Working papers

No. 2419
An Anatomy of U.S. Establishments’ Trade Linkages in Global Value Chains
Aaron Flaaen, Fariha Kamal, Eunhee Lee and Kei-Mu Yi
Abstract: Global value chains (GVC) are a pervasive feature of modern production, but they are hard to measure. Using U.S. Census microdata, we develop novel measures of the linkages between U.S. manufacturing establishments’ imports and exports. We document three new GVC patterns. First, for every dollar of exports, imported inputs represent 13 cents in 2002 and 20 cents by 2017, substantially higher than what aggregate data suggests. Second, we find strong complementarities between input and output markets reflected in “round-trip” trade linkages where an establishment sources inputs from and exports output to the same country. Third, we find a strong positive association between regional trade agreements and GVC trade flows. The aggregate data used to build global input-output tables requires proportionality assumptions that we find mute these relationships. Finally, with a global firms model, we show that the roundtrip results are consistent with a notion of country-specific fixed costs that are at least partially common between sourcing (imports) and foreign sales (exports).

DOI: https://doi.org/10.24149/wp2419

No. 2418
Structural Change in Sub-Saharan Africa: An Open Economy Perspective
Gaaitzen de Vries, Hagen Kruse, Emmanuel Mensah, Yabo Vidogbena and Kei-Mu Yi
Abstract: We study the evolution of manufacturing value added shares in 11 sub-Saharan African (SSA) countries through the lens of an open economy model of structural change. Our analysis leverages recent developments in input-output tables in SSA countries. Our model allows for income effects via non-homothetic preferences, substitution and relative price effects, as well as comparative advantage and specialization effects. We calibrate our model to include each SSA country with nine other major economies for each year between 2000 and 2018. We also do a similar set of calibrations for 11 developing Asian (DA) countries. Our main results are that domestic and foreign sectoral TFP are important drivers of structural change. Trade integration over time plays only a small role. However, trade is important as a transmission mechanism of foreign productivity trends. Finally, the drivers and mechanisms of industrialization are broadly similar in low-income SSA and DA countries.

DOI: https://doi.org/10.24149/wp2418

No. 2417
Gender Gaps in the Federal Reserve System
Deepa D. Datta and Nitzan Tzur-Ilan
Abstract: To better understand the stalled progress of women in economics, we construct new data on women’s representation and research output in one of the largest policy institutions—the Federal Reserve System. We document a slight increase in women’s representation over the past 20 years, in line with academic trends. We also document a significant gender gap in research output, especially for years in which economists have greater domestic responsibilities, but nearly absent gender gaps in policy output and career progression. This work complements existing research on women in academia, allowing a more comprehensive examination of progress in the economics profession.

DOI: https://doi.org/10.24149/wp2417

No. 2416
Real Exchange Rates and the Global Financial Cycle
Appendix
J. Scott Davis and Andrei Zlate
Abstract: This paper looks at the effect of fluctuations in the global financial cycle on real exchange rates (RER). We show that, on average, a downturn in the global financial cycle leads to RER depreciation relative to the U.S. dollar. However, quantitatively there is considerable heterogeneity in the RER responses among advanced, emerging and developing economies; between net creditor and net debtor countries; and also over time. Prior to 2007, the global financial cycle had less effect on advanced than on emerging market economies' RER, whereas post-2007 the effect was about the same in the two groups of countries. Finally, we decompose the RER changes into changes in the nominal exchange rate and changes in aggregate price levels. We find that in advanced economies, nearly all RER adjustment occurred through nominal exchange rates throughout the sample period. In the emerging and developing economies, the RER adjustment was mixed prior to 2007, when changes in the RER were driven by both nominal exchange rate changes and inflation differentials, whereas nominal exchange rate adjustments dominated post-2007.

DOI: https://doi.org/10.24149/wp2416
Appendix DOI: https://doi.org/10.24149/wp2416app

No. 2415
The Problem of Quality Change in Historical Price Statistics: An Illustrative Example Using Baedeker Travel Guides
Jarod Coulter, Braden Strackman and Mark A. Wynne
Abstract: The problem of accurately measuring inflation in the face of constant improvement in the quality of goods is a long-standing one in economics. This paper uses a novel dataset on the prices of the travel guidebooks published by the German publishing house Baedeker between 1832 and 1944 to construct a hedonic price index for guidebooks. Comparing these indexes to the list prices of these guidebooks, we show that the failure to adjust for improvements in the quality of the guidebooks over time imparts a substantial upward bias to measured inflation. For example, for German-language guidebooks, nominal prices increased 76 percentage points more than quality-adjusted prices between 1843–1913, suggesting an average upward bias over this period of 1.1 percentage points a year. Similarly, we find substantial average upwards bias of 1.5 and 1.7 percentage points a year for French-language guidebooks over 1859–1913 and English-language guidebooks over 1868–1913, respectively.

DOI: https://doi.org/10.24149/wp2415

No. 2414
Nonparametric Local Projections
Sílvia Gonçalves, Ana María Herrera, Lutz Kilian and Elena Pesavento
Abstract: Nonlinearities play an increasingly important role in applied work when studying the responses of macroeconomic aggregates to policy shocks. Seemingly natural adaptations of the popular local linear projection estimator to nonlinear settings may fail to recover the population responses of interest. In this paper we study the properties of an alternative nonparametric local projection estimator of the conditional and unconditional responses of an outcome variable to an observed identified shock. We discuss alternative ways of implementing this estimator and how to allow for data-dependent tuning parameters. Our results are based on data generating processes that involve, respectively, nonlinearly transformed regressors, state-dependent coefficients and nonlinear interactions between shocks and state variables. Monte Carlo simulations show that a local-linear specification of the estimator tends to work well in reasonably large samples and is robust to nonlinearities of unknown form.

DOI: https://doi.org/10.24149/wp2414

No. 2413
Labor Market Effects of Worker- and Employer-Targeted Immigration Enforcement
Pia M. Orrenius, Madeline Zavodny and Chloe Smith
Abstract: Hiring someone who is not authorized to work in the United States is illegal, and employers who knowingly hire unauthorized immigrant workers may face civil and criminal penalties. The federal government uses a variety of actions, including worksite raids and paperwork audits, to enforce the prohibition on hiring unauthorized workers. Compliance costs and the possibility of becoming the target of an immigration enforcement action may affect U.S. businesses’ decisions about whom to hire as well as how many workers to employ and how much to pay them, but little previous research has studied such potential impacts. We find that increases in worksite enforcement actions in an industry raise employment but reduce the average wage. Enforcement also boosts both hires and separations, so worker turnover rises. Actions that target employers—audits, investigations, fines and criminal charges—have larger effects than raids, which target workers. The results are consistent with businesses shifting to on-the-books or legal workers when immigration enforcement activity increases. However, tougher enforcement does not lead to an increase in business sign-ups in E-Verify or IMAGE, which are two federal government programs that can help businesses determine whether workers are authorized. This suggests that, even in the face of tougher enforcement, employers find it costly to use programs that check workers’ employment eligibility.

DOI: https://doi.org/10.24149/wp2413

No. 2412
Monetary Policy Interactions: The Policy Rate, Asset Purchases and Optimal Policy with an Interest Rate Peg
Appendix
Isabel Gödl-Hanisch, Ronald Mau and Jonathan Rawls
Abstract: We study monetary policy in a New Keynesian model with a variable credit spread and scope for central bank asset purchases to matter. A novel financial and labor market interaction generates an endogenous cost-push channel in the Phillips curve and a credit wedge in the IS curve. These channels arise due to a liquidity premium to long-term debt present in our model. The “divine coincidence” holds with the nominal short rate and central bank balance sheet available as policy tools—dual-instrument policy. Targeting the liquidity premium using balance sheet policy provides a determinate equilibrium with a fixed policy rate, as does inflation-targeting balance sheet policy. While the liquidity premium in our model depends on unobservable components, the slope of the yield curve serves as a proxy for the liquidity premium when thinking about implementable monetary policy strategies that respond to observable variables alone. We quantify the welfare costs to various monetary policy strategies relative to the analytically derived optimal dual-instrument policy.

DOI: https://doi.org/10.24149/wp2412
Appendix DOI: https://doi.org/10.24149/wp2412app

No. 2411
Do Human Capital Adjustments Protect Youths from Structural Change?
Tucker Smith
Abstract: Structural changes to labor demand can have lasting consequences on the employment and earnings of workers in affected industries and geographies. However, individuals coming of age may avoid similar fates if they internalize salient changes to the returns to education and adjust their human capital investments. This paper studies the effects of exposure to structural labor demand shocks during youth and adolescence on human capital accumulation and later-life earnings. I use student-level administrative data from Texas and a modified difference-in-differences design that compares changes in outcomes across cohorts of students living in areas that were more or less exposed to Chinese import competition. Students exposed to larger shocks were 4% more likely to enroll in college and 8% more likely to earn a bachelor’s degree. I provide evidence that these adjustments, along with shifts of fields of study away from those directly exposed to import competition in both high school and college, shielded students from more than 90% of the shock’s negative effects on later-life earnings. My results contribute a silver lining to the gloomy findings of prior work on the long-term effects of “the China shock” and other negative labor demand shocks: if individuals coming of age sufficiently adjust their human capital investments, they can emerge relatively unscathed.

DOI: https://doi.org/10.24149/wp2411

No. 2410
What Imports to Import Prices?
Enrique Martínez García and Braden W. Strackman
Abstract: This study offers new insights into exchange rate pass-through (ERPT) using U.S. import price indexes by country-of-origin, covering two decades of monthly data. Focusing on the largest U.S. trading partners, our analysis shows that ERPT is more muted than previously estimated, with freight costs having no measurable impact on import prices and foreign production costs exerting only limited influence. We also observe significant heterogeneity in countries’ short-run responses, shaped by differences in trade composition and pricing strategies. Consistent estimates across common dynamic panel estimators underscore the robustness of these findings. The results suggest that exchange rate fluctuations may have a weaker direct effect on U.S. inflation than earlier studies implied, underscoring the need to reconsider current models of pricing behavior and inflation dynamics.

DOI: https://doi.org/10.24149/wp2410

No. 2409
The Macroeconomics of Labor, Credit and Financial Market Imperfections
Miroslav Gabrovski, Ioannis Kospentaris and Lucie Lebeau
Abstract: An increasing share of corporate loans, a critical source of firm credit, are sold off banks’ balance sheets and actively traded in a secondary over-the-counter market. We develop a microfounded equilibrium search-theoretic model with labor, credit and financial markets to explore how this secondary loan market affects the real economy, highlighting a trade-off: while the market reduces the steady-state level of unemployment by 0.6pp, it amplifies its response to a 1% productivity drop from 3.6% to 4.3%. Secondary market frictions matter significantly: eliminating them would not only reduce unemployment by 1.2pp, but also dampen its volatility down to 2.7%.

DOI: https://doi.org/10.24149/wp2409

No. 2408
What Fuels the Volatility of Electricity Prices?
Alessio Saretto, Anastasia Shcherbakova and Jeremy Lin
Abstract: We use emergency outages of coal generators as an exogenous source of variation in the power generation stack to study how changes in marginal fuel affect real-time prices. Contrary to anecdotal evidence, we find that wholesale prices are less volatile when natural gas is on the margin more often.

DOI: https://doi.org/10.24149/wp2408

No. 2407
The Postpandemic U.S. Immigration Surge: New Facts and Inflationary Implications
Anton Cheremukhin, Sewon Hur, Ronald Mau, Karel Mertens, Alexander W. Richter and Xiaoqing Zhou
Abstract: The U.S. experienced an extraordinary postpandemic surge in unauthorized immigration. This paper combines administrative data on border encounters and immigration court records with household survey data to document two new facts about these immigrants: They tend to be hand-to-mouth consumers and low-skilled workers that complement the existing workforce. We build these features into a model with capital, household heterogeneity and population growth to study the inflationary effects of this episode. Contrary to the popular view, we find little effect on inflation, as the increase in supply was largely offset by an increase in demand.

DOI: https://doi.org/10.24149/wp2407

Globalization Institute No. 430
The Contribution of Foreign Holdings of U.S. Treasury Securities to the U.S. Long-Term Interest Rate: An Empirical Investigation of the Impact of the Zero Lower Bound
Yixiang Zhang and Enrique Martínez García
Abstract: We find empirical evidence of a possible structural break in the relationship between the foreign holdings of U.S. Treasury securities and the U.S. long-term interest rate occurring at the time when U.S. monetary policy became constrained at the zero-lower bound (ZLB). The estimated marginal effect of the foreign holdings ratio on the U.S. long-term interest rate, particularly its long-run effect, appears to have become stronger during the ZLB regime than it was before. We argue that the leading explanation of this apparent break is the nonlinearity introduced by the ZLB. Motivated by theory, we propose a flexible nonlinear specification to deal with the ZLB—a threshold single-equation error-correction model splitting the sample in two regimes, pre-ZLB and ZLB, which replaces the observed Fed Funds rate with a shadow Fed Funds rate derived from a Tobit-IV model to incorporate a broader measure of the stance of monetary policy. With this setup, we find no significant structural break in the relationship between foreign holdings and long-term rates at the ZLB. Therefore, we argue that the ZLB is a leading cause of the apparent shift in the empirical relationship. We also show that the estimated effects are not just statistically significant, but also economically significant. Through counterfactual analysis, we show that changes in China’s holdings of U.S. Treasury securities played an important role in explaining the 2004-2006 interest rate conundrum period and kept the long-term interest rate from going even lower in the recent ZLB period.

DOI: https://doi.org/10.24149/gwp430

No. 2406
Marriage Market Sorting in the U.S.
Anton Cheremukhin, Paulina Restrepo-Echavarria and Antonella Tutino
Abstract: We examine shifts in the U.S. marriage market, assessing how online dating, demographic changes and evolving societal norms influence mate choice and broader sorting trends. Using a targeted search model, we analyze mate selection based on factors such as education, age, race, income and skill. Intriguingly, despite the rise of online dating, preferences, mate choice and overall sorting patterns showed negligible change from 2008 to 2021. However, a longer historical view from 1960 to 2020 reveals a trend toward preferences for similarity, particularly concerning income, education and skills. Our findings refute two out of three potential explanations – reduced search costs and growing spatial segregation – as potential causes of these long-term shifts. In particular, we conclude that people’s capacity to process and evaluate information hasn’t improved despite technological advancements. Among the remaining demographic factors, we identify enhanced workforce participation and college attainment among women as the primary drivers of the U.S. marriage market transformation. Furthermore, we find that the corresponding changes in mate preferences and increased assortativeness by skill and education over this timeframe account for about half of the increased income inequality among households.

DOI: https://doi.org/10.24149/wp2406

No. 2405
Do Bill Shocks Induce Energy Efficiency Investments?
Corey Lang, Kevin Nakolan, David S. Rapson and Reid Taylor
Abstract: Inattention can lead to suboptimal investment in energy efficiency. We study whether electricity bill shocks draw attention to the benefits of home energy efficiency investments. Our novel identification strategy builds on the fact that prolonged extreme weather events (which raise electricity costs for many customers) fall within a single billing cycle for some customers but are split across cycles for others. We find that households exposed to average sized bill shocks are 22 percent more likely to invest in energy efficiency than households with normal bills. This result suggests that inattention is indeed a factor in residential energy decisions and utilities may be able to leverage bill shocks to promote efficiency investments.

DOI: https://doi.org/10.24149/wp2405

Globalization Institute No. 429
Xtpb: The Pooled Bewley Estimator of Long Run Relationships in Dynamic Heterogeneous Panels
Priyanka Asnani, Alexander Chudik and Braden Strackman
Codes
Abstract: This paper introduces a new Stata command, xtpb, that implements the Chudik, Pesaran and Smith (2023a) Pooled Bewley (PB) estimator of long-run relationships in dynamic heterogeneous panel-data models. The PB estimator is based on the Bewley (1979) transform of the autoregressive-distributed lag model and it is applicable under a similar setting as the widely used pooled mean group (PMG) estimator of Pesaran, Shin and Smith (1999). Two bias-correction methods and a bootstrapping algorithm for more accurate small-sample inference robust to arbitrary cross-sectional dependence of errors are also implemented. An empirical illustration reproduces the PB estimates of the consumption function as in Chudik, Pesaran and Smith (2023a).

DOI: https://doi.org/10.24149/gwp429

Globalization Institute No. 428
Deindustrialization and Industry Polarization
Michael Sposi, Kei-Mu Yi and Jing Zhang
Abstract: We add to recent evidence on deindustrialization and document a new pattern: increasing industry polarization over time. We assess whether these new features of structural change can be explained by a dynamic open economy model with two primary driving forces, sector-biased productivity growth and sectoral trade integration. We calibrate the model to the same countries used to document our patterns. We find that sector-biased productivity growth is important for deindustrialization by reducing the relative price of manufacturing to services, and sectoral trade integration is important for industry polarization through increased specialization. The interaction of these two driving forces is also essential as increased trade openness transmits global technological change to each country's relative prices, sectoral specialization and sectoral trade imbalances.

DOI: https://doi.org/10.24149/gwp428

Globalization Institute No. 427
Unequal Climate Policy in an Unequal World (Revised January 2025)
Elisa Belfiori, Daniel Carroll and Sewon Hur
Abstract: We study climate policy in an economy with heterogeneous households, two types of goods (clean and dirty), and a climate externality from the dirty good. Using household expenditure and emissions data, we document that low-income households have higher emissions per dollar spent than high-income households, making a flat carbon tax regressive. We build a model that captures this fact and study climate policies that are neutral with respect to the income distribution. We show that the constrained optimal carbon tax in a heterogeneous economy is heterogeneous: Higher-income households face a higher rate. If uniformity of the carbon tax is desired, this property must be imposed as an additional constraint. In this case, the tax is lower than the unconstrained carbon tax. Finally, we embed this model into a standard incomplete markets framework to quantify the policy effects on the economy, climate and welfare, and we find a Pareto-improving result. The uniform climate policy is welfare-improving for every household.
Original paper
DOI: https://doi.org/10.24149/gwp427r1

No. 2404
When Is the Use of Gaussian-inverse Wishart-Haar Priors Appropriate?
Atsushi Inoue and Lutz Kilian
Abstract: Several recent studies have expressed concern that the Haar prior typically employed in estimating sign-identified VAR models is driving the prior about the structural impulse responses and hence their posterior. In this paper, we provide evidence that the quantitative importance of the Haar prior for posterior inference has been overstated. How sensitive posterior inference is to the Haar prior depends on the width of the identified set of a given impulse response. We demonstrate that this width depends not only on how much the identified set is narrowed by the identifying restrictions imposed on the model, but also depends on the data through the reduced-form model parameters. Hence, the role of the Haar prior can only be assessed on a case-by-case basis. We show by example that, when the identification is sufficiently tight, posterior inference based on a Gaussian-inverse Wishart-Haar prior provides a reasonably accurate approximation.

DOI: https://doi.org/10.24149/wp2404

No. 2403
Geopolitical Oil Price Risk and Economic Fluctuations (Revised November 2024)
Lutz Kilian, Michael D. Plante and Alexander W. Richter
Abstract: This paper studies the general equilibrium effects of time-varying geopolitical risk in the oil market by simultaneously modeling downside risk from disasters, oil storage and the endogenous determination of oil price and macroeconomic uncertainty in the global economy. Notwithstanding the attention geopolitical events in oil markets have attracted, we find that geopolitical oil price risk is not a major driver of global macroeconomic fluctuations. Even when allowing for the possibility of an unprecedented 20 percent drop in global oil production, it takes a large increase in the probability of such a disaster to cause a sizable recessionary impact.
Original paper
DOI: https://doi.org/10.24149/wp2403r1

Globalization Institute No. 426
Time-varying Persistence of House Price Growth: The Role of Expectations and Credit Supply
Chi-Young Choi, Alexander Chudik and Aaron Smallwood
Abstract: High persistence is a prominent feature of price movements in U.S. housing markets, i.e., house prices grow faster this period if they grew faster last period. This paper provides two additional new insights to the literature on U.S. house price movements. First, there exists a significant time variation in the persistence of house price growth, both at the national and city level. Second, there is considerable heterogeneity in the time-varying persistence across different regions, particularly in areas that were historically less persistent, such as the capital-poor regions in the Midwest and South. This study conducts additional regression analyses to determine the main factor behind the time-varying persistence, with a particular focus on two housing demand factors: extrapolative expectations and credit supply expansion. Our results suggest that the time variation in the persistence of urban house price growth is better aligned with credit supply expansion than with extrapolative expectations. These findings remain robust even when accounting for potential endogeneity and reverse causality concerns.

DOI: https://doi.org/10.24149/gwp426

No. 2402
Texas Manufacturing Outlook Survey: Survey Methodology, Performance and Forecast Accuracy
Jesus Cañas, Aparna Jayashankar, Emily Kerr and Diego Morales-Burnett
Abstract: The Texas Manufacturing Outlook Survey (TMOS) is a monthly survey of area manufacturers conducted by the Federal Reserve Bank of Dallas. TMOS indexes provide timely information on manufacturing activity in Texas, which is useful for understanding broader changes in regional economic conditions. This paper describes the survey methodology and analyzes the explanatory and predictive power of TMOS indexes with regard to other measures of state economic activity. Regression analysis shows that several TMOS indexes successfully track changes in Texas employment, gross domestic product and consumer price index. Forecasting exercises show that several TMOS indexes are also useful in predicting future changes in some of these regional economic indicators.

DOI: https://doi.org/10.24149/wp2402

No. 2401
The Impact of the 2022 Oil Embargo and Price Cap on Russian Oil Prices (Revised January 2025)
Lutz Kilian, David Rapson and Burkhard Schipper
Abstract: This paper documents the effect of the oil embargo and price cap on Russian oil exports in the wake of the Russian invasion of Ukraine in February 2022. We show that the embargo forced Russia to accept a $32/bbl discount on its Urals crude in March 2023 relative to January 2022, nearly half of which is directly attributable to the higher cost of shipping crude oil over longer distances, as Russia diverted much of its crude oil exports to India. Based on a calibrated model of global oil supply and demand, the remainder ($17/bbl) can be explained by increased Indian bargaining power. We also provide a similar analysis for the ESPO price discount on exports to China. In contrast, the price cap deprived Russia of the financial resources it spent on assembling a “shadow” fleet of tankers, but its effect on the Russian oil export price was negligible once the adoption of the price cap had facilitated the use of Western services to transport Russian oil to Asia.
Original paper
DOI: https://doi.org/10.24149/wp2401r1

No. 2316
A Narrative Analysis of Federal Appropriations for Research and Development
Andrew J. Fieldhouse and Karel Mertens
Abstract: This paper provides a narrative analysis of postwar federal appropriations for the research and development (R&D) activities of the Department of Defense, Department of Energy, National Aeronautics and Space Administration, National Institutes of Health and National Science Foundation—five agencies that consistently account for the vast majority of federal outlays for all types of R&D. We build a novel dataset quantifying the enacted full-year appropriations for all budgetary accounts funding R&D activities at these five agencies over fiscal years 1947-2019. We use this dataset to isolate a subset of 218 “significant” changes in real appropriations for each agency, and we analyze numerous primary and secondary sources to understand the context and motivation. Based on these sources, we classify each significant change in federal R&D appropriations as either “endogenous” or “exogenous” to short-run macroeconomic developments. The exogenous changes in R&D appropriations are intended as instrumental variables for studying the causal effects of government R&D in appropriately specified empirical models.

DOI: https://doi.org/10.24149/wp2316

Globalization Institute No. 425
Exchange Rate Determination Under Limits to CIP Arbitrage (Revised September 2024, new title)
Appendix
Philippe Bacchetta, J. Scott Davis and Eric van Wincoop
Abstract: Recent theories of exchange rate determination have emphasized limited UIP arbitrage by international financial institutions. New regulations since 2008 have also led to imperfect CIP arbitrage. We show that under limited CIP arbitrage the exchange rate and CIP deviation are jointly determined by equilibrium in the FX spot and swap markets. The model is used to investigate the impact of a wide range of financial shocks. The exchange rate is affected by a new set of financial shocks that operate through the swap market, which have no effect under perfect CIP arbitrage. More familiar financial shocks that impact the spot market have an amplified effect on the exchange rate as a result of their feedback to the swap market. Implications of the model are consistent with a broad range of evidence.
Original paper
Original appendix
DOI: https://doi.org/10.24149/gwp425r1
Appendix DOI: https://doi.org/10.24149/gwp425appr1

No. 2315
Deposit Convexity, Monetary Policy and Financial Stability
Chart data
Emily Greenwald, Sam Schulhofer-Wohl and Joshua Younger
Abstract: In principle, bank deposits can be withdrawn on demand. In practice, depositors tend to maintain stable balances for long periods, allowing banks to fund long-dated assets. Nevertheless, the cost of deposit funding influences banks’ capacity for maturity transformation. Banks and researchers conventionally model the response of deposit interest rates to market interest rates as constant, implying that deposits have nearly constant duration. Contrary to this standard assumption, we show empirically that the “beta” of deposit rates to market rates increases as market rates rise, causing the duration of deposits to fall. The amount of duration risk delivered to bank balance sheets via this channel from March 2022 to September 2023 is comparable in magnitude to the amount of duration risk absorbed by each of the several large-scale asset purchase programs the Federal Reserve has undertaken since 2008. Dynamic betas present a significant challenge to bank portfolio hedgers by introducing large and dynamic risks that are difficult to model and impractical to replicate on the asset side of the balance sheet. As a result, deposit convexity amplifies monetary policy transmission and increases financial fragility, mechanisms that recent banking stresses have highlighted.

DOI: https://doi.org/10.24149/wp2315

Globalization Institute No. 424
Living Up to Expectations: The Effectiveness of Forward Guidance and Inflation Dynamics Post-Global Financial Crisis (Revised April 2025, new title)
Stephen J. Cole, Enrique Martínez García and Eric Sims
Abstract: This paper studies the effectiveness of forward guidance when central banks face private agents with heterogeneous expectations allowing for a degree of bounded rationality. Exploiting unique survey-based measures of expected inflation, output growth and interest rates, we estimate a small-scale New Keynesian model with forward guidance shocks for the United States and the other G7 countries plus Spain. We find that the share of fully-informed rational expectations (FIRE) agents in aggregate expectations is similar for the U.S., the U.K., Germany and other major advanced economies (albeit far from one); however, Japan’s share is much lower. For each country, the estimate of the share of FIRE agents has declined over time as VAR-based expectations—the heuristic approach assumed under bounded rationality—became more prominent in explaining the more recent data. Forward guidance has correspondingly grown less effective. In a counterfactual analysis, we document that, in the wake of the global financial crisis, inflation would have been significantly higher and the zero lower bound on short-term interest rates much less of a constraint had the public fully incorporated central banks’ forward guidance statements as FIRE agents do. Moreover, inflation would have declined more, and somewhat faster, in the wake of the post-COVID-19 inflation surge as well.
Original paper
DOI: https://doi.org/10.24149/gwp424r1

No. 2314
Investing in the Batteries and Vehicles of the Future: A View Through the Stock Market (Revised March 2024)
Michael Plante
Abstract: A large number of companies operating in the EV and battery supply chain have listed on a U.S. stock exchange in recent years. I compile a unique data set of high-frequency stock returns for those companies and investigate the extent to which an “industry” factor specific to the EV and battery supply chain (an “EV” factor) can explain their returns. Those returns are decomposed into systematic and idiosyncratic components, with the former given by a set of latent factors extracted from a large panel of stock returns using high-frequency principal components. It is found that a market factor and a factor associated with tech stocks have good explanatory power for the stocks of interest. I identify an “EV” factor as the first principal component of the idiosyncratic returns and find it has relatively good explanatory power for EV and battery stocks, often exceeding that of the tech factor. There is also evidence for a lithium factor that plays an important role in the returns of lithium companies.
Original paper
DOI: https://doi.org/10.24149/wp2314r1

Globalization Institute No. 423
Mean Group Distributed Lag Estimation of Impulse Response Functions in Large Panels (Revised May 2024)
Chi-Young Choi and Alexander Chudik
Abstract: This paper develops Mean Group Distributed Lag (MGDL) estimation of impulse responses of common shocks in large panels with one or two cross-section dimensions. We derive sufficient conditions for asymptotic normality, and document satisfactory small sample performance using Monte Carlo experiments. Three empirical illustrations showcase the usefulness of MGDL estimators: crude oil price pass-through to U.S. city- and product-level retail prices; retail price effects of U.S. monetary policy shocks; and house price effects of U.S. monetary policy shocks.
Original paper
DOI: https://doi.org/10.24149/gwp423r1

No. 2313
Marriage and Work Among Prime-Age Men
Adam Blandin, John Bailey Jones and Fang Yang
Abstract: Married men work substantially more hours than men who have never been married, even after controlling for observables. Panel data reveal that much of this gap is attributable to an increase in work in the years leading up to marriage. Two potential explanations for this increase are: (i) men hit by positive labor market shocks are more likely to marry; and (ii) the prospect of marriage increases men’s labor supply. We quantify the relative importance of these two channels using a structural life-cycle model of marriage and labor supply. Our calibration implies that marriage substantially increases male labor supply. Counterfactual simulations suggest that if men were unable to marry, prime-age male work hours would fall by 7%, and if marriage rates fell to the extent observed, men born around 1980 would work 2% fewer hours than men born around 1960.

DOI: https://doi.org/10.24149/wp2313

No. 2312
Oil Price Shocks and Inflation
Lutz Kilian and Xiaoqing Zhou
Abstract: Despite growing interest in the impact of oil and other energy price shocks on inflation and inflation expectations, until recently this question has not received much attention. This survey not only presents empirical results for the U.S. economy, but expands the analysis to include other major economies. We find that only in the euro area and in the U.K. energy price shocks are associated with a material increase in core consumer prices. This helps explain the somewhat more persistent response of headline inflation in these countries than in the U.S. or Canada. Inflation is even less sensitive to energy price shocks in Japan. We document that energy price shocks played a more important role in explaining headline inflation in the euro area in 2021 and 2022 than in the U.S. This does not mean that energy price shocks have de-anchored inflation expectations, however. While suitable data on long-run inflation expectations are scant, neither for the U.S. nor the U.K. is there evidence that energy price shocks have materially changed long-run inflation expectations.

DOI: https://doi.org/10.24149/wp2312

Globalization Institute No. 422
A Theory of Capital Flow Retrenchment
Appendix
J. Scott Davis and Eric van Wincoop
Abstract: The empirical literature shows that gross capital inflows and outflows both decline following a negative global shock. However, to generate a positive co-movement between gross inflows and outflows, the theoretical literature relies on asymmetric shocks across countries. We present a model where there is heterogeneity across investors within countries, but there are no asymmetries across countries. We show that a negative global shock (rise in global risk-aversion) generates an identical drop in gross inflows and outflows. The within-country heterogeneity relates to the willingness of investors to hold risky assets and foreign assets.

DOI: https://doi.org/10.24149/gwp422
Appendix DOI: https://doi.org/10.24149/gwp422app

No. 2311
High-Yield Debt Covenants and Their Real Effects
Falk Bräuning, Victoria Ivashina and Ali Ozdagli
Abstract: High-yield debt, including leveraged loans, features incurrence financial covenants or "cov-lite" provisions. These covenants differ from traditional loans' maintenance covenants, as they preserve equity control rights but impose specific restrictions on the borrower after crossing the covenant threshold. Contrary to the prevailing belief that incurrence covenants offer limited protection for creditors, our research reveals a significant and sudden decline in investment upon triggering these covenants. This evidence highlights a novel propagation mechanism for economic shocks, wherein contractual restrictions play a crucial role in the highly-leveraged corporate sector, becoming binding well before default or bankruptcy occurs.

DOI: https://doi.org/10.24149/wp2311

No. 2310
How to Construct Monthly VAR Proxies Based on Daily Futures Market Surprises
Lutz Kilian
Abstract: It is common in applied work to estimate responses of macroeconomic aggregates to news shocks derived from surprise changes in daily futures prices around the date of policy announcements. This requires mapping the daily surprises into a monthly shock that may be used as an external instrument in a monthly VAR model or local projection. The standard approach has been to sum these daily surprises over the course of a given month when constructing the monthly proxy variable, ignoring the accounting relationship between daily and average monthly price data. In this paper, I provide a new approach to constructing monthly proxies from daily surprises that takes account of this link and revisit the question of how to use OPEC announcements to identify news shocks in VAR models of the global oil market. The proposed approach calls into question the interpretation of the identified shock as oil supply news and implies quantitatively and qualitatively different estimates of the macroeconomic impact of OPEC announcements.

DOI: https://doi.org/10.24149/wp2310

No. 2309
Global Transportation Decarbonization
David Rapson and Erich Muehlegger
Abstract: A number of policy proposals call for replacing fossil fuels in the name of decarbonization, but these fuels will be difficult to replace due to their as-yet unrivaled bundle of attributes: abundance, ubiquity, energy density, transportability and cost. There is a growing commitment to electrification as the dominant decarbonization pathway for transportation. While deep electrification is promising for road vehicles in wealthy countries, it will face steep obstacles. In other sectors and in the developing world, it’s not even in pole position. Global transportation decarbonization will require decoupling emissions from economic growth, and decoupling emissions from growth will require not only new technologies, but cooperation in governance. The menu of policy options is replete with tradeoffs, particularly as the primacy of energy security and reliability (over emissions abatement) has once again been demonstrated in Europe and elsewhere.

DOI: https://doi.org/10.24149/wp2309

No. 2308
Financial Shocks in an Uncertain Economy
Chiara Scotti
Abstract: The past 15 years have been eventful. The Global Financial Crisis (GFC) reminded us of the importance of a stable financial system to a well-functioning economy, one with low and stable inflation and maximum employment. Given the recent banking stress, we ponder this issue again. The pandemic was a huge shock surrounded by much uncertainty, making precise forecasts within traditional models difficult. And more recently, there has been continuous talk of a soft landing and recession risks.

In this paper, I focus on some of the lessons we have learned over the years: (i) uncertainty and tail risk have cyclical variation; (ii) financial shocks can have a significant effect on macroeconomic outcomes; (iii) the impact of shocks is stronger in periods of high volatility.

These lessons have important implications for policymakers in today’s environment.

DOI: https://doi.org/10.24149/wp2308

No. 2307
Complementary Currencies and Liquidity: The Case of Coca-Base Money
Cristian Frasser and Lucie Lebeau
Abstract: In coca-growing villages of Colombia, where pesos are scarce, coca-base is not only used as the main input for cocaine production—it also acts as a complementary currency (CC), circulating locally as a medium of exchange for day-to-day transactions. This paper provides a clear rationale for the economically-motivated adoption of a CC in a small open economy underprovided with official currency. An equilibrium currency shortage arises endogenously in our model, whereby shocks to the local supply of currency have a real impact on local trade and welfare. We show how a CC can mitigate the underprovision of liquidity and derive general insights relating the CC’s characteristics to its ability to supplement the official currency. In an application, we quantify the unintended consequences of various anti-narcotic policies pursued by the Colombian government on liquidity provision in coca-growing villages and identify the least-harmful policy tools given the policy objectives at stake.

DOI: https://doi.org/10.24149/wp2307

Globalization Institute No. 421
On the Nexus of Monetary Policy and Financial Stability: Novel Asset Market Monitoring Tools for Building Economic Resilience and Mitigating Financial Risks
Enrique Martínez-García, Valerie Grossman and Lauren Spits
Abstract: In this note we argue that asset pricing bubbles are an important source of financial instabilities. First, the literature has tended to overlook bubbles and their consequences under the premise that they are hard to detect in real time. We suggest that novel statistical techniques allow us to overcome those prejudices as they provide valuable signals of emerging exuberance in real‐time. Second, monetary policy has been slow to recognize that financial instability arising from bubbles can have adverse effects on the transmission mechanism of monetary policy itself and on the types of risks faced by policymakers. We argue that measuring and monitoring episodes of exuberance in housing—but also in other asset classes—can be useful not just for thinking about macroprudential strategies but also to conduct risk analysis for monetary policy.

DOI: https://doi.org/10.24149/gwp421

No. 2306
Money Matters: Broad Divisia Money and the Recovery of Nominal GDP from the COVID-19 Recession
Michael D. Bordo and John V. Duca
Abstract: The rise of inflation in 2021 and 2022 surprised many macroeconomists who ignored the earlier surge in money growth because past instability in the demand for simple-sum monetary aggregates had made these aggregates unreliable indicators. We find that the demand for more theoretically-based Divisia aggregates can be modeled and that their growth rates provide useful information for future nominal GDP growth.

Unlike M2 and Divisia-M2, whose velocities do not internalize shifts in liabilities across commercial and shadow banks, the velocities of broader Divisia monetary aggregates are more stable and can be reasonably empirically modeled in both the short run and the long run through the COVID-19 pandemic and to date. In the long run, these velocities depend on regulatory changes and mutual fund costs that affect the substitutability of money for other financial assets. In the short run, we control for swings in mortgage activity and use vaccination rates and an index of the stringency of government pandemic restrictions to control for the unusual effects of the pandemic.

The velocity of broad Divisia money temporarily declines during crises like the Great and COVID Recessions, but later rebounds. In each recession monetary policy lowered short-term interest rates to zero and engaged in quantitative easing of about $4 trillion. Nevertheless, broad money growth was more robust in the COVID Recession, likely reflecting that the banking system was less impaired and could promote rather than hinder multiple deposit creation. Partly as a result, our framework implies that nominal GDP growth and inflationary pressures rebounded much more quickly from the COVID Recession versus the Great Recession. We consider different scenarios for future Divisia money growth and the unwinding of the pandemic that have different implications for medium-term nominal GDP growth and inflationary pressures as monetary policy tightening seeks to restore low inflation.

DOI: https://doi.org/10.24149/wp2306

No. 2305
The Returns to Government R&D: Evidence from U.S. Appropriations Shocks (Revised November 2024)
Appendix
Andrew J. Fieldhouse and Karel Mertens
Abstract: Based on a narrative classification of all significant postwar changes in R&D appropriations for five major federal agencies, we find that an increase in nondefense R&D appropriations leads to increases in various measures of innovative activity and higher business-sector productivity in the long run. We structurally estimate the production function elasticity of nondefense government R&D capital using the SP-IV methodology of Lewis and Mertens (2023) and obtain implied returns of 140 to 210 percent over the postwar period. The estimates indicate that government-funded R&D accounts for one-fifth of business-sector TFP growth since WWII, and imply substantial underfunding of nondefense R&D.
Revision 1
Revision 1 appendix
Original paper
Original appendix
DOI: https://doi.org/10.24149/wp2305r2
Appendix DOI: https://doi.org/10.24149/wp2305appr2

Globalization Institute No. 420
A Theory of Net Capital Flows over the Global Financial Cycle
J. Scott Davis and Eric van Wincoop
Abstract: We develop a theory to account for changes in net capital flows of safe and risky assets over the global financial cycle. We show empirically that countries that have a net debt of safe assets experience a rise in net outflows of safe assets (reduced accumulation of safe debt) during a downturn in the global financial cycle. This is accomplished through a rise in total net outflows and a drop in net outflows of risky assets. We develop a multi-country portfolio choice model that can account for these facts. The theory relies on cross-country heterogeneity in the share of an investor's portfolio invested in risky assets. A global drop in risky asset prices changes relative wealth across countries due to this heterogeneity, which leads to changes in net flows of safe and risky assets. The model is applied to 20 advanced countries and calibrated to reflect observed cross-country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for net capital flows are quantitatively consistent with the data.

DOI: https://doi.org/10.24149/gwp420

No. 2304
Estimating Macroeconomic News and Surprise Shocks (Revised March 2024, new title November 2023)
Appendix
Lutz Kilian, Michael D. Plante and Alexander W. Richter
Abstract: The importance of understanding the economic effects of TFP news and surprise shocks is widely recognized in the literature. A common VAR approach is to identify responses to TFP news shocks by maximizing the variance share of TFP over a long horizon. Under suitable conditions, this approach also implies an estimate of the surprise shock. We find that these TFP max share estimators tend to be strongly biased when applied to data generated from DSGE models with shock processes that match the TFP moments in the data, both in the presence of TFP measurement error and in its absence. Incorporating a measure of TFP news into the VAR model and adapting the identification strategy substantially reduces the bias and RMSE of the impulse response estimates, even when there is sizable measurement error in the news variable. When applying this method to the data, we find that news shocks are slower to diffuse to TFP and have a smaller effect on real activity than implied by the TFP max share method.
Revision 1
Original paper
DOI: https://doi.org/10.24149/wp2304r2
Appendix DOI: https://doi.org/10.24149/wp2304app

No. 2303
Debt Maturity and Commitment on Firm Policies
Andrea Gamba and Alessio Saretto
Abstract: If firms can issue debt only at discrete dates, debt maturity is an effective device against the commitment problem on debt and investment policies. With shorter maturities, debt dynamics are less persistent and more valuable because upward leverage adjustments are faster and long-run leverage lower. Debt maturities that are relatively shorter than asset maturities increase marginal q, and reduce underinvestment. A decomposition of the credit spread consistent with equilibrium shows that the component due to the commitment problem on future debt issuances is sizeable when leverage and default risk are low, and is lower for shorter maturity.

DOI: https://doi.org/10.24149/wp2303

No. 2302
State-Dependent Local Projections
Sílvia Gonçalves, Ana María Herrera, Lutz Kilian and Elena Pesavento
Abstract: Do state-dependent local projections asymptotically recover the population responses of macroeconomic aggregates to structural shocks? The answer to this question depends on how the state of the economy is determined and on the magnitude of the shocks. When the state is exogenous, the local projection estimator recovers the population response regardless of the shock size. When the state depends on macroeconomic shocks, as is common in empirical work, local projections only recover the conditional response to an infinitesimal shock, but not the responses to larger shocks of interest in many applications. Simulations suggest that fiscal multipliers may be off by as much as 40 percent.

DOI: https://doi.org/10.24149/wp2302

No. 2301
Heterogeneity in the Pass-Through from Oil to Gasoline Prices: A New Instrument for Estimating the Price Elasticity of Gasoline Demand
Lutz Kilian and Xiaoqing Zhou
Abstract: We propose a new instrument for estimating the price elasticity of gasoline demand that exploits systematic differences across U.S. states in the pass-through of oil price shocks to retail gasoline prices. We show that these differences are primarily driven by the cost of producing and distributing gasoline, which varies with states’ access to oil and gasoline transportation infrastructure, refinery technology and environmental regulations, creating cross-sectional gasoline price shocks in response to an aggregate oil price shock. Time-varying estimates do not support the view that the gasoline demand elasticity has declined in absolute value to near zero since the 1980s. The elasticity was stable near -0.3 until the end of 2014. It rose to about -0.2 in 2015-16, but has remained stable since 2016. Gasoline demand is more responsive in states with lower personal income, higher unemployment rates and lower urban population shares. There is no evidence for an asymmetry in the elasticity with respect to positive and negative gasoline price shocks. We illustrate how these elasticity estimates inform the recent policy debate about the impact of gasoline tax holidays on consumers’ discretionary income, about the demand destruction from the spike in gasoline prices after the invasion of Ukraine and about the impact of rising gasoline prices on carbon emissions.

DOI: https://doi.org/10.24149/wp2301

No. 2224
A Broader Perspective on the Inflationary Effects of Energy Price Shocks
Lutz Kilian and Xiaoqing Zhou
Abstract: Consumers purchase energy in many forms. Sometimes energy goods are consumed directly, for instance, in the form of gasoline used to operate a vehicle, electricity to light a home or natural gas to heat a home. At other times, the cost of energy is embodied in the prices of goods and services that consumers buy, say when purchasing an airline ticket or when buying online garden furniture made from plastic to be delivered by mail. Previous research has focused on quantifying the pass-through of the price of crude oil or the price of motor gasoline to U.S. inflation. Neither approach accounts for the fact that percent changes in refined product prices need not be proportionate to the percent change in the price of oil, that not all energy is derived from oil and that the correlation of price shocks across energy markets is far from one. This paper develops a vector autoregressive model that quantifies the joint impact of shocks to several energy prices on headline and core CPI inflation. Our analysis confirms that focusing on gasoline price shocks alone will underestimate the inflationary pressures emanating from the energy sector, but not enough to overturn the conclusion that much of the observed increase in headline inflation in 2021 and 2022 reflected non-energy price shocks.

DOI: https://doi.org/10.24149/wp2224

Globalization Institute No. 419
Commodity Exports, Financial Frictions and International Spillovers
Appendix
Romain Houssa, Jolan Mohimont and Christopher Otrok
Abstract: This paper offers a solution to the international co-movement puzzle found in open-economy macroeconomic models. We develop a small open-economy (SOE) dynamic stochastic general equilibrium (DSGE) model describing three endogenous channels that capture spillovers from the world to a commodity exporter: a world commodity price channel, a domestic commodity supply channel and a financial channel. We estimate our model with Bayesian methods on two commodity-exporting SOEs, namely Canada and South Africa. In addition to explaining international business cycle synchronization, the new model attributes an important fraction of business cycle fluctuations to foreign shocks in the SOEs.

