Board of Governors of the Federal Reserve System

Abstract:

In economics, we need to forecast the present because reliable and comprehensive measures of the state of the economy are released with a substantial delay and considerable measurement error. Nowcasting exploits timely data to obtain early estimates of the state of the economy and updates these estimates continuously as new macroeconomic data are released. In this chapter, we describe how the framework used to nowcast GDP has evolved and is applied worldwide.

Keywords: Dynamic factor model, forecasting, nowcasting

DOI: https://doi.org/10.17016/IFDP.2023.1385

Abstract:

We use historical data and a calibrated model of the world economy to study how a synchronous monetary tightening can amplify cross-border transmission of monetary policy. The empirical analysis shows that historical episodes of synchronous tightening are associated with tighter financial conditions and larger effects on economic activity than asynchronous ones. In the model, a sufficiently large synchronous tightening can disrupt intermediation of credit by global financial intermediaries causing large output losses and an increase in sacrifice ratios, that is, output lost for a given reduction in inflation. We use this framework to show that there are gains from coordination of international monetary policy.

Keywords: Monetary Policy; Inflation; International Spillovers; Financial Frictions; Open Economy Macroeconomics; Panel Data Estimation.

DOI: https://doi.org/10.17016/IFDP.2023.1384

Abstract:

This paper uses U.S. loan-level credit register data and the 2018–2019 Trade War to test for the effects of international trade uncertainty on domestic credit supply. We exploit cross-sectional heterogeneity in banks’ ex-ante exposure to trade uncertainty and find that an increase in trade uncertainty is associated with a contraction in bank lending to all firms irrespective of the uncertainty that the firms face. This baseline result holds for lending at the intensive and extensive margins. We document two channels underlying the estimated credit supply effect: a wait-and-see channel by which exposed banks assess their borrowers as riskier and reduce the maturity of their loans and a financial frictions channel by which exposed banks facing relatively higher balance sheet constraints contract lending more. The decline in credit supply has real effects: firms that borrow from more exposed banks experience lower debt growth and investment rates. These effects are stronger for firms that are more reliant on bank finance.

Keywords: Trade uncertainty, bank loans, global value chains, trade finance, trade war

DOI: https://doi.org/10.17016/IFDP.2023.1383

Abstract:

This paper investigates a unique policy designed to maintain employment during the privatization of East German firms after the fall of the Iron Curtain. The policy required new owners of the firms to commit to employment targets, with penalties for non-compliance. Using a dynamic model, we highlight three channels through which employment targets impact firms: distorted employment decisions, increased productivity, and higher exit rates. Our empirical analysis, using a novel dataset and instrumental variable approach, confirms these findings. We estimate a 22% points higher annual employment growth rate, a 14% points higher annual productivity growth, and a 3.6% points higher probability of exit for firms with binding employment targets. Our calibrated model further demonstrates that without these targets, aggregate employment would have been 15% lower after 10 years. Additionally, an alternative policy of productivity investment subsidies proved costly and less effective in the short term.

Keywords: Industrial policy, Privatizations, Productivity, Size-dependent regulations.

DOI: https://doi.org/10.17016/IFDP.2023.1382

Abstract:

We develop a two-country macroeconomic model that we fit to a set of aggregate prices and quantities for the U.S. and the rest of the world. In addition to a standard array of shocks, the model includes time variation in agents’ preference for safe bonds. We allow for a component of this time variation to be common across countries and biased toward dollar-denominated safe assets, and refer to this component as global flight to safety (GFS). We find that GFS shocks are the most important shocks driving world business cycles, and are also important drivers of activity in the U.S. and especially abroad. An adverse GFS shock lowers global GDP and inflation, widens global corporate credit spreads, and appreciates the dollar. These effects are very close to those obtained from a structural VAR which uses the excess bond premium (Gilchrist and Zakrajšek, 2012) as proxy for global flight to safety. 

Keywords: Econometrics and economic theory; International economics; Macroeconomic activity.

DOI: https://doi.org/10.17016/IFDP.2023.1381

Abstract:

Differences in consumption patterns across demographic groups mean that international price shocks differentially affect such groups. We construct import price indexes for U.S. consumer groups that vary by age, race, sex, education, and urban status. Black consumers and college graduates experienced significantly higher import price inflation from 1996-2018 compared to other groups, such as high school dropouts, rural consumers, and consumers over 60. Sensitivity to international price shocks varies widely, implying movements in exchange rates and foreign prices, both during our sample and during the Covid-19 pandemic, drove sizable differences in import price inflation – and total inflation – across groups.

