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 2019-077
Effective Lower Bound Risk (PDF)

Timothy S. Hills, Taisuke Nakata, and Sebastian Schmidt

Abstract: Even when the policy rate is currently not constrained by its effective lower bound (ELB), the possibility that the policy rate will become constrained in the future lowers today's inflation by creating tail risk in future inflation and thus reducing expected inflation. In an empirically rich model calibrated to match key features of the U.S. economy, we find that the tail risk induced by the ELB causes inflation to undershoot the target rate of 2 percent by as much as 50 basis points at the economy's risky steady state. Our model suggests that achieving the inflation target may be more difficult now than before the Great Recession, if the likely decline in long-run neutral rates has led households and firms to revise up their estimate of the frequency of future ELB events.

Keywords: Deflationary Bias, Disinflation, Effective Lower Bound, Inflation Targeting, Risky Steady State, Tail Risk


FEDS 2019-076
The Global Equilibrium Real Interest Rate: Concepts, Estimates, and Challenges (PDF)

Abstract: Real interest rates have been persistently below historical norms over the past decade, leading economists and policymakers to view the equilibrium real interest rate as likely to be low for some time. Various definitions and approaches to estimating the equilibrium real interest rate are examined, including approaches based on the term-structure of interest rates and small macroeconomic models. The individual-country approaches common in the literature are extended to allow for global trend and cyclical factors. The analysis finds that global factors dominate the downward trend in the equilibrium interest rate across 13 advanced economies. A corollary of this finding is that the U.S. equilibrium rate may be substantially lower than estimated in U.S.-only studies. The analysis also highlights how the common global trend confounds empirical assessments of the determinants of movements in the equilibrium rate and the need to better integrate term-structure and macroeconomic approaches.

Keywords: Global Factors, Natural Rate, World Interest Rate


FEDS 2019-075
In Search of Lost Time Aggregation (PDF)

Abstract: In 1960, Working noted that time aggregation of a random walk induces serial correlation in the first difference that is not present in the original series. This important contribution has been overlooked in a recent literature analyzing income and consumption in panel data. I examine Blundell, Pistaferri and Preston (2008) as an important example for which time aggregation has quantitatively large effects. Using new techniques to correct for the problem, I find the estimate for the partial insurance to transitory shocks, originally estimated to be 0.05, increases to 0.24. This larger estimate resolves the dissonance between the low partial consumption insurance estimates of Blundell, Pistaferri and Preston (2008) and the high marginal propensities to consume found in the natural experiment literature.

Keywords: Consumption, Income, Time Aggregation


FEDS 2019-074
A Coherent Framework for Predicting Emerging Market Credit Spreads with Support Vector Regression (PDF)

Gary Anderson and Alena Audzeyeva

Abstract: We propose a coherent framework using support vector regression (SRV) for generating and ranking a set of high quality models for predicting emerging market sovereign credit spreads. Our framework adapts a global optimization algorithm employing an hv-block cross-validation metric, pertinent for models with serially correlated economic variables, to produce robust sets of tuning parameters for SRV kernel functions. In contrast to previous approaches identifying a single "best" tuning parameter setting, a task that is pragmatically improbable to achieve in many applications, we proceed with a collection of tuning parameter candidates, employing the Model Confidence Set test to select the most accurate models from the collection of promising candidates. Using bond credit spread data for three large emerging market economies and an array of input variables motivated by economic theory, we apply our framework to identify relatively small sets of SVR models with su perior out-of-sample forecasting performance. Benchmarking our SRV forecasts against random walk and conventional linear model forecasts provides evidence for the notably superior forecasting accuracy of SRV-based models. In contrast to routinely used linear model benchmarks, the SRV-based models can generate accurate forecasts using only a small set of input variables limited to the country-specific credit-spread-curve factors, lending some support to the rational expectation theory of the term structure in the context of emerging market credit spreads. Consequently, our evidence indicates a better ability of highly flexible SVR to capture investor expectations about future spreads reflected in today's credit spread curve.

Keywords: Emerging Markets, Machine Learning, Out-of-sample Predictability, Soverign Cedi Spreads, Support Vector Machine Regressions


FEDS 2019-073
Tractable Rare Disaster Probability and Options-Pricing (PDF)

Robert J. Barro and Gordon Y. Liao

Abstract: We derive an option-pricing formula from recursive preference and estimate rare disaster probability. The new options-pricing formula applies to far-out-of-the money put options on the stock market when disaster risk dominates, the size distribution of disasters follows a power law, and the economy has a representative agent with Epstein-Zin utility. The formula conforms with options data on the S&P 500 index from 1983-2018 and for analogous indices for other countries. The disaster probability, inferred from monthly fixed effects, is highly correlated across countries, peaks during the 2008-2009 financial crisis, and forecasts equity index returns and growth vulnerabilities in the economy.

Keywords: Disaster Probability, Option Prices, Rare Disaster, Tail Risk, Uncertainty, Volatility


FEDS 2019-072
Okun Revisited: Who Benefits Most from a Strong Economy (PDF)

Stephanie R. Aaronson, Mary C. Daly, William L. Wascher, and David W. Wilcox

Abstract: Previous research has shown that the labor market experiences of less advantaged groups are more cyclically sensitive than the labor market experiences of more advantaged groups; in other words, less advantaged groups experience a high-beta version of the aggregate fluctuations in the labor market. For example, when the unemployment rate of whites increases by 1 percentage point, the unemployment rates of African Americans and Hispanics rise by well more than 1 percentage point, on average. This behavior is observed across other labor-market indicators, and is roughly reversed when the unemployment rate declines. We update this work to include the post-Great Recession period and extend the analysis to consider whether these high-beta relationships change when the labor market is especially tight. We find suggestive evidence that when the labor market is already strong, a further increment of strengthening provides a modest extra benefit to some disadvantaged groups, relative to earlier in the labor-market cycle. In addition, we provide preliminary evidence suggesting that these gains are somewhat persistent for African Americans and women.

Keywords: Business Cycles, Inequality, Labor supply and demand, Racial Disparities, Unemployment


FEDS 2019-071
The Welfare Costs of Misaligned Incentives: Energy Inefficiency and the Principal-Agent Problem (PDF)

Abstract: In many settings, misaligned incentives and inadequate monitoring lead employees to take self-interested actions contrary to their employer's wishes, giving rise to the classic principal-agent problem. In this paper, I identify and quantify the costs of misaligned incentives in the context of an energy efficiency appliance replacement program. I show that contractors (agents) hired by the electric utility (the principal) increase their compensation by intentionally misreporting program data to deliberately authorize replacement of non-qualified refrigerators. I provide empirical estimates of the impacts of misaligned incentives on (1) the effectiveness of energy efficiency retrofits and (2) welfare. I estimate that unqualified replacements reduce welfare by an average of $106 and save only half as much electricity as replacements that follow program guidelines. The same program without a principal-agent distortion would increase welfare by $60 per replacement. The resul ts provide novel evidence of how principal-agent distortions in the implementation of a potentially beneficial program can undermine its value.

Keywords: Energy efficiency, Firm behavior, Principal-agent problem


FEDS 2019-070
Bottom-up leading macroeconomic indicators: An application to non-financial corporate defaults using machine learning (PDF)

Tyler Pike, Horacio Sapriza, and Tom Zimmermann

Abstract: This paper constructs a leading macroeconomic indicator from microeconomic data using recent machine learning techniques. Using tree-based methods, we estimate probabilities of default for publicly traded non-financial firms in the United States. We then use the cross-section of out-of-sample predicted default probabilities to construct a leading indicator of non-financial corporate health. The index predicts real economic outcomes such as GDP growth and employment up to eight quarters ahead. Impulse responses validate the interpretation of the index as a measure of financial stress.

Keywords: Corporate Default, Early Warning Indicators, Economic Activity, Machine Learning


FEDS 2019-069
Trends in Household Portfolio Composition (PDF)

Jesse Bricker, Kevin B. Moore, and Jeffrey P. Thompson

Abstract: We use data from the Survey of Consumer Finances (SCF) to explore how household asset portfolios in the United States have evolved from 1989 to 2016. Throughout this period, two key assets—housing and financial market assets—have driven the aggregate household balance sheet evolution. However, aggregates mask great heterogeneity in balance sheet composition across the wealth distribution, and most families hold a relatively small share of assets in financial markets and larger shares in housing and other nonfinancial assets. We also describe the typical life cycle asset accumulation processes among low, middle, and high-income families which—though varying dramatically by level—are quite similar. Finally, we use household balance sheets to describe how financial vulnerability has changed over time.

Keywords: Distribution of wealth, household finance, household wealth


FEDS 2019-068
What are the Price Effects of Trade? Evidence from the U.S. and Implications for Quantitative Trade Models (PDF)

Xavier Jaravel and Erick Sager

Abstract: This paper finds that U.S. consumer prices fell substantially due to increased trade with China. With comprehensive price micro-data and two complementary identification strategies, we estimate that a 1pp increase in import penetration from China causes a 1.91% decline in consumer prices. This price response is driven by declining markups for domestically-produced goods, and is one order of magnitude larger than in standard trade models that abstract from strategic price-setting. The estimates imply that trade with China increased U.S. consumer surplus by about $400,000 per displaced job, and that product categories catering to low-income consumers experienced larger price declines.

