Showing papers in "Journal of Money, Credit and Banking in 1980"

Rational Expectations and Macroeconomic Stabilization Policy: An Overview

Abstract: THE OBJECT OF THIS PAPER is to describe the impact on macroeconomic stabilization analysis of the rational expectations "revolution" of the past decade spearheaded by Lucas [32, 33, 34, 36], Sargent [53, 54], Sargent and Wallace [56], and Barro [2, 3, 5]. Thus the primary intention is to bring together and summarize existing ideas, rather than to create new ones. Some of the arguments in sections S8 have not, however, been discussed in print. And while the paper is intended to be something of a survey, it does not claim to present an evenhanded or "balanced" account of all issues. Like most writers, my inclination is to try to develop a persuasive version of my current views, even while recognizing that these views will doubtless undergo considerable modification as time passes. The section following these introductory remarks includes a brief discussion of the appropriateness, for macroeconomic analysis, of the hypothesis that expectations are formed rationally. Then section 3 lays out the "basic model" within which two

Credit Rationing and Implicit Contract Theory

Abstract: THE RECENT SURVEY by Baltensperger [S] shows that the question of why bankers undertake nonprice rationing of credit is still very much unanswered. Previous attempts to address the question have ended up merely assuming the answer. For example, the attempts prior to the 1960s all involved the assumption that interest rates could not adjust so as always to clear the market for credit, the attempt by Hodgman [9] did not really address the issue of interest rate determination, and the later attempt by Jaffee and Modigliani [10] involved the assumption that banks cannot charge different rates to all of their customers. The only analysis in the literature that is free from this criticism is that of Jaffee and Russell [11], which focuses on adverse selection concerning default by dishonest customers. Meanwhile, recent developments in the theory of labor contracts (e.g., [1, 2, 3, 4, 7]) have made progress in answering the closely analogous question of why firms lay workers off rather than adjust wages. The purpose of the present paper is to show how these developments can be used and extended so as to provide a tentative answer to the question of why bankers ration credit. 1

Vehicle Currencies And the Structure Of International Exchange

Abstract: This paper is concerned with the reasons why some currencies, such as the pound sterling and the U.S. dollar, have come to serve as "vehicles" for exchanges of other currencies. It develops a three-country model of payments equilibrium with transaction costs, and shows how one currency can emerge as an international medium of exchange. Transaction costs are then made endogenous, and it is shown how the underlying structure of payments limits, without necessarily completely determining, the choice and role of a vehicle currency. Finally, a dynamic model is developed, and the way in which one currency can displace another as the international medium of exchange is explored.

The Exchange Rate and the International Transmission of Business Cycle Disturbances: Some Evidence from the Great Depression

Abstract: ADVOCATES OF THE FLEXIBLE EXCHANGE RATE SYSTEM have often claimed that this financial system insulates an economy from foreign business cycle disturbances. This claim has been viewed lately with considerable skepticism. Many leading economists have argued that while flexible exchange rates enable a country to independently determine (the rate of growth of) its money supply, they will not prevent foreign disturbances from affecting the demand for real cash balances through channels such as capital flows, currency substitution, or the wageprice setting process. Domestic output and prices, thus, will not be much more independent of foreign output and prices under flexible exchange rates. l The theoretical arguments purporting that the insulation powers of the flexible exchange rate are limited have found empirical support in the recent experience in which output and price fluctuations have continued to be related among many coun-

A Model of U.S. Financial and Nonfinancial Economic Behavior

Abstract: AT THE BEGINNING of this or any calendar quarter, economic agents in the United States-households, business firms, financial institutions, governments-held certain measurable quantities of a variety of assets, financial and real. The great bulk of financial assets were the debts of other resident agents; some were debts of foreigners. The bulk of real assets were land and reproducible consumers' or producers' durable goods located within the country. We also owned real properties abroad, just as foreigners owned some here. These asset and debt positions were the cumulative results of past saving and investment, past portfolio behavior, and past capital gains and losses, realized or unrealized. During the current quarter, these balance sheets will change. Households will be deciding how much to add to their wealth and in what form. Businesses will be deciding how much real capital to accumulate and how to finance their investments. Governments will be running and financing budget surpluses or deficits; in this particular quarter no doubt they will be on balance in deficit and will have to issue new interest-bearing debts or new monetary liabilities. Probably they will issue some of each. The country's net position vis-a-vis the rest of the world will decline by the deficit in the external current account. This deficit too will have its financial counterparts. At the same time, all these agents, and foreigners as well, will be reshuffling their initial balance sheets. The transactions and revaluations resulting

