Showing papers by "Federal Reserve System published in 2010"

Political Uncertainty and Corporate Investment Cycles

Abstract: We document cycles in corporate investment corresponding with the timing of national elections around the world. During election years, firms reduce investment expenditures by an average of 4.8% relative to non-election years, controlling for growth opportunities and economic conditions. The magnitude of the investment cycles varies with different country and election characteristics. We investigate several potential explanations and find evidence supporting the hypothesis that political uncertainty leads firms to reduce investment expenditures until the electoral uncertainty is resolved. These findings suggest that political uncertainty is an important channel through which the political process affects real economic outcomes.

Global banks and international shock transmission: evidence from the crisis

Abstract: Global banks played a significant role in transmitting the 2007-09 financial crisis to emerging-market economies. We examine adverse liquidity shocks on main developed-country banking systems and their relationships to emerging markets across Europe, Asia, and Latin America, isolating loan supply from loan demand effects. Loan supply in emerging markets across Europe, Asia, and Latin America was affected significantly through three separate channels: 1) a contraction in direct, cross-border lending by foreign banks; 2) a contraction in local lending by foreign banks' affiliates in emerging markets; and 3) a contraction in loan supply by domestic banks, resulting from the funding shock to their balance sheets induced by the decline in interbank, cross-border lending. Policy interventions, such as the Vienna Initiative introduced in Europe, influenced the lending-channel effects on emerging markets of shocks to head-office balance sheets.

The Labor Market in the Great Recession

Abstract: From the perspective of a wide range of labor market outcomes, the recession that began in 2007 represents the deepest downturn in the postwar era. Early on, the nature of labor market adjustment displayed a notable resemblance to that observed in past severe downturns. During the latter half of 2009, however, the path of adjustment exhibited important departures from that seen during and after prior deep recessions. Recent data point to two warning signs going forward. First, the record rise in long-term unemployment may yield a persistent residue of long-term unemployed workers with weak search effectiveness. Second, conventional estimates suggest that the extension of Emergency Unemployment Compensation may have led to a modest increase in unemployment. Despite these forces, we conclude that the problems facing the U.S. labor market are unlikely to be as severe as the European unemployment problem of the 1980s.

Interbank Tiering and Money Center Banks

Abstract: This paper provides evidence that interbank markets are tiered rather than flat, in the sense that most banks do not lend to each other directly but through money center banks acting as intermediaries. We capture the concept of tiering by developing a core-periphery model, and devise a procedure for fitting the model to real-world networks. Using Bundesbank data on bilateral interbank exposures among 1800 banks, we find strong evidence of tiering in the German banking system. Moreover, bankspecific features, such as balance sheet size, predict how banks position themselves in the interbank market. This link provides a promising avenue for understanding the formation of financial networks.

Large-Scale Asset Purchases by the Federal Reserve: Did They Work?

Abstract: Since December 2008, the Federal Reserve’s traditional policy instrument, the target federal funds rate, has been effectively at its lower bound of zero. In order to further ease the stance of monetary policy as the economic outlook deteriorated, the Federal Reserve purchased substantial quantities of assets with medium and long maturities. In this paper, we explain how these purchases were implemented and discuss the mechanisms through which they can affect the economy. We present evidence that the purchases led to economically meaningful and long-lasting reductions in longer-term interest rates on a range of securities, including securities that were not included in the purchase programs. These reductions in interest rates primarily reflect lower risk premiums, including term premiums, rather than lower expectations of future short-term interest rates.

Effects of Fiscal Stimulus in Structural Models

Abstract: The paper assesses, using seven structural models used heavily by policymaking institutions, the effectiveness of temporary fiscal stimulus. Models can, more easily than empirical studies, account for differences between fiscal instruments, for differences between structural characteristics of the economy, and for monetary-fiscal policy interactions. Findings are: (i) There is substantial agreement across models on the sizes of fiscal multipliers. (ii) The sizes of spending and targeted transfers multipliers are large. (iii) Fiscal policy is most effective if it has some persistence and if monetary policy accommodates it. (iv) The perception of permanent fiscal stimulus leads to significantly lower initial multipliers.