DOI: https://doi.org/10.24149/gwp419
Appendix DOI: https://doi.org/10.24149/gwp419app

No. 2223
Macroeconomic Responses to Uncertainty Shocks: The Perils of Recursive Orderings
Lutz Kilian, Michael D. Plante and Alexander W. Richter
Abstract: A common practice in empirical macroeconomics is to examine alternative recursive orderings of the variables in structural vector autoregressive (VAR) models. When the implied impulse responses look similar, the estimates are considered trustworthy. When they do not, the estimates are used to bound the true response without directly addressing the identification challenge. A leading example of this practice is the literature on the effects of uncertainty shocks on economic activity. We prove by counterexample that this practice is invalid in general, whether the data generating process is a structural VAR model or a dynamic stochastic general equilibrium model.

DOI: https://doi.org/10.24149/wp2223

No. 2222
Why Has U.S. Stock Ownership Doubled Since the Early 1980s? Equity Participation Over the Past Half Century
John V. Duca and Mark Walker
Abstract: The U.S. stock ownership rate doubled between 1983 and 2001 but remains below predictions of some equity participation models. Consistent with calibration studies by Heaton and Lucas (2000) and Gomes and Michaelides (2005), mutual fund costs and indicators of background labor risk are significantly related to stock ownership over 1964-2019. Coefficient estimates and continuous data on driving variables can be used to create a continuous proxy for stock ownership, which could help researchers gauge the effects of shocks that are transmitted via equity participation. Typically omitted asset transfer costs can help analyze other aspects of household portfolio behavior.

DOI: https://doi.org/10.24149/wp2222

No. 2221
The Dual Beveridge Curve (Revised February 2024)
Anton Cheremukhin and Paulina Restrepo-Echavarria
Abstract: The recent behavior of the Beveridge Curve significantly differs from past recessions and is hard to explain with traditional gradual changes in fundamentals. We propose a novel dual vacancy model where we acknowledge that not all vacancies are made equal—when firms post a vacancy they can hire from unemployment or they can poach a worker from another firm. Our dual vacancy model segments the labor market into separate search processes for unemployed and employed workers and provides a better fit to the data than traditional models assuming a homogeneous market. By analyzing labor market data from 2000 onwards, we estimate the proportions of the two types of vacancies and find a significant rise in poaching vacancies since the mid-2010s. The behavior of the share of poaching vacancies is explained by the residual hires to quits ratio and by an increasing trend in the profit-cost ratio of these positions. Once we adjust the Beveridge Curve to only include vacancies for the unemployed, the recent puzzling behavior disappears. These results imply that a slowdown in the demand for overall workers is likely to have a diminished effect on unemployment, affecting the implications of monetary policy for unemployment.
Original paper
DOI: https://doi.org/10.24149/wp2221r1

Globalization Institute No. 418
Just Do IT? An Assessment of Inflation Targeting in a Global Comparative Case Study (Revised August 2024)
Roberto Duncan, Enrique Martínez García and Patricia Toledo
Abstract: This paper introduces novel measures to assess the effectiveness of inflation targeting (IT) and examines its performance across a broad sample of advanced economies (AEs) and emerging market and developing economies (EMDEs). Utilizing synthetic control methods, the study reveals heterogeneous effects of IT on inflation. The results indicate modest reductions in inflation levels, with greater gains observed in EMDEs compared to AEs. Statistically significant reductions are found in approximately one-third of the countries. However, nearly half of the economies experienced substantial improvements in stabilizing inflation near target levels under IT, relative to estimated counterfactual scenarios. IT also enhances economic resilience cushioning inflation from large external shocks, particularly during the 2007-09 Global Financial Crisis, with statistically significant gains observed in two-thirds of EMDEs. Additionally, the effectiveness of IT—both in shifting inflation levels and maintaining stability around target—is significantly correlated with indices of exchange rate stability and monetary policy independence, especially in EMDEs. These findings suggest that the performance of IT regimes is subject to the constraints imposed by the impossibility trilemma of international finance.
Original paper
DOI: https://doi.org/10.24149/gwp418r1

No. 2220
The Electric Ceiling: Limits and Costs of Full Electrification
David Rapson and James Bushnell
Abstract: Electrification is a centerpiece of global decarbonization efforts. Yet there are reasons to be skeptical of the inevitability, or at least the optimal pace, of the transition. We discuss several under-appreciated costs of full, or even deep, electrification. Consumer preferences can operate in favor of and in opposition to electrification goals; and electrification is likely to encounter physical and economic obstacles when it reaches some as-yet-unknown level. While we readily acknowledge the external benefits of decarbonization, we also explore several under-appreciated external costs. The credibility and eventual success of decarbonization efforts is enhanced by foreseeing and ideally avoiding predictable but non-obvious costs of promising abatement pathways. Thus, even with all of its promise, the degree of electrification may ultimately reach a limit.

DOI: https://doi.org/10.24149/wp2220

No. 2219
Nonlinear Budget Set Regressions for the Random Utility Model
Soren Blomquist, Anil Kumar, Che-Yuan Liang and Whitney K. Newey
Abstract: This paper is about the nonparametric regression of a choice variable on a nonlinear budget set when there is general heterogeneity, i.e., in the random utility model (RUM). We show that utility maximization makes this a three-dimensional regression with piecewise linear, convex budget sets with a more parsimonious specification than previously derived. We show that the regression allows for measurement and/or optimization errors in the outcome variable. We characterize all of the restrictions of utility maximization on the budget set regression and show how to check these restrictions. We formulate nonlinear budget set effects that can be identified by this regression and give automatic debiased machine learners of these effects. We find that in practice nonconvexities in the budget set have little effect on these estimates. We use control variables to allow for endogeneity of budget sets and adjust for productivity growth in taxable income. We apply the results to estimate .52 as the elasticity of an overall tax rate change in Sweden. We also find that the restrictions of utility maximization are satisfied at the choices made by nearly all individuals in the data.

DOI: https://doi.org/10.24149/wp2219

No. 2218
Central Bank Digital Currency: Financial Inclusion vs. Disintermediation
Jeremie Banet and Lucie Lebeau
Abstract: An overlapping-generations model with income heterogeneity is developed to analyze the impact of introducing a Central Bank Digital Currency (CBDC) on financial inclusion, and its potential adverse effect on bank funding. We highlight the role of two design parameters: the fixed cost of CBDC usage and the interest rate it pays, and derive principles for maximum inclusion and for mitigating the inclusion-intermediation trade-off. Agents’ choice of money instrument is endogenously driven by income heterogeneity. Pre-CBDC, wealthier agents adopt deposits, while poorer agents adopt cash and remain unbanked. CBDCs with low fixed costs (and low interest rates) are adopted by cash holders and directly increase inclusion. CBDCs with high fixed costs (and high interest rates) are adopted by deposit holders and increase inclusion by raising deposit rates. The former allows for more favorable inclusion-intermediation trade-offs. We calibrate the model to match the U.S. income distribution and aggregate share of unbanked households. A CBDC 50% cheaper (30% more expensive) than bank deposits decreases financial exclusion by 93% (71%) without impacting intermediation. In comparison, making the deposit market perfectly competitive would only decrease exclusion by 45%.

DOI: https://doi.org/10.24149/wp2218

No. 2217
A Rescue or a Trap?—An Analysis of Parent PLUS Student Loans
Wenhua Di, Carla Fletcher and Jeff Webster
Abstract: Parents taking out loans for their children’s college educations may face an excessive debt burden that jeopardizes their own financial security. This paper examines the experience of Parent Loan for Undergraduate Students (PLUS) borrowers using administrative data from a large student loan guaranty agency. We find that PLUS borrowers are more likely to default if their children attend low-resource institutions, typically ones where lower-income enrollments predominate. Although parent PLUS generally outperforms student loans, PLUS performance is sensitive to program costs during difficult economic times. In contrast, student outcomes depend more on educational outcomes. Interviews with borrowers confirm that PLUS borrowers have more experience handling debt than their children, but there is a lack of communication on repayment obligations and expectations between generations. This study reveals the differing consequences of parent and student borrowing for higher education and the troublesome PLUS program design that poses challenges to certain borrowers.

DOI: https://doi.org/10.24149/wp2217

No. 2216
Consumption and Hours in the United States and Europe
Lei Fang and Fang Yang
Abstract: We document large differences between the United States and Europe in allocations of expenditures and time for both market and home activities. Using a life-cycle model with home production and endogenous retirement, we find that the cross-country differences in consumption tax, social security system, income tax and TFP together can account for 68-95 percent of the cross-country variations and more than half of the average differences between Europe and the United States in aggregate hours and expenditures. These factors can also account well for the cross-country differences in allocations by age and generate substantially lower market hours in Europe for the age group of sixty and above as in the data. All the factors, except income tax, are quantitatively important for determining cross-country differences in expenditure allocations. While the differences in social security system and income tax are crucial in explaining the difference in market hours around retirement ages, TFP and consumption tax are more important for the difference in market hours for prime ages.

DOI: https://doi.org/10.24149/wp2216

No. 2215
Operational Loss Recoveries and the Macroeconomic Environment: Evidence from the U.S. Banking Sector
W. Scott Frame, Nika Lazaryan, Ping McLemore and Atanas Mihov
Abstract: Using supervisory data from large U.S. bank holding companies (BHCs), we document that operational loss recovery rates decrease in macroeconomic downturns. This procyclical relationship varies by business lines and loss event types and is robust to alternative data aggregations, macroeconomic measurement horizons and estimation methodologies. Further analysis shows that resource constraints faced by BHC risk management functions are a plausible explanation for these patterns. Our findings offer new evidence on how economic shocks transmit to banking industry losses with implications for risk management and supervision.

DOI: https://doi.org/10.24149/wp2215

No. 2214
Are Equity Option Returns Abnormal? IPCA Says No
Amit Goyal and Alessio Saretto
Abstract: We show that much of the profitability in equity option return strategies, which try to capture option mispricing by taking exposure to underlying volatility, can be explained by an IPCA model. The alpha reduction, relative to competing static factor models, is between 50% and 75% depending on the computing model and the type of option position.

DOI: https://doi.org/10.24149/wp2214

No. 2213
Interest Rate Surprises: A Tale of Two Shocks
Ricardo Nunes, Ali Ozdagli and Jenny Tang
Abstract: Interest rate surprises around FOMC announcements reveal both the surprise in the monetary policy stance (the pure policy shock) and interest rate movements driven by exogenous information about the economy from the central bank (the information shock). In order to disentangle the effects of these two shocks, we use interest rate changes on days of macroeconomic data releases. On these release dates, there are no pure policy shocks, which allows us to identify the impact of information shocks and thereby distill pure policy shocks from interest rate surprises around FOMC announcements. Our results show that there is a prominent central bank information component in the widely used high-frequency policy rate surprise measure. When we remove this central bank information component, the estimated effects of monetary policy shocks are more pronounced relative to those estimated using the entire policy rate surprise.

DOI: https://doi.org/10.24149/wp2213

No. 2212
Uncertainty, Stock Prices and Debt Structure: Evidence from the U.S.-China Trade War
Ali Ozdagli and Jianlin Wang
Abstract: Using the recent U.S.-China trade war as a laboratory, we show that policy uncertainty shocks have a significant impact on stock prices. This impact is less negative for firms that heavily rely on bank debt whereas non-bank debt does not have a mitigating effect. Moreover, the mitigating effect of bank debt is concentrated among zombie firms. A zombie firm that derives half of its capital from bank debt has no negative stock price reaction to increased uncertainty. These results are consistent with bank debt providing insurance for zombie firms in bad economic times.

DOI: https://doi.org/10.24149/wp2212

No. 2211
Heterogeneity and the Effects of Aggregation on Wage Growth
Robert Rich and Joseph Tracy
Abstract: This paper focuses on the implications of alternative methods of aggregating individual wage data for the behavior of economy-wide wage growth. The analysis is motivated by evidence of significant heterogeneity in individual wage growth and its cyclicality. Because of this heterogeneity, the choice of aggregation will affect the properties of economy-wide wage growth measures. To assess the importance of this consideration, we provide a decomposition of wage growth into aggregation effects and composition effects and use the decomposition to compare growth in an average wage—specifically average hourly earnings—to a measure of average wage growth from the Survey of Income and Program Participation. We find that aggregation effects largely account for average hourly earnings growth being persistently lower and less cyclical than average wage growth over the period 1990-2015, with these effects reflecting a disproportionate weighting of high-earning workers. The analysis also indicates that composition effects now play a more limited role in the cyclicality of wage growth compared to results reported in previous studies for earlier time periods.

DOI: https://doi.org/10.24149/wp2211

Globalization Institute No. 417
Flexible Average Inflation Targeting: How Much Is U.S. Monetary Policy Changing?
Jarod Coulter, Roberto Duncan and Enrique Martínez-García
Abstract: One major outcome of the Federal Reserve’s 2019–20 framework review was the adoption of a Flexible Average Inflation Targeting (FAIT) strategy in August 2020. Using synthetic control methods, we document that U.S. inflation rose post-FAIT considerably more than predicted had the strategy not changed (an average of 1.18 percentage points during 2020:M8-2022:M2). To explore the extent to which targeting average inflation delayed the Fed’s response and contributed to post-FAIT inflation, we adopt a version of the open-economy New Keynesian model in Martínez-García (2021) and document the economic consequences of adopting alternative measures of average inflation as policy objectives. We document three additional major findings using this general equilibrium setup: First, depending on how far back and how much weight is assigned to past inflation misses, the policy outcomes under FAIT are similar to those under the pre-FAIT regime. Secondly, we find that the implementation of FAIT can have large effects over short periods of time as it tends to delay action. However, over longer periods of time—such as the 1984:Q1-2019:Q4 pre-FAIT period—its effects wash out and appear negligible. Finally, we find that different average inflation measures explain an average of 0.5 percentage points per quarter of the post-FAIT inflation surge, indicating that targeting average inflation by itself can only explain part of the inflation spike since August 2020.

DOI: https://doi.org/10.24149/gwp417

No. 2210
Demographic Transition, Industrial Policies and Chinese Economic Growth (Revised February 2024)
Michael Dotsey, Wenli Li and Fang Yang
Abstract: We build a unified framework to quantitatively examine how demographic transition and industrial policies have contributed to China’s economic growth in the past five decades. On the demographic side, we consider evolutions in government population-control policies, life expectancy and pension income replacement. Industrial policies include changes in the speed of the growth of entrepreneurship, industry-specific interest subsidies and financial intermediation costs. Our analyses suggest that the demographic transition alone barely affects the aggregate savings rate, mainly due to general equilibrium feedback effects from prices. However, demographics account for a considerable fraction of the increase in per capita output growth since 1970. By comparison, industrial policy changes contribute significantly to the rise in both the aggregate savings rate and per capita output growth during the period. Notably, the interactions between the demographic transition and industrial policy changes cause aggregate savings to rise, but have little effect on per capita output growth. A novel factor of the model is endogenous human capital accumulation, a driver of per capita output growth. Our results are robust to the endogenization of fertility decisions.
Original paper
DOI: https://doi.org/10.24149/wp2210r1

No. 2209
Audit Partners and Loan Loss Provisioning: Evidence from U.S. Bank Holding Companies (Revised November 2024, new title)
Gauri Bhat, Hemang Desai, Christoffer Koch, Erik J. Mayer and Nitzan Tzur-Ilan (Revised November 2024, new authors)
Abstract: Using confidential data on audit partner names from 2006 to 2019 for bank holding companies (BHCs), we examine partners' impact on loan loss provisioning. Using a fixed effects approach, we find some evidence that individual partners affect provisioning, especially at public BHCs and BHCs audited by large audit firms. However, these results do not obtain in the post-financial crisis period. We also examine the association between partner tenure and provisioning. We find that allowance is increasing in partner tenure, particularly for public BHCs and small BHCs. The result for small BHCs is obtained in the post-financial crisis period as well. Thus, partner heterogeneity is more likely to manifest during periods of high economic uncertainty, but otherwise, there seems to be consistency in approach to audits across partners within a firm. Our results also suggest that audit scrutiny increases as the partners stay longer with the engagement, especially for small BHCs.
Original paper
DOI: https://doi.org/10.24149/wp2209r1

No. 2208
A Robust Test for Weak Instruments for 2SLS with Multiple Endogenous Regressors (Revised September 2024, new title)
Appendix
Daniel J. Lewis and Karel Mertens
Abstract: We develop a test for instrument strength based on the bias of two-stage least squares (2SLS) that (1) generalizes the tests of Stock and Yogo (2005) and Sanderson and Windmeijer (2016) to be robust to heteroskedasticity and autocorrelation, and (2) extends the Montiel Olea and Pflueger (2013) robust test for models with a single endogenous regressor to multiple endogenous regressors. Our test can be based either on Stock and Yogo’s (2005) absolute bias criterion or on the 2SLS bias relative to Montiel Olea and Pflueger’s (2013) worst-case benchmark. We also develop extensions to test whether instruments are weak for individual 2SLS coefficients. In simulations, our test controls size and is powerful, and we provide efficient code packages for its practical implementation. We demonstrate our testing procedures in the context of the estimation of state-dependent fiscal multipliers as in Ramey and Zubairy (2018).
Revision 1
Original paper
DOI: https://doi.org/10.24149/wp2208r2
Appendix DOI: https://doi.org/10.24149/wp2208app

No. 2207
The Impact of Minority Representation at Mortgage Lenders
W. Scott Frame, Ruidi Huang, Erik J. Mayer and Adi Sunderam
Abstract: We study links between the labor market for loan officers and access to mortgage credit. Using novel data matching the (near) universe of mortgage applications to loan officers, we find that minorities are significantly underrepresented among loan officers. Minority borrowers are less likely to complete mortgage applications, have completed applications approved, and to ultimately take-up a loan. These disparities are significantly reduced when minority borrowers work with minority loan officers. Minority borrowers working with minority loan officers also have lower default rates. Our results suggest that minority underrepresentation among loan officers has adverse effects on minority borrowers’ access to credit.

DOI: https://doi.org/10.24149/wp2207

Globalization Institute No. 416
The Global Financial Cycle and Capital Flows During the COVID-19 Pandemic (Revised November 2022)
J. Scott Davis and Andrei Zlate
Abstract: We estimate the heterogeneous effect of the global financial cycle on exchange rates and cross-border capital flows during the COVID-19 pandemic, using weekly exchange rate and portfolio flow data for a panel of 59 advanced and emerging market economies. We begin by estimating a global financial cycle (GFC) index at the weekly frequency with data through the end of 2021, and observe an outsized decline in the index over a period of just four weeks during February and March 2020. We then estimate the country-specific sensitivities of exchange rates and capital flows to fluctuations in the GFC. We show that the ability of the GFC to explain fluctuations in exchange rates and capital flows increased dramatically during the pandemic crisis. By using the law of the total variance we are able to decompose a panel of country-specific exchange rate or capital flow series into the time-series variance of the cross-sectional mean and the cross-sectional variance around that mean. We show that the GFC mainly explains the time-series variance of the cross-sectional mean. In addition, during the pandemic crisis like the COVID pandemic in 2020, relevant high-frequency indicators such as the weekly changes in cases and vaccination rates, which varied in timing and intensity across countries, improve the cross-sectional fit of our model by just as much as standard macroeconomic fundamentals such as the current account, reserves and net foreign assets.
Original paper
DOI: https://doi.org/10.24149/gwp416r1

No. 2206
How Do Mortgage Rate Resets Affect Consumer Spending and Debt Repayment? Evidence from Canadian Consumers
Katya Kartashova and Xiaoqing Zhou
Abstract: One of the most important channels through which monetary policy affects the real economy is changes in mortgage rates. This paper studies the effects of mortgage rate changes resulting from monetary policy shifts on homeowners’ spending, debt repayment and defaults. The Canadian institutional setting facilitates the design of identification strategies for causal inference, since the vast majority of mortgages in the country experience predetermined, periodic and automatic contract renewals with the mortgage rate reset based on the prevailing market rate. This allows us to exploit quasi-random variation in the timing of the rate reset and present causal evidence for both rate declines and increases, with the help of detailed, representative consumer credit panel data. We find asymmetric effects of rate changes on spending, debt repayment and defaults. Our results can be rationalized by the conventional cash-flow effect in conjunction with changes in consumer expectations about future interest rates upon the reset. Given the pervasiveness of Canadian-type mortgages in many other OECD countries, our findings have broader implications for the transmission of monetary policy to the household sector.

DOI: https://doi.org/10.24149/wp2206

No. 2205
When Do State-Dependent Local Projections Work?
Sílvia Gonçalves, Ana María Herrera, Lutz Kilian and Elena Pesavento
Abstract: Many empirical studies estimate impulse response functions that depend on the state of the economy. Most of these studies rely on a variant of the local projection (LP) approach to estimate the state-dependent impulse response functions. Despite its widespread application, the asymptotic validity of the LP approach to estimating state-dependent impulse responses has not been established to date. We formally derive this result for a structural state-dependent vector autoregressive process. The model only requires the structural shock of interest to be identified. A sufficient condition for the consistency of the state-dependent LP estimator of the response function is that the first- and second-order conditional moments of the structural shocks are independent of current and future states, given the information available at the time the shock is realized. This rules out models in which the state of the economy is a function of current or future realizations of the outcome variable of interest, as is often the case in applied work. Even when the state is a function of past values of this variable only, consistency may hold only at short horizons.

DOI: https://doi.org/10.24149/wp2205

No. 2204
Dynamic Identification Using System Projections on Instrumental Variables (Revised July 2024)
Appendix (Revised July 2024)
Daniel J. Lewis and Karel Mertens
Abstract: We propose System Projections on Instrumental Variables (SP-IV) to estimate structural relationships using regressions of structural impulse responses obtained from local projections or vector autoregressions. Relative to IV with distributed lags of shocks as instruments, SP-IV imposes weaker exogeneity requirements and can improve efficiency and increase effective instrument strength relative to the typical 2SLS estimator. We describe inference under strong and weak identification. The SP-IV estimator outperforms other estimators of Phillips Curve parameters in simulations. We estimate the Phillips Curve implied by the main business cycle shock of Angeletos et al. (2020) and find that the impulse responses are consistent with weak but also relatively strong cyclical connections between inflation and unemployment.
Revision 2
Revision 1
Original paper
Original appendix
DOI: https://doi.org/10.24149/wp2204r3
Appendix DOI: https://doi.org/10.24149/wp2204appr1

No. 2203
Financial Technology and the Transmission of Monetary Policy: The Role of Social Networks (Revised February 2023, new title)
Xiaoqing Zhou
Abstract: Financial technology-based (FinTech) lending is expected to ease U.S. mortgage market frictions that have weakened the transmission of monetary policy to households. This paper establishes that social networks play a key role in consumers’ adoption of FinTech lending, which amplifies the effects of a monetary stimulus. I provide causal estimates of the network effect on FinTech adoption using county-level data. To quantify the role of FinTech lending and network spillovers in the transmission of monetary policy shocks, I build a heterogeneous-agent model with social learning. The model shows that the consumption response to a monetary stimulus is 13% higher in the presence of FinTech lending and network spillovers, and that about half of this improvement is accounted for by network spillovers.
Original paper
DOI: https://doi.org/10.24149/wp2203r1

No. 2202
Endogenous Option Pricing
Andrea Gamba and Alessio Saretto
Abstract: We show that a structural model of firm decisions can produce very flexible implied volatility surfaces: upward and downward sloping, u-shaped. A calibrated version of the model is able to match many unconditional financial characteristics of the average option-able stock, and can help explain how, contrary to simple economic intuition, more valuable growth and contraction options are associated with a more negatively sloped implied volatility curve (i.e., a more negatively skewed implied distribution).

DOI: https://doi.org/10.24149/wp2202

Globalization Institute No. 415
Revisiting the Great Ratios Hypothesis (Revised April 2023)
Alexander Chudik, M. Hashem Pesaran and Ron P. Smith
Abstract: Kaldor called the constancy of certain ratios stylized facts, whereas Klein and Kosobud called them great ratios. While they often appear in theoretical models, the empirical literature finds little evidence for them, perhaps because the procedures used cannot deal with lack of cointegration, two-way causality and cross-country error dependence. We propose a new system pooled mean group estimator that can deal with these features. Monte Carlo results show it performs well compared with other estimators, and using it on a dataset over 150 years and 17 countries, we find support for five of the seven ratios considered.
Original paper
DOI: https://doi.org/10.24149/gwp415r1

No. 2201
The Matching Function and Nonlinear Business Cycles
Joshua Bernstein, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: The Cobb-Douglas matching function is ubiquitous in search and matching models, even though it imposes a constant matching elasticity that is unlikely to hold empirically. Using a general constant returns to scale matching function, this paper first derives analytical conditions that determine how the cyclicality of the matching elasticity amplifies or dampens the nonlinear dynamics of the job finding and unemployment rates. It then demonstrates that these effects are quantitatively significant and driven by plausible variation in the matching elasticity.

DOI: https://doi.org/10.24149/wp2201

Globalization Institute No. 414
Social Distancing, Vaccination and Evolution of COVID-19 Transmission Rates in Europe (Revised July 2022)
Codes
Alexander Chudik, M. Hashem Pesaran and Alessandro Rebucci
Abstract: This paper provides estimates of COVID-19 transmission rates and explains their evolution for selected European countries since the start of the pandemic taking account of changes in voluntary and government-mandated social distancing, incentives to comply, vaccination and the emergence of new variants. Evidence based on panel data modeling indicates that the diversity of outcomes that we document may have resulted from the non-linear interaction of mandated and voluntary social distancing and the economic incentives that governments provided to support isolation. The importance of these factors declined over time, with vaccine uptake driving heterogeneity in country experiences in 2021. Our approach also allows us to identify the basic reproduction number, R0, which is precisely estimated around 5, which is much larger than the values in the range of 2.4 – 3.9 assumed in the extant literature.
Revision 1
Original paper
Original codes
DOI: https://doi.org/10.24149/gwp414r2

Globalization Institute No. 413
On the Distributional Effects of International Tariffs (Revised March 2023)
Daniel Carroll and Sewon Hur
Abstract: We provide a quantitative analysis of the distributional effects of the 2018 increase in tariffs by the U.S. and its major trading partners. We build a trade model with incomplete asset markets and households that are heterogeneous in their age, income, wealth and labor skill. When tariff revenues are used to reduce distortionary taxes on consumption, labor and capital income, the average welfare loss from the trade war is equivalent to a permanent 0.1 percent reduction in consumption. Much larger welfare losses are concentrated among retirees and low-wealth households, while only wealthy households experience a welfare gain.
Original paper
DOI: https://doi.org/10.24149/gwp413r1

No. 2117
Comment on Giacomini, Kitagawa and Read’s ‘Narrative Restrictions and Proxies’
Lutz Kilian
Abstract: In a series of recent studies, Raffaella Giacomini and Toru Kitagawa have developed an innovative new methodological approach to estimating sign-identified structural VAR models that seeks to build a bridge between Bayesian and frequentist approaches in the literature. Their latest paper with Matthew Read contains thought-provoking new insights about modeling narrative restrictions in sign-identified structural VAR models. My discussion puts their contribution into the context of Giacomini and Kitagawa’s broader research agenda and relates it to the larger literature on estimating structural VAR models subject to sign restrictions.

DOI: https://doi.org/10.24149/wp2117

No. 2116
The Impact of Rising Oil Prices on U.S. Inflation and Inflation Expectations in 2020-23
Lutz Kilian and Xiaoqing Zhou
Abstract: Predictions of oil prices reaching $100 per barrel during the winter of 2021/22 have raised fears of persistently high inflation and rising inflation expectations for years to come. We show that these concerns have been overstated. A $100 oil scenario of the type discussed by many observers, would only briefly raise monthly headline inflation, before fading rather quickly. However, the short-run effects on headline inflation would be sizable. For example, on a year-over-year basis, headline PCE inflation would increase by 1.8 percentage points at the end of 2021 under this scenario, but only by 0.4 percentage points at the end of 2022. In contrast, the impact on measures of core inflation such as trimmed mean PCE inflation is only 0.4 and 0.3 percentage points in 2021 and 2022, respectively. These estimates already account for any increases in inflation expectations under the scenario. The peak response of the 1-year household inflation expectation would be 1.2 percentage points, while that of the 5-year expectation would be 0.2 percentage points.

DOI: https://doi.org/10.24149/wp2116

No. 2115
Empirical Bayes Control of the False Discovery Exceedance
Pallavi Basu, Luella Fu, Alessio Saretto and Wenguang Sun
Abstract: In sparse large-scale testing problems where the false discovery proportion (FDP) is highly variable, the false discovery exceedance (FDX) provides a valuable alternative to the widely used false discovery rate (FDR). We develop an empirical Bayes approach to controlling the FDX. We show that for independent hypotheses from a two-group model and dependent hypotheses from a Gaussian model fulfilling the exchangeability condition, an oracle decision rule based on ranking and thresholding the local false discovery rate (lfdr) is optimal in the sense that the power is maximized subject to FDX constraint. We propose a data-driven FDX procedure that emulates the oracle via carefully designed computational shortcuts. We investigate the empirical performance of the proposed method using simulations and illustrate the merits of FDX control through an application for identifying abnormal stock trading strategies.

DOI: https://doi.org/10.24149/wp2115

Globalization Institute No. 412
Monetary Policy Uncertainty and Economic Fluctuations at the Zero Lower Bound
Rachel Doehr and Enrique Martínez-García
Abstract: We propose a TVP-VAR with stochastic volatility for the unemployment rate, core inflation and the federal funds rate augmented with survey-based interest rate expectations and uncertainty and a FAVAR with a wider set of observable variables and alternative monetary policy measures in order to explore U.S. monetary policy, accounting for the zero lower bound. We find that a rise in monetary policy uncertainty increases unemployment and lowers core inflation; the effects on unemployment in particular are robust (a gradual 0.4 percentage point increase), lasting more than two years after the initial shock. Interest rate uncertainty shocks explain a significant portion of macro fluctuations, particularly after the 2007-09 global financial crisis contributing to push the unemployment rate one percentage point higher during the early phase of the subsequent recovery. Furthermore, we find that higher interest rate uncertainty makes forward guidance shocks (but also federal funds rate shocks) less effective at moving unemployment and core inflation. We also posit a theoretical model to provide the structural backbone for our empirical results, via an “option value” channel. Theory yields sizeable real effects and a muted monetary policy transmission mechanism as firms choose to postpone investment decisions in response to heightened interest rate uncertainty.

DOI: https://doi.org/10.24149/gwp412

No. 2114
Wealth Inequality and Return Heterogeneity During the COVID-19 Pandemic
Katya Kartashova and Xiaoqing Zhou
Abstract: Wealth inequality in the U.S., measured by the top 1% wealth share, experienced dramatic changes in the first year of the COVID-19 pandemic. Economic theory suggests that the key to understanding wealth inequality is heterogeneity in the return to net worth across households. To understand the dynamics of wealth inequality during the COVID-19 pandemic, we develop a novel methodology that allows us to estimate the returns to net worth for different groups of households at relatively high frequency. We show that portfolio heterogeneity and asset price movements are the main determinants of wealth returns and inequality, whereas saving-rate heterogeneity and within-class return differences played a minor role. As the stock market continued to outperform the housing market, the return of the wealthy has risen faster than that of other households, reinforcing the wealth concentration at the top. We also document a widening racial return gap between white and black households later in the pandemic. Nearly all of the racial differences in the wealth return, however, are explained by the differences in wealth, not by race itself. Whereas the previous literature has evaluated return heterogeneity and its implications for long-run wealth inequality in low-frequency data, our analysis suggests that return heterogeneity together with large asset price movements is also key to understanding short-run dynamics in wealth inequality.

DOI: https://doi.org/10.24149/wp2114

No. 2113
Bargaining Under Liquidity Constraints: Nash vs. Kalai in the Laboratory
John Duffy, Lucie Lebeau and Daniela Puzzello
Abstract: We report on an experiment in which buyers and sellers engage in semi-structured bargaining in two dimensions: how much of a good the seller will produce and how much money the buyer will offer the seller in exchange. Our aim is to evaluate the empirical relevance of two axiomatic bargaining solutions, the generalized Nash bargaining solution and Kalai's proportional bargaining solution. These bargaining solutions predict different outcomes when buyers are constrained in their money holdings. We first use the case when the buyer is not liquidity constrained to estimate the bargaining power parameter, which we find to be equal to 1/2. Then, imposing liquidity constraints on buyers, we find strong evidence in support of the Kalai proportional solution and against the generalized Nash solution. Our findings have policy implications, e.g., for the welfare cost of inflation in search-theoretic models of money.

DOI: https://doi.org/10.24149/wp2113

Globalization Institute No. 411
Firm Entry and Exit and Aggregate Growth
Jose Asturias, Sewon Hur, Timothy J. Kehoe and Kim J. Ruhl
Abstract: Applying the Foster, Haltiwanger and Krizan (FHK) (2001) decomposition to plant-level manufacturing data from Chile and Korea, we find that the entry and exit of plants account for a larger fraction of aggregate productivity growth during periods of fast GDP growth. To analyze this relationship, we develop a model of firm entry and exit based on Hopenhayn (1992). When we introduce reforms that reduce entry costs or reduce barriers to technology adoption into a calibrated model, we find that the entry and exit terms in the FHK decomposition become more important as GDP grows rapidly, just as they do in the data from Chile and Korea.

DOI: https://doi.org/10.24149/gwp411

No. 2112
The Local Fiscal Multiplier of Intergovernmental Grants: Evidence from Federal Medicaid Assistance to States
Seth Giertz and Anil Kumar
Abstract: Advocates of Medicaid expansion argue that federal Medicaid assistance to states fosters economic activity, generating positive local multiplier effects. Furthermore, during economic downturns, Congress regularly tweaks federal match rates for state Medicaid spending – including during the COVID-19 public health emergency – in order to assist states. Despite heavy reliance on Medicaid funding formulas, identifying the economic effect of these federal transfers has proved challenging. This is because federal Medicaid assistance (to states) is endogenous, since funding levels are correlated with unobserved factors driving state economic activity. To address this concern, we construct an instrument based on a slope discontinuity in the federal matching rate for state Medicaid spending. Using state-level panel data from 1990 to 2013, we find that federal Medicaid assistance does stimulate economic activity, but the implied cost per job created is quite high and the multiplier is well below 1. Despite modest economic effects over the entire sample period, we find that federal Medicaid assistance provided powerful fiscal stimulus to states after the Great Recession when the implied multiplier shot up to 1.5.

DOI: https://doi.org/10.24149/wp2112

Globalization Institute No. 410
A Theory of Gross and Net Capital Flows over the Global Financial Cycle (Revised December 2022, new title)
J. Scott Davis and Eric van Wincoop
Abstract: We develop a theory to account for changes in gross and net capital flows over the global financial cycle (GFC). The theory relies critically on portfolio heterogeneity among investors within and across countries, related to risky portfolio shares and portfolio shares allocated to foreign assets. A global drop in risky asset prices during a downturn of the GFC changes relative wealth within and across countries due to portfolio heterogeneity. This leads to changes in gross and net capital flows that are consistent with the stylized facts: all countries experience a decline in gross capital flows (retrenchment), while countries that have a net debt of safe assets experience a rise in total net outflows and net outflows of safe assets and a drop in net outflows of risky assets. The model is applied to 20 advanced countries and calibrated to micro data related to within country portfolio heterogeneity, as well as cross country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for gross and net capital flows are quantitatively consistent with the data.
Original paper
DOI: https://doi.org/10.24149/gwp410r1

No. 2111
Wage Setting Under Targeted Search
Anton Cheremukhin and Paulina Restrepo-Echavarria
Abstract: When setting initial compensation, some firms set a fixed, non-negotiable wage while others bargain. In this paper we propose a parsimonious search and matching model with two-sided heterogeneity, where the choice of wage-setting protocol, wages, search intensity and degree of randomness in matching are endogenous. We find that posting and bargaining coexist as wage-setting protocols if there is sufficient heterogeneity in match quality, search costs or market tightness and that labor market tightness and relative costs of search play a key role in the optimal choice of the wage-setting mechanism. Finally, we show that bargaining prevalence is positively correlated with wages, residual wage dispersion and labor market tightness, both in the model and in the data.

DOI: https://doi.org/10.24149/wp2111

No. 2110
Household Inflation Expectations and Consumer Spending: Evidence from Panel Data
Mary A. Burke and Ali Ozdagli
Abstract: Recent research offers mixed results concerning the relationship between inflation expectations and consumption, using qualitative measures of readiness to spend. We revisit this question using survey panel data of actual spending from the U.S. between 2009 and 2012 that also allows us to control for household heterogeneity. We find that durables spending increases with expected inflation only for selected types of households while nondurables spending does not respond to expected inflation. Moreover, spending decreases with expected unemployment. These results imply a limited stimulating effect of inflation expectations on aggregate consumption, which could be reversed if inflation and unemployment expectations move together.

DOI: https://doi.org/10.24149/wp2110

No. 2109
Countercyclical Fluctuations in Uncertainty are Endogenous
Joshua Bernstein, Michael Plante, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: This paper uses a battery of calibrated and estimated structural models to determine the causal drivers of the negative correlation between output and aggregate uncertainty. We find the transmission of uncertainty shocks to output is weak, while aggregate uncertainty endogenously responds to first moment shocks in the presence of labor market search frictions. This indicates that countercyclical movements in aggregate uncertainty are endogenous responses to changes in output, rather than exogenous impulses. A vector autoregression on simulated data shows recursive identification techniques do not robustly identify structural uncertainty shocks.

DOI: https://doi.org/10.24149/wp2109

No. 2108
Container Trade and the U.S. Recovery
Lutz Kilian, Nikos Nomikos and Xiaoqing Zhou
Abstract: Since the 1970s, exports and imports of manufactured goods have been the engine of international trade and much of that trade relies on container shipping. This paper introduces a new monthly index of the volume of container trade to and from North America. Incorporating this index into a structural macroeconomic VAR model facilitates the identification of shocks to domestic U.S. demand as well as foreign demand for U.S. manufactured goods. We show that, unlike in the Great Recession, the primary determinant of the U.S. economic contraction in early 2020 was a sharp drop in domestic demand. Although detrended data for personal consumption expenditures and manufacturing output suggest that the U.S. economy has recovered to near 90% of pre-pandemic levels as of March 2021, our structural VAR model shows that the component of manufacturing output driven by domestic demand had only recovered to 57% of pre-pandemic levels and that of real personal consumption only to 78%. The difference is mainly accounted for by unexpected reductions in frictions in the container shipping market.

DOI: https://doi.org/10.24149/wp2108

Globalization Institute No. 409
Pooled Bewley Estimator of Long-Run Relationships in Dynamic Heterogenous Panels (Revised November 2023)
Codes
Alexander Chudik, M. Hashem Pesaran and Ron P. Smith
Abstract: Using a transformation of the autoregressive distributed lag model due to Bewley, a novel pooled Bewley (PB) estimator of long-run coefficients for dynamic panels with heterogeneous short-run dynamics is proposed. The PB estimator is directly comparable to the widely used Pooled Mean Group (PMG) estimator, and is shown to be consistent and asymptotically normal. Monte Carlo simulations show good small sample performance of PB compared to the existing estimators in the literature, namely PMG, panel dynamic OLS (PDOLS) and panel fully-modified OLS (FMOLS). Application of two bias-correction methods and a bootstrapping of critical values to conduct inference robust to cross-sectional dependence of errors are also considered. The utility of the PB estimator is illustrated in an empirical application to the aggregate consumption function.
Revision 1
Original paper
Supplement to original paper
DOI: https://doi.org/10.24149/gwp409r2

No. 2107
Conspicuous Consumption: Vehicle Purchases by Non-Prime Consumers
Wenhua Di and Yichen Su
Abstract: Consumers with higher income often spend more on luxury goods. As a result, lower-income consumers who seek to increase their perceived income and social status may be motivated to purchase conspicuous luxury goods. Lower-income consumers may also desire to emulate the visible consumption displayed by their wealthier peers. Using a unique vehicle financing dataset, we find that consumers with lower credit scores value vehicle brand prestige more than average consumers. The stronger preferences for prestige lead non-prime consumers to purchase more expensive vehicles than they otherwise would have. We find evidence that the preferences for prestige are driven both by status signaling and peer emulation motives. Furthermore, we show that larger vehicle purchases financed by auto loans lead to worse loan performance and credit standing for non-prime consumers.

DOI: https://doi.org/10.24149/wp2107

No. 2106
Nonlinear Search and Matching Explained
Joshua Bernstein, Alexander W. Richter and Nathaniel Throckmorton
Abstract: Competing explanations for the sources of nonlinearity in search and matching models indicate that they are not fully understood. This paper derives an analytical solution to a textbook model that highlights the mechanisms that generate nonlinearity and quantifies their contributions. Procyclical variation in the matching elasticity creates nonlinearity in the job finding rate, which interacts with the law of motion for unemployment. These results show the matching function choice is not innocuous. Quantitatively, the Den Haan et al. (2000) matching function more than doubles the skewness of unemployment and welfare cost of business cycles, compared to the Cobb-Douglas specification.

DOI: https://doi.org/10.24149/wp2106

No. 2105
Paycheck Protection Program: County-Level Determinants and Effect on Unemployment
Pavel Kapinos
Abstract: This paper uses U.S. county-level data to study the determinants and effects of the Paycheck Protection Program (PPP). The paper first overviews the timeline and institutional aspects of the PPP, implemented in the second quarter of 2020 and worth about $669 billion in forgivable small business loans guaranteed by the Small Business Administration (SBA). It then studies the determinants of the county-level ratios of PPP loans per job lost during the original unemployment surge associated with the onset of the COVID-19 pandemic in late March 2020 and finds that it does not appear to be a major driver of the PPP loan concentration; instead, it was primarily driven by the local banking conditions and demographic factors. The second part of this paper uses the method of local projections to determine whether the participation in the PPP program improved economic conditions following its implementation. Impulse responses in the standard linear framework are positive and statistically significant, albeit economically negligible, suggesting that the PPP was entirely ineffective in stabilizing labor market conditions. Extending the framework to state-dependent local projections reverses this result: PPP lending had a significant effect on reducing unemployment on average and especially in counties with strong banking liquidity and an educated labor force.

DOI: https://doi.org/10.24149/wp2105

Globalization Institute No. 408
COVID-19 Fiscal Support and Its Effectiveness
Alexander Chudik, Kamiar Mohaddes and Mehdi Raissi
Abstract: This paper uses a threshold-augmented Global VAR model to quantify the macroeconomic effects of countries’ discretionary fiscal actions in response to the COVID-19 pandemic and its fallout. Our results are threefold: (1) fiscal policy is playing a key role in mitigating the effects of the pandemic; (2) all else equal, countries that implemented larger fiscal support are expected to experience less output contractions; (3) emerging markets are also benefiting from the synchronized fiscal actions globally through the spillover channel and reduced financial market volatility.

DOI: https://doi.org/10.24149/gwp408

No. 2104
How Foreign- and U.S.-Born Latinos Fare During Recessions and Recoveries
Pia M. Orrenius and Madeline Zavodny
Abstract: Latinos make up the nation’s largest ethnic minority group. The majority of Latinos are U.S. born, making the progress and well-being of Latinos no longer just a question of immigrant assimilation but also of the effectiveness of U.S. educational institutions and labor markets in equipping young Latinos to move out of the working class and into the middle class. One significant headwind to progress among Latinos is recessions. Economic outcomes of Latinos are far more sensitive to the business cycle than are outcomes for non-Hispanic whites. Latinos also have higher poverty rates than whites, although the gap had been falling prior to the pandemic. Deep holes in the pandemic safety net further imperiled Latino progress in 2020 and almost surely will in 2021 as well. Policies that would help working-class and poor Latinos include immigration reform and education reform and broader access to affordable health care.

DOI: https://doi.org/10.24149/wp2104

Globalization Institute No. 407
COVID-19 Time-Varying Reproduction Numbers Worldwide: An Empirical Analysis of Mandatory and Voluntary Social Distancing
Codes
Alexander Chudik, M. Hashem Pesaran and Alessandro Rebucci
Abstract: This paper estimates time-varying COVID-19 reproduction numbers worldwide solely based on the number of reported infected cases, allowing for under-reporting. Estimation is based on a moment condition that can be derived from an agent-based stochastic network model of COVID-19 transmission. The outcomes in terms of the reproduction number and the trajectory of per-capita cases through the end of 2020 are very diverse. The reproduction number depends on the transmission rate and the proportion of susceptible population, or the herd immunity effect. Changes in the transmission rate depend on changes in the behavior of the virus, reflecting mutations and vaccinations, and changes in people's behavior, reflecting voluntary or government mandated isolation. Over our sample period, neither mutation nor vaccination are major factors, so one can attribute variation in the transmission rate to variations in behavior. Evidence based on panel data models explaining transmission rates for nine European countries indicates that the diversity of outcomes resulted from the non-linear interaction of mandatory containment measures, voluntary precautionary isolation and the economic incentives that governments provided to support isolation. These effects are precisely estimated and robust to various assumptions. As a result, countries with seemingly different social distancing policies achieved quite similar outcomes in terms of the reproduction number. These results imply that ignoring the voluntary component of social distancing could introduce an upward bias in the estimates of the effects of lock-downs and support policies on the transmission rates.

