Showing papers in "Journal of Money, Credit and Banking in 2006"

The Credit Cycle and the Business Cycle: New Findings Using the Loan Officer Opinion Survey

Abstract: VAR analysis on a measure of bank lending standards collected by the Federal Reserve reveals that shocks to lending standards are significantly correlated with innovations in commercial loans at banks and in real output. Credit standards strongly dominate loan rates in explaining variation in business loans and output. Standards remain significant when we include various proxies for loan demand, suggesting that part of the standards fluctuations can be identified with changes in loan supply. Standards are also significant in structural equations of some categories of inventory investment, a GDP component closely associated with bank lending. The estimated impact of a moderate tightening of standards on inventory investment is of the same order of magnitude as the decline in inventory investment over the typical recession.

New Evidence on the Lending Channel

Abstract: The response of aggregate lending to monetary policy is stronger in state banking markets where financially constrained banks have more market share. On the other hand, there is little difference in the response of state output across the market share financially constrained banks, implying that the aggregate elasticity of output to bank lending is very small, if not zero. I conclude that while small firms might view bank loans as special, they are not special enough for the lending channel to be an important part of how monetary policy works.

Macroeconomic Dynamics and Credit Risk: A Global Perspective

Abstract: This paper presents a new approach to modeling conditional credit loss distributions. Asset value changes of firms in a credit portfolio are linked to a dynamic global macroeconometric model, allowing macroeffects to be isolated from idiosyncratic shocks from the perspective of default (and hence loss). Default probabilities are driven primarily by how firms are tied to business cycles, both domestic and foreign, and how business cycles are linked across countries. We allow for firm-specific business cycle effects and the heterogeneity of firm default thresholds using credit ratings. The model can be used, for example, to compute the effects of a hypothetical negative equity price shock in South East Asia on the loss distribution of a credit portfolio with global exposures over one or more quarters. We show that the effects of such shocks on losses are asymmetric and nonproportional, reflecting the highly nonlinear nature of the credit risk model.

Same Financial Development yet Different Economic Growth--Why?

Abstract: We re-study the relationship between financial development and real GDP per capita growth in 48 countries. What we find is an interesting evidence that only stock market development has positive effects on growth and that banking development has an unfavorable, if not negative, effect on growth. We examine whether or not these impacts are a product of various financial and economic conditional variables. Our conditional variables consist of financial liberalization, two sets of country development dummies, crises in banking and currency dummies, the creditor protection index as well as the anti-director and corruption indices. Our results clearly show that the conditional variables of financial liberalization, high-income level, and good shareholder protection mitigate the negative impacts of banking development on growth. In contrast, the conditional variables of middle-income level, regional Latin American, Sub-Saharan African and East Asian dummies, banking and currency crises, good creditor protection, and higher corruption strengthen the negative impacts of banking development on growth. Next, the conditional variables of middle-income level, Latin American, Sub-Saharan African, and East Asian dummies strengthen the positive impacts of stock market development on growth, whereas the conditional variables of financial liberalization mitigate the positive impacts of stock market development on growth. Last, we find that the relationship between growth and bank development is better described as a weak inverse Ushape. This inverse U-shape becomes stronger when additional stock market variables are squared. Thus, financial development and growth may, in fact, be in a nonlinear form.

A Portfolio View of Banking with Interest and Noninterest Activities

Abstract: This paper uses a portfolio framework to evaluate the impact of increased noninterest income on equity market measures of return and risk of U.S. bank holding companies from 1997 to 2004. The results indicate that the banks most reliant on activities that generate noninterest income do not earn higher average equity returns, but are much more risky as measured by return volatility (both total and idiosyncratic) and market betas. This suggests that the pervasive shift toward noninterest income has not improved the risk/return outcomes of U.S. banks in recent years.

Equity and Bond Market Signals as Leading Indicators of Bank Fragility

Abstract: We analyse the ability of the distance to default and subordinated bond spreads to signal bank fragility in a sample of EU banks. We find leading properties for both indicators. The distance to default exhibits lead times of 6-18 months. Spreads have signal value close to problems only. We also find that implicit safety nets weaken the predictive power of spreads. Further, the results suggest complementarity between both indicators. We also examine the interaction of the indicators with other information and find that their additional information content may be small but not insignifi- cant. The results suggest that market indicators reduce type II errors relative to predictions based on accounting information only.

Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates

Abstract: We determine optimal monetary policy under commitment in a forwardlooking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. While the empirical magnitude of U.S. mark-up shocks seems too small to entail zero nominal interest rates, shocks affecting the natural real interest rate plausibly lead to a binding lower bound. Under optimal policy, however, this occurs quite infrequently and does not imply positive average inflation rates in equilibrium. Interestingly, the presence of binding real rate shocks alters the policy response to (non-binding) markup shocks.

Macro Factors and the Term Structure of Interest Rates

Abstract: This paper presents an essentially affine model of the term structure of interest rates making use of macroeconomic factors and their long-run expectations. The model extends the approach pioneered by Kozicki and Tinsley (2001) by modeling consistently long-run inflation expectations simultaneously with the term structure. Application to the U.S. economy shows the importance of long-run inflation expectations in the modeling of long-term bond yields. The paper also provides a macroeconomic interpretation for the latent factors found in standard finance models of the yield curve: the level factor represents the long-run inflation expectation of agents; the slope factor captures business cycle conditions; and the curvature factor expresses a clear independent monetary policy factor.

Taylor Rules and the Deutschmark-Dollar Real Exchange Rate

Abstract: We explore the link between an interest rate rule for monetary policy and the behavior of the real exchange rate. The interest rate rule, in conjunction with some standard assumptions, implies that the deviation of the real exchange rate from its steady state depends on the present value of a weighted sum of inflation and output gap differentials. The weights are functions of the parameters of the interest rate rule. An initial look at German data yields some support for the model.

Is There a Cost Channel of Monetary Policy Transmission? An Investigation into the Pricing Behavior of 2,000 Firms

Abstract: The paper exploits a unique panel, covering some 2,000 Italian manufacturing firms and 14 years of data on individual prices and individual interest rates paid on several types of debt, to address the question of the existence of a channel of transmission of monetary policy operating through the effect of interest expenses on the marginal cost of production. It has been argued that this mechanism may explain the dimension of the real effects of monetary policy, give a rationale for the positive short-run response of prices to interest rate increases (the “price puzzle”) and call for a more gradual monetary policy response to shocks. We find robust evidence in favor of the presence of a cost channel of monetary policy transmission, proportional to the amount of working capital held by each firm. The channel is large enough to have non-trivial monetary policy implications.

Have Increases in Federal Reserve Transparency Improved Private Sector Interest Rate Forecasts

Abstract: Yes. This paper shows that, since the late 1980s, U.S. financial markets and private sector forecasters have become (1) better able to forecast the federal funds rate at horizons out to several months, (2) less surprised by Federal Reserve announcements, (3) more certain of their interest rate forecasts ex ante, as measured by interest rate options, and (4) less diverse in the cross-sectional variety of their interest rate forecasts. We also present evidence that strongly suggests increases in Federal Reserve transparency played a role: for example, private sector forecasts of GDP and inflation have not experienced similar improvements over the same period, indicating that the improvement in interest rate forecasts has been special.

Has U.S. Monetary Policy Changed? Evidence from Drifting Coefficients and Real-Time Data

Abstract: Despite the large amount of empirical research on monetary policy rules, there is surprisingly little consensus on the nature or even the existence of changes in the conduct of U.S. monetary policy. Three issues appear central to this disagreement: (1) the specific type of changes in the policy coefficients, (2) the treatment of heteroskedasticity, and (3) the real-time nature of the data used. This paper addresses these issues in the context of forwardlooking Taylor rules with drifting coefficients. The estimation is based on real-time data and accounts for the presence of heteroskedasticity in the policy shock. The findings suggest important but gradual changes in the rule coefficients, not adequately captured by the usual split-sample estimation. In contrast to Orphanides (2002, 2003), I find that the Fed's response to the real-time forecast of inflation was weak in the second half of the 1970s, perhaps not satisfying Taylor's principle as suggested by Clarida, Gali, and Gertler (2000). However, the response to inflation was strong before 1973 and gradually regained strength from the early 1980s onward. Moreover, as in Orphanides (2003), the Fed's response to real activity fell substantially and lastingly during the 1970s.