The Macroeconomic Implications of Rising Wage Inequality in the United States

Abstract: In recent decades, American workers have faced a rising college premium, a narrowing gender gap, and increasing wage volatility. This paper explores the quantitative and welfare implications of these changes. The framework is an incomplete-markets life cycle model in which individuals choose education, intrafamily time allocation, and savings. Given the observed history of the U.S. wage structure, the model replicates key trends in cross-sectional inequality in hours worked, earnings, and consumption. Recent cohorts enjoy welfare gains, on average, as higher relative wages for college graduates and for women translate into higher educational attainment and a more even division of labor within the household.

How Has the Monetary Transmission Mechanism Evolved Over Time

Abstract: We discuss the evolution in macroeconomic thought on the monetary policy transmission mechanism and present related empirical evidence. The core channels of policy transmission - the neoclassical links between short-term policy interest rates, other asset prices such as long-term interest rates, equity prices, and the exchange rate, and the consequent effects on household and business demand - have remained steady from early policy-oriented models (like the Penn-MIT-SSRC MPS model) to modern dynamic-stochastic-general-equilibrium (DSGE) models. In contrast, non-neoclassical channels, such as credit-based channels, have remained outside the core models. In conjunction with this evolution in theory and modeling, there have been notable changes in policy behavior (with policy more focused on price stability) and in the reduced form correlations of policy interest rates with activity in the United States. Regulatory effects on credit provision have also changed significantly. As a result, we review the empirical evidence on the changes in the effect of monetary policy actions on real activity and inflation and present new evidence, using both a relatively unrestricted factor-augmented vector autoregression (FAVAR) and a DSGE model. Both approaches yield similar results: Monetary policy innovations have a more muted effect on real activity and inflation in recent decades as compared to the effects before 1980. Our analysis suggests that these shifts are accounted for by changes in policy behavior and the effect of these changes on expectations, leaving little role for changes in underlying private-sector behavior (outside shifts related to monetary policy changes).

The Changing Nature of Financial Intermediation and the Financial Crisis of 2007–2009

Abstract: The current financial crisis has highlighted the changing role of financial institutions and the growing importance of the shadow banking system, which grew on the back of the securitization of assets and the integration of banking with capital market developments. This trend has been most pronounced in the United States but has had a profound influence on the global financial system as a whole. In a market-based financial system, banking and capital market developments are inseparable, and funding conditions are closely tied to the fluctuations in leverage of market-based financial intermediaries. Balance-sheet growth of market-based financial intermediaries provides a window on liquidity in the sense of the availability of credit, whereas financial crises tend to be associated with contractions of balance sheets. We describe the changing nature of financial intermediation in the marketbased financial system, chart the course of the recent financial crisis, and outline the policy responses that have been implemented by the Federal Reserve and other central banks to counter it.

DSGE Models for Monetary Policy Analysis

Abstract: Monetary DSGE models are widely used because they fit the data well and can be used to address important monetary policy questions. We provide a selective review of these developments. Policy analysis with DSGE models requires using data to assign numerical values to model parameters. The paper describes and implements Bayesian moment matching and impulse response matching procedures for this purpose.

Forecasting the Price of Oil

Abstract: We address some of the key questions that arise in forecasting the price of crude oil. What do applied forecasters need to know about the choice of sample period and about the tradeoffs between alternative oil price series and model specifications? Are real and nominal oil prices predictable based on macroeconomic aggregates? Does this predictability translate into gains in out-of-sample forecast accuracy compared with conventional no-change forecasts? How useful are oil futures prices in forecasting the spot price of oil? How useful are survey forecasts? How does one evaluate the sensitivity of a baseline oil price forecast to alternative assumptions about future oil demand and oil supply conditions? How does one quantify risks associated with oil price forecasts? Can joint forecasts of the price of oil and of U.S. real GDP growth be improved upon by allowing for asymmetries?