DOI: https://doi.org/10.24149/gwp407

No. 2103
Mortgage Borrowing and the Boom-Bust Cycle in Consumption and Residential Investment
Xiaoqing Zhou
Abstract: This paper studies the transmission of the major shocks in the U.S. housing market in the 2000s to consumption and residential investment. Using geographically disaggregated data, I show that residential investment is more responsive to these shocks than consumption, as measured by elasticities and the implied contributions to GDP growth. I develop a structural life-cycle model featuring multiple types of housing investment to understand the large responses of residential investment. Consistent with the microdata, the model generates lumpy debt accumulation, lumpy housing investment and a strong correlation between mortgage borrowing and housing investment at the early stage of the life cycle. In the model, households move up the property ladder by increasing their mortgage debt after they have accumulated enough home equity. Since liquidity constraints and fixed costs prevent especially young homeowners from acquiring their desired home, shocks to their borrowing capacity have a large impact on residential investment.

DOI: https://doi.org/10.24149/wp2103

No. 2102
Dry Bulk Shipping and the Evolution of Maritime Transport Costs, 1850-2020
David S. Jacks and Martin Stuermer
Abstract: We provide evidence on the dynamic effects of fuel price shocks, shipping demand shocks and shipping supply shocks on real dry bulk freight rates in the long run. We first analyze a new and large dataset on dry bulk freight rates for the period from 1850 to 2020, finding that they followed a downward but undulating path with a cumulative decline of 79%. Next, we turn to understanding the drivers of booms and busts in the dry bulk shipping industry, finding that shipping demand shocks strongly dominate all others as drivers of real dry bulk freight rates in the long run. Furthermore, while shipping demand shocks have increased in importance over time, shipping supply shocks in particular have become less relevant.

DOI: https://doi.org/10.24149/wp2102

Globalization Institute No. 406
Optimal Bailouts in Banking and Sovereign Crises (Revised February 2024)
Sewon Hur, César Sosa-Padilla and Zeynep Yom
Abstract: We study optimal bailout policies amidst banking and sovereign crises. Our model features sovereign borrowing with limited commitment, where domestic banks hold government debt and extend credit to the private sector. Bank capital shocks can trigger banking crises, prompting the government to consider extending guarantees over bank assets. This poses a trade-off: Larger bailouts relax financial frictions and increase output, but increase fiscal needs and default risk (creating a ‘diabolic loop’). Optimal bailouts exhibit clear properties. The fraction of banking losses the bailouts cover is (i) decreasing in government debt; (ii) increasing in aggregate productivity and (iii) increasing in the severity of banking crises. Even though bailouts mitigate the adverse effects of banking crises, the economy is ex ante better off without bailouts: Having access to bailouts lowers the cost of defaults, which in turn increases the default frequency, and reduces the levels of debt, output and consumption.
Original paper
DOI: https://doi.org/10.24149/gwp406r1

No. 2101
How the New Fed Municipal Bond Facility Capped Muni-Treasury Yield Spreads in the COVID-19 Recession
Michael D. Bordo and John V. Duca
Published as: Bordo, Michael D. and John V. Duca (2023), "How the New Fed Municipal Bond Facility Capped Municipal-Treasury Yield Spreads in the COVID-19 Recession," Journal of the Japanese and International Economies, 67: 101245. https://doi.org/10.1016/j.jjie.2022.101245.
Abstract: For over two centuries, the municipal bond market has been a source of systemic risk, which returned early in the COVID-19 downturn when borrowing from securities markets became costly for many private and public entities, and some found it difficult to borrow at all. Indeed, just before the Fed announced its unprecedented intervention into the municipal (muni) bond market, spreads of muni over Treasury yields rose in line with the unemployment rate and appeared headed to levels not seen since the Great Depression, when real municipal gross investment plunged 35 percent below 1929 levels. To prevent a repeat, the Fed created the Municipal Liquidity Facility (MLF) to purchase newly issued, (near) investment grade state and local government bonds at normal ratings-based interest rate spreads over Treasury bonds plus a fee of 100 basis points, later reduced to 50 basis points. Despite a modest take-up, the MLF has effectively capped muni spreads at near normal levels plus the Fed fee and limited the extent to which interest rate spreads could have amplified the impact of the COVID pandemic. To establish the MLF the Fed needed Treasury indemnification against default losses. There are concerns about whether the creation of the MLF could undermine the efficiency of the bond market if the facility lasts too long and could induce moral hazard among borrowers. How the MLF will be unwound will affect these downside aspects and help answer the question whether the program’s benefits exceed its costs.

DOI: https://doi.org/10.24149/wp2101

No. 2031
The Labor Market Impact of a Pandemic: Validation and Application of a Do-It-Yourself CPS
Alexander Bick and Adam Blandin
Abstract: The Current Population Survey (CPS) is a central source of U.S. labor market data. We show that, for a few thousand dollars, researchers can quickly design and implement their own online survey to supplement the CPS. The survey closely follows core features of the CPS, ensuring that outcomes are conceptually compatible and allowing researchers to weight and validate results using the official CPS. Yet the survey also allows for faster data collection, added flexibility and novel questions. We show that the survey provided useful estimates of U.S. labor market aggregates several weeks ahead of the CPS during the turbulent start of the COVID-19 recession. We then assess the extent of downward nominal wage rigidity at the onset of the pandemic, finding that wage reductions were widespread, but were more common for job-switchers and recalled workers. We discuss a wide range of additional applications.

DOI: https://doi.org/10.24149/wp2031

No. 2030
The Role of the Prior in Estimating VAR Models with Sign Restrictions
Atsushi Inoue and Lutz Kilian
Abstract: Several recent studies have expressed concern that the Haar prior typically imposed in estimating sign-identified VAR models may be unintentionally informative about the implied prior for the structural impulse responses. This question is indeed important, but we show that the tools that have been used in the literature to illustrate this potential problem are invalid. Specifically, we show that it does not make sense from a Bayesian point of view to characterize the impulse response prior based on the distribution of the impulse responses conditional on the maximum likelihood estimator of the reduced-form parameters, since the prior does not, in general, depend on the data. We illustrate that this approach tends to produce highly misleading estimates of the impulse response priors. We formally derive the correct impulse response prior distribution and show that there is no evidence that typical sign-identified VAR models estimated using conventional priors tend to imply unintentionally informative priors for the impulse response vector or that the corresponding posterior is dominated by the prior. Our evidence suggests that concerns about the Haar prior for the rotation matrix have been greatly overstated and that alternative estimation methods are not required in typical applications. Finally, we demonstrate that the alternative Bayesian approach to estimating sign-identified VAR models proposed by Baumeister and Hamilton (2015) suffers from exactly the same conceptual shortcoming as the conventional approach. We illustrate that this alternative approach may imply highly economically implausible impulse response priors.

DOI: https://doi.org/10.24149/wp2030

No. 2029
How New Fed Corporate Bond Programs Dampened the Financial Accelerator in the COVID-19 Recession
Michael D. Bordo and John V. Duca
Published as: Bordo, Michael D. and John V. Duca (2022), "How New Fed Corporate Bond Programs Cushioned the COVID-19 Recession," Journal of Banking & Finance, 136:106413. https://doi.org/10.1016/j.jbankfin.2022.106413.
Abstract: In the financial crisis and recession induced by the COVID-19 pandemic, many investment-grade firms became unable to borrow from securities markets. In response, the Fed not only reopened its commercial paper funding facility but also announced it would purchase newly issued and seasoned bonds of corporations rated as investment grade before the COVID pandemic. A careful splicing of different unemployment rate series enables us to assess the effectiveness of recent Fed interventions in these long-term debt markets over long sample periods, spanning the Great Depression, Great Recession and COVID Recession. Findings indicate that the announcement of forthcoming corporate bond backstop facilities had helped stop risk premia from rising further than they had by late-March 2020. In doing so, these Fed facilities have limited the role of external finance premia in amplifying the macroeconomic impact of the COVID pandemic. Nevertheless, the corporate bond programs blend the roles of the Federal Reserve in conducting monetary policy via its balance sheet, acting as a lender of last resort and pursuing credit policies.

DOI: https://doi.org/10.24149/wp2029

Globalization Institute No. 405
Sudden Stops in Emerging Economies: The Role of World Interest Rates and Foreign Exchange Intervention (Revised September 2021, new title)
J. Scott Davis, Michael B. Devereux and Changhua Yu
Abstract: Emerging economies are prone to 'sudden stops', characterized by a collapse in external borrowing and aggregate demand. Sudden stops may be triggered by a spike in world interest rates, which causes rapid private sector deleveraging. In response to a rise in interest rates, deleveraging is individually rational, but in the aggregate, the effect on the real exchange rate may tighten borrowing constraints so much that it precipitates a large crisis. A central bank can intervene by selling foreign reserves when world interest rates are rising, and prevent excess aggregate deleveraging. But the central bank cannot borrow reserves. Then, to intervene during a crisis, the central bank must acquire reserves in advance, which is costly. The optimal reserve management policy trades off the insurance benefits of reserves during a crisis against the welfare costs of accumulating reserves before a crisis.
Original paper
DOI: https://doi.org/10.24149/gwp405r1

Globalization Institute No. 404
Trade Integration, Global Value Chains and Capital Accumulation
Michael Sposi, Kei-Mu Yi and Jing Zhang
Abstract: Motivated by increasing trade and fragmentation of production across countries since World War II, we build a dynamic two-country model featuring sequential, multistage production and capital accumulation. As trade costs decline over time, global-value-chain (GVC) trade expands across countries, particularly more in the faster growing country, consistent with the empirical pattern. The presence of GVC trade boosts capital accumulation and economic growth and magnifies dynamic gains from trade. At the same time, endogenous capital accumulation shapes comparative advantage across countries, impacting the dynamics of GVC trade: a country becoming more capital abundant concentrates more on the capital-intensive stage of the production.

DOI: https://doi.org/10.24149/gwp404

Globalization Institute No. 403
Get the Lowdown: The International Side of the Fall in the U.S. Natural Rate of Interest (Revised February 2021)
Appendix
Enrique Martínez-García
Abstract: I investigate the downward drift of U.S. interest rates from 1984:Q1 to 2019:Q4. For this, I bring the workhorse two-country New Keynesian model to data on the U.S. and an aggregate of its major trading partners using Bayesian techniques. I show that the U.S. natural (or equilibrium) interest rate recovered from the model has fallen more gradually than the long-run U.S. real rate, cushioned by productivity shocks. Since inflation expectations became well-anchored in the ‘90s, this implies that the continued interest rate decline is largely explained by the real rate tracking the natural rate downward. Foreign productivity spillovers have had significant effects on the U.S. natural rate and on U.S. output potential. However, foreign shock propagation contributed little to the upswing in U.S. output relative to potential or to sustaining inflation close to target, both of which are attributed almost entirely to mark-up compression (cost-push shocks) and an accommodative monetary policy in the U.S.
Original paper
Original appendix
DOI: https://doi.org/10.24149/gwp403r1
Appendix DOI: https://doi.org/10.24149/gwp403appr1

No. 2028
The Geography of Jobs and the Gender Wage Gap
Sitian Liu and Yichen Su
Abstract: Prior studies have shown that women are more willing to trade off wages for short commutes than men. Given the gender difference in commuting preferences, we show that the wage return to commuting (i.e., the wage penalty for reducing commute time) that stems from the spatial distribution of jobs contributes to the gender wage gap. We propose a simple job choice model, which predicts that differential commuting preferences would lead to a larger gender wage gap for workers who face greater wage returns to commuting based on their locations of residence and occupations. We then show empirical evidence that validates the model's prediction. Moreover, we estimate the model components: (i) the indifference curves between wages and commutes by gender, and (ii) the wage return to commuting faced by each worker. Our model shows that differential commuting choices account for about 16-21% of the gender wage gap on average, but the contribution varies widely across residential locations. The model also shows that policies that increase commute speed or density in the central city neighborhoods could moderately lower the gender wage gap.

DOI: https://doi.org/10.24149/wp2028

Globalization Institute No. 402
A Counterfactual Economic Analysis of COVID-19 Using a Threshold Augmented Multi-Country Model
Alexander Chudik, Kamiar Mohaddes, M. Hashem Pesaran, Mehdi Raissi and Alessandro Rebucci
Abstract: This paper develops a threshold-augmented dynamic multi-country model (TG-VAR) to quantify the macroeconomic effects of COVID-19. We show that there exist threshold effects in the relationship between output growth and excess global volatility at individual country levels in a significant majority of advanced economies and in the case of several emerging markets. We then estimate a more general multi-country model augmented with these threshold effects as well as long-term interest rates, oil prices, exchange rates and equity returns to perform counterfactual analyses. We distinguish common global factors from trade-related spillovers, and identify the COVID-19 shock using GDP growth forecast revisions of the IMF in 2020Q1. We account for sample uncertainty by bootstrapping the multi-country model estimated over four decades of quarterly observations. Our results show that the COVID-19 pandemic will lead to a significant fall in world output that is most likely long-lasting, with outcomes that are quite heterogenous across countries and regions. While the impact on China and other emerging Asian economies is estimated to be less severe, the United States, the United Kingdom and several other advanced economies may experience deeper and longer-lasting effects. Non-Asian emerging markets stand out for their vulnerability. We show that no country is immune to the economic fallout of the pandemic because of global interconnections as evidenced by the case of Sweden. We also find that long-term interest rates could fall significantly below their recent lows in core advanced economies, but this does not seem to be the case in emerging markets.

DOI: https://doi.org/10.24149/gwp402

Globalization Institute No. 401
Land Price Dynamics and Macroeconomic Fluctuations with Imperfect Substitution in Real Estate Markets (Revised June 2021, new title)
J. Scott Davis, Kevin X.D. Huang and Ayse Sapci
Abstract: The collateral channel, whereby an increase in residential house prices leads to an increase in commercial property prices, loosening firm borrowing constraints and leading to higher firm investment, is weaker when residential and commercial real estate are imperfect substitutes. We first show in a reduced form regression with firm level data that the strength of local zoning regulations has a negative effect on the estimated increase in firm investment following an increase in local residential real estate prices. We then modify the DSGE model of the collateral channel in Liu, Wang and Zha (2013) to allow imperfect substitutability between residential and commercial land. With Bayesian estimation and U.S. data, we estimate that the elasticity of substitution between the two types of land is 0.88. Variance decompositions and impulse responses show that the strength of the collateral channel linking house prices and investment is weaker when the two types of land are imperfect substitutes.
Original paper
DOI: https://doi.org/10.24149/gwp401r1

No. 2027
Understanding the Estimation of Oil Demand and Oil Supply Elasticities
Lutz Kilian
Abstract: This paper examines the advantages and drawbacks of alternative methods of estimating oil supply and oil demand elasticities and of incorporating this information into structural VAR models. I not only summarize the state of the literature, but also draw attention to a number of econometric problems that have been overlooked in this literature. Once these problems are recognized, seemingly conflicting conclusions in the recent literature can be resolved. My analysis reaffirms the conclusion that the one-month oil supply elasticity is close to zero, which implies that oil demand shocks are the dominant driver of the real price of oil. The focus of this paper is not only on correcting some misunderstandings in the recent literature, but on the substantive and methodological insights generated by this exchange, which are of broader interest to applied researchers.

DOI: https://doi.org/10.24149/wp2027

Globalization Institute No. 400
The Distributional Effects of COVID-19 and Optimal Mitigation Policies (Revised May 2022, new title October 2020)
Sewon Hur
Abstract: This paper develops a quantitative heterogeneous agent–life cycle model with a fully integrated epidemiological model in which economic decisions affect the spread of COVID-19 and vice versa. The calibrated model is used to study the distributional consequences and effectiveness of mitigation policies such as a stay-at-home subsidy and a stay-at-home order. First, the stay-at-home subsidy is preferred because it reduces deaths by more and output by less, leading to a larger average welfare gain that benefits all individuals. Second, Pareto-improving mitigation policies can reduce deaths by nearly 45 percent without any corresponding reduction in output relative to no public mitigation. Finally, it is possible to simultaneously improve public health and economic outcomes, suggesting that debates regarding a supposed tradeoff between economic and health objectives may be misguided.
Revision 3
Revision 2
Revision 1
Original paper
DOI: https://doi.org/10.24149/gwp400r4

Globalization Institute No. 399
Monetary Policy and Economic Performance Since the Financial Crisis
Dario Caldara, Etienne Gagnon, Enrique Martínez-García and Christopher J. Neely
Abstract: We review the macroeconomic performance over the period since the Global Financial Crisis and the challenges in the pursuit of the Federal Reserve’s dual mandate. We characterize the use of forward guidance and balance sheet policies after the federal funds rate reached the effective lower bound. We also review the evidence on the efficacy of these tools and consider whether policymakers might have used them more forcefully. Finally, we examine the post-crisis experience of other major central banks with these policy tools.

DOI: https://doi.org/10.24149/gwp399

No. 2026
The Business Cycle Mechanics of Search and Matching Models
Joshua Bernstein, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: This paper estimates a real business cycle model with unemployment driven by shocks to labor productivity and the job separation rate. We make two contributions. First, we develop a new identification scheme based on the matching elasticity that allows the model to perfectly match a range of labor market moments, including the volatilities of unemployment and vacancies. Second, we use our model to revisit the importance of shocks to the job separation rate and highlight how their correlation with labor productivity affects their transmission mechanism.

DOI: https://doi.org/10.24149/wp2026

Globalization Institute No. 396
A Generalized Time Iteration Method for Solving Dynamic Optimization Problems with Occasionally Binding Constraints
Ayşe Kabukçuoğlu and Enrique Martínez-García
Abstract: We study a generalized version of Coleman (1990)’s time iteration method (GTI) for solving dynamic optimization problems. Our benchmark framework is an irreversible investment model with labor-leisure choice. The GTI algorithm is simple to implement and provides advantages in terms of speed relative to Howard (1960)’s improvement algorithm. A second application on a heterogeneous-agents incomplete-markets model further explores the performance of GTI.

DOI: https://doi.org/10.24149/gwp396

Globalization Institute No. 394
Variable Selection in High Dimensional Linear Regressions with Parameter Instability (Revised August 2024, new title January 2023)
Alexander Chudik, M. Hashem Pesaran and Mahrad Sharifvaghefi
Abstract: This paper considers the problem of variable selection allowing for parameter instability. It distinguishes between signal and pseudo-signal variables that are correlated with the target variable, and noise variables that are not, and investigates the asymptotic properties of the One Covariate at a Time Multiple Testing (OCMT) method proposed by Chudik et al. (2018) under parameter insatiability. It is established that OCMT continues to asymptotically select an approximating model that includes all the signals and none of the noise variables. Properties of post selection regressions are also investigated, and in-sample fit of the selected regression is shown to have the oracle property. The theoretical results support the use of unweighted observations at the selection stage of OCMT, whilst applying down-weighting of observations only at the forecasting stage. Monte Carlo and empirical applications show that OCMT without down-weighting at the selection stage yields smaller mean squared forecast errors compared to Lasso, Adaptive Lasso and boosting.
Revision 2
Revision 1
Revsion 1 supplement
Original paper
Original supplement
DOI: https://doi.org/10.24149/gwp394r3

No. 2025
Oil Prices, Gasoline Prices and Inflation Expectations: A New Model and New Facts
Lutz Kilian and Xiaoqing Zhou
Abstract: The conventional wisdom that inflation expectations respond to the level of the price of oil (or the price of gasoline) is based on testing the null hypothesis of a zero slope coefficient in a static single-equation regression model fit to aggregate data. Given that the regressor in this model is not stationary, the null distribution of the t-test statistic is nonstandard, invalidating the use of the normal approximation. Once the critical values are adjusted, these regressions provide no support for the conventional wisdom. Using a new structural vector regression model, however, we demonstrate that gasoline price shocks may indeed drive one-year household inflation expectations. The model shows that there have been several such episodes since 1990. In particular, the rise in household inflation expectations between 2009 and 2013 is almost entirely explained by a large increase in gasoline prices. However, on average, gasoline price shocks account for only 39% of the variation in household inflation expectations since 1981.

DOI: https://doi.org/10.24149/wp2025

No. 2024
The Impact of the COVID-19 Pandemic on the Demand for Density: Evidence from the U.S. Housing Market (Revised October 2020)
Sitian Liu and Yichen Su
Abstract: Cities are shaped by the strength of agglomeration and dispersion forces. We show that the COVID-19 pandemic has re-introduced disease transmission as a dispersion force in modern cities. We use detailed housing data to study the impact of the COVID-19 pandemic on the location demand for housing. We find that the pandemic has led to a reduced demand for housing in neighborhoods with high population density. The reduced demand for density is driven partially by the diminished need of living close to jobs that are telework-compatible and the declining value of access to consumption amenities. Neighborhoods with high pre-COVID-19 home prices also see a greater drop in housing demand. While the national housing market recovered after June, we show that the pandemic's negative effect on the demand for density persisted and strengthened, indicating that the change in the demand for density has lasted beyond an aggregate recovery of housing demand.
Original paper
DOI: https://doi.org/10.24149/wp2024r1

No. 2023
Haste Makes Waste: Banking Organization Growth and Operational Risk
W. Scott Frame, Ping McLemore and Atanas Mihov
Abstract: This study shows that banking organization growth is associated with higher operational losses per dollar of total assets and incidence of tail risks. Event studies using M&A activity and instrumental variable regressions provide consistent evidence. The relationship between banking organization growth and operational risk varies by loss event types and balance sheet categories. We demonstrate that higher growth predicts worse operational risk realizations during the global financial crisis. These findings have implications for bank performance, risk management and supervision in a continually consolidating banking industry.

DOI: https://doi.org/10.24149/wp2023

No. 2022
Joint Bayesian Inference about Impulse Responses in VAR Models
Atsushi Inoue and Lutz Kilian
Abstract: Structural VAR models are routinely estimated by Bayesian methods. Several recent studies have voiced concerns about the common use of posterior median (or mean) response functions in applied VAR analysis. In this paper, we show that these response functions can be misleading because in empirically relevant settings there need not exist a posterior draw for the impulse response function that matches the posterior median or mean response function, even as the number of posterior draws approaches infinity. As a result, the use of these summary statistics may distort the shape of the impulse response function which is of foremost interest in applied work. The same concern applies to error bands based on the upper and lower quantiles of the marginal posterior distributions of the impulse responses. In addition, these error bands fail to capture the full uncertainty about the estimates of the structural impulse responses. In response to these concerns, we propose new estimators of impulse response functions under quadratic loss, under absolute loss and under Dirac delta loss that are consistent with Bayesian statistical decision theory, that are optimal in the relevant sense, that respect the dynamics of the impulse response functions and that are easy to implement. We also propose joint credible sets for these estimators derived under the same loss function. Our analysis covers a much wider range of structural VAR models than previous proposals in the literature including models that combine short-run and long-run exclusion restrictions and models that combine zero restrictions, sign restrictions and narrative restrictions.

DOI: https://doi.org/10.24149/wp2022

No. 2021
The Shale Revolution and the Dynamics of the Oil Market
Nathan S. Balke, Xin Jin and Mine Yücel
Abstract: We build and estimate a dynamic, structural model of the world oil market in order to quantify the impact of the shale revolution. We model the shale revolution as a dramatic decrease in shale production costs and explore how the resultant increase in shale production affects the level and volatility of oil prices over our sample. We find that oil prices in 2018 would have been roughly 36% higher had the shale revolution not occurred and that the shale revolution implies a reduction in current oil price volatility around 25% and a decline in long-run volatility of over 50%.

DOI: https://doi.org/10.24149/wp2021

No. 2020
Quantitative Easing and Agency MBS Investment and Financing Choices by Mortgage REITs (Revised May 2021, new title)
W. Scott Frame and Eva Steiner
Abstract: An emerging literature documents a link between central bank quantitative easing (QE) and financial institution credit risk-taking. This paper tests the complementary hypothesis that QE may also affect financial risk-taking. We study Agency MREITs – levered shadow banks that invest in guaranteed U.S. Agency mortgage-backed securities (MBS) and that are principally funded with repo debt. We first show that Agency MREIT asset growth is inversely related to the Federal Reserve’s Agency MBS purchases, reflecting investor portfolio rebalancing. We then document that Agency MREITs increased financial leverage during the later stages of QE, consistent with “reaching for yield” behavior. However, Agency MREITs countered the heightened solvency risk by extending repo maturity and increased hedging of their funding costs to reduce liquidity and interest rate risk. The findings suggest that research linking QE to increased credit risk-taking should account for contemporaneous changes in financing choices and risk management.
Original paper
DOI: https://doi.org/10.24149/wp2020r1

No. 2019
Impulse Response Analysis for Structural Dynamic Models with Nonlinear Regressors
Sílvia Gonçalves, Ana María Herrera, Lutz Kilian and Elena Pesavento
Abstract: We study the construction of nonlinear impulse responses in structural dynamic models that include nonlinearly transformed regressors. Such models have played an important role in recent years in capturing asymmetries, thresholds and other nonlinearities in the responses of macroeconomic variables to exogenous shocks. The conventional approach to estimating nonlinear responses is by Monte Carlo integration. We show that the population impulse responses in this class of models may instead be derived analytically from the structural model. We use this insight to study under what conditions linear projection (LP) estimators may be used to recover the population impulse responses. We find that, unlike in vector autoregressive models, the asymptotic equivalence between estimators based on the structural model and LP estimators breaks down. Only in one important special case can the population impulse response be consistently estimated by LP methods. The construction of this LP estimator, however, differs from the LP approach currently used in the literature. Simulation evidence suggests that the modified LP estimator is less accurate in finite samples than estimators based on the structural model, when both are valid.

DOI: https://doi.org/10.24149/wp2019

Globalization Institute No. 392
Mind the Gap!—A Monetarist View of the Open-Economy Phillips Curve
Appendix
Ayşe Dur and Enrique Martínez-García
Abstract: In many countries, inflation has become less responsive to domestic factors and more responsive to global factors over the past decades. We introduce money and credit into the workhorse open-economy New Keynesian model. With this framework, we show that: (i) an efficient forecast of domestic inflation is based solely on domestic and foreign slack, and (ii) global liquidity (global money as well as global credit) is tied to global slack in equilibrium. Then, motivated by the theory, we evaluate empirically the performance of open-economy Phillips-curve-based forecasts constructed using global liquidity measures (such as G7 credit growth and G7 money supply growth) instead of global slack as predictive regressors. Using 50 years of quarterly U.S. data, we document that these global liquidity variables perform significantly better than their domestic counterparts and outperform in practice the poorly-measured indicators of global slack that global liquidity proxies for.

DOI: https://doi.org/10.24149/gwp392
Appendix DOI: https://doi.org/10.24149/gwp392app

No. 2018
Entry and Exit, Unemployment, and the Business Cycle (Revised January 2021, new title)
Joshua Bernstein, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: Establishment entry and exit is strongly correlated with output and unemployment. This paper examines how these linkages affect business cycle dynamics through the lens of a search and matching model augmented to include multi-worker establishments that endogenously enter and exit. Analytical results show cyclical entry and exit cause reallocation of inputs that amplifies and skews business cycle dynamics. When the model is calibrated to the data, it generates realistic asymmetry in output and unemployment, data-consistent counter-cyclical endogenous uncertainty and a 55% higher welfare cost than the model without entry and exit.
Original paper
DOI: https://doi.org/10.24149/wp2018r1

No. 2017
Work from Home Before and After the COVID-19 Outbreak (Revised February 2021, new title)
Alexander Bick, Adam Blandin and Karel Mertens
Abstract: Based on novel survey data, we document the evolution of commuting behavior in the U.S. over the course of the COVID-19 pandemic. Work from home (WFH) increased sharply and persistently after the outbreak, and much more so among some workers than others. Using theory and evidence, we argue that the observed heterogeneity in WFH transitions is consistent with potentially more permanent changes to work arrangements in some occupations, and not just temporary substitution in response to greater health risks. Consistent with increased WFH adoption, many more – especially higher-educated – workers expect to WFH in the future.
Revision 1
Original paper
DOI: https://doi.org/10.24149/wp2017r2

No. 2016
Are the Largest Banking Organizations Operationally More Risky?
Filippo Curti, W. Scott Frame and Atanas Mihov
Abstract: This study demonstrates that, among large U.S. bank holding companies (BHCs), the largest ones are exposed to more operational risk. Specifically, they have higher operational losses per dollar of total assets, a result largely driven by the BHCs' failure to meet professional obligations to clients and/or faulty product design. Operational risk at the largest U.S. institutions is also found to: (i) be particularly persistent, (ii) have a counter-cyclical component (higher losses occur during economic downturns) and (iii) materialize through more frequent tail-risk events. We illustrate two plausible channels of BHC size that contribute to operational risk – institutional complexity and moral hazard incentives arising from “too-big-to-fail." Our findings have important implications for large banking organization performance, risk and supervision.

DOI: https://doi.org/10.24149/wp2016

Globalization Institute No. 389
A Matter of Perspective: Mapping Linear Rational Expectations Models into Finite-Order VAR Form
Enrique Martínez-García
Abstract: This paper considers the characterization of the reduced-form solution of a large class of linear rational expectations models. I show that under certain conditions, if a solution exists and is unique, it can be cast in finite-order VAR form. I also investigate the conditions for the VAR form to be stationary with a well-defined residual variance-covariance matrix in equilibrium, for the shocks to be recoverable, and for local identification of the structural parameters for estimation from the sample likelihood. An application to the workhorse New Keynesian model with accompanying Matlab codes illustrates the practical use of the finite-order VAR representation. In particular, I argue that the identification of monetary policy shocks based on structural VARs can be more closely aligned with theory using the finite-order VAR form of the model solution characterized in this paper.

DOI: https://doi.org/10.24149/gwp389

No. 2015
A Quantitative Model of the Oil Tanker Market in the Arabian Gulf
Lutz Kilian, Nikos Nomikos and Xiaoqing Zhou
Abstract: Using a novel dataset, we develop a structural model of the Very Large Crude Carrier (VLCC) market between the Arabian Gulf and the Far East. We study how fluctuations in oil tanker rates, oil exports, shipowner profits, and bunker fuel prices are determined by shocks to the supply and demand for oil tankers, to the utilization of tankers, and to bunker fuel costs. Our analysis shows that time charter rates respond only slightly to fuel cost shocks. In response to higher fuel costs, voyage profits decline, as cost shocks are only partially passed on to round-trip voyage rates. Oil exports from the Arabian Gulf also decline, reflecting lower demand for VLCCs. Positive utilization shocks are associated with higher profits, a slight increase in time charter rates and slightly lower fuel prices and oil export volumes. Tanker supply and tanker demand shocks have persistent effects on time charter rates, round-trip voyage rates, the volume of oil exports, fuel prices, and profits with the expected sign.

DOI: https://doi.org/10.24149/wp2015

No. 2014
Mobility and Engagement Following the SARS-Cov-2 Outbreak (Revised June 2020, new title)
Tyler Atkinson, Jim Dolmas, Christoffer Koch, Evan Koenig, Karel Mertens, Anthony Murphy and Kei-Mu Yi
Abstract: We develop a Mobility and Engagement Index (MEI) based on a range of mobility metrics from Safegraph geolocation data, and validate the index with mobility data from Google and Unacast. We construct MEIs at the county, MSA, state and nationwide level, and link these measures to indicators of economic activity. According to our measures, the bulk of sheltering-in-place and social disengagement occurred during the week of March 15 and simultaneously across the U.S. At the national peak of the decline in mobility in early April, localities that engaged in a 10% larger decrease in mobility than average saw an additional 0.6% of their populations claiming unemployment insurance, an additional 2.8 percentage point reduction in small businesses employment, an additional 2.6 percentage point increase in small business closures, and an additional 3.2 percentage point reduction in new-business applications. A gradual and broad-based resumption of mobility and engagement started in the third week of April.

DOI: https://doi.org/10.24149/wp2014

No. 2013
Villains or Scapegoats? The Role of Subprime Borrowers in Driving the U.S. Housing Boom
James Conklin, W. Scott Frame, Kristopher Gerardi and Haoyang Liu
Abstract: An expansion in mortgage credit to subprime borrowers is widely believed to have been a principal driver of the 2002–2006 U.S. house price boom. By contrast, this paper documents a robust, negative correlation between the growth in the share of purchase mortgages to subprime borrowers and house price appreciation at the county-level during this time. Using two different instrumental variables approaches, we also establish causal evidence that house price appreciation lowered the share of purchase loans to subprime borrowers. Further analysis using micro-level credit bureau data shows that higher house price appreciation lowered the transition rate into first-time homeownership for subprime individuals. Finally, the paper documents that subprime borrowers did not play a significant role in the increased speculative activity and underwriting fraud that the literature has linked directly to the housing boom. Taken together, these results are more consistent with subprime borrowers being priced out of housing boom markets rather than inflating prices in those markets.

DOI: https://doi.org/10.24149/wp2013

No. 2012
A Novel MIMIC-Style Model of European Bank Technical Efficiency and Productivity Growth
Marwan Izzeldin, Emmanuel Mamatzakis, Anthony Murphy and Mike Tsionas
Abstract: Using Bayesian Monte Carlo methods, we augment a stochastic distance function measure of bank efficiency and productivity growth with indicators of capitalization, return and risk. Our novel Multiple Indicator-Multiple Cause (MIMIC) style model generates more precise estimates of policy relevant parameters such as returns to scale, technical inefficiency and productivity growth. We find considerable variation in the performance of EU-15 banks over the period 2008 to 2015. For the vast majority of banks, productivity growth – the sum of efficiency and technical changes – is negative, implying that the industry would benefit from innovation. We show that greater technical efficiency is associated with higher profitability, higher capital, a lower probability of default and lower return volatility.

DOI: https://doi.org/10.24149/wp2012

Globalization Institute No. 384
Checking the Path Towards Recovery from the COVID-19 Isolation Response
Finn E. Kydland and Enrique Martínez-García
Abstract: This paper examines the impact of the behavioral changes and governments' responses to the spread of the COVID-19 pandemic using a unique dataset of daily private forecasters' expectations on a sample of 32 emerging and advanced economies from January 1 till April 13, 2020. We document three important lessons from the data: First, there is evidence of a relation between the stringency of the policy interventions and the health outcomes consistent with slowing down the spread of the pandemic. Second, we find robust evidence that private forecasters have come to anticipate a sizeable contraction in economic activity followed by a check mark recovery as a result of the governments' increasingly stringent response. The evidence suggests also that workplace restrictions have further contributed to the downturn and to the subsequent sluggish recovery—opening up the question about the costs of tighter work restrictions. Finally, we argue inflation expectations have not changed significantly so far. Through the lens of the neoclassical growth model, these changes in macro expectations can result from the resulting work disruptions and the potential productivity slowdown from the gradual de-escalation of the confinement.

DOI: https://doi.org/10.24149/gwp384

Globalization Institute No. 383
exuber: Recursive Right-Tailed Unit Root Testing with R (Revised October 2021)
Code
Kostas Vasilopoulos, Efthymios Pavlidis and Enrique Martínez-García
Abstract: This paper introduces the R package exuber for testing and date-stamping periods of mildly explosive dynamics (exuberance) in time series. The package computes test statistics for the supremum ADF test (SADF) of Phillips, Wu and Yu (2011), the generalized SADF (GSADF) of Phillips, Shi and Yu (2015a,b), and the panel GSADF proposed by Pavlidis, Yusupova, Paya, Peel, Martínez-García, Mack and Grossman (2016); generates finite-sample critical values based on Monte Carlo and bootstrap methods; and implements the corresponding date-stamping procedures. The recursive least-squares algorithm that we introduce in our implementation of these techniques utilizes the matrix inversion lemma and in that way achieves significant speed improvements. We illustrate the speed gains in a simulation experiment, and provide illustrations of the package using artificial series and a panel on international house prices.
Original paper
DOI: https://doi.org/10.24149/gwp383r1

No. 2011
Measuring Real Activity Using a Weekly Economic Index (Revised March 2021, new title)
Daniel J. Lewis, Karel Mertens, James H. Stock and Mihir Trivedi
Abstract: This paper describes a weekly economic index (WEI) developed to track the rapid economic developments associated with the onset of and policy response to the novel coronavirus in the United States. The WEI is a weekly composite index of real economic activity, with eight of 10 series available the Thursday after the end of the reference week. In addition to being a weekly real activity index, the WEI has strong predictive power for output measures and provided an accurate nowcast of current-quarter GDP growth in the first half of 2020, with weaker performance in the second half. We document how the WEI responded to key events and data releases during the first 10 months of the pandemic.
Original paper
DOI: https://doi.org/10.24149/wp2011r1

No. 2010
COVID-19: A View from the Labor Market
Joshua Bernstein, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: This paper examines the response of the U.S. labor market to a large and persistent job separation rate shock, motivated by the ongoing economic effects of the COVID-19 pandemic. We use nonlinear methods to analytically and numerically characterize the responses of vacancy creation and unemployment. Vacancies decline in response to the shock when firms expect persistent job destruction and the number of unemployed searching for work is low. Quantitatively, under our baseline forecast the unemployment rate peaks at 19.7%, 2 months after the shock, and takes 1 year to return to 5%. Relative to a scenario without the shock, unemployment uncertainty rises by a factor of 11. Nonlinear methods are crucial. In the linear economy, the unemployment rate “only” rises to 9.2%, vacancies increase, and uncertainty is unaffected. In both cases, the severity of the COVID-19 shock depends on the separation rate persistence.

DOI: https://doi.org/10.24149/wp2010

Globalization Institute No. 382
Voluntary and Mandatory Social Distancing: Evidence on COVID-19 Exposure Rates from Chinese Provinces and Selected Countries
Alexander Chudik, M. Hashem Pesaran and Alessandro Rebucci
Abstract: This paper considers a modification of the standard Susceptible-Infected-Recovered (SIR) model of epidemics that allows for different degrees of compulsory as well as voluntary social distancing. It is shown that the fraction of the population that self-isolates varies with the perceived probability of contracting the disease. Implications of social distancing both on the epidemic and recession curves are investigated and their trade off is simulated under a number of different social distancing and economic participation scenarios. We show that mandating social distancing is very effective at flattening the epidemic curve, but is costly in terms of employment loss. However, if targeted towards individuals most likely to spread the infection, the employment loss can be somewhat reduced. We also show that voluntary self-isolation driven by individuals’ perceived risk of becoming infected kicks in only towards the peak of the epidemic and has little or no impact on flattening the epidemic curve. Using available statistics and correcting for measurement errors, we estimate the rate of exposure to COVID-19 for 21 Chinese provinces and a selected number of countries. The exposure rates are generally small, but vary considerably between Hubei and other Chinese provinces as well as across countries. Strikingly, the exposure rate in Hubei province is around 40 times larger than the rates for other Chinese provinces, with the exposure rates for some European countries being 3-5 times larger than Hubei (the epicenter of the epidemic). The paper also provides country-specific estimates of the recovery rate, showing it to be about 21 days (a week longer than the 14 days typically assumed), and relatively homogeneous across Chinese provinces and for a selected number of countries.

DOI: https://doi.org/10.24149/gwp382

No. 2009
Complementarity and Macroeconomic Uncertainty
Tyler Atkinson, Michael Plante, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: Macroeconomic uncertainty—the conditional volatility of the unforecastable component of a future value of a time series—shows considerable variation in the data. A typical assumption in business cycle models is that production is Cobb-Douglas. Under that assumption, this paper shows there is usually little, if any, endogenous variation in output uncertainty, and first moment shocks have similar effects in all states of the economy. When the model departs from Cobb-Douglas production and assumes capital and labor are gross complements, first-moment shocks have state-dependent effects and can cause meaningful variation in uncertainty compared to the data. Estimating several variants of a nonlinear real business cycle model reveals the data strongly prefers a model with high complementarity between capital and labor inputs.

DOI: https://doi.org/10.24149/wp2009

No. 2008
A Quantitative Evaluation of the Housing Provident Fund Program in China
Xiaoqing Zhou
Abstract: The Housing Provident Fund (HPF) is the largest public housing program in China. It was created in 1999 to enhance homeownership. This program involves a mandatory saving scheme based on labor income. Past deposits are refunded when the worker purchases a house or retires. Moreover, the program provides mortgages at subsidized rates to facilitate these home purchases. I calibrate a heterogeneous-agent life-cycle model to quantify the effects of these policies. My analysis shows that a housing program with these features is expected to raise the rate of homeownership by 8.7 percentage points and to increase the average home size by 20%. I discuss the economic mechanisms by which these outcomes are achieved and which features of the HPF program are most effective. I also consider several extensions of the model such as requiring employers to contribute to the program and allowing renters to withdraw funds from the HPF.

DOI: https://doi.org/10.24149/wp2008

No. 2007
Understanding the Exposure at Default Risk of Commercial Real Estate Construction and Land Development Loans
Shan Luo and Anthony Murphy
Abstract: We study and model the determinants of exposure at default (EAD) for large U.S. construction and land development loans from 2010 to 2017. EAD is an important component of credit risk, and commercial real estate (CRE) construction loans are more risky than income producing loans. This is the first study modeling the EAD of construction loans. The underlying EAD data come from a large, confidential supervisory dataset used in the U.S. Federal Reserve’s annual Comprehensive Capital Assessment Review (CCAR) stress tests. EAD reflects the relative bargaining ability and information sets of banks and obligors. We construct OLS and Tobit regression models, as well as several other machine-learning models, of EAD conversion measures, using a four-quarter horizon. The popular LEQ and CCF conversion measure is unstable, so we focus on EADF and AUF measures. Property type, the lagged utilization rate and loan size are important drivers of EAD. Changing local and national economic conditions also matter, so EAD is sensitive to macro-economic conditions. Even though default and EAD risk are negatively correlated, a conservative assumption is that all undrawn construction commitments will be fully drawn in default.

DOI: https://doi.org/10.24149/wp2007

No. 2006
The Econometrics of Oil Market VAR Models
Lutz Kilian and Xiaoqing Zhou
Abstract: Oil market VAR models have become the standard tool for understanding the evolution of the real price of oil and its impact in the macro economy. As this literature has expanded at a rapid pace, it has become increasingly difficult for mainstream economists to understand the differences between alternative oil market models, let alone the basis for the sometimes divergent conclusions reached in the literature. The purpose of this survey is to provide a guide to this literature. Our focus is on the econometric foundations of the analysis of oil market models with special attention to the identifying assumptions and methods of inference. We not only explain how the workhorse models in this literature have evolved, but also examine alternative oil market VAR models. We help the reader understand why the latter models sometimes generated unconventional, puzzling or erroneous conclusions. Finally, we discuss the construction of extraneous measures of oil demand and oil supply shocks that have been used as external or internal instruments for VAR models.

DOI: https://doi.org/10.24149/wp2006

No. 2005
How Does Immigration Fit into the Future of the U.S. Labor Market?
Pia M. Orrenius, Madeline Zavodny and Stephanie Gullo
Abstract: U.S. GDP growth is anticipated to remain sluggish over the next decade, and slow labor force growth is a key underlying reason. Admitting more immigrants is one way U.S. policymakers can bolster growth in the workforce and the economy. A larger role for immigrant workers also can help mitigate other symptoms of the economy’s long-run malaise, such as low productivity growth, declining domestic geographic mobility, and falling entrepreneurship, as well as help address the looming mismatch between the skills U.S. employers want and the skills U.S. workers have. While some might argue that technological change and globalization mean there is less need to admit immigrant workers, such arguments fail to account for both recent data and historical experience. Of course, immigration—like anything else—is not without costs, which are disproportionately borne by the least educated. A plan to increase employment-based immigration as a way to spur economic growth could be paired with new programs to help low-skilled U.S. natives and earlier immigrants so that the benefits of immigration are shared more equitably.

DOI: https://doi.org/10.24149/wp2005

No. 2004
The Effect of Immigration on Business Dynamics and Employment
Pia M. Orrenius, Madeline Zavodny and Alexander Abraham
Abstract: Immigration, like any positive labor supply shock, should increase the return to capital and spur business investment. These changes should have a positive impact on business creation and expansion, particularly in areas that receive large immigrant inflows. Despite this clear prediction, there is sparse empirical evidence on the effect of immigration on business dynamics. One reason may be data unavailability since public-access firm-level data are rare. This study examines the impact of immigration on business dynamics and employment by combining U.S. data on immigrant inflows from the Current Population Survey with data on business formation and survival and job creation and destruction from the National Establishment Time Series (NETS) database for the period 1997 to 2013. The results indicate that immigration increases the business growth rate by boosting business survival and raises employment by reducing job destruction. The effects are largely driven by less-educated immigrants.