Keywords: exchange-rate passthrough, import price inflation, inequality

DOI: https://doi.org/10.17016/IFDP.2023.1380

Abstract:

We document a strong empirical connection between corporate taxation and the manufacturing labor share, both in the US and across OECD countries. Our estimates associate 30 percent to 60 percent of the observed decline in labor shares with the fall in corporate taxation. Using an equilibrium model of an industry where firms differ in their capital intensities, we show that lower corporate tax rates reduce the labor share by raising the market share of capital-intensive firms. The tax elasticity of the labor share depends on the joint distribution of labor intensities and value added at the micro level. Given the empirical distribution in the US manufacturing sector, our quantitative analysis suggests that corporate tax cuts explain a significant part of the decline in the manufacturing labor share since the 1950s. The shift away from traditionally large, labor-intensive production units raised the concentration of market shares and reduced the concentration of employment.

Keywords: Labor share of income, corporate taxation, industry dynamics, firm size distribution

DOI: https://doi.org/10.17016/IFDP.2023.1379

Abstract:

In this paper, we estimate exchange rate elasticities of international tourism. Both the bilateral exchange rate and the U.S. dollar exchange rate relative to tourism origin countries are important drivers of tourism flows. The U.S. dollar exchange rate is more important for tourism destination countries with higher U.S. dollar borrowing, pointing toward a complementarity between U.S. dollar pricing and financing. Country-specific dominant currencies (CSDCs) play only a minor role on average but are important for tourism-dependent countries and those with a high concentration of foreign tourists. Consistent with dominant currency pricing, we also find that local hotel prices do increase strongly when the domestic currency depreciates against the U.S. dollar. The importance of the U.S. dollar exchange rate represents a strong piece of evidence of dominant currency pricing (DCP) in the international trade of services. The results suggest that the benefits of exchange rate flexibility for tourism-dependent countries may be weaker than previously thought and that a broad appreciation of the U.S. dollar is associated with a significant decline in tourism flows globally.

Keywords: Exchange rates, trade flows, tourism, dominant currency pricing

DOI: https://doi.org/10.17016/IFDP.2023.1378

Abstract:

This paper studies the role of expectations in driving export adjustment. We assemble bilateral data on spot exchange rates, one year ahead exchange rate forecasts and HS2-product export data for 11 exporting countries and 64 destinations, covering the 2006–2014 period. Results from fixed effects regressions and an instrumental variables approach show that expectations of exchange rate changes are an important channel for export adjustment. A one percent expected exchange rate depreciation over the next year is associated with a 0.96 percent increase in the extensive margin (entry of new exporters) in the 2SLS regression, with statistically insignificant effects on total exports or the intensive margin. We provide intuition for these findings with a simple model with heterogeneous firms and sticky prices, and use our model to discuss the implications of anticipation for subsequent export growth and trade elasticity measurement.

Keywords: Exchange rates, heterogeneous firms, international trade

DOI: https://doi.org/10.17016/IFDP.2023.1377

Abstract:

Using recently available daily S&P 500 index option expirations, we examine the ex ante pricing of uncertainty surrounding key economic releases and the determinants of risk premia associated with these releases. The cost of insurance against price, variance, and downside risk is higher for options that span U.S. CPI, FOMC, Nonfarm Payroll, and GDP releases compared to neighboring expirations. We calculate release-driven forward equity and variance risk premia and find that premia vary considerably across economic releases and increase with risk aversion as well as with monetary policy and real economic uncertainty. The empirical framework presented in this paper can be used to examine the ex ante pricing of a wide variety of events.

Keywords: Variance Risk, Uncertainty, Risk Premium, Macroeconomic Releases, FOMC, Inflation, Tail Risk

DOI: https://doi.org/10.17016/IFDP.2023.1376

Abstract:

Most statistical agencies construct sectoral real GDP using double deflation and base period prices. When the base period price used for intermediate inputs is not equal to their marginal revenue product, such as when firms apply a markup, real GDP fluctuations become mechanically linked to variations in intermediate inputs. This is because these inputs generate profits that are incorporated into real value added. Taking this channel into account, we demonstrate that real GDP reported in national accounts substantially diverges from a theory-consistent "physical" value added. This, in turn, has implications for the measurement of productivity. Between 1999 and 2021, "physical" productivity cumulative growth in the Finance sector was 15pp lower compared to the Solow Residual, while it was 15pp higher in the Manufacturing sector.

Keywords: Economic Measurement, National Accounts, Markups, Productivity

DOI: https://doi.org/10.17016/IFDP.2023.1375

Abstract:

We use machine learning techniques on textual data to identify financial crises. The onset of a crisis and its duration have implications for real economic activity, and as such can be valuable inputs into macroprudential, monetary, and fiscal policy. The academic literature and the policy realm rely mostly on expert judgment to determine crises, often with a lag. Consequently, crisis durations and the buildup phases of vulnerabilities are usually determined only with the benefit of hindsight. Although we can identify and forecast a portion of crises worldwide to various degrees with traditional econometric techniques and using readily available market data, we find that textual data helps in reducing false positives and false negatives in out-of-sample testing of such models, especially when the crises are considered more severe. Building a framework that is consistent across countries and in real time can benefit policymakers around the world, especially when international coordination is required across different government policies.