Keywords: China, Inequality, Markups, Prices, Trade


FEDS 2019-067
Sellin' in the Rain: Adaptation to Weather and Climate in the Retail Sector (PDF)

Abstract: Using novel methodology and proprietary daily store-level sporting goods and apparel brand data, I find that, consistent with long-run adaptation to climate, sales sensitivity to weather declines with historical norms and variability of weather. Short-run adaptation to weather shocks is dominated by changes in what people buy and how they buy it, with little intertemporal substitution. Over four weeks, a one-standard deviation one-day weather shock shifts sales by about 10 percent. While switching between indoor and outdoor stores offsets a small portion of contemporaneous responses to weather, I find no evidence that ecommerce offsets any of the effects.

Keywords: adaptation, climate change, lasso, machine learning, retail, sales, weather


FEDS 2019-066
Policy Uncertainty and Bank Mortgage Credit (PDF)

Abstract: We document that banks reduce supply of jumbo mortgage loans when policy uncertainty increases as measured by the timing of US gubernatorial elections in banks' headquarter states. The reduction is larger for more uncertain elections. We utilize high-frequency, geographically granular loan data to address an identification problem arising from changing demand for loans: (1) the microeconomic data allow for state/time (quarter) fixed effects; (2) we observe banks reduce lending not just in their home states but also outside their home states when their home states hold elections; (3) we observe important cross-sectional differences in the way banks with different characteristics respond to policy uncertainty. Overall, the findings suggest that policy uncertainty has a real effect on residential housing markets through banks' credit supply decisions and that it can spill over across states through lending by banks serving multiple states.

Keywords: Bank Mortgage Credit, Gubernatorial Elections, Housing Market, Policy Uncertainty


FEDS 2019-065
Improving the Accuracy of Economic Measurement with Multiple Data Sources: The Case of Payroll Employment Data (PDF)

Abstract: This paper combines information from two sources of U.S. private payroll employment to increase the accuracy of real-time measurement of the labor market. The sources are the Current Employment Statistics (CES) from BLS and microdata from the payroll processing firm ADP. We briefly describe the ADP-derived data series, compare it to the BLS data, and describe an exercise that benchmarks the data series to an employment census. The CES and the ADP employment data are each derived from roughly equal-sized samples. We argue that combining CES and ADP data series reduces the measurement error inherent in both data sources. In particular, we infer "true" unobserved payroll employment growth using a state-space model and find that the optimal predictor of the unobserved state puts approximately equal weight on the CES and ADP-derived series. Moreover, the estimated state contains information about future readings of payroll employment.

Keywords: big data, economic measurement, labor market, state-space models


FEDS 2019-064
Monetary Policy and Bank Equity Values in a Time of Low and Negative Interest Rates (PDF)

Miguel Ampudia and Skander J. Van den Heuvel

Abstract: Does banks' exposure to interest rate risk change when interest rates are very low or even negative? Using a high-frequency event study methodology and intraday data, we find that the effect of surprise interest rate cuts announced by the ECB on European bank equity values – an effect that is normally positive – has become negative since interest rates in the euro area reached zero and below. Since then, a further unexpected cut of 25 basis points in the short-term policy rate lowered banks' stock prices by about 2% on average, compared to a 1% increase in normal times. In the cross section, this 'reversal' was far more pronounced for banks with a more traditional, deposit-intensive funding mix. We argue that the reversal as well as its cross-sectional pattern can be explained by the zero lower bound on interest rates on retail deposits.

Keywords: Bank profitability, Interest rate risk, Monetary policy, Negative interest rates


FEDS 2019-063
Exporters of Services: A Look at U.S. Exporters outside of the Manufacturing Sector (PDF)

Abstract: Using transaction data for the U.S., this paper presents a series of stylized facts on exporters in services industries. We find that most of the basic facts on manufacturing exporters extend to the services sectors with three important differences. First, the participation rate of services firms in foreign markets is much lower than that of manufacturing firms. Second, the size premia at services exporters are significantly higher than those among manufacturers. Third, the survival rates of services exporters tend to be lower than that of manufacturing exporters. All three facts are compatible with the hypothesis that firms in services sectors face larger trade costs. A simple calibration suggests that services firms face two-to-three-time higher fixed costs than manufacturing exporters.

Keywords: Exporters of Services, Extensive and Intensive Margins, Firm Heterogeneity, Trade Costs


FEDS 2019-062
Parental Proximity and Earnings After Job Displacements (PDF)

Patrick Coate, Pawel Krolikowski, and Mike Zabek

Abstract: The earnings of young adults who live in the same neighborhoods as their parents completely recover after a job displacement, unlike the earnings of young adults who live farther away, which permanently decline. Nearby workers appear to benefit from help with childcare since grandmothers are less likely to be employed after their child's job displacement and since the earnings benefits are concentrated among young adults who have children. The result also suggests that parental employment networks improve earnings. Differences in job search durations, transfers of housing services, and geographic mobility, however, are too small to explain the result.

Keywords: Adult Children, Childcare, Family ties, Job loss, Parents, Transfers


FEDS 2019-061
CECL and the Credit Cycle (PDF)

Bert Loudis and Ben Ranish

Abstract: We find that that the Current Expected Credit Loss (CECL) standard would slightly dampen fluctuations in bank lending over the economic cycle. In particular, if the CECL standard had always been in place, we estimate that lending would have grown more slowly leading up to the financial crisis and more rapidly afterwards. We arrive at this conclusion by estimating historical allowances under CECL and modeling how the impact on accounting variables would have affected banks' lending and capital distributions. We consider a variety of approaches to address uncertainty regarding the management of bank capital and predictability of credit losses.

Keywords: ALLL, Accounting policy, CECL, Loans, Provisioning


FEDS 2019-060
A Simple Model of Voluntary Reserve Targets with Tolerance Bands (PDF)

Abstract: This note presents a simplifed version of the model of voluntary reserve targets (VRT) developed in Baughman and Carapella (forthcoming), with a Walrasian interbank market. First, the model makes transparent the role of target setting in controlling the market rate. Second, the simplicity of the model allows for an analysis of the interaction between VRT and tolerance bands, which are a common tool for controlling rate variability. We find that the persistent overshooting of interbank rates observed during the Bank of England's experiment with VRT may derive from the interaction between target setting and tolerance bands, a new explanation relative to the literature. We also suggest a simple remedy.

Keywords: Monetary Policy Implementation, Tolerance Bands, Voluntary Reserve Tartgets


FEDS 2019-059
Variance Disparity and Market Frictions (PDF)

Abstract: This paper introduces a new model-free approach to measuring the expectation of market variance using VIX derivatives. This approach shows that VIX derivatives carry different information about future variance than S&P 500 (SPX) options, especially during the 2008 financial crisis. I find that the segmentation is associated with frictions such as funding illiquidity, market illiquidity, and asymmetric information. When they are segmented, VIX derivatives contribute more to the variance discovery process than SPX options. These findings imply that VIX derivatives would offer a better estimate of expected variance than SPX options, and that a measure of segmentation may be useful for policymakers as it signals the severity of frictions.

Keywords: VIX derivative, asymmetric information, economic uncertainty, illiquidity, implied variance


FEDS 2019-058
Transparency and collateral: the design of CCPs' loss allocation rules (PDF)

Gaetano Antinolfi, Francesca Carapella, and Francesco Carli

Abstract: This paper adopts a mechanism design approach to study optimal clearing arrangements for bilateral financial contracts in which an assessment of counterparty risk is crucial for efficiency. The economy is populated by two types of agents: a borrower and lender. The borrower is subject to limited commitment and holds private information about the severity of such lack of commitment. The lender can acquire information at a cost about the commitment of the borrower, which affects the assessment of counterparty risk. When truthful revelation by the borrower is not incentive compatible, the mechanism designer optimally trades off the value of information about the lack of commitment of the borrower with the cost of incentivizing the lender to acquire such information. Central clearing of these financial contracts through a central counterparty (CCP) allows lenders to mutualize their counterparty risks, but this insurance may weaken incentives to acquire and reveal informatio n about such risks. If information acquisition is incentive compatible, then lenders choose central clearing. If it is not, they may prefer bilateral clearing to prevent strategic default by borrowers and to economize on costly collateral. Central clearing is analyzed under different institutional features observed in financial markets, which place different restrictions on the contract space in the mechanism design problem. The interaction between the costly information acquisition and the limited commitment friction differs significantly in each clearing arrangement and in each set of restrictions. This results in novel lessons about the desirability of central versus bilateral clearing depending on traders' characteristics and the institutional features defining the operation of the CCP.