Microeconomic Evidence on Price-Setting

Abstract: The last decade has seen a burst of micro price studies. Many studies analyze data underlying national CPIs and PPIs. Others focus on more granular subnational grocery store data. We review these studies with an eye toward the role of price setting in business cycles. We summarize with ten stylized facts: prices change at least once a year, with temporary price discounts and product turnover often playing an important role. After excluding many short-lived prices, prices change closer to once a year. The frequency of price changes differs widely across goods, however, with more cyclical goods exhibiting greater price flexibility. The timing of price changes is little synchronized across sellers. The hazard (and size) of price changes does not increase with the age of the price. The cross-sectional distribution of price changes is thick-tailed, but contains many small price changes too. Finally, strong linkages exist between price changes and wage changes.

The large scale asset purchases had large international effects

Abstract: The Federal Reserve's large scale asset purchases (LSAP) of agency debt, MBSs and long-term U.S. Treasuries not only reduced long-term U.S. bond yields also significantly reduced long-term foreign bond yields and the spot value of the dollar. These changes were much too large to have been generated by chance and they closely followed LSAP announcement times. These changes in U.S. and foreign bond yields are roughly consistent with a simple portfolio choice model. Likewise, the exchange rate responses to LSAP announcements are roughly consistent with a UIP-PPP based model. The success of the LSAP in reducing long-term interest rates and the value of the dollar shows that central banks are not toothless when short rates hit the zero bound.

Market-Based Corrective Actions

Abstract: Many economic agents take corrective actions based on information inferred from market prices of firms' securities. Examples include directors and activists intervening in the management of firms and bank supervisors taking actions to improve the health of financial institutions. We provide an equilibrium analysis of such situations in light of a key problem: if agents use market prices when deciding on corrective actions, prices adjust to reflect this use and potentially become less revealing. We show that market information and agents' information are complementary, and discuss measures that can increase agents' ability to learn from market prices. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

How Has the Monetary Transmission Mechanism Evolved Over Time

Abstract: We discuss the evolution in macroeconomic thought on the monetary policy transmission mechanism and present related empirical evidence. The core channels of policy transmission — the neoclassical links between short-term policy interest rates, other asset prices such as long-term interest rates, equity prices, and the exchange rate, and the consequent effects on household and business demand — have remained steady from early policy-oriented models (like the Penn-MIT-SSRC MPS model) to modern dynamic, stochastic general equilibrium (DSGE) models. In contrast, non-neoclassical channels, such as credit-based channels, have remained outside the core models. In conjunction with this evolution in theory and modeling, there have been notable changes in policy behavior (with policy more focused on price stability) and in the reduced form correlations of policy interest rates with activity in the United States. Regulatory effects on credit provision have also changed significantly. As a result, we review the empirical evidence on the changes in the effect of monetary policy actions on real activity and inflation and present new evidence, using both a relatively unrestricted factor-augmented vector autoregression (FAVAR) and a DSGE model. Both approaches yield similar results: Monetary policy innovations have a more muted effect on real activity and inflation in recent decades as compared to the effects before 1980. Our analysis suggests that these shifts are accounted for by changes in policy behavior and the effect of these changes on expectations, leaving little role for changes in underlying private-sector behavior (outside shifts related to monetary policy changes).

Social Capital and Political Accountability

Abstract: In this paper, we investigate a channel through which social (or civic) capital may improve economic wellbeing and the functioning of institutions: political accountability. The main idea is that voters who share values and beliefs that foster cooperation are more likely to base their vote on criteria of social welfare rather than narrow personal interest. We frame this intuition into a simple model of political accountability with retrospective voting and heterogeneous endowments of civic attitudes. We then take this conjecture to the data using information on the Italian members of Parliament in the postwar period (1948–2001). The empirical evidence shows that the electoral punishment of political misbehavior is considerably larger in electoral districts with high social capital, where political misbehavior refers to receiving a request of criminal prosecution or shirking in parliamentary activity, and social capital is measured by blood donation (or by non-profit organizations and electoral turnout). Accordingly, political misbehaviors are less frequent in electoral districts where civic attitudes are widespread.

