IFDP 2021-1333
Non-Linear Employment Effects of Tax Policy

Domenico Ferraro and Giuseppe Fiori


We study the non-linear propagation mechanism of tax policy in a heterogeneous agent equilibrium business cycle model with search frictions in the labor market and an extensive margin of employment adjustment. The model exhibits endogenous job destruction and endogenous hiring standards in the form of occasionally-binding zero-surplus constraints. After parameterizing the model using U.S. data, we find that the dynamic response of employment to a temporary change in the labor income tax is highly non-linear, displaying sizable asymmetries and state-dependence. Notably, the response to a tax rate cut is at least twice as large in a recession as in an expansion.

DOI: https://doi.org/10.17016/IFDP.2021.1333

IFDP 2021-1332
U.S. Housing as a Global Safe Asset: Evidence from China Shocks

William Barcelona, Nathan Converse, and Anna Wong


This paper demonstrates that the measured stock of China's holding of U.S. assets could be much higher than indicated by the U.S. net international investment position data due to unrecorded historical Chinese inflows into an increasingly popular global safe haven asset: U.S. residential real estate. We first use aggregate capital flows data to show that the increase in unrecorded capital inflows in the U.S. balance of payment accounts over the past decade is mainly linked to inflows from China into U.S. housing markets. Then, using a unique web traffic dataset that provides a direct measure of Chinese demand for U.S. housing at the zip code level, we estimate via a difference-in-difference matching framework that house prices in major U.S. cities that are highly exposed to demand from China have on average grown 7 percentage points faster than similar neighborhoods with low exposure over the period 2010-2016. These average excess price growth gaps co-move closely with macro-level measures of U.S. capital inflows from China, and tend to widen following periods of economic stress in China, suggesting that Chinese households view U.S. housing as a safe haven asset.

Keywords: China, housing and real estate, capital flows, safe assets

DOI: https://doi.org/10.17016/IFDP.2021.1332

IFDP 2021-1331
Between College and That First Job: Designing and Evaluating Policies for Hiring Diversity


Despite widespread caste disparities, compensatory hiring policies remain absent from the Indian private sector. This paper employs novel administrative data on the job search from an elite college and evaluates policies to promote hiring diversity. Application reading, written aptitude tests, large group debates, and job choices do not explain caste disparities. Disparities arise primarily between the final round, comprising non-technical personal interviews, and job offers; the emergence closely parallels caste revelation. For promoting diversity, hiring subsidies — similar in spirit to the government-proposed Diversity Index — are twice as cost-effective as improving pre-college achievement. Conversely, quotas mirror a hiring tax and reduce university recruitment by 7%.

DOI: https://doi.org/10.17016/IFDP.2021.1331

IFDP 2021-1330
Trade Policy is Real News: Theory and Evidence

George Alessandria and Carter Mix


We evaluate the aggregate effects of changes in trade barriers when these changes can be implemented slowly over time and trade responds gradually to changes in trade barriers because firm-level trade costs make exporting a dynamic decision. Our model shows how expectations of changes in trade barriers affect the economy. We find that while decreases in trade barriers increase economic activity, expectations of lower future trade barriers temporarily decrease investment, hours worked, and output. Further- more, canceling an expected decline in future trade barriers raises investment and output in the short run but substantially lowers medium-run growth. These effects are larger when the expected reform is bigger. In the data, we find that countries with more trade growth after the General Agreement on Tariffs and Trade (GATT) rounds decreased investment and hours worked in the years leading to the tariff cuts, as predicted by our model.

Keywords: Trade Policy, Business Cycles, Sunk Costs, Gains from Trade

DOI: https://doi.org/10.17016/IFDP.2021.1330

IFDP 2021-1329
The Pitfalls of Using Location Quotients to Identify Clusters and Represent Industry Specialization in Small Regions

Mariya Pominova, Todd Gabe, Andrew Crawley


This paper examines the use of location quotients, a measure of regional business activity relative to the national benchmark, as an indicator of sectoral agglomeration in small cities and towns, and as a measure of industry specialization that might impact the number of new business startups in these places. Using establishment-level data on businesses located in Maine, our findings suggest that the addition of one "hypothetical" establishment in very small towns leads to a dramatic change in the magnitude of the region-industry location quotient. At population sizes of about 4,100 or more people, however, location quotients are reasonably stable. Regression results from an analysis of the relationship between new business activity and regional industry specialization show that the effect of location quotients on business startups switches from "inelastic" to "elastic" at a population size cutoff of about 2,600 residents. Overall, our findings suggest that researchers and practitioners should exercise caution when using location quotients to study small regions.