DOI: https://doi.org/10.24149/wp2004

Globalization Institute No. 379
Shock-Dependent Exchange Rate Pass-Through: Evidence Based on a Narrative Sign Approach
Lian An, Mark A. Wynne and Ren Zhang
Abstract: This paper studies shock-dependent exchange rate pass-through for Japan with a Bayesian structural vector autoregression model. We identify the shocks by complementing the traditional sign and zero restrictions with narrative sign restrictions related to the Plaza Accord. We find that the narrative sign restrictions are highly informative, and substantially sharpen and even change the inferences of the structural vector autoregression model originally identified with only the traditional sign and zero restrictions. We show that there is a significant variation in the exchange rate pass-through across different shocks. Nevertheless, the exogenous exchange rate shock remains the most important driver of exchange rate fluctuations. Finally, we apply our model to “forecast” the dynamics of the exchange rate and prices conditional on certain foreign exchange interventions in 2018, which provides important policy implications for our shock-identification exercise.

DOI: https://doi.org/10.24149/gwp379

No. 2003
Distant Lending, Specialization, and Access to Credit
Wenhua Di and Nathaniel Pattison
Abstract: Small business lending has historically been very local, but distances between small businesses and their lenders have steadily increased over the last forty years. This paper investigates a new lending strategy made possible by distant small business lending: industry specialization. Using data on all Small Business Administration 7(a) loans from 2001-2017, we document a substantial increase in remote, specialized small business lenders, i.e., lenders that originate many distant loans and concentrate these loans within a small number of industries. These lenders target low-risk industries and, consistent with expertise, experience better loan performance within these industries. We then examine whether this industry-specialized lending serves as a substitute or complement to traditional, geographically specialized lending. We exploit the staggered entry of a remote, specialized lender to estimate the impact of specialized lending on credit access. Entry significantly increases total lending, with no evidence of substitution away from other lenders. The results indicate that specialized lending can deepen credit markets by providing new loans to low-risk but underfinanced small businesses.

DOI: https://doi.org/10.24149/wp2003

No. 2002
Who Signs up for E-Verify? Insights from DHS Enrollment Records
Pia Orrenius, Madeline Zavodny and Sarah Greer
Abstract: E-Verify is a federal electronic verification system that allows employers to check whether their newly hired workers are authorized to work in the United States. To use E-Verify, firms first must enroll with the Department of Homeland Security (DHS). Participation is voluntary for most private-sector employers in the United States, but eight states currently require all or most employers to use E-Verify. This article uses confidential data from DHS to examine patterns of employer enrollment in E-Verify. The results indicate that employers are much more likely to sign up in mandatory E-Verify states than in states without such mandates, but enrollment is still below 50 percent in states that require its use. Large employers are far more likely to sign up than small employers. In addition, employers are more likely to newly enroll in E-Verify when a state’s unemployment rate or population share of likely unauthorized immigrants rises. However, enrollment rates are lower in industries with higher shares of unauthorized workers. Taken as a whole, the results suggest that enrolling in the program is costly for employers in terms of both compliance and difficulty in hiring workers. A strictly enforced nationwide mandate that all employers use an employment eligibility program like E-Verify would be incompatible with the current reliance on a large unauthorized workforce. Allowing more workers to enter legally or legalizing existing workers might be necessary before implementing E-Verify nationally.

DOI: https://doi.org/10.24149/wp2002

No. 2001
Did the Tax Cuts and Jobs Act Create Jobs and Stimulate Growth? (Revised August 2023, new title April 2022)
Anil Kumar
Abstract: The Tax Cuts and Jobs Act (TCJA) of 2017 is the most extensive overhaul of the U.S. income tax code since the Tax Reform Act of 1986. Existing estimates of TCJA’s economic impact are based on economic projections using pre-TCJA estimates of tax effects. I exploit plausibly exogenous state-level variation in tax changes from TCJA and find that an income tax cut equaling 1 percent of GDP led to a 1.2-percentage-point faster job growth and nearly 1.5 percentage points higher GDP growth over two years following the law change. While the estimates are imprecise, the overall pattern suggests that the TCJA stimulated economic growth. The estimates imply a two-year tax cut multiplier of 1.5 and a cost per job of $105,000. The estimated growth effect was driven by a nearly 1.3-percentage-point increase in the labor force participation rate.
Revision 1
Original paper
DOI: https://doi.org/10.24149/wp2001r2

No. 1916
Does Drawing Down the U.S. Strategic Petroleum Reserve Help Stabilize Oil Prices?
Lutz Kilian and Xiaoqing Zhou
Abstract: We study the efficacy of releases from the U.S. Strategic Petroleum Reserve (SPR) within the context of fully specified models of the global oil market that explicitly allow for storage demand as well as unanticipated changes in the SPR. Using novel identifying strategies and evaluation methods, we examine seven questions. First, how much have exogenous shocks to the SPR contributed to the variability in the real price of oil? Second, how much would a one-time exogenous reduction in the SPR lower the real price of oil? Third, are exogenous SPR releases partially or fully offset by increases in private sector oil inventories and how does this response affect the transmission of SPR policy shocks? Fourth, how effective were actual SPR policy interventions, consisting of sequences of exogenous changes in the SPR, at lowering the real price of oil? Fifth, are there differences in the effectiveness of SPR emergency drawdowns and SPR exchanges? Sixth, how much did the creation and expansion of the SPR contribute to higher real oil prices? Finally, how much would selling half of the oil in the SPR, as recently proposed by the White House, lower the global price of oil (and hence the U.S. price of motor gasoline) and how much fiscal revenue would it generate?

DOI: https://doi.org/10.24149/wp1916

No. 1915
Rationally Inattentive Savers and Monetary Policy Changes: A Laboratory Experiment
Andrea Civelli, Cary Deck and Antonella Tutino
Abstract: We present a model where rationally inattentive agents decide how much to save while imperfectly tracking interest rate changes. Suitable assumptions on agents’ preferences and interest rate distribution allow us to derive testable theoretical predictions and their implications for monetary policy. We probe these predictions using a laboratory experiment with induced inattention that closely reflects the theoretical assumptions. We find that, empirically, the laboratory data corroborates the results of the theoretical model. In particular, we show that experimental subjects respond to changes in the interest rate policy environment with: (1) a decrease in savings when the utility gain from savings does not compensate for the cognitive cost of tracking the interest rate; (2) more informed and deliberate consumption/investment choices when the monetary authority stabilizes the economy by lowering the volatility of the policy rate, implementing a version of Delphic forward guidance; (3) a slight decrease in information processing but no behavioral changes in consumption when the monetary authority signals current monetary policy stance, implementing a version of Odyssean forward guidance; (4) a sizable decrease in investment when their perception of the outlook deteriorates. These experimental and theoretical findings agree with the empirical literature on the effect of monetary policy on households’ consumption behavior in U.S. data and abroad.

DOI: https://doi.org/10.24149/wp1915

Globalization Institute No. 375
The Effect of Central Bank Credibility on Forward Guidance in an Estimated New Keynesian Model (Revised March 2021)
Stephen J. Cole and Enrique Martínez-García
Abstract: This paper examines the effectiveness of forward guidance in an estimated New Keynesian model with imperfect central bank credibility. We estimate credibility for the U.S. Federal Reserve with Bayesian methods exploiting survey data on interest rate expectations from the Survey of Professional Forecasters (SPF). The results provide important takeaways: (1) The estimate of Federal Reserve credibility in terms of forward guidance announcements is relatively high, which indicates muted forward guidance effectiveness relative to the fully credible case. Hence, anticipation effects are attenuated and, accordingly, output and inflation do not respond as favorably to forward guidance announcements. (2) The so-called “forward guidance puzzle” is shown to arise, at least in part, from the unrealistically large responses of macroeconomic variables to forward guidance statements in structural models that do not incorporate imperfect credibility and heterogeneous expectations. (3) Imperfect monetary authority credibility provides a plausible explanation to the evidence of forecasting error predictability based on forecasting disagreement found in the SPF data. Thus, accounting for imperfect credibility is important to model the formation of expectations in the economy and to understand the transmission mechanism of forward guidance announcements.
Revision 1
Original paper
DOI: https://doi.org/10.24149/gwp375r2

No. 1914
Oil Prices, Exchange Rates and Interest Rates
Lutz Kilian and Xiaoqing Zhou
Abstract: There has been much interest in the relationship between the price of crude oil, the value of the U.S. dollar, and the U.S. interest rate since the 1980s. For example, the sustained surge in the real price of oil in the 2000s is often attributed to the declining real value of the U.S. dollar as well as low U.S. real interest rates, along with a surge in global real economic activity. Quantifying these effects one at a time is difficult not only because of the close relationship between the interest rate and the exchange rate, but also because demand and supply shocks in the oil market in turn may affect the real value of the dollar and real interest rates. We propose a novel identification strategy for disentangling the causal effects of traditional oil demand and oil supply shocks from the effects of exogenous variation in the U.S. real interest rate and in the real value of the U.S. dollar. We empirically evaluate popular views about the role of exogenous real exchange rate shocks in driving the real price of oil, and we examine the extent to which shocks in the global oil market drive the U.S. real exchange rate and U.S. real interest rates. Our evidence for the first time provides direct empirical support for theoretical models of the link between these variables.

DOI: https://doi.org/10.24149/wp1914

No. 1913
The Rising Value of Time and the Origin of Urban Gentrification
Yichen Su
Abstract: In recent decades, gentrification has transformed American central city neighborhoods. I estimate a spatial equilibrium model to show that the rising value of high-skilled workers’ time contributes to the gentrification of American central cities. I show that the increasing value of time raises the cost of commuting and exogenously increases the demand for central locations by high-skilled workers. While change in the value of time has a modest direct effect on gentrification of central cities, the effect is substantially magnified by endogenous amenity improvement driven by the changes in local skill mix.

DOI: https://doi.org/10.24149/wp1913

No. 1912
Monopsony in Spatial Equilibrium
Matthew E. Kahn and Joseph Tracy
Abstract: An emerging labor economics literature studies the consequences of firms exercising market power in local labor markets. These monopsony models have implications for trends in earnings inequality. The extent of this market power is likely to vary across local labor markets. In choosing what market to live and work in, workers trade off wages, rents and local amenities. Building on the Rosen/Roback spatial equilibrium model, we investigate how the existence of local monopsony power affects the cross-sectional spatial distribution of wages and rents across cities. We find an employment-weighted elasticity of land prices to concentration of –0.034—similar to Rinz (2018)’s reported elasticity of compensation to concentration. This finding has implications for who bears the economic incidence of labor market power. We present two extensions of the model focusing on the role of migration costs and worker skill heterogeneity.

DOI: https://doi.org/10.24149/wp1912

No. 1911
Making Sense of Increased Synchronization in Global House Prices
John V. Duca
Published as: Duca, John V. (2020), "Making Sense of Increased Synchronization in Global House Prices," Journal of European Real Estate Research 13 (1): 5-16. https://doi.org/10.1108/JERER-11-2019-0044.
Abstract: Evidence indicates that house prices have become somewhat more synchronized during this century, likely reflecting more correlated movements in long-term interest rates and macroeconomic cycles that are related to trends in globalization and international portfolio diversification. Nevertheless, the trend toward increased synchronization has not been continuous, reflecting that house prices depend on other fundamentals, which are not uniform across countries or cities. Theory and limited econometric evidence indicate that the more common are fundamentals, the more in-synch house price cycles will become and the more substitution effects may matter. In addition, real estate markets that are open to immigration and foreign investment have become more sensitive to shifts in the international demand for property by migrants or investors.

DOI: https://doi.org/10.24149/wp1911

Globalization Institute No. 369
Drilling Down: The Impact of Oil Price Shocks on Housing Prices
Valerie Grossman, Enrique Martínez-García, Luis Bernardo Torres and Yongzhi Sun
Abstract: This paper investigates the impact of oil price shocks on house prices in the largest urban centers in Texas. We model their dynamic relationship taking into account demand- and supply-side housing fundamentals (personal disposable income per capita, long-term interest rates and rural land prices) as well as their varying dependence on oil activity. We show the following: 1) Oil price shocks have limited pass-through to house prices—the highest pass-through is found among the most oil-dependent cities where, after 20 quarters, the cumulative response of house prices is 21 percent of the cumulative effect on oil prices. Still, among less oil-dependent urban areas, the house price response to a one standard deviation oil price shock is economically significant and comparable in magnitude to the response to a one standard deviation income shock. 2) Omitting oil prices when looking at housing markets in oil-producing areas biases empirical inferences by substantially overestimating the effect of income shocks on house prices. 3) The empirical relationship linking oil price fluctuations to house prices has remained largely stable over time, in spite of the significant changes in Texas’ oil sector with the onset of the shale revolution in the 2000s.

DOI: https://doi.org/10.24149/gwp369

No. 1910
Refining the Workhorse Oil Market Model
Xiaoqing Zhou
Abstract: The Kilian and Murphy (2014) structural vector autoregressive model has become the workhorse model for the analysis of oil markets. I explore various refinements and extensions of this model, including the effects of (1) correcting an error in the measure of global real economic activity, (2) explicitly incorporating narrative sign restrictions into the estimation, (3) relaxing the upper bound on the impact price elasticity of oil supply, (4) evaluating the implied posterior distribution of the structural models, and (5) extending the sample. I demonstrate that the substantive conclusions of Kilian and Murphy (2014) are largely unaffected by these changes.

DOI: https://doi.org/10.24149/wp1910

No. 1909
The Propagation of Regional Shocks in Housing Markets: Evidence from Oil Price Shocks in Canada
Lutz Kilian and Xiaoqing Zhou
Abstract: Shocks to the demand for housing that originate in one region may seem important only for that regional housing market. We provide evidence that such shocks can also affect housing markets in other regions. Our analysis focuses on the response of Canadian housing markets to oil price shocks. Oil price shocks constitute an important source of exogenous regional variation in income in Canada because oil production is highly geographically concentrated. We document that, at the national level, real oil price shocks account for 11% of the variability in real house price growth over time. At the regional level, we find that unexpected increases in the real price of oil raise housing demand and real house prices not only in oil-producing regions, but also in other regions. We develop a theoretical model of the propagation of real oil price shocks across regions that helps understand this finding. The model differentiates between oil-producing and non-oil-producing regions and incorporates multiple sectors, trade between provinces, government redistribution, and consumer spending on fuel. We empirically confirm the model prediction that oil price shocks are propagated to housing markets in non-oil-producing regions by the government redistribution of oil revenue and by increased interprovincial trade.

DOI: https://doi.org/10.24149/wp1909

No. 1908
The Uniform Validity of Impulse Response Inference in Autoregressions
Atsushi Inoue and Lutz Kilian
Abstract: Existing proofs of the asymptotic validity of conventional methods of impulse response inference based on higher-order autoregressions are pointwise only. In this paper, we establish the uniform asymptotic validity of conventional asymptotic and bootstrap inference about individual impulse responses and vectors of impulse responses when the horizon is fixed with respect to the sample size. For inference about vectors of impulse responses based on Wald test statistics to be uniformly valid, lag-augmented autoregressions are required, whereas inference about individual impulse responses is uniformly valid under weak conditions even without lag augmentation. We introduce a new rank condition that ensures the uniform validity of inference on impulse responses and show that this condition holds under weak conditions. Simulations show that the highest finite-sample accuracy is achieved when bootstrapping the lag-augmented autoregression using the bias adjustments of Kilian (1999). The conventional bootstrap percentile interval for impulse responses based on this approach remains accurate even at long horizons. We provide a formal asymptotic justification for this result.

DOI: https://doi.org/10.24149/wp1908

No. 1907
Facts and Fiction in Oil Market Modeling (Revised December 2020)
Lutz Kilian
Abstract: A series of recent articles has called into question the validity of VAR models of the global market for crude oil. These studies seek to replace existing oil market models by structural VAR models of their own based on different data, different identifying assumptions, and a different econometric approach. Their main aim has been to revise the consensus in the literature that oil demand shocks are a more important determinant of oil price fluctuations than oil supply shocks. Substantial progress has been made in recent years in sorting out the pros and cons of the underlying econometric methodologies and data in this debate, and in separating claims that are supported by empirical evidence from claims that are not. The purpose of this paper is to take stock of the VAR literature on global oil markets and to synthesize what we have learned. Combining this evidence with new data and analysis, I make the case that the concerns regarding the existing VAR oil market literature have been overstated and that the results from these models are quite robust to changes in the model specification.
Original paper
DOI: https://doi.org/10.24149/wp1907r1

No. 1906
Do Monetary Policy Announcements Shift Household Expectations? (Revised January 2020)
Daniel J. Lewis, Christos Makridis and Karel Mertens
Abstract: We use a decade of daily survey data from Gallup to study how monetary policy influences households' beliefs about economic conditions. We first document that public confidence in the state of the economy reacts instantaneously to certain types of macroeconomic news. Next, we show that surprises to the Federal Funds target rate are among the news that have statistically significant and instantaneous effects on economic confidence. Specifically, we find that a surprise increase in the target rate robustly leads to an immediate decline in household confidence, at odds with previous findings that suggest consumers are largely inattentive to economic developments. Monetary policy news about forward guidance and asset purchases does not have similarly clear and robust immediate effects on household beliefs. We document heterogeneity across demographics in the responsiveness of macroeconomic beliefs to aggregate news, and we relate our findings to existing evidence on informational rigidities.
Original paper
DOI: https://doi.org/10.24149/wp1906r1

No. 1905
Do Immigrants Threaten U.S. Public Safety?
Pia Orrenius and Madeline Zavodny
Abstract: Opponents of immigration often claim that immigrants, particularly those who are unauthorized, are more likely than U.S. natives to commit crimes and that they pose a threat to public safety. There is little evidence to support these claims. In fact, research overwhelmingly indicates that immigrants are less likely than similar U.S. natives to commit violent and property crimes, and that areas with more immigrants have similar or lower rates of violent and property crimes than areas with fewer immigrants. There are relatively few studies specifically of criminal behavior among unauthorized immigrants, but the limited research suggests that these immigrants also have a lower propensity to commit crime than their native-born peers, although possibly a higher propensity than legal immigrants. Evidence about legalization programs is consistent with these findings, indicating that a legalization program reduces crime rates. Meanwhile, increased border enforcement, which reduces unauthorized immigrant inflows, has mixed effects on crime rates. A large-scale legalization program, which is not currently under serious consideration, has more potential to improve public safety and security than several other policies that have recently been proposed or implemented.

DOI: https://doi.org/10.24149/wp1905

No. 1904
Uncertainty and Labor Market Fluctuations
Soojin Jo and Justin J. Lee
Abstract: We investigate how a macroeconomic uncertainty shock affects the labor market. We focus on the uncertainty transmission mechanism, for which we employ a set of worker flow indicators in addition to labor stock variables. We incorporate common factors from such indicators into a framework that can simultaneously estimate historical macroeconomic uncertainty and its impacts on the macroeconomy and labor market. We find firms defer hiring as the real option value of waiting increases. Moreover, significantly more workers are laid off while voluntary quits drop, suggesting other mechanisms such as the aggregate demand channel play a crucial role.

DOI: https://doi.org/10.24149/wp1904

No. 1903
Two Measures of Core Inflation: A Comparison
Jim Dolmas and Evan F. Koenig
Abstract: Trimmed-mean Personal Consumption Expenditure (PCE) inflation does not clearly dominate ex-food-and-energy PCE inflation in real-time forecasting of headline PCE inflation. However, trimmed-mean inflation is the superior communications and policy tool because it is a less-biased real-time estimator of headline inflation and because it more successfully filters out headline inflation’s transitory variation, leaving only cyclical and trend components.

DOI: https://doi.org/10.24149/wp1903

Globalization Institute No. 360
Upstream, Downstream & Common Firm Shocks
Everett Grant and Julieta Yung
Abstract: We develop a multi-sector DSGE model to calculate upstream and downstream industry exposure networks from U.S. input-output tables and test the relative importance of shocks from each direction by comparing these with estimated networks of firms’ equity return responses to one another. The correlations between the upstream exposure and equity return networks are large and statistically significant, while the downstream exposure networks have lower — but still positive — correlations that are not statistically significant. These results suggest a low short-term elasticity of substitution across inputs transmitting shocks from suppliers, but more flexible ties with downstream firms. Additionally, both the DSGE model and simulations of our empirical approach highlight the importance of accounting for common factors in network estimation, which become more important over our 1989-2017 sample period, explaining 11.7% of equity return variation over the first ten years and 35.0% over the final ten.

DOI: https://doi.org/10.24149/gwp360

Globalization Institute No. 359
Ties That Bind: Estimating the Natural Rate of Interest for Small Open Economies (Revised March 2021)
Valerie Grossman, Enrique Martínez-García, Mark A. Wynne and Ren Zhang
Abstract: This paper estimates the natural rate of interest for six small open economies (Australia, Canada, South Korea, Sweden, Switzerland and the U.K.) with a structural New Keynesian model using Bayesian techniques. Our empirical analysis establishes the following four main findings: First, we show that the open economy framework provides a better fit of the data than its closed economy counterpart for the six countries we investigate. Second, we also show that, in all six countries, a Taylor (1993)-type monetary policy rule that tracks the Wicksellian short-term natural rate fits the data better than a rule that does not. Third, we show that the natural interest rates of all six countries have shifted downwards and strongly comoved with each other over the past 35 years. Fourth, our findings illustrate that foreign output shocks (spillovers from the rest of the world) are a major contributor to the dynamics of the natural rate in these six small open economies and that those natural rates strongly comove also with the existing U.S. natural rate estimates.
Original paper
DOI: https://doi.org/10.24149/gwp359r1

No. 1902
The Contribution of Jump Signs and Activity to Forecasting Stock Price Volatility (Revised December 2022)
Ruijun Bu, Rodrigo Hizmeri, Marwan Izzeldin, Anthony Murphy and Mike G. Tsionas
Published as: Bu, Ruijun, Rodrigo Hizmeri, Marwan Izzeldin, Anthony Murphy and Mike Tsionas (2023), "The Contribution of Jump Signs and Activity to Forecasting Stock Price Volatility," Journal of Empirical Finance, (70): 144-164. https://doi.org/10.1016/j.jempfin.2022.12.001.
Abstract: We propose a novel approach to decompose realized jump measures by type of activity (finite/infinite) and sign, and also provide noise-robust versions of the ABD jump test (Andersen et al., 2007b) and realized semivariance measures. We find that infinite (finite) jumps improve the forecasts at shorter (longer) horizons; but the contribution of signed jumps is limited. As expected, noise-robust measures deliver substantial forecast improvements at higher sampling frequencies, although standard volatility measures at the 300-second frequency generate the smallest MSPEs. Since no single model dominates across sampling frequency and forecasting horizon, we show that model averaged volatility forecasts—using time-varying weights and models from the model confidence set—generally outperform forecasts from both the benchmark and single best extended HAR model. Finally, forecasts using volatility and jump measures based on transaction sampling are inferior to the forecasts from clock-based sampling.
Revision 1
Original paper
DOI: https://doi.org/10.24149/wp1902r2

Globalization Institute No. 358
Capital Controls as Macro-prudential Policy in a Large Open Economy
J. Scott Davis and Michael B. Devereux
Abstract: The literature on optimal capital controls for macro-prudential policy has focused on capital controls in a small open economy. This ignores the spillover effects to the rest of the world. This paper re-examines the case for capital controls in a large open economy, where domestic financial constraints may bind following a large negative shock. There is a tension between the desire to tax inflows to manipulate the terms of trade and tax outflows for macro-prudential purposes. Non-cooperative capital controls are ineffective as macro-prudential policy. Cooperative policy will ignore terms-of-trade manipulation and thus cooperative capital controls yield more effective macro-prudential policy.

DOI: https://doi.org/10.24149/gwp358

Globalization Institute No. 357
Global Drivers of Gross and Net Capital Flows
J. Scott Davis, Giorgio Valente and Eric van Wincoop
Abstract: While prior to the global financial crisis, the empirical international capital flow literature has focused on net capital flows (the current account), since the crisis there has been an increased focus on gross flows. In this paper we jointly analyze global drivers of gross flows (outflows plus inflows) and net flows (outflows minus inflows) by estimating a latent factor model. We find evidence of two global factors, which we call the GFC (global financial cycle) factor and a commodity price factor as they closely track respectively the Miranda-Agrippino and Rey asset price factor and an average of oil and gas prices. These factors together account for half the variance of gross flows in advanced countries and forty percent of the variance of gross flows in emerging markets. But remarkably, they also account for forty percent of the variance of net capital flows in both groups of countries. We also analyze the heterogeneity across countries in the impact of the two factors. One of the key findings is that the impact of the GFC factor on both gross and net capital flows is stronger in countries that have larger net debt liabilities. Other asset classes (FDI and portfolio equity) do not significantly impact the exposure to the GFC factor.

DOI: https://doi.org/10.24149/gwp357

Globalization Institute No. 356
Estimation of Impulse Response Functions When Shocks are Observed at a Higher Frequency than Outcome Variables
Alexander Chudik and Georgios Georgiadis
Abstract: This paper proposes mixed-frequency distributed-lag (MFDL) estimators of impulse response functions (IRFs) in a setup where (i) the shock of interest is observed, (ii) the impact variable of interest is observed at a lower frequency (as a temporally aggregated or sequentially sampled variable), (iii) the data-generating process (DGP) is given by a VAR model at the frequency of the shock, and (iv) the full set of relevant endogenous variables entering the DGP is unknown or unobserved. Consistency and asymptotic normality of the proposed MFDL estimators is established, and their small-sample performance is documented by a set of Monte Carlo experiments. The proposed approach is then applied to estimate the daily pass-through of changes in crude oil prices observed at a daily frequency to U.S. gasoline consumer prices observed at a weekly frequency. We find that the pass-through is fast, with about 28% of the crude oil price changes passed through to retail gasoline prices within five working days, and that the speed of the pass-through has increased over time.

DOI: https://doi.org/10.24149/gwp356

Globalization Institute No. 353
Estimating Impulse Response Functions When the Shock Series Is Observed
Chi-Young Choi and Alexander Chudik
Abstract: We compare the finite sample performance of a variety of consistent approaches to estimating Impulse Response Functions (IRFs) in a linear setup when the shock of interest is observed. Although there is no uniformly superior approach, iterated approaches turn out to perform well in terms of root mean-squared error (RMSE) in diverse environments and sample sizes. For smaller sample sizes, parsimonious specifications are preferred over full specifications with all ‘relevant’ variables.

DOI: https://doi.org/10.24149/gwp353

Globalization Institute No. 352
Foreign Exchange Reserves as a Tool for Capital Account Management
J. Scott Davis, Ippei Fujiwara, Kevin X.D. Huang and Jiao Wang
Abstract: Many recent theoretical papers have argued that countries can insulate themselves from volatile world capital flows by using a variable tax on foreign capital as an instrument of monetary policy. But at the same time many empirical papers have argued that only rarely do we observe these cyclical capital taxes used in practice. In this paper we construct a small open economy model where the central bank can engage in sterilized foreign exchange intervention. When private agents can freely buy and sell foreign bonds, sterilized foreign exchange intervention has no effect. But we analytically prove that when private agents cannot freely buy and sell foreign bonds, that is, under acyclical capital controls, optimal sterilized foreign exchange intervention is equivalent to an optimally chosen tax on foreign capital. Numerical simulations of the model show that a variable capital tax is a reasonable approximation for sterilized foreign exchange intervention under the levels of capital controls observed in many emerging markets.

DOI: https://doi.org/10.24149/gwp352

No. 1901
Closer to One Great Pool? Evidence from Structural Breaks in Oil Price Differentials
Michael Plante and Grant Strickler
Abstract: We show that the oil market has become closer to “one great pool,” in the sense that price differentials between crude oils of different qualities have generally become smaller over time. We document, in particular, that many of these quality-related differentials experienced a major structural break in or around 2008, after which there was a marked reduction in their means and, in many cases, volatilities. Several factors explain these shifts, including a growing ability of the global refinery sector to process lower-quality crude oil and the U.S. shale boom, which has unexpectedly boosted the supply of high-quality crude oil. Differentials between crude oils of similar quality in general did not experience breaks in or around 2008, although we do find evidence of breaks at other times. We also show that these structural breaks can affect tests of stationarity for many price differentials.

DOI: https://doi.org/10.24149/wp1901

Globalization Institute No. 351
Identifying Global and National Output and Fiscal Policy Shocks Using a GVAR
Supplement
Alexander Chudik, M. Hashem Pesaran and Kamiar Mohaddes
Abstract: The paper contributes to the growing Global VAR (GVAR) literature by showing how global and national shocks can be identified within a GVAR framework. The usefulness of the proposed approach is illustrated in an application to the analysis of the interactions between public debt and real output growth in a multi-country setting, and the results are compared to those obtained from standard single-country VAR analysis. We find that on average (across countries) global shocks explain about one-third of the long-horizon forecast error variance of output growth, and about one-fifth of the long-run variance of the rate of change of debt-to-GDP. Evidence on the degree of cross-sectional dependence in these variables and their innovations is exploited to identify the global shocks, and priors are used to identify the national shocks within a Bayesian framework. It is found that posterior median debt elasticity with respect to output is much larger when the rise in output is due to a fiscal policy shock, as compared to when the rise in output is due to a positive technology shock. The cross-country average of the median debt elasticity is 1.58 when the rise in output is due to a fiscal expansion as compared to 0.75 when the rise in output follows from a favorable output shock.

DOI: https://doi.org/10.24149/gwp351
Supplement DOI: https://doi.org/10.24149/gwp351supp

No. 1815
Argentina’s “Missing Capital” Puzzle and Limited Commitment Constraints
Marek Kapička, Finn E. Kydland and Carlos E. Zarazaga
Abstract: Capital accumulation in Argentina was slow in the 1990s, despite high total factor productivity (TFP) growth and low international interest rates. A possible explanation for the “missing capital” is that foreign investors were reluctant to take advantage of the high returns to investment seemingly offered by that small open economy under such favorable conditions, on the grounds that previous historical developments had led them to perceive Argentina as a country prone to external debt “opportunistic defaults.” The paper examines this conjecture from the perspective of an optimal contract between foreign lenders and a small open economy subject to limited commitment constraints. Numerical experiments for a deterministic version of that analytical framework show that limited commitment constraints introduce an asymmetry to the capital accumulation process of small open economies: the responses of investment to positive TFP shocks are muted and shortlived, while those to negative TFP shocks are large and persistent. Furthermore, under some circumstances, a lower international interest rate environment can magnify the asymmetry. A quantitative implementation of the model economy to data from Argentina accounts, in line with asymmetry just described, for the rapid decline that that country’s capital stock experienced, along with a falling TFP during the 1980s, as well as for the lack of any visible recovery of that stock during the significant surges of TFP observed between 1992-1998 and 2002-2008. In the absence of the limited commitment constraint, Argentina’s capital stock in 2008 would have been 50% higher than it actually was.

DOI: https://doi.org/10.24149/wp1815

No. 1814
Inflation and the Gig Economy: Have the Rise of Online Retailing and Self-Employment Disrupted the Phillips Curve?
John V. Duca
Abstract: During the recovery from the Great Recession, inflation did not reach the central bank’s 2 percent objective as quickly as many models had predicted. This coincided with increases in online shopping, which arguably made retail markets more contestable and damped retail inflation. This hypothesis is tested using data on the online share of retail sales, which are incorporated into an econometric model. Results imply that the rise of online retail has flattened the Phillips Curve, reducing the sensitivity of inflation to unemployment rate changes. Improvement in fit from just including the online share is tiny—so far. Other results indicate that market-based price indexes are more sensitive to unemployment than measures such as core PCE, which puts a sizable weight on items with imputed prices that may slowly adjust to market conditions. Further, measures of online sales that internalize substitution between online and traditional mail order sales better help track the impact of online sales on inflation dynamics.

A complementary factor is the “gig” economy and the rise of self-employment, which by reducing the bargaining power of labor, could lower the natural rate of unemployment. Model performance and fits are improved using a hybrid approach in which the rise of online sales can flatten the slope of the Phillips Curve by reducing retail pricing power and the prevalence of gig or self-employment can lower the natural rate of unemployment.

By omitting important structural changes in both goods and labor markets, conventional Phillips Curve models have failed to track how the rise of online retailing has flattened the Phillips Curve and how the rise of the gig economy (self-employment) has lowered the natural rate of unemployment. One notable difference between the price-price and wage-price results is that the combined effects of online shopping and self-employment are more notable on wage inflation than on price inflation. This could plausibly reflect that improvements in information technology may have undermined the pricing power of workers in labor markets to a greater degree than they have affected the pricing power of producers in goods markets.

DOI: https://doi.org/10.24149/wp1814

Globalization Institute No. 349
Mean Group Estimation in Presence of Weakly Cross-Correlated Estimators
Alexander Chudik and M. Hashem Pesaran
Abstract: This paper extends the mean group (MG) estimator for random coefficient panel data models by allowing the underlying individual estimators to be weakly cross-correlated. Weak cross-sectional dependence of the individual estimators can arise, for example, in panels with spatially correlated errors. We establish that the MG estimator is asymptotically correctly centered, and its asymptotic covariance matrix can be consistently estimated. The random coefficient specification allows for correct inference even when nothing is known about the weak cross-sectional dependence of the errors. This is in contrast to the well-known homogeneous case, where cross-sectional dependence of errors results in incorrect inference unless the nature of the cross-sectional error dependence is known and can be taken into account. Evidence on small sample performance of the MG estimators is provided using Monte Carlo experiments with both strictly and weakly exogenous regressors and cross-sectionally correlated innovations.

DOI: https://doi.org/10.24149/gwp349

No. 1813
Rationally Inattentive Consumer: An Experiment
Andrea Civelli, Cary Deck, Justin D. LeBlanc and Antonella Tutino
Abstract: This paper presents a laboratory experiment that directly tests the theoretical predictions of consumption choices under rational inattention. Subjects are asked to select consumption when income is random. They can optimally decide to reduce uncertainty about income by acquiring signals about it. The informativeness of the signals directly relates to the cognitive effort required to process the information. We find that subjects’ behavior is largely in line with the predictions of the theory: 1) Subjects optimally make stochastic consumption choices; 2) They respond to incentives and changes in the economic environment by varying their attention and consumption; 3) They respond asymmetrically to positive and negative shocks to income, with negative shocks triggering stronger and faster reactions than positive shocks.

DOI: https://doi.org/10.24149/wp1813

Globalization Institute No. 348
Modeling Time-Variation Over the Business Cycle (1960-2017): An International Perspective
Enrique Martínez-García
Abstract: In this paper, I explore the changes in international business cycles with quarterly data for the eight largest advanced economies (U.S., U.K., Germany, France, Italy, Spain, Japan, and Canada) since the 1960s. Using a time-varying parameter model with stochastic volatility for real GDP growth and inflation allows their dynamics to change over time, approximating nonlinearities in the data that otherwise would not be adequately accounted for with linear models (Granger et al. (1991), Granger (2008)). With that empirical model, I document a period of declining macro volatility since the 1980s, followed by increasing (and diverging) inflation volatility since the mid-1990s. I also find significant shifts in inflation persistence and cyclicality, as well as in macro synchronization and even forecastability. The 2008 global recession appears to have had an impact on some of this. I ground my empirical strategy on the reduced-form solution of the workhorse New Keynesian model and, motivated by theory, explore the relationship between greater trade openness (globalization) and the reported shifts in international business cycles. I show that globalization has sizeable (yet nonlinear) effects in the data consistent with the implications of the model—yet globalization’s contribution is not a foregone conclusion, depending crucially on more than the degree of openness of the international economy.

DOI: https://doi.org/10.24149/gwp348

No. 1812
Global Trends in Interest Rates
Marco Del Negro, Domenico Giannone, Marc P. Giannoni and Andrea Tambalotti
Abstract: The trend in the world real interest rate for safe and liquid assets fluctuated close to 2 percent for more than a century, but has dropped significantly over the past three decades. This decline has been common among advanced economies, as trends in real interest rates across countries have converged over this period. It was driven by an increase in the convenience yield for safety and liquidity and by lower global economic growth.

DOI: https://doi.org/10.24149/wp1812

Globalization Institute No. 343
The Heterogeneous Effects of Global and National Business Cycles on Employment in U.S. States and Metropolitan Areas
Codes
Alexander Chudik, Janet Koech and Mark A. Wynne
Abstract: The growth of globalization in recent decades has increased the importance of external factors as drivers of the business cycle in many countries. Globalization affects countries not just at the macro level but at the level of states and metro areas as well. This paper isolates the relative importance of global, national and region-specific shocks as drivers of the business cycle in individual U.S. states and metro areas. We document significant heterogeneity in the sensitivity of states and metro areas to global shocks, and show that direct trade linkages are not the only channel through which the global business cycle impacts regional economies.

DOI: https://doi.org/10.24149/gwp343

No. 1811
A Closer Look at the Behavior of Uncertainty and Disagreement: Micro Evidence from the Euro Area
Robert Rich and Joseph Tracy
Abstract: This paper examines point and density forecasts of real GDP growth, inflation and unemployment from the European Central Bank’s Survey of Professional Forecasters. We present individual uncertainty measures and introduce individual point- and density-based measures of disagreement. The data indicate substantial heterogeneity and persistence in respondents’ uncertainty and disagreement, with uncertainty associated with prominent respondent effects and disagreement associated with prominent time effects. We also examine the co-movement between uncertainty and disagreement and find an economically insignificant relationship that is robust to changes in the volatility of the forecasting environment. This provides further evidence that disagreement is not a reliable proxy for uncertainty.

DOI: https://doi.org/10.24149/wp1811

Globalization Institute No. 342
Explosive Dynamics in House Prices? An Exploration of Financial Market Spillovers in Housing Markets Around the World (Revised September 2018)
Enrique Martínez-García and Valerie Grossman
Abstract: Asset prices in general, and real house prices in particular, are often characterized by a nonlinear data-generating process which displays mildly explosive behavior in some periods. Here, we investigate the emergence of explosiveness in the dynamics of real house prices and the role played by asset market spillovers. We establish a timeline of periodically-collapsing episodes of explosiveness for a panel of 23 countries from the Federal Reserve Bank of Dallas’ International House Price Database (Mack and Martínez-García (2011)) between first quarter 1975 and fourth quarter 2015 using the recursive unit root test methodology proposed by Phillips et al. (2015a,b). Motivated by the theory of financial arbitrage, we examine within a dynamic panel logit/probit framework whether macro fundamentals—and, more specifically, financial variables—help predict episodes of explosiveness in real house prices. We find that interest rate spreads and real stock market growth together with standard macro variables (growth in personal disposable income per capita and inflation) are amongst the best predictors. We, therefore, argue that financial developments in other asset markets play a significant role in the emergence of explosiveness in housing markets.
Original paper
DOI: https://doi.org/10.24149/gwp342r1

No. 1810
Labor Market Effects of Credit Constraints: Evidence from a Natural Experiment (Revised February 2023)
Anil Kumar and Che-Yuan Liang
Abstract: We exploit the 1997 and 2003 constitutional amendments in Texas—allowing home equity loans and lines of credit for non-housing purposes—as natural experiments to estimate the effect of easier credit access on the labor market. Using state-level as well as micro data and the synthetic control approach, we find that easier access to housing credit led to a 1.2 percentage point average decline in the labor force participation rate between 1997 and 2007. We show that our findings are remarkably robust to improved synthetic control methods based on insights from machine-learning. We also find that declines in the labor force participation rate were larger among females, prime age individuals, the college-educated and homeowners. Our research shows that negative labor market effects of easier credit access should be an important factor when assessing its stimulative impact on overall growth.
Revision 2
Revision 1
Original paper
DOI: https://doi.org/10.24149/wp1810r3

No. 1809
Hispanics in the U.S. Labor Market: A Tale of Three Generations
Pia M. Orrenius and Madeline Zavodny
Abstract: Immigrants’ descendants typically assimilate toward mainstream social and economic outcomes across generations. Hispanics in the United States are a possible exception to this pattern. Although there is a growing literature on intergenerational progress, or lack thereof, in education and earnings among Hispanics, there is little research on employment differences across immigrant generations. Using data from 1996 to 2017, this study reveals considerable differences in Hispanics’ employment rates across immigrant generations. Hispanic immigrant men tend to have higher employment rates than non-Hispanic whites and second- and third-plus generation Hispanics. Hispanic immigrant women have much lower employment rates, but employment rates rise considerably in the second generation. Nonetheless, U.S.-born Hispanic women are less likely than non-Hispanic white women to work. The evidence thus suggests segmented assimilation, in which the descendants of Hispanic immigrants have worse outcomes across generations. While relatively low education levels do not appear to hamper Hispanic immigrants’ employment, they play a key role in explaining low levels of employment among Hispanic immigrants’ descendants. Race and selective ethnic attrition may also contribute to some of the patterns uncovered here.

DOI: https://doi.org/10.24149/wp1809

No. 1808
Valuation Risk Revalued (Revised May 2019)
Oliver de Groot, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: This paper shows the recent success of valuation risk (time-preference shocks in Epstein-Zin utility) in resolving asset pricing puzzles rests sensitively on an undesirable asymptote that occurs because the preference specification fails to satisfy a key restriction on the weights in the Epstein-Zin time-aggregator. When we revise the preferences to satisfy the restriction in a simple asset pricing model, the puzzles resurface. However, when estimating a sequence of Bansal-Yaron long-run risk models, we find valuation risk under the revised specification consistently improves the ability of the models to match asset price and cash-flow dynamics.
Original paper
DOI: https://doi.org/10.24149/wp1808r1

No. 1807
Texas Service Sector Outlook Survey: Survey Methodology and Performance
Jesus Cañas and Amy Jordan
Abstract: The Texas Service Sector Outlook Survey (TSSOS) and Texas Retail Outlook Survey (TROS) are monthly surveys of service sector and retail firms in Texas conducted by the Federal Reserve Bank of Dallas. TSSOS and TROS track the Texas private services sector, including general service businesses, retailers and wholesalers. The surveys provide invaluable information on regional economic conditions—information that Dallas Fed economists and the Bank president use in the formulation of monetary policy. This paper describes the survey’s methodology and analyzes the explanatory and predictive power of TSSOS and TROS indexes with regard to Texas employment growth. Regression analysis shows that several TSSOS and TROS indexes help explain monthly variation in Texas employment. In addition, most TSSOS and TROS indexes are also useful in forecasting Texas employment growth.

DOI: https://doi.org/10.24149/wp1807

No. 1806
The Impact of the Dodd-Frank Act on Small Business
Michael D. Bordo and John V. Duca
Abstract: There are concerns that the Dodd-Frank Act (DFA) has impeded small-business lending. By increasing the fixed regulatory compliance requirements needed to make business loans and operate a bank, the DFA disproportionately reduced the incentives for all banks to make very modest loans and reduced the viability of small banks, whose small-business share of commercial and industrial (C&I) loans is generally much higher than that of larger banks. Despite an economic recovery, the small-loan share of C&I loans at large banks and banks with $300 or more million in assets has fallen 9 percentage points since the DFA was passed in 2010, with the magnitude of the decline twice as large at small banks. Controlling for cyclical effects and bank size, we find that these declines in the small-loan share of C&I loans are almost all statistically attributed to the change in regulatory regime. Examining Federal Reserve survey data, we find evidence that the DFA prompted a relative tightening of bank credit standards on C&I loans to small versus large firms, consistent with the DFA inducing a decline in small-business lending through loan supply effects. We also empirically model the pace of business formation, finding that it had downshifted around the time when the DFA and the Sarbanes-Oxley Act were announced. Timing patterns suggest that business formation has more recently ticked higher, coinciding with efforts to provide regulatory relief to smaller banks via modifying rules implementing the DFA. The upturn contrasts with the impact of the Sarbanes-Oxley Act, which appears to persistently restrain business formation.

DOI: https://doi.org/10.24149/wp1806

No. 1805
The Dynamic Effects of Personal and Corporate Income Tax Changes in the United States: Reply to Jentsch and Lunsford (Revised February 2019)
Karel Mertens and Morten O. Ravn
Abstract: In this reply to a comment by Jentsch and Lunsford, we show that, when focusing on the relevant impulse responses, the evidence for economic and statistically significant macroeconomic effects of tax changes in Mertens and Ravn (2013) remains present for a range of asymptotically valid inference methods.
Original paper
DOI: https://doi.org/10.24149/wp1805r1

No. 1804
The Zero Lower Bound and Estimation Accuracy (Revised February 2019)
Tyler Atkinson, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: During the Great Recession, many central banks lowered their policy rate to its zero lower bound (ZLB), creating a kink in the policy rule and calling into question linear estimation methods. There are two promising alternatives: estimate a fully nonlinear model that accounts for precautionary savings effects of the ZLB or a piecewise linear model that is much faster but ignores the precautionary savings effects. Repeated estimation with artificial datasets reveals some advantages of the nonlinear model, but they are not large enough to justify the longer estimation time, regardless of the ZLB duration in the data. Misspecification of the estimated models has a much larger impact on accuracy. It biases the parameter estimates and creates significant differences between the predictions of the models and the data generating process.
Original paper
DOI: https://doi.org/10.24149/wp1804r1

No. 1803
The Near Term Growth Impact of the Tax Cuts and Jobs Act
Karel Mertens
Abstract: This note uses existing empirical estimates of the macroeconomic effects of tax changes to project the near term impact of the Tax Cuts and Jobs Act on US GDP growth. Applying recent reduced form estimates of tax multipliers with the projected revenue impact of the Act yields a level of GDP that is predicted to be 1.3% higher by 2020, with most of the growth front-loaded in 2018. Accounting for the composition of the Act in terms of its individual and corporate provisions leads to a similar GDP increase by 2020, but with stronger growth in 2018 and a partial reversal in the following years. Accounting for the impact of TCJA on marginal individual tax rates raises the projected growth impact considerably, while accounting for the distribution of the tax changes across income groups suggests a more delayed positive impact on GDP. These projections are conditional on mean-reverting dynamics of future taxes that are estimated from postwar US data.

