Working papers from the Federal Reserve Bank of Dallas are preliminary drafts circulated for professional comment.

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2011 Working Papers

1112
Experimental Evidence on Rational Inattention
Anton Cheremukhin, Anna Popova and Antonella Tutino
Abstract: We show that rational inattention theory of Sims (2003) provides a rationalization of choice models à la Luce and gives a structural interpretation to probability curvature parameters as reflecting costs of processing information. We use data from a behavioral experiment to show that people behave according to predictions of the theory. We estimate attitudes to risk and costs of information for individual participants and document overwhelming heterogeneity in these parameters among a relatively homogeneous sample of people. We characterize, both theoretically and empirically, the aggregation biases this heterogeneity implies and find these biases to be substantial.

1111
Monetary Policy, Financial Stability, and the Distribution of Risk
Evan F. Koenig
Abstract: In an economy in which debt obligations are fixed in nominal terms, but there are otherwise no nominal rigidities, a monetary policy that targets inflation inefficiently concentrates risk, tending to increase the financial distress that accompanies adverse real shocks. Nominal-income targeting spreads risk more evenly across borrowers and lenders, reproducing the equilibrium that one would observe if there were perfect capital markets. Empirically, inflation surprises have no independent influence on measures of financial strain once one controls for shocks to nominal GDP.

1110
Financial Literacy and Mortgage Equity Withdrawals
John V. Duca and Anil Kumar
Abstract: The recent U.S. consumption boom and the subsequent surge in mortgage defaults have been linked to mortgage equity withdrawals (MEWs). MEWs are correlated with covariates consistent with a permanent income framework augmented for credit-constraints. Nevertheless, many households are financially illiterate. We assess the unexplored linkages between “active MEW” and measures of financial literacy using panel data from the Health and Retirement Study (HRS). Findings indicate that declines in mortgage interest rates encouraged MEWs. Nevertheless, financially illiterate households were significantly more likely to withdraw housing equity via traditional first or second mortgages (including cash-out mortgage refinancings but not home equity loans). We find that the financially less savvy are 3–5 percentage points more likely to engage in this type of MEW relative to those who answered financial literacy questions correctly. Also significant were state differences in debtor versus creditor interests in bankruptcy, with loan demand effects outweighing loan supply effects across states.

1109
Trends in Poverty and Inequality among Hispanics
Pia Orrenius and Madeline Zavodny
Abstract: Since the 1970s, the poverty rate has remained largely unchanged among Hispanics but has declined among non-Hispanic whites and blacks, particularly before the onset of the recent recession. The influx of large numbers of immigrants partially explains why poverty rates have not fallen over time among Hispanics. In 2009, Hispanics were more than twice as likely to be poor than non-Hispanic whites. Lower average English ability, low levels of educational attainment, part-time employment, the youthfulness of Hispanic household heads, and the 2007–09 recession are important factors that have pushed up the Hispanic poverty rate relative to non-Hispanic whites. In addition, income inequality is greater among Hispanics than among non-Hispanic whites, although lower than among non-Hispanic blacks. Income inequality is lower among foreign-born Hispanics than among Hispanic natives.

1108
Factors Behind the Convergence of Economic Performance Across U.S. States
Keith R. Phillips, James Nordlund and Roberto Coronado
Abstract: The rolling recessions of the 1970s and 1980s were characterized by industry and region specific shocks that led to large dispersions in the economic performance of regions across the U.S. The 1970s were primarily impacted by sharply rising energy prices that hit the manufacturing states hard while stimulating growth in the energy states. The 1980s began with declines in the Farm Belt, followed by declines in the Energy Belt, the Rust (manufacturing) Belt, and finally, due to declines in defense spending, a decline in the Gun Belt. Simple measures of regional dispersion such as the population-weighted variance of job growth across states show that the economic dispersion was historically high during these two decades. The 1990s saw a continuous decline in regional economic dispersion and the 2000s has seen historically low levels of dispersion. Perhaps the biggest surprise this decade has been the low levels of dispersion of economic performance over the past several years given the significant energy price shocks and the depth of the national economic recession. In this paper, we look at the likely causes of economic dispersion across regions and test for the major influences both in the rise of dispersion in the 1970s and 1980s and the subsequent fall in the 1990s and 2000s. Major factors that we test include state industrial structure, oil price shocks and bank integration.

1107
The Impact of the Maquiladora Industry on U.S. Border Cities
Jesús Cañas, Roberto Coronado, Robert W. Gilmer and Eduardo Saucedo
Abstract: For decades, the maquiladora industry has been a major economic engine along the U.S.–Mexico border. Since the 1970s, researchers have analyzed how the maquiladora industry affects cities along both sides of the border. Gordon Hanson (2001) produced the first comprehensive study on the impact of the maquiladoras on U.S. border cities, considering the impact of these in-bond plants on both employment and wages. His estimates became useful rules of thumb for the entire U.S.–Mexico border. These estimates have become dated, as Hanson's study covered the period from 1975 to 1997. The purpose of this paper is to update Hanson's results using data from 1990 to 2006 and to extend the estimates to specific border cities. For the border region as a whole, we find that the impact of a 10 percent increase in maquiladora production leads to a 0.5 to 0.9 percent change in employment. However, we also find that the border average is quite misleading, with large differences among individual border cities. Cities along the Texas–Mexico border benefit the most from growing maquiladora production. We also estimate the cross-border maquiladora impacts before and after 2001 when border security begins to rise, the maquiladora industry entered a severe recession and extensive restructuring and global low-wage competition intensified as China joined the World Trade Organization. Empirical results indicate that U.S. border cities are less responsive to growth in maquiladora production from 2001 to 2006 than in the earlier period; however, when looking into specific sectors, we find that U.S. border city employment in service sectors are far more responsive post-2001.

