models. We study solutions for an endowment economy, an RBC model and a Sudden Stops model with an occasionally binding credit constraint. First-order, second-order, risky steady state and DynareOBC solutions are compared v. fixed-point-iteration global solutions in the time and frequency domains. The solutions differ in key respects, including measures of precautionary savings, cyclical moments, impulse response functions, financial premia and macro responses to credit constraints, and periodograms of consumption, foreign assets and net exports. The global method is easy to implement and faster than local methods for the endowment model. Local methods are faster for the RBC model and the global and DynareOBC solutions are of comparable speed. These findings favor global methods except when prevented by the curse of dimensionality and urge caution when using local methods. Of the latter, first-order solutions are preferable because results are very similar to second-order methods.


FEDS 2020-005
Consumption Heterogeneity: Micro Drivers and Macro Implications

Edmund Crawley and Andreas Kuchler

Abstract: This paper explores the microfoundations of consumption models and quantifies the macro implications of consumption heterogeneity. We propose a new empirical method to estimate the response of consumption to permanent and transitory income shocks for different groups of households. We then apply this method to administrative data from Denmark. The large sample size, along with detailed household balance sheet information, allows us to finely divide the population along relevant dimensions. We find that households that stand to lose from an interest rate hike are significantly more responsive to income shocks than those that stand to gain. Following a 1-percentage-point interest rate increase, we estimate that consumption growth decreases by a 1/4 percentage point through this interest rate exposure channel alone, making this channel substantially larger than the intertemporal substitution channel that is at the core of representative agent New Keynesian models.


FEDS 2020-004
Confidence, financial literacy and investment in risky assets: Evidence from the Survey of Consumer Finances

Andrej Cupák, Pirmin Fessler, Joanne W. Hsu, Piotr R. Paradowski

Abstract: We employ recent Survey of Consumer Finances (SCF) microdata from the US to analyze the impacts of confidence in one's own financial knowledge, confidence in the economy, and objective financial literacy on investment in risky financial assets (equity and bonds) on both the extensive and intensive margins. Controlling for a rich set of covariates including risk aversion, we find that objective financial literacy is positively related to investment in risky assets as well as debt securities. Moreover, confidence in own financial skills additionally increases the probability of holding risky assets and bonds. While these relationships are rather robust for the extensive margin, they break down with regard to the conditional share of financial wealth in risky assets of those who actually hold them. The relevance of financial literacy as well as confidence varies considerably with the distribution of wealth as well as across several socio-economic dimensions such as age, education and race.


FEDS 2020-003
Short-term Planning, Monetary Policy, and Macroeconomic Persistence

Abstract: This paper uses aggregate data to estimate and evaluate a behavioral New Keynesian (NK) model in which households and firms plan over a finite horizon. The finite-horizon (FH) model outperforms rational expectations versions of the NK model commonly used in empirical applications as well as other behavioral NK models. The better fit of the FH model reflects that it can induce slow-moving trends in key endogenous variables which deliver substantial persistence in output and inflation dynamics. In the FH model, households and firms are forward-looking in thinking about events over their planning horizon but are backward looking regarding events beyond that point. This gives rise to persistence without resorting to additional features such as habit persistence and price contracts indexed to lagged inflation. The parameter estimates imply that the planning horizons of most households and firms are less than two years which considerably dampens the effects of expected fut ure changes of monetary policy on the macroeconomy.

Keywords: Finite-horizon planning, learning, monetary policy, New Keynesian model, Bayesian estimation.


FEDS 2020-002
Monetary Policy and Birth Rates: The Effect of Mortgage Rate Pass-Through on Fertility

Fergus Cumming and Lisa Dettling

Abstract: This paper examines whether monetary policy pass-through to mortgage interest rates affects household fertility decisions. Using administrative data on mortgages and births in the UK, our empirical strategy exploits variation in the timing of when families were eligible for a rate adjustment, coupled with the large reductions in the monetary policy rate that occurred during the Great Recession. We estimate that each 1 percentage point drop in the policy rate increased birth rates by 2 percent. In aggregate, this pass-through of accommodative monetary policy to mortgage rates was sufficiently large to outweigh the headwinds of the Great Recession and prevent a "baby bust" in the UK, in contrast to the US. Our results provide new evidence on the nature of monetary policy transmission to households and suggest a new mechanism via which mortgage contract structures can affect both aggregate demand and supply.


FEDS 2020-001
The Power of Narratives in Economic Forecasts

Steven A. Sharpe, Nitish R. Sinha and Christopher A. Hollrah

Abstract: We apply textual analysis tools to the narratives that accompany Federal Reserve Board economic forecasts to measure the degree of optimism versus pessimism expressed in those narratives. Text sentiment is strongly correlated with the accompanying economic point forecasts, positively for GDP forecasts and negatively for unemployment and inflation forecasts. Moreover, our sentiment measure predicts errors in FRB and private forecasts for GDP growth and unemployment up to four quarters out. Furthermore, stronger sentiment predicts tighter than expected monetary policy and higher future stock returns. Quantile regressions indicate that most of sentiment's forecasting power arises from signaling downside risks to the economy and stock prices.


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Last Update: March 30, 2020