Is the Exchange Rate a Shock Absorber or a Source of Shocks? New Empirical Evidence

Abstract: This paper analyses the role of the real exchange rate in a structural vector autoregression framework for the United Kingdom, Euro area, Japan, and Canada vis-a´-vis the United States. A new identification strategy is proposed building on sign restrictions. The results are compared to the benchmark conventional approach of Clarida and Gali (1994) based on longrun zero restrictions. Although the restrictions are derived from the same theoretical model, the results are strikingly different. In contrast to the benchmark model, an important role for nominal shocks in explaining real exchange rate fluctuations is found. Hence, the exchange rate can rather be considered as a source of shocks instead of a shock absorber.

Disagreement and Biases in Inflation Expectations

Abstract: Empirical work documents substantial disagreement in inflation expectations obtained from survey data. Furthermore, the extent of such disagreement varies systematically over time in a way that reflects the level and variance of current inflation. This paper oers a simple explanation for these facts based on asymmetries in the forecasters’ costs of over- and under-predicting inflation. Our model implies biased forecasts with positive serial correlation in forecast errors and a cross-sectional dispersion that rises with the level and the variance of the inflation rate. It also implies that forecast errors at dierent horizons can be predicted through the spread between the short- and long-term variance of inflation. We find empirically that these patterns are present in inflation forecasts from the Survey of Professional Forecasters. A constant bias component, not explained by asymmetric loss and rational expectations, is required to explain the shift in the sign of the bias observed for a substantial portion of forecasters around 1982.

Performance Changes Around Bank Mergers: Revenue Enhancements versus Cost Reductions

Abstract: This paper examines operating performance around commercial bank mergers. We find that industry-adjusted operating performance of merged banks increases significantly after the merger, large bank mergers produce greater performance gains than small bank mergers, activity focusing mergers produce greater performance gains than activity diversifying mergers, geographically focusing mergers produce greater performance gains than geographically diversifying mergers, and performance gains are larger after the implementation of nationwide banking in 1997. Further, we find improved performance is the result of both revenue enhancements and cost reduction activities. However, revenue enhancements are most significant in those mergers that also experience reduced costs.

Deregulation, Consolidation, and Efficiency: Evidence from the Spanish Insurance Industry

Abstract: This paper provides new information on the effects of deregulation and consolidation in financial services markets by analyzing the Spanish insurance industry. The sample period 1989-98 spans the introduction of the European Union's (EU) Third Generation Insurance Directives, which deregulated the EU insurance market. Deregulation has led to dramatic changes in the Spanish insurance market; the number of firms declined by 35%, average firm size increased by 275%, and unit prices declined significantly in both life and non-life insurance. We analyze the causes and effects of consolidation using modern frontier efficiency analysis to estimate cost, technical, and allocative efficiency, as well as using Malmquist analysis to measure total factor productivity (TFP) change. The results show that many small, inefficient, and financially underperforming firms were eliminated from the market due to insolvency or liquidation. As a result, the market experienced significant growth in TFP over the sample period. Consolidation not only reduced the number of firms operating with increasing returns to scale but also increased the number operating with decreasing returns to scale. Hence, many large firms should focus on improving efficiency by adopting best practices rather than on further growth.

The Deflation Bias and Committing to Being Irresponsible

Abstract: I model deflation, at zero nominal interest rate, in a microfounded general equilibrium model. I show that one can analyze deflation as a credibility problem if three conditions are satisfied. First: The government's only policy instrument is increasing the money supply by open market operations in short-term bonds. Second: The economy is subject to large negative demand shocks. Third: The government cannot commit to future policy. I call the credibility problem that arises under these conditions the deflation bias. I propose several policies to solve it. They all involve printing money or issuing nominal debt. In addition they require cutting taxes, buying real assets such as stocks, or purchasing foreign exchange. The government "credibly commits to being irresponsible" by pursuing these policies. It commits to higher money supply in the future so that the private sector expects inflation instead of deflation. This is optimal since it curbs deflation and increases output by lowering the real rate of return.

