Showing papers by "Federal Reserve System published in 2011"
TL;DR: The authors decompose the effects of NAFTA and find that 93% of Mexico's, 58% of Canada's and 55% of the United States' trade effects can be attributed to NAFTA's tariff reductions.
Abstract: We build into a Ricardian model the role of trade in intermediate inputs, sectoral linkages and differing productivity levels across sectors. We also propose a method to estimate sectoral trade elasticities. In our model, the trade effects due to overall tariff reductions account for most of the observed changes in trade flows for NAFTA members. We decompose the effects of NAFTA and find that 93% of Mexico’s, 58% of Canada’s and 55% of the United States’ trade effects can be attributed to NAFTA’s tariff reductions. Trade in intermediate inputs and input-output linkages can amplify the welfare effects of tariff reductions.
703 citations
TL;DR: Tax cuts can deepen a recession if the short-term nominal interest rate is zero, according to a standard New Keynesian business cycle model as mentioned in this paper, and this tax cut deepens a recession because it increases deflationary pressures.
Abstract: Tax cuts can deepen a recession if the short-term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures. Another example is a cut in capital taxes. This tax cut deepens a recession because it encourages people to save instead of spend at a time when more spending is needed. Fiscal policies aimed directly at stimulating aggregate demand work better. These policies include 1) a temporary increase in government spending; and 2) tax cuts aimed directly at stimulating aggregate demand rather than aggregate supply, such as an investment tax credit or a cut in sales taxes. The results are specific to an environment in which the interest rate is close to zero, as observed in large parts of the world today.
595 citations
TL;DR: In this paper, the authors review patterns in migration within the US over the past thirty years and find only limited roles for the housing market contraction and the economic recession in reducing migration recently.
Abstract: We review patterns in migration within the US over the past thirty years. Internal migration has fallen noticeably since the 1980s, reversing increases from earlier in the century. The decline in migration has been widespread across demographic and socioeconomic groups, as well as for moves of all distances. Although a convincing explanation for the secular decline in migration remains elusive and requires further research, we find only limited roles for the housing market contraction and the economic recession in reducing migration recently. Despite its downward trend, migration within the US remains higher than that within most other developed countries.
588 citations
TL;DR: In this paper, a structural model that encompasses both symmetric and asymmetric models as special cases is proposed, and correctly computed impulse responses are of roughly the same magnitude in either direction, consistent with formal tests for symmetric responses.
Abstract: How much does real gross domestic product (GDP) respond to unanticipated changes in the real price of oil? Commonly used censored oil price vector autoregressive models suggest a substantial decline in real GDP in response to unexpected increases in the real price of oil, yet no response to unexpected declines. We show that these estimates are invalid. Based on a structural model that encompasses both symmetric and asymmetric models as special cases, correctly computed impulse responses are of roughly the same magnitude in either direction, consistent with formal tests for symmetric responses. We discuss implications for theoretical models and for policy responses to energy price shocks.
501 citations
TL;DR: This paper found that effort provision is significantly different between treatments in the way predicted by models of expectation-based reference-dependent preferences: if expectations are high, subjects work longer and earn more money than if expectations were low.
Abstract: A key open question for theories of reference-dependent preferences is what determines the reference point. One candidate is expectations: what people expect could affect how they feel about what actually occurs. In a real-effort experiment, we manipulate the rational expectations of subjects and check whether this manipulation influences their effort provision. We find that effort provision is significantly different between treatments in the way predicted by models of expectation-based reference-dependent preferences: if expectations are high, subjects work longer and earn more money than if expectations are low.
469 citations
TL;DR: In this paper, the authors address the endogeneity problem of stock return volatility by instrumenting for volatility with a measure of a firm's customer base concentration, and find that the negative effect of idiosyncratic risk on investment is partly due to managerial risk aversion, and the negative relationship between idiosyncratic uncertainty and investment is stronger for firms with high levels of insider ownership.