DOI: https://doi.org/10.17016/IFDP.2021.1329

IFDP 2021-1328
Financial Stability Governance and Central Bank Communications


We investigate how central banks' governance frameworks influence their financial stability communication strategies and assess the effectiveness of these strategies in preventing a worsening of financial cycle conditions. We develop a simple conceptual framework of how central banks communicate about financial stability and how communication shapes the evolution of the financial cycle. We apply our framework using data on the governance characteristics of 24 central banks and the sentiment conveyed in their financial stability reports. We find robust evidence that communications by central banks participating in interagency financial stability committees more effectively mitigate a deterioration in financial conditions and advert a potential financial crisis. After observing a deterioration in conditions, such central banks also transmit a calmer message, suggesting that the ability to use policy tools other than communications strengthens incentives not to just "cry wolf".

DOI: https://doi.org/10.17016/IFDP.2021.1328

IFDP 2021-1327
Corporate stress and bank nonperforming loans: Evidence from Pakistan

Ali M. Choudhary and Anil K. Jain


Using detailed administrative Pakistani credit registry data, we show that banks with low leverage ratios are both significantly slower and less likely to recognize a loan as nonperforming than other banks that lend to the same firm. Moreover, we find suggestive evidence that this lack of recognition impedes loan curing, with banks with low leverage ratios reporting significantly higher final default rates than other banks for the same borrower (even after controlling for differences in loan terms). Our empirical findings are consistent with the theoretical prediction that classifying a nonperforming loan is more expensive for banks with less capital.

Keywords: Credit markets, banks, corporate debt, evergreening, nonperforming loans.

DOI: https://doi.org/10.17016/IFDP.2021.1327

IFDP 2021-1326
Macroeconomic and Financial Risks: A Tale of Mean and Volatility


We study the joint conditional distribution of GDP growth and corporate credit spreads using a stochastic volatility VAR. Our estimates display significant cyclical co-movement in uncertainty (the volatility implied by the conditional distributions), and risk (the probability of tail events) between the two variables. We also find that the interaction between two shocks--a main business cycle shock as in Angeletos et al. (2020) and a main financial shock--is crucial to account for the variation in uncertainty and risk, especially around crises. Our results highlight the importance of using multivariate nonlinear models to understand the determinants of uncertainty and risk.

Keywords: Uncertainty, tail risk, joint conditional distributions, main shocks.

DOI: https://doi.org/10.17016/IFDP.2021.1326

IFDP 2021-1325
Global Banking and Firm Financing: A Double Adverse Selection Channel of International Transmission


This paper proposes a "double adverse selection channel" of international transmission. It shows, theoretically and empirically, that financial systems with both global and local banks exhibit double adverse selection in credit allocation across firms. Global (local) banks have a comparative advantage in extracting information on global (local) risk, and this double information asymmetry creates a segmented credit market where each bank lends to the worst firms in terms of the unobserved risk factor. Given a bank funding (e.g., monetary policy) shock, double adverse selection affects firm financing at the extensive and price margins, generating spillover and amplification effects across countries.

DOI: https://doi.org/10.17016/IFDP.2021.1325

IFDP 2021-1324
Sharing Asymmetric Tail Risk: Smoothing, Asset Prices and Terms of Trade

Giancarlo Corsetti, Anna Lipinska, Giovanni Lombardo


Crises and tail events have asymmetric effects across borders, raising the value of arrangements improving insurance of macroeconomic risk. Using a two-country DSGE model, we provide an analytical and quantitative analysis of the channels through which countries gain from sharing (tail) risk. Riskier countries gain in smoother consumption but lose in relative wealth and average consumption. Safer countries benefit from higher wealth and better average terms of trade. Calibrated using the empirical distribution of moments of GDP-growth across countries, the model suggests non-negligible quantitative effects. We offer an algorithm for the correct solution of the equilibrium using DSGE models under complete markets, at higher order of approximation.

