Showing papers by "Federal Reserve Bank of Dallas published in 2010"

Demand Spillovers and the Collapse of Trade in the Global Recession

Abstract: This paper uses a global input-output framework to quantify U.S. and European Union (EU) demand spillovers and the elasticity of world trade to GDP during the global recession of 2008–09. Cross-border intermediate goods linkages have implications for the transmission of shocks and the relationship between demand, trade, and production across countries. This paper finds that 20–30 percent of the decline in U.S. and EU final demand was borne by foreign countries, with the North American Free Trade Agreement (NAFTA) and emerging Europe hit hardest. Allowing final demand to change in all countries simultaneously, the framework presented here delivers an elasticity of world trade to GDP of 2.8. Thus, demand forces alone can account for roughly 70 percent of the trade collapse. Large changes in demand for durables play an important role in driving these results.

Limited enforcement, financial intermediation, and economic development: a quantitative assessment*

Abstract: We present a model of economic development where the importance of financial differences caused by limited enforcement can be measured. Economies where enforcement is poor direct less capital to the production sector and employ less efficient technologies. Calibrated simulations reveal that the resulting effect on output is large. Furthermore, the model correctly predicts that the average scale of production should rise with the quality of enforcement. Finally, we find that the importance of limited enforcement rises with the importance of capital in production.

Methodological advances in the assessment of equilibrium exchange rates1

Abstract: This paper reviews three different concepts of equilibrium exchange rates that are widely used in policy analysis and constitute the backbone of the IMF CGER assessment: the Macroeconomic Balance, the External Sustainability and the reduced form approaches. We raise a number of econometric issues that were previously neglected, proposing some methodological advances to address them. The first issue relates to the presence of model uncertainty in deriving benchmarks for the current account, introducing Bayesian averaging techniques as a solution. The second issue reveals that, if one considers all the sets of plausible identification schemes, the uncertainty surrounding export and import exchange rate elasticities is large even at longer horizons. The third issue discusses the uncertainty associated to the estimation of a reduced form relationship for the real exchange rate, concluding that inference can be improved by panel estimation. The fourth and final issue addresses the presence of strong and weak cross section dependence in panel estimation, suggesting which panel estimators one could use in this case. Overall, the analysis puts forward a number of innovative solutions in dealing with the large uncertainties surrounding equilibrium exchange rate estimates.

Credit, Housing Collateral and Consumption: Evidence from the UK, Japan and the US

Abstract: The consumption behaviour of UK, US and Japanese households is examined and compared using a modern Ando-Modigliani style consumption function The models incorporate income growth expectations, income uncertainty, housing collateral and other credit effects These models therefore capture important parts of the financial accelerator The evidence is that credit availability for UK and US but not Japanese households has undergone large shifts since 1980 The average consumption-to-income ratio shifted up in the UK and US as mortgage down-payment constraints eased and as the collateral role of housing wealth was enhanced by financial innovations, such as home equity loans The estimated housing collateral effect is roughly similar in the US and UK, while land prices in Japan still have a negative effect on consumer spending Together with evidence for negative real interest rate effects in the UK and US and positive ones in Japan, this suggests important differences in the transmission of monetary and credit shocks between Japan and the US, UK and other credit-liberalized economies

VAR Estimation and Forecasting When Data Are Subject to Revision

Abstract: We show that Howrey’s method for producing economic forecasts when data are subject to revision is easily generalized to handle the case where data are produced by a sophisticated statistical agency. The proposed approach assumes that government estimates are efficient with a finite lag. It takes no stand on whether earlier revisions are the result of “news” or of reductions in “noise.” We present asymptotic performance results in the scalar case and illustrate the technique using several simple models of economic activity. In each case, it outperforms both conventional VAR analysis and the original Howrey method. It produces GDP forecasts that are competitive with those of professional forecasters. Special cases and extensions of the analysis are discussed in a series of appendices that are available online.