Keywords: Central counterparties, Limited Commitment, collateral


FEDS 2019-057
From Transactions Data to Economic Statistics: Constructing Real-time, High-frequency, Geographic Measures of Consumer Spending (PDF)

Abstract: Access to timely information on consumer spending is important to economic policymakers. The Census Bureau's monthly retail trade survey is a primary source for monitoring consumer spending nationally, but it is not well suited to study localized or short-lived economic shocks. Moreover, lags in the publication of the Census estimates and subsequent, sometimes large, revisions diminish its usefulness for real-time analysis. Expanding the Census survey to include higher frequencies and subnational detail would be costly and would add substantially to respondent burden. We take an alternative approach to fill these information gaps. Using anonymized transactions data from a large electronic payments technology company, we create daily estimates of retail spending at detailed geographies. Our daily estimates are available only a few days after the transactions occur, and the historical time series are available from 2010 to the present. When aggregated to the national leve l, the pattern of monthly growth rates is similar to the official Census statistics. We discuss two applications of these new data for economic analysis: First, we describe how our monthly spending estimates are useful for real-time monitoring of aggregate spending, especially during the government shutdown in 2019, when Census data were delayed and concerns about the economy spiked. Second, we show how the geographic detail allowed us quantify in real time the spending effects of Hurricanes Harvey and Irma in 2017.

Keywords: Big Data, Consumer spending, Macroeconomic Forecasting


FEDS 2019-056
Regulating Financial Networks Under Uncertainty (PDF)

Abstract: I study the problem of regulating a network of interdependent financial institutions that is prone to contagion when there is uncertainty regarding its precise structure. I show that such uncertainty reduces the scope for welfare-improving interventions. While improving network transparency potentially reduces this uncertainty, it does not always lead to welfare improvements. Under certain conditions, regulation that reduces the risk-taking incentives of a small set of institutions can improve welfare. The size and composition of such a set crucially depend on the interplay between (i) the (expected) susceptibility of the network to contagion, (ii) the cost of improving network transparency, (iii) the cost of regulating institutions, and (iv) investors' preferences.

Keywords: Financial networks, contagion, policy design under uncertainty


FEDS 2019-055
Measuring the Liquidity Profile of Mutual Funds (PDF)

Sirio Aramonte, Chiara Scotti, and Ilknur Zer

Abstract: We measure the liquidity profile of open-end mutual funds using the sensitivity of their daily returns to aggregate liquidity. We study how this sensitivity changes around real-activity macroeconomic announcements that reveal large surprises about the state of the economy and after three relevant market events: Bill Gross's departure from PIMCO, Third Avenue Focused Credit Fund's suspension of redemptions, and the effect of Lehman Brothers' collapse on Neuberger Berman. Results show that, following negative news, the sensitivity to aggregate liquidity increases for less-liquid mutual funds, like those that invest in the stocks of small companies and in high-yield corporate bonds. The effect is more pronounced during stress periods, suggesting that a deterioration in the funds' liquidity could amplify vulnerabilities in situations of already weak macroeconomic conditions.

Keywords: Asset management, liquidity trasformation, market liquidity, mutual funds


FEDS 2019-054
Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics (PDF)

Mathias S. Kruttli, Brigitte Roth Tran, and Sumudu W. Watugala

Abstract: We investigate the uncertainty dynamics surrounding extreme weather events through the lens of option and stock markets by identifying market responses to the uncertainty regarding both potential hurricane landfall and subsequent economic impact. Stock options on firms with establishments exposed to the landfall region exhibit increases in implied volatility of 5-10 percent, reflecting impact uncertainty. Using hurricane forecasts, we show that landfall uncertainty and potential impact uncertainty are reflected in prices before landfall. We find no evidence that markets incorporate better hurricane forecasts than those from NOAA. Improvements to hurricane forecasts could have economically significant effects in financial markets.

Keywords: Extreme weather events, climate finance, hurricanes, implied volatility, stock returns, uncertainty


FEDS 2019-053
Expectations-Driven Liquidity Traps: Implications for Monetary and Fiscal Policy (PDF)

Taisuke Nakata and Sebastian Schmidt

Abstract: We study optimal monetary and fiscal policy in a New Keynesian model where occasional declines in agents' confidence give rise to persistent liquidity trap episodes. There is no straightforward recipe for enhancing welfare in this economy. Raising the inflation target or appointing an inflation-conservative central banker mitigates the inflation shortfall away from the lower bound but exacerbates deflationary pressures at the lower bound. Using government spending as an additional policy instrument worsens allocations at and away from the lower bound. However, appointing a policymaker who is sufficiently less concerned with government spending stabilization than society eliminates expectations-driven liquidity traps.

Keywords: Discretion, Effective Lower Bound, Fiscal policy, Monetary policy, Policy Delegation, Sunspot Equilibria


FEDS 2019-052
Shock Transmission through Cross-Border Bank Lending: Credit and Real Effects (PDF)

Galina Hale, Tümer Kapan, and Camelia Minoiu

Abstract: We study the transmission of financial shocks across borders through international bank connections. Using data on cross-border interbank loans among 6,000 banks during 1997-2012, we estimate the effect of asset-side exposures to banks in countries experiencing systemic banking crises on profitability, credit, and the performance of borrower firms. Crisis exposures reduce bank returns and tighten credit conditions for borrowers, constraining investment and growth. The effects are larger for foreign borrowers, including in countries not experiencing banking crises. Our results document the extent of cross-border crisis transmission, but also highlight the resilience of financial networks to idiosyncratic shocks.

Accessible materials (.zip)

Keywords: bank loans, banking crises, cross-border interbank exposures, real economy, shock transmission


FEDS 2019-051
When do low-frequency measures really measure transaction costs? (PDF)

Abstract: We compare popular measures of transaction costs based on daily data with their high-frequency data-based counterparts. We find that for U.S. equities and major foreign exchange rates, (i) the measures based on daily data are highly upward biased and imprecise; (ii) the bias is a function of volatility; and (iii) it is primarily volatility that drives the dynamics of these liquidity proxies both in the cross section as well as over time. We corroborate our results in carefully designed simulations and show that such distortions arise when the true transaction costs are small relative to volatility. Many financial assets exhibit this property, not only in the last two decades, but also in the previous century. We document that using low-frequency measures as liquidity proxies in standard asset pricing tests may produce sizable biases and spurious inferences about the pricing of aggregate volatility or liquidity risk.

Accessible materials (.zip)

Keywords: Liquidity Risk, Transaction Costs, Volatility


FEDS 2019-050
The Effects of Bank Capital Buffers on Bank Lending and Firm Activity: What Can We Learn from Five Years of Stress-Test Results? (PDF)

Abstract: We use bank-firm matched data from regulatory filings (FR Y-14) to study how the capital buffers that large U.S. banks must satisfy to "pass" the quantitative component of the Federal Reserve's CCAR stress tests impact banks' C&I lending and firms' C&I loan volumes, overall debt, investment spending, and employment. We find that larger stress-test capital buffers lead to material reductions in bank C&I lending. A 1 p.p. larger capital buffer results in a 2 p.p. lower (four-quarter) growth rate of utilized loans and a 1 1/2 p.p. lower growth rate of committed loans. The effects on firm loan volumes are larger, when we look at the loans that firms obtain from banks subject to stress tests. A firm that borrows from banks that on a weighted-average basis face a 1 p.p. larger stress-test capital buffer, experiences a 4 p.p. lower rate of growth in utilized loans and a 3 p.p. lower rate of growth of committed credit lines. However, when we consider firms' overall debt volum es we find no impact of higher stress-test capital buffers, suggesting that firms can find other sources of credit to substitute for the reduction in loans that they face from banks subject to stress tests. We also find that firm investment and employment are largely unaffected by the capital buffers implied by stress tests. Because in the U.S. the consequences for banks of not meeting their stress-test capital buffers are similar to those of not satisfying an activated countercyclical capital buffer (CCyB), our findings are informative for the effects of the CCyB. Our results suggest that activating the CCyB in the U.S. would likely reduce the lending of the banks to which the CCyB applies, but would likely not impact the overall debt volumes, investment, and employment of the firms that borrow from these banks.

Accessible materials (.zip)

Keywords: Bank capital, Bank lending, Regulatory capital


FEDS 2019-049
Accounting for Innovations in Consumer Digital Services: IT still matters (PDF)

David M. Byrne and Carol Corrado

Abstract: This paper develops a framework for measuring digital services in the face of ongoing innovations in the delivery of content to consumers. We capture what Brynjolfsson and Saunders (2009) call "free goods" as the capital services generated by connected consumers' stocks of IT digital goods; this service flow augments the existing measure of personal consumption in GDP. Its value is determined by the intensity with which households use their IT capital to consume content delivered over networks, and its volume depends on the quality of the IT capital. Consumers pay for delivery services, however, and the complementarity between device use and network use enables us to develop a quality-adjusted price measure for the access services already included in GDP. Our new estimates imply that accounting for innovations in consumer content delivery matters: The innovations boost consumer surplus by nearly $1,800 (2017 dollars) per connected user per year for the full period of this study (1987 to 2017) and contribute more than 1/2 percentage point to US real GDP growth during the last ten. All told, our more complete accounting of innovations is (conservatively) estimated to have moderated the post-2007 GDP growth slowdown by nearly .3 percentage points per year.