DOI: https://doi.org/10.17016/IFDP.2021.1324

IFDP 2021-1323
Expansionary Austerity: Reallocating Credit Amid Fiscal Consolidation

Bernardo Morais, Javier Perez-Estrada, Jose-Luis Peydro, Claudia Ruiz-Ortega


We study the impact of public debt limits on economic growth exploiting the introduction of a Mexican law capping the debt of subnational governments. Despite larger fiscal consolidation, states with higher ex-ante public debt grew substantially faster after the law, albeit at the expense of increased extreme poverty. Credit registry data suggests that the mechanism behind this result is a reduction in crowding out. After the law, banks operating in more indebted states reallocate credit away from local governments and into private firms. The unwinding of crowding out is stronger for riskier firms, firms borrowing from banks more exposed to local public debt, and for firms operating in states with lower public spending on infrastructure projects.

DOI: https://doi.org/10.17016/IFDP.2021.1323

IFDP 2021-1322
The Intangible Gender Gap: An Asset Channel of Inequality

Carlos F. Avenancio-Leon and Leslie Sheng Shen


We propose an "asset channel of inequality" that contributes to gender inequities. We establish that industries with low (high) gender pay gaps have high (low) shares of tangible assets. Because asset tangibility determines firms' ability to collateralize assets and borrow, credit conditions affect industries differently. We show that credit expansions further reduce the pay gap in low-pay-gap industries while leaving it unaffected in high-pay-gap industries, making low-pay-gap industries more appealing for women. Consequently, gender sorting across industries increases, which then cements gender roles and accentuates workplace gender bias. Ultimately, credit expansions help women "swim upstream" but also reinforce glass ceilings.

DOI: https://doi.org/10.17016/IFDP.2021.1322

IFDP 2021-1321
U.S. Monetary Policy Spillovers to Emerging Markets: Both Shocks and Vulnerabilities Matter


Using a macroeconomic model, we explore how sources of shocks and vulnerabilities matter for the transmission of U.S. monetary changes to emerging market economies (EMEs). We utilize a calibrated two-country New Keynesian model with financial frictions, partly-dollarized balance sheets, and imperfectly anchored inflation expectations. Contrary to other recent studies that also emphasize the sources of shocks, our approach allows the quantification of effects on real macroeconomic variables as well, in addition to financial spillovers. Moreover, we model the most relevant vulnerabilities structurally. We show that higher U.S. interest rates arising from stronger U.S. aggregate demand generate modestly positive spillovers to economic activity in EMEs with stronger fundamentals, but can be adverse for vulnerable EMEs. In contrast, U.S. monetary tightenings driven by a more-hawkish policy stance cause a substantial slowdown in activity in all EMEs. Our model also captures the challenging policy tradeos that EME central banks face. We show that these tradeoffs are more favorable when inflation expectations are well anchored.

DOI: https://doi.org/10.17016/IFDP.2021.1321

IFDP 2021-1320
The Economic Effects of Firm-Level Uncertainty: Evidence Using Subjective Expectations

Giuseppe Fiori and Filippo Scoccianti


This paper uses over two decades of Italian survey data on business managers' expectations to measure subjective firm-level uncertainty and quantify its economic effects. We document that firm-level uncertainty persists for a few years and varies across firms' demographic characteristics. Uncertainty induces long-lasting economic effects over a broad array of real and financial variables. The source of uncertainty matters with firms responding only to downside uncertainty, that is, uncertainty about future adverse outcomes. Economy-wide uncertainty, constructed aggregating firm-level uncertainty, is countercyclical but uncorrelated with typical proxies in the literature, and accounts for a sizable amount of GDP variation during crises.