Abstract: We find a significant negative effect of idiosyncratic stock-return volatility on investment. We address the endogeneity problem of stock return volatility by instrumenting for volatility with a measure of a firm's customer base concentration. We propose that
the negative effect of idiosyncratic risk on investment is partly due to managerial risk aversion, and find that the negative relationship between idiosyncratic uncertainty and
investment is stronger for firms with high levels of insider ownership. Several mecha nisms can mitigate this effect namely the use of option-based compensation and shareholder monitoring. We find that the investment-idiosyncratic relationship is weaker for firms that make use of option-based compensation, and insider ownership does not matter for firms primarily held by institutional investors.
444 citations
TL;DR: In this article, the authors examined the relationship between adverse liquidity shocks on main developed country banking systems to emerging markets across Europe, Asia, and Latin America, isolating loan supply from loan demand effects.
Abstract: Global banks played a significant role in the transmission of the 2007 to 2009 crisis to emerging market economies. This paper examines the relationships between adverse liquidity shocks on main developed-country banking systems to emerging markets across Europe, Asia, and Latin America, isolating loan supply from loan demand effects. Loan supply in emerging markets was significantly affected through three separate channels: a contraction in direct, cross-border lending by foreign banks; a contraction in local lending by foreign banks’ affiliates in emerging markets; and a contraction in loan supply by domestic banks resulting from the funding shock to their balance sheet 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 head office balance sheet shocks. Moreover, openness to international funding was not the main vehicle of propagation. Rather, it was exposure to international funding from source country banking systems that were ex ante more likely to suffer from the liquidity shock.
393 citations
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TL;DR: This article examined the historical record, including Budget Speeches and IMFdocuments, to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to prospective economic conditions.
Abstract: This paper investigates the short-term effects of fiscal consolidation on economic activity in OECD economies. We examine the historical record, including Budget Speeches and IMFdocuments, to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to prospective economic conditions. Using this new dataset, our estimates suggest fiscal consolidation has contractionary effects on private domestic demand and GDP. By contrast, estimates based on conventional measures of the fiscal policy stance used in the literature support the expansionary fiscal contractions hypothesis but appear to be biased toward overstating expansionary effects.
388 citations
TL;DR: This article analyzed the comparative advantages of large and small banks in specific lending technologies and found that small banks have a comparative advantage in relationship lending, but this appears to be strongest for lending to the largest firms.
Abstract: Under the current paradigm in small business lending research, large banks tend to specialize in lending to relatively large, informationally transparent firms using “hard” information, while small banks have advantages in lending to smaller, less transparent firms using “soft” information. We go beyond this paradigm to analyze the comparative advantages of large and small banks in specific lending technologies. Our analysis begins with the identification of fixed-asset lending technologies used to make small business loans. Our results suggest that large banks do not have equal advantages in all of these hard lending technologies and these advantages are not all increasing monotonically in firm size, contrary to the predictions of the current paradigm. We also analyze lines of credit without fixed-asset collateral to focus on relationship lending. We confirm that small banks have a comparative advantage in relationship lending, but this appears to be strongest for lending to the largest firms.
384 citations
01 Feb 2011
TL;DR: This paper conducted an event-study analysis of Operation Twist and used its estimated effects to assess what should be expected for the recent policy of quantitative easing by the Federal Reserve, dubbed “QE2.”
Abstract: This paper undertakes a modern event-study analysis of Operation Twist and uses its estimated effects to assess what should be expected for the recent policy of quantitative easing by the Federal Reserve, dubbed “QE2.” The paper first shows that Operation Twist and QE2 are similar in magnitude. It then identifies six significant, discrete announcements in the course of Operation Twist that could have had a major effect on financial markets and shows that four did have statistically significant effects. The cumulative effect of these six announcements on longer-term Treasury yields is highly statistically significant but moderate, amounting to about 15 basis points (bp). This estimate is consistent both with time-series analysis undertaken not long after the event and with the lower end of empirical estimates of Treasury supply effects in the literature. The effects of Operation Twist on long-term agency and corporate bond yields are also statistically significant but smaller, about 13 bp for agency securities and 2 to 4 bp for corporates. Thus, the effects of Operation Twist seem to diminish substantially as one moves from Treasury securities toward private sector credit instruments.