DOI: https://doi.org/10.24149/wp1803

Globalization Institute No. 338
New Perspectives on Forecasting Inflation in Emerging Market Economies: An Empirical Assessment
Roberto Duncan and Enrique Martínez-García
Abstract: We use a broad-range set of inflation models and pseudo out-of-sample forecasts to assess their predictive ability among 14 emerging market economies (EMEs) at different horizons (1 to 12 quarters ahead) with quarterly data over the period 1980Q1-2016Q4. We find, in general, that a simple arithmetic average of the current and three previous observations (the RW-AO model) consistently outperforms its standard competitors - based on the root mean squared prediction error (RMSPE) and on the accuracy in predicting the direction of change. These include conventional models based on domestic factors, existing open-economy Phillips curve-based specifications, factor-augmented models, and time-varying parameter models. Often, the RMSPE and directional accuracy gains of the RW-AO model are shown to be statistically significant. Our results are robust to forecast combinations, intercept corrections, alternative transformations of the target variable, different lag structures, and additional tests of (conditional) predictability. We argue that the RW-AO model is successful among EMEs because it is a straightforward method to downweight later data, which is a useful strategy when there are unknown structural breaks and model misspecification.

DOI: https://doi.org/10.24149/gwp338

No. 1802
OPEC in the News
Michael Plante
Published as: Plante, Michael (2019), "OPEC in the News,” Energy Economics 80: 163-172. https://doi.org/10.1016/j.eneco.2018.12.025.
Abstract: This paper introduces a newspaper article count index related to OPEC that rises in response to important OPEC meetings and events connected with OPEC production levels. I use this index to measure how interest in OPEC varies over time and investigate how oil price volatility behaves when the index unexpectedly changes. I find that unexpected increases in the newspaper index are strongly associated with higher levels of oil price volatility, both realized and implied. In some cases, interest levels and price volatility appear to be driven by the OPEC event itself, such as the Iraq invasion of Kuwait. In other cases, such as the oil price collapses in late 2008 and late 2014, price volatility and interest levels in an OPEC event appear to be responding endogenously to developments in the oil market or broader economy. The newspaper index is highly correlated with Google search volume data on OPEC, an alternative measure of the amount of attention paid to OPEC events.

DOI: https://doi.org/10.24149/wp1802

No. 1801
The Death of the Phillips Curve?
Anthony Murphy
Abstract: Are inflation dynamics well captured by Phillips Curve models, or has this framework become less relevant over time? The evidence for the U.S. suggests that the slopes of the price and wage Phillips Curves– the short-run inflation-unemployment trade-offs – are low and have got a little flatter. For example, the recursive estimate of the unemployment coefficient in the core PCE Phillips Curve has fallen a little from -0.09 to -0.07 since the Great Recession. However, the decline is not statistically significant. Dynamic forecasts from the wage and price Phillips Curves estimated using data ending in 2007q4, almost 10 years ago, are pretty close to inflation today. This suggests that (i) low current inflation is not that surprising, and (ii) factors such as increased globalization, increased e-commerce activity, changes in concentration, the aging of the U.S. population and mismeasurement of the NAIRU are not that important (or offset each other). The Phillips Curve is still a useful, albeit imprecise, framework for understanding inflation.

DOI: https://doi.org/10.24149/wp1801

Globalization Institute No. 333
Structural Change and Global Trade (Revised October 2018)
Logan T. Lewis, Ryan Monarch, Michael Sposi and Jing Zhang
Abstract: Services, which are less traded than goods, rose from 58 percent of world expenditure in 1970 to 79 percent in 2015. In a trade model featuring nonhomothetic preferences and input-output linkages, we find that such structural change has restrained the growth in world trade to GDP by 16 percentage points over this period. This magnitude is similar to how much declining trade costs have boosted openness. Moreover, structural change dampens the measured gains from trade by incorporating endogenous responses of expenditure shares to the trade regime. Ongoing structural change implies declining openness, even absent rising protectionism.
Revision 1
Original paper
DOI: https://doi.org/10.24149/gwp333r2

Globalization Institute No. 332
Demographics and the Evolution of Global Imbalances (Revised April 2019)
Michael Sposi
Abstract: The age distribution evolves asymmetrically across countries, influencing relative saving rates and labor supply. Emerging economies experienced faster increases in working age shares than advanced economies did. Using a dynamic, multicountry model I quantify the effect of demographic changes on trade imbalances across 28 countries since 1970. Counterfactually holding demographics constant reduces net exports in emerging economies and boosts them in advanced economies. On average, a one percentage point increase in a country’s working age share, relative to the world, increases its ratio of net exports to GDP by one-third of a percentage point. These findings alleviate the allocation puzzle.
Original paper
DOI: https://doi.org/10.24149/gwp332r1

No. 1711
Why Haven’t Regional Wages Converged?
Jason L. Saving
Abstract: Regional wage convergence has long been predicted across the United States as barriers to factor mobility have fallen, yet there is little evidence (apart from a brief period in the 1970s and 1980s) that convergence has actually occurred. Why not? I reexamine this issue by developing a model in which fiscal policy differences across states endogenously impact labor supply across jurisdictions. I find that states whose safety nets are relatively generous will tend to drive out workers, raising wages for those who remain while also prompting net outmigration to less generous states. This suggests that regional wage convergence requires not only free factor mobility but also the coordination of fiscal policy across jurisdictions.

DOI: https://doi.org/10.24149/wp1711

No. 1710
Industry Effects of Oil Price Shocks: Re-Examination
Soojin Jo, Lilia Karnizova and Abeer Reza
Abstract: Sectoral responses to oil price shocks help determine how these shocks are transmitted through the economy. Textbook treatments of oil price shocks often emphasize negative supply effects on oil importing countries. By contrast, the seminal contribution of Lee and Ni (2002) has shown that almost all U.S. industries experience oil price shocks largely through a reduction in their respective demands. Only industries with very high oil intensities face a supply-driven reduction. In this paper, we re-examine this seminal findings using two additional decades of data. Further, we apply updated empirical methods, including structural factor-augmented vector autoregressions, that take into account how industries are linked among themselves and with the remainder of the macro-economy. Our results confirm the original finding of Lee and Ni that demand effects of oil price shocks dominate in all but a handful of U.S. industries.

DOI: https://doi.org/10.24149/wp1710

Globalization Institute No. 330
Geographic Inequality of Economic Well-being among U.S. Cities: Evidence from Micro Panel Data
Chi-Young Choi and Alexander Chudik
Abstract: We analyze the geographic inequality of economic well-being among U.S. cities by utilizing a novel measure of quantity based product-level economic well-being, i.e., the number of goods and services that can be purchased by consumers with an average city wage. We find a considerable cross-city dispersion in the economic well-being and the geographic dispersion has been on the steady rise since the mid-1990s for most goods and services under study. Strong geographic correlations exist in the local economic well-being and our empirical analysis based on a Global VAR (GVAR) model suggests that national shocks are an important source behind it. On average, about 30-35% of the variance of local well-being is explained by common national shocks, but the impact of common national shocks varies considerably across products, albeit to a lesser extent across cities. Nationwide unemployment shock, for example, has a stronger effect in the products whose prices are adjusted more frequently and in the cities that have a larger fraction of high-skill workers. Taken together, our results indicate that the geographic inequality of economic well-being observed in the U.S. has proceeded over time mainly through the products with more flexible price adjustments and in the cities with higher concentration of skilled workers.

DOI: https://doi.org/10.24149/gwp330

No. 1709
Does Medicaid Generosity Affect Household Income? (Revised April 2018)
Anil Kumar
Published as: Kumar, Anil (2020), "Does Medicaid Generosity Affect Household Income?” Economic Modelling. https://doi.org/10.1016/j.econmod.2020.01.004.
Abstract: Almost all recent literature on Medicaid and labor supply has used Affordable Care Act (ACA)-induced Medicaid eligibility expansions in various states as natural experiments. Estimated effects on employment and earnings differ widely due to differences in the scope of eligibility expansion across states and are potentially subject to biases due to policy endogeneity. Using a Regression Kink Design (RKD) framework, this paper takes a uniquely different approach to the identification of the effect of Medicaid generosity on household income. Both state-level data and March CPS data from 1980–2013 suggest that generous federal funding of state-level Medicaid costs has a negative effect on household income. The negative impact of Medicaid generosity on household income is more pronounced at the lower end of the household income distribution and on the income and earnings of female heads.
Original paper
DOI: https://doi.org/10.24149/wp1709r1

Globalization Institute No. 328
Monetary Policy Divergence, Net Capital Flows, and Exchange Rates: Accounting for Endogenous Policy Responses
Scott Davis and Andrei Zlate
Abstract: This paper measures the effect of monetary tightening in key advanced economies on net capital flows and exchange rates around the world. Measuring this effect is complicated by the fact that the domestic monetary policies of affected economies respond endogenously to the foreign tightening shock. Using a structural VAR framework with quarterly panel data we estimate the impulse responses of domestic policy variables and net capital flows to a foreign monetary tightening shock. We find that the endogenous responses of domestic monetary policy depends on each economy’s capital account openness and exchange rate regime. We develop a method to plot counter-factual impulse responses for net capital outflows under the assumption that domestic interest rates are held constant despite foreign monetary tightening. Our results suggests that failing to account for the endogenous response of domestic monetary policy biases down the estimated elasticity of net capital flows to foreign interest rates by as much as ¼ for floaters and ½ for peggers with open capital accounts.

DOI: https://doi.org/10.24149/gwp328

No. 1708
The U.S. Shale Oil Boom, the Oil Export Ban, and the Economy: A General Equilibrium Analysis
Nida Çakır Melek, Michael Plante and Mine Yücel
Abstract: This paper examines the effects of the U.S. shale oil boom in a two-country DSGE model where countries produce crude oil, refined oil products, and a non-oil good. The model incorporates different types of crude oil that are imperfect substitutes for each other as inputs into the refining sector. The model is calibrated to match oil market and macroeconomic data for the U.S. and the rest of the world (ROW). We investigate the implications of a significant increase in U.S. light crude oil production similar to the shale oil boom. Consistent with the data, our model predicts that light oil prices decline, U.S. imports of light oil fall dramatically, and light oil crowds out the use of medium crude by U.S. refiners. In addition, fuel prices fall and U.S. GDP rises. We then use our model to examine the potential implications of the former U.S. crude oil export ban. The model predicts that the ban was a binding constraint in 2013 through 2015. We find that the distortions introduced by the policy are greatest in the refining sector. Light oil prices become artificially low in the U.S., and U.S. refineries produce inefficiently high amount of refined products, but the impact on refined product prices and GDP are negligible.

DOI: https://doi.org/10.24149/wp1708

Globalization Institute No. 327
An Augmented Anderson-Hsiao Estimator for Dynamic Short-T Panels (Revised March 2021, new title March 2020)
Codes
Alexander Chudik and M. Hashem Pesaran
Abstract: This paper introduces the idea of self-instrumenting endogenous regressors in settings when the correlation between these regressors and the errors can be derived and used to bias-correct the moment conditions. The resulting bias-corrected moment conditions are less likely to be subject to the weak instrument problem and can be used on their own or in conjunction with other available moment conditions to obtain more efficient estimators. This approach can be applied to estimation of a variety of models such as spatial and dynamic panel data models. This paper focuses on the latter, and proposes a new estimator for short T dynamic panels by augmenting Anderson and Hsiao (AAH) estimator with bias-corrected quadratic moment conditions in first differences which substantially improve the small sample performance of the AH estimator without sacrificing on the generality of its underlying assumptions regarding the fixed effects, initial values and heteroskedasticity of error terms. Using Monte Carlo experiments it is shown that AAH estimator represents a substantial improvement over the AH estimator and more importantly it performs well even when compared to Arellano and Bond and Blundell and Bond (BB) estimators that are based on more restrictive assumptions, and continues to have satisfactory performance in cases where the standard GMM estimators are inconsistent. Finally, to decide between AAH and BB estimators we also propose a Hausman type test which is shown to work well when T is small and n sufficiently large.
Revision 1
Original paper
DOI: https://doi.org/10.24149/gwp327r2

No. 1707
Equity Regulation and U.S. Venture Capital Investment
Tyler Atkinson and John V. Duca
Abstract: There is a growing consensus that the long-run per capita growth rate of the U.S. economy has drifted lower since the early 2000s, consistent with a perceived slowdown in business dynamism. One factor that may have contributed to this is a downshift in venture capital investment and its failure to recover in line with stock prices, as pre-2003 patterns would suggest. Critics have argued that this is associated with the increased regulatory burden for publically traded firms to comply with the Sarbanes-Oxley Act of 2002 (SOX). There is inconclusive evidence of SOX deterring firms from becoming publically traded as indicated by IPO activity, a proxy reflecting several factors that may not be as tied to innovation as venture capital. Earlier tests of SOX’s impact on venture capital activity, which tended to focus on cross-sectional evidence, were hampered by a short time-series sample following the Internet-stock bust of the early 2000s. Taking advantage of the large-sized rise, fall, and recovery in stock prices since then, this study assesses whether the time-series behavior of venture capital investment shifted following SOX. We find evidence of a time-series break in the middle of our sample, consistent with the passage of SOX. Estimates indicate that the slower post-SOX pace of venture capital investment is mainly attributed to a reduced elasticity of such investment with respect to stock prices rather than to a simple downshift in the level of investment. Our estimates suggest that a cost-benefit analysis of SOX could be worthwhile, especially given concerns that the long-run growth rate of U.S. productivity and GDP has been unusually sluggish and the emerging consensus that excessive debt financing—not equity financing—is more tied to the subset of financial crises associated with severe macroeconomic downturns.

DOI: https://doi.org/10.24149/wp1707

Globalization Institute No. 325
Detecting Periods of Exuberance: A Look at the Role of Aggregation with an Application to House Prices (Revised July 2018)
Efthymios Pavlidis, Enrique Martinez-Garcia and Valerie Grossman
Abstract: The recently developed SADF and GSADF unit root tests of Phillips and Yu (2011) and Phillips et al. (2015a,b) have become popular in the literature for detecting exuberance in asset prices. In this paper, we examine through simulation experiments the effect of cross-sectional aggregation on the power properties of these tests. The simulation design considered is based on simulated data and actual housing data for both U.S. metropolitan areas and international housing markets and thus allows us to draw conclusions for different levels of aggregation. Our findings suggest that aggregation lowers the power of both the SADF and GSADF tests. The effect, however, is much larger for the SADF test. We also provide evidence that tests based on panel data techniques, namely the panel GSADF test recently proposed by Pavlidis et al. (2016), can perform substantially better than univariate tests applied to aggregated series. Furthermore, we also illustrate the date-stamping procedure under the univariate/panel GSADF procedure uncovering novel evidence on the role of interest rates and policy uncertainty as factors explaining episodes of widespread mildly explosive dynamics in housing markets.
Original paper
DOI: https://doi.org/10.24149/gwp325r1

Globalization Institute No. 323
Globalization and the Increasing Correlation between Capital Inflows and Outflows
J. Scott Davis and Eric van Wincoop
Abstract: The correlation between capital inflows and outflows has increased substantially over time in a sample of 128 advanced and developing countries. We provide evidence that this is a result of an increase in financial globalization (stock of external assets and liabilities). This dominates the effect of an increase in trade globalization (exports plus imports), which reduces the correlation between capital inflows and outflows. In the context of a two-country model with 14 shocks we show that the theoretical impact of financial and trade globalization on the correlation between capital inflows and outflows is consistent with the data.

DOI: https://doi.org/10.24149/gwp323

Globalization Institute No. 321
Good Policies or Good Luck? New Insights on Globalization and the International Monetary Policy Transmission Mechanism
Enrique Martínez-García
Abstract: The open-economy dimension is central to the discussion of the trade-offs that monetary policy faces in an increasingly integrated world. I investigate the monetary policy transmission mechanism in a two-country workhorse New Keynesian model where policy is set according to Taylor (1993) rules. I find that a common monetary policy isolates the effects of trade openness on the cross-country dispersion alone, and that the establishment of a currency union as a means of deepening economic integration may lead to indeterminacy. I argue that the common (coordinated) monetary policy equilibrium is the relevant benchmark for policy analysis showing that in that case open economies tend to experience lower macro volatility, a flatter Phillips curve, and more accentuated trade-offs between inflation and slack. Moreover, the trade elasticity often magnifies the effects of trade integration (globalization) beyond what conventional measures of trade openness would imply. I also discuss how other features such as the impact of a common and stronger anti-inflation bias, technological diffusion across countries, and the sensitivity of labor supply to real wages influence the quantitative effects of policy and openness in this context. Finally, I conclude that these theoretical predictions are largely consistent with the stylized facts of the Great Moderation.

DOI: https://doi.org/10.24149/gwp321

Globalization Institute No. 317
In No Uncertain Terms: The Effect of Uncertainty on Credit Frictions and Monetary Policy (Revised February 2021, new title)
Supplement
Nathan S. Balke, Enrique Martínez-García and Zheng Zeng
Abstract: We examine the interaction of uncertainty and credit frictions in a New Keynesian framework. The model considers credit frictions arising from costly-state verification in the provision of loans to fund the acquisition of capital by entrepreneurs and includes three types of time-varying stochastic volatility shocks related to monetary policy uncertainty, financial risk (micro-uncertainty) and macro-uncertainty. Key parameters are estimated by the Simulated Method of Moments using U.S. data from 1984:Q1 until 2014:Q4. We find: 1. Micro-uncertainty has first-order effects that are significantly larger than the effects of macro-uncertainty and monetary policy uncertainty. 2. Poor credit conditions exacerbate the economic drag from micro-uncertainty shocks, amplify the effects of monetary policy shocks and mitigate the impact of TFP shocks. 3. A degree of asymmetry and non-scalability appears in response to monetary policy shocks, dependent on the degree of nominal rigidities and initial conditions. 4. Monetary policy uncertainty accounts for about one-third of the business cycle volatility largely by affecting the size of monetary policy shocks.
Revision 1
Revision 1 supplement
Original paper
Original supplement
DOI: https://doi.org/10.24149/gwp317r2
Supplement DOI: https://doi.org/10.24149/gwp317suppr2

Globalization Institute No. 316
Estimating the Natural Rate of Interest in an Open Economy
Supplement | Codes
Mark A. Wynne and Ren Zhang
Abstract: The concept of the natural or equilibrium rate of interest has attracted a lot of attention from monetary policymakers in recent years. Most attempts to estimate the natural rate use a closed economy framework. We argue that in the face of greater integration of global product and capital markets, an open economy framework is more appropriate. We provide some initial estimates of the natural rate for the United States and Japan in a two-country framework. Our identifying assumptions include a close relationship between the time-varying natural rate of interest and the low-frequency fluctuations of potential output growth in both the home country and the foreign country. Our results suggest that the natural rates in both countries are mainly determined by their own trend growth rates of potential output. Nevertheless, the other country's trend growth plays an important role in several specific periods. The gap between the actual real interest rate and our estimated natural rate offers valuable insights into the recent stance of monetary policy in both of these two countries.

DOI: https://doi.org/10.24149/gwp316

Globalization Institute No. 315
Measuring the World Natural Rate of Interest
Supplement | Codes
Mark A. Wynne and Ren Zhang
Abstract: This paper makes the first attempt to estimate the time-varying natural rate jointly with the output gap and trend potential output growth for the world as a whole using a simple unobserved components model broadly following the methodology developed by Laubach and Williams (2003). We find that the world natural rate has been trending down for the past few decades. Nearly half of the variation in the natural rate is accounted for by the trend potential output growth rate. However, the relationship between the world natural interest rate and the world trend growth is modest and not statistically significant.

DOI: https://doi.org/10.24149/gwp315

No. 1706
Uncertainty Shocks in a Model of Effective Demand: Comment
Oliver de Groot, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: Basu and Bundick (2017) show a second moment intertemporal preference shock creates meaningful declines in output in a sticky price model with Epstein and Zin (1991) preferences. The result, however, rests on the way they model the shock. If a preference shock is included in Epstein-Zin preferences, the distributional weights on current and future utility must sum to 1, otherwise it creates an asymptote in the response to the shock with unit intertemporal elasticity of substitution. When we change the preferences so the weights sum to 1, the asymptote disappears as well as their main results—uncertainty shocks generate small increases in output and comovement with consumption and investment that is at odds with the data. We examine three changes to the model—recalibration, a risk-premium shock, and a disaster risk-type shock—to try and restore their results, but in all three cases the model is unable to match VAR evidence.

DOI: https://doi.org/10.24149/wp1706

No. 1705
A New Way to Quantify the Effect of Uncertainty (Revised February 2018)
Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: This paper develops a new way to quantify the effect of uncertainty and other higher-order moments. First, we estimate a nonlinear model using Bayesian methods with data on uncertainty, in addition to common macro time series. This key step allows us to decompose the exogenous and endogenous sources of uncertainty, calculate the effect of volatility following the cost of business cycles literature, and generate data-driven policy functions for any higher-order moment. Second, we use the Euler equation to analytically decompose consumption into several terms—expected consumption, the ex-ante real interest rate, and the ex-ante variance and skewness of future consumption, technology growth, and inflation—and then use the policy functions to filter the data and create a time series for the effect of each term. We apply our method to a familiar New Keynesian model with a zero lower bound constraint on the nominal interest rate and two stochastic volatility shocks, but it is adaptable to a broad class of models.
Original paper
DOI: https://doi.org/10.24149/wp1705r1

Globalization Institute No. 313
The Double-Edged Sword of Global Integration: Robustness, Fragility & Contagion in the International Firm Network
Everett Grant and Julieta Yung
Abstract: We estimate global inter-firm networks across all major industries from 1981 through 2016 and provide the first empirical tests for both robust (beneficial) and fragile (harmful) network behavior, relating firms' health with global integration. More connected firms are less likely to be in distress and have higher profit growth and equity returns, but are also more exposed to direct contagion from distressed neighboring firms and network level crises. Our analysis reveals the centrality of finance in the international firm network and increased globalization, with greater potential for crises to spread globally when they do occur.

DOI: https://doi.org/10.24149/gwp312

No. 1704
New Findings on the Fiscal Impact of Immigration in the United States
Pia Orrenius
Abstract: The National Academies of Sciences, Engineering, and Medicine (2016) report on the economic and fiscal effects of immigration included the first set of comprehensive fiscal impacts published in twenty years. The estimates highlight the pivotal role of the public goods assumption. If immigrants are assigned the average cost of public goods, such as national defense and interest on the debt, then immigration’s fiscal impact is negative in both the short and long run. However, marginal cost calculations are more relevant for policy decisions, and the report shows that if immigrants are assigned the marginal cost of public goods, then the long-run fiscal impact is positive and the short-run effect is negative but very small (less negative than that of natives). Moreover, highly-educated immigrants confer large positive fiscal impacts, contributing far more in taxes than they consume in public benefits. To the extent that immigrants impose net costs, these are concentrated at the state and local level and are largely due to the costs of public schooling.

DOI: https://doi.org/10.24149/wp1704

No. 1703
How Taxes and Required Returns Drove Commercial Real Estate Valuations over the Past Four Decades
John V. Duca, Patric H. Hendershott and David C. Ling
Published as: Duca, John V., Patric H. Hendershott, and David C. Ling (2017), “How Taxes and Required Returns Drove Commercial Real Estate Valuations over the Past Four Decades,” National Tax Journal 70 (3), 549–584.
Abstract: We document the evolution of U.S. tax law regarding commercial real estate (CRE) since 1975, noting changes in income and capital gains tax rates and tax depreciation methods. The most prominent changes were the 1981 and 1986 Tax Acts, but numerous significant changes occurred in the last dozen years. We then compute the present value of tax depreciation per dollar of acquisition price and an effective tax rate for CRE. We explain the quarterly variation in CRE capitalization rates using an error correction framework and find that the long run estimates are statistically significant in the way theory would suggest. Moreover, the required financial asset return and the tax depreciation variable temporally predict (“cause”) capitalization rates in the long run, but not vice versa.

DOI: https://doi.org/10.24149/wp1703

Globalization Institute No. 308
Exploring the Nexus Between Inflation and Globalization Under Inflation Targeting Through the Lens of New Zealand’s Experience
Ayşe Kabukçuoğlu and Enrique Martínez-García and Mehmet Ali Soytaş
Abstract: We investigate empirically the inflation dynamics in New Zealand, a small open economy and a pioneer in inflation targeting, under various open-economy Phillips curve specifications. Our forecasting exercise suggests that open-economy Phillips curves under standard measures of global slack do not help forecast domestic inflation, possibly indicating measurement problems with global slack itself. In turn, under a stable inflation target we still find that (i) global inflation and (ii) global inflation and oil prices have information content for headline CPI and core CPI inflation over the 1997:Q3-2015:Q1 period and appear to be reliable proxies for global slack in forecasting inflation.

DOI: https://doi.org/10.24149/gwp308

No. 1702
Macroeconomic Uncertainty Through the Lens of Professional Forecasters
Soojin Jo and Rodrigo Sekkel
Abstract: We analyze the evolution of macroeconomic uncertainty in the United States, based on the forecast errors of consensus survey forecasts of various economic indicators. Comprehensive information contained in the survey forecasts enables us to capture a real-time subjective measure of uncertainty in a simple framework. We jointly model and estimate macroeconomic (common) and indicator-specific uncertainties of four indicators, using a factor stochastic volatility model. Our macroeconomic uncertainty has three major spikes aligned with the 1973–75, 1980, and 2007–09 recessions, while other recessions were characterized by increases in indicator-specific uncertainties. We also show that the selection of data vintages affects the estimates and relative size of jumps in estimated uncertainty series. Finally, our macroeconomic uncertainty has a persistent negative impact on real economic activity, rather than producing “wait-and-see” dynamics.

DOI: https://doi.org/10.24149/wp1702

Globalization Institute No. 296
Capital Accumulation and Dynamic Gains from Trade (Revised November 2018)
B. Ravikumar, Ana Maria Santacreu and Michael Sposi
Abstract: We compute welfare gains from trade in a dynamic, multicountry model with capital accumulation and trade imbalances. We develop a gradient-free method to compute the exact transition paths following a trade liberalization. We find that (i) larger countries accumulate a current account surplus, and financial resources flow from larger countries to smaller countries, boosting consumption in the latter, (ii) countries with larger short-run trade deficits accumulate capital faster, (iii) the gains are nonlinear in the reduction in trade costs, and (iv) capital accumulation accounts for substantial gains. The net foreign asset position before the liberalization is positively correlated with the gains. The tradables intensity in consumption goods production determines the static gains, and the tradables intensity in investment goods production determines the dynamic gains that include capital accumulation.
Revision 1
Original paper
DOI: https://doi.org/10.24149/gwp296r2

No. 1701
Unauthorized Mexican Workers in the United States: Recent Inflows and Possible Future Scenarios
Pia M. Orrenius and Madeline Zavodny
Abstract: The U.S. economy has long relied on immigrant workers, many of them unauthorized, yet estimates of the inflow of unauthorized workers and the determinants of that inflow are hard to come by. This paper provides estimates of the number of newly arriving unauthorized workers from Mexico, the principal source of unauthorized immigrants to the United States, and examines how the inflow is related to U.S. and Mexico economic conditions. Our estimates suggest that annual inflows of unauthorized workers averaged about 170,000 during 1996-2014 but were much higher before the economic downturn that began in 2007. Labor market conditions in the U.S. and Mexico play key roles in this migrant flow. The models estimated here predict that annual unauthorized inflows from Mexico will be about 100,000 in the future if recent economic conditions persist, and higher if the U.S. economy booms or the Mexican economy weakens.

DOI: https://doi.org/10.24149/wp1701

No. 1616
Fiscal Stabilization and the Credibility of the U.S. Budget Sequestration Spending Austerity
Ruiyang Hu, Carlos E. Zarazaga
Abstract: Fiscal imbalances predating the Great Recession but aggravated by it prompted the U.S. Congress to enact in 2011 legislation that, in the absence of other measures, would trigger two years later a so-called “budget sequestration” procedure that implied reducing government discretionary spending to unprecedented low levels over the following decade. For that reason, economic agents may not have expected this “fiscal stabilization measure of last resort” to be sustainable when it was put into effect in 2013 as scheduled. This is exactly the issue this paper set out to explore, on the grounds that sizing up the expectations that economic agents had about the budget sequestration can provide powerful insights on how fiscal stabilization is likely to proceed in the U.S., going forward. The paper makes inferences about the credibility enjoyed by the budget sequestration with an adapted version of the Business Cycle Accounting approach, originally developed for other purposes. The main finding is that the evidence favors a scenario in which spending cuts are half the size of those actually implied by the sequester. The paper takes this result as an indication that the U.S. is unlikely to address its unresolved fiscal imbalances with just spending austerity, an interpretation consistent with existing literature that traces the seemingly anomalous behavior of economic variables during the Great Recession and its aftermath to alternative fiscal stabilization mechanisms.

DOI: https://doi.org/10.24149/wp1616

No. 1615
What Drives Economic Policy Uncertainty in the Long and Short Runs? European and U.S. Evidence over Several Decades
John V. Duca, Jason L. Saving
Abstract: Economic policy uncertainty (EPU) has increased markedly in recent years in the U.S. and Europe, and some have posited a link between this phenomenon and subpar economic growth in advanced economies (see Baker, Bloom, and Davis, 2015). But methodological and data concerns have thus far raised doubts about whether EPU contains marginal and exogenous information about other economic phenomena. Our work analyzes the impact on EPU of several possibly endogenous variables, such as inflation and unemployment rates in countries where EPU is measured. We also consider longer-term technological factors, such as media fragmentation, which by undermining political consensus may indirectly elevate EPU. We find that about 40 percent of EPU movements can be explained by long- and short-run movements in these determinants, which is consistent with limited evidence that de-trended movements in EPU may contain marginal information about GDP growth and other macro variables.

DOI: https://doi.org/10.24149/wp1615

No. 1614
What Drives Commodity Price Booms and Busts?
David S. Jacks, Martin Stuermer
Abstract: What drives commodity price booms and busts? We provide evidence on the dynamic effects of commodity demand shocks, commodity supply shocks, and inventory demand shocks on real commodity prices. In particular, we analyze a new data set of price and production levels for 12 agricultural, metal, and soft commodities from 1870 to 2013. We identify differences in the type of shock driving prices of the various types of commodities and relate these differences to commodity types which reflect differences in long-run elasticities of supply and demand. Our results show that demand shocks strongly dominate supply shocks.

DOI: https://doi.org/10.24149/wp1614

No. 1613
The Roles of Inflation Expectations, Core Inflation, and Slack in Real-Time Inflation Forecasting
N. Kundan Kishor, Evan F. Koenig
Abstract: Using state-space modeling, we extract information from surveys of long-term inflation expectations and multiple quarterly inflation series to undertake a real-time decomposition of quarterly headline PCE and GDP-deflator inflation rates into a common long-term trend, common cyclical component, and high-frequency noise components. We then explore alternative approaches to real-time forecasting of headline PCE inflation. We find that performance is enhanced if forecasting equations are estimated using inflation data that have been stripped of high-frequency noise. Performance can be further improved by including an unemployment-based measure of slack in the equations. The improvement is statistically significant relative to benchmark autoregressive models and also relative to professional forecasters at all but the shortest horizons. In contrast, introducing slack into models estimated using headline PCE inflation data or conventional core inflation data causes forecast performance to deteriorate. Finally, we demonstrate that forecasting models estimated using the Kishor-Koenig (2012) methodology-which mandates that each forecasting VAR be augmented with a flexible state-space model of data revisions-consistently outperform the corresponding conventionally estimated forecasting models.

DOI: https://doi.org/10.24149/wp1613

No. 1612
Forward Guidance and the State of the Economy
Benjamin D. Keen, Alexander W. Richter, Nathaniel A. Throckmorton
Published as: Keen, Benjamin D., Alexander W. Richter and Nathaniel A. Throckmorton (2017), "Forward Guidance and the State of the Economy," Economic Inquiry 55 (4): 1593-1624.
Abstract: This paper examines forward guidance using a nonlinear New Keynesian model with a zero lower bound (ZLB) constraint on the nominal interest rate. Forward guidance is modeled with news shocks to the monetary policy rule. The effectiveness of forward guidance depends on the state of the economy, the speed of the recovery, the ZLB constraint, the degree of uncertainty, the monetary response to inflation, the size of the news shocks, and the forward guidance horizon. Specifically, the stimulus from forward guidance falls as the economy deteriorates or as households expect a slower recovery. When the ZLB binds, less uncertainty about the economy or an expectation of a stronger response to inflation reduces the benefit of forward guidance. Forward guidance via a news shock is less stimulative than an unanticipated monetary policy shock around the steady state, but a news shock is more stimulative near the ZLB and always has a larger cumulative effect on output. When the central bank extends the forward guidance horizon, the cumulative effect initially increases but then decreases. These results indicate that there are limits to the stimulus forward guidance can provide, but that stimulus is largest when the news is communicated early in a recession.

DOI: https://doi.org/10.24149/wp1612

No. 1611
Estimating Taxable Income Responses with Elasticity Heterogeneity (Revised March 2018)
Anil Kumar, Che-Yuan Liang
Abstract: Previous research on estimating the elasticity of taxable income (ETI) only allowed one source of heterogeneity. By additionally introducing elasticity heterogeneity, we show that existing methods yield elasticities that are biased and local. We propose a novel instrument based on tax rate changes across the entire taxable income distribution to overcome these shortcomings. We illustrate the empirical importance of elasticity heterogeneity by using the NBER tax panel for 1979-1990. Reconciling the remarkable divergence of estimates in the previous literature, we find that a positive elasticity heterogeneity bias explains previous high estimates, whereas overweighting of inelastic taxpayers accounts for previous low estimates. Estimation based on the new instrument yields a global ETI of around 0.7.
Revision 1
Original paper
DOI: https://doi.org/10.24149/wp1611r2

No. 1610
Targeted Search in Matching Markets (Revised December 2018)
Anton Cheremukhin, Paulina Restrepo-Echavarria and Antonella Tutino
Abstract: We propose a parsimonious matching model where people's choice of whom to meet endogenizes the degree of randomness in matching. The analysis highlights the interaction between a productive motive, driven by the surplus attainable in a match, and a strategic motive, driven by reciprocity of interest of potential matches. We find that the interaction between these two motives differs with preferences – vertical versus horizontal – and that this interaction implies that preferences estimated using our model can look markedly different from those estimated using a model where the degree of randomness is not endogenous. We illustrate these results using data on the U.S. marriage market and finish by showing that the model can rationalize the finding of aspirational dating.
Original paper
DOI: https://doi.org/10.24149/wp1610r1

No. 1609
Student Loan Relief Programs: Implications for Borrowers and the Federal Government
Wenhua Di, Kelly D. Edmiston
Abstract: As college costs increase and more students fund their education through borrowing, debt load and delinquency rates have become significant problems on a number of levels. Student loan obligations are challenging to manage for new graduates with lower earnings and borrowers in financial hardship. This paper discusses the federal student loan repayment relief programs that are available and estimates their borrower and fiscal impacts. The implications of relief plans on borrowers’ costs and the federal budget vary for different loan amounts, income levels, and relief program.

It is challenging for policymakers to design programs that adequately balance the risks between borrowers and taxpayers. Existing programs are also tremendously complicated, making it difficult for borrowers to make informed decisions on repayment programs. This paper examines how the various programs work in practice and considers their likely outcomes over a set of income-debt-program scenarios to bring much needed clarity to the repayment environment. In our analysis, lower-income borrowers and borrowers who will have significant remaining balance forgiven at the end of the required repayment period are generally more likely to benefit from student loan relief programs, but participation of these borrowers can be very costly from a fiscal perspective.

DOI: https://doi.org/10.24149/wp1609

No. 1608
Residual Seasonality in U.S. GDP Data
Keith R. Phillips, Jack Wang
Abstract: Rudebush et al (2015a, b) and the Bureau of Economic Analysis find the presence of residual seasonality in the official estimates of U.S. real gross domestic product (GDP). Directly seasonally adjusting official seasonally adjusted GDP, which we refer to as double seasonal adjustment, could revise the first quarter growth in the past several years upward by an average of about 1.5 percentage points. The presence of residual seasonality can significantly distort current analysis of national and regional economies. In this paper we look more closely at the U.S. GDP data and study the quality of the seasonal adjustment when it is applied to data that has already been indirectly seasonally adjusted. We find that double seasonal adjustment can lead to estimates that are of moderate quality. While the optimal method would be to directly seasonally adjust the aggregate not seasonally adjusted data, if this is not possible, double seasonally adjusted data would likely lead to better estimates.

DOI: https://doi.org/10.24149/wp1608

No. 1607
The Rank Effect for Commodities
Ricardo T. Fernholz, Christoffer Koch
Abstract: We uncover a large and significant low-minus-high rank effect for commodities across two centuries. There is nothing anomalous about this anomaly, nor is it clear how it can be arbitraged away. Using nonparametric econometric methods, we demonstrate that such a rank effect is a necessary consequence of a stationary relative asset price distribution. We confirm this prediction using daily commodity futures prices and show that a portfolio consisting of lower-ranked, lower-priced commodities yields 23% higher annual returns than a portfolio consisting of higher-ranked, higher-priced commodities. These excess returns have a Sharpe ratio nearly twice as high as the U.S. stock market yet are uncorrelated with market risk. In contrast to the extensive literature on asset pricing factors and anomalies, our results are structural and rely on minimal and realistic assumptions for the long-run properties of relative asset prices.

DOI: https://doi.org/10.24149/wp1607

No. 1606
Are Nonlinear Methods Necessary at the Zero Lower Bound?
Alexander W. Richter, Nathaniel A. Throckmorton
Abstract: This paper examines the importance of the zero lower bound (ZLB) constraint on the nominal interest rate by estimating three variants of a small-scale New Keynesian model: (1) a nonlinear model with an occassionally binding ZLB constraint; (2) a constrained linear model, which imposes the constraint in the filter but not the solution; and (3) an unconstrained linear model, which never imposes the constraint. The posterior distributions are similar, but important differences arise in their predictions at the ZLB. The nonlinear model fits the data better at the ZLB and primarily attributes the ZLB to a reduction in household demand due to discount factor shocks. In the linear models, the ZLB is due to large contractionary monetary policy shocks, which is at odds with the Fed’s expansionary policy during the Great Recession. Posterior predictive analysis shows the nonlinear model is partially able to account for the increase in output volatility and the negative skewness in output and inflation that occurred during the ZLB period, whereas the linear models predict almost no changes in those statistics. We also compare the results from our nonlinear model to the quasi-linear solution based on OccBin. The quasi-linear model fits the data better than the linear models, but it still generate too little volatility at the ZLB and predicts that a large policy shock caused the ZLB to bind in 2008Q4.

DOI: https://doi.org/10.24149/wp1606

No. 1605
Economic Policy Uncertainty and the Credit Channel: Aggregate and Bank Level U.S. Evidence over Several Decades
Michael D. Bordo, John V. Duca and Christoffer Koch
Published as: Bordo, Michael D., John V. Duca and Christoffer Koch (2016), "Economic Policy Uncertainty and the Credit Channel: Aggregate and Bank Level U.S. Evidence over Several Decades," Journal of Financial Stability 26: 90-106.
Abstract: Economic policy uncertainty affects decisions of households, businesses, policy makers and financial intermediaries. We first examine the impact of economic policy uncertainty on aggregate bank credit growth. Then we analyze commercial bank entity level data to gauge the effects of policy uncertainty on financial intermediaries' lending. We exploit the cross-sectional heterogeneity to back out indirect evidence of its effects on businesses and households. We ask (i) whether, conditional on standard macroeconomic controls, economic policy uncertainty affected bank level credit growth, and (ii) whether there is variation in the impact related to banks' balance sheet conditions; that is, whether the effects are attributable to loan demand or, if impact varies with bank level financial constraints, loan supply. We find that policy uncertainty has a significant negative effect on bank credit growth. Since this impact varies meaningfully with some bank characteristics - particularly the overall capital-to-assets ratio and bank asset liquidity-loan supply factors at least partially (and significantly) help determine the influence of policy uncertainty. Because other studies have found important macroeconomic effects of bank lending growth on the macroeconomy, our findings are consistent with the possibility that high economic policy uncertainty may have slowed the U.S. economic recovery from the Great Recession by restraining overall credit growth through the bank lending channel.

DOI: https://doi.org/10.24149/wp1605

No. 1604
Why Are Big Banks Getting Bigger?
Ricardo T. Fernholz and Christoffer Koch
Abstract: The U.S. banking sector has become substantially more concentrated since the 1990s, raising questions about both the causes and implications of this consolidation. We address these questions using nonparametric empirical methods that characterize dynamic power law distributions in terms of two shaping factors — the reversion rates (a measure of crosssectional mean reversion) and idiosyncratic volatilities of assets for different size-ranked banks. Using quarterly data for subsidiary commercial banks and thrifts and their parent bank-holding companies, we show that the greater concentration of U.S. bank-holding company assets is a result of lower mean reversion, a result consistent with policy changes such as interstate branching deregulation and the repeal of Glass-Steagall. In contrast, the greater concentration of both U.S. commercial bank and thrift assets is a result of higher idiosyncratic volatility, yet, idiosyncratic volatility of parent bank-holding company assets fell. This contrast suggests that diversification through non-banking activities has reduced the idiosyncratic asset volatilities of the largest bank-holding companies and affected systemic risk.

DOI: https://doi.org/10.24149/wp1604

No. 1603
Irregular Immigration in the European Union
Pia M. Orrenius and Madeline Zavodny
Abstract: Unauthorized immigration is on the rise again in the EU. Although precise estimates are hard to come by, proximity to nations in turmoil and the promise of a better life have drawn hundreds of thousands of irregular migrants to the EU in 2014-2015. Further complicating the ongoing challenge is the confounding flow of humanitarian migrants, who are fleeing not for a job but for their lives. Those who flee for better economic conditions are irregular migrants, not humanitarian migrants, but the lines between the two are often blurred. This policy brief surveys the state of irregular immigration to the EU and draws on lessons from the U.S. experience. It focuses on economic aspects of unauthorized immigration. There are economic benefits to receiving countries as well as to unauthorized migrants themselves, but those benefits require that migrants are able to access the labor market and that prices and wages are flexible. Meanwhile, mitigating fiscal costs requires limiting access to public assistance programs for newcomers. Successfully addressing irregular migration is likely to require considerable coordination and cost-sharing among EU member states.

DOI: https://doi.org/10.24149/wp1603

No. 1602
Targeted Business Incentives and the Debt Behavior of Households
Wenhua Di and Daniel L. Millimet
Published as: Di, Wenhua and Daniel L. Millimet (2017), "Targeted Business Incentives and the Debt Behavior of Households," Empirical Economics 52 (3): 1115-1142.
Abstract: The empirical effects of place-based tax incentive schemes designed to aid low-income communities are unclear. While a growing number of studies find beneficial effects on employment, there is little investigation into other behaviors of households affected by such programs. We analyze the impact of the Texas Enterprise Zone Program on household debt and delinquency. Specifically, we utilize detailed information on all household liabilities, delinquencies, and credit scores from the Federal Reserve Bank of New York Consumer Credit Panel/Equifax, a quarterly longitudinal 5% random sample of all individuals in the US with a social security number and a credit report. We identify the causal effect of the program by using a sharp regression discontinuity approach that exploits the known institutional rules of the program. We find a modest positive impact on the repayment of retail loans, and the evidence of an increase in the delinquency rates of auto loans, as well as in Chapter 13 bankruptcy filings.

DOI: https://doi.org/10.24149/wp1602

No. 1601
Why Does the FDIC Sue?
Christoffer Koch and Ken Okamura
Abstract: Cases the Federal Deposit Insurance Corporation (FDIC) pursues against the directors and officers of failed commercial banks for (gross) negligence are important for the corporate governance of U.S. commercial banks. These cases shape the kernel of bank corporate governance, as they guide expectations of bankers and regulators in defining the limits of acceptable behavior under financial distress. We examine the differences in behavior of all 408 U.S. commercial banks that were taken into receivership between 2007–2012. Sued banks had different balance sheet dynamics in the three years prior to failure. These banks were generally larger, faster growing, obtained riskier funding and were more “optimistic”. We find evidence that the behavior of bank boards adjusts in an out-of-sample set of banks. Our results suggest the FDIC does not only pursue “deep pockets”, but sets corporate governance standards for all banks by suing negligent directors and officers.

