Showing papers by "Federal Reserve System published in 2018"

Measuring Geopolitical Risk

Abstract: We present a monthly indicator of geopolitical risk based on a tally of newspaper articles covering geopolitical tensions, and examine its evolution and effects since 1985. The geopolitical risk (GPR) index spikes around the Gulf War, after 9/11, during the 2003 Iraq invasion, during the 2014 Russia-Ukraine crisis, and after the Paris terrorist attacks. High geopolitical risk leads to a decline in real activity, lower stock returns, and movements in capital flows away from emerging economies and towards advanced economies. When we decompose the index into threats and acts components, the adverse effects of geopolitical risk are mostly driven by the threat of adverse geopolitical events. Extending our index back to 1900, geopolitical risk rose dramatically during the World War I and World War II, was elevated in the early 1980s, and has drifted upward since the beginning of the 21st century.

Changing Business Dynamism and Productivity: Shocks vs. Responsiveness

Abstract: The pace of job reallocation has declined in all U.S. sectors since 2000. In standard models, aggregate job reallocation depends on (a) the dispersion of idiosyncratic productivity shocks faced by businesses and (b) the marginal responsiveness of businesses to those shocks. Using several novel empirical facts from business microdata, we infer that the pervasive post-2000 decline in reallocation reflects weaker responsiveness in a manner consistent with rising adjustment frictions and not lower dispersion of shocks. The within-industry dispersion of TFP and output per worker has risen, while the marginal responsiveness of employment growth to business-level productivity has weakened. The responsiveness in the post-2000 period for young firms in the high-tech sector is only about half (in manufacturing) to two thirds (economy wide) of the peak in the 1990s. Counterfactuals show that weakening productivity responsiveness since 2000 accounts for a significant drag on a ggregate productivity.

Implications of US Tax Policy for House Prices, Rents, and Homeownership

Abstract: This paper studies the impact of the preferential tax treatment of housing, including the mortgage interest deduction, on equilibrium house prices, rents, and homeownership. We build a dynamic model of housing tenure choice that features a realistic progressive tax system in which owner-occupied housing services are tax-exempt, and mortgage interest payments and property taxes are tax deductible. We simulate the eect of various tax reform proposals on the housing market, and nd that repealing existing tax deductions causes house prices to decline and also increases the homeownership rate. Our results challenge the widely held view that the mortgage interest tax deduction promotes homeownership.

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

Abstract: This article proposes a new class of copula-based dynamic models for high-dimensional 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-dimensional covariance matrices and on recent work on models for general time-varying distributions. Our use of copula-based models enables 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 2008–2009, the joint probability of distress (a measure of systemic risk) is substantially higher now than in the precrisis period. Supplementary materials for this article are available online.

The Elusive Costs of Inflation: Price Dispersion during the U.S. Great Inflation

Abstract: A key policy question is: how high an inflation rate should central banks target? This depends crucially on the costs of inflation. An important concern is that high inflation will lead to inefficient price dispersion. Workhorse New Keynesian models imply that this cost of inflation is very large. An increase in steady-state inflation from 0% to 10% yields a welfare loss that is an order of magnitude greater than the welfare loss from business cycle fluctuations in output in these models. We assess this prediction empirically using a new data set on price behavior during the Great Inflation of the late 1970s and early 1980s in the United States. If price dispersion increases rapidly with inflation, we should see the absolute size of price changes increasing with inflation: price changes should become larger as prices drift further from their optimal level at higher inflation rates. We find no evidence that the absolute size of price changes rose during the Great Inflation. This suggests that the standard New Keynesian analysis of the welfare costs of inflation is wrong and its implications for the optimal inflation rate need to be reassessed. We also find that (nonsale) prices have not become more flexible over the past 40 years.

New Perspectives on the Decline of US Manufacturing Employment

Abstract: We use relatively unexplored dimensions of US microdata to examine how US manufacturing employment has evolved across industries, firms, establishments, and regions. These data provide support for both trade- and technology-based explanations of the overall decline of employment over this period, while also highlighting the difficulties of estimating an overall contribution for each mechanism. Toward that end, we discuss how more careful analysis of these trends might yield sharper insights.

The performance effects of gender diversity on bank boards

Abstract: Previous literature has shown mixed results on the role of female participation on bank boards and bank performance: some papers find that more women on boards enhance financial performance, while others find negative or no effects. Applying instrumental variables methods to data on approximately 90 U.S. bank holding companies over the 1999–2015 period, we argue that these inconclusive results are due to the fact that there is a non-linear, U-shaped relationship between gender diversity on boards and various measures of bank performance: female participation has a positive effect once a threshold level of gender diversity is achieved. Furthermore, this positive effect is only observed in better capitalized banks. Our results suggest that continuing the voluntary expansion of gender diversity on bank boards will be value-enhancing, provided that they are well capitalized.