The Causes of U.S. Bank Expansion Overseas: The Case of Great Britain

Abstract: IN RECENT YEARS there has been a rapid increase in the activity of American banks outside the borders of the United States. This growth of foreign business has been far greater than that of domestic business. For example, while total assets of all U.S. commercial banks grew from $255.7 billion in 1960 to $1,486 billion in 1978, the total assets of overseas branches rose from $3.5 billion to $306 billion over the same period. Paralleling this growth was the increase in the number of overseas branches and subsidiaries from 131 in 1960 to 1,433 in 1978.1 Although the growth of new international markets (such as the Eurodollar market) that have arisen with the international expansion of commercial banking has been extensively investigated, little attention has been paid to the motivating factors underlying overseas bank expansion. This paper proposes to fill this gap in the literature by examining the factors affecting the expansion of U.S. banks into Great Britain, a country that has, so far, been the most important area for overseas business.2 International expansion of banking may be affected by both economic and regu-

Monetary Policy Reaction Functions, Consistent Expectations, and The Burns Era

Abstract: THIS PAPER ESTIMATES monetary policy reaction functions for the 197W77 period using monthly data. These estimates shed light on several questions regarding monetary policy during the Burns era. During this period the Federal Reserve expressed an increased interest in the behavior of monetary aggregates that led to the articulation of specific growth targets for these aggregates. However, a number of analysts have questioned the degree to which the Federal Reserve has systematically responded to deviations from such targets and its willingness to allow the variability of interest rates required for effective control of the money stock. Critics have also charged that during the Burns era the Federal Reserve failed to take syetematic and sustained action in response to price instability, and that attempts to curb inflation consisted of short periods of monetary stringency interspersed with periods of relative ease dictated by concerns over rising unemployment. In the international sphere, the move to a floating exchange rate for the dollar (March 1973) has raised the question of whether and to what extent Federal Reserve policy has responded to changes in the strength of the dollar. More broadly, critics have charged that the Federal Reserve has not responded in a balanced systematic way to stabilization targets, that instead it has responded erratically, attempting to achieve one goal and then another, some say in part due to

Are New Classical Models Plausible Enough to Guide Policy

Abstract: Rational Expectations and Other Elements of New Classical Macro Models The current renaissance of classical macroeconomics provides impressive new theoretical support for some old and strong propositions about economic mechanism and government policy Rationality of expectations is one essential component of the new classical approach, methodologically the most interesting, insightful, and innovative By itself, however, it does not lead to the strong propositions that excite the consumers, not just the producers, of economic theory There are several other ingredients in the models that generate the dramatic conclusions I want to remind you of two of these at the outset; some other aspects of these models will come up in my comments on the individual papers The two are the assumption of continuous market-clearing equilibrium and the specification of imperfections and asymmetries in the information on which economic agents act and form expectations The two are connected in the sense that information gaps play in the new macroeconomics very much the same role that failures of prices to clear markets play in the Keynesian tradition, by which I mean the neoclassical synthesis reviewed in Lucas's paper The market-clearing assumption is just that, an assumption It is not justified by any new direct evidence that a Walrasian auctioneer process generates the prices observed from day to day or month to month or year to year, or by any new theory telling how separate Marshallian markets or administered prices yield Walrasian results In one of his seminal articles, Robert Lucas introduces the assumption quite casually, saying:

Rational-Expectations-with-Misperceptions As a Theory of the Business Cycle

Abstract: In my judgment, the theory of rational-expectations-with-misperceptions provides an explanation of the business cycle that: represents a constructive effort to deal with questions that sorely needed to be asked, is logically impeccable and theoretically satisfying in its response to those questions, does not identify in operational terms the specific nature of the cyclical process, and fails to account for the duration and many key features of the actual cycle.

