Showing papers by "Federal Reserve System published in 2013"

The Decline of the U.S. Labor Share

Abstract: Over the past quarter century, labor’s share of income in the United States has trended downward, reaching its lowest level in the postwar period after the Great Recession. A detailed examination of the magnitude, determinants, and implications of this decline delivers five conclusions. First, about a third of the decline in the published labor share appears to be an artifact of statistical procedures used to impute the labor income of the self-employed that underlies the headline measure. Second, movements in labor’s share are not solely a feature of recent U.S. history: The relative stability of the aggregate labor share prior to the 1980s in fact veiled substantial, though offsetting, movements in labor shares within industries. By contrast, the recent decline has been dominated by the trade and manufacturing sectors. Third, U.S. data provide limited support for neoclassical explanations based on the substitution of capital for (unskilled) labor to exploit technical change embodied in new capital goods. Fourth, prima facie evidence for institutional explanations based on the decline in unionization is inconclusive. Finally, our analysis identifies offshoring of the labor-intensive component of the U.S. supply chain as a leading potential explanation of the decline in the U.S. labor share over the past 25 years.

The Surprisingly Swift Decline of U.S. Manufacturing Employment

Abstract: This paper links the sharp drop in US manufacturing employment after 2000 to a change in US trade policy that eliminated potential tariff increases on Chinese imports. Industries more exposed to the change experience greater employment loss, increased imports from China, and higher entry by US importers and foreign-owned Chinese exporters. At the plant level, shifts toward less labor-intensive production and exposure to the policy via input-output linkages also contribute to the decline in employment. Results are robust to other potential explanations of employment loss, and there is no similar reaction in the European Union, where policy did not change. (JEL D72, E24, F13, F16, L24, L60, P33)

Classroom Peer Effects and Student Achievement

Abstract: We analyze the impact of classroom peers’ ability (measured by their individual fixed effects) on student achievement for all Florida public school students in grades 3–10 over a 6-year period. We control for both student and teacher fixed effects, thereby alleviating biases due to endogenous assignment of both peers and teachers. Under linear-in-means specifications, estimated peer effects are small to nonexistent, but we find some sizable and significant peer effects within nonlinear models. We also find that classroom peers, as compared with the broader group of grade-level peers at the same school, exert a greater influence on individual achievement gains.

Revisiting the Minimum Wage-Employment Debate: Throwing Out the Baby with the Bathwater?

Abstract: We revisit the minimum wage-employment debate, which is as old as the Department of Labor. In particular, we assess new studies claiming that the standard panel data approach used in much of the "new minimum wage research" is flawed because it fails to account for spatial heterogeneity. These new studies use research designs intended to control for this heterogeneity and conclude that minimum wages in the United States have not reduced employment. We explore the ability of these research designs to isolate reliable identifying information and test the untested assumptions in this new research about the construction of better control groups. Our evidence points to serious problems with these research designs. We conclude that the evidence still shows that minimum wages pose a tradeoff of higher wages for some against job losses for others, and that policymakers need to bear this tradeoff in mind when making decisions about increasing the minimum wage.

The Signaling Channel for Federal Reserve Bond Purchases

Abstract: Previous research has emphasized the portfolio balance effects of Federal Reserve bond purchases, in which a reduced bond supply lowers term premia. In contrast, we find that such purchases have important signaling effects that lower expected future short-term interest rates. Our evidence comes from a model-free analysis and from dynamic term structure models that decompose declines in yields following Fed announcements into changes in risk premia and expected short rates. To overcome problems in measuring term premia, we consider bias-corrected model estimation and restricted risk price estimation. In comparison with other studies, our estimates of signaling effects are larger in magnitude and statistical significance.