Consumers' Use of Debit Cards: Patterns, Preferences, and Price Response

Abstract: Debit card use at the point of sale has grown dramatically in recent years in the United States and now exceeds the number of credit card transactions. However, many questions remain regarding patterns of debit card use, consumer preferences when using debit, and how consumers might respond to explicit pricing of card transactions. Using a new nationally representative consumer survey, this paper describes the current use of debit cards by U.S. consumers, including how demographics affect use. In addition, consumers' stated reasons for using debit cards are used to analyze how consumers substitute between debit and other payment instruments. We also examine the relationship between household financial conditions and payment choice. Finally, we use a key variable on bank-imposed transaction fees to analyze price sensitivity of card use, and find a 12% decline in overall use in reaction to a mean 1.8% fee charged on certain debit card transactions; we believe this represents the first microeconomic evidence in the United States on price sensitivity for a card payment at the point of sale.

Does Political Instability Lead to Higher Inflation? A Panel Data Analysis

Abstract: Economists generally accept the proposition that high inflation rates generate inefficiencies that reduce society's welfare and economic growth. However, determining the causes of the worldwide diversity of inflationary experiences is an important challenge not yet satisfactorily confronted by the profession. Based on a dataset covering around 100 countries for the period 1960–99 and using modern panel data econometric techniques to control for endogeneity, this paper shows that a higher degree of political instability is associated with higher inflation. The paper also draws relevant policy implications for the optimal design of inflation stabilization programs and of the institutions favorable to price stability.

The Effect of Government Spending on Private Consumption: A Puzzle?

Abstract: The empirical finding that cyclical changes in government spending tend to be associated with positive responses of private consumption has been interpreted as a challenge for representative agent intertemporal optimizing theories, which usually imply that the negative wealth effect of higher fiscal spending reduces the households' consumption and leisure. The present paper shows that the evidence can be explained by a standard real business cycle type model. With a nonadditively separable utility function and a small intertemporal consumption elasticity, higher fiscal spending can raise consumption and lower investment, as in the data. The nonseparable utility model is shown to imply the same consumption Euler equation as a model with "rule-of-thumb" consumers who mechanically spend their income.

Technical Trading-Rule Profitability, Data Snooping, and Reality Check: Evidence from the Foreign Exchange Market

Abstract: We report evidence on the profitability and statistical significance among 2,127 technical trading rules. The best rules are found to be significantly profitable based on standard tests. We then employ White’s (2000) Reality Check to evaluate these rules and find that data-snooping biases do not change the basic conclusions for the full sample. A sub-sample analysis indicates that the data-snooping problem is more serious in the second half of the sample. Profitability becomes much weaker in the more recent period, suggesting that the foreign exchange market becomes more efficient over time. Evidence from cross exchange rates confirms the basic findings.

Lessons from the JMCB Archive

Abstract: We examine the online archive of the Journal of Money, Credit, and Banking, in which an author is required to deposit the data and code that replicate the results of his paper. We find that most authors do not fulfill this requirement. Of more than 150 empirical articles, fewer than 15 could be replicated. Despite all this, there is no doubt that a data/code archive is more conducive to replicable research than the alternatives. We make recommendations to improve the functioning of the archive.

A Quantitative Comparison of Sticky-Price and Sticky-Information Models of Price Setting

Abstract: I estimate sticky-price and sticky-information models of price setting for the United States via maximum-likelihood techniques, reaching several conclusions. First, the sticky-price model fits best, and captures inflation dynamics as well as reduced-form equations once hybrid-behavior is allowed. Second, the importance of hybrid behavior in sticky-price models is potentially consistent with a role for some information imperfections, such as sticky information, as a complement to nominal price rigidities. Finally, the favorable results herein for the hybrid sticky-price model when evaluated by statistics that summarize the relative fit of different models is consistent with the existing literature that is both supportive and dismissive of such models, as this literature has largely ignored fit in evaluating such models. Many previous studies have focused on ancillary issues, such as the standard errors associated with certain parameters or Granger-causality tests that may not provide much information about sticky-price models.