Accessible materials (.zip)

Keywords: Consumer Digital Services, Consumer Durables, Consumer Surplus, Digital Transformation, Information and Communication Technology (ICT), Price Measurement, Productivity


FEDS 2019-048
Reach for Yield by U.S. Public Pension Funds (PDF)

Lina Lu, Matthew Pritsker, Andrei Zlate, Kenechukwu Anadu, and James Bohn

Abstract: This paper studies whether U.S. public pension funds reach for yield by taking more investment risk in a low interest rate environment. To study funds' risk-taking behavior, we first present a simple theoretical model relating risk-taking to the level of risk-free rates, to their underfunding, and to the fiscal condition of their state sponsors. The theory identifies two distinct channels through which interest rates and other factors may affect risk-taking: by altering plans' funding ratios, and by changing risk premia. The theory also shows the effect of state finances on funds' risk-taking depends on incentives to shift risk to state debt holders. To study the determinants of risk-taking empirically, we create a new methodology for inferring funds' risk from limited public information on their annual returns and portfolio weights for the interval 2002-2016. In order to better measure the extent of underfunding, we revalue funds' liabilities using discount rate s that better reflect their risk. We find that funds on average took more risk when risk-free rates and funding ratios were lower, which is consistent with both the funding ratio and the risk-premia channels. Consistent with risk-shifting, we also find more risk-taking for funds affiliated with state or municipal sponsors with weaker public finances. We estimate that up to one-third of the funds' total risk was related to underfunding and low interest rates at the end of our sample period.

Accessible materials (.zip)

Keywords: U.S. public pension funds, Value at Risk, duration-matched discount rates, reach for yield, state public debt, underfunding


FEDS 2019-047
Leveraged Bank Loan versus High Yield Bond Mutual Funds (PDF)

Ayelen Banegas and Jessica Goldenring

Abstract: Since the financial crisis, the markets for Bank Loan (BL) and High Yield Bond (HYB) mutual funds (MFs) have grown significantly, with assets under management increasing from $19 billion and $75 billion to close to $117 billion and $225 billion, respectively, as of December 2018. This short paper characterizes the universe of BL MFs and compare it against that of HYB MFs on several dimensions. We document that BL and HYB MFs' respective market share of leverage loans (LL) and high yield (HY) corporate bonds outstanding increased since the mid-2000s. We also show that in terms of portfolio allocations, HYB and BL MFs hold around 60 percent of B, BB and BBB-rated assets and that exposure to foreign fixed-income markets is relatively small for both types of MFs. Finally, we document that net flows as a share of assets were larger and more volatile for BL MFs than for their HYB counterparts and that HYB MFs significantly outperformed BL MFs since early 2000.

Accessible materials (.zip)

Keywords: High yield bonds, Leveraged loans, Mutual funds


FEDS 2019-046
The Impact of Credit Risk Mispricing on Mortgage Lending during the Subprime Boom (PDF)

James A. Kahn and Benjamin S. Kay

Abstract: We provide new evidence that credit supply shifts contributed to the U.S. subprime mortgage boom and bust. We collect original data on both government and private mortgage insurance premiums from 1999-2016, and document that prior to 2008, premiums did not vary across loans with widely different observable characteristics that we show were predictors of default risk. Then, using a set of post-crisis insurance premiums to fit a model of default behavior, and allowing for time-varying expectations about house price appreciation, we quantify the mispricing of default risk in premiums prior to 2008. We show that the flat premium structure, which necessarily resulted in safer mortgages cross-subsidizing riskier ones, produced substantial adverse selection. Government insurance maintained an even flatter premium structure even post-crisis, and consequently also suffered from adverse selection. But after 2008 it reduced its exposure to default risk through a combination of higher premiums and rationing at the extensive margin.

Accessible materials (.zip)

Keywords: Default Risk, Financial Crisis, Housing Finance, Mortgage Insurance


FEDS 2019-045
How does the interaction of macroprudential and monetary policies affect cross-border bank lending? (PDF)

El?d Takáts and Judit Temesvary

Abstract: We combine a rarely accessed BIS database on bilateral cross-border lending flows with cross-country data on macroprudential regulations. We study the interaction between the monetary policy of major international currency issuers (USD, EUR and JPY) and macroprudential policies enacted in source (home) lending banking systems. We find significant interactions. Tighter macroprudential policy in a home country mitigates the impact on lending of monetary policy of a currency issuer. For instance, macroprudential tightening in the UK mitigates the negative impact of US monetary tightening on USD-denominated cross-border bank lending outflows from UK banks. Vice-versa, easier macroprudential policy amplifies impacts. The results are economically significant.

Accessible materials (.zip)

Keywords: Cross-border claims, Diff-in-diff analysis, Macroprudential policy, Monetary policy


FEDS 2019-044
Mixed Signals: Investment Distortions with Adverse Selection (PDF)

R. Matthew Darst and Ehraz Refayet

Abstract: We study how adverse selection distorts equilibrium investment allocations in a Walrasian credit market with two-sided heterogeneity. Representative investor and partial equilibrium economies are special cases where investment allocations are distorted above perfect information allocations. By contrast, the general setting features a pecuniary externality that leads to trade and investment allocations below perfect information levels. The degree of heterogeneity between informed agents' type governs the direction of the distortion. Moreover, contracts that complete markets dampen the impact of pecuniary externalities and change equilibrium distortions. Implications for empirical design in credit market studies and financial stability are discussed.

Accessible materials (.zip)

Keywords: asymmetric information, cost of capital, credit defaul swaps, investment, pecuniary externality, signalling


FEDS 2019-043
A Unified Measure of Fed Monetary Policy Shocks (PDF)

Chunya Bu, John Rogers, and Wenbin Wu

Abstract: Identification of Fed monetary policy shocks is complex, in light of the distinct policymaking regimes before, during, and after the ZLB period of December 2008 to December 2015. We develop a heteroscedasticity-based partial least squares approach, combined with Fama-MacBeth style cross-section regressions, to identify a US monetary policy shock series that usefully bridges periods of conventional and unconventional policymaking and is effectively devoid of the central bank information effect. Our series has moderately high correlation with well-known shocks in the literature, but has crucially important differences. Following conventional tests, we find scant evidence of the information effect in our measure. We attribute the source of these different findings to our econometric procedure and our use of the full maturity spectrum of interest rate instruments in constructing our measure. We then present evidence confirming an hypothesis in the literature that the information effect can lead to the result that shocks to monetary policy have transmission effects with signs that differ from traditional theory. We find that shocks to series that are devoid of (embody) the information effect display conventionally-signed (perverse) impulse responses of output and inflation. This provides evidence of first-order importance to staff at central banks undertaking quantitative theoretical modeling of the effects of monetary policy.

Accessible materials (.zip)

Original paper: PDF


FEDS 2019-042
Inflation and Deflationary Biases in Inflation Expectations (PDF)

Michael J. Lamla, Damjan Pfajfar, and Lea Rendell

Abstract: We explore the consequences of losing confidence in the price-stability objective of central banks by quantifying the inflation and deflationary biases in inflation expectations. In a model with an occasionally binding zero-lower-bound constraint, we show that an inflation bias as well as a deflationary bias exist as a steady-state outcome. We assess the predictions of this model using unique individual-level inflation expectations data across nine countries that allow for a direct identification of these biases. Both inflation and deflationary biases are present (and sizable) in inflation expectations of these individuals. Among the euro-area countries in our sample, we can document significant differences in perceptions of the European Central Bank's objectives, despite having a common monetary policy.

Accessible materials (.zip)

Keywords: ZLB, confidence in central banks, deflationary bias, inflation bias, inflation expectations, microdata


FEDS 2019-041
The costs and benefits of liquidity regulations: Lessons from an idle monetary policy tool (PDF)

Christopher J. Curfman and John Kandrac

Abstract: We investigate how liquidity regulations affect banks by examining a dormant monetary policy tool that functions as a liquidity regulation. Our identification strategy uses a regression kink design that relies on the variation in a marginal high-quality liquid asset (HQLA) requirement around an exogenous threshold. We show that mandated increases in HQLA cause banks to reduce credit supply. Liquidity requirements also depress banks' profitability, though some of the regulatory costs are passed on to liability holders. We document a prudential benefit of liquidity requirements by showing that banks subject to a higher requirement before the financial crisis had lower odds of failure.

Accessible materials (.zip)

Keywords: Monetary policy, bank failure, bank lending, liquidity regulation, required reserves


FEDS 2019-040
Bond Risk Premiums at the Zero Lower Bound (PDF)

Martin M. Andreasen, Kasper Jørgensen, and Andrew Meldrum

Abstract: This paper documents a significantly stronger relationship between the slope of the yield curve and future excess bond returns on Treasuries from 2008-2015 than before 2008. This new predictability result is not matched by the standard shadow rate model with Gaussian factor dynamics, but extending the model with regime-switching in the (physical) dynamics of the factors at the lower bound resolves this shortcoming. The model is also consistent with the downwards trend in surveys on short rate expectations at long horizons, but requires a break in the level of its factors to closely fit the low level of these surveys since 2015.