371 citations
TL;DR: In this paper, the authors propose a formal test of the hypothesis that energy prices are predetermined with respect to U.S. macroeconomic aggregates. But they find no compelling evidence of feedback at daily or monthly horizons.
Abstract: We propose a formal test of the hypothesis that energy prices are predetermined with respect to U.S. macroeconomic aggregates. The test is based on regressing changes in daily energy prices on daily news from U.S. macroeconomic data releases. Using a wide range of macroeconomic news, we find no compelling evidence of feedback at daily or monthly horizons, contradicting the view that energy prices respond instantaneously to macroeconomic news and consistent with the commonly used identifying assumption that there is no feedback from U.S. macroeconomic aggregates to monthly innovations in energy prices.
TL;DR: In this article, the authors quantify the effect of recourse on default and find that recourse affects default by lowering the borrower's sensitivity to negative equity, and that defaults are more likely to occur through a lender-friendly procedure, such as a deed in lieu, in states that allow deficiency judgments.
Abstract: We quantify the effect of recourse on default and find that recourse affects default by lowering the borrower's sensitivity to negative equity. At the mean value of the default option for defaulted loans, borrowers are 30% more likely to default in non-recourse states. Furthermore, for homes appraised at $500,000 to $750,000, borrowers are twice as likely to default in non-recourse states. We also find that defaults are more likely to occur through a lender-friendly procedure, such as a deed in lieu, in states that allow deficiency judgments. We find no evidence that mortgage interest rates are lower in recourse states. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.
TL;DR: In this article, the authors adopt a systemic risk indicator measured by the price of insurance against systemic financial distress and assess individual banks' marginal contributions to the systemic risk using publicly available data to the 19 bank holding companies covered by the U.S. Supervisory Capital Assessment Program (SCAP).
Abstract: We adopt a systemic risk indicator measured by the price of insurance against systemic financial distress and assess individual banks’ marginal contributions to the systemic risk. The methodology is applied using publicly available data to the 19 bank holding companies covered by the U.S. Supervisory Capital Assessment Program (SCAP), with the systemic risk indicator peaking around $1.1 trillion in March 2009. Our systemic risk contribution measure shows interesting similarity to and divergence from the SCAP loss estimates under stress test scenarios. In general, we find that a bank’s contribution to the systemic risk is roughly linear in its default probability but highly nonlinear with respect to institution size and asset correlation.
TL;DR: Using a range of structural and statistical models, the authors found that previous research understated the ZLB threat by focusing too much on the Great Moderation experience, and relying on structural models whose dynamics cannot generate sustained ZLB episodes.
Abstract: Prior to the financial crisis, most economists probably did not view the zero lower bound (ZLB) as a major problem for central banks. Using a range of structural and statistical models, we find that previous research understated the ZLB threat by ignoring uncertainty about model parameters and latent variables, focusing too much on the Great Moderation experience, and relying on structural models whose dynamics cannot generate sustained ZLB episodes. Our analysis also suggests that the Federal Reserve's asset purchases, while materially improving macroeconomic conditions, did not prevent the ZLB constraint from having first-order adverse effects on real activity and inflation.
TL;DR: The authors decompose industrial production into components arising from aggregate and sector-specific shocks, and find that nearly all of IP variability is associated with common factors, while the role of idiosyncratic shocks increased considerably after the mid-1980s, explaining half of the quarterly variation in IP.
Abstract: Using factor methods, we decompose industrial production (IP) into components arising from aggregate and sector-specific shocks. An approximate factor model finds that nearly all of IP variability is associated with common factors. We then use a multisector growth model to adjust for the effects of input-output linkages in the factor analysis. Thus, a structural factor analysis indicates that the Great Moderation was characterized by a fall in the importance of aggregate shocks while the volatility of sectoral shocks was essentially unchanged. Consequently, the role of idiosyncratic shocks increased considerably after the mid-1980s, explaining half of the quarterly variation in IP.