Is there a fiscal free lunch in a liquidity trap

Abstract: This paper uses a DSGE model to examine the eects of an expansion in government spending in a liquidity trap. The spending multiplier can be much larger than in the normal situation if the liquidity trap is very persistent, and …scal stimulus can be rapidly implemented. Moreover, the budgetary costs may be minimal as the large response of output boosts tax revenues, allowing for something close to a "…scal free lunch." However, we caution that the multiplier may be much smaller under plausible implementation lags for many types of public spending,and/or if the liquidity trap lasts less than two years. In addition, because the marginal impact of …scal expansion decreases in the scale of the outlay, it is crucial to distinguish between average and marginal multipliers.

Does Inflation Targeting Anchor Long-Run Inflation Expectations? Evidence from the U.S., UK, and Sweden

Abstract: We investigate the extent to which inflation expectations have been more firmly anchored in the United Kingdom–-a country with an explicit inflation target–-than in the United States–-a country with no such target–-using the difference between far-ahead forward rates on nominal and inflation-indexed bonds as a measure of compensation for expected inflation and inflation risk at long horizons. We show that far-ahead forward inflation compensation in the U.S. exhibits substantial volatility, especially at low frequencies, and displays a highly significant degree of sensitivity to economic news. Similar patterns are evident in the UK prior to 1997, when the Bank of England was not independent, but have been strikingly absent since the Bank of England gained independence in 1997. Our findings are further supported by comparisons of dispersion in longer-run inflation expectations of professional forecasters and by evidence from Sweden, another inflation-targeting country with a relatively long history of inflation-indexed bonds. Our results support the view that an explicit and credible inflation target helps to anchor the private sector's views regarding the distribution of long-run inflation outcomes. (JEL: E31, E52, E58)

Predicting Global Stock Returns

Abstract: I test for stock return predictability in the largest and most comprehensive data set analyzed so far, using four common forecasting variables: the dividend-price (DP) and earnings-price (EP) ratios, the short interest rate, and the term spread. The data contain over 20,000 monthly observations from 40 international markets, including 24 developed and 16 emerging economies. In addition, I develop new methods for predictive regressions with panel data. Inference based on the standard fixed effects estimator is shown to suffer from severe size distortions in the typical stock return regression, and an alternative robust estimator is proposed. The empirical results indicate that the short interest rate and the term spread are fairly robust predictors of stock returns in developed markets. In contrast, no strong or consistent evidence of predictability is found when considering the EP and DP ratios as predictors.

Large-Scale Asset Purchases by the Federal Reserve: Did They Work?