Housing markets and the financial crisis of 2007-2009: lessons for the future

Abstract: An unsustainable weakening of credit standards induced a US mortgage and housing bubble whose consumption impact was amplified by innovations altering the collateral role of housing. In countries with more stable credit standards, any overshooting of construction and house prices owed more to traditional housing supply and demand factors. Housing collateral effects on consumption varied, depending on the liquidity of housing wealth. Lessons include recognizing the importance of financial innovation, regulation, housing policies, and global financial imbalances for fueling credit, construction, house price and consumption cycles that vary across countries.

Mexican Immigrant Employment Outcomes over the Business Cycle

Abstract: The United States is beginning to emerge from the deepest downturn the country has experienced since the Great Depression. As of October 2009, the number of unemployed persons had risen by 8.2 million since the “Great Recession” began in December 2007. All demographic groups have experienced job losses, but some groups have been more adversely affected than others. Repeating the pattern of most previous downturns, the recession’s impact has been worst for low education and minority workers. One group that has been particularly hard hit is Mexican immigrants. Data from the Current Population Survey indicate that between the first quarter of 2007 and the second quarter of 2009, the unemployment rate among Mexican immigrants rose from 4.2 percent to 11.3 percent, and their employment rate dropped by 5 percentage points. In contrast, during that period the unemployment rate among non-Hispanic white natives rose from 3.7 percent to 7.8 percent, and their employment rate fell by 2.6 percentage points. Mexican immigrants tend to be particularly vulnerable to economic downturns because of their relatively low skill levels. They make up one-fourth of all workers who do not have a high school diploma or equivalent and over one-half of workers who have completed at most eighth grade. When the economy slows, employers look to shed their least productive employees first. Employers tend to invest less in training low skilled workers and therefore have less

Identifying the Global Transmission of the 2007-09 Financial Crisis in a GVAR Model

Abstract: The paper analyses and compares the role that the tightening in liquidity conditions and the collapse in risk appetite played for the global transmission of the financial crisis. Dealing with identification and the large dimensionality of the empirical exercise with a Global VAR approach, the findings highlight the diversity of the transmission process. While liquidity shocks have had a more severe impact on advanced economies, it was mainly the decline in risk appetite that affected emerging market economies. The tightening of financial conditions was a key transmission channel for advanced economies, whereas for emerging markets it was mainly the real side of the economy that suffered. Moreover, there are some striking differences also within types of economies, with Europe being more adversely affected by the fall in risk appetite than other advanced economies.

The Role of Inventories and Speculative Trading in the Global Market for Crude Oil

Abstract: We develop a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to the flow demand and flow supply. The forward-looking element of the real price of oil is identified with the help of data on oil inventories. The model estimates rule out explanations of the 2003-08 oil price surge based on unexpectedly diminishing oil supplies and based on speculative trading. Instead, we find that this surge was caused by fluctuations in the flow demand for oil driven by the global business cycle. There is evidence, however, that speculative demand shifts played an important role during earlier oil price shock episodes including 1979, 1986, and 1990. Recently, it has been suggested that it is possible for speculative trading to occur even without any change in oil inventories, if the short-run price elasticity of oil demand is zero. Our structural model allows us to obtain an estimate of this elasticity based on shifts of the supply curve along the demand curve. We show that, even after accounting for the role of inventories in smoothing oil consumption, our estimate of the price elasticity of oil demand is not close to zero and much higher than traditional estimates from dynamic models that do not account for price endogeneity. This eliminates speculation as an explanation of the 2003-08 oil price surge.

The Global Slack Hypothesis

Abstract: We illustrate the analytical content of the global slack hypothesis in the context of a variant of the widely used New Open-Economy Macro model of Clarida, Gali, and Gertler (2002) under the assumptions of both producer currency pricing and local currency pricing. The model predicts that the Phillips curve for domestic CPI inflation will be flatter under most plausible parameterizations, the more important international trade is to the domestic economy. The model also predicts that foreign output gaps will matter for inflation dynamics, along with the domestic output gap. We also show that the terms of trade gap can capture foreign influences on domestic CPI inflation in an open economy as well. When the Phillips curve includes the terms of trade gap rather than the foreign output gap, the response of domestic inflation to the domestic output gap is the same as in the closed-economy case ceteris paribus. We also note the conceptual and statistical difficulties of measuring the output gaps and suggest that measurement error bias can be a serious concern in the estimation of the open-economy Phillips curve relationship with reduced-form regressions when global slack is not actually observed.

