Staff working papers in the International Finance and Discussion Papers (IFDP) series are primarily materials produced by staff in the Division of International Finance. These topics are focused on, though by no means limited to, international macroeconomics, international trade, global finance, financial institutions, and markets, as well as international capital flows.

IFDP 2022-1344
Monetary Policy and Homeownership: Empirical Evidence, Theory, and Policy Implications

Daniel A. Dias and Joao B. Duarte

Abstract:

We show that monetary policy affects homeownership decisions and argue that this effect is an important and overlooked channel of monetary policy transmission. We first document that monetary policy shocks are a substantial driver of fluctuations in the U.S. homeownership rate and that monetary policy affects households' housing tenure choices. We then develop and calibrate a two-agent New Keynesian model that can replicate the estimated transmission of monetary policy shocks to homeownership rates and housing rents. We find that the calibrated model provides an explanation to the "price puzzle" and delivers two important results with policy implications. First, the homeownership decision channel amplifies the redistributive effects of monetary policy, with contractionary shocks benefiting more outright homeowners and disadvantaging more renters and homeowners with a mortgage. Second, a monetary authority that reacts to a price index that includes housing rents generates excess house price, rents, and output volatility and larger real effects.

DOI: https://doi.org/10.17016/IFDP.2022.1344

IFDP 2022-1343
The Dominant Currency Financing Channel of External Adjustment

Camila Casas, Sergii Meleshchuk, Yannick Timmer

Abstract:

We provide evidence of a new channel of how exchange rates affect trade. Using a novel identification strategy that exploits firms' foreign currency debt maturity structure in Colombia around a large depreciation, we show that firms experiencing a stronger debt revaluation of dominant currency debt due to a home currency depreciation compress imports relatively more while exports are unaffected. Dominant currency financing does not lead to an import compression for firms that export, hold foreign currency assets, or are active in the foreign exchange derivatives markets, as they are all hedged against a revaluation of their debt. These findings can be rationalized through the prism of a model with costly state verification and foreign currency borrowing. Dominant currency pricing mutes the effects of dominant currency financing on imports relative to producer currency pricing.

DOI: https://doi.org/10.17016/IFDP.2022.1343

IFDP 2022-1342
Spread Too Thin: The Impact of Lean Inventories

Abstract:

Widespread adoption of just-in-time (JIT) production has reduced inventory holdings. This paper finds that JIT creates a trade-off between firm profitability and vulnerability to large shocks. Empirically, JIT adopters experience higher sales and less volatility while also exhibiting heightened cyclicality and sensitivity to natural disasters. I explain these facts in a structurally estimated general equilibrium model where firms can adopt JIT. Relative to a no-JIT economy, the estimated model implies a 1.3% increase in firm value. At the same time, an unanticipated shock results in a roughly 15% deeper output contraction. This occurs because firms "stock out" or hoard materials.

DOI: https://doi.org/10.17016/IFDP.2022.1342

IFDP 2022-1341
Forecast Revisions as Instruments for News Shocks

Abstract:

Upon arrival of macroeconomic news, economic agents update their beliefs about the long-run fundamentals of the economy. I show that signals about the agents’ long-run expectations, proxied by the economic outlook revisions of professional forecasters, convey sufficient information to identify the effects of expected future technological changes, or news shocks. A major advantage of this approach from the existing news shock literature is that it does not depend on an empirical measure for technology, or on assumptions about common trends and timing of the technological change. I show that technological news shocks cause a strong anticipation effect in investment and an increase in hours, while there is less evidence of consumption smoothing over time---in line with news-driven business cycle models featuring a key role of financial frictions.

Keywords: instrumental variable, news shock, professional forecasts, proxy SVAR

DOI: https://doi.org/10.17016/IFDP.2022.1341

IFDP 2022-1340
Monetary Policy in a Model of Growth

Abstract:

Empirical evidence suggests that recessions have long-run effects on the economy's productive capacity. Recent literature embeds endogenous growth mechanisms within business cycle models to account for these "scarring" effects. The optimal conduct of monetary policy in these settings, however, remains largely unexplored. This paper augments the standard sticky-price New Keynesian (NK) to allow for endogenous dynamics in aggregate productivity. The model has a representation similar to the two-equation NK model, with an additional condition linking productivity growth to current and expected future output gaps. Absent state contingency in the subsidies that correct the externalities associated with productivity growth, optimal monetary policy sets inflation above target whenever the subsidies fall short of the externalities. In the recovery from a spell at the ZLB, the optimal discretionary policy sets inflation temporarily above target, helping mitigate the long-run damage. Following a cost-push shock that creates inflationary pressure, the central bank tolerates a larger rise in inflation than in a model with exogenous productivity. The gains from commitment include the central bank's ability to make credible promises about future output gaps in a way that allows it to manipulate current productivity growth.

Keywords: Business cycles; Growth; Optimal monetary policy; Hysteresis; Scarring.

DOI: https://doi.org/10.17016/IFDP.2022.1340

IFDP 2022-1339
Reusing Natural Experiments

Davidson Heath, Matthew C. Ringgenberg, Mehrdad Samadi, and Ingrid M. Werner

Abstract:

After a natural experiment is first used, other researchers often reuse the setting, examining different outcome variables. We use simulations based on real data to illustrate the multiple hypothesis testing problem that arises when researchers reuse natural experiments. We then provide guidance for future inference based on popular empirical settings including difference-in-differences regressions, instrumental variables regressions, and regression discontinuity designs. When we apply our guidance to two extensively studied natural experiments, business combination laws and the Regulation SHO pilot, we find that many results that were statistically significant using single hypothesis testing do not survive corrections for multiple hypothesis testing.