Market Expectations in the Cross‐Section of Present Values

Abstract: Returns and cash flow growth for the aggregate U.S. stock market are highly and robustly predictable. Using a single factor extracted from the cross-section of book-tomarket ratios, we find an out-of-sample return forecasting R 2 of 13% at the annual frequency (0.9% monthly). We document similar out-of-sample predictability for returns on value, size, momentum, and industry portfolios. We present a model linking aggregate market expectations to disaggregated valuation ratios in a latent factor system. Spreads in value portfolios’ exposures to economic shocks are key to identifying predictability and are consistent with duration-based theories of the value premium. THE MOST COMMON APPROACH to measuring aggregate return and cash flow expectations is predictive regression. As suggested by the present value relationship between prices, discount rates, and future cash flows, research shows that the aggregate price-dividend ratio is among the most informative predictive variables. Typical in-sample estimates find that about 10% of annual return variation can be accounted for by forecasts based on the aggregate book-tomarket ratio, but find little or no out-of-sample predictive power. 1 In this paper we show that reliance on aggregate quantities drastically understates the degree of value ratios’ predictive content for both returns and cash flow growth, and hence understates the volatility of investor expectations. Our estimates suggest that as much as 13% of the out-of-sample variation in annual market returns (as much as 12% for dividend growth), and somewhat more of the insample variation, can be explained by the cross-section of past disaggregated value ratios. To harness disaggregated information we represent the cross-section of assetspecific book-to-market ratios as a dynamic latent factor model. We relate disaggregated value ratios to aggregate expected market returns and cash flow growth. Our model is based on the idea that the same dynamic state variables driving aggregate expectations also govern the dynamics of the entire panel ∗ Kelly is with Booth School of Business, University of Chicago, and Pruitt is with the Board of Governors of the Federal Reserve System. The view expressed here are those of the authors and do not necessarily reflect the views of the Federal Reserve System or its staff. 1 See Cochrane (2005) and Koijen and Van Nieuwerburgh (2011) for surveys of return and cash flow predictability evidence using the aggregate price-dividend ratio. Similar results obtain from forecasts based on the aggregate book-to-market ratio.

Unemployment Dynamics in the OECD

Abstract: We provide a set of comparable estimates for the rates of in‡ow to and out‡ow from unemployment for fourteen OECD economies using publicly available data. We then devise a method to decompose changes in unemployment into contributions accounted for by changes in in‡ow and out‡ow rates for cases where unemployment deviates from its ‡ow steady state, as it does in many countries. Our decomposition reveals that ‡uctuations in both in‡ow and out‡ow rates contribute substantially to unemployment variation within countries. For Anglo-Saxon economies we …nd approximately a 20:80 in‡ow/out‡ow split to unemployment variation, while for Continental European and Nordic countries, we observe much closer to a 50:50 split. Using the estimated ‡ow rates we compute gross worker ‡ows into and out of unemployment. In all economies we observe that increases in in‡ows lead increases in unemployment, whereas out‡ows lag a ramp up in unemployment.

Now-Casting and the Real-Time Data Flow

Abstract: The term now-casting is a contraction for now and forecasting and has been used for a long-time in meteorology and recently also in economics. In this paper we survey recent developments in economic now-casting with special focus on those models that formalize key features of how market participants and policy makers read macroeconomic data releases in real time, which involves: monitoring many data, forming expectations about them and revising the assessment on the state of the economy whenever realizations diverge sizeably from those expectations. (Prepared for G. Elliott and A. Timmermann, eds., Handbook of Economic Forecasting, Volume 2, Elsevier-North Holland)

A Network Analysis of Global Banking: 1978-2010

Abstract: We analyze the global banking network using data on cross-border banking flows for 184 countries during 1978–2010. We find that the density of the global banking network defined by these flows is procyclical, expanding and contracting with the global cycle of capital flows. We also find that country connectedness in the network tends to rise before banking and debt crises and to fall in their aftermath. Despite a historically unique build-up in aggregate flows prior to the global financial crisis, network density in 2007 was comparable to earlier peaks. This suggests that factors other than connectedness, such as the location of the initial shock to the core of the network, have contributed to the severity of the crisis. The global financial crisis stands out as an unusually large perturbation to the global banking network, with indicators of network density in 2008 reaching all-time lows.

The Nature of Countercyclical Income Risk

Abstract: We study business cycle variation in individual earnings risk using a confidential and very large data set from the US Social Security Administration. Contrary to past research, we find that the variance of idiosyncratic shocks is not countercyclical. Instead, it is the left-skewness of shocks that is strongly countercyclical: during recessions, large upward earnings movements become less likely, whereas large drops in earnings become more likely. Second, we find that the fortunes during recessions are predictable by observable characteristics before the recession. Finally, the cyclicality of earnings risk is dramatically different for the top 1 percent compared with the rest of the population.

Distracted Directors: Does Board Busyness Hurt Shareholder Value?

Abstract: This paper examines the impact of independent director busyness on firm value in a setting that addresses a key challenge that the board of directors is an endogenously determined institution. We use the deaths of directors and CEOs as a natural experiment to generate exogenous variation in the time and resources available to independent directors at interlocked firms. The sudden loss of such key co-employees is an ‘attention shock’ because it increases the board committee workload for some independent directors at the interlocked firm – the ‘treatment group’, but not others – the ‘control group’. In a hand-collected sample of 2,551 (592) firms that share a non-deceased independent director with 633 (189) firms subject to director (CEO) deaths, difference-in-differences estimates reveal that investors react negatively to these attention shocks. There is a significant negative stock market reaction of -0.79% (-0.95%) for director-interlocked firms in the treatment group, but no reaction for those in the control group. The treatment effect is significantly magnified by interlocking directors’ busyness (e.g., board size and number of outside directorships), the importance of their roles in the firm (e.g., type of committee membership), and their degree of actual independence (e.g., board classification). Overall, these results provide endogeneity-free evidence that independent directors’ busyness is detrimental to board monitoring quality and shareholder value.