DOI: https://doi.org/10.24149/wp1601

Globalization Institute Working Papers

Globalization Institute No. 294
Capital Goods Trade, Relative Prices, and Economic Development
Piyusha Mutreja, B. Ravikumar and Michael Sposi
Abstract: International trade in capital goods has quantitatively important effects on economic development through two channels: capital formation and aggregate TFP. We embed a multi country, multi sector Ricardian model of trade into a neoclassical growth framework. Our model matches several trade and development facts within a unified framework: the world distribution of capital goods production and trade, cross-country differences in investment rate and price of final goods, and cross-country equalization of price of capital goods. Reducing barriers to trade capital goods allows poor countries to access more efficient means of capital goods production abroad, leading to relatively higher capital output ratios. Meanwhile, poor countries can specialize more in their comparative advantage—non-capital goods production—and increase their TFP. The income gap between rich and poor countries declines by 40 percent by eliminating barriers to trade capital goods.

DOI: https://doi.org/10.24149/gwp294

Globalization Institute No. 290
A One-Covariate at a Time, Multiple Testing Approach to Variable Selection in High-Dimensional Linear Regression Models
Supplement 1 | Supplement 2
Alexander Chudik, George Kapetanios and M. Hashem Pesaran
Abstract: Model specification and selection are recurring themes in econometric analysis. Both topics become considerably more complicated in the case of large-dimensional data sets where the set of specification possibilities can become quite large. In the context of linear regression models, penalised regression has become the de facto benchmark technique used to trade off parsimony and fit when the number of possible covariates is large, often much larger than the number of available observations. However, issues such as the choice of a penalty function and tuning parameters associated with the use of penalized regressions remain contentious. In this paper, we provide an alternative approach that considers the statistical significance of the individual covariates one at a time, whilst taking full account of the multiple testing nature of the inferential problem involved. We refer to the proposed method as One Covariate at a Time Multiple Testing (OCMT) procedure. The OCMT provides an alternative to penalised regression methods: It is based on statistical inference and is therefore easier to interpret and relate to the classical statistical analysis, it allows working under more general assumptions, it is faster, and performs well in small samples for almost all of the different sets of experiments considered in this paper. We provide extensive theoretical and Monte Carlo results in support of adding the proposed OCMT model selection procedure to the toolbox of applied researchers. The usefulness of OCMT is also illustrated by an empirical application to forecasting U.S. output growth and inflation.

DOI: https://doi.org/10.24149/gwp290

Globalization Institute No. 288
Financial Performance and Macroeconomic Fundamentals in Emerging Market Economies over the Global Financial Cycle
Scott Davis and Andrei Zlate
Abstract: This paper explores the relationship between financial performance and macroeconomic fundamentals in emerging market economies not only in times of crises, but in general during crisis and non-crisis years over the global financial cycle. Using a panel framework with data for 119 emerging market economies at an annual frequency, we examine whether the relationship between performance and fundamentals varies in magnitude and/or switches sign between crisis and non-crisis years. We find that better macroeconomic fundamentals (such as a stronger net foreign asset positions and higher stocks of foreign exchange reserves) are associated with better financial performance not just during crisis episodes, but also during normal times. Quantitatively, the impact of fundamentals on performance is smaller during normal times than during crisis years, but works in the same direction and is statistically significant. The results are consistent with those of recent empirical studies on the link between financial performance and fundamentals during episodes of global financial stress, but generalizes the results to the global financial cycle.

DOI: https://doi.org/10.24149/gwp288

Globalization Institute No. 287
Macroeconomic News and Asset Prices Before and After the Zero Lower Bound 
Christoffer Koch and Julieta Yung
Abstract: With short-term policy interest rates constrained by their effective zero lower bound (ZLB), monetary policy relied on communicating the future path of policy conditional on incoming macroeconomic data. Motivated by this, we exploit intra-day prices to investigate how updates on the state of the U.S. economy affect interest rates and exchange rates before and after the ZLB. We find that releases reflecting the dual mandate of the Fed rose in importance and – as an ex-post acknowledgement of the sources of the Great Recession – additional housing market indicators and GDP revisions, that hitherto left markets unaffected, became market movers.

DOI: https://doi.org/10.24149/gwp287

Globalization Institute No. 285
Finite-Order VAR Representation of Linear Rational Expectations Models: With Some Lessons for Monetary Policy (Revised August 2018)
Enrique Martínez-García
Abstract: This paper considers the characterization via finite-order VARs of the solution of a large class of linear rational expectations (LRE) models. I propose a unified approach that uses a companion Sylvester equation to check the existence and uniqueness of a solution to the canonical (first-order) LRE model in finite-order VAR form and a quadratic matrix equation to characterize it decoupling the backward- and forward-looking aspects of the model. I also investigate the fundamentalness of the shocks recovered. Solving LRE models by this procedure is straightforward to implement, general in its applicability, efficient in the use of computational resources, and can be handled easily with standard matrix algebra. An application to the workhorse New Keynesian model with accompanying Matlab codes is provided to illustrate the practical implementation of the methodology. I argue that existing empirical evidence on the transmission mechanism of monetary policy shocks from structural VARs (when the specification is inconsistent with theory due to the identification restrictions, lag specification, etc.) should be taken with a grain of salt as it may not have a proper structural interpretation.
Revision 1
Original paper
DOI: https://doi.org/10.24149/gwp285r2

Globalization Institute No. 284
Diversification and Specialization of U.S. States | Codes
Janet Koech and Mark A. Wynne
Abstract: This paper documents the evolution of the international relationships of individual U.S. states along three dimensions: trade, migration, and finance. We examine how specialized or diversified state economies differ in terms of the products they export and with whom they trade, the origins of the immigrants who live in the state, and the origins of the foreign banks operating in the state. We show that states that are diversified along one of these dimensions are often quite specialized along others. New York is–perhaps, not surprisingly–the most diversified state in terms of global linkages.

DOI: https://doi.org/10.24149/gwp284

Globalization Institute No. 283
Central Bank Communications: A Case Study 
J.Scott Davis and Mark A. Wynne
Abstract: Over the past twenty five years, central bank communications have undergone a major revolution. Central banks that previously shrouded themselves in mystery now embrace social media to get their message out to the widest audience. The Federal Reserve System has not always been at the forefront of these changes, but the volume of information about monetary policy that the Federal Open Market Committee (FOMC) now releases dwarfs what it was releasing a quarter century ago. In this paper we focus on just one channel of FOMC communications, the post-meeting statement. We document how it has evolved over time, and in particular the extent to which it has become more detailed, but also more difficult to understand. We then use a VAR with daily financial market data to estimate a daily time series of U.S. monetary policy shocks. We show how these shocks on Fed statement release days have gotten larger as the statement has gotten longer and more detailed, and we show that the length and complexity of the statement has a direct effect on the size of the monetary policy shock following a Fed decision.

DOI: https://doi.org/10.24149/gwp283

Globalization Institute No. 281
Half-Panel Jackknife Fixed Effects Estimation of Panels with Weakly Exogenous Regressors 
Supplement | Codes
Alexander Chudik, M. Hashem Pesaran and Jui-Chung Yang
Abstract: This paper considers estimation and inference in fixed effects (FE) panel regression models with lagged dependent variables and/or other weakly exogenous (or predetermined) regressors when N(the cross section dimension) is large relative to T (the time series dimension). The paper first derives a general formula for the bias of the FE estimator which is a generalization of the Nickell type bias derived in the literature for the pure dynamic panel data models. It shows that in the presence of weakly exogenous regressors, inference based on the FE estimator will result in size distortions unless N / T is sufficiently small. To deal with the bias and size distortion of FE estimator when N is large relative to T, the use of half-panel Jackknife FE estimator is proposed and its asymptotic distribution is derived. It is shown that the bias of the proposed estimator is of order T -2, and for valid inference it is only required that N / T 3 0, as N, T jointly. Extensions to panel data models with time effects (TE), for balanced as well as unbalanced panels, are also provided. The theoretical results are illustrated with Monte Carlo evidence. It is shown that the FE estimator can suffer from large size distortions when N > T, with the proposed estimator showing little size distortions. The use of half-panel jackknife FE-TE estimator is illustrated with two empirical applications from the literature.

DOI: https://doi.org/10.24149/gwp281

Globalization Institute No. 280
Exposure to International Crises: Trade vs. Financial Contagion 
Everett Grant
Abstract: I identify new patterns in countries' economic performance over the 2007-2014 period based on proximity through distance, trade, and finance to the US subprime mortgage and Eurozone debt crisis areas. To understand the causes of the cross-country variation, I develop an open economy model with two transmission channels that can be shocked separately: international trade and finance. The model is the first to include a government and heterogeneous firms that can default independently of one another and has a novel endogenous cost of sovereign default. I calibrate the model to the average experiences of countries near to and far from the crisis areas. Using these calibrations, disturbances on the order of those observed during the late 2000s are separately applied to each channel to study transmission. The results suggest credit disruption as the primary contagion driver, rather than the trade channel. Given the substantial degree of financial contagion, I run a series of counterfactuals studying the efficacy of capital controls and find that they would be a useful tool for preventing similarly severe contagion in the future, so long as there is not capital immobility to the degree that the local sovereign can default without suffering capital flight.

DOI: https://doi.org/10.24149/gwp280

Globalization Institute No. 274
The Market Resources Method for Solving Dynamic Optimization Problems 
Ayşe Kabukçuoğlu and Enrique Martínez-García
Abstract: We introduce the market resources method (MRM) for solving dynamic optimization problems. MRM extends Carroll’s (2006) endogenous grid point method (EGM) for problems with more than one control variable using policy function iteration. The MRM algorithm is simple to implement and provides advantages in terms of speed and accuracy over Howard’s policy improvement algorithm. Codes are available.

DOI: https://doi.org/10.24149/gwp274

Globalization Institute No. 268
Big Data Analytics: A New Perspective 
Supplement 1 | Supplement 2
A. Chudik, G. Kapetanios and M. H. Pesaran
Abstract: Model specification and selection are recurring themes in econometric analysis. Both topics become considerably more complicated in the case of large-dimensional data sets where the set of specification possibilities can become quite large. In the context of linear regression models, penalised regression has become the de facto benchmark technique used to trade off parsimony and fit when the number of possible covariates is large, often much larger than the number of available observations. However, issues such as the choice of a penalty function and tuning parameters associated with the use of penalised regressions remain contentious. In this paper, we provide an alternative approach that considers the statistical significance of the individual covariates one at a time, whilst taking full account of the multiple testing nature of the inferential problem involved. We refer to the proposed method as One Covariate at a Time Multiple Testing (OCMT) procedure. The OCMT has a number of advantages over the penalised regression methods: It is based on statistical inference and is therefore easier to interpret and relate to the classical statistical analysis, it allows working under more general assumptions, it is computationally simple and considerably faster, and it performs better in small samples for almost all of the five different sets of experiments considered in this paper. Despite its simplicity, the theory behind the proposed approach is quite complicated. We provide extensive theoretical and Monte Carlo results in support of adding the proposed OCMT model selection procedure to the toolbox of applied researchers.

DOI: https://doi.org/10.24149/gwp268

Globalization Institute No. 267
Economic Fundamentals and Monetary Policy Autonomy 
Scott Davis
Abstract: During a time of rising world interest rates, the central bank of a small open economy may be motivated to increase its own interest rate to keep from suffering a destabilizing outflow of capital and depreciation in the exchange rate. This is especially true for a small open economy with a current account deficit, which relies on foreign capital inflows to finance this deficit. This paper will investigate the underlying structural characteristics that would lead an economy with a floating exchange rate to adjust their interest rate in line with the foreign interest rate, and thus adopt a de facto exchange rate ”peg”. Using a panel data regression similar to that in Shambaugh (QJE 2004) and most recently in Klein and Shambaugh (AEJ Macro 2015), this paper shows that the method of current account financing has a large effect on whether or not the central bank will opt for exchange rate and capital flow stabilization during a time of rising world interest rates. A current account deficit financed mainly through reserve depletion or the accumulation of private sector debt will cause the central bank to pursue de facto exchange rate stabilization, whereas a current account deficit financed through equity or FDI will not. Quantitatively, reserve depletion of about 7% of GDP will motivate the central bank with a floating currency to adjust its interest rate in line with the foreign interest rate to where it appears that the central bank has an exchange rate peg.

DOI: https://doi.org/10.24149/gwp267

Globalization Institute No. 266
Wages and Human Capital in Finance: International Evidence, 1970-2005 
Hamid Boustanifar, Everett Grant and Ariell Reshef
Abstract: We study the allocation and compensation of human capital in the finance industry in a set of developed economies in 1970-2005. Finance relative skill intensity and skilled wages generally increase but not in all countries, and to varying degrees. Skilled wages in finance account for 36% of increases in overall skill premia, although finance only accounts for 5.4% of skilled private sector employment, on average. Financial deregulation, financial globalization and bank concentration are the most important factors driving wages in finance. Differential investment in information and communication technology does not have causal explanatory power. High finance wages attract skilled international immigration to finance, raising concerns for "brain drain".

DOI: https://doi.org/10.24149/gwp266

Globalization Institute No. 262
Quantitative Assessment of the Role of Incomplete Asset Markets on the Dynamics of the Real Exchange Rate 
Enrique Martínez-García
Published as: Martinez-Garcia, Enrique (2016), "A Quantitative Assessment of the Role of Incomplete Asset Markets on the Dynamics of the Real Exchange Rate," Open Economies Review 27 (5): 945-967.
Abstract: I develop a two-country New Keynesian model with capital accumulation and incomplete international asset markets that provides novel insights on the effect that imperfect international risk-sharing has on international business cycles and RER dynamics. I find that business cycles appear similar whether international asset markets are complete or not when driven by a combination of non-persistent monetary shocks and persistent productivity (TFP) shocks. In turn, international asset market incompleteness has sizeable effects if (persistent) investment-specific technology (IST) shocks are a main driver of business cycles. I also show that the model with incomplete international asset markets can approximate the RER volatility and persistence observed in the data, for instance, if IST shocks are near-unitroot. Hence, I conclude that the nature of shocks, the extent of financial integration across countries and the existing limitations on asset trading are central to understand the dynamics of the real exchange rate and the endogenous international transmission over the business cycles.

DOI: https://doi.org/10.24149/gwp262

Globalization Institute No. 261
Inflation as a Global Phenomenon—Some Implications for Policy Analysis and Forecasting 
Ayşe Kabukçuoğlu and Enrique Martínez-García
Abstract: We evaluate the performance of inflation forecasts based on the open-economy Phillips curve by exploiting the spatial pattern of international propagation of inflation. We model these spatial linkages using global inflation and either domestic slack or oil price fluctuations, motivated by a novel interpretation of the forecasting implications of the workhorse openeconomy New Keynesian model (Martínez-García and Wynne (2010), Kabukcuoglu and Martínez-García (2014)). We find that incorporating spatial interactions yields significantly more accurate forecasts of local inflation in 14 advanced countries (including the U.S.) than a simple autoregressive model that captures only the temporal dimension of the inflation dynamics.

DOI: https://doi.org/10.24149/gwp261

No. 1506
Non-Renewable Resources, Extraction Technology and Endogenous Growth (Revised August 2019)
Gregor Schwerhoff and Martin Stuermer
Abstract: We document that global resource extraction has strongly increased with economic growth, while prices have exhibited stable trends for almost all major non-renewable resources from 1700 to 2018. Why have resources not become scarcer as suggested by standard economic theory? We develop a theory of extraction technology, geology and growth grounded in stylized facts. Rising resource demand incentivizes firms to invest in new technology to increase their economically extractable reserves. Prices remain constant because increasing returns from the geological distribution of resources offset diminishing returns in innovation. As a result, the aggregate growth rate depends partly on the geological distribution of resources. For example, a greater average concentration of a resource in the Earth's crust leads to more resource extraction, a lower price and a higher growth rate on the balanced growth path. Our paper provides economic and geologic microfoundations explaining why flat resource prices and increasing production are reasonable assumptions in economic models of climate change.
Original paper
DOI: https://doi.org/10.24149/wp1506r1

No. 1505
Seasonal Adjustment of State and Metro CES Jobs Data
Keith R. Phillips and Jianguo Wang
Published as: Phillips, Keith R. and Jianguo Wang (2016), "Seasonal Adjustment of Hybrid Time Series: An Application to U.S. Regional Jobs Data," Journal of Economic and Social Measurement 41 (2): 191-202.
Abstract: Hybrid time series data often require special care in estimating seasonal factors. Series such as the state and metro area Current Employment Statistics produced by the Bureau of Labor Statistics (BLS) are composed of two different source series that often have two different seasonal patterns. In this paper we address the process to test for differing seasonal patterns within the hybrid series. We also discuss how to apply differing seasonal factors to the separate parts of the hybrid series. Currently the BLS simply juxtaposes the two different sets of seasonal factors at the transition point between the benchmark part of the data and the survey part. We argue that the seasonal factors should be extrapolated at the transition point or that an adjustment should be made to the level of the unadjusted data to correct for a bias in the survey part of the data caused by differing seasonal factors at the transition month.

DOI: https://doi.org/10.24149/wp1505

No. 1504
The Other (Commercial) Real Estate Boom and Bust: The Effects of Risk Premia and Regulatory Capital Arbitrage
John V. Duca and David C. Ling
Abstract: The last decade’s boom and bust in U.S. commercial real estate (CRE) prices was at least as large as that in the housing market and also had a large effect on bank failures. Nevertheless, the role of CRE in the Great Recession has received little attention. This study estimates cohesive models of short-run and long-run movements in capitalization rates (rent-to-price-ratio) and risk premiums across the four major types of commercial properties. Results indicate that CRE price movements were mainly driven by sharp declines in required risk premia during the boom years, followed by sharp increases during the bust phase. Using decompositions of estimated long-run equilibrium factors, our results imply that much of the decline in CRE risk premiums during the boom was associated with weaker regulatory capital requirements. The return to normal risk premia levels in 2009 and 2010 was first driven by a steep rise in general risk premia that occurred after the onset of the Great Recession and later by a tightening of effective capital requirements on commercial mortgage-backed securities (CMBS) resulting from the Dodd-Frank Act. In contrast to the mid-2000s boom, the recovery in CRE prices since 2010 has been mainly driven by declines in real Treasury yields to unusually low levels. Our findings have important implications for the channels through which macro-prudential regulation may or may not be effective in limiting unsustainable increases in asset prices.

DOI: https://doi.org/10.24149/wp1504

No. 1503
Money and Velocity During Financial Crisis: From the Great Depression to the Great Recession
Richard G. Anderson, Michael Bordo, and John V. Duca
Published as: Anderson, Richard G., Michael Bordo, and John V. Duca (2017), "Money and Velocity During Financial Crises: From the Great Depression to the Great Recession,” Journal of Economic Dynamics and Control 81, 32-49.
Abstract: This study models the velocity (V2) of broad money (M2) since 1929, covering swings in money [liquidity] demand from changes in uncertainty and risk premia spanning the two major financial crises of the last century: the Great Depression and Great Recession. V2 is notably affected by risk premia, financial innovation, and major banking regulations. Findings suggest that M2 provides guidance during crises and their unwinding, and that the Fed faces the challenge of not only preventing excess reserves from fueling a surge in M2, but also countering a fall in the demand for money as risk premia return to normal amid velocity shifts stemming from financial reform.

DOI: https://doi.org/10.24149/wp1503

No. 1502
Are Income Taxes Destined to Rise? The Fiscal Imbalance and Future Tax Policy
Jason L. Saving and Alan D. Viard
Published as: Saving, Jason L. and Alan Viard (2015), "Are Income Taxes Destined to Rise? Fiscal Imbalance and Future Tax Policy in the United States," National Tax Journal, 68 (2): 235-250.
Abstract: We present a model of optimizing government behavior in which a need for increased revenue leads to the introduction of a new revenue source, such as a VAT, accompanied by a reduction in income taxes. We argue that this is a plausible outcome for the United States, in view of international experience and recent fiscal reform proposals, and has important implications for individual investment decisions.

DOI: https://doi.org/10.24149/wp1502

No. 1501
Declining Female Labor Supply Elasticities in the U.S. and Implications for Tax Policy: Evidence from Panel Data
Anil Kumar and Che-Yuan Liang
Published as: Kumar, Anil and Che-Yuan Liang (2016), "Declining Female Labor Supply Elasticities in the U.S. and Implications for Tax Policy: Evidence from Panel Data," National Tax Journal 69 (3): 481-516.
Abstract: Recent work has provided compelling evidence of a long-term decline in US female labor supply elasticities with respect to wages and to income. While previous work used cross-sectional data from the Current Population Survey (CPS), we reexamine the trend for married women using panel data from the Panel Study of Income Dynamics (PSID) from 1980 to 2006. We find evidence in support of a long-term decline in married females’ labor supply elasticities on the participation margin, but less so on the hours margin. We also extend the analysis to investigating the implications of these results on welfare effects of tax reforms. Policy simulations indicate that shrinking elasticities, mostly concentrated on the participation margin, have contributed to a dramatic decline in welfare gains from actual and potential tax reforms since the 1980’s.

DOI: https://doi.org/10.24149/wp1501

Globalization Institute Working Papers

Globalization Institute No. 259
Lottery-Related Anomalies: The Role of Reference-Dependent Preferences 
Li An, Huijun Wang, Jian Wang and Jianfeng Yu
Abstract: Previous empirical studies find that lottery-like stocks significantly underperform their non-lottery-like counterparts. Using five different measures of the lottery features in the literature, we document that the anomalies associated with these measures are state-dependent: the evidence supporting these anomalies is strong and robust among stocks where investors have lost money, while among stocks where investors have gained profits, the evidence is either weak or even reversed. Several potential explanations for such empirical findings are examined and we document support for the explanation based on reference-dependent preferences. Our results provide a united framework to understand the lottery-related anomalies in the literature.

DOI: https://doi.org/10.24149/gwp318

Globalization Institute No. 247
The Cyclicality of (Bilateral) Capital Inflows and Outflows 
J. Scott Davis
Abstract: Recent research has shown that gross capital inflows and outflows are positively correlated and highly procyclical. This poses a puzzle since most theory predicts that capital inflows and outflows should be negatively correlated, and while capital inflows should be procyclical, capital outflows should be countercyclical. This previous work has examined the behavior of aggregate capital inflows and outflows (capital flows between a country and the rest of the world). This paper shows that bilateral capital inflows and outflows (flows between a pair of countries) are also positively correlated and strongly procyclical. This empirical finding poses a new puzzle. The data suggests that any model that can explain capital flows at the bilateral level needs to rely on market incompleteness and non-diversification. In addition, the data suggests that this positive correlation and procyclicality is largely the feature of crisis episodes. After controlling for crisis episodes, we find that bilateral capital flows move positively with GDP in the country receiving the capital and co-move negatively in the country sending the capital.

DOI: https://doi.org/10.24149/gwp247

Globalization Institute No. 245
Is There a Debt-threshold Effect on Output Growth? 
Alexander Chudik, Kamiar Mohaddes, M. Hashem Pesaran and Mehdi Raissi
Published as: Chudik, Alexander, Kamiar Mohaddes, M. Hashem Pesaran and Mehdi Raissi (2017), "Is There a Debt-threshold Effect on Output Growth?" Review of Economics and Statistics 99 (1): 135-150.
Abstract: This paper studies the long-run impact of public debt expansion on economic growth and investigates whether the debt-growth relation varies with the level of indebtedness. Our contribution is both theoretical and empirical. On the theoretical side, we develop tests for threshold effects in the context of dynamic heterogeneous panel data models with crosssectionally dependent errors and illustrate, by means of Monte Carlo experiments, that they perform well in small samples. On the empirical side, using data on a sample of 40 countries (grouped into advanced and developing) over the 1965-2010 period, we find no evidence for a universally applicable threshold effect in the relationship between public debt and economic growth, once we account for the impact of global factors and their spillover effects. Regardless of the threshold, however, we find significant negative long-run effects of public debt build-up on output growth. Provided that public debt is on a downward trajectory, a country with a high level of debt can grow just as fast as its peers.

DOI: https://doi.org/10.24149/gwp245

Globalization Institute No. 243
On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments 
Enrique Martínez-García
Published as: Martínez-García, Enrique (2015), "On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments," Economics Letters 134: 86-89.
Abstract: I show that parity realignments alone do not suffice to ensure the long-run sustainability of an exchange rate target zone with imperfect credibility due to the gambler’s ruin problem. However, low credibility and frequent realignments can destabilize the exchange rate.

DOI: https://doi.org/10.24149/gwp243

Globalization Institute No. 240
Monetary Policy Expectations and Economic Fluctuations at the Zero Lower Bound  (Revised November 2021)
Appendix
Rachel Doehr and Enrique Martínez-García
Abstract: We propose a recursive VAR model augmented with survey-based measures of future interest rates to identify the effects of forward guidance on the U.S. economy. Our results show that when interest rates are away from the zero lower bound (ZLB), an exogenous shift in the perception toward higher future interest rates leads to an increase in current economic activity. However, when policy rates fall to the ZLB, economic activity decreases following an upward revision to expected future interest rates. These findings are robust to alternative estimation frameworks, identification schemes and data sources. We also provide a structural interpretation for our findings in the context of the workhorse New Keynesian model with news shocks about future monetary policy (forward guidance). In this setting, the monetary authority cannot accommodate the anticipatory effects from higher future interest rates while at the ZLB, which drags economic activity today. In turn, away from the ZLB, there is policy room to cut rates and revert the negative economic impacts of the anticipated policy. Similarly, announcing future lower interest rates while keeping interest rates at the ZLB today boosts current economic activity while the reverse can happen if, instead, policy rates are lifted above the ZLB to cool down the nascent expansion. Therefore, our empirical results and theoretical insights suggest that managing monetary policy expectations is a useful policy tool for stimulating economic activity, but its transmission mechanism is different at and away from the ZLB.
Original paper
DOI: https://doi.org/10.24149/gwp240r1
Appendix DOI: https://doi.org/10.24149/gwp240appr1

Globalization Institute No. 235
Forecasting Inflation in Open Economies: What Can a NOEM Model Do?  (Revised December 2022, new title)
Appendix
Roberto Duncan and Enrique Martínez-García
Abstract: This paper evaluates the forecasting ability when inflation is viewed as an inherently global phenomenon through the lens of the workhorse New Open Economy Macro (NOEM) model. The NOEM model emphasizes the importance of cross-country spillovers arising through trade and its reduced form solution can be represented by a finite-order VAR which provides a tractable model of inflation forecasting. We use Bayesian techniques to estimate this VAR specification—we name it NOEM-BVAR—and pseudo-out-of-sample forecasts to assess its forecasting performance at different horizons in a diverse set of 18 countries. On average, the NOEM-BVAR specification produces a similar or even lower root mean square prediction error (RMSPE) than its standard competitors, which include both purely statistical models and theoretically-based forecasting models (e.g., Phillips-curve-type alternatives and others with global inflation measures). In a number of cases, the gains in smaller RMSPEs are statistically significant, especially at short horizons. The NOEM-BVAR model is also accurate in predicting the direction of change for inflation and is often better than its competitors along this dimension as well. Even though purely statistical models can be useful prediction tools, the NOEM-BVAR is attractive among those forecasting models motivated by economic theory.
Original paper
DOI: https://doi.org/10.24149/gwp235r1
Appendix DOI: https://doi.org/10.24149/gwp235appr1

Globalization Institute No. 231
Evolving Comparative Advantage, Sectoral Linkages, and Structural Change 
Michael Sposi
Abstract: I quantitatively examine the effects of location-and sector-specific productivity growth on structural change across countries from 1970–2011. The results shed new light on the “hump shape" in industry's share in GDP across levels of development. There are two key features. First, otherwise identical changes in the composition of final demand translate differently into changes in the composition of value added because of systematic differences in sectoral linkages. Second, the mapping between sector-specific productivity and the composition of final demand systematically differs because of the relative importance of two components within final demand: final domestic expenditures and net exports.

DOI: https://doi.org/10.24149/gwp231

Globalization Institute No. 226
The Asymmetric Effects of Deflation on Consumption Spending: Evidence from the Great Depression 
J. Scott Davis
Published as: Davis, J. Scott (2015), "The Asymmetric Effects of Deflation On Consumption Spending: Evidence from the Great Depression," Economic Letters 130: 105-108.
Abstract: Does expected deflation lead to a fall in consumption spending? Using data for U.S. grocery store sales and department store sales from 1919 to 1939, this paper shows that expected price changes have asymmetric effects on consumption spending. Department store sales (durable consumption) react negatively to the expectation of falling prices, but grocery store sales (non-durable consumption) do not react to expected price changes.

DOI: https://doi.org/10.24149/gwp226

Globalization Institute No. 225
The Global Component of Local Inflation: Revisiting the Empirical Content of the Global Slack Hypothesis with Bayesian Methods 
Enrique Martínez-García
Published as: Martínez-García, Enrique (2015), "The Global Component of Local Inflation: Revisiting the Empirical Content of the Global Slack Hypothesis with Bayesian Methods," in Monetary Policy in the Context of the Financial Crisis: New Challenges and Lessons, ed. William A. Barnett and Fredj Jawadi (Bingley, UK: Emerald Group Publishing Limited), 51-112.
Abstract: The global slack hypothesis is central to the discussion of the trade-offs that monetary policy faces in an increasingly more integrated world. The workhorse New Open Economy Macro (NOEM) model of Martínez-García and Wynne (2010), which fleshes out this hypothesis, shows how expected future local inflation and global slack affect current local inflation. In this paper, I propose the use of the orthogonalization method of Aoki (1981) and Fukuda (1993) on the workhorse NOEM model to further decompose local inflation into a global component and an inflation differential component. I find that the log-linearized rational expectations model of Martínez-García and Wynne (2010) can be solved with two separate subsystems to describe each of these two components of inflation. I estimate the full NOEM model with Bayesian techniques using data for the U.S. and an aggregate of its 38 largest trading partners from 1980Q1 until 2011Q4. The Bayesian estimation recognizes the parameter uncertainty surrounding the model and calls on the data (inflation and output) to discipline the parameterization. My findings show that the strength of the international spillovers through trade—even in the absence of common shocks—is reflected in the response of global inflation and is incorporated into local inflation dynamics. Furthermore, I find that key features of the economy can have different impacts on global and local inflation—in particular, I show that the parameters that determine the import share and the price-elasticity of trade matter in explaining the inflation differential component but not the global component of inflation.

DOI: https://doi.org/10.24149/gwp225

Globalization Institute No. 224
Pegging the Exchange Rate to Gain Monetary Policy Credibility 
J. Scott Davis and Ippei Fujiwara
Abstract: Central banks that lack credibility often tie their exchange rate to that of a more credible partner in order to “import” credibility. We show in a small open economy model that a central bank that displays “limited credibility” can deliver significant improvements to a social welfare function that contains no role for exchange rate stabilization by maximizing an objective function that places weight on exchange rate stabilization, and thus the central bank with limited credibility will peg their currency to that of a more credible partner. As the central bank’s credibility improves it will place less weight on exchange rate stabilization in its objective function and thus loosen the peg. When the central bank is perfectly credible its objective function and the social welfare function are identical; it places no weight on exchange rate stabilization and allows the currency to freely float. Empirical results using a panel of both developed and developing countries show that as central banks become more independent they tend to allow more currency flexibility.

DOI: https://doi.org/10.24149/gwp224

Globalization Institute No. 223
Long-Run Effects in Large Heterogenous Panel Data Models with Cross-Sectionally Correlated Errors 
Alexander Chudik, Kamiar Mohaddes, M. Hashem Pesaran and Mehdi Raissi
Abstract: This paper develops a cross-sectionally augmented distributed lag (CS-DL) approach to the estimation of long-run effects in large dynamic heterogeneous panel data models with crosssectionally dependent errors. The asymptotic distribution of the CS-DL estimator is derived under coefficient heterogeneity in the case where the time dimension (T) and the crosssection dimension (N) are both large. The CS-DL approach is compared with more standard panel data estimators that are based on autoregressive distributed lag (ARDL) specifications. It is shown that unlike the ARDL type estimator, the CS-DL estimator is robust to misspecification of dynamics and error serial correlation. The theoretical results are illustrated with small sample evidence obtained by means of Monte Carlo simulations, which suggest that the performance of the CS-DL approach is often superior to the alternative panel ARDL estimates particularly when T is not too large and lies in the range of 30≤T<100.

DOI: https://doi.org/10.24149/gwp223

No. 1416
Texas Manufacturing Outlook Survey: Survey Methodology and Performance
Jesus Cañas and Emily Kerr
Abstract: The Texas Manufacturing Outlook Survey (TMOS) is a monthly survey of area manufacturers conducted by the Federal Reserve Bank of Dallas. TMOS indexes provide timely information on manufacturing activity in Texas, which is useful for understanding broader changes in regional economic conditions. This paper describes the survey methodology and analyzes the explanatory and predictive power of TMOS indexes with regard to other measures of state economic activity. Regression analysis shows that several TMOS indexes successfully explain monthly changes in Texas employment and quarterly changes in gross state product. Forecasting exercises show that several TMOS indexes, particularly general business activity and growth rate of orders, are useful in predicting changes in Texas employment.

DOI: https://doi.org/10.24149/wp1416

No. 1415
The Impact of Temporary Protected Status on Immigrants’ Labor Market Outcomes
Pia Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2015), "The Impact of Temporary Protected Status on Immigrants’ Labor Market Outcomes," American Economic Review Papers and Proceedings 105 (5): 576-580.
Abstract: The United States currently provides Temporary Protected Status (TPS) to more than 300,000 immigrants from selected countries. TPS is typically granted if dangerous conditions prevail in the home country due to armed conflict or a natural disaster. Individuals with TPS cannot be deported and are allowed to stay and work in the United States temporarily. Despite the increased use of TPS in recent years, little is known about how TPS affects labor market outcomes for beneficiaries, most of whom are unauthorized prior to receiving TPS. This study examines how migrants from El Salvador who are likely to have received TPS fare in the labor market compared with other migrants. The results suggest that TPS eligibility leads to higher employment rates among women and higher earnings among men. The results have implications for recent programs that allow some unauthorized immigrants to receive temporary permission to remain and work in the United States.

DOI: https://doi.org/10.24149/wp1415

No. 1414
150 Years of Boom and Bust: What Drives Mineral Commodity Prices?
Martin Stuermer
Abstract: My paper provides long-run evidence on the dynamic effects of supply and demand shocks on mineral commodity prices. I assemble and analyze a new data set of price and production levels of copper, lead, tin, and zinc from 1840 to 2010. Price fluctuations are primarily driven by demand rather than supply shocks. Demand shocks affect the price persistently for up to five-teen years, whereas the effect of mineral supply shocks persists for a maximum of five years. My paper shows that price surges caused by rapid industrialization are a recurrent phenomenon throughout history. Mineral commodity prices return to their declining or stable trends in the long run.

DOI: https://doi.org/10.24149/wp1414

No. 1413
Industrialization and the Demand for Mineral Commodities
Martin Stuermer
Abstract: This paper uses a new data set extending back to 1840 to investigate how industrialization affects the derived demand for mineral commodities. I establish that there is substantial heterogeneity in the long-run effect of manufacturing output on demand across five commodities after controlling for sectoral change, substitution and technological development. My results imply substantial differences across commodities with regard to future demand from industrializing countries and with regard to the effect of demand shocks on prices. Models should include non-Gormand preferences to account for this heterogeneity.

DOI: https://doi.org/10.24149/wp1413

No. 1412
Macroelasticities and the U.S. Sequestration Budget Cuts
Carlos Zarazaga
Abstract: Microeconomic studies keep reporting that the intertemporal substitution in consumption and the Frisch elasticity of aggregate labor supply have signi ficantly lower values than macroeconomic models find consistent with the dynamics of aggregate variables. The paper argues that in the U.S. such dynamics have been infl‡uenced since 2013 by the temporary spending cuts imposed by the so-called budget sequestration. The paper exploits the "policy experiment" features of that measure to gauge macroelasticity values from the evidence associated with it, adopting to that effect a macroeconomic model constructed according to the methodological principles advocated by the real business cycle literature. Readings of the preliminary evidence available at the time of this writing with such a measuring device do not particularly favor high values for either of the two macroelasticities under study. Although it’s too early to be conclusive, this finding illustrates how existing disagreements about the value of key macroelasticities can eventually be narrowed down by applying the approach proposed in this paper to the evidence coming out of the budget sequestration policy, as it unfolds over time.

DOI: https://doi.org/10.24149/wp1412

No. 1411
Asymmetric Firm Dynamics under Rational Inattention
Anton Cheremukhin and Antonella Tutino
Abstract: We study the link between business failures, markups and business cycle asymmetry in the U.S. economy with a model of optimal rm exit under rational inattention. We show that the model’s predictions of lagged, counter-cyclical and positively skewed markups together with counter-cyclical exit rates are consistent with the empirical evidence. Moreover, our model uncovers a new mechanism that links information processing with the business cycle. It predicts countercyclical attention to economic conditions consistent with survey evidence.

DOI: https://doi.org/10.24149/wp1411

No. 1410
Do Restrictions on Home Equity Extraction Contribute to Lower Mortgage Defaults? Evidence from a Policy Discontinuity at the Texas’ Border
Anil Kumar
Abstract: Texas is the only US state that limits home equity borrowing to 80 percent of home value. This paper exploits this policy discontinuity around the Texas’ interstate borders and uses a multidimensional regression discontinuity design framework to find that limits on home equity borrowing in Texas lowered the likelihood of mortgage default by about 1 percentage point for all mortgages and 2-4 percentage points for nonprime mortgages. Estimated nonprime mortgage default hazards within 25 to 100 miles on either side of the Texas’ border are about 15 percent smaller as one crosses into Texas.

DOI: https://doi.org/10.24149/wp1410

No. 1409
A Closer Look at the Phillips Curve Using State Level Data
Anil Kumar and Pia Orrenius
Published as: Kumar, Anil and Pia M. Orrenius (2016), "A Closer Look at the Phillips Curve Using State-Level Data," Journal of Macroeconomics 47 (Part A): 84-102.
Abstract: Studies that estimate the Phillips curve for the U.S. use mainly national-level data and find mixed evidence of nonlinearity, with some recent studies either rejecting nonlinearity or estimating only modest convexity. In addition, most studies do not make a distinction between the relative impacts of short-term vs. long-term unemployment on wage inflation. Using state-level data from1982 to 2013, we find strong evidence that the wage-price Phillips curve is nonlinear and convex; declines in the unemployment rate below the average unemployment rate exert significantly higher wage pressure than changes in the unemployment rate above the historical average. We also find that the short-term unemployment rate has a strong relationship with both average and median wage growth, while the long-term unemployment rate appears to influence only median wage growth.

DOI: https://doi.org/10.24149/wp1409

No. 1408
Income Inequality and Political Polarization: Time Series Evidence Over Nine Decades
John V. Duca and Jason L. Saving
Published as: Duca, John V. and Jason L. Saving (2016), "Income Inequality and Political Polarization: Time Series Evidence Over Nine Decades," Review of Income and Wealth 62 (3): 445-466.
Abstract: Rising income inequality and political polarization have led some to hypothesize that the two are causally linked. Properly interpreting such correlations is complicated by the multiple factors that drive each of these phenomena, potential feedbacks between inequality and polarization, measurement issues, and statistical challenges for modeling non-stationary variables. We find that a more precise measure of inequality (the inverted Pareto-Lorenz coefficient) is statistically related to polarization while a less precise one (top 1% income share) is not, and that there are bi-directional feedbacks between polarization and inequality. Findings support a nuanced view of the links between polarization and inequality.

DOI: https://doi.org/10.24149/wp1408

No. 1407
Fuel Subsidies, the Oil Market and the World Economy
Nathan Balke, Michael Plante and Mine Yücel
Published as: Balke, Nathan S., Michael D. Plante and Mine K. Yücel (2015), "Fuel Subsidies, the Oil Market and the World Economy,” The Energy Journal 36 (SI1): 99-127. https://doi.org/10.5547/01956574.36.SI1.nbal.
Abstract: This paper studies the effects of oil producing countries' fuel subsidies on the oil market and the world economy. We identify 24 oil producing countries with fuel subsidies where retail fuel prices are about 34 percent of the world price. We construct a two-country model where one country represents the oil-exporting subsidizers and the second the oil-importing bloc, and calibrate the model to match recent data. We find that the removal of subsidies would reduce the world price of oil by six percent. The removal of subsidies is unambiguously welfare enhancing for the oil-importing countries. Welfare can also improve in the oil-exporting countries, depending upon the extent to which they are net exporters of oil and on oil supply and demand elasticities.

DOI: https://doi.org/10.24149/wp1407

No. 1406
Deposit Interest Rate Ceilings as Credit Supply Shifters: Bank Level Evidence on the Effects of Regulation Q
Christoffer Koch
Published as: Koch, Christoffer (2015), "Deposit Interest Rate Ceilings as Credit Supply Shifters: Bank Level evidence on the Effects of Regulation Q," Journal of Banking & Finance 61: 316-326.
Abstract: Shocks emanating from and propagating through the banking system have recently gained interest in the macroeconomics literature, yet they are not a feature unique to the 2008/09 financial crisis. Banking disintermediation shocks occured frequently during the Great Inflation era due to fixed deposit rate ceilings. I estimate the effect of deposit rate ceilings inscribed in Regulation Q on the transmission of federal funds rate changes to bank level credit growth using a historic bank level data set spanning half a century from 1959 to 2013 with about two million observations. Measures of the degree of bindingness of Regulation Q suggest that individual banks’ lending growth was smaller the more binding the legally fixed rate ceiling. Interaction terms with monetary policy suggest that the policy impact on bank level credit growth was non-linear at the ceiling “kink” and significantly larger when rate ceilings were in place. At the bank level, short-term interest rates exceeding the legally fixed deposit rate ceilings identify bank loan supply shifts that disappeared with deposit rate deregulation and thus weakened the credit channel of monetary transmission since the early 1980s.

DOI: https://doi.org/10.24149/wp1406

No. 1405
The Zero Lower Bound and Endogenous Uncertainty
Michael Plante, Alexander W. Richter and Nathaniel A. Throckmorton
Published as: Plante, Michael, Alexander W. Richter and Nathaniel A. Throckmorton (2018), "The Zero Lower Bound and Endogenous Uncertainty,” The Economic Journal 128 (611): 1730-1757. https://doi.org/10.1111/ecoj.12445.
Abstract: This paper documents a strong negative correlation between macroeconomic uncertainty and real GDP growth since the Great Recession. Prior to that event the correlation was weak, even when conditioning on recessions. At the same time, many central banks reduced their policy rate to its zero lower bound (ZLB), which we contend contributed to the strong correlation between macroeconomic uncertainty and real GDP growth. To test that theory, we use a model where the ZLB occasionally binds. The model roughly matches the correlation in the data—away from the ZLB the correlation is weak but strongly negative when the ZLB binds.

DOI: https://doi.org/10.24149/wp1405

No. 1404
Heterogeneous Bank Lending Responses to Monetary Policy: New Evidence from a Real-time Identification
John C. Bluedorn, Christopher Bowdler and Christoffer Koch
Published as: Bluedorn, John C., Christopher Bowdler and Christoffer Koch (2017), "Heterogeneous Bank Lending Responses to Monetary Policy: New Evidence from a Real-time Identification," International Journal of Central Banking 13 (1): 95-149.
Abstract: We present new evidence on how heterogeneity in banks interacts with monetary policy changes to impact bank lending, at both the bank and U.S. state levels. Using an exogenous policy measure identified from narratives on FOMC intentions and real-time economic forecasts, we find much stronger dynamic effects and greater heterogeneity in U.S. bank lending responses than that found in previous research based on realized federal funds rate changes. Our findings suggest that studies using realized monetary policy changes confound monetary policy’s effects with those of changes in expected macrofundamentals. In fact, estimates from identified monetary policy changes lead to a reversal of U.S. states’ ranking by credit’s sensitivity to policy. We also extend Romer and Romer (2004)’s identification scheme, and expand the time and balance sheet coverage of the U.S. banking sample.

DOI: https://doi.org/10.24149/wp1404

No. 1403
How Do E-Verify Mandates Affect Unauthorized Immigrant Workers?
Pia M. Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2015), "The Impact of E-Verify Mandates on Labor Market Outcomes," Southern Economic Journal 81 (4): 947-959.
Abstract: A number of states have adopted laws that require employers to use the federal government’s E-Verify program to check workers’ eligibility to work legally in the United States. Using data from the Current Population Survey, this study examines whether such laws affect labor market outcomes among Mexican immigrants who are likely to be unauthorized. We find evidence that E-Verify mandates reduce average hourly earnings among likely unauthorized male Mexican immigrants while increasing labor force participation and employment among likely unauthorized female Mexican immigrants. In contrast, the mandates appear to lead to better labor market outcomes among workers likely to compete with unauthorized immigrants. Employment and earnings rise among male Mexican immigrants who are naturalized citizens in states that adopt E-Verify mandates, and earnings rise among U.S.-born Hispanic men.