Abstract: 1. INTRODUCTION In December 2008, the Federal Open Market Committee (FOMC) lowered the target for the federal funds rate to a range of 0 to 25 basis points. With its traditional policy instrument set as low as possible, the Federal Reserve faced the challenge of how to further ease the stance of monetary policy as the economic outlook deteriorated. The Federal Reserve responded in part by purchasing substantial quantities of assets with medium and long maturities in an effort to drive down private borrowing rates, particularly at longer maturities. These large-scale asset purchases (LSAPs) have greatly increased the size of the Federal Reserve's balance sheet, and the additional assets may remain in place for years to come. To be sure, the Federal Reserve undertook other important initiatives to combat the financial crisis. It launched a number of facilities to relieve financial strains at specific types of institutions and in specific markets. In addition, in an attempt to provide even more stimulus, it used public communications about its policy intentions to lower market expectations of the federal funds rate in the future. All of these strategies were designed to ease financial conditions and to support a sustained economic recovery. Over time, though, the credit extended by the liquidity facilities has declined, and the dominant component of the Federal Reserve's balance sheet has become the assets accumulated through the LSAP programs. The decision to purchase large volumes of assets through March 2010 came in two steps. In November 2008, the Federal Reserve announced purchases of housing agency debt and agency mortgage-backed securities (MBS) of up to $600 billion. In March 2009, the FOMC decided to substantially expand its purchases of agency-related securities and to purchase longer term Treasury securities as well, with total asset purchases of up to $1.75 trillion, an amount twice the magnitude of total Federal Reserve assets prior to 2008. (1) The FOMC stated that the increased purchases of agency-related securities should "provide greater support to mortgage lending and housing markets" and that purchases of longer term Treasury securities should "help improve conditions in private credit markets." In this paper, we review the Federal Reserve's experience with implementing the LSAPs through March 2010 and describe some of the challenges raised by such large purchases in a relatively short time. In addition, we discuss the economic mechanisms through which LSAPs may be expected to stimulate the economy and present some empirical evidence on those effects. In particular, LSAPs reduce the supply to the private sector of assets with long duration (and, in the case of mortgage securities, highly negative convexity) and increase the supply of assets (bank reserves) with zero duration and convexity. (2) To the extent that private investors do not view these assets as perfect substitutes, the reduction in supply of the riskier longer term assets reduces the risk premiums required to hold them and thus reduces their yields. We assess the extent to which LSAPs had the desired effects on market interest rates using two different approaches and find that the purchases resulted in economically meaningful and long-lasting reductions in longer term interest rates on a range of securities, including securities that were not included in the purchase programs. We show that these reductions in interest rates primarily reflect lower risk premiums rather than lower expectations of future short-term interest rates. (3) We conclude with a discussion of issues raised by these policies and potential lessons for implementing monetary policy at the zero bound in the future. 2. HOW LSAPS AFFECT THE ECONOMY The primary channel through which LSAPs appear to work is by affecting the risk premium on the asset being purchased. By purchasing a particular asset, a central bank reduces the amount of the security that the private sector holds, displacing some investors and reducing the holdings of others, while simultaneously increasing the amount of short-term, risk-free bank reserves held by the private sector. …

Oil and the Great Moderation

Abstract: We assess the extent to which the greater US macroeconomic stability since the mid-1980s can be accounted for by changes in oil shocks and the oil elasticity of gross output. We estimate a DSGE model and perform counterfactual simulations. We nest two popular explanations for the Great Moderation: smaller (non-oil\link real shocks and better monetary policy. We find that oil played an important role in the stabilisation. Around half of the reduced volatility of inflation is explained by better monetary policy alone, and 57% of the reduced volatility of GDP growth is attributed to smaller TFP shocks. Oil related effects explain around a third.

Financial Crises and Bank Failures: A Review of Prediction Methods

Abstract: In this article we provide a summary of empirical results obtained in several economics and operations research papers that attempt to explain, predict, or suggest remedies for financial crises or banking defaults; we also outline the methodologies used in them. We analyze financial and economic circumstances associated with the US subprime mortgage crisis and the global financial turmoil that has led to severe crises in many countries. The intent of this article is to promote future empirical research for preventing bank failures and financial crises.

International Capital Flows and the Returns to Safe Assets in the United States, 2003-2007