Accessible version (.zip)

Keywords: Dynamic term structure model, bond return predictability, regime-switching, shadow rate model, structural break


FEDS 2019-039
The Role of U.S. Monetary Policy in Global Banking Crises (PDF)

Bora Durdu, Alex Martin, and Ilknur Zer

Abstract: We examine the role of U.S. monetary policy in global financial stability by using a cross-country database spanning the period from 1870-2010 across 69 countries. U.S. monetary policy tightening increases the probability of banking crises for those countries with direct linkages to the U.S., either in the form of trade links or significant share of USD-denominated liabilities. Conversely, if a country is integrated globally, rather than having a direct exposure, the effect is ambiguous. One possible channel we identify is capital flows: If the correction in capital flows is disorderly (e.g., sudden stops), the probability of banking crises increases. These findings suggest that the effect of U.S. monetary policy in global banking crises is not uniform and largely dependent on the nature of linkages with the U.S.

Accessible version (.zip)

Keywords: Banking Crises, Financial Stability, Monetary Policy Shocks, Sudden Stops


FEDS 2019-038
Benchmarking Operational Risk Stress Testing Models (PDF)

Filippo Curti, Marco Migueis, and Robert Stewart

Abstract: The Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) requires large bank holding companies (BHCs) to project losses under stress scenarios. In this paper, we propose multiple benchmarks for operational loss projections and document the industry distribution relative to these benchmarks. The proposed benchmarks link BHCs' loss projections with both financial characteristics and metrics of historical loss experience. These benchmarks capture different measures of exposure and together provide a comprehensive view of the reasonability of model outcomes. Furthermore, we employ several approaches to assess the conservatism of BHCs' stress loss projections and our estimates for the conservatism of loss projections for the median bank range from the 90th percentile to above the 99th percentile of the operational loss distribution.

Accessible version (.zip)

Keywords: Benchmarking, Operational Risk, Stress testing


FEDS 2019-037
Credible Forward Guidance (PDF)

Taisuke Nakata and Takeki Sunakawa

Abstract: We analyze credible forward guidance policies in a sticky-price model with an effective lower bound (ELB) constraint on nominal interest rates by solving a series of optimal sustainable policy problems indexed by the duration of reputational loss. Lower-for-longer policies---while effective in stimulating the economy at the ELB---are potentially time-inconsistent, as the associated overheating of the economy in the aftermath of a crisis is undesirable ex post. However, if reneging on a lower-for-longer promise leads to a loss of reputation and prevents the central bank from effectively using lower-for-longer policies in future crises, these policies can be time-consistent. We find that, even without an explicit commitment technology, the central bank can still credibly keep the policy rate at the ELB for an extended period---though not as extended under the optimal commitment policy---and meaningfully mitigate the adverse effects of the ELB constraint on economy activity.

Accessible version (.zip)

Keywords: Credibility, Effective Lower Bound, Forward Guidance, Sustainable Plan, Time-Consistency


FEDS 2019-036
Optimal Inflation Target with Expectations-Driven Liquidity Traps (PDF)

Philip Coyle and Taisuke Nakata

Abstract: In expectations-driven liquidity traps, a higher inflation target is associated with lower inflation and consumption. As a result, introducing the possibility of expectations-driven liquidity traps to an otherwise standard model lowers the optimal inflation target. Using a calibrated New Keynesian model with an effective lower bound (ELB) constraint on nominal interest rates, we find that even a very small probability of falling into an expectations-driven liquidity trap lowers the optimal inflation target nontrivially. Our analysis provides a reason to be cautious about the argument that central banks should raise their inflation targets in light of a higher likelihood of hitting the ELB.
Accessible materials (.zip)

Keywords: Liquidity Traps, Optimal Inflation Target, Sunspot Shock, Zero Lower Bound


FEDS 2019-035
Measuring Labor-Force Participation and the Incidence and Duration of Unemployment (PDF)

Hie Joo Ahn and James D. Hamilton

Abstract: The underlying data from which the U.S. unemployment rate, labor-force participation rate, and duration of unemployment are calculated contain numerous internal contradictions. This paper catalogs these inconsistencies and proposes a reconciliation. We find that the usual statistics understate the unemployment rate and the labor-force participation rate by about two percentage points on average and that the bias in the latter has increased since the Great Recession. The BLS estimate of the average duration of unemployment overstates by 50 percent the true duration of uninterrupted spells of unemployment and misrepresents what happened to average durations during the Great Recession and its recovery.
Accessible materials (.zip)

Keywords: Labor-force participation rate, Measurement errors, Unemployment duration, Unemployment rate


FEDS 2019-034
Business Dynamics in the National Establishment Time Series (NETS) (PDF)

Abstract: Business microdata have proven useful in a number of fields, but the main sources of comprehensive microdata are subject to significant confidentiality restrictions. A growing number of papers instead use a private data source seeking to cover the universe of U.S. business establishments, the National Establishment Time Series (NETS). Previous research documents the representativeness of NETS in terms of the distribution of employment and establishment counts across industry, geography, and establishment size. But there exists considerable need among researchers for microdata suitable for studying business dynamics--birth, growth, decline, and death. We evaluate NETS in terms of its ability to corroborate key insights from the business dynamics literature with a particular focus on the behavior of new and young firms. We find that NETS microdata exhibit patterns of business dynamics that are markedly different from official administrative sources, limiting the usefuln ess of NETS for studying these topics.
Accessible materials (.zip)

Keywords: business microdata, economic measurement, entrepreneurship, firm dynamics, high-growth firms, job flows


FEDS 2019-033
A Generalized Approach to Indeterminacy in Linear Rational Expectations Models (PDF)

Francesco Bianchi and Giovanni Nicolò

Abstract: We propose a novel approach to deal with the problem of indeterminacy in Linear Rational Expectations models. The method consists of augmenting the original state space with a set of auxiliary exogenous equations to provide the adequate number of explosive roots in presence of indeterminacy. The solution in this expanded state space, if it exists, is always determinate, and is identical to the indeterminate solution of the original model. The proposed approach accommodates determinacy and any degree of indeterminacy, and it can be implemented even when the boundaries of the determinacy region are unknown. Thus, the researcher can estimate the model using standard packages without restricting the estimates to the determinacy region. We apply our method to estimate the New-Keynesian model with rational bubbles by Galí (2017) over the period 1982:Q4 until 2007:Q3. We find that the data support the presence of two degrees of indeterminacy, implying that the central bank was not reacting strongly enough to the bubble component.
Accessible materials (.zip)

Keywords: Bayesian methods, General Equilibrium, Indeterminacy, Solution method


FEDS 2019-032
Some International Evidence for Keynesian Economics Without the Phillips Curve (PDF)

Roger E.A. Farmer and Giovanni Nicolò

Abstract: Farmer and Nicolò (2018) show that the Farmer Monetary (FM)-model outperforms the three-equation New-Keynesian (NK)-model in post war U.S. data. In this paper, we compare the marginal data density of the FM-model with marginal data densities for determinate and indeterminate versions of the NK-model for three separate samples using U.S., U.K. and Canadian data. We estimate versions of both models that restrict the parameters of the private sector equations to be the same for all three countries. Our preferred specification is the constrained version of the FM-model which has a marginal data density that is more than 30 log points higher than the NK alternative. Our findings also demonstrate that cross-country macroeconomic differences are well explained by the different shocks that hit each economy and by differences in the ways in which national central banks reacted to those shocks.

Accessible materials (.zip)

Keywords: Bayesian methods, General Equilibrium, Indeterminacy, International business cycles, Keynes, Monetary policy, Phillips Curve


FEDS 2019-031
Understanding Bank and Nonbank Credit Cycles: A Structural Exploration (PDF)

Abstract: We explore the structural drivers of bank and nonbank credit cycles using an estimated medium-scale macro model that allows for bank and nonbank financial intermediation. We posit economy-wide aggregate and sectoral disturbances to potentially drive bank and nonbank credit growth. We find that sectoral shocks affecting the balance sheets of entrepreneurs who borrow from the financial sector are important for the business cycle frequency fluctuations in bank and nonbank credit growth. Economy-wide entrepreneurial risk shocks gain predominance for explaining the longer-horizon comovement between the two series.

Accessible materials (.zip)

Keywords: Banks, Capital requirements, Credit cycles, DSGE models, Leverage, Nonbanks


FEDS 2019-030
When Simplicity Offers a Benefit, Not a Cost: Closed-Form Estimation of the GARCH(1,1) Model that Enhances the Efficiency of Quasi-Maximum Likelihood (PDF)

Abstract: Simple, multi-step estimators are developed for the popular GARCH(1,1) model, where these estimators are either available entirely in closed form or dependent upon a preliminary estimate from, for example, quasi-maximum likelihood. Identification sources to asymmetry in the model's innovations, casting skewness as an instrument in a linear, two-stage least squares estimator. Properties of regular variation coupled with point process theory establish the distributional limits of these estimators as stable, though highly non-Gaussian, with slow convergence rates relative to the √n-case. Moment existence criteria necessary for these results are consistent with the heavy-tailed features of many financial returns. In light-tailed cases that support asymptotic normality for these simple estimators, conditions are discovered where the simple estimators can enhance the asymptotic efficiency of quasi-maximum likelihood estimation. In small samples, extensive Monte Carlo experiments reveal these efficiency enhancements to be available for (very) heavy tailed cases. Consequently, the proposed simple estimators are members of the class of multi-step estimators aimed at improving the efficiency of the quasi-maximum likelihood estimator.