DOI: https://doi.org/10.24149/wp1403

No. 1402
A Theory of Targeted Search
Anton Cheremukhin, Antonella Tutino and Paulina Restrepo-Echavarria
Abstract: We present a theory of targeted search, where people with a finite information processing capacity search for a match. Our theory explicitly accounts for both the quantity and the quality of matches. It delivers a unique equilibrium that resides in between the random matching and the directed search outcomes. The equilibrium that emerges from this middle ground is inefficient relative to the constrained Pareto allocation. Our theory encompasses the outcomes of the random matching and the directed search literature as limiting cases.

DOI: https://doi.org/10.24149/wp1402

No. 1401
What Drives the Shadow Banking System in the Short and Long Run?
John V. Duca
Abstract: This paper analyzes how risk and other factors altered the relative use of short-term business debt funded by the shadow banking system since the early 1960s. Results indicate that the share was affected over the long-run not only by changing information and reserve requirement costs, but also by shifts in the impact of regulations on bank versus nonbank credit sources—such as Basel I in 1990 and reregulation in 2010. In the short-run, the shadow share rose when deposit interest rate ceilings were binding, the economic outlook improved, or risk premia declined, and fell when event risks disrupted financial markets.

DOI: https://doi.org/10.24149/wp1401

Globalization Institute Working Papers

Globalization Institute No. 214
The Macroeconomic Effects of Debt- and Equity-Based Capital Inflows 
J. Scott Davis
Published as: Davis, J. Scott (2015), "The Macroeconomic Effects of Debt- and Equity-Based Capital Inflows," Journal of Macroeconomics 46: 81-95.
Abstract: This paper will consider whether debt- and equity-based capital inflows have different macroeconomic effects. Using external instruments in a structural VAR, we first identify the component of capital inflows that is driven not by domestic economic and financial conditions but by conditions in the rest of the world. We then estimate the response to an exogenous shock to debt or equity-based capital inflows in a structural VAR model that includes domestic variables like GDP, inflation, the exchange rate, stock prices, credit growth, and interest rates. An exogenous increase in debt inflows leads to a significant increase in GDP, inflation, stock prices and credit growth and an appreciation of the exchange rate. An exogenous increase in equity-based capital inflows has almost no effect on the same variables. Thus the macroeconomic effects of exogenous capital inflows are almost entirely due to changes in debt, not equity-based.

DOI: https://doi.org/10.24149/gwp214

Globalization Institute No. 213
A Multi-Country Approach to Forecasting Output Growth Using PMIs 
Alexander Chudik, Valerie Grossman and M. Hashem Pesaran
Published as: Chudik, Alexander, Valerie Grossman and M. Hashem Pesaran (2016), "A Multi-Country Approach to Forecasting Output Growth Using PMIs," Journal of Econometrics 192 (2): 349-365.
Abstract: This paper derives new theoretical results for forecasting with Global VAR (GVAR) models. It is shown that the presence of a strong unobserved common factor can lead to an undetermined GVAR model. To solve this problem, we propose augmenting the GVAR with additional proxy equations for the strong factors and establish conditions under which forecasts from the augmented GVAR model (AugGVAR) uniformly converge in probability (as the panel dimensions N,T→ ∞ such that N/T→ x for some 0 < x < ∞) to the infeasible optimal forecasts obtained from a factor-augmented high-dimensional VAR model. The small sample properties of the proposed solution are investigated by Monte Carlo experiments as well as empirically. In the empirical part, we investigate the value of the information content of Purchasing Managers Indices (PMIs) for forecasting global (48 countries) growth, and compare forecasts from AugGVAR models with a number of datarich forecasting methods, including Lasso, Ridge, partial least squares and factor-based methods. It is found that (a) regardless of the forecasting methods considered, PMIs are useful for nowcasting, but their value added diminishes quite rapidly with the forecast horizon, and (b) AugGVAR forecasts do as well as other data-rich forecasting techniques for short horizons, and tend to do better for longer forecast horizons.

DOI: https://doi.org/10.24149/gwp213

Globalization Institute No. 207
Can Interest Rate Factors Explain Exchange Rate Fluctuations? 
Julieta Yung
Abstract: This paper explores whether interest rate factors, derived from the yield curve, can explain exchange rate fluctuations at different horizons. Using a dynamic term structure model under no-arbitrage, exchange rates are modeled as the ratio of two countries’ stochastic discount factors. Key to this framework is that factors are observable, which allows the model to be estimated by Maximum Likelihood. Results show that interest rate factors can explain half of the variation in one-year exchange rates and up to ninety percent of five-year movements, for free-floating currencies from 1999 to 2014. These findings suggest that yield curves contain important information for modeling exchange rate dynamics, particularly at longer horizons.

DOI: https://doi.org/10.24149/gwp207

Globalization Institute No. 191
Benefits of Foreign Ownership: Evidence from Foreign Direct Investment in China 
Jian Wang and Xiao Wang
Published as: Wang, Jian and Xiao Wang (2015), "Benefits of Foreign Ownership: Evidence from Foreign Direct Investment in China," Journal of International Economics 97 (2): 325-338.
Abstract: To examine the effect of foreign direct investment, this paper compares the post-acquisition performance changes of foreign- and domestic-acquired firms in China. Unlike previous studies, we investigate the purified effect of foreign ownership by using domestic-acquired firms as the control group. After controlling for the acquisition effect that also exists in domestic acquisitions, we find no evidence in the data that foreign ownership can bring productivity gains to target firms. In contrast, a strong and robust finding is that foreign ownership significantly improves target firms' financial conditions and exports relative to domestic-acquired firms. Foreign acquisition is also found to improve output, employment and income for target firms. These findings highlight the financial channel through which FDI benefits income and economic growth of host countries.

DOI: https://doi.org/10.24149/gwp191

Globalization Institute No. 190
Technical Note on "Assessing Bayesian Model Comparison in Small Samples" 
Enrique Martínez-García and Mark A. Wynne 
Abstract: This technical note is developed as a companion to the paper ‘Assessing Bayesian Model Comparison in Small Samples’ (Globalization and Monetary Policy Institute working paper no. 189). Taking the workhorse open-economy model of Martínez-García and Wynne (2010) with nominal rigidities under monopolistic competition as our Data-Generating Process, we investigate with simulated data how Bayesian model comparison based on posterior odds performs when the model becomes arbitrarily close to a closed-economy and/or an economy with flexible prices and perfect competition. This technical note elaborates on three key technical points relevant for Martínez-García and Wynne (2014). First, we explain the building blocks of the open-economy model of Martínez-García and Wynne (2010). We also derive the equilibrium conditions (and the steady state) under producer-currency pricing. Second, we discuss the log-linearization of the equilibrium conditions around the deterministic steady state and our benchmark parameterization. The linear rational expectations model that results from the log-linearization is used to simulate the data under our benchmark parameterization. These simulated data is used in Martínez-García and Wynne (2014) to conduct their Bayesian model comparison exercises. Third, we describe the Bayesian estimation and model comparison techniques with special emphasis on the questions of: (a) how we elicit priors on the models themselves and the parameters of a given model, and (b) how we compute posterior model probabilities. Simultaneously, commentary is provided whenever appropriate to clarify the economic significance of the assumptions embedded in our workhorse open-economy model.

DOI: https://doi.org/10.24149/gwp190

Globalization Institute No. 189
Assessing Bayesian Model Comparison in Small Samples 
Enrique Martínez-García and Mark A. Wynne
Published as: Martínez-García, Enrique and Mark A. Wynne (2014), "Assessing Bayesian Model Comparison in Small Samples," in Bayesian Model Comparison, ed. Ivan Jeliazkov and Dale J. Poirer (Bingley, UK: Emerald Group Publishing Limited), 71-115.
Abstract: We investigate the Bayesian approach to model comparison within a two-country framework with nominal rigidities using the workhorse New Keynesian open-economy model of Martínez-García and Wynne (2010). We discuss the trade-offs that monetary policycharacterized by a Taylor-type rule faces in an interconnected world, with perfectly flexible exchange rates. We then use posterior model probabilities to evaluate the weight of evidence in support of such a model when estimated against more parsimonious specifications that either abstract from monetary frictions or assume autarky by means of controlled experiments that employ simulated data. We argue that Bayesian model comparison with posterior odds is sensitive to sample size and the choice of observable variables for estimation. We show that posterior model probabilities strongly penalize overfitting which can lead us to favor a less parameterized model against the true data-generating process when the two become arbitrarily close to each other. We also illustrate that the spill-overs from monetary policy across countries have an added confounding effect.

DOI: https://doi.org/10.24149/gwp189

Globalization Institute No. 183
Capital Goods Trade and Economic Development 
Piyusha Mutreja, B. Ravikumar and Michael Sposi
Abstract: Almost 80 percent of capital goods production in the world is concentrated in 10 countries. Poor countries import most of their capital goods. We argue that international trade in capital goods has quantitatively important effects on economic development through two channels: (i) capital formation and (ii) aggregate TFP. We embed a multi country, multi sector Ricardian model of trade into a neoclassical growth model. Barriers to trade result in a misallocation of factors both within and across countries. We calibrate the model to bilateral trade flows, prices, and income per worker. Our model matches several trade and development facts within a unified framework. It is consistent with the world distribution of capital goods production, cross-country differences in investment rate and price of final goods, and cross-country equalization of price of capital goods and marginal product of capital. The cross-country income differences decline by more than 50 percent when distortions to trade are eliminated, with 80 percent of the change in each country’s income attributable to change in capital. Autarky in capital goods results in an income loss of 17 percent for poor countries, with all of the loss stemming from decreased capital.

DOI: https://doi.org/10.24149/gwp183

Globalization Institute No. 180
Theory and Practice of GVAR Modeling 
Alexander Chudik and M. Hashem Pesaran
Published as: Chudik, Alexander & M. Hashem Pesaran (2016), "Theory and Practice of GVAR Modeling," Journal of Economic Surveys 30 (1): 165-197.
Abstract: The Global Vector Autoregressive (GVAR) approach has proven to be a very useful approach to analyze interactions in the global macroeconomy and other data networks where both the cross-section and the time dimensions are large. This paper surveys the latest developments in the GVAR modeling, examining both the theoretical foundations of the approach and its numerous empirical applications. We provide a synthesis of existing literature and highlight areas for future research.

DOI: https://doi.org/10.24149/gwp180

Globalization Institute No. 178
Credit Booms, Banking Crises, and the Current Account 
J. Scott Davis, Adrienne Mack, Wesley Phoa and Anne Vandenabeele
Published as: Davis, J. Scott, Adrienne Mack, Wesley Phoa and Anne Vandenabeele (2016), "Credit Booms, Banking Crises, and the Current Account," Journal of International Money and Finance 60: 360-377.
Abstract: What is the marginal effect of an increase in the private sector debt-to-GDP ratio on the probability of a banking crisis? This paper shows that the marginal effect of rising debt levels depends on an economy's external position. When the current account is in surplus or in balance, the marginal effect of an increase in debt is rather small; a 10 percentage point increase in the private sector debt-to-GDP ratio increases the probability of a crisis by about 1 to 2 percentage points. However, when the economy is running a sizable current account deficit, implying that any increase in the debt ratio is financed through foreign borrowing, this marginal effect can be large. When a country has a current account deficit of 10% of GDP (which is similar to the value in the Eurozone periphery on the eve of the recent crisis) a 10 percentage point increase in the private sector debt ratio leads to a 10 percentage point increase in the probability of a crisis.

DOI: https://doi.org/10.24149/gwp178

Globalization Institute No. 174
Inflation Targeting and the Anchoring of Inflation Expectations: Cross-country Evidence from Consensus Forecasts 
J. Scott Davis
Abstract: Using survey data of inflation expectations across a 36 developed and developing countries, this paper examines whether the adoption of inflation targeting has helped to anchor inflation expectations. We examine the response of inflation expectations following a shock to inflation, inflation expectations, and oil prices. For the 13 countries that adopted inflation targeting midway through the time period used in this study, there is a significant difference in the responses between the earlier and the later subperiods. A shock leads to a positive, significant, and persistent increase inflation expectations in the earlier, pre-targeting subperiod, but the same response is much less significant and persistent in the later, posttargeting subperiod. For the control group of 23 countries that did not adopt inflation targeting during this time period, there is no difference between responses in the earlier and the later sub-periods.

DOI: https://doi.org/10.24149/gwp174

Globalization Institute No. 171
Capital Controls as an Instrument of Monetary Policy 
Scott Davis and Ignacio Presno
Abstract: Large swings in capital flows into and out of emerging markets can potentially lead to excessive volatility in asset prices and credit supply. In order to lessen the impact of capital flows on financial instability, a number of researchers and policy markers have recently proposed the use of capital controls. This paper considers the benefit of adding capital controls as a potential instrument of monetary policy in a small open economy. In a DSGE framework, we find that when domestic agents are subject to collateral constraints and the value of collateral is subject to fluctuations driven by foreign capital inflows and outflows, the adoption of temporary capital controls can lead to a significant welfare improvement. The benefits of capital controls are present even when monetary policy is determined optimally, implying that there may be a role for capital controls to exist side-by-side with conventional monetary tools as an instrument of monetary policy.

DOI: https://doi.org/10.24149/gwp171

Globalization Institute No. 169
A Contribution to the Chronology of Turning Points in Global Economic Activity (1980-2012) 
Valerie Grossman, Adrienne Mack and Enrique Martínez-García
Published as: Valerie Grossman, Adrienne Mack and Enrique Martínez-García (2015), "A Contribution to the Chronology of Turning Points in Global Economic Activity (1980–2012)," Journal of Macroeconomics 46: 170-185.
Abstract: The Database of Global Economic Indicators (DGEI) of the Federal Reserve Bank of Dallas is aimed at standardizing and disseminating world economic indicators for the study of globalization. It includes a core sample of 40 countries with available indicators and broad coverage for quarterly real GDP, and the monthly series of industrial production (IP), Purchasing Managers Index (PMI), merchandise exports and imports, headline CPI, CPI (ex. food and energy), PPI/WPI inflation, nominal and real exchange rates, and official/policy interest rates (see Grossman, Mack, and Martínez-García (2013)). This paper aims to codify in a systematic way the chronology of global business cycles for DGEI. We propose a novel chronology based on IP data for a sample of 84 countries at a monthly frequency from 1980 until now, and assess the turning points obtained as a signal of the underlying state of the economy as tracked by the indicators of DGEI. We conclude by proposing and also evaluating global recession probability forecasts up to 12 months ahead. The logit model proposed uses the DGEI aggregate indicators to offer advanced warning of turning point in the global cycle—by this metric a global downturn in 2013 does not appear likely.

DOI: https://doi.org/10.24149/gwp169

No. 1309
Disastrous Disappointments: Asset-Pricing with Disaster Risk and Disappointment Aversion
Jim Dolmas
Abstract: In this paper, I combine disappointment aversion, as employed by Routledge and Zin [28] and Campanale, Castro and Clementi [9], with rare disasters in the spirit of Rietz [27], Barro [4], Gourio [16], Gabaix [15] and others. I find that, when the model’s representative agent is endowed with an empirically plausible degree of disappointment aversion, a rare disaster model can produce moments of asset returns that match the data reasonably well, using disaster probabilities and disaster sizes much smaller than have been employed previously in the literature. This is good news. Quantifying the disaster risk faced by any one country is inherently difficult with limited time series data. And, it is open to debate whether the disaster risk relevant to, say, US investors is well-approximated by the sizable risks found by Barro [4] and co-authors [6, 7, 26] in cross-country data. On the other hand, we have evidence (see [30], [8], or [11]) that individuals tend to over-weight bad or disappointing outcomes, relative to the outcomes’ weights under expected utility. Recognizing aversion to disappointment means that disaster risks need not be nearly as large as suggested by the cross-country evidence for a rare disaster model to produce average equity premia and risk-free rates that match the data. I illustrate the interaction between disaster risk and disappointment aversion both analytically and in the context of a simple Rietz-like model of asset-pricing with rare disasters. I then analyze a richer model, in the spirit of Barro [4], with a distribution of disaster sizes, Epstein-Zin preferences, and partial default (in the event of a disaster) on the economy’s ‘risk-free’ asset. For small elasticities of intertemporal substitution, the model is able to match almost exactly the means and standard deviations of the equity return and risk-free rate, for disaster risks one-half or one-fourth the estimated sizes from Barro [4]. For larger elasticities of intertemporal substitution, the model’s fit is less satisfactory, though it fails in a direction not often viewed as problematic—it under-predicts the volatility of the risk-free rate. Even so, apart from that failing, the results are broadly similar to those obtained by Gourio [16], but with disaster risks one-half or one-fourth as large.

DOI: https://doi.org/10.24149/wp1309

No. 1308
A Closer Look at Potential Distortions in State RGDP: The Case of the Texas Energy Sector
Keith Phillips, Raul Hernandez and Benjamin Scheiner
Published as: Phillips, Keith, Raul Hernandez and Benjamin Scheiner (2014), "A Closer Look at Potential Distortions in State Real Gross Domestic Product: the Case of the Texas Energy Sector," Journal of Economic and Social Measurement 39 (1-2): 105-119.
Abstract: Surprisingly, from 1997 to 2010 Texas RGDP in oil and gas extraction was strongly negatively correlated with oil prices and with factors of production such as employment and the drilling rig count. It also had a slight negative correlation with physical production of oil and gas. In Texas the oil and gas sector is large and volatile enough to have a significant influence on overall RGDP growth so that when oil prices spike up (down) Texas RGDP generally weakens (strengths), which is in contrast to other indicators such as state job growth and real personal income. In this paper we investigate several potential sources of why RGDP in oil and gas extraction has a negative correlation with factors of production and units of output. We then use several different approximations of RGDP in oil and gas extraction to see which seems to be a good substitute for the current estimates produced by the BEA. We find that a measure based on changes in Texas physical production of oil and gas results in an estimate of total state RGDP that is more highly correlated with Texas job growth and closer to the correlation of these measures nationally.

DOI: https://doi.org/10.24149/wp1308

No. 1307
Tobin LIVES: Integrating Evolving Credit Market Architecture into Flow of Funds Based Macro-models
John Duca and John Muellbauer
Published as: Duca, John and John Muellbauer (2014), "Tobin LIVES: Integrating Evolving Credit Market Architecture into Flow of Funds Based Macro-models," in A Flow of Funds Perspective on the Financial Crisis, Volume II: Macroeconomic Imbalances and Risks to Financial Stability, ed. Bernard Winkler, Ad van Riet and Peter Bull (New York: Palgrave MacMillian), 11-39.
Abstract: After the global financial crisis, there is greater awareness of the need to understand the interactions between the financial sector and the real economy and hence the potential for financial instability. Data from the financial flow of funds, previously relatively neglected, are now seen as crucial to the data monitoring carried out by central banks. This paper revisits earlier efforts to understand financial-real linkages, such those of Tobin and the Yale School, and proposes a modeling framework for analysing the household flow of funds jointly with consumption. The consumption function incorporates household income, portfolios of assets and debt held at the end of the previous period, credit availability, and asset prices and interest rates. In a general equilibrium setting, these all have to be endogenised and since households make consumption and housing purchase decisions jointly with portfolio decisions, there is much to be gained in modeling a household sub-system of equations. Major evolutionary structural change – namely the evolving credit architecture facing households – is handled by our ‘Latent Interactive Variable Equation System’. A by-product is improved understanding of the secular decline in US saving rate, as well as of the household financial accelerator. Moreover, the models discussed in this paper offer new ways of interpreting data on credit, money and asset prices, which are crucial for central banks.

DOI: https://doi.org/10.24149/wp1307

No. 1306
Immigrants in the U.S. Labor Market
Pia M. Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2014), "Immigrants in the U.S. Labor Market," in Undecided Nation: Political Gridlock and the Immigration Crisis, ed. Tony Payan and Erika de la Garza (Switzerland: Springer), 189-207.
Abstract: Immigrants supply skills that are in relatively short supply in the U.S. labor market and account for almost half of labor force growth since the mid-1990s. Migrant inflows have been concentrated at the low and high ends of the skill distribution. Large-scale unauthorized immigration has fueled growth of the low-skill labor force, which has had modest adverse fiscal and labor market effects on taxpayers and U.S.-born workers. High-skilled immigration has been beneficial in most every way, fueling innovation and spurring entrepreneurship in the high tech sector. Highly skilled immigrants have had a positive fiscal impact, contributing more in tax payments than they use in public services. Immigration reform appears to be on the horizon, and policies such as a legalization initiative, a guest-worker program and more permanent visas for high-skilled workers would likely be an improvement over the status quo.

DOI: https://doi.org/10.24149/wp1306

No. 1305
Spurious Seasonal Patterns and Excess Smoothness in the BLS Local Area Unemployment
Keith R. Phillips and Jianguo Wang
Published as: Phillips, Keith and Jianguo Wang (2014), "A note on spurious seasonal patterns and other distortions in the BLS local area unemployment statistics," Journal of Economic and Social Measurement 39 (3): 145-152.
Abstract: State level unemployment statistics are some of the most important and widely used data sources for local analysts and public officials to gauge the health of their state’s economy. We find statistically significant seasonal patterns in the state level seasonally adjusted Local Area Unemployment Statistics (LAUS) released by the U.S. Bureau of Labor Statistics (BLS). We find that the pro-rata factors used in the benchmarking process can invoke spurious seasonal patterns in this data. We also find that the Henderson 13 filter used by the BLS to smooth the seasonally adjusted data may reduce monthly volatility too much in the sense that the aggregated state data is much smoother than the independently estimated national data. To reduce these problems, we suggest that the BLS use seasonally adjusted data when benchmarking regions to national totals.

DOI: https://doi.org/10.24149/wp1305

No. 1304
Monetary Policy, the Tax Code, and the Real Effects of Energy Shocks
William T. Gavin, Benjamin D. Keen and Finn E. Kydland
Published as: Gavin, William T., Benjamin D. Keen and Finn E. Kydland (2015), "Monetary Policy, the Tax Code, and the Real Effects of Energy Shocks," Review of Economic Dynamics 18 (3): 694-707.
Abstract: This paper develops a monetary model with taxes to account for the apparently asymmetric and time-varying effects of energy shocks on output and hours worked in post-World War II U.S. data. In our model, the real effects of an energy shock are amplified when the monetary authority responds to that shock by changing its inflation objective. Specifically, higher inflation raises households’ nominal capital gains taxes since those taxes are not indexed to inflation. The increase in taxes behaves as a negative wealth effect and generates an immediate decline in output, investment, and hours worked. The large drop in investment then causes a gradual but very persistent decline in the capital stock. That protracted decline in the capital stock is associated with an extended period of low productivity growth and high inflation. Those real effects from the increase in nominal capital gains taxes are magnified by the tax on nominal interest income, which is also not indexed to inflation. A prolonged period of higher inflation and lower productivity growth following a negative energy shock is consistent with the stagflation of the 1970s. The negative effects, however, subsided greatly after 1980 because the Volcker disinflation policy prevented the Fed from accommodating negative energy shocks with higher inflation.

DOI: https://doi.org/10.24149/wp1304

No. 1303
The Long–run Macroeconomic Impacts of Fuel Subsidies
Michael Plante
Published as: Plante, Michael (2014), "The Long–run Macroeconomic Impacts of Fuel Subsidies,” Journal of Development Economics 107: 129-143. https://doi.org/10.1016/j.jdeveco.2013.11.008.
Abstract: Many developing and emerging market countries have subsidies on fuel products. Using a small open economy model with a non-traded sector I show how these subsidies impact the steady state levels of macroeconomic aggregates such as consumption, labor supply, and aggregate welfare. These subsidies can lead to crowding out of non-oil consumption, inefficient inter-sectoral allocations of labor, and other distortions in macroeconomic variables. Across steady states aggregate welfare is reduced by these subsidies. This result holds for a country with no oil production and for a net exporter of oil. The distortions in relative prices introduced by the subsidy create most of the welfare losses. How the subsidy is financed is of secondary importance. Aggregate welfare is significantly higher if the subsidies are replaced by lump-sum transfers of equal value.

DOI: https://doi.org/10.24149/wp1303

No. 1302
The Prospect of Higher Taxes and Weak Job Growth During the Recovery from The Great Recession: Macro versus Micro Frisch Elasticities
Carlos E.J.M. Zarazaga
Abstract: Labor input growth during the recovery of the U.S. economy from the Great Recession of 2008–2009 has been considerably lower than expected. A number of scholars have attributed this disappointing outcome to the prospect of higher taxes, induced by the fiscal imbalances that will materialize in coming decades under current policies. The paper examines this fiscal sentiment hypothesis from the perspective of a neoclassical growth model, under the assumption that the typical household's preferences can be represented by a utility function that implies a constant intertemporal (Frisch) elasticity of substitution for aggregate hours of work, and for a hypothetical tax regime that incorporates the Congressional Budget Office's assessment of the U.S. fiscal situation. The paper finds that the empirical relevance of the fiscal sentiment hypothesis depends on whether this Frisch elasticity of labor supply is closer to the relatively large values needed to account for the observed volatility of labor input at business cycle frequencies, than to the lower values estimated by microeconomic and quasi–experimental studies.

DOI: https://doi.org/10.24149/wp1302

No. 1301
Fiscal Sentiment and the Weak Recovery from the Great Recession: A Quantitative Exploration
Finn E. Kydland and Carlos E. J. M. Zarazaga
Abstract: The U.S. economy isn't recovering from the deep Great Recession of 2008–2009 with the strength predicted by models that incorporate a variety of shocks and frictions in the basic analytical framework of the neoclassical growth model. It has been argued that the counterfactual predictions shouldn't be attributed to inherent features of that framework, but to the omission from the analysis of the prospects of an imminent switch to a higher taxes regime prompted by the unprecedented fiscal challenges faced by the U.S. economy in peacetime. The paper explores quantitatively this fiscal sentiment hypothesis. The main finding is that the hypothesis can account for a substantial fraction of the decline in investment and labor input in the aftermath of the Great Recession, relative to their pre–recession trends. These results require, however, a qualification: The perceived higher taxes must fall almost exclusively on capital income.

DOI: https://doi.org/10.24149/wp1301

Globalization Institute Working Papers

Globalization Institute No. 166
Database of Global Economic Indicators (DGEI): A Methodological Note
Valerie Grossman, Adrienne Mack and Enrique Martínez-García
Published as: Valerie Grossman, Adrienne Mack and Enrique Martínez-García (2014), "A New Database of Global Economic Indicators," Journal of Economics and Social Measurement 39 (3): 163-197.
Abstract: The Database of Global Economic Indicators (DGEI) from the Federal Reserve Bank of Dallas is aimed at standardizing and disseminating world economic indicators for policy analysis and scholarly work on the role of globalization. The purpose of DGEI is to offer a broad perspective on how economic developments around the world influence the U.S. economy with a wide selection of indicators. DGEI is automated within an Excel-VBA and E-views framework for the processing and aggregation of multiple country time series. It includes a core sample of 40 countries with available indicators and broad coverage. Country groupings include rest of the world (ex. the U.S.) aggregates and subgroups of countries by development attainment and trade openness. The indicators currently tracked include real GDP, industrial production (IP), Purchasing Managers’ Index (PMI), merchandise exports and imports, headline CPI, CPI (ex. food and energy), PPI/WPI inflation, nominal and real exchange rates, and official/policy interest rates. All series are monthly, with the exception of real GDP which is reported at a quarterly frequency. Aggregation is based on trade shares with the U.S. The Globalization and Monetary Policy Institute publishes the aggregate indicators as well as additional country detail on its website with an accompanying slideshow on Global Economic Conditions. This note provides a technical description of the methodology implemented to construct the DGEI.

DOI: https://doi.org/10.24149/gwp166

Globalization Institute No. 165
Monitoring Housing Markets for Episodes of Exuberance: An Application of the Phillips et al. (2012, 2013) GSADF Test on the Dallas Fed International House Price Database
Efthymios Pavlidis, Alisa Yusupova, Ivan Paya, David Peel, Enrique Martínez-García, Adrienne Mack and Valerie Grossman
Abstract: The detection of explosive behavior in house prices and the implementation of early warning diagnosis tests are of great importance for policy-making. This paper applies the GSADF test developed by Phillips et al. (2012) and Phillips et al. (2013), a novel procedure for testing, detection and date-stamping of explosive behavior, to the data from the Dallas Fed International House Price Database documented in Mack and Martínez-García (2011). We discuss the use of the GSADF test to monitor international housing markets. We assess the international boom and bust cycle experienced during the past 15 years through this lens— with special attention to the United States, the United Kingdom, and Spain. Our empirical results suggest that these three countries experienced a period of exuberance in housing prices during the late 90s and the first half of the 2000s that cannot be attributed solely to the behavior of fundamentals. Looking at all 22 countries covered in the International House Price Database, we detect a pattern of synchronized explosive behavior during the last international house boom-bust episode not seen before.

DOI: https://doi.org/10.24149/gwp165

Globalization Institute No. 162
Debt, Inflation and Growth Robust Estimation of Long-Run Effects in Dynamic Panel Data Models
Alexander Chudik, Kamiar Mohaddes, Hashem Pesaran and Mehdi Raissi
Abstract: This paper investigates the long-run effects of public debt and inflation on economic growth. Our contribution is both theoretical and empirical. On the theoretical side, we develop a cross-sectionally augmented distributed lag (CS-DL) approach to the estimation of long-run effects in dynamic heterogeneous panel data models with cross-sectionally dependent errors. The relative merits of the CS-DL approach and other existing approaches in the literature are discussed and illustrated with small sample evidence obtained by means of Monte Carlo simulations. On the empirical side, using data on a sample of 40 countries over the 1965-2010 period, we find significant negative long-run effects of public debt and inflation on growth. Our results indicate that, if the debt to GDP ratio is raised and this increase turns out to be permanent, then it will have negative effects on economic growth in the long run. But if the increase is temporary then there are no long-run growth effects so long as debt to GDP is brought back to its normal level. We do not find a universally applicable threshold effect in the relationship between public debt and growth. We only find statistically significant threshold effects in the case of countries with rising debt to GDP ratios.

DOI: https://doi.org/10.24149/gwp162

Globalization Institute No. 160
U.S. Business Cycles, Monetary Policy and the External Finance Premium
Enrique Martínez-García
Published as: Martínez-García, Enrique (2014), "U.S. Business Cycles, Monetary Policy and the External Finance Premium," in Advances in Non-linear Economic Modeling: Theory and Applications, ed. Frauke Schleer-van Gellecom (Berlin: Springer), 41-114.
Abstract: I investigate a model of the U.S. economy with nominal rigidities and a financial accelerator mechanism à la Bernanke et al. (1999). I calculate total factor productivity and monetary policy deviations for the U.S. and quantitatively explore the ability of the model to account for the cyclical patterns of GDP (excluding government), investment, consumption, the share of hours worked, inflation and the quarterly interest rate spread between the Baa corporate bond yield and the 20-year Treasury bill rate during the Great Moderation. I show that the magnitude and cyclicality of the external finance premium depend nonlinearly on the degree of price stickiness (or lack thereof) in the Bernanke et al. (1999) model and on the specification of both the target Taylor (1993) rate for policy and the exogenous monetary shock process. The strong countercyclicality of the external finance premium induces substitution away from consumption and into investment in periods where output grows above its long-run trend as the premium tends to fall below its steady state and financing investment becomes temporarily cheaper. The less frequently prices change in this environment, the more accentuated the fluctuations of the external finance premium are and the more dominant they become on the dynamics of investment, hours worked and output. However, these features—the countercyclicality and large volatility of the spread—are counterfactual and appear to be a key impediment limiting the ability of the model to account for the U.S. data over the Great Moderation period.

DOI: https://doi.org/10.24149/gwp160

Globalization Institute No. 153
Large Panel Data Models with Cross-Sectional Dependence: A Survey
Alexander Chudik and M. Hashem Pesaran
Published as: Chudik, Alexander and M. Hashem Pesaran (2015), "Large Panel Data Models with Cross-Sectional Dependence: A Survey," in The Oxford Handbook of Panel Data, ed. Badi H. Baltagi (New York: Oxford University Press), 3-45.
Abstract: This paper provides an overview of the recent literature on estimation and inference in large panel data models with cross-sectional dependence. It reviews panel data models with strictly exogenous regressors as well as dynamic models with weakly exogenous regressors. The paper begins with a review of the concepts of weak and strong cross-sectional dependence, and discusses the exponent of cross-sectional dependence that characterizes the different degrees of cross-sectional dependence. It considers a number of alternative estimators for static and dynamic panel data models, distinguishing between factor and spatial models of cross-sectional dependence. The paper also provides an overview of tests of independence and weak cross-sectional dependence.

DOI: https://doi.org/10.24149/gwp153

Globalization Institute No. 146
Common Correlated Effects Estimation of Heterogeneous Dynamic Panel Data Models with Weakly Exogenous Regressors
Supplement
Alexander Chudik and M. Hashem Pesaran
Published as: Chudik, Alexander and M. Hashem Pesaran (2015), "Common Correlated Effects Estimation of Heterogeneous Dynamic Panel Data Models with Weakly Exogenous Regressors," Journal of Econometrics 188 (2): 393-420.
Abstract: This paper extends the Common Correlated Effects (CCE) approach developed by Pesaran (2006) to heterogeneous panel data models with lagged dependent variable and/or weakly exogenous regressors. We show that the CCE mean group estimator continues to be valid but the following two conditions must be satisfied to deal with the dynamics: a sufficient number of lags of cross section averages must be included in individual equations of the panel, and the number of cross section averages must be at least as large as the number of unobserved common factors. We establish consistency rates, derive the asymptotic distribution, suggest using co-variates to deal with the effects of multiple unobserved common factors, and consider jackknife and recursive de-meaning bias correction procedures to mitigate the small sample time series bias. Theoretical findings are accompanied by extensive Monte Carlo experiments, which show that the proposed estimators perform well so long as the time series dimension of the panel is sufficiently large.

DOI: https://doi.org/10.24149/gwp146

Globalization Institute No. 139
Trade Barriers and the Relative Price Tradables
Michael Sposi
Published as: Sposi, Michael (2015), "Trade Barriers and the Relative Price of Tradables," Journal of International Economics 92 (2): 398-411.
Abstract: In this paper I quantitatively address the role of trade barriers in explaining why prices of services relative to tradables are positively correlated with levels of development across countries. I argue that trade barriers play a crucial role in shaping the cross-country pattern of specialization across many heterogenous tradable goods. The pattern of specialization feeds into cross-country productivity differences in the tradables sector and is reflected in the relative price of services. I show that the existing pattern of specialization implies that the tradables-sector productivity gap between rich and poor countries is more than 80 percent larger than it would be under free trade. In turn, removing trade barriers would eliminate 64 percent of the disparity in the relative price of services between rich and poor countries, without systematically altering the cross-country pattern of the absolute price of tradables.

DOI: https://doi.org/10.24149/gwp139

Globalization Institute No. 138
Spatial Considerations on the PPP Debate
Michele Ca'Zorzi and Alexander Chudik
Abstract: This paper studies the influence of aggregating across space when (i) testing the PPP theory or more generally pair-wise cointegration and (ii) evaluating the PPP puzzle. Our contribution is threefold: we show that aggregating foreign data and applying an ADF test may lead to erroneously reject the PPP hypothesis. We then show, on the basis of theoretical arguments as well as Monte Carlo experiments, that a sizable bias in the estimates of half-life deviations to PPP may be due to the effect of aggregation across space. We finally illustrate empirically the importance of spatial considerations when estimating the speed of price convergence among euro area countries.

DOI: https://doi.org/10.24149/gwp138

Globalization Institute No. 137
Distribution Capital and the Short- and Long-Run Import Demand Elasticity
Mario J. Crucini and J. Scott Davis
Published as: Crucini, Mario J. and J. Scott Davis (2016), "Distribution Capital and the Short- and Long-Run Import Demand Elasticity," Journal of International Economics 100: 203-219.
Abstract: International business-cycle models assume that home and foreign goods are poor substitutes. International trade models assume they are close substitutes. This paper constructs a model where this discrepancy is due to frictions in distribution. Imports need to be combined with a local non-traded input, distribution capital, which is slow to adjust. As a result, imported and domestic goods appear as poor substitutes in the short run. In the long run this non-traded input can be reallocated, and quantities can shift following a change in relative prices. Thus the observed substitutability between home and foreign goods gets larger as time passes.

DOI: https://doi.org/10.24149/gwp137

Globalization Institute No. 136
The GVAR Approach and the Dominance of the U.S. Economy
Alexander Chudik and Vanessa Smith
Abstract: This paper extends the recent literature about global macroeconomic modelling by allowing the presence of a globally dominant economy. Our contribution is both theoretical and empirical. From a theoretical standpoint, we follow Chudik and Pesaran (2011 and 2012) to derive the GVAR approach as an approximation to two Infinite-Dimensional VAR (IVAR) models featuring nonstationary variables: one corresponding to the world consisting of several small open economies (benchmark model), and one corresponding to the world featuring a dominant economy (extended model). It is established that in the presence of a dominant economy, restrictions implied by the asymptotic analysis of a system without a dominant economy are no longer valid. The theoretical framework is then brought to the data by estimating both versions of the GVAR model featuring 33 countries for the period 1979(Q2)–2003(Q4). We found some support for the extended version of the GVAR model, allowing the US to be the dominant player in the world economy.

DOI: https://doi.org/10.24149/gwp136

Globalization Institute No. 135
International Trade Price Stickiness and Exchange Rate Pass-through in Micro Data: A Case Study on U.S.–China Trade
Mina Kim, Deokwoo Nam, Jian Wang and Jason Wu
Abstract: Price-setting behavior of exporters and exchange rate pass-through (ERPT) are crucial issues in international macroeconomics. This paper studies these topics, using a novel dataset of goods-level US-China trade prices collected by the US Bureau of Labor Statistics. We document that the duration of U.S.–China trade prices has declined almost 30 percent since China began appreciating its currency in 2005. A benchmark menu cost model that is calibrated to the data can replicate the documented decrease in price stickiness. We also estimate ERPT of RMB appreciation into U.S. import prices between 2005 and 2008. The lifelong ERPT is close to one for prices that have at least one change, while the pass-through is less than half when all goods are included. The difference in pass-through rates is a result of about one third of the goods never experiencing a price change.

DOI: https://doi.org/10.24149/gwp135

No. 1206
Has Income Inequality or Media Fragmentation Increased Political Polarization?
John V. Duca and Jason Saving
Published as: Duca, John V. and Jason L. Saving (2017), "Has Income Inequality or Media Fragmentation Increased Political Polarization," Contemporary Economic Policy 35 (2): 392-413.
Abstract: The increasing polarization of Congressional voting patterns has been attributed to factors including generational shifts, economic conditions, increased media fragmentation, and greater income inequality. The first of these factors is difficult to test with time series data owing to the low frequency of generational shifts, while the tendency of business cycles to reverse suggests that economic cycles are unable to account for long-term shifts in polarization. This leaves two main possible long-run drivers: the increasingly fragmented state of American media as stressed by Prior (2005, 2007) and Duca and Saving (2012a), and increased income inequality, as emphasized by McCarty, Poole, and Rosenthal (2006, forthcoming) and Stiglitz (2012).

Using statistical techniques suitable for analyzing variables with shifting long-run averages we find evidence indicating that media fragmentation has played a more important role than inequality, at least as tracked by available data and measures. Periods when the share of Americans with access to cable or satellite TV has risen are followed by upward shifts in polarization. Furthermore, our results suggest that the polarization arising from media fragmentation or inequality may make it more difficult to achieve the political consensus needed to address major challenges, such as the long-run fiscal imbalances facing the United States.

No. 1205
Campbell and Cochrane meet Melino and Yang: Reverse Engineering the Surplus Ratio in a Mehra–Prescott Economy
Jim Dolmas
Abstract: The habit model of Campbell and Cochrane (1999) specifies a process for the 'surplus ratio'—the excess of consumption over habit, relative to consumption—rather than an evolution for the habit stock. It's not immediately apparent if their formulation can be accommodated within the Markov chain framework of Mehra and Prescott (1985). This note illustrates one way to create a Campbell and Cochrane-like model within the Mehra–Prescott framework. A consequence is that we can perform another sort of reverse-engineering exercize-we can calibrate the resulting model to match the stochastic discount factor derived in the Mehra–Prescott framework by Melino and Yang (2003). The Melino–Yang SDF, combined with Mehra and Prescott's consumption process, yields asset returns that exactly match the first and second moments of the data, as estimated by Mehra and Prescott.

A byproduct of the exercize is an equivalent (in terms of SDFs) representation of Campbell–Cochrane preferences as a state-dependent version of standard time-additively-separable, constant relative risk aversion preferences. When calibrated to exactly match the asset return data, both the utility discount factor and the coefficient of relative risk aversion vary with the Markov state. Not surprisingly, our Campbell–Cochrane preferences are equivalent to a state-dependent representation with strongly countercyclical risk aversion. Less expected is the equivalent utility discount factor-it is uniformly greater than one, and countercyclical. In their analysis, Melino and Yang ruled out state-dependent specifications where the utility discount factor exceeds one. Our model gives one plausible rationalization for such a specification.

No. 1204
Reentering Asset Poverty after an Exit: Evidence from the PSID
Tammy Leonard and Wenhua Di
Published as: Leonard, Tammy and Wenhua Di (2014), "Is Household Wealth Sustainable? An Examination of Asset Poverty Reentry After an Exit," Journal of Family and Economic Issues 35 (2): 131-144.
Abstract: In order to be successful at improving household's financial self‐sufficiency and stability, asset‐building policies must be designed to prevent households from falling back into asset poverty once they exit it. This paper uses the Panel Study of Income Dynamics data from 1994 to 2007 to analyze the influence of life events, demographics and financial behaviors on the duration out of asset poverty. We find evidence that suggests there are structural barriers to asset acquisition. Asset accumulation at levels equal to nine months worth of income at the income poverty level or greater is important for improving a family's odds of permanently escaping asset poverty. Additionally, minimizing debt and diversifying the asset portfolio to include more productive assets are important for maintaining assets. This paper provides some insights on policies to help individuals more successfully transition out of asset poverty.

No. 1203
PCE Inflation and Core Inflation
Julie K. Smith
Abstract: This paper investigates the forecasting accuracy of the trimmed mean inflation rate of the Personal Consumption Expenditure (PCE) deflator. Earlier works have examined the forecasting ability of limited-influence estimators (trimmed means and the weighted median) of the Consumer Price Index but none have compared the weighted median and trimmed mean of the PCE. Also addressed is the systematic bias that appears due to the differences in the means of inflation measures over the sample. This paper supports earlier results that limited-influence estimators provide better forecasts of future inflation than does the popular measure of core inflation, PCE inflation minus food and energy; therefore, these limited-influence estimators are core inflation.

No. 1202
How Should Monetary Policy Respond to Changes in the Relative Price of Oil? Considering Supply and Demand Shocks
Michael Plante
Published as: Plante, Michael (2014), "How Should Monetary Policy Respond to Changes in the Relative Price of Oil? Considering Supply and Demand Shocks,” Journal of Economic Dynamics and Control 44: 1-19. https://doi.org/10.1016/j.jedc.2014.04.002.
Abstract: This paper examines optimal monetary policy in a New Keynesian model, where the relative price of oil is affected by exogenous supply shocks and a productivity-driven demand shock. When wages are flexible, stabilizing core inflation is optimal and the nominal rate rises (falls) in response to a demand (supply) shock. When both prices and wages are sticky, core inflation falls (rises) in response to the demand (supply) shock. Stabilizing CPI inflation generates small welfare losses only if the demand shock is the main driver of oil prices. Based on a VAR estimated using post-1986 data for the U.S., both shocks have had minimal impacts on core inflation. The federal funds rate rises in response to the demand shock but falls in response to the supply shock, consistent with the predictions of the theoretical model for a policy that stabilizes core inflation.

No. 1201
Time-Varying Oil Price Volatility and Macroeconomic Aggregates
Michael Plante and Nora Traum
Abstract: We illustrate the theoretical relation among output, consumption, investment, and oil price volatility in a real business-cycle model. The model incorporates demand for oil by a firm, as an intermediate input, and by a household, used in conjunction with a durable good. We estimate a stochastic volatility process for the real price of oil over the period 1986–2011 and utilize the estimated process in a nonlinear approximation of the model. For realistic calibrations, an increase in oil price volatility produces a temporary decrease in durable spending, while precautionary savings motives lead investment and real GDP to rise. Irreversible capital and durable investment decisions do not overturn this result.

Globalization Institute Working Papers

Globalization Institute No. 134
The Effect of Commodity Price Shocks on Underlying Inflation: The Role of Central Bank Credibility 
J. Scott Davis
Abstract: This paper seeks to document and explain the effect of a commodity price shock on underlying core inflation, and how that effect changes both across time and across countries. Impulse responses derived from a structural VAR model show that across many countries there was a break in the response of core inflation to a commodity price shock. In an earlier period, a shock to commodity prices would lead to a large and significant increase in core inflation, but in later periods, the effect was insignificant. To explain this, we construct a large-scale DSGE model with both headline and core inflation, and most significantly, a mechanism whereby fluctuations in inflation caused by purely transitory shocks can become incorporated into long-term inflation expectations. Inflation has a trend and a cyclical component. Private agents cannot distinguish between the two, so a cyclical fluctuation in inflation may be confused for a shift in the trend component. Bayesian estimation reveals that there was a change between the earlier and the later periods in the parameter that governs the anchoring of expectations. Impulse responses derived from simulations of the model show that this change in the effect of commodity prices on core inflation is driven by the change in the anchoring of inflation expectations.