TL;DR: In this paper, the authors evaluate the cost implications of breaking up the largest banks into banks of smaller size and show that these economies are not driven by too-big-to-fail considerations.
Abstract: Earlier studies found little evidence of scale economies at large banks; later studies using data from the 1990s uncovered such evidence, providing a rationale for very large banks seen worldwide. Using more recent data, we estimate scale economies using two production models. The standard risk-neutral model finds little evidence of scale economies. The model using more general risk preferences and endogenous risk-taking finds large scale economies. We show that these economies are not driven by too-big-to-fail considerations. We evaluate the cost implications of breaking up the largest banks into banks of smaller size.
TL;DR: The authors examined the role of counterparty risk and liquidity hoarding in the U.S. overnight interbank market during the financial crisis of 2008 and found that the day after Lehman Brothers' bankruptcy, loan terms become more sensitive to borrower characteristics, and poorly performing large banks see an increase in spreads of 25 basis points, but are borrowing 1% less on average.
Abstract: We examine the importance of liquidity hoarding and counterparty risk in the U.S. overnight interbank market during the financial crisis of 2008. Our findings suggest that counterparty risk plays a larger role than does liquidity hoarding: the day after Lehman Brothers' bankruptcy, loan terms become more sensitive to borrower characteristics. In particular, poorly performing large banks see an increase in spreads of 25 basis points, but are borrowing 1% less, on average. Worse performing banks do not hoard liquidity. While the interbank market does not freeze entirely, it does not seem to expand to meet latent demand.
TL;DR: In this article, the authors analyze asset-backed commercial paper conduits, which experienced a shadow-banking "run" and played a central role in the early phase of the financial crisis of 2007-09.
Abstract: We analyze asset-backed commercial paper conduits, which experienced a shadow-banking “run” and played a central role in the early phase of the financial crisis of 2007-09. We document that commercial banks set up conduits to securitize assets worth $1.3 trillion while insuring the newly securitized assets using explicit guarantees. We show that regulatory arbitrage was the main motive behind setting up conduits: the guarantees were structured so as to reduce regulatory capital requirements, more so by banks with less capital, and while still providing recourse to bank balance sheets for outside investors. Consistent with such recourse, we find that conduits provided little risk transfer during the 'run': losses from conduits remained with banks rather than outside investors and banks with more exposure to conduits had lower stock returns.
TL;DR: In this paper, the authors put this literature into perspective, contrast it with more traditional approaches, highlight directions for further research, and reconcile some seemingly conflicting results reported in the literature.
Abstract: It is customary to suggest that the asymmetry in the transmission of oil price shocks to real output is well established. Much of the empirical work cited as being in support of asymmetry, however, has not directly tested the hypothesis of an asymmetric transmission of oil price innovations. Moreover, many of the papers quantifying these asymmetric responses are based on censored oil price VAR models that have recently been shown to be invalid. Other studies are based on dynamic correlations in the data and do not distinguish between cause and effect. Recently, several new methods of testing and quantifying asymmetric responses of U.S. real economic activity to positive and negative oil price innovations have been developed. We put this literature into perspective, contrast it with more traditional approaches, highlight directions for further research, and reconcile some seemingly conflicting results reported in the literature.
TL;DR: This article examined the impact of bank capital ratios on bank lending by comparing differences in loan growth to differences in capital ratios at sets of banks that are matched based on geographic area as well as size and various business characteristics.
TL;DR: In this article, the authors show that for most size-sorted firm categories of listed US firms, the procyclicality of debt and equity issuance decreases monotonically with firm size.
Abstract: Debt and equity issuance are procyclical for most size-sorted firm categories of listed US firms and the procyclicality of equity issuance decreases monotonically with firm size. At the aggregate level, however, the results for equity issuance are not conclusive due to different behavior of the largest firms, especially those in the top one percent. During a deterioration in economic conditions, firms limit the impact of the reduction in external financing on investment by shedding financial assets. This is true for a worsening in aggregate as well as firm-specific conditions.