Oil Price Shocks and U.S. Economic Activity: An International Perspective

Abstract: Oil price shocks are thought to have played a prominent role in U.S. economic activity. In this paper, we employ Bayesian methods with a dynamic stochastic general equilibrium model of world economic activity to identify the various sources of oil price shocks and economic fluctuation and to assess their effects on U.S. economic activity. We find that changes in oil prices are best understood as endogenous. Oil price shocks in the 1970s and early 1980s and the 2000s reflect differing mixes of shifts in oil supply and demand, and differing sources of oil price shocks have differing effects on economic activity. We also find that U.S. output fluctuations owe mostly to domestic shocks, with productivity shocks contributing to weakness in the 1970s and 1980s and strength in the 2000s.

Fiscal Policy in an Expectations Driven Liquidity Trap

Abstract: We examine the impact of fiscal policy interventions in an environment where the short term nominal interest rate is at the zero bound. In the basic New Keynesian model in which the monetary authority operates a Taylor rule, globally multiple equilibria arise, some of which display all the features of a liquidity trap. A loss in confidence can set the economy on a deflationary path that eventually prevents the monetary authority from adjusting the interest rate and can lead to potentially very large output drops. Contrary to a line of recent papers, we find that demand stimulating policies become less effective in a liquidity trap than in normal circumstances. The key reason is that demand stimulus leads agents to believe that things are even worse than they thought. In contrast, supply side policies, such as cuts in labor income taxes, lead to relative optimism and become more powerful.

An analysis of the neighborhood impacts of a mortgage assistance program: A spatial hedonic model

Abstract: Down payment or closing cost assistance is an effective program in addressing the wealth constraints of low-and moderate-income homebuyers. However, the spillover effect of such programs on the neighborhood is unknown. This paper estimates the impact of the City of Dallas Mortgage Assistance Program (MAP) on nearby home values using a hedonic model of home sales from 1990 to 2006. We define neighborhoods of 1,000 feet around each sale and estimate the average differences in sales prices between neighborhoods with various numbers of MAP properties before and after their appearance. We find that MAP properties tend to locate in neighborhoods with lower property values; however, unless a concentration of MAP properties forms, the infusion of MAP properties has little detrimental impact on neighboring property values. Moreover, low concentration of MAP properties has a modest positive impact on surrounding property values. © 2010 by the Association for Public Policy Analysis and Management.

Reassessing FHA Risk

Abstract: Federal Housing Administration (FHA) insurance has doubled over the past two years and is projected to redouble to $1.5 trillion over the next five. Despite clear signs of strain in the FHA's Mutual Mortgage Insurance Fund, a recent actuarial review indicates that the FHA will not need any form of government support. We identify four risk factors that make such a funding request more likely; the review underestimates how many FHA borrowers are underwater and in economic distress; it uses measures of house values that lower loss estimates; it does not incorporate early-warning signals of future losses that are available from mortgage delinquency; and it ignores potential risks associated with recent down-payment assistant programs despite higher losses on previous programs of this type. We propose measures that could be taken to improve the predictive accuracy of FHA risk assessment.

The Quantitative Role of Capital Goods Imports in US Growth

Abstract: Over the last 40 years, an increasing share of U.S. aggregate E&S investment expenditure has been allocated to capital-goods imports. While capital-goods imports were only 3.5 percent of E&S investment in 1967, by 2008 their share had risen tenfold to 36 percent. The goal of this paper is to measure the contribution of capital-goods imports to growth in U.S. output per hour using a simple growth accounting exercise. We find that capital-goods imports have contributed 20 to 30 percent to growth in U.S. output per hour between 1967 and 2008. More importantly, we find that capital-goods imports have been an increasing source of growth for the US economy: the average contribution of capital-goods imports to growth in U.S .output per hour has increased noticeably since 1967.(This abstract was borrowed from another version of this item.)