Keywords: False Positive, Multiple Hypothesis Testing, Natural Experiments

DOI: https://doi.org/10.17016/IFDP.2022.1339

IFDP 2022-1338
A Journey in the History of Sovereign Defaults on Domestic-Law Public Debt

Aitor Erce, Enrico Mallucci and Mattia Picarelli

Abstract:

We introduce a novel database on sovereign defaults that involve public debt instruments governed by domestic law. By systematically reviewing a large number of sources, we identify 134 default and restructuring events of domestic debt instruments, in 52 countries from 1980 to 2018. Domestic-law defaults are a global phenomenon. Over time, they have become larger and more frequent than foreign-law defaults. Domestic-law debt restructurings proceed faster than foreign ones, often through extensions of maturities and amendments to the coupon structure. While face value reductions are rare, net-present-value losses for creditors are still large. Unilateral amendments and post-default restructuring are the norm, but negotiated pre-default restructurings are becoming increasingly frequent. We also document that domestic-law defaults typically involve debt denominated in local currency and held by resident investors. We complement our analysis with a collection "sovereign histories", which provide the fine details about each episode.

DOI: https://doi.org/10.17016/IFDP.2022.1338

IFDP 2022-1337
The Dynamics of Global Sourcing

Abstract:

This paper studies an import model that incorporates both static crosscountry interdependence and dynamic dependence in firm-level decisions. I find that the benefit of sourcing from one country increases as a firm imports from more countries. Furthermore, using a partial identification approach under the revealed preferences assumption, I provide evidence for the sunk costs of importing, which make establishing relationships with new sellers costlier than maintaining existing ones. The coexistence of cross-country interdependence and sunk costs implies that temporary trade policy changes can have long-lasting effects on both the targeted and non-targeted markets through firm-level decisions.

DOI: https://doi.org/10.17016/IFDP.2022.1337

IFDP 2022-1336
Devaluations, Deposit Dollarization, and Household Heterogeneity

Abstract:

We study the aggregate and re-distributive effects of currency devaluations in a small open economy heterogeneous households model with leverage-constrained banks. Our framework captures three stylized facts about liability dollarization in emerging economies: i) banks and firms borrow in foreign currency; ii) households save in dollar-denominated local bank deposits; and iii) such deposits are mainly held by wealthier households. The resulting currency mismatch causes an erosion of banks' net worth during a devaluation, depressing credit supply. The ensuing macroeconomic downturn is amplified by a strong reduction of consumption among poorer households in response to rising borrowing costs and falling labor income. Richer households are partially insured, as they are holding a larger share of their wealth in foreign currency denominated assets. We show that a larger currency hedging by wealthier households deepens the recession and amplifies the negative spillovers for poorer agents. When deposit dollarization is high, welfare gains can arise if monetary policy dampens a depreciation.

DOI: https://doi.org/10.17016/IFDP.2022.1336

IFDP 2022-1335
Cross-Sectional Financial Conditions, Business Cycles and The Lending Channel

Abstract:

I document business cycle properties of the full cross-sectional distributions of U.S. stock returns and credit spreads from financial and nonfinancial firms. The skewness of returns of financial firms (SRF) best predicts economic activity, while being a barometer for lending conditions. SRF also affects firm-level investment beyond firms' balance sheets, and adverse SRF shocks lead to macroeconomic downturns with tighter lending conditions in vector autoregressions (VARs). These results are consistent with a lending channel in which cross-sectional financial firms' balance sheets play a prominent role in business cycles. I rationalize this argument with a model that matches the VAR evidence.

SRF monthly data (CSV) and SRF monthly data definitions (TXT) (Updated: Feburary 4, 2022)
SRF quarterly data (CSV) and SRF quarterly data definitions (TXT) (Updated: Feburary 4, 2022)

Keywords: Cross-sectional, skewness, business cycles, lending channel

DOI: https://doi.org/10.17016/IFDP.2022.1335

IFDP 2022-1334
Stablecoins: Growth Potential and Impact on Banking

Gordon Y. Liao and John Caramichael

Abstract:

Stablecoins have experienced tremendous growth in the past year, serving as a possible breakthrough innovation in the future of payments. In this paper, we discuss the current use cases and growth opportunities of stablecoins, and we analyze the potential for stablecoins to broadly impact the banking system. The impact of stablecoin adoption on traditional banking and credit provision can vary depending on the sources of inflow and the composition of stablecoin reserves. Among the various scenarios, a two-tiered banking system can both support stablecoin issuance and maintain traditional forms of credit creation. In contrast, a narrow bank approach for digital currencies can lead to disintermediation of traditional banking, but may provide the most stable peg to fiat currencies. Additionally, dollar-pegged stablecoins backed by adequately safe and liquid collateral can potentially serve as a digital safe haven currency during periods of crypto market distress.

DOI: https://doi.org/10.17016/IFDP.2022.1334

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.

ISSN 2767-4509 (Online)

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Last Update: May 19, 2022