Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macro-economic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross-correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the "Great Moderation"?

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Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach

We estimate a dynamic stochastic general equilibrium (DSGE) model for the US economy. The model incorporates many types of real and nominal frictions: sticky nominal price and wage setting, habit formation in consumption, investment adjustment costs, variable capital utilisation and fixed costs in production. It also contains many types of shocks including productivity, labour supply, investment, preference, cost-push and monetary policy shocks. Using Bayesian estimation techniques, the relative importance of the various frictions and shocks in explaining the US business cycle are empirically investigated. We also show that this model is able to outperform standard VAR and BVAR models in out-of-sample prediction.

/pdf/shocks-and-frictions-in-us-business-cycles-a-bayesian-dsge-2gcs6kvruw.pdf

Shocks and frictions in US business cycles: A Bayesian DSGE approach

This essay discusses the effect of technical change on wage inequality. I argue that the behavior of wages and returns to schooling indicates that technical change has been skill-biased during the past sixty years. Furthermore, the recent increase in inequality is most likely due to an acceleration in skill bias. In contrast to twentieth century developments, most technical change during the nineteenth century appears to be skill-replacing. I suggest that this is because the increased supply of unskilled workers in the English cities made the introduction of these technologies profitable. On the other hand, the twentieth-century has been characterized by skill-biased technical change because the rapid increase in the supply of skilled workers has induced the development of skill-complementary technologies. The recent acceleration in skill bias is in turn likely to have been a response to the acceleration in the supply of skills during the past several decades.

Technical Change, Inequality, and the Labor Market

There is a large body of literature that concludes that—when confronted with increased competition—banks rationally choose more risky portfolios. We argue that this literature has had a significant influence on regulators and central bankers. We review the empirical literature and conclude that the evidence is best described as “mixed.” We then show that existing theoretical analyses of this topic are fragile, since there exist fundamental risk-incentive mechanisms that operate in exactly the opposite direction, causing banks to become more risky as their markets become more concentrated. These mechanisms should be essential ingredients of models of bank competition.

The Theory of Bank Risk Taking and Competition Revisited

Using bank-level data, the authors apply the Panzar and Rosse (1987) methodology to estimate the extent to which changes in input prices are reflected in revenues earned by specific banks in 50 countries' banking systems. They then relate this competitiveness measure to indicators of countries' banking system structures and regulatory regimes. The authors find systems with greater foreign bank entry and fewer entry and activity restrictions to be more competitive. They find no evidence that the competitiveness measure negatively relates to banking system concentration. Their findings confirm that contestability determines effective competition, especially by allowing (foreign) bank entry and reducing activity restrictions on banks.

/pdf/what-drives-bank-competition-some-international-evidence-2xobydieqo.pdf

What drives bank competition? some international evidence

This paper examines how personal bankruptcy and bankruptcy exemptions affect the supply and demand for credit. While generous state-level bankruptcy exemptions are probably viewed by most policy-makers as benefiting less-well-off borrowers, our results using data from the 1983 Survey of Consumer Finances suggest that they increase the amount of credit held by high-asset households and reduce the availability and amount of credit to low-asset households, conditioning on observable characteristics. Thus, bankruptcy exemptions redistribute credit toward borrowers with high assets. Interest rates on automobile loans for low-asset households also appear to be higher in high exemption states.

/pdf/personal-bankruptcy-and-credit-supply-and-demand-1m4iqftopn.pdf

Personal Bankruptcy and Credit Supply and Demand

The paper shows that mispriced deposit insurance and capital regulation were of second-order importance in determining the capital structure of large U.S. and European banks during 1991 to 2004. Instead, standard cross-sectional determinants of non-financial firms' leverage carry over to banks, except for banks whose capital ratio is close to the regulatory minimum. Consistent with a reduced role of deposit insurance, we document a shift in banks' liability structure away from deposits towards non-deposit liabilities. We find that unobserved time-invariant bank fixed-effects are ultimately the most important determinant of banks' capital structures and that banks' leverage converges to bank specific, time-invariant targets. Copyright 2010, Oxford University Press.

/pdf/the-determinants-of-bank-capital-structure-5gbcwpclr9.pdf

The Determinants of Bank Capital Structure

This paper documents that standard cross-sectional determinants of firm leverage also apply to the capital structure of large banks in the United States and Europe. We find a remarkable consistency in sign, significance and economic magnitude. Like non-financial firms, banks appear to have stable capital structures at levels that are specific to each individual bank. The results suggest that capital requirements may only be of second-order importance for banks' capital structures and confirm the robustness of current corporate finance findings in a holdout sample of banks.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1478335_code485639.pdf?abstractid=1478335

We analyse the ability to the distance-to-default and bond spreads to signal bank fragility. We show that both indicators are complete and unbiased and that spreads are non-linear in the probability of bank default. We empirically test these properties in a sample of EU banks. We find leading properties for both indicators. The distance-to-default exhibits lead times of 6 to 18 months. Spreads have signal value close to default only, in line with the theory. We also find that implicit safety nets weaken the predictive power of spreads. Further, the results suggest complementarity between both indicators, reducing type I errors. We also examine the interaction of the indicators with other bank information.

/pdf/equity-and-bond-market-signals-as-leading-indicators-of-bank-3qohy938xc.pdf

Equity and Bond Market Signals as Leading Indicators of Bank Fragility

The recent wave of mergers in the euro area raises the question, whether the increase in concentration has at least in part offset the increase in competition in European banking through deregulation. We test this question by estimating a simple Cournot model of bank pricing. We construct country and product specific measures of bank concentration and find that for loans and demand deposits, increasing concentration may have resulted in less competitive pricing by banks, whereas for savings and time deposits, the model is rejected, suggesting increases in contestability and/or efficiency in these markets. These findings are robust across a wide variety of econometric specifications. Finally, the paper discusses some implications for tests of the effect of concentration on monetary policy transmission.

Reint Gropp

Papers

Personal Bankruptcy and Credit Supply and Demand

The Determinants of Bank Capital Structure

The Determinants of Bank Capital Structure

Equity and Bond Market Signals as Leading Indicators of Bank Fragility

Bank Concentration and Retail Interest Rates