Immigrants' Employment Outcomes Over the Business Cycle

Abstract: Immigrants have figured prominently in U.S. economic growth for decades, but the recent recession hit them hard. Immigrantsﾒ labor market outcomes began deteriorating even before the recession was officially underway, largely as a result of the housing bust. An analysis of employment and unemployment rates over the past 15 years shows that immigrants' labor market outcomes are more cyclical than those of natives. The greater cyclicality of immigrants' employment and unemployment is concentrated among less-educated immigrants, but college-educated immigrants nonetheless have more cyclically-sensitive employment outcomes than college-educated natives.

The minimum wage and Latino workers

Abstract: Latinos comprise a large and growing share of the low-skilled labor force in the U.S. and may be disproportionately affected by minimum wage laws as a result. We compare the effects of minimum wage laws on employment and earnings among Hispanic immigrants and natives compared with non-Hispanic whites and blacks. We focus on adults who have not finished high school and on teenagers, groups likely to earn low wages. Conventional economic theory predicts that higher minimum wages lead to higher hourly earnings among people who are employed but lower employment rates. Data from the Current Population Survey during the period 1994-2007 indicate that there is a significant disemployment effect of higher minimum wages on Latino teenagers, although it is smaller for foreign- than native-born Latinos. Adult Latino immigrants' earnings are less affected by minimum wage laws than other low-education natives, and their employment rates appear to increase when the minimum wage rises. We investigate whether skill levels and undocumented status help explain these findings.

Optimal Target Criteria for Stabilization Policy

Abstract: This paper considers a general class of nonlinear rational-expectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is: (i) consistent with the model's structural equations, (ii) strong enough to imply a unique equilibrium, and (iii) optimal, in the sense that a commitment to adjust the policy instrument at all dates so as to satisfy the target criterion maximizes the objective function. The proposed optimal target criterion is a linear equation that must be satisfied by the projected paths of certain economically relevant "target variables." It takes the same form at all times and generally involves only a small number of target variables, regardless of the size and complexity of the model. While the projected path of the economy requires information about the current state, the target criterion itself can be stated without reference to a complete description of the state of the world. We illustrate the application of the method to a nonlinear DSGE model with staggered price-setting, in which the objective of policy is to maximize household expected utility.

Optimal Interest-Rate Rules in a Forward-Looking Model, and Inflation Stabilization Versus Price-Level Stabilization

Abstract: This paper characterizes the properties of various interest-rate rules in a basic forward-looking model. We compare simple Taylor rules and rules that respond to price-level fluctuations (called Wicksellian rules). We argue that by introducing an appropriate amount of history dependence in policy, Wicksellian rules perform better than optimal Taylor rules in terms of welfare, robustness to alternative shock processes, and are less prone to equilibrium indeterminacy. A simple Wicksellian rule augmented with a high degree of interest rate inertia resembles a robustly optimal rule, i.e., a monetary policy rule that implements the optimal plan and that is also completely robust to the specification of exogenous shock processes.

The Information Revolution and Small Business Lending: The Missing Evidence

Abstract: This paper provides empirical confirmation for Petersen and Rajan's (2002) widely accepted conjecture that information technology was the primary driver of the observed increase in small business borrower-lender distances in the United States in recent years. Using a different data source for small business loans, we show that annual increases in borrower-lender distances were slow and steady prior to 1993 (the end point in Petersen and Rajan's data) but accelerated rapidly after that. Importantly, we are able to assign at least half of this acceleration to the adoption of credit scoring technologies by the lending banks. Our tests also reveal strong statistical associations between lending distances and borrower characteristics, lender characteristics, market conditions, regulatory constraints, moral hazard incentives, and principal-agent incentives.

Econometric Analysis of High Dimensional VARs Featuring a Dominant Unit

Abstract: This paper extends the analysis of infinite dimensional vector autoregressive models (IVAR) proposed in Chudik and Pesaran (2010) to the case where one of the variables or the cross section units in the IVAR model is dominant or pervasive. This extension is not straightforward and involves several technical difficulties. The dominant unit influences the rest of the variables in the IVAR model both directly and indirectly, and its effects do not vanish even as the dimension of the model (N) tends to infinity. The dominant unit acts as a dynamic factor in the regressions of the non-dominant units and yields an infinite order distributed lag relationship between the two types of units. Despite this it is shown that the effects of the dominant unit as well as those of the neighborhood units can be consistently estimated by running augmented least squares regressions that include distributed lag functions of the dominant unit. The asymptotic distribution of the estimators is derived and their small sample properties investigated by means of Monte Carlo experiments.