Fluctuating Exchange Rates and the International Transmission of Economic Disturbances

Abstract: The purpose of the present study is to examine the claims made for fluctuating exchange rates, and particularly to examine these claims from the point of view of the theory of unemployment.... We ask ourselves how cyclical movements of output in one part of the world would affect output elsewhere. In short, would stable countries be insulated from unstable ones under such a monetary arrangement, or would income and employment in every country still be dependent, as under the gold standard, upon economic conditions in the rest of the world? [7]

The Long-Run and Short-Run Demand for Money, Revisited

Abstract: THE MONEY MARKET plays a critical role in virtually all theories of income determination and is, as a result, one of the keystones of econometric modeling. Because of its central role, and to obtain unbiased and useful forecasts, considerable effort has been expended to specify and test the competing theories of money demand. Thus, much of the literature of the 1960s and early 1970s focused on whether the evidence favored the transactions or asset (or utility) theories of money demand. (The asset (utility) model appears in [16, 35]; the inventory-theoretic (transactions) approach appears in [1, 37]. Extensive reviews of the literature are available in [29, 3].) Papers by Chow [9], M. Friedman [15], Laidler [30, 31], and Meltzer [35] stand out as classics in theoretical and empirical work on money demand and are buttressed by an enormous supporting cast of papers and books that also suggest that money is demanded because it provides utility and is held for asset motives in contrast to the transactions motives stressed by the Keynesian model. The neoclassical resurgence that emphasizes monetary aggregates as opposed to money-market conditions has been fostered, in part, by these findings.

An Integrated Model of Household Flow-of-Funds Allocations

Abstract: This paper extends the multivariate stock-adjustment model commonly used in empirical studies of portfolio behavior in order to analyze the complete set of flow allocation decisions made by households (including consumption, expenditures on durables and houses, and various financial aggregates). The model is then confronted with quarterly household sector data from the United States Flow of Funds Accounts for the period 1954 to 1975. Besides presenting OLS estimates, we test parameter restrictions suggested by our theoretical structure; the data supports the view that the explanatory power of the model is enhanced by allowing non-zero cross-effects on interest rates and lagged stocks, and by the integration of real and financial decisions. While these results are encouraging, the specification requires a large number of independent variables. This leads, in many cases, to rather poor determination of a number of coefficients. We therefore combine with the data some inexact subjective information about the coefficients, using the Theil-Goldberger mixed estimation technique. The OLS estimates and the mixed estimates are then compared by examining the forecasting accuracy of the model in- and out-of-sample. Overall the model performs very well, and the simulation results confirm that inclusion of prior information is of considerable value for forecasting purposes. Since the publication of William Brainard and James Tobin's pioneering paper, "Pitfalls in Financial Model Building," the multivariate stock-adjustment model has been widely used to study dynamic portfolio adjustment. The framework which they developed is especially useful for analyzing a given sector's allocation of a predetermined aggregate among competing alternatives; when dealing with the household sector most applications (including their own) have specified wealth as a predetermined aggregate which, in turn, was allocated to various assets and liabilities. The purpose of the present paper is (This abstract was borrowed from another version of this item.)

Economies of Scale and Deposit-Taking Financial Institutions in Canada: Study of British Columbia Credit Unions

Abstract: ECONON4IES OF SCALE ESTIMATES obtained from a sample of credit unions active in British Columbia over the 1972-75 period are reported in this paper. Detailed balance sheet and income statement data were applied to reduced-form cost equations in a series of cross-sectional regressions. The regression results were used to (1) plot long-run average cost curves for three different production technologies, (2) identify the output levels at which adoption of electronic bookkeeping machines ("tronics") and computer systems become feasible, and (3) estimate the economies or diseconomies associated with branch versus unit banking. The cost minimization model is based on the seminal work of Benston [3, 4] and Bell and Murphy [2], modified to reflect institutional and structural differences peculiar to these small Canadian deposit-taking institutions. The results are broadly consistent with those reported in a similar study of commercial banks in the United States [8]. By focusing on smaller institutions however, we are able to uncover significant differences in the scale economies realized by manual versus tronicsbased production functions. Additional insights are also provided on the extra costs

Credit Rationing and the Home Mortgage Market

Abstract: ONE MARKET IN WHICH it is widely believed that credit rationing does take place is the residential mortgage market. Studies in which lenders at thrift institutions and commercial banks have been interviewed report that nonprice terms, such as the loan-to-value ratio, maturity, and the customer relationship, are used to allocate mortgage funds, especially during periods of credit restraint (see [1, 23]). Empirical studies though have not tended to support this hypothesis. Two recent studies [13, 17] have reviewed previous work on the mortgate market. The conclusion from these two studies is that investigations of the mortgage market have found little, if any, evidence that mortgage terms, other than the interest rate, influence the demand for and supply of mortgage funds, and therefore there is little evidence that the availability of funds is an important determinant of the amount of mortgage funds outstanding. The purpose of this paper is to analyze credit rationing in the home mortgage market. We believe that there are significant differences between the home and the multifamily mortgage markets (see [14]), and that credit rationing will be more important in the home mortgage market. Most previous studies of the mortgage market have used an aggregate series that included both home and multifamily mortgages (see, e.g., [20, 21]). Credit rationing is discussed in section 2. A model of the home mortgage market is