Abstract: A broad array of domestic institutional factors ‐including problems with the originate-to-distribute model for mortgage loans, deteriorating lending standards, defi ciencies in risk management, confl icting incentives for the government-sponsored enterprises (GSEs), and shortcomings of supervision and regulation‐ were the primary sources of the US housing boom and bust and the associated fi nancial crisis. In addition, the extended rise in US house prices was likely also supported by long-term interest rates (including mortgage rates) that were surprisingly low, given the level of short-term rates and other macro fundamentals ‐a development that Greenspan (2005) dubbed a “conundrum.” The “global saving glut” (GSG) hypothesis (Bernanke, 2005 and 2007) argues that increased capital infl ows to the United States from countries in which desired saving greatly exceeded desired investment ‐including Asian emerging markets and commodity exporters‐ were an important reason that US longer-term interest rates during this period were lower than expected. This essay investigates further the effects of capital infl ows to the United States on US longer-term interest rates; however, we look beyond the overall size of the infl ows emphasised by the GSG hypothesis to examine the implications for US yields of the portfolio preferences of foreign creditors. We present evidence that, in the spirit of Caballero and Krishnamurthy (2009), foreign investors during this period tended to prefer US assets perceived to be safe. In particular, foreign investors ‐especially the GSG countries‐ acquired a substantial share of the new issues of US Treasuries, Agency debt, and Agency-sponsored mortgage-backed securities. The downward pressure on yields exerted by infl ows from the GSG countries was reinforced by the portfolio preferences of other foreign investors. We focus particularly on the case of Europe: although Europe did not run a large current account surplus as did the GSG countries, we show that it leveraged up its international balance sheet, issuing external liabilities to fi nance substantial purchases of apparently safe US “private label” mortgage-backed securities and other fi xed-income products. The strong demand for apparently safe assets by both domestic and foreign investors not only served to reduce yields on these assets but also provided additional incentives for the US fiservices industry to develop structured investment products that “transformed” risky loans into highly-rated securities. Our fi ndings do not challenge the view that domestic factors, including those listed above, were the primary sources of the housing boom and bust in the United States. However, examining how changes in the pattern of international capital fl ows affected yields on US assets helps provide a deeper understanding of the origins and dynamics of the crisis.

Term Structure Models and the Zero Bound: An Empirical Investigation of Japanese Yields

Abstract: When Japanese short-term bond yields were near their zero bound, yields on long-term bonds showed substantial fluctuation, and there was a strong positive relationship between the level of interest rates and yield volatilities/risk premia. We explore whether several families of dynamic term structure models that enforce a zero lower bound on short rates imply conditional distributions of Japanese bond yields consistent with these patterns. Multi-factor "shadow-rate" and quadratic-Gaussian models, evaluated at their maximum likelihood estimates, capture many features of the data. Furthermore, model-implied risk premiums track realized excess returns during extended periods of near-zero short rates. In contrast, the conditional distributions implied by non-negative affine models do not match thier sample counterparts, and standard Gaussian affine models generate implausibly large negative risk premiums.

Accounting for the Rise in Consumer Bankruptcies

Abstract: Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thousand working age population in 1970 to 8.5 in 2002. We use a heterogeneous agent life-cycle model with competitive financial intermediaries who can observe households’ earnings, age and current asset holdings to evaluate several commonly oered explanations. We find that an increase in uncertainty (income shocks, expense uncertainty) cannot quantitatively account for the rise in bankruptcies. Instead, stories related to a change in the credit market environment are more plausible. In particular, we find that a combination of a decrease in the credit market transactions cost together with a decline in “stigma” does a good job in accounting for the rise in consumer bankruptcy. We also argue that the abolition of usury laws and other legal changes have played little role.

Optimal Monetary Policy in an Operational Medium-Sized DSGE Model

Abstract: We show how to construct optimal policy projections in Ramses, the Riksbank’s openeconomy medium-sized DSGE model for forecasting and policy analysis. Bayesian estimation of the parameters of the model indicates that they are relatively invariant to alternative policy assumptions and supports that the model may be regarded as structural in a stable low inflation environment. Past policy of the Riksbank until 2007:3 (the end of the sample used) is better explained as following a simple instrument rule than as optimal policy under commitment. We show and discuss the differences between policy projections for the estimated instrument rule and for optimal policy under commitment, under alternative definitions of the output gap, different initial values of the Lagrange multipliers representing policy in a timeless perspective, and different weights in the central-bank loss function.

The Contribution of the Minimum Wage to US Wage Inequality over Three Decades: A Reassessment

Abstract: We reassess the effect of minimum wages on US earnings inequality using additional decades of data and an IV strategy that addresses potential biases in prior work. We find that the minimum wage reduces inequality in the lower tail of the wage distribution, though by substantially less than previous estimates, suggesting that rising lower tail inequality after 1980 primarily reflects underlying wage structure changes rather than an unmasking of latent inequality. These wage effects extend to percentiles where the minimum is nominally nonbinding, implying spillovers. We are unable to reject that these spillovers are due to reporting artifacts, however. (JEL J22, J31, J38, K31)