Accessible materials (.zip) | Appendix (PDF)

Keywords: GARCH models, Closed form estimation, Heavy tails, Instrumental variables, Regular variation


FEDS 2019-029
Second-Home Buying and the Housing Boom and Bust (PDF)

Abstract: The effects of the surge in second-home buying (homeowners acquiring nonprimary residences) on the housing boom and bust remain an open question partly because reliable geographic data is currently unavailable. This paper constructs local data on second-home buying by merging credit bureau data with mortgage servicing records. The identification strategy exploits the fact that the vacation share of housing in 2000 predicts second-home origination shares during the boom years, while also uncorrelated with other boom-bust drivers including proxies for local housing expectations, the use of alternative and privately securitized mortgages, and supply constraints. Areas with plausibly exogenous increases in second-home buying experienced a sharper boom and bust. Overall, second-home buying could explain about 30 percent and 10 percent of the run-up in construction employment and house prices, respectively, from 2000 to 2006.
Revised paper: Accessible materials (.zip)

Original paper: PDF | Accessible materials (.zip)

Keywords: Real estate investors, housing boom, speculation


FEDS 2019-028
Likelihood Evaluation of Models with Occasionally Binding Constraints (PDF)

Abstract: Applied researchers interested in estimating key parameters of DSGE models face an array of choices regarding numerical solution and estimation methods. We focus on the likelihood evaluation of models with occasionally binding constraints. We document how solution approximation errors and likelihood misspeci cation, related to the treatment of measurement errors, can interact and compound each other.
Accessible materials (.zip)

Keywords: Measurement error, Occasionally binding constraints, Particle filter, Solution error


FEDS 2019-027
The Marginal Effect of Government Mortgage Guarantees on Homeownership (PDF)

Abstract: The U.S. government guarantees a majority of residential mortgages, which is often justified as a means to promote homeownership. In this paper we use property-level data to estimate the effect of government mortgage guarantees on homeownership, by exploiting variation of the conforming loan limits (CLLs) along county borders. We find substantial effects on government guarantees, but find no robust effect on homeownership. This finding suggests that government guarantees could be considerably reduced with modest effects on homeownership, which is relevant for housing finance reform plans that propose to reduce the government's involvement in the mortgage market by reducing the CLLs.
Accessible materials (.zip)

Keywords: Federal Housing Administration, Government mortgage guarantees, Government-sponsored enterprises, Homeownership


FEDS 2019-026
Assessing Macroeconomic Tail Risk (PDF)

Francesca Loria, Christian Matthes, and Donghai Zhang

Abstract: What drives macroeconomic tail risk? To answer this question, we borrow a definition of macroeconomic risk from Adrian et al. (2019) by studying (left-tail) percentiles of the forecast distribution of GDP growth. We use local projections (Jordà, 2005) to assess how this measure of risk moves in response to economic shocks to the level of technology, monetary policy, and financial conditions. Furthermore, by studying various percentiles jointly, we study how the overall economic outlook--as characterized by the entire forecast distribution of GDP growth--shifts in response to shocks. We find that contractionary shocks disproportionately increase downside risk, independently of what shock we look at.
Accessible materials (.zip)


FEDS 2019-025
Information in Yield Spread Trades (PDF)

Abstract: Using positions data on bond futures, I document that speculators' spread trades contain private information about future economic activities and asset prices. Strong steepening trades are associated with negative payroll surprises in subsequent months and can predict asset markets' reaction to future payroll releases, suggesting that speculators hold superior information about future payrolls. Steepening trades can also predict the rise of stock prices within a few hours before subsequent FOMC announcements, implying that the pre-FOMC stock drift is driven by informed speculation. Overall, evidence highlights spread traders' superior information and its important role in explaining announcement returns and pre-announcement drifts.
Accessible materials (.zip)

Keywords: Business Cycle, Informed Trading, Macroeconomic Announcements, Pre-FOMC, Term Structure


FEDS 2019-024
Uncertainty shocks, monetary policy and long-term interest rates (PDF)

Gianni Amisano and Oreste Tristani

Abstract: We study the relationship between monetary policy and long-term rates in a structural, general equilibrium model estimated on both macro and yields data from the United States. Regime shifts in the conditional variance of productivity shocks, or "uncertainty shocks", are an important model ingredient. First, they account for countercyclical movements in risk premia. Second, they induce changes in the demand for precautionary saving, which affects expected future real rates. Through changes in both risk-premia and expected future real rates, uncertainty shocks account for about 1/2 of the variance of long-term nominal yields over long horizons. The remaining driver of long-term yields are changes in in ation expectations induced by conventional, autoregressive shocks. Long-term in ation expectations implied by our model are in line with those based on survey data over the 1980s and 1990s, but less dogmatically anchored in the 2000s.
Appendix (PDF)
Accessible materials (.zip)

Keywords: Bayesian Estimation, Monetary Policy Rules, Regime Switches, Term Structure Of Interest Rates, Uncertainty Shocks


FEDS 2019-023
How does the strength of monetary policy transmission depend on real economic activity? (PDF)

Abstract: We study the relationship between the strength of the bank credit channel (BCC) of monetary policy and real GDP growth in the United States using quarterly commercial bank level data between 1986 and 2008. We find that the BCC was significantly stronger during periods of low economic growth. Monetary policy is more effective through this channel in spurring economic activity during periods of low growth, rather than in cooling the economy when growth is high. Furthermore, we find that the BCC operated through a broader range of loan categories and banks than previously documented, underscoring this channel's economic relevance.

Accessible materials (.zip)

Keywords: Bank balance sheet, Bank lending channel, GDP growth, Monetary policy transmission


FEDS 2019-022
Marketplace Lending and Consumer Credit Outcomes: Evidence from Prosper (PDF)

Abstract: In 2005, Prosper launched the first peer-to-peer lending website in the US, allowing for consumers to apply for and receive loans entirely online. To understand the effect of this new credit source, we match application-level data from Prosper to credit bureau data. Post application, borrowers' credit scores increase and their credit card utilization rates fall relative to non-borrowers in the short run. In the longer run, total debt levels for borrowers are higher that of non-borrowers. Differences in mortgage debt are particularly large and increasing over time. Despite increased debt levels relative to non-borrowers, delinquency rates for borrowers are significantly lower.

Accessible materials (.zip)

Keywords: Marketplace lending, Online lending, Peer-to-peer lending, Prosper Marketplace, disintermediation


FEDS 2019-021
Do Greasy Wheels Curb Inequality? (PDF)

Abstract: I document a disparity in the cyclicality of the allocative wage-the labor costs considered when deciding to form or dissolve an employment relationship-across levels of educational attainment. Specifically, workers with a bachelors degree or more exhibit an allocative wage that is highly pro-cyclical while high school dropouts exhibit no statistically discernible cyclical pattern. I also assess the response to monetary policy shocks of both employment and allocative wages across education groups. The less educated respond to monetary policy shocks on the employment margin while the more educated respond on the wage margin. An important takeaway is that conventional monetary policy easing reduces employment inequality but increases wage inequality. I embed these findings in a New Keynesian framework that includes price and heterogeneous wage rigidity and show that heterogeneity results in welfare losses due to fluctuations that exceed those of the output-gap and price-level equivalent representative agent economy. The excess welfare loss is borne by the least educated.

This paper was modified on April 3, 2019, to correct a typo in Equation 6.6.

Accessible materials (.zip)

Keywords: Inequality, Monetary policy, Wage Rigidity


FEDS 2019-020
Duration dependence, monetary policy asymmetries, and the business cycle (PDF)

Abstract: We produce business cycle chronologies for U.S. states and evaluate the factors that change the probability of moving from one phase to another. We find strong evidence for positive duration dependence in all business cycle phases but find that the effect is modest relative to other state- and national-level factors. Monetary policy shocks also have a strong influence on the transition probabilities in a highly asymmetric way. The effect of policy shocks depends on the current state of the cycle as well as the sign and size of the shock.

Accessible materials (.zip)

Keywords: Duration analysis, business cycles, hazard rates, monetary policy asymmetries


FEDS 2019-019
New Financial Stability Governance Structures and Central Banks (PDF)

Rochelle M. Edge and J. Nellie Liang

Abstract: We evaluate the institutional frameworks developed to implement time-varying macroprudential policies in 58 countries. We focus on new financial stability committees (FSCs) that have grown dramatically in number since the global financial crisis, and their interaction with central banks, and infer countries' revealed preferences for effectiveness versus political economy considerations. Using cluster analysis, we find that only one-quarter of FSCs have both good processes and good tools to implement macroprudential actions, and that instead most FSCs have been designed to improve communication and coordination among existing regulators. We also find that central banks are not especially able to take macroprudential actions when FSCs are not set up to do so. We conclude that about one-half of the countries do not have structures to take or direct actions and avoid risks of policy inertia. Rather countries' decisions appear to be consistent with strengthening the politica l legitimacy of macroprudential policies with prominent roles for the ministry of finance and avoiding placing additional powers in central banks that already are strong in microprudential supervision and have high political independence for monetary policy. The evidence suggests that countries are placing a relatively low weight on the ability of policy institutions to take action and a high weight on political economy considerations in developing their financial stability governance structures.