TL;DR: Cwik and Wieland as discussed by the authors investigated whether the spending package announced by euro area governments for 2009 and 2010 is likely to boost GDP by more than one for one and found that the planned increase in government spending will reduce private consumption and investment significantly.
Abstract: The global financial crisis has led to a renewed interest in discretionary fiscal stimulus. Advocates of discretionary measures emphasize that government spending can stimulate additional private spending – the Keynesian multiplier effect. Thus, we investigate whether the spending package announced by euro area governments for 2009 and 2010 is likely to boost GDP by more than one for one. Because of modelling uncertainty, it is essential that such policy evaluations be robust to alternative modelling assumptions and parameterizations. We use five different empirical macroeconomic models with Keynesian features such as price and wage rigidities to evaluate the impact of the fiscal stimulus. Four of them suggest that the planned increase in government spending will reduce private consumption and investment significantly. Only a model that largely ignores the forward-looking behavioural response of consumers and firms implies crowding-in of private spending. We review a range of issues that may play a role in the recession of 2008–2009. Implementation lags are found to reinforce crowding-out and may even cause an initial contraction. Zero-bound effects may lead the central bank to abstain from interest rate hikes and increase the GDP impact of government spending. Crowding-in, however, requires an immediate anticipation of at least two years at the zero bound. Using a multi-country model, we find that spillovers between euro area countries are negligible or even negative, because direct demand effects are offset by the indirect effect of a euro appreciation. New-Keynesian dynamic stochastic general equilibrium (DSGE) models provide a strong case for government savings packages. Announced with sufficient lead time, spending cuts induce a significant short-run stimulus and crowding-in of private spending.
— Tobias Cwik and Volker Wieland
TL;DR: The authors found that hours are as volatile as output and that a large fraction of labor adjustment takes place along the intensive margin, and that the volatility of hours relative to output has increased over time.
TL;DR: In this paper, the forecasting performance of Bayesian VARs is affected by a number of specification choices, including tightness and lag length, and the role of the optimal choice of the tightness, of the lag length and of both.
Abstract: In this paper we discuss how the forecasting performance of Bayesian VARs is affected by a number of specification choices. In the baseline case, we use a Normal-Inverted Wishart (N-IW) prior that, when combined with a (pseudo-) iterated approach, makes the analytical computation of h-step ahead forecasts feasible and simple, in particular when using standard and fixed values for the tightness and the lag length. We then assess the role of the optimal choice of the tightness, of the lag length and of both; compare alternative approaches to h-step ahead forecasting (direct, iterated and pseudo-iterated); discuss the treatment of the error variance and of cross-variable shrinkage; and address a set of additional issues, including the size of the VAR, modeling in levels or growth rates, and the extent of forecast bias induced by shrinkage. We obtain a large set of empirical results, but we can summarize them by saying that we find very small losses (and sometimes even gains) from the adoption of specification choices that make BVAR modeling quick and easy. This finding could therefore further enhance the diffusion of the BVAR as an econometric tool for a vast range of applications.
TL;DR: In this paper, a quantitative general equilibrium model was used to study the relationship between the cyclicality and volatility of housing investment, and the procyclicality of debt in the US economy.
TL;DR: In this paper, the authors investigate whether securitization was associated with risky lending in the corporate loan market by examining the performance of individual loans held by CLOs and find that adverse selection problems in corporate loan securitizations are less severe than commonly believed.
Abstract: In this paper, we investigate whether securitization was associated with risky lending in the corporate loan market by examining the performance of individual loans held by CLOs. We employ two different datasets that identify loan holdings for a large set of CLOs and find that adverse selection problems in corporate loan securitizations are less severe than commonly believed. Using a battery of performance tests, we find that loans securitized before 2005 performed no worse than comparable unsecuritized loans originated by the same bank. Even loans originated by the bank that acts as the CLO underwriter do not show underperformance relative to the rest of the CLO portfolio. While there is some evidence of underperformance for securitized loans originated between 2005 and 2007, it is not consistent across samples, performance measures, and horizons. Overall, we argue that the securitization of corporate loans is fundamentally different from securitization of other assets classes because securitized loans are fractions of syndicated loans. Therefore, mechanisms used to align incentives in a lending syndicate are likely to reduce adverse selection in the choice of CLO collateral.