Can’t Pay or Won’t Pay? Unemployment, Negative Equity, and Strategic Default

Abstract: This paper uses new data from the PSID to quantify the relative importance of negative equity versus ability to pay, in driving mortgage defaults between 2009 and 2013. These data allow us to construct household budgets sets that provide better measures of ability to pay. Changes in ability to pay have large estimated effects. Job loss has an equivalent effect on the propensity to default as a 35% decline in equity. Strategic motives are also found to be quantitatively important, as we estimate more than 38% of households in default could make their mortgage payments without reducing consumption. Received September 29, 2015; editorial decision June 2, 2017 by Editor Philip Strahan. Authors have furnished an Internet Appendix, which is available on the Oxford University PressWeb site next to the link to the final published paper online.

Asset Price Dynamics in Partially Segmented Markets

Abstract: Citation: Greenwood, Robin, Samuel G. Hanson, and Gordon Y. Liao. "Asset Price Dynamics in Partially Segmented Markets." Review of Financial Studies 31, no. 9 (September 2018): 3307–3343. (Internet Appendix Here: http://www.people.hbs.edu/shanson/smc_IA_20170910.pdf.) Link to publisher's version: https://academic.oup.com/rfs/article-abstract/31/9/3307/4985215?redirectedFrom=fulltext Keywords: System Shocks, Asset Pricing

Unemployment Insurance as a Housing Market Stabilizer

Abstract: This paper studies the impact of unemployment insurance (UI) on the housing market. Exploiting heterogeneity in UI generosity across US states and over time, we find that UI helps the unemployed avoid mortgage default. We estimate that UI expansions during the Great Recession prevented more than 1.3 million foreclosures and insulated home values from labor market shocks. The results suggest that policies that make mortgages more affordable can reduce foreclosures even when borrowers are severely underwater. An optimal UI policy during housing downturns would weigh, among other benefits and costs, the deadweight losses avoided from preventing mortgage defaults.

The Tradeoffs in Leaning Against the Wind

Abstract: Credit booms sometimes lead to financial crises and subsequent severe and persistent economic slumps. So should monetary policy “lean against the wind” and counteract excess credit growth, or should it focus only on inflation and output stability? We study this issue quantitatively in a small New Keynesian dynamic stochastic general equilibrium model in which the risk of financial crises depends on “excess credit.” We compare monetary policy rules responding to the output gap to rules that respond to excess credit. We find that responding to credit can lead to a lower average probability of financial crisis, at the cost of higher cyclical volatility in inflation and output. We discuss the factors that affect the desirability of leaning against the wind.

Bank Lending in Times of Large Bank Reserves

Abstract: Reserves held by the U.S. banking system rose from under $50 billion before 2008 to $2.8 trillion by 2014. Some economists argue that such a large quantity of reserves could lead to overly expansive bank lending as the economy recovers, regardless of the Federal Reserve’s interest rate policy. In contrast, we show that the amount of bank reserves has no effect on bank lending in a frictionless model of the current banking system, in which interest is paid on reserves and there are no binding reserve requirements. Moreover, we find that with balance sheet costs, large reserve balances may instead be contractionary.

Expectations Uncertainty and Household Economic Behavior

Abstract: We show that there exists significant heterogeneity across U.S. households in how uncertain they are in their expectations regarding personal and macroeconomic outcomes, and that uncertainty in expectations predicts households' choices. Individuals with lower income or education, more precarious finances, and living in counties with higher unemployment are more uncertain in their expectations regarding own-income growth, inflation, and national home price changes. People with more uncertain expectations, even accounting for their socioeconomic characteristics, exhibit more precaution in their consumption, credit, and investment behaviors.

Sticky Expectations and Consumption Dynamics

Abstract: Macroeconomic models often invoke consumption "habits" to explain the substantial persistence of macroeconomic consumption growth. to explain the substantial But a large literature has found no evidence of habits in the micro-economic datasets that measure the behavior of individual households. We show that the apparent conflict can be explained by a model in which consumers have accurate knowledge of their personal circumstances but `sticky expectations' about the macro-economy. In our model, the persistence of aggregate consumption growth reflects consumers' imperfect attention to aggregate shocks. Our proposed degree of (macro) inattention has negligible utility costs, because aggregate shocks constitute only a tiny proportion of the uncertainty that consumers face. JEL Classification: D83, D84, E21, E32

Liquidity Crises in the Mortgage Market

Abstract: Non-banks originated about half of all mortgages in 2016, and 75% of mortgages insured by the FHA or VA. Both shares are much higher than those observed at any point in the 2000s. We describe in this paper how non-bank mortgage companies are vulnerable to liquidity pressures in both their loan origination and servicing activities, and we document that this sector in aggregate appears to have minimal resources to bring to bear in a stress scenario. We show how the same liquidity issues unfolded during the financial crisis, leading to the failure of many non-bank companies, requests for government assistance, and harm to consumers. The high share of non-bank lenders in FHA and VA lending suggests that the government has significant exposure to the vulnerabilities of non-bank lenders, but this issue has received very little attention in the housing-reform debate.