Keywords: Uncertainty, business cycles, investment, expectations, cash holdings, downside uncertainty

DOI: https://doi.org/10.17016/IFDP.2021.1320

IFDP 2021-1319
Revisiting Capital-Skill Complementarity, Inequality, and Labor Share

Lee Ohanian, Musa Orak, Shihan Shen


This paper revisits capital-skill complementarity and inequality, as in Krusell, Ohanian, Rios-Rull and Violante (KORV, 2000). Using their methodology, we study how well the KORV model accounts for more recent data, including the large changes in the labor's share of income that were not present in KORV. We study both labor share of gross income (as in KORV), and income net of depreciation. We also use nonfarm business sector output as an alternative measure of production to real GDP. We find strong evidence for continued capital-skill complementarity in the most recent data, and we also find that the model continues to closely account for the skill premium. The model captures the average level of labor share, though it overpredicts its level by 2-4 percentage points at the end of the period.

Keywords: Capital-skill complementarity, elasticity of substitution, inequality, labor share, skill premium, technological change.

DOI: https://doi.org/10.17016/IFDP.2021.1319

IFDP 2021-1318
The Global Determinants of International Equity Risk Premiums

Juan M. Londono and Nancy R. Xu


We examine the commonality in international equity risk premiums by linking empirical evidence for the international stock return predictability of US downside and upside variance risk premiums (DVP and UVP, respectively) with implications from an international asset pricing framework, which takes the perspective of a US/global investor and features asymmetric global macroeconomic, financial market, and risk aversion shocks. We find that DVP and UVP predict international stock returns through different global equity risk premium determinants: bad and good macroeconomic uncertainties, respectively. Across countries, US investors demand lower macroeconomic risk compensation but higher financial market risk compensation for more-integrated countries.

DOI: https://doi.org/10.17016/IFDP.2021.1318

IFDP 2021-1317
The Global Transmission of Real Economic Uncertainty


Using a sample of 30 countries representing about 65% of the global GDP, we find that real economic uncertainty (REU) has negative long-lasting domestic economic effects and transmits across countries. The international spillover effects of REU are (i) additional to those of domestic REUs, (ii) statistically significant, and (iii) economically meaningful. Trade ties play a key role in explaining why uncertainty generated in one country can affect economic outcomes in other countries. Based on this evidence, we construct a novel index for global REU as the trade-weighted average of all countries' REUs. We disentangle the effects of the domestic and foreign components of global REU and find that, on average, innovations to the foreign component can contribute up to 28% of the future variation in domestic industrial production, with the effect being disproportionately larger on its manufacturing component, the component contributing the most to the tradable goods sector, than on its retail sales component.

Keywords: Economic effects of uncertainty, International transmission, Spillovers

DOI: https://doi.org/10.17016/IFDP.2021.1317

IFDP 2021-1316
Price Setting and Volatility: Evidence from Oil Price Volatility Shocks


How do changes in aggregate volatility alter the impulse response of output to monetary policy? To analyze this question, I study whether individual prices in Producer Price Index micro data are more likely to change and to move in the same direction when aggregate volatility is high, which would increase aggregate price exibility and reduce the effectiveness of monetary policy. Taking advantage of plausibly exogenous oil price volatility shocks and heterogeneity in oil usage across industries, I find that price changes are more dispersed and less frequent, implying that prices are less likely to move in the same direction when aggregate volatility is high. This contrasts with findings in the literature about idiosyncratic volatility. I use a state-dependent pricing model to interpret my findings. Random menu costs are necessary for the model to match the positive empirical relationship between oil price volatility and price change dispersion. This is the case because random menu costs reduce the extent to which firms with prices far from their optimum all act in a coordinated fashion when volatility increases. The model implies that increases in aggregate volatility do not substantially reduce the ability of monetary policy to stimulate output.