Accessible materials (.zip)

Keywords: Central bank independence, Countercyclical capital buffer, Financial stability committees, Macroprudential policy


FEDS 2019-018
Does Price Regulation Affect Competition? Evidence from Credit Card Solicitations (PDF)

Yiwei Dou, Geng Li, and Joshua Ronen

Abstract: We study the unintended consequences of consumer financial regulations, focusing on the CARD Act, which restricts consumer credit card issuers' ability to raise interest rates. We estimate the competitive responsiveness--the degree to which a credit card issuer changes offered interest rates in response to changes in interest rates offered by its competitors--as a measure of competition in the credit card market. Using small business card offers, which are not subject to the Act, as a control group, we find a significant decline in the competitive responsiveness after the Act. The decline in responsiveness is more pronounced for competitors' reductions, as opposed to increases, in interest rates, and is more pronounced in areas with more subprime borrowers. The reduced competition underscores the potential unintended consequence of regulating the consumer credit market and contributes toward a more comprehensive and balanced evaluation of the costs and benefits of consumer financial regulations.

Accessible materials (.zip)

Keywords: CARD Act, Competitive responsiveness, Credit card market, Regulations


FEDS 2019-017
Introducing the Distributional Financial Accounts of the United States (PDF)

Abstract: This paper describes the construction of the Distributional Financial Accounts (DFAs), a new dataset containing quarterly estimates of the distribution of U.S. household wealth since 1989, and provides the first look at the resulting data. The DFAs build on two existing Federal Reserve Board statistical products --- quarterly aggregate measures of household wealth from the Financial Accounts of the United States and triennial wealth distribution measures from the Survey of Consumer Finances --- to incorporate distributional information into a national accounting framework. The DFAs complement other existing sources of data on the wealth distribution by using a more comprehensive measure of household wealth and by providing quarterly data on a timely basis. We encourage policymakers, researchers, and other interested parties to use the DFAs to help understand issues related to the distribution of U.S. household wealth.

Accessible materials (.zip)

Keywords: Economic data, economic measurement, household economics, inequality, national accounts, wealth distribution, wealth dynamics


FEDS 2019-016
The Limits of p-Hacking: a Thought Experiment (PDF)

Abstract: Suppose that asset pricing factors are just p-hacked noise. How much p-hacking is required to produce the 300 factors documented by academics? I show that, if 10,000 academics generate 1 factor every minute, it takes 15 million years of p-hacking. This absurd conclusion comes from applying the p-hacking theory to published data. To fit the fat right tail of published t-stats, the p-hacking theory requires that the probability of publishing t-stats < 6.0 is infinitesimal. Thus it takes a ridiculous amount of p-hacking to publish a single t-stat. These results show that p-hacking alone cannot explain the factor zoo.

Accessible materials (.zip)

Keywords: Stock return anomalies, multiple testing, p-hacking, publication bias


FEDS 2019-015
Who Values Access to College? (PDF)

Kartik Athreya, Felicia F. Ionescu, Urvi Neelakantan, and Ivan Vidangos

Abstract: A first glance at US data suggests that college -- given its mean returns and sharply subsidized cost for all enrollees -- could be of great value to most. Using an empirically-disciplined human capital model that allows for variation in college readiness, we show otherwise. While the top decile of valuations is indeed large (40 percent of consumption), nearly half of high school completers place zero value on access to college. Subsidies to college currently flow to those already best positioned to succeed and least sensitive to them. Even modestly targeted alternatives may therefore improve welfare. As proof of principle, we show that redirecting subsidies away from those who would nonetheless enroll -- towards a stock index retirement fund for those who do not even when college is subsidized -- increases ex-ante welfare by 1 percent of mean consumption, while preserving aggregate enrollment and being budget neutral.

Accessible materials (.zip)

Keywords: Financial Investment, Higher Education, Human Capital


FEDS 2019-014
Inferring Term Rates from SOFR Futures Prices (PDF)

Abstract: The Alternative Reference Rate Committee, a group of private-sector market participants convened by the Federal Reserve, has recommended that markets transition to the use of the Secured Overnight Financing Rate (SOFR) in financial contracts that currently reference US dollar LIBOR. This paper examines the feasibility of using SOFR futures prices to construct forward-looking term reference rates that are conceptually similar to the term LIBOR rates commonly used in loan contracts. We show that futures-implied term SOFR rates have closely tracked federal funds OIS rates over the eight months since SOFR futures began trading. To examine the performance of our approach over a longer time horizon, we compare term rates derived from federal funds futures with observed overnight rates and OIS rates from 2000 to the present. Consistent with prior research, we find that futures-implied term rates accurately predict realized compounded overnight rates during most periods.

Accessible materials (.zip)

Keywords: Derivatives, futures, and options, LIBOR, SOFR, financial contracts, interest rates, reference rates


FEDS 2019-013
Test Questions, Economic Outcomes, and Inequality (PDF)

Abstract: Standard achievement scales aggregate test questions without considering their relationship to economic outcomes. This paper uses question-level data to improve the measurement of achievement in two ways. First, the paper constructs alternative achievement scales by relating individual questions directly to school completion and labor market outcomes. Second, the paper leverages the question data to construct multiple such scales in order to correct for biases stemming from measurement error. These new achievement scales rank students differently than standard scales and typically yield achievement gaps by race, gender, and household income that are larger by 0.1 to 0.5 standard deviations. Differential performance on test questions can fully explain black-white differences in both wages and lifetime earnings and can explain roughly half of the difference in these outcomes between youth from high- versus low-income households. By contrast, test questions do not explain gender differences in labor market outcomes.

Accessible materials (.zip)

Keywords: achievement gaps, human capital, inequality, measurement error


FEDS 2019-012
Getting Smart About Phones: New Price Indexes and the Allocation of Spending Between Devices and Services Plans in Personal Consumption Expenditures (PDF)

David M. Byrne, Daniel E. Sichel, and Ana Aizcorbe

Abstract: This paper addresses two measurement issues for mobile phones. First, we develop a new mobile phone price index using hedonic quality-adjusted prices for smartphones and a matched-model index for feature phones. Our index falls at an average annual rate of 17 percent during 2010-2018, close to the rate of decline in the price index used in the GDP Accounts. Given relatively flat average prices over this period, our index points to substantial quality improvement. Second, we propose a methodology to disentangle purchases of phones and wireless services when they are bundled together as part of a long-term service contract. Getting the allocation right is especially important for real PCE because the price deflators for phones and wireless services exhibit very different trends. Our adjusted estimates suggest that real PCE spending currently captured in the category Cellular Phone Services increased 4 percentage points faster than is reflected in published data.

Accessible materials (.zip)

Keywords: Cell phone, hedonic indexes, mobile phone, personal consumption expenditures, price indexes, quality adjustment, smartphone


FEDS 2019-011
Over-the-Counter Market Liquidity and Securities Lending (PDF)

Abstract: This paper studies how over-the-counter market liquidity is affected by securities lending. We combine micro-data on corporate bond market trades with securities lending transactions and individual corporate bond holdings by U.S. insurance companies. Applying a difference-in-differences empirical strategy, we show that the shutdown of AIG's securities lending program in 2008 caused a statistically and economically significant reduction in the market liquidity of corporate bonds predominantly held by AIG. We also show that an important mechanism behind the decrease in corporate bond liquidity was a shift towards relatively small trades among a greater number of dealers in the interdealer market.

Accessible materials (.zip)

Keywords: broker-dealers, corporate bonds, insurance companies, market liquidity, over-the-counter markets, securities lending


FEDS 2019-010
Lifecycle Patterns of Saving and Wealth Accumulation (PDF)

Laura J. Feiveson and John Sabelhaus

Abstract: Empirical analysis of U.S. income, saving and wealth dynamics is constrained by a lack of high-quality and comprehensive household-level panel data. This paper uses a pseudo-panel approach, tracking types of agents by birth cohort and across time through a series of cross-section snapshots synthesized with macro aggregates. The key micro source data is the Survey of Consumer Finances (SCF), which captures the top of the wealth distribution by sampling from administrative records. The SCF has the detailed balance sheet components, incomes, and interfamily transfers needed to use both sides of the intertemporal budget constraint and thus solve for saving and consumption. The wealth change decomposition by age and agent type provides a new set of benchmarks for heterogeneous agent macro models, reconciling observed anomalies about lifecycle saving behavior and emphasizing the importance of generally unmeasured incomes (interfamily transfers and capital gains) in wealth accumulation dynamics.