The Shift from Active to Passive Investing: Potential Risks to Financial Stability?

Abstract: The past couple of decades have seen a significant shift in assets from active to passive investment strategies We examine the potential effects of this shift for financial stability through four different channels: (1) effects on investment funds’ liquidity transformation and redemption risks; (2) passive strategies that amplify market volatility; (3) increases in asset-management industry concentration; and (4) the effects on valuations, volatility, and comovement of assets that are included in indexes Overall, the shift from active to passive investment strategies appears to be increasing some types of risk while diminishing others: The shift has probably reduced liquidity transformation risks, although some passive strategies amplify market volatility, and passive-fund growth is increasing asset-management industry concentration We find mixed evidence that passive investing is contributing to the comovement of asset returns and liquidity

Option-Based Credit Spreads

Abstract: We present a novel empirical benchmark for analyzing credit risk using "pseudo firms" that purchase traded assets financed with equity and zero-coupon bonds. By no-arbitrage, pseudo bonds are equivalent to Treasuries minus put options on pseudo firm assets. Empirically, like corporate spreads, pseudo bond spreads are large, countercyclical, and predict lower economic growth. Using this framework, we find that bond market illiquidity, investors' overestimation of default risks, and corporate frictions do not seem to explain excessive observed credit spreads but, instead, a risk premium for tail and idiosyncratic asset risks is the primary determinant of corporate spreads.

Congenital Chagas Disease in the United States: Cost Savings through Maternal Screening.

Abstract: Chagas disease, also called American trypanosomiasis, is caused by Trypanosoma cruzi, which is spread by triatomine insect vectors.1,2 Infected insects are found from southern South America to the southern states of the United States, although vector transmission to humans is very rare in the United States.3–5 Vector control has been very successful in many endemic regions.1,2,6 Transmission can also occur through blood transfusions, organ transplantation, consumption of insect feces in food, and from mother to child during gestation.3 Almost all endemic countries have instituted screening of blood products.1,2 Despite the existence of domestic and wild animal reservoirs, significant progress in reducing incidence is possible through rigorous domestic vector control and screening of blood and organ donors.1 Congenital transmission, on the other hand, could perpetuate the existence of Chagas disease indefinitely, even in countries or regions with no or almost no autochthonous vector transmission.7–10 This article uses a decision-analytic model to evaluate the societal economic cost of maternal screening to identify and treat infected newborns and their mothers compared with the societal cost of undiagnosed or late-diagnosed Chagas disease in the United States. Prevalence. The World Health Organization estimates that there are 5.7 million people infected with T. cruzi in Latin America1 and about 400,000 Latin Americans with Chagas disease residing in Europe, Japan, and the United States.4,6,11 Successful programs in domestic and peridomestic vector control reduced the estimated number of new cases from 700,000 per year in the 1970s to 40,000 per year in 2010.1,6 Vector transmission has been the predominant mode, but with control programs and blood bank screening, incidence is decreasing. Congenital transmission, however, accounts for 9,000 new cases per year in Central and South America1 and several hundred more in the United States and Europe.4,12 The Pan American Health Organization estimates that a quarter of new cases are caused by congenital transmission.7,13

The Liquidity Effects of Official Bond Market Intervention

Abstract: To “ensure depth and liquidity,” the European Central Bank intervened in sovereign debt markets through its Securities Markets Programme (SMP), providing a unique opportunity to estimate the effects of large-scale asset purchases on sovereign bond liquidity premia. From reduced-form estimates, we find robust, economically significant impact and lasting reductions in sovereign bonds’ liquidity premia in response to official purchases. We develop a search-based asset-pricing model to understand our empirical results. The theory implies that bond liquidity premia fall in response to both official purchases and rising sovereign default probabilities, as seen in the data.

International Spillovers of Monetary Policy: Conventional Policy vs. Quantitative Easing

Abstract: This paper evaluates the popular view that quantitative easing exerts greater international spillovers than conventional monetary policies. We employ a novel approach to compare the international spillovers of conventional and balance sheet policies undertaken by the Federal Reserve. In principle, conventional monetary policy affects bond yields and financial conditions by affecting the expected path of short rates, while balance-sheet policy is believed act through the term premium. To distinguish the effects of these two types of policies we use a term structure model to decompose longer-term bond yields into expected short-term interest rates and term premiums. We then examine the relative effects of changes in these two components of yields on changes in exchange rates and foreign bond yields. We find that the dollar is more sensitive to expected short-term interest rates than to term premia; moreover, the rise in the sensitivity of the dollar to monetary policy announcements since the GFC owes more to an increased sensitivity of the dollar to expected interest rates than to term premiums. We also find that changes in short rates and term premiums have similar effects on foreign yields. All told, our findings contradict the popular view that quantitative easing exerts greater international spillovers than conventional monetary policies.