Keywords: Volatility, Ss model, Menu cost, Monetary policy, Oil

DOI: https://doi.org/10.17016/IFDP.2021.1316

IFDP 2021-1315
Supply of Sovereign Safe Assets and Global Interest Rates


We estimate that the supply of sovereign safe assets is a major driver of neutral interest rates--real rates consistent with both economic activity and inflation at their trends. We find this result using an empirical cross-country model with many economic drivers for the neutral rates of 11 advanced economies during the 1960-2019 period. The increasing availability of safe assets after 2008 has pushed up neutral rates, preventing them from continuing their previous decline because of other drivers. We also evaluate the "global savings glut" hypothesis. We estimate that since 1994 the global accumulation of international exchange reserves in safe assets has lowered the availability of these assets to the private sector and, thus pushed down neutral rates. Finally, we find that economies' neutral rates are subject to important global spillovers from developments in other economies.

Keywords: neutral interest rates, safe assets, international reserves, global savings glut.

DOI: https://doi.org/10.17016/IFDP.2021.1315

IFDP 2021-1314
From Micro to Macro: A Note on the Analysis of Aggregate Productivity Dynamics Using Firm-Level Data

Daniel A. Dias and Carlos Robalo Marques


In the empirical literature, the analysis of aggregate productivity dynamics using firm-level productivity has mostly been based on changes in the mean of log-productivity. This paper shows that there can be substantial quantitative and qualitative differences in the results relative to when the analysis is based on changes in the mean of productivity, and discusses the circumstances under which such differences are likely to happen. We use firm-level data for Portugal for the period 2006-2015 to illustrate the point. When the mean of productivity is used, we estimate that TFP and labor productivity for the whole economy increased by 17.7 percent and 5.2 percent, respectively, over this period. But, when the mean of log-productivity is used, we estimate that these two productivity measures declined by 4.3 percent and 1.8 percent, respectively. Similarly disparate results are obtained for productivity decompositions regarding the contributions for productivity growth of surviving, entering and exiting firms.

Keywords: Jensen's inequality, productivity decomposition, geometric mean.

DOI: https://doi.org/10.17016/IFDP.2021.1314

IFDP 2021-1313
Back to the Present: Learning about the Euro Area through a Now-casting Model


We build a model for simultaneously now-casting economic conditions in the euro area and its three largest member countries|Germany, France, and Italy. The model formalizes how market participants and policymakers monitor the euro area by incorporating all market moving indicators in real time. We find that area wide and country-specific data provide informative signals to now-cast the economic conditions in the euro area and member countries. The model provides accurate predictions of economic conditions in real time over a period that covers the past three recessions.

This paper was reposted April 2, 2021, with the following changes: In Figure 1, bars decomposing the nowcasted euro-area GDP growth across its main countries have been added, and an associated sentence on page 2 has been revised to reflect this.

Keywords: Now-casting, euro area, dynamic factor models

DOI: https://doi.org/10.17016/IFDP.2021.1313

IFDP 2021-1312
The Dollar and Corporate Borrowing Costs


We show that U.S. dollar movements affect syndicated loan terms for U.S. borrowers, even for those without trade exposure. We identify the effect of dollar movements using spread and loan amount adjustments during the syndication process. Using this high-frequency, within loan variation, we find that a one standard deviation increase in the dollar index increases spreads by up to 15 basis points and reduces loan amounts and underpricing by up to 2 percent and 7 basis points, respectively. These effects are concentrated in dollar appreciations. Our results suggest that global factors reflected in the dollar affect U.S. borrowing costs.

Keywords: loan pricing, syndicated loans, dollar, institutional investors, risk taking.

DOI: https://doi.org/10.17016/IFDP.2021.1312

IFDP 2021-1311
Dynamic Econometrics in Action: A Biography of David F. Hendry


David Hendry has made–and continues to make–pivotal contributions to the econometrics of empirical economic modeling, economic forecasting, econometrics software, substantive empirical economic model design, and economic policy. This paper reviews his contributions by topic, emphasizing the overlaps between different strands in his research and the importance of real-world problems in motivating that research.

Note: This paper was republished shortly after publication to update the date on the title page.