Keywords: Financial Crises, Machine Learning, Natural Language Processing

DOI: https://doi.org/10.17016/IFDP.2023.1374

Abstract:

We uncover the major drivers of macro aggregates and the real exchange rate at business cycle frequencies in Group of Seven countries. The estimated main drivers of key macro variables resemble each other and account for a modest fraction of the real exchange rate variances. Dominant drivers of the real exchange rate are orthogonal to main drivers of business cycles, generate a significant deviation of the uncovered interest parity condition, and lead to small movements in net exports. We use these facts to evaluate international business cycle models accounting for the dynamics of both macro aggregates and the real exchange rate.

Keywords: international business cycles, real exchange rate, uncovered interest parity

DOI: https://doi.org/10.17016/IFDP.2023.1373

Abstract:

Motivated by cognitive theories verifying that investors have limited capacity to process information, we study the effects of information overload on stock market dynamics. We construct an information overload index using textual analysis tools on daily data from The New York Times since 1885. We structure our empirical analysis around a discrete-time learning model, which links information overload with asset prices and trading volume when investors are attention constrained. We find that our index is associated with lower trading volume and predicts higher market returns for up to 18 months, even after controlling for standard predictors and other news-based measures. Information overload also affects the cross-section of stock returns: Investors require higher risk premia to hold small, high beta, high volatile, and unprofitable stocks. Such findings are consistent with theories emphasizing that information overload increases information and estimation risk and deteriorates investors' decision accuracy amid their limited attention.

Keywords: Limited attention, dispersion, sentiment, predicting returns, behavioral biases

DOI: https://doi.org/10.17016/IFDP.2023.1372

Abstract:

We provide evidence for a causal link between the US economy and the global financial cycle. Using intraday data, we show that US macroeconomic news releases have large and significant effects on global risky asset prices. Stock price indexes of 27 countries, the VIX, and commodity prices all jump instantaneously upon news releases. The responses of stock indexes co-move across countries and are large - often comparable in size to the response of the S&P 500. Further, US macroeconomic news explains on average 23 percent of the quarterly variation in foreign stock markets. The joint behavior of stock prices, bond yields, and risk premia suggests that systematic US monetary policy reactions to news do not drive the estimated effects. Instead, the evidence points to a direct effect on investor’ risk-taking capacity. Our findings show that a byproduct of the United States' central position in the global financial system is that news about its business cycle has large effects on global financial conditions.

Keywords: Global Financial Cycle, High-frequency event study, International spillovers, Macroeconomic announcements, Monetary policy, Stock returns, VIX

DOI: https://doi.org/10.17016/IFDP.2023.1371

Abstract:

We assess the quantitative relevance of expectations-driven sovereign debt crises, focusing on the Southern European crisis of the early 2010’s and the Argentine default of 2001. The source of multiplicity is the one in Calvo (1988). Key for multiplicity is an output process featuring long periods of either high growth or stagnation that we estimate using data for those countries. We find that expectations-driven debt crises are quantitatively relevant but state dependent, as they only occur during stagnations. Expectations are a major driver explaining default rates and credit spread differences between Spain and Argentina.

Keywords: Self-fulfilling debt crises, sovereign default, multiplicity, stagnations.

DOI: https://doi.org/10.17016/IFDP.2023.1370

Abstract:

The COVID-19 pandemic has led to an unprecedented shift of consumption from services to goods. We study this demand reallocation in a multi-sector model featuring sticky prices, input-output linkages, and labor reallocation costs. Reallocation costs hamper the increase in the supply of goods, causing inflationary pressures. These pressures are amplified by the fact that goods prices are more flexible than services prices. We estimate the model allowing for demand reallocation, sectoral productivity, and aggregate labor supply shocks. The demand reallocation shock explains a large portion of the rise in U.S. inflation in the aftermath of the pandemic.

Keywords: Sectoral Reallocation, Inflation, Input-Output Models, Moment-matching exercise

DOI: https://doi.org/10.17016/IFDP.2023.1369

Abstract:

We review the "climate action plans" of Global Systemically Important Banks (GSIBs) and the progress they are making toward achieving them. G-SIBs have identified the drivers of climate risk and their transmission channels to credit and other risks. Additionally, some have started to measure and model these risks. While most GSIBs have committed to fully offsetting their emissions by mid-century, they are only beginning to measure financed emissions resulting from their loans and investments, which comprise the vast majority of their emissions. G-SIBs have also committed to increase green finance and have started to do so. All told, despite some progress by large global banks to address climate change considerations, much work lies ahead to properly measure and disclose climate-related risks, and to better align financing activities with their net-zero targets.

Keywords: Climate change, banks, climate finance, environmental reporting

DOI: https://doi.org/10.17016/IFDP.2023.1368