1106
Offshoring and Volatility: More Evidence from Mexico's Maquiladora Industry
Roberto A. Coronado
Abstract: In recent papers, Bergin, Feenstra, and Hanson (2007 and 2009, hereafter BFH) analyze the impact that offshoring has in employment and output volatility, particularly on the Mexican maquiladora industry. Their empirical results indicate that employment and output in the offshoring manufacturing plants in Mexico are more volatile than their counterparts in the U.S. Such empirical results suggest that the maquiladora industry (offshoring) can help the U.S. industrial sector to better absorb shocks. In this paper, I expand BFH's empirical analysis in different directions. The empirical results I provide here suggest that the volatility in employment and output in Mexico's maquiladoras is greater than the one estimated by BFH. Therefore, offshoring via the maquiladora industry in Mexico can act as a greater cushion for business cycle fluctuations in the U.S.

1105
Did Residential Electricity Rates Fall After Retail Competition? A Dynamic Panel Analysis
Adam Swadley and Mine Yücel
Abstract: A key selling point for the restructuring of electricity markets was the promise of lower prices, that competition among independent power suppliers would lower electricity prices to retail customers. There is not much consensus in earlier studies on the effects of electricity deregulation, particularly for residential customers. Part of the reason for not finding a consistent link with deregulation and lower prices was that the removal of the transitional price caps led to higher prices. In addition, the timing of the removal of price caps coincided with rising fuel prices, which were passed on to consumers in a competitive market. Using a dynamic panel model, we analyze the effect of participation rates, fuel costs, market size, a rate cap and a switch to competition for 16 states and the District of Columbia. We find that an increase in participation rates, price controls, a larger market, and high shares of hydro in electricity generation lower retail prices, while increases in natural gas and coal prices increase rates. The effects of a competitive retail electricity market are mixed across states, but generally appear to lower prices in states with high participation and raise prices in states that have little customer participation.

1104
Shifting Credit Standards and the Boom and Bust in U.S. House Prices
John V. Duca, John Muellbauer and Anthony Murphy
Abstract: The U.S. house price boom has been linked to an unsustainable easing of mortgage credit standards. However, standard time series models of U.S. house prices omit credit constraints and perform poorly in the 2000s. We incorporate data on credit constraints for first-time buyers into a model of U.S. house prices based on the (inverted) demand for housing services. The model yields not only a stable long-run cointegrating relationship, a reasonable speed of adjustment, plausible income and price elasticities and an improved fit, but also sensible estimates of tax credit effects and the possible bottom in real house prices.

1103
House Prices and Credit Constraints: Making Sense of the U.S. Experience
John V. Duca, John Muellbauer and Anthony Murphy
Abstract: Most U.S. house price models break down in the mid-2000s due to the omission of exogenous changes in mortgage credit supply (associated with the subprime mortgage boom) from house price-to-rent ratio and inverted housing demand models. Previous models lack data on credit constraints facing first-time homebuyers. Incorporating a measure of credit conditions—the cyclically adjusted loan-to-value ratio for first-time buyers—into house price-to-rent ratio models yields stable long-run relationships, more precisely estimated effects, reasonable speeds of adjustment and improved model fits.

1102
Labor Matching: Putting the Pieces Together
Anton A. Cheremukhin
Abstract: The original Mortensen–Pissarides model possesses two elements that are absent from the commonly used simplified version: the job destruction margin and training costs. I find that these two elements enable a model driven by a single aggregate shock to simultaneously explain most movements involving unemployment, vacancies, job destruction, job creation, the job finding rate and wages. The job destruction margin's role in propagating aggregate shocks is to create an additional pool of unemployed at the onset of a recession. The role of training costs is to explain the simultaneous decline in vacancies and slow response of job creation.

1101
Did the Commercial Paper Funding Facility Prevent a Great Depression-Style Money Market Meltdown?
John V. Duca
Abstract: This paper analyzes how risk premia—and other factors affecting the comparative advantages of security-funded versus deposit-funded short-run debt—altered the relative use of debt funded by securities markets since the early-1960s and the relative use of commercial paper during the recent financial crisis. Results indicate that lower risk premia, higher information costs, and reserve requirement costs induce less relative use of commercial paper and short-run debt funded by securities markets. This paper also finds that Federal Reserve interventions in the money market helped prevent the commercial paper market from melting down to the extent seen during the early 1930s.