TL;DR: In this article, the authors show that simple pricing strategies are often nearly optimal for firms with more than a few products and that bundle size pricing is more profitable than offering the individual products priced separately and tends to closely approximate the profits from mixed bundling.
Abstract: Multiproduct firms can set separate prices for all possible bundled combinations of its products "mixed bundling"). However, this is impractical for firms with more than a few products, because the number of prices increases exponentially with the number of products. We find that simple pricing strategies are often nearly optimal. Specifically, we show that bundle-size pricing--setting prices that depend only on the size of bundle purchased--tends to be more profitable than offering the individual products priced separately and tends to closely approximate the profits from mixed bundling. (JEL D24, D42, L11, L13, L25)
TL;DR: In this paper, a survey of recent developments in the evaluation of point forecasts is presented, including advancements in the estimation of forecasts at the population level, evaluation of forecasts in the infinite sample, and evaluation of conditional versus unconditional point forecasts.
Abstract: This chapter surveys recent developments in the evaluation of point forecasts. Taking West’s (2006) survey as a starting point, we briefly cover the state of the literature as of the time of West’s writing. We then focus on recent developments, including advancements in the evaluation of forecasts at the population level (based on true, unknown model coefficients), the evaluation of forecasts in the infinite sample (based on estimated model coefficients), and the evaluation of conditional versus unconditional forecasts. We present original results in a few subject areas: the optimization of power in determining the split of a sample into in-sample and out-of-sample portions; whether the accuracy of inference in evaluation of multi-step forecasts can be improved with judicious choice of heteroskedasticity-and-autocorrelation estimator (it can); and the extension of West’s (1996) theory results for population-level, unconditional forecast evaluation to the case of conditional forecast evaluation.
TL;DR: This article found that speculative trading activity largely reacts to market conditions and reduces volatility levels, consistent with the hypothesis that speculators provide valuable liquidity to the market, and suggest that hedge funds (with approximately constant risk tolerance as in Deuskar and Johnson [2010]) improve overall market quality.
Abstract: We employ data over 2005-2009 which uniquely identify categories of traders to test whether speculators like hedge funds and swap dealers cause price changes or volatility. We find little evidence that speculators destabilize financial markets. To the contrary, speculative trading activity largely reacts to market conditions and reduces volatility levels, consistent with the hypothesis that speculators provide valuable liquidity to the market. These results hold across a variety of products and suggest that hedge funds (with approximately constant risk tolerance as in Deuskar and Johnson [2010]) improve overall market quality.
TL;DR: In this paper, the authors use information on changes in families' saving, investing, and spending behavior to consider the potential longer-term consequences of the current recession on households' finances and decisions.
Abstract: In 2009, the Federal Reserve Board implemented a survey of families that participated in the 2007 Survey of Consumer Finances (SCF) to gain detailed information on the effects of the recent recession on all types of households. Using data from the 2007-09 SCF panel, we highlight the variation in households' financial experiences by examining the distribution of changes in families' balance sheets. Further, we use information on changes in families' saving, investing, and spending behavior to consider the potential longer-term consequences of the current recession on households' finances and decisions. Most families experienced a decline in wealth between 2007 and 2009, but many families saw only small changes on net, and others saw substantial increases in their wealth. This pattern of gains and losses typically holds within demographic groups. Changes in families' wealth over the period appear to reflect changes in asset values (particularly the value of homes, stocks, and businesses) rather than changes in the level of ownership of assets and debts or in the amount of debt held. On the whole, families appear more cautious in 2009 than in 2007, as most families reported greater desired buffer savings, and many expressed concern over future income and employment.