The Determination of Long-Term Interest Rates: Implications for Fiscal and Monetary Policies

Abstract: THE YIELDS AND PRICES of long-term assets play an important role in the complex interrelationships that connect financial and nonfinancial behavior in an economy like that of the United States. Long-term interest rates are a major component of the cost of financial capital to corporate borrowers and, consequently, a key determinant of physical capital formation through business investment in new plant and equipment. Long-term interest rates may also affect other typically debt-financed physical investments like residential construction, although the evidence there is less straightforward. Equity yields constitute another large component of the cost of corporate financial capital, and hence another determinant of business investment. Movements in equity prices (and, to a lesser extent, bond prices) also account for much of the variation in households' overall wealth positions and thereby importantly influence consumer spending. In sum, long-term asset yields and prices are a large part of the story of how what happens in the financial markets including monetary policy and the financial aspects of fiscal policy affects the nonfinancial economy. In light of the importance of long-term asset yields and prices even in a nonfinan-

Money in the United Kingdom: 1833-1880

Abstract: No abstract available.

The Valid Core of Rationality Hypotheses In the Theory of Expectations

Abstract: SECTION 1 DESCRIBES THE BACKGROUND of the debate from which the recent literature on rational expectations has emerged, and section 2 summarizes the salient features of the most ambitious version the "hard-line" version-of the rational-expectations hypothesis. This version will be interpreted as including two general propositions, one of which distinguishes sharply between the effects of the systematic and those of the stochastic components of demand policy, and the other of which denies the effectiveness of demand policies directed at the "real" variables of the economy. Following the formulation of these two propositions in section 2, sections 3 through 6 describe four qualifications of the propositionsessentially four classes or types of qualiScation that I believe need to be stressed. Several authors usually associated with "rational expectations theory" have recognized the validity of some of these, but no reasonably comprehensive discussion has so far been presented of the qualifications that I regard as essential even in a first approximation to reality. Hence, no analysis has been developed of what remains after allowance for these qualifications or limitations. I suggest that quite a bit of substance does indeed remain, and that we are left essentially with what in other writings I suggested calling the credibility hypothesis. The reason why that hypothesis may be so referred to is that it places the emphasis on the difference between

Bank Holding Company Characteristics and the Upstreaming of Bank Funds: Note

Abstract: The premise of integration underlies the current trend in the regulatory approach to bank holding companies (BHCs), reflecting the supervisors' concern that financial problems may be transferred among affiliates to the detriment of the subsidiary banks. There are several ways by which this may be accomplished, but the one that is central to this study is for the parent to require its banking subsidiaries to pay dividends beyond what would normally be considered pradent (in terms of the banks' own needs for internally generated capital) or to levy fees in excess of the value of services it provides them. Evidence was reported in [6] that banks affiliated with holding companies have followed significantly more liberal dividend policies in recent years than have comparable independent banks. The present investigation extends the prior study and represents the first attempt to analyze intraholding company funds flows for a large number of banks in a systematic fashion. The specific bypothesis tested states that there are observable characteristics of a holding company system, such as the financing techniques of the parent and the comparative importance of nonbanking organizations within the group, that are influential in determining the degree of upstreaming of funds by banking subsidiaries to the parent firm. Since such payments have the potential for adversely affecting a bank's capital position and its soundness, the identification of variables related to these payments should be important to regulators in their surveillance of banking firms.

The Role of Commercial Banks' Portfolio Behavior in the Determination of Treasury Security Yields

Abstract: BECAUSE OF THE PROMINENCE of commercial banks in the U.S. financial system, banks' portfolio behavior is instrumental in most discussions of financial markets. Commercial banks interact directly with all sectors of the economy through their role as depository financial intermediaries. Commercial banks also hold more different categories of assets than any other type of financial institution . Thus, changes in monetary policy and/or the nonbank public's demands forboth money and credit are immediately reflected by adjustments in commercial banks' portfolios, which may be ultimately transmitted throughout the entire financial system. An important element of the transmission mechanism linking commercial banks' portfolio adjustment to other financial markets is their Treasury security portfolios. l The determinants of commercial banks' holdings of Treasury securities may include such items as deposit flows, changes in the nonbank public' s demand for bank credit, and other factors reflecting the short-run determinants of commercial banks' invest-