DOI: https://doi.org/10.17016/IFDP.2021.1311

IFDP 2021-1310
Globalization, Trade Imbalances and Labor Market Adjustment

Rafael Dix-Carneiro, Joao Paulo Pessoa, Ricardo Reyes-Heroles, Sharon Traiberman


We study the role of global trade imbalances in shaping the adjustment dynamics in response to trade shocks. We build and estimate a general equilibrium, multi-country, multi-sector model of trade with two key ingredients: (a) Consumption-saving decisions in each country commanded by representative households, leading to endogenous trade imbalances; (b) labor market frictions across and within sectors, leading to unemployment dynamics and sluggish transitions to shocks. We use the estimated model to study the behavior of labor markets in response to globalization shocks, including shocks to technology, trade costs, and inter-temporal preferences (savings gluts). We find that modeling trade imbalances changes both qualitatively and quantitatively the short- and long-run implications of globalization shocks for labor reallocation and unemployment dynamics. In a series of empirical applications, we study the labor market effects of shocks accrued to the global economy, their implications for the gains from trade, and we revisit the "China Shock" through the lens of our model. We show that the US enjoys a 2.2 percent gain in response to globalization shocks. These gains would have been 73 percent larger in the absence of the global savings glut, but they would have been 40 percent smaller in a balanced-trade world.

Keywords: Globalization, labor markets, trade imbalances

DOI: https://doi.org/10.17016/IFDP.2021.1310

IFDP 2021-1309
Bought, Sold and Bought Again: The Impact of Complex Value Chains on Export Elasticities

François de Soyres, Erik Frohm, Vanessa Gunnella and Elena Pavlova


Global value chain (GVC) participation affects the relationship between trade volumes and exchange rate movements. Guided by a simple theory, we show that exports react to the exchange rate between the country producing value added contained in exports and the country of final absorption for this value added. Three predictions follow: (i) a higher share of foreign value added in exports reduce the responsiveness of export volumes to exchange rate changes, (ii) a greater share of exports that returns as imports also reduce the responsiveness of export volumes and (iii) a higher share of inputs that are further reexported increase the responsiveness of exports to the trading partner's nominal effective exchange rate. Using a large origin-sector-destination level panel data set covering the period 1995-2009 and around 85% of world GDP, we find strong empirical support for these predictions. We further show that some sectors in some countries can experience a decline in gross exports when their currency depreciates.

Keywords: export elasticities, global value chains, currency unions, exchange rate passthrough

DOI: https://doi.org/10.17016/IFDP.2021.1309

IFDP 2021-1308
The Financial (In)Stability Real Interest Rate, R**

Ozge Akinci, Gianluca Benigno, Marco Del Negro, and Albert Queralto


We introduce the concept of financial stability real interest rate using a macroeconomic banking model with an occasionally binding financing constraint as in Gertler and Kiyotaki (2010). The financial stability interest rate, r**, is the threshold interest rate that triggers the constraint being binding.

Increasing imbalances in the financial sector measured by an increase in leverage are accom- panied by a lower threshold that could trigger financial instability events. We also construct a theoretical implied financial condition index and show how it is related to the gap between the natural and financial stability interest rates.

DOI: https://doi.org/10.17016/IFDP.2021.1308

IFDP 2021-1307
Optimizing Credit Gaps for Predicting Financial Crises: Modelling Choices and Tradeoffs


Credit gaps are good predictors for financial crises, and banking regulators recommend using them to inform countercyclical capital buffers for banks. Researchers typically create credit gap measures using trend-cycle decomposition methods, which require many modelling choices, such as the method used, and the smoothness of the underlying trend. Other choices hinge on the tradeoffs implicit in how gaps are used as early warning indicators (EWIs) for predicting crises, such as the preference over false positives and false negatives. We evaluate how the performance of credit-gap-based EWIs for predicting crises is influenced by these modelling choices. For the most common trend-cycle decomposition methods used to recover credit gaps, we find that optimally smoothing the trend enhances out-of-sample prediction. We also show that out-of sample performance improves further when we consider a preference for robustness of the credit gap estimates to the arrival of new information, which is important as any EWI should work in real-time. We offer several practical implications.

Keywords: Credit, Credit Gap, Optimization, Predictive Power, Robustness, Trend-cycle decomposition.

DOI: https://doi.org/10.17016/IFDP.2021.1307

Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.

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Last Update: January 06, 2021