Rising Intangible Capital, Shrinking Debt Capacity, and the US Corporate Savings Glut

Abstract: This paper explores the hypothesis that the rise in intangible capital is a fundamental driver of the secular trend in US corporate cash holdings over the last decades. Using a new measure, we show that intangible capital is the most important firm-level determinant of corporate cash holdings. Our measure accounts for almost as much of the secular increase in cash since the 1980s as all other determinants together. We then develop a new dynamic dynamic model of corporate cash holdings with two types of productive assets, tangible and intangible capital. Since only tangible capital can be pledged as collateral, a shift toward greater reliance on intangible capital shrinks the debt capacity of firms and leads them to optimally hold more cash in order to preserve financial flexibility. In the model, firms with growth options tend to hold more cash in anticipation of (S,s)-type adjustments in physical capital because they want to avoid raising costly external finance. We show that this mechanism is quantitatively important, as our model generates cash holdings that are up to an order of magnitude higher than the standard benchmark and in line with their empirical averages for the last two decades. Overall, our results suggest that technological change has contributed significantly to recent changes in corporate liquidity management.

College Major Choice and the Gender Gap

Abstract: This paper studies how college majors are chosen, focusing on the underlying gender gap. I collect a data set of Northwestern University sophomores that contains their subjective expectations about choice-specific outcomes, and estimate a model where majors are chosen under uncertainty. Enjoying coursework, and gaining parents' approval are the most important determinants in the choice for both genders. However, males and females differ in their preferences in the workplace, with males caring about the pecuniary outcomes in the workplace much more than females. The gender gap is mainly due to gender differences in preferences and tastes, and not because females are underconfident about their academic ability or fear monetary discrimination. The findings in this paper make a case for policies that change attitudes toward gender roles.

Social Capital and Political Accountability

Abstract: We investigate a channel through which social 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 vote based on criteria of social welfare rather than narrow personal interest. We frame this intuition into a simple model of political agency and take it to the data using information on the criminal prosecutions and absenteeism rates of Italian members of Parliament. Empirical evidence shows that the electoral punishment of these misbehaviors is considerably larger in districts with higher social capital.

Time-Varying Systemic Risk: Evidence from a Dynamic Copula Model of CDS Spreads

Abstract: This paper proposes a new class of copula-based dynamic models for high dimension conditional distributions, facilitating the estimation of a wide variety of measures of systemic risk. Our proposed models draw on successful ideas from the literature on modeling high dimension covariance matrices and on recent work on models for general time-varying distributions. Our use of copula-based models enable the estimation of the joint model in stages, greatly reducing the computational burden. We use the proposed new models to study a collection of daily credit default swap (CDS) spreads on 100 U.S. firms over the period 2006 to 2012. We find that while the probability of distress for individual firms has greatly reduced since the financial crisis of 2008-09, the joint probability of distress (a measure of systemic risk) is substantially higher now than in the pre-crisis period.

Capital-Skill Complementarity and the Skill Premium in a Quantitative Model of Trade

Abstract: Technological change has reduced the relative price of capital goods. Reductions in trade costs make it cheaper to import capital goods. With capital-skill complementarity, both can increase the skill premium. I construct a general-equilibrium trade model with capital-skill complementarity to study the impact of changing worldwide trade costs and technologies on the skill premium. The impacts of trade costs and technical change are comparable, especially in developing countries, and much larger than Stolper-Samuelson effects. I find that both skilled and unskilled labor gain from trade, and that larger gains from trade are associated with larger increases in the skill premium. (JEL E22, F11, F16, J24, O33)

Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy

Abstract: The recent financial crisis and ensuing recession appear to have put the productive capacity of the economy on a lower and shallower trajectory than the one that seemed to be in place prior to 2007. Using a version of an unobserved components model introduced by Fleischman and Roberts, we estimate that potential GDP in late 2014 was about 7 percent below the trajectory it appeared to be on prior to 2007. We argue that a significant portion of the recent damage to the supply side of the economy plausibly was endogenous to the weakness in aggregate demand. Endogeneity of supply with respect to demand provides a strong motivation for a vigorous policy response to a weakening in aggregate demand, and we present optimal-control simulations showing how monetary policy might respond to such endogeneity in the absence of other considerations. We then discuss how other considerations—such as increased risks of financial instability or inflation instability—could cause policymakers to exercise restraint in their response to cyclical weakness.