Technology-Hours Redux: Tax Changes and the Measurement of Technology Shocks

Abstract: A number of empirical studies find that permanent technological improvements give rise to a temporary drop in hours worked. This finding seriously questions the technology-driven business cycle hypothesis. In this paper we argue that it is important to control for permanent changes in taxes, which invalidate the standard long run identifying assumptions for technology shocks and induce low frequency fluctuations in hours worked. Using the narrative data of Romer and Romer (2010), we find that tax shocks have significant long run effects on aggregate hours, output and labor productivity. We also find that, after controlling for tax shocks, permanent shocks to labor productivity generate short run increases in hours worked and are an important source of fluctuations in US output.

Is tighter fiscal policy expansionary under fiscal dominance?: hypercrowding out in latin america

Abstract: That the current real value of any government's net liabilities always equals the present discounted value of future primary surpluses is a mathematical condition (Appendix) for solvency. Sometimes, these equivalences find their expressions in stresses not much to a government's liking. We will define governments in accordance with how they handle their liabilities. Governments that rely on inflation or outright default to keep debt-to-gross domestic product (GDP) ratios on a sustainable trajectory are said to operate in a regime of fiscal dominance. Since World War II, the governments of some of Latin America's largest economies have pursued policies that have led to fiscal dominance. This has created credibility problems when Latin American governments announced adjustment policies. Fiscal dominance also explains much of the large risk premia that Latin American governments have to pay when borrowing at home or abroad. Even when default is not in the plans of a government, the fact that more inflationary countries are more likely to default creates tough going for them when they try to resort to financial markets. Fiscally dominated countries also have less scope to pursue inflation targeting, as their policy options are limited by the fiscal position of the government. Successfully implementing inflation targeting depends upon a persistently strong fiscal adjustment by the government. But the effect of changes in fiscal policy by fiscally dominated governments also run contrary to accepted wisdom for governments with high credibility. Monetarily dominant governments, in contrast, maintain fiscal balance by using combinations of spending cuts and tax increases when fiscal pressures mount. In regimes with such traditions, markets forgive the occasional policy departure. Most analysis of the effects of active fiscal policies for such countries concludes that countercyclical deficit strategies can trigger an economic expansion, even if it is partial and temporary. Regardless of which domination category a country is in, loosening its fiscal policy leads to some degree of crowding out. That is, a government's deficit financing requirements crowd out the borrowing efforts of the private sector. In monetarily dominated regimes, crowding out will be only partial. As a result, conventionally expansionary (contractionary) fiscal policy may cause GDP to expand (contract), as is typical of industrial countries. In the worst case for monetarily dominant regimes, a rise in interest rates caused by larger fiscal deficits completely crowds out private investment and fiscal policy has no effect on GDP. But in countries with histories of inflation and default, attended by expectations that the future will bring more or worse, crowding out can be even stronger. A change in fiscal policy may have such extreme effects on interest rates that they swamp any positive impulses that a direct change in policy may have. In this extreme case, an increase in fiscal deficits becomes contractionary rather than expansionary. We refer to this extreme phenomenon as hypercrowding out. Viewed from the opposite direction, hypercrowding out in fiscally dominant countries means that fiscal tightening becomes expansionary. Raising the primary fiscal surplus lowers real interest rates so much that GDP expands despite the direct contraction of aggregate demand from fiscal tightening. We test for the presence of hypercrowding out in Brazil, Chile, Colombia, Costa Rica, Ecuador, Mexico, Peru, Uruguay, and Venezuela starting in the middle-1990s and ending in the first half of the present decade. A substantial literature focuses on Brazil as having exhibited signs of fiscal dominance, which can be associated with hypercrowding out. Our results suggest that while Brazil has experienced hypercrowding out, so have several other Latin American countries. We also examine ties between indicators of fiscal dominance and the duration of sovereign default for each of our nine countries. …