Fleshing out the Monetary Transmission Mechanism: Output Composition and the Role of Financial Frictions

Abstract: Financial frictions affect the way in which different macroeconomic series respond to a monetary policy shock. We embed the financial accelerator of Bernanke, Gertler, and Gilchrist (1999) into a medium-scale DSGE model and evaluate the relative importance of financial frictions in explaining monetary transmission. Specifically, we apply minimum distance estimation based on impulse responses for the Volcker-Greenspan period. Apart from providing estimates for structural parameters, our procedure lends itself for specification tests that can be used to assess the relative fit of various restricted models. Financial frictions turn out to be of lesser importance for the descriptive success of our model.

Loan Collateral Decisions and Corporate Borrowing Costs

Abstract: We examine the relation between borrowing costs and the presence of loan collateral. We find the presence of collateral increases with default risk, consistent with low quality borrowers reducing their risks and borrowing costs through the use of collateral. By explicitly controlling for the interdependence between the decision to pledge collateral and borrowing costs, we find that secured loans have predicted spreads substantially lower than if they had been made on an unsecured basis. Alternatively, loans made on an unsecured basis have spreads not substantially different from if they had been secured. The evidence suggests that collateral pledging decisions are generally consistent with borrowing cost minimization.

The daily market for funds in Europe: what has changed with the EMU?

Abstract: This paper shows that the existence of deposit and lending facilities combined with an averaging provision for the reserve requirement are powerful tools to stabilize the overnight rate. We reach this conclusion by comparing the behavior of this rate in Germany before and after the start of the EMU. The analysis of the German experience allows us to isolate the effects on the overnight rate of these particular instruments of monetary policy. To illustrate that this outcome is a general conclusion and not a particular result of the German market, we develop a theoretical model of reserve management, which is able to reproduce our empirical findings.

Corporate investment with financial constraints: Sensitivity of investment to funds from voluntary asset sales

Abstract: We examine the importance of financial constraints for firm investment by looking at the relationship between investment expenditures and proceeds from voluntary asset sales. Asset sales provide a cleaner indicator of liquidity than cash flows since it appears not to be positively correlated with investment opportunities. The cross-sectional differences in firm investment are examined using an endogenous switching regression model with unknown sample separation. We find that cash obtained from asset sales is a significant determinant of corporate investment and that the sensitivity of investment to proceeds from asset sales is significantly stronger for firms that are likely to be financially constrained.

A Small-Sample Study of the New-Keynesian Macro Model

Abstract: This paper presents a small-sample study of the three-equation-three variable New-Keynesian macro model. While the point estimates imply that the Fed has been stabilizing inflation fluctuations since 1980, our econometric analysis suggests considerable uncertainty regarding the stance of the Fed against inflation. The canonical New-Keynesian macro model is strongly rejected by the likelihood ratio test, but we propose the direction in which it needs to be modified in order to fit the data.

Additional Evidence of Long-Run Purchasing Power Parity with Restricted Structural Change

Abstract: We investigate two alternative versions of Purchasing Power Parity (PPP): reversion to a constant mean in the spirit of Cassel and reversion to a constant trend in the spirit of Balassa and Samuelson, using long-span real exchange rate data for industrialized countries. We develop unit root tests that both account for structural change and maintain a long-run mean or trend. With conventional tests, previous research finds evidence of some variant of PPP for 9 of the 16 countries. With the unit root tests in the presence of restricted structural change, we find evidence of PPP for five additional countries.

Capital and Risk: New Evidence on Implications of Large Operational Losses

Abstract: Operational risk is currently receiving significant media attention, as financial scandals have appeared regularly and multiple events have exceeded one billion dollars in impact. Regulators have also been devoting attention to this risk and are finalizing proposals that would require banks to hold capital for potential operational losses. This paper uses newly available loss data to model operational risk at internationally active banks. Our results suggest that the amount of capital held for operational risk will often exceed capital held for market risk and that the largest banks could choose to allocate several billion dollars in capital to operational risk.