Accessible materials (.zip)

Original paper: PDF | Accessible materials (.zip)

Keywords: Consumption, Household income, Lifecycle, Saving, Wealth


FEDS 2019-009
Monetary Policy Strategies for a Low-Rate Environment (PDF)

Ben S. Bernanke, Michael T. Kiley, and John M. Roberts

Abstract: In low-rate environments, policy strategies that involve holding rates “lower for longer” (L4L) may mitigate the effects of the effective lower bound (ELB). However, these strategies work in part by managing the public’s expectations, which is not always realistic. Using the Fed’s large-scale macroeconometric model, we study the effectiveness of L4L policies when financial market participants are forward-looking but other agents are not. We find that the resulting limited ability to manage expectations reduces but does not eliminate the advantages of L4L policies. The best policies provide adequate stimulus at the ELB while avoiding sizable overshoots of inflation and output.
Appendix (PDF)

Accessible materials (.zip)

Keywords: Intererst rates, Model comparison, Monetary policy


FEDS 2019-008
Stress Testing Household Debt (PDF)

Abstract: We estimate a county-level model of household delinquency and use it to conduct "stress tests" of household debt. Applying house price and unemployment rate shocks from Comprehensive Capital Analysis Review (CCAR) stress tests, we find that forecasted delinquency rates for the recent stock of debt are moderately lower than for the stock of debt before the 2007-09 financial crisis, given the same set of shocks. This decline in expected delinquency rates under stress reflects an improvement in debt-to-income ratios and an increase in the share of debt held by borrowers with relatively high credit scores. Under an alternative scenario where the size of house price shocks depends on housing valuations, we forecast a much lower delinquency rate than occurred during the crisis, reflecting more reasonable housing valuations than pre-crisis. Stress tests using other scenarios for the path of house prices and unemployment also support the conclusion that household debt curren tly poses a lower risk to financial stability than before the financial crisis.

Accessible materials (.zip)

Keywords: Delinquency, Household debt, Loan default, Stress testing


FEDS 2019-007
Trade Exposure and the Evolution of Inflation Dynamics (PDF)

Simon Gilchrist and Egon Zakrajsek

Abstract: The diminished sensitivity of inflation to changes in resource utilization that has been observed in many advanced economies over the past several decades is frequently linked to the increase in global economic integration. In this paper, we examine this "globalization" hypothesis using both aggregate U.S. data on measures of inflation and economic slack and a rich panel data set containing producer prices, wages, output, and employment at a narrowly defined industry level. Our results indicate that the rising exposure of the U.S. economy to international trade can indeed help explain a significant fraction of the overall decline in responsiveness of aggregate inflation to fluctuations in economic activity. This flattening of the U.S. Phillips curve is supported strongly by our cross-sectional evidence, which shows that increased trade exposure significantly attenuates the response of inflation to fluctuations in output across industries. Our estimates indicate that the inflation-output tradeoff is about three times larger for low-trade intensity industries compared with their high-trade intensity counterparts.

Accessible materials (.zip)

Keywords: Inflation, Phillips curve, Trade share, globalization


FEDS 2019-006
Robust Inference in First-Price Auctions: Experimental Findings as Identifying Restrictions (PDF)

Abstract: In laboratory experiments bidding in first-price auctions is more aggressive than predicted by the risk-neutral Bayesian Nash Equilibrium (RNBNE) - a finding known as the overbidding puzzle. Several models have been proposed to explain the overbidding puzzle, but no canonical alternative to RNBNE has emerged, and RNBNE remains the basis of the structural auction literature. Instead of estimating a particular model of overbidding, we use the overbidding restriction itself for identification, which allows us to bound the valuation distribution, the seller's payoff function, and the optimal reserve price. These bounds are consistent with RNBNE and all models of overbidding and remain valid if different bidders employ different bidding strategies. We propose simple estimators and evaluate the validity of the bounds numerically and in experimental data.

Accessible materials (.zip)

Keywords: Experimental Findings, First-Price Auction, Partial Identification, Robust Inference, Structural Estimation


FEDS 2019-005
Banks as Regulated Traders (PDF)

Abstract: This paper uses detailed high-frequency regulatory data to evaluate whether trading increases or decreases systemic risk in the U.S. banking sector. We estimate the sensitivity of weekly bank trading net profits to a variety of aggregate risk factors, which include equities, fixed-income, derivatives, foreign exchange, and commodities. We find that U.S. banks had large trading exposures to equity market risk before the introduction of the Volcker Rule in 2014 and that they curtailed these exposures afterwards. Pre-rule equity risk exposures were large across the board of the main asset classes, including fixed-income. There is also evidence of smaller exposures to credit and currency risk. We corroborate the main finding on equity risk with a quasi-natural experiment that exploits the phased-in introduction of reporting requirements to refine identification, and an optimal changepoint regression that estimates time-varying exposures to address rebalancing. A stress-test calibration indicates that the Volcker Rule was an effective financial-stability regulation, as even a 5% drop in stock market returns would have led to material aggregate trading losses for banks in the pre-Volcker period, as large as about 3% (1.5%) of sector-wide market risk weighted assets (tier 1 capital).

Accessible materials (.zip)

Keywords: bank trading, regulation, risk exposures, systemic risk


FEDS 2019-004
Karl Brunner and U.K. Monetary Debate (PDF)

Abstract: Although he was based in the United States, leading monetarist Karl Brunner participated in debates in the United Kingdom on monetary analysis and policy from the 1960s to the 1980s. During the 1960s, his participation in the debates was limited to research papers, but in the 1970s, as monetarism attracted national attention, Brunner made contributions to U.K. media discussions. In the pre-1979 period, he was highly critical of the U.K. authorities’ nonmonetary approach to the analysis and control of inflation--an approach supported by leading U.K. Keynesians. In the early 1980s, Brunner had direct interaction with Prime Minister Margaret Thatcher on issues relating to monetary control and monetary strategy. He was unsuccessful in persuading her to use the monetary base--instead of a short-term interest rate--as the instrument for implementing monetary policy. However, following his interventions, the U.K. authorities during the 1980s assigned weight to the monetary base as an indicator and target of monetary policy. Brunner’s imprint on U.K. monetary policy has also been felt in the twenty-first century. Brunner’s analysis, with Allan Meltzer, of the monetary transmission mechanism helped provide the basis for the policy of quantitative easing followed by the Bank of England.
Accessible materials (.zip)

Keywords: Karl Brunner, U.K. monetary policy, monetarism, monetary base control, transmission mechanism


FEDS 2019-003
Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve's Current Policy Toolkit (PDF)

Abstract: We simulate the FRB/US model and a number of statistical models to quantify some of the risks stemming from the effective lower bound (ELB) on the federal funds rate and to assess the efficacy of adjustments to the federal funds rate target, balance sheet policies, and forward guidance to provide monetary policy accommodation in the event of a recession. Over the next decade, our simulations imply a roughly 20 to 50 percent probability that the federal funds rate will be constrained by the ELB at some point. We also find that forward guidance and balance sheet polices of the kinds used in response to the Global Financial Crisis are modestly effective in speeding up the labor market recovery and return of inflation to 2 percent following an economic slump. However, these policies have only small effects in limiting the initial rise in the unemployment rate during a recession because of transmission lags. As with any model-based analysis, we also discuss a number of c aveats regarding our results.
Accessible materials (.zip)

Keywords: Effective lower bound, Federal Reserve balance sheets, Forward guidance, Large-scale asset purchases, Monetary policy


FEDS 2019-002
Evaluating the conditionality of judgmental forecasts (PDF)

Abstract: We propose a framework to evaluate the conditionality of forecasts. The crux of our framework is the observation that a forecast is conditional if revisions to the conditioning factor are faithfully incorporated into the remainder of the forecast. We consider whether the Greenbook, Blue Chip, and the Survey of Professional Forecasters exhibit systematic biases in the manner in which they incorporate interest rate projections into the forecasts of other macroeconomic variables. We do not find strong evidence of systematic biases in the three economic forecasts that we consider, as the interest rate projections in these forecasts appear to be efficiently incorporated into forecasts of other economic variables.
Accessible materials (.zip)

Keywords: Conditional forecast, Forecast efficiency, Macroeconomic forecasting


FEDS 2019-001
The Monetary Base in Allan Meltzer's Analytical Framework (PDF)

Abstract: This analysis of Allan Meltzer’s analytical framework focuses on the role that Meltzer assigned to the monetary base. For many years, Meltzer suggested that central banks should use the monetary base as their policy instrument, in place of a short-term nominal interest rate. However, he recognized that in practice central banks did not follow this prescription. He believed that the monetary base could play an important role even when an interest rate was used as the instrument. Meltzer’s reasoning was twofold: (i) The monetary base might shed light on the behavior of important asset prices that mattered for aggregate demand. (ii) The base might serve as a useful indicator of the likely future course of the money stock. In later years, while still emphasizing the valuable indicator properties of the monetary base, Meltzer accepted that interest-rate-based rules could deliver monetary control and economic stabilization. For the situation in which the short-term nom inal interest rate was at its lower bound, Meltzer continued to stress quantities as monetary policy instruments. He felt that, at the lower bound, the central bank remained able, through quantitative easing, to boost asset prices, the money stock, and the economy. Such stimulative actions implied increases in the monetary base; however, Meltzer did acknowledge that the manner in which the base was increased (that is, what asset purchases generated the increase) figured importantly in securing the stimulus.
Accessible materials (.zip)

Keywords: monetarism, monetary base, money supply, transmission mechanism


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Last Update: November 08, 2019