Do Small Businesses Still Prefer Community Banks

Abstract: We formulate and test hypotheses about the role of bank type – small versus large, single-market versus multimarket, and local versus nonlocal banks – in banking relationships. The conventional paradigm suggests that “community banks” – small, single-market, local institutions – are better able to form strong relationships with informationally opaque small businesses, while “megabanks” – large, multimarket, nonlocal institutions – tend to serve more transparent firms. Using the 2003 Survey of Small Business Finance (SSBF), we conduct two sets of tests. First, we test for the type of bank serving as the “main” relationship bank for small businesses with different firm and owner characteristics. Second, we test for the strength of these main relationships by examining the probability of multiple relationships and relationship length as functions of main bank type and financial fragility, as well as firm and owner characteristics. The results are often not consistent with the conventional paradigm, perhaps because of changes in lending technologies and deregulation of the banking industry.

Unemployment, Negative Equity, and Strategic Default

Abstract: Using new household level data, we quantitatively assess the roles that (i) job loss, (ii) negative equity, and (iii) wealth (including unsecured debt, liquid, and illiquid assets) play in default decisions. In sharp contrast to prior studies that proxy for individual unemployment status using regional unemployment rates, we find that individual unemployment is the strongest predictor of default. We find that individual unemployment increases the probability of default by 5-13 percentage points, ceteris paribus, compared to the sample average default rate of 3.9%. We also find that only 13.9% of defaulters have both negative equity and enough liquid or illiquid assets to make 1 month’s mortgage payment. This suggests that “ruthless,” or “strategic” default during the 2007-2009 recession is relatively rare, and suggests that policies designed to promote employment, such as payroll tax cuts, are most likely to stem defaults in the long run rather than policies that temporarily modify mortgages.

Credit Spreads as Predictors of Real-Time Economic Activity: A Bayesian Model-Averaging Approach

Abstract: Employing a large number of financial indicators, we use Bayesian model averaging (BMA) to forecast real-time measures of economic activity. The indicators include credit spreads based on portfolios, constructed directly from the secondary market prices of outstanding bonds, sorted by maturity and credit risk. Relative to an autoregressive benchmark, BMA yields consistent improvements in the prediction of the cyclically sensitive measures of economic activity at horizons from the current quarter out to four quarters hence. The gains in forecast accuracy are statistically significant and economically important and owe almost exclusively to the inclusion of credit spreads in the set of predictors.

The Signaling Channel for Federal Reserve Bond Purchases

Abstract: Previous research has emphasized the portfolio balance effects of Federal Reserve bond purchases, in which a reduced bond supply lowers term premia. In contrast, we find that such purchases have important signaling effects that lower expected future shortterm interest rates. Our evidence comes from a model-free analysis and from dynamic term structure models that decompose declines in yields following Fed announcements into changes in risk premia and expected short rates. To overcome problems in measuring term premia, we consider bias-corrected model estimation and restricted risk price estimation. We also characterize the estimation uncertainty regarding the relative importance of the signaling and portfolio balance channels.

Risk Premiums in Dynamic Term Structure Models with Unspanned Macro Risks

Abstract: This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. We develop a novel arbitrage-free dynamic term structure model in which bond investment decisions are influenced by real output and inflation risks that are unspanned by (imperfectly correlated with) information about the shape of the Treasury yield curve. Our model reveals that, over the period 1985-2007, these unspanned macro risks accounted for a large portion of the variation in forward terms premiums, and there was pronounced cyclical variation in the market prices of level and slope risks. We compare fitted term premiums for the post-2007 crisis period to those from a model with spanned macro risks, and use our findings to reassess some of Chairman Bernanke's remarks on the interplay between term premiums, the shape of the yield curve, and the macroeconomy.

How Effective Were the Federal Reserve Emergency Liquidity Facilities? Evidence from the Asset‐Backed Commercial Paper Money Market Mutual Fund Liquidity Facility

Abstract: The events following Lehman's failure in 2008 and the current turmoil emanating from Europe highlight the structural vulnerabilities of short-term credit markets and the role of central banks as back-stop liquidity providers. The Federal Reserve's response to financial disruptions in the United States importantly included the creation of liquidity facilities. Using a differences-in-differences approach, we evaluate one of the most unusual of these interventions—the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. We find that this facility helped stabilize asset outflows from money market funds and reduced asset-backed commercial paper yields significantly.