Globalization Institute No. 132
IKEA: Product, Pricing, and Pass-Through 
Marianne Baxter and Anthony Landry
Abstract: With over 300 stores in 40 countries, IKEA is a major international presence in retail housewares and furnishings. IKEA publishes country-specific catalogs with local-currency prices guaranteed to hold for 1 year. This paper explores a new dataset of IKEA products and catalog prices covering six countries for the time period 1994–2010. The dataset, with over 140,000 observations, is uniquely poised to shed light on the way in which a large multinational retailer operates in a setting characterized by a very large number of goods, distributed and priced in many countries. Thus, the goal of this paper is to document the choices made by IKEA in several related decision areas. In doing so, this paper provides evidence against which existing theories can be evaluated and revised in the light of this new information.

Globalization Institute No. 131
Core Import Price Inflation in the United States 
Janet Koech and Mark A. Wynne
Published as: Koech, Janet and Mark A. Wynne (2013), "Core Import Price Inflation in the United States," Open Economies Review 24 (4): 717-730.
Abstract: The cross-section distribution of U.S. import prices exhibits some of the fat-tailed characteristics that are well documented for the cross-section distribution of U.S. consumer prices. This suggests that limited-influence estimators of core import price inflation might outperform headline or traditional measures of core import price inflation. We examine whether limited influence estimators of core import price inflation help forecast overall import price inflation. They do not. However, limited influence estimators of core import price inflation do seem to have some predictive power for headline consumer price inflation in the medium term.

Globalization Institute No. 129
Price Equalization Does Not Imply Free Trade 
Piyusha Mutreja, B. Ravikumar, Raymond Riezman and Michael Sposi
Published as: Mutreja, Piyusha, B. Ravikumar, Raymond Riezman and Michael Sposi (2015), "Price Equalization Does Not Imply Free Trade," Federal Reserve Bank of St. Louis Review 97 (4): 323-339.
Published as: Mutreja, Piyusha, B. Ravikumar, Raymond Riezman and Michael Sposi (2014), "Price Equalization, Trade Flows, and Barriers to Trade," European Economic Review 70: 383-398.
Abstract: In this paper we show that price equalization alone is not sufficient to establish that there are no barriers to international trade. There are many barrier combinations that deliver price equalization, but each combination implies a different volume of trade. Therefore, in order to make statements about trade barriers it is necessary to know the trade flows. We demonstrate this first theoretically in a simple two-country model. We then extend the result quantitatively to a multicountry model with two sectors. We show that for the case of capital goods trade, barriers have to be large in order to be consistent with the observed trade flows. Our model also implies that capital goods prices look similar across countries, an implication that is consistent with data. Zero barriers to trade in capital goods will deliver price equalization in capital goods, but cannot reproduce the observed trade flows in our model.

Globalization Institute No. 123
Global Slack as a Determinant of U.S. Inflation 
Enrique Martínez-García and Mark A. Wynne
Abstract: Resource utilization, or "slack," is widely held to be an important determinant of inflation dynamics. As the world has become more globalized in recent decades, some have argued that the concept of slack that is relevant is global rather than domestic (the "global slack hypothesis"). This line of argument is consistent with standard New Keynesian theory. However, the empirical evidence is fragile, at best, possibly because of a disconnect between empirical and theory-consistent measures of output gaps.

Globalization Institute No. 119
Modelling Global Trade Flows: Results from a GVAR Model 
Matthieu Bussière, Alexander Chudik and Giulia Sestieri
Abstract: This paper uses a Global Vector Auto-Regression (GVAR) model featuring 21 emerging market and advanced economies to investigate the factors behind the dynamics of global trade flows, with a particular view on the issue of global trade imbalances and on the conditions of their unwinding. The GVAR approach enables us to make two key contributions: first, to model international linkages among a large number of countries, which is a key asset given the diversity of countries and regions involved in global imbalances, and second, to model exports and imports jointly. The latter proves to be very important due to the internationalization of production chains. The model can be used to gauge the effect on trade flows of various scenarios, such as an output shock in the United States, a shock to the US real effective exchange rate and shocks to foreign (e.g., German and Chinese) variables. Results indicate that changes in domestic and foreign demand have a much stronger effect on trade flows than changes in relative trade prices. In addition, we show how the model can be used to monitor trade developments, with an application to the Great Trade Collapse.

Globalization Institute No. 117
Central Bank Credibility and the Persistence of Inflation and Inflation Expectations
J. Scott Davis
Abstract: This paper introduces a model where agents are unsure about the central bank's inflation target. They believe that the central bank's inflation target could lie between two extremes, and their beliefs vary depending on the central bank's stock of credibility. They form the expectations used in price and wage setting using this perceived inflation target, and they use past observations of inflation to update their beliefs about the credibility of the central bank. Thus a series of high inflation observations can lead them to believe (incorrectly) that the central bank has adopted a high target. High inflation expectations are incorporated into price and wage setting decisions, and a transitory shock to inflation can become very persistent. The model with endogenous credibility can match the volatility and persistence of both inflation and measures of long-term inflation expectations that we see in the data. The model is then calibrated to match the observed levels of Federal Reserve credibility in the 1980s and the 2000s. By simply changing the level of credibility, holding all else fixed, the model can explain nearly all of the observed changes in the volatility and persistence of inflation and inflation expectations in the U.S. from the 1980s to today.

Globalization Institute No. 114
Are Predictable Improvements in TFP Contractionary or Expansionary: Implications from Sectoral TFP?
Deokwoo Nam and Jian Wang
Published as: Nam, Deokwoo and Jian Wang (2014), "Are Predictable Improvements in TFP Contractionary or Expansionary: Implications from Sectoral TFP?" Economics Letters 124 (2): 171-175.
Abstract: We document in the US data: (1) The dominant predictable component of investment-sector TFP is its long-run movements, and a favorable shock to predictable changes in investmentsector TFP induces a broad economic boom that leads actual increases in investment-sector TFP by almost two years, and (2) predictable changes in consumption-sector TFP occur mainly at short forecast horizons, and a favorable shock to such predictable changes leads to immediate reductions in hours worked, investment, and output as well as an immediate rise in consumption-sector TFP. We argue that these documented differences in the responses to shocks to predictable sectoral TFP changes can reconcile the seemingly contradictory findings in Beaudry and Portier (2006) and Barsky and Sims (2011), whose analyses are based on aggregate TFP measures. In addition, we find that shocks to predictable changes in investment-sector TFP account for 50% of business cycle fluctuations in consumption, hours, investment, and output, while shocks to predictable changes in consumption-sector TFP explain only a small fraction of business cycle fluctuations of these aggregate variables.

Globalization Institute No. 112
A Simple Model of Price Dispersion
Alexander Chudik
Published as: Chudik, Alexander (2012), "A Simple Model of Price Dispersion," Economics Letters 117 (1): 344-347.
Abstract: This article considers a simple stock-flow matching model with fully informed market participants. Unlike in the standard matching literature, prices are assumed to be set ex-ante. When sellers pre-commit themselves to sell their products at an advertised price, the unique equilibrium is characterized by price dispersion due to the idiosyncratic match payoffs (in a marketplace with full information). This provides new insights into the price dispersion literature, where price dispersion is commonly assumed to be generated by a costly search of uninformed buyers.

Globalization Institute No. 111
The Perils of Aggregating Foreign Variables in Panel Data Models
Michele Ca' Zorzi, Alexander Chudik and Alistair Dieppe
Abstract: The curse of dimensionality refers to the difficulty of including all relevant variables in empirical applications due to the lack of sufficient degrees of freedom. A common solution to alleviate the problem in the context of open economy models is to aggregate foreign variables by constructing trade-weighted cross-sectional averages. This paper provides two key contributions in the context of static panel data models. The first is to show under what conditions the aggregation of foreign variables (AFV) leads to consistent estimates (as the time dimension T is fixed and the cross section dimension N → ∞). The second is to design a formal test to assess the admissibility of the AFV restriction and to evaluate the small sample properties of the test by undertaking Monte Carlo experiments. Finally, we illustrate an application in the context of the current account empirical literature where the AFV restriction is rejected.

Globalization Institute No. 108
Accounting for Real Exchange Rates Using Micro-Data
Mario J. Crucini and Anthony Landry
Abstract: The classical dichotomy predicts that all of the time series variance in the aggregate real exchange rate is accounted for by nontraded goods in the CPI basket because traded goods obey the Law of One Price. In stark contrast, Engel (1999) found that traded goods had comparable volatility to the aggregate real exchange. Our work reconciles these two views by successfully applying the classical dichotomy at the level of intermediate inputs into the production of final goods using highly disaggregated retail price data. Since the typical good found in the CPI basket is about equal parts traded and nontraded inputs, we conclude that the classical dichotomy applied to intermediate inputs restores its conceptual value.

Globalization Institute No. 107
Liquidity, Risk and the Global Transmission of the 2007–08 Financial Crisis and the 2010–11 Sovereign Debt Crisis
Alexander Chudik and Marcel Fratzscher
Abstract: The paper analyses the transmission of liquidity shocks and risk shocks to global financial markets. Using a Global VAR methodology, the findings reveal fundamental differences in the transmission strength and pattern between the 2007–08 financial crisis and the 2010–11 sovereign debt crisis. Unlike in the former crisis, emerging market economies have become much more resilient to adverse shocks in 2010–11. Moreover, a fight-to-safety phenomenon across asset classes has become particularly strong during the 2010–11 sovereign debt crisis, with risk shocks driving down bond yields in key advanced economies. The paper relates this evolving transmission pattern to portfolio choice decisions by investors and finds that countries' sovereign rating, quality of institutions and their financial exposure are determinants of cross-country differences in the transmission.

Globalization Institute No. 105
Bayesian Estimation of NOEM Models: Identification and Inference in Small Samples
Enrique Martínez-García, Diego Vilán and Mark Wynne
Published as: Martínez-García, Enrique, Diego Vilán and Mark A. Wynne (2012), "Bayesian Estimation of NOEM Models: Identification and Inference in Small Samples," in DSGE Models in Macroeconomics: Estimation, Evaluation, and New Development, ed. Nathan Balke, Fabio Canova, Fabio Milani and Mark A. Wynne (Bingley, UK: Emerald Group Publishing Limited), 137-199.
Abstract: The global slack hypothesis (e.g., Martínez-García and Wynne [2010]) is central to the discussion of the trade-offs monetary policy faces in an increasingly more open world economy. Open-Economy (forward-looking) New Keynesian Phillips curves describe how expected future inflation and a measure of global output gap (global slack) affect the current inflation rate. This paper studies the (potential) weak identification of these relationships in the context of a fully specified structural model using Bayesian estimation techniques. We trace the problems to sample size, rather than misspecification bias. We conclude that standard macroeconomic time series with a coverage of less than forty years are subject to potentially serious identification issues, and also to model selection errors. We recommend estimation with simulated data prior to bringing the model to the actual data as a way of detecting parameters that are susceptible to weak identification in short samples.

No. 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 em- pirically, the aggregation biases this heterogeneity implies and find these biases to be substantial.

No. 1111
Monetary Policy, Financial Stability, and the Distribution of Risk
Evan F. Koenig
Published as: Koenig, Evan F. (2013), "Like a Good Neighbor: Monetary Policy, Financial Stability, and the Distribution of Risk," International Journal of Central Banking 9 (2): 57-82.
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.

No. 1110
Financial Literacy and Mortgage Equity Withdrawals
John V. Duca and Anil Kumar
Published as: Duca, John V. and Anil Kumar (2014), "Financial Literacy and Mortgage Equity Withdrawals," Journal of Urban Economics 80: 62-75.
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.

No. 1109
Trends in Poverty and Inequality among Hispanics
Pia Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2014), "Trends in Poverty and Inequality among Hispanics," in The Economics of Inequality, Poverty, and Discrimination in the 21st Century, ed. Robert S. Rycroft (Santa Barbara, CA: Praeger), 217-235.
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.

No. 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.

No. 1107
The Impact of the Maquiladora Industry on U.S. Border Cities
Jesús Cañas, Roberto Coronado, Robert W. Gilmer and Eduardo Saucedo
Published as: Cañas, Jesus, Robert Coronado, Robert W. Gilmer and Eduardo Saucedo (2013), "The Impact of the Maquiladora Industry on U.S. Border Cities," Growth and Change 44 (3): 415-442.
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.

No. 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.

No. 1105
Did Residential Electricity Rates Fall After Retail Competition? A Dynamic Panel Analysis
Adam Swadley and Mine Yücel
Published as: Swadley, Adam and Mine Yücel (2011), "Did Residential Electricity Rates Fall After Retail Competition? A Dynamic Panel Analysis," Energy Policy 39 (12): 7702-7711.
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.

No. 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.

No. 1103
House Prices and Credit Constraints: Making Sense of the U.S. Experience
John V. Duca, John Muellbauer and Anthony Murphy
Published as: Duca, John V., John Muellbauer and Anthony Murphy (2011), "House Prices and Credit Constraints: Making Sense of the U.S. Experience," The Economic Journal 121 (552): 533-551.
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.

No. 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.

No. 1101
Did the Commercial Paper Funding Facility Prevent a Great Depression-Style Money Market Meltdown?
John V. Duca
Published as: Duca, John V. (2013), "Did the Commercial Paper Funding Facility Prevent a Great Depression-Style Money Market Meltdown?" Journal of Financial Stability 9 (4): 747-758.
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.

Globalization Institute Working Papers

Globalization Institute No. 103
Size, Openness, and Macroeconomic Interdependence
Alexander Chudik and Roland Straub
Abstract: The curse of dimensionality, a problem associated with analyzing the interaction of a relatively large number of endogenous macroeconomic variables, is a prevailing issue in the open economy macro literature. The most common practice to mitigate this problem is to apply the so-called Small Open Economy Framework (SOEF). In this paper, we aim to review under which conditions the SOEF is a justifiable approximation and how severe the consequences of violation of key conditions might be. Thereby, we use a multicountry general equilibrium model as a laboratory. First, we derive the conditions that ensure the existence of the equilibrium and study the properties of the equilibrium using large N asymptotics. Second, we show that the SOEF is a valid approximation only for economies (i) that have a diversified foreign trade structure and if (ii) there is no globally dominant economy in the system. Third, we illustrate that macroeconomic interdependence is primarily related to the degree of trade diversification, and not to the extent of trade openness. Furthermore, we provide some evidence on the pattern of global macroeconomic interdependence by calculating probability impulse response functions in our calibrated multicountry model using data for 153 economies.

Globalization Institute No. 102
How Have Global Shocks Impacted the Real Effective Exchange Rates of Individual Euro Area Countries Since the Euro's Creation?
Matthieu Bussiere, Alexander Chudik and Arnaud Mehl
Published as: Bussiere, Matthieu, Alexander Chudik and Arnaud Mehl (2013), "How Have Global Shocks Impacted the Real Effective Exchange Rates of Individual Euro Area Countries Since the Euro's Creation?" The B.E. Journal of Macroeconomics 13 (1): 1-48.
Abstract: This paper uncovers the response pattern to global shocks of euro area countries' real effective exchange rates before and after the start of Economic and Monetary Union (EMU), a largely open ended question when the euro was created. We apply to that end a newly developed methodology based on high dimensional VAR theory. This approach features a dominant unit to a large set of over 60 countries' real effective exchange rates and is based on the comparison of two estimated systems: one before and one after EMU. We find strong evidence that the pattern of responses depends crucially on the nature of global shocks. In particular, post-EMU responses to global US dollar shocks have become similar to Germany's response before EMU, i.e. to that of the economy that used to issue Europe's most credible legacy currency. By contrast, post-EMU responses of euro area countries to global risk aversion shocks have become similar to those of Italy, Portugal or Spain before EMU, i.e. of economies of the euro area's periphery. Our findings also suggest that the divergence in external competitiveness among euro area countries over the last decade, which is at the core of today's debate on the future of the euro area, is more likely due to country-specific shocks than to global shocks.

Globalization Institute No. 101
Aggregation in Large Dynamic Panels
M. Hashem Pesaran and Alexander Chudik
Published as: Pesaran, M. Hashem and Alexander Chudik (2014), "Aggregation in Large Dynamic Panels," Journal of Econometrics 178 (Part 2): 273-285.
Abstract: This paper investigates the problem of aggregation in the case of large linear dynamic panels, where each micro unit is potentially related to all other micro units, and where micro innovations are allowed to be cross sectionally dependent. Following Pesaran (2003), an optimal aggregate function is derived and used (i) to establish conditions under which Granger's (1980) conjecture regarding the long memory properties of aggregate variables from "a very large scale dynamic, econometric model" holds, and (ii) to show which distributional features of micro parameters can be identified from the aggregate model. The paper also derives impulse response functions for the aggregate variables, distinguishing between the effects of macro and aggregated idiosyncratic shocks. Some of the findings of the paper are illustrated by Monte Carlo experiments. The paper also contains an empirical application to consumer price inflation in Germany, France and Italy, and re-examines the extent to which "observed" inflation persistence at the aggregate level is due to aggregation and/or common unobserved factors. Our findings suggest that dynamic heterogeneity as well as persistent common factors are needed for explaining the observed persistence of the aggregate inflation.

Globalization Institute No. 100
Thousands of Models, One Story: Current Account Imbalances in the Global Economy
Michele Ca' Zorzi, Alexander Chudik and Alistair Dieppe
Published as: Ca' Zorzi, Michele, Alexander Chudik and Alistair Dieppe (2012), "Thousands of Models, One Story: Current Account Imbalances in the Global Economy," Journal of International Money and Finance 31 (6): 1319-1338.
Abstract: The global financial crisis has led to a revival of the empirical literature on current account imbalances. This paper contributes to that literature by investigating the importance of evaluating model and parameter uncertainty prior to reaching any firm conclusion. We explore three alternative econometric strategies: examining all models, selecting a few, and combining them all. Out of thousands (or indeed millions) of models a story emerges. The chance that current accounts were aligned with fundamentals prior to the financial crisis appears to be minimal.

Globalization Institute No. 99
A Cross-Country Quarterly Database of Real House Prices: A Methodological Note
Adrienne Mack and Enrique Martínez-García
Abstract: We build from (mainly) publicly available national sources a database of (nominal and real) house prices—complemented with data on private disposable income (PDI)—for 19 advanced countries at a quarterly frequency, starting in the first quarter of 1975. We select a house price index for each country that is consistent with the U.S. FHFA quarterly nationwide house price index for existing single-family houses (formerly called OFHEO house price index), and extend the country series back to 1975 with available historical data whenever necessary. Each house price index is seasonallyadjusted over the entire sample period and then rebased to 2005 = 100. The house price indexes are expressed in nominal terms, and also in real terms using the personal consumption expenditure (PCE) deflator of the corresponding country. PDIs are always quoted in per capita terms using working age population of the corresponding country and can be similarly expressed in real terms with the PCE deflator. We aggregate all 19 countries in our database, weighted by their purchasing power parity-adjusted GDP shares in 2005, to compute an average (nominal and real) house price series and an average (nominal and real) per capita PDI series.

Globalization Institute No. 98
Do Mood Swings Drive Business Cycles and is it Rational?
Paul Beaudry, Deokwoo Nam and Jian Wang
Abstract: This paper provides new evidence in support of the idea that bouts of optimism and pessimism drive much of US business cycles. In particular, we begin by using sign-restriction based identification schemes to isolate innovations in optimism or pessimism and we document the extent to which such episodes explain macroeconomic fluctuations. We then examine the link between these identified mood shocks and subsequent developments in fundamentals using alternative identification schemes (i.e., variants of the maximum forecast error variance approach). We find that there is a very close link between the two, suggesting that agents' feelings of optimism and pessimism are at least partially rational as total factor productivity (TFP) is observed to rise 8–10 quarters after an initial bout of optimism. While this later finding is consistent with some previous findings in the news shock literature, we cannot rule out that such episodes reflect self-fulfilling beliefs. Overall, we argue that mood swings account for over 50 percent of business-cycle fluctuations in hours and output.

Globalization Institute No. 96
A Real-Time Historical Database for the OECD
Adriana Z. Fernandez, Evan F. Koenig and Alex Nikolsko-Rzhevskyy
Abstract: Ongoing economic globalization makes real-time international data increasingly relevant, though little work has been done on collecting and analyzing real-time data for economies other than the U.S. In this paper, we introduce and examine a new international real-time dataset assembled from original quarterly releases of 13 quarterly variables presented in the OECD Main Economic Indicators from 1962 to 1998 for 26 OECD countries. By merging this data with the current OECD real-time dataset, which starts in 1999, researchers get access to a standard, up-to-date resource. To illustrate the importance of using real-time data in macroeconomic analysis, we consider five economic applications analyzed from a real-time perspective.

Globalization Institute No. 95
Borders and Big Macs
Anthony Landry
Published as: Landry, Anthony (2013), "Borders and Big Mac," Economics Letters 120 (2): 318-322. 
Abstract: I measure the extent of international market segmentation using local, national, and international Big Mac prices. I show that the bulk of time-series price volatility observed across the United States arises between neighboring locations. Using these data, I provide new estimates of border frictions for 14 countries. I find that borders generally introduce only small price wedges, far smaller than those observed across neighboring locations. When expressing these wedges in terms of distance equivalents, I find that border widths are small in relation to price variations observed across the United States. This suggests that international markets are well integrated.

Globalization Institute No. 89
Financial Integration and International Business Cycle Co-movement: Wealth Effects vs. Balance Sheet Effects
Scott Davis
Published as: Davis, J. Scott (2014), "Financial Integration and International Business Cycle Co-movement," Journal of Monetary Economics 64: 99-111. 
Abstract: This paper investigates the effect of international financial integration on international business cycle co-movement. We first show with a reduced form empirical approach how capital market integration (equity) has a negative effect on business cycle co-movement while credit market integration (debt) has a positive effect. We then construct a model that can replicate these empirical results. In the model, capital market integration is modeled as crossborder equity ownership and involves wealth effects. Credit market integration is modeled as cross-border borrowing and lending between credit constrained entrepreneurs and banks, and thus involves balance sheet effects. The wealth effect tends to reduce cross-country output correlation, but balance sheet effects serve to increase correlation as a negative shock in one country causes loan losses on the balance sheets of foreign banks. In versions of the model with a financial accelerator and balance sheet effects, credit market integration has a positive effect on cyclical correlation. However, in versions of the model without the financial accelerator and balance sheet effects, credit market integration has a negative effect on cyclical correlation.

Globalization Institute No. 85
Optimal Monetary Policy Under Financial Sector Risk
Scott Davis and Kevin X.D. Huang
Abstract: We consider whether or not a central bank should respond directly to financial market conditions when setting monetary policy. Specifically, should a central bank put weight on interbank lending spreads in its Taylor rule policy function? Using a model with risk and balance sheet effects in both the real and financial sectors (Davis, "The Adverse Feedback Loop and the Effects of Risk in the both the Real and Financial Sectors" Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Paper No. 66, November 2010) we find that when the conventional parameters in the Taylor rule (the coefficients on the lagged interest rate, inflation, and the output gap) are optimally chosen, the central bank should not put any weight on endogenous fluctuations in the interbank lending spread. However, the central bank should adjust the risk free rate in response to fluctuations in the spread that occur because of exogenous financial shocks, but we find that the central bank should not be too aggressive in its easing policy. Optimal policy calls for a two-thirds of a percentage point cut in the risk free rate in response to a financial shock that causes a one percentage point increase in interbank lending spreads.

Globalization Institute No. 74
A Redux of the Workhorse NOEM Model with Capital Accumulation and Incomplete Asset Markets
Enrique Martínez-García
Abstract: I build a symmetric two-country model that incorporates nominal rigidities, local-currency pricing and monopolistic competition distorting the goods markets. The model is similar to the framework developed in Martínez-García and Søndergaard (2008a, 2008b), but it also introduces frictions in the assets markets by restricting the financial assets available to two uncontingent nominal bonds in zero-net supply and by adding quadratic costs on international borrowing (see, e.g., Benigno and Thoenissen (2008) and Benigno (2009). The technical part of the paper contains three basic calculations. First, I derive the equilibrium conditions of the open economy model under local-currency pricing and incomplete asset markets. Second, I compute the zero-inflation (deterministic) steady state and discuss what happens with a non-zero net foreign asset position. Third, I derive the log-linearization of the equilibrium conditions around the deterministic steady state. The quantitative part of the paper aims to give a broad overview of the role that incomplete international asset markets can play in accounting for the persistence and volatility of the real exchange rate. I find that the simulation of the incomplete and complete asset markets models is almost indistinguishable whenever the business cycle is driven primarily by either nonpersistent monetary or persistent productivity (but not permanent) shocks. In turn, asset market incompleteness has more sizeable wealth effects whenever the cycle is driven by persistent (but not permanent) investment-specific technology shocks, resulting in significantly lower real exchange rate volatility.

Globalization Institute No. 70
Exchange Rate Pass-through: Evidence Based on Vector Autoregression with Sign Restrictions
Lian An and Jian Wang
Published as: An, Lisa and Jian Wang (2012), "Exchange Rate Pass-through: Evidence Based on Vector Autoregression with Sign Restrictions," Open Economies Review 23 (2): 359-380. 
Abstract: We estimate exchange rate pass-through (PT) into import, producer and consumer price indexes for nine OECD countries, using a method proposed by Uhlig (2005). In a Vector Autoregression (VAR) model, we identify the exchange rate shock by imposing restrictions on the signs of impulse responses for a small subset of variables. These restrictions are consistent with a large class of theoretical models and previous empirical findings. We find that exchange rate PT is less than one at both short and long horizons. Among three price indexes, exchange rate PT is greatest for import price index and smallest for consumer price index. In addition, greater exchange rate PT is found in an economy which has a smaller size, higher import share, more persistent exchange rate, more volatile monetary policy, higher inflation rate, and less volatile aggregate demand.

No. 1009
The Impact of Hurricanes on Housing Prices: Evidence from U.S. Coastal Cities
Anthony Murphy and Eric Strobl
Abstract: We investigate the effect of hurricane strikes on housing prices in U.S. coastal cities. To this end, we construct a new index of hurricane destruction which varies over time and space. Using this index and an annual, two equation, dynamic equilibrium correction panel model with area and time fixed effects, we model the effects of hurricanes on real house process and real incomes. In our model hurricanes have a direct effect on house prices and an indirect effect via a fall in local incomes. Our results show that the typical hurricane strike raises real house prices for a number of years, with a maximum effect of between 3% to 4% three years after occurrence. There is also a small negative effect on real incomes. These results are stable across models and subsamples.

No. 1008
Yield Spreads As Predictors of Economic Activity: A Real-Time VAR Analysis
N. Kundan Kishor and Evan F. Koenig
Published as: N. Kundan Kishor and Evan F. Koenig (2014), "Credit Indicators as Predictors of Economic Activity: A Real–Time VAR Analysis," Journal of Money, Credit and Banking 46 (2-3): 545-564.
Abstract: We undertake a real-time VAR analysis of the usefulness of the term spread, the junk-bond spread, the ISM's New Orders Index, and broker/dealer equity for predicting growth in non-farm employment. To get around the "apples and oranges" problem described by Koenig, Dolmas and Piger (2003), we augment each VAR we consider with a flexible state-space model of employment revisions. This methodology produces jobs forecasts consistently superior to those obtained using conventional VAR analysis. They are also superior to Federal Reserve Greenbook forecasts and to median forecasts from the Survey of Professional Forecasters. The junk-bond spread is by far the best single predictor of future jobs growth. However, the term spread has some incremental predictive power at medium-to-long horizons. The incremental predictive power of broker/dealer equity, while small, exceeds that of the ISM index at every horizon.

No. 1007
Do Remittances Boost Economic Development? Evidence From Mexican States
Pia M. Orrenius, Madeline Zavodny, Jesús Cañas and Roberto Coronado
Published as: Orrenius, Pia M., Madeline Zavodny, Jesús Cañas and Roberto Coronado (2010), "Do Remittances Boost Economic Development? Evidence From Mexican States," Law and Business Review of the Americas 16 (4): 803-822.
Abstract: Remittances have been promoted as a development tool because they can raise incomes and reduce poverty rates in developing countries. Remittances may also promote development by providing funds that recipients can spend on education or health care or invest in entrepreneurial activities. From a macroeconomic perspective, remittances can boost aggregate demand and thereby GDP as well as spur economic growth. However, remittances may also have adverse macroeconomic impacts by increasing income inequality and reducing labor supply among recipients. We use state-level data from Mexico during 2003–07 to examine the aggregate effect of remittances on employment, wages, unemployment rates, the wage distribution, and school enrollment rates. While employment, wages and school enrollment have risen over time in Mexican states, these trends are not accounted for by increasing remittances. However, two-stage least squares specifications among central Mexican states suggest that remittances shift the wage distribution to the right, reducing the fraction of workers earning the minimum wage or less.

No. 1006
The Impact of LIHTC Program on Local Schools
Wenhua Di and James C. Murdoch
Published as: Di, Wenhua and James C. Murdoch (2013), "The Impact of LIHTC Program on Local Schools," Journal of Housing Economics 22 (4): 308-320.
Abstract: The low-income housing tax credit (LIHTC) program has developed over two million rental homes for low-income households since 1986. The perception of deterioration in school quality has been a main reason for community opposition to LIHTC projects in middle-and upper-income areas. In this paper, we examine the impact of LIHTC projects on the nearby school performance. The LIHTC projects tend to have positive and statistically significant impacts on school performance the year they are placed in service and this finding is robust to various specifications. Offsetting these, the one year lag effects are negative and of similar or smaller magnitude.

No. 1005
Rationally Inattentive Macroeconomic Wedges
Antonella Tutino
Published as: Tutino, Antonella (2011), "Rationally Inattentive Macroeconomic Wedges," Journal of Economic Dynamics and Control 35 (3): 344-362.
Abstract: This paper argues that the solution to a dynamic optimization problem of consumption and labor under finite information-processing capacity can simultaneously explain the intertemporal and intratemporal labor wedges. It presents a partial equilibrium model, where a representative risk adverse consumer chooses information about wealth with limited attention. The paper compares ex-post realizations of models with finite and infinite capacity. The model produces macroeconomic wedges and measures of elasticity consistent with the literature. These findings suggest that a consumption-labor model with information-processing constraints can explain the difference between predicted and observed consumption and employment behavior.

No. 1004
The Labor Wedge as a Matching Friction
Anton A. Cheremukhin and Paulina Restrepo-Echavarria
Published as: Cheremukhin, Anton A. and Paulina Restrepo-Echabarria (2014), "The Labor Wedge as a Matching Friction," European Economic Review 68: 71-92.
Abstract: The labor wedge accounts for a large fraction of business cycle fluctuations. This paper uses a search and matching model to decompose the labor wedge into three classes of labor market frictions and evaluate their role. We find that frictions to job destruction and bargaining commonly considered in the search literature are not helpful in explaining the labor wedge. We also identify an asymmetric effect of separation, bargaining and matching frictions on unemployment, as well as a potential solution to Shimer's puzzle.

No. 1003
Oil Price Shocks and U.S. Economic Activity: An International Perspective
Nathan S. Balke, Stephen P.A. Brown and Mine K. Yücel
Abstract: Oil price shocks are thought to have played a prominent role in U.S. economic activity. In this paper, we employ Bayesian methods with a dynamic stochastic general equilibrium model of world economic activity to identify the various sources of oil price shocks and economic fluctuation and to assess their effects on U.S. economic activity. We find that changes in oil prices are best understood as endogenous. Oil price shocks in the 1970s and early 1980s and the 2000s reflect differing mixes of shifts in oil supply and demand, and differing sources of oil price shocks have differing effects on economic activity. We also find that U.S. output fluctuations owe mostly to domestic shocks, with productivity shocks contributing to weakness in the 1970s and 1980s and strength in the 2000s.

No. 1002
Credit, Housing Collateral and Consumption: Evidence from the U.K., Japan and the U.S.
Janine Aron, John V. Duca, John Muellbauer, Keiko Murata and Anthony Murphy
Published as: Aron, Janine, John V. Duca, John Muellbauer, Keiko Murata and Anthony Murphy (2012), "Credit, Housing Collateral and Consumption: Evidence from the U.K., Japan and the U.S.," Review of Income and Wealth 58 (3): 397-423.
Abstract: The consumption behaviour of U.K., U.S. and Japanese households is examined and compared using a modern Ando-Modigliani style consumption function. The models incorporate income growth expectations, income uncertainty, housing collateral and other credit effects. These models therefore capture important parts of the financial accelerator. The evidence is that credit availability for U.K. and U.S. but not Japanese households has undergone large shifts since 1980. The average consumption-to-income ratio shifted up in the U.K. and U.S. as mortgage downpayment constraints eased and as the collateral role of housing wealth was enhanced by financial innovations, such as home equity loans. The estimated housing collateral effect is roughly similar in the U.S. and U.K., while land prices in Japan still have a negative effect on consumer spending. Together with evidence for negative real interest rate effects in the U.K. and U.S. and positive ones in Japan, this suggests important differences in the transmission of monetary and credit shocks between Japan and the U.S., U.K. and other credit-liberalized economies.

No. 1001
An Analysis of the Neighborhood Impacts of a Mortgage Assistance Program: A Spatial Hedonic Model
Wenhua Di, Jielai Ma, James C. Murdoch
Published as: Di, Wenhua, Jielai Ma and James C. Murdoch (2010), "An Analysis of the Neighborhood Impacts of a Mortgage Assistance Program: A Spatial Hedonic Model," Journal of Policy Analysis and Management 29 (4): 682-697.
Abstract: Down-payment or closing-cost assistance is an effective program in addressing the wealth constraints of low- and moderate-income homebuyers. However, the spillover effect of such programs on the neighborhood is unknown. This paper estimates the impact of the City of Dallas Mortgage Assistance Program (MAP) on nearby home values using a hedonic model of home sales from 1990 to 2006. We define neighborhoods of 1,000 feet around each sale and estimate the average differences in sales prices between neighborhoods with various numbers of MAP properties before and after their appearance. We find that MAP properties tend to locate in neighborhoods with lower property values; however, unless a concentration of MAP properties forms, the infusion of MAP properties has little detrimental impact on neighboring property values. Moreover, low concentration of MAP properties has a modest positive impact on surrounding property values.

Globalization Institute Working Papers

Globalization Institute No. 66
The Adverse Feedback Loop and the Effects of Risk in Both the Real and Financial Sectors 
Scott Davis
Abstract: Recessions that are accompanied by financial crises tend to be more severe and are followed by slower recoveries than ordinary recessions. This paper introduces a new Keynesian model with financial frictions on both the demand and supply side of the credit markets that can explain this empirical finding. Following a shock that leads to a decline in economic activity, an adverse feedback loop arises where falling profits and asset values lead to increased defaults in the real sector, and these increased defaults lead to increased loan losses in the banking sector. Following this increase in loan losses, financial frictions in the banking sector imply that the banking sector itself may face difficulty obtaining funds. This disruption in the intermediation process leads to a further decline in output and asset prices in the real sector. In simulations of the model it is found that this feedback loop operating through the balance sheets of financial intermediaries can lead to as much as a 20 percent increase in business cycle volatility, and impulse response analysis shows that in the presence of financial frictions the path back to the steady state after a shock is much slower.

Globalization Institute No. 64
The Effects of News About Future Productivity on International Relative Prices: An Empirical Investigation 
Deokwoo Nam and Jian Wang
Abstract: In this paper, we find that expected (news) and unexpected (contemporaneous) components of productivity changes have opposite effects on the U.S. real exchange rate. Following Barsky and Sims' (2010) identification method, we decompose U.S. total factor productivity (TFP) into news and contemporaneous productivity changes. The U.S. real exchange rate appreciates following a favorable news shock to TFP, while it depreciates in response to a positive contemporaneous shock. In addition, the identified news TFP shocks play a much more important role than the identified contemporaneous TFP shocks in driving the U.S. real exchange rate. These findings provide empirical guidance to important international macroeconomic issues, such as the international transmission of productivity shocks and the modeling of exchange rate volatility.

Globalization Institute No. 61
Understanding the Effect of Productivity Changes on International Relative Prices: The Role of News Shocks 
Deokwoo Nam and Jian Wang
Abstract: The terms of trade and the real exchange rate of the U.S. appreciate when the U.S. labor productivity increases relative to the rest of the world. This finding is at odds with predictions from standard international macroeconomic models. In this paper, we find that incorporating news shocks to total factor productivity (TFP) in an otherwise standard dynamic stochastic general equilibrium (DSGE) model with variable capital utilization can help the model replicate the above empirical finding. Labor productivity increases in our model after a positive news shock to TFP because of an increase in capital utilization. Under some plausible calibrations, the wealth effect of good news about future productivity can increase domestic demand strongly and induce an increase in home prices relative to foreign prices.

Globalization Institute No. 60
International Real Business Cycles with Endogenous Markup Variability 
Scott Davis and Kevin X.D. Huang
Published as: Davis, Scott and Kevin X.D. Huang (2011), "International Real Business Cycles with Endogenous Markup Variability," Journal of International Economics 85 (2): 302-316.
Abstract: The aggregate impact of decisions made at the level of the individual firm has recently attracted a lot of attention in both the macro and trade literatures. We adapt the benchmark international real business cycle model to a game-theoretic environment to add a channel for the strategic interaction among domestic and foreign firms. We show how the sum of strategic pricing decisions made at the level of the individual firm can have significant effects on the volatility and cross country co-movement of GDP and its components. Specifically we show that the addition of this one channel for strategic interaction leads to a significant increase in the cross-country co-movement of production and investment, as well as a significant decrease in the volatility of investment and the trade balance over the benchmark IRBC model.

Globalization Institute No. 53
Trends in U.S. Hours and the Labor Wedge 
Simona E. Cociuba and Alexander Ueberfeldt
Abstract: From 1980 until 2007, U.S. average hours worked increased by 13 percent, due to a large increase in female hours. At the same time, the U.S. labor wedge, measured as the discrepancy between a representative household's marginal rate of substitution between consumption and leisure and the marginal product of labor, declined substantially. We examine these trends in a model with heterogeneous households: married couples, single males and single females. Our quantitative analysis shows that the shrinking gender wage gaps and increasing labor income taxes observed in U.S. data are key determinants of hours and the labor wedge. Changes in our model's labor wedge are driven by distortionary taxes and non-distortionary factors, such as cross-sectional differences in households' labor supply and productivity. We conclude that the labor wedge measured from a representative household model partly reflects imperfect household aggregation.

Globalization Institute No. 47
The Quantitative Role of Capital-Goods Imports in U.S. Growth 
Michele Cavallo and Anthony Landry
Published as: Cavallo, Michele and Anthony Landry (2010), "The Quantitative Role of Capital-Goods Imports in U.S. Growth," American Economic Review 100 (2): 78-82.
Abstract: Over the last 40 years, an increasing share of U.S. aggregate E&S investment expenditure has been allocated to capital-goods imports. While capital-goods imports were only 3.5 percent of E&S investment in 1967, by 2008 their share had risen tenfold to 36 percent. The goal of this paper is to measure the contribution of capital-goods imports to growth in U.S. output per hour using a simple growth accounting exercise. We find that capital-goods imports have contributed 20 to 30 percent to growth in U.S. output per hour between 1967 and 2008. More importantly, we find that capital-goods imports have been an increasing source of growth for the U.S. economy: the average contribution of capital-goods imports to growth in U.S. output per hour has increased noticeably since 1967.

Globalization Institute No. 43
Transitional Dynamics of Output and Factor Income Shares: Lessons from East Germany 
Simona E. Cociuba
Abstract: I evaluate the quantitative implications of technology change and government policies for output and factor income shares during East Germany's transition since 1990. I model an economy that gains access to a high productivity technology embodied in new plants. As existing low productivity plants decrease production, the capital income share varies due to variation in the profit share of these plants. Two policies—transfers and governmentmandated wage increases—have opposite effects on output growth, but both contribute to reducing the capital share during the transition. The model's output and capital share line up with counterparts in East German data.

No. 0906
Credit Market Shocks: Evidence From Corporate Spreads and Defaults
Roland Meeks
Abstract: Several recent papers have found that exogenous shocks to spreads paid in corporate credit markets are a substantial source of macroeconomic fluctuations. An alternative explanation of the data is that spreads respond endogenously to expectations of future default. We use a simple model of bond spreads to derive sign restrictions on the impulse-response functions of a VAR that identify credit shocks in the bond market, and compare them to results from a benchmark recursive VAR. We find that credit market shocks cause a persistent decline in output, prices and policy rates. Historical decompositions clearly show the negative effect of adverse credit market shocks on output in the recent recession. The identified credit shocks are unrelated to exogenous innovations to monetary policy and measures of bond market liquidity, but are related to measures of risk compensation. In contrast to results found using the benchmark restrictions, our identified credit shocks account for relatively little of the variance of output. Our results are consistent with a role for shocks in financial crises, but also with a lesser but non-zero role in normal business fluctuations.

No. 0905
Measuring Oil-Price Shocks Using Market-Based Information
Tao Wu and Michele Cavallo
Abstract: We study the effects of oil-price shocks on the U.S economy combining narrative and quantitative approaches. After examining daily oil-related events since 1984, we classify them into various event types. We then develop measures of exogenous shocks that avoid endogeneity and predictability concerns. Estimation results indicate that oil-price shocks have had substantial and statistically signi cant effects during the last 25 years. In contrast, traditional VAR approaches imply much weaker and insignificant effects for the same period. This discrepancy stems from the inability of VARs to separate exogenous oil-supply shocks from endogenous oil-price fluctuations driven by changes in oil demand.

No. 0904
Preventing a Repeat of the Money Market Meltdown of the Early 1930s
John V. Duca
Abstract: This paper analyzes the meltdown of the commercial paper market during the Great Depression, and relates those findings to the recent financial crisis. Theoretical models of financial frictions and information problems imply that lenders will make fewer noncollateralized loans or investments and relatively more extensions of collateralized finance in times of high risk premiums. This study investigates the relevance of such theories to the Great Depression by analyzing whether the increased use of a collateralized form of business lending (bankers acceptances) relative to that of non-collateralized commercial paper can be econometrically attributable to measures of corporate credit/financial risk premiums. Because commercial paper and bankers acceptances are short-lived, they are more timely measures of the availability of short-term credit than are bank or business failures and the level or growth rate of the stock of bank loans, whose maturities were often longer and were renegotiable. In this way, the study adds to the literature on financial market frictions during the Great Depression, which aside from analyzing securities prices, typically investigates the behavior of credit-related variables that lag current conditions, such as bank failures, bankruptcies, the stock of money, or outstanding bank loans.

In particular, the real level of bankers acceptances and their use relative to noncollateralized commercial paper were strongly and positively related to spreads between corporate and treasury bond yields. Also significant were short-run events, such as the October 1929 stock market crash and the 1933 bank holiday episode that sparked flights to quality in the bond market and a flight to collateral (BAs) in the money market and perhaps away from the loan market. Furthermore, these shifts in the composition of external finance were large, supporting the view that financial frictions and reduced credit availability may have played an important role in depressing the U.S. economy during the 1930s.

The paper also relates these findings to the current financial crisis by examining how the relative use of commercial paper reacted to yield spreads during the current crisis, taking into account Federal Reserve actions to improve liquidity conditions in the money markets. Results suggest that these efforts may have, at least so far, helped prevent the commercial paper market from melting down to the extent seen during the early 1930s.

No. 0903
How Robust Are Popular Models of Nominal Frictions?
Benjamin D. Keen and Evan F. Koenig
Abstract: This paper analyzes three popular models of nominal price and wage frictions to determine which best fits post-war U.S. data. We construct a dynamic stochastic general equilibrium (DSGE) model and use maximum likelihood to estimate each model's parameters. Because previous research finds that the conduct of monetary policy and the behavior of inflation changed in the early 1980s, we examine two distinct sample periods. Using a Bayesian, pseudo-odds measure as a means for comparison, a sticky price and wage model with dynamic indexation best fits the data in the early-sample period, whereas either a sticky price and wage model with static indexation or a sticky information model best fits the data in the late-sample period. Our results suggest that price- and wage-setting behavior may be sensitive to changes in the monetary policy regime. If true, the evaluation of alternative monetary policy rules may be even more complicated than previously believed.

No. 0902
Improving the ACCRA U.S. Regional Cost of Living Index
Keith R. Phillips and Christina Daly
Published as: Phillips, Keith R. and Christina Daly (2010), "Improving the ACCRA U.S. Regional Cost of Living Index," Journal of Economic and Social Measurement 35 (1-2): 33-42.
Abstract: The broadest and most commonly used measure of the cost of living across U.S. cities is the American Chamber of Commerce Research Association (ACCRA) index. This index is used by business and government organizations and the media to to rank living standards and real wages across U.S. cities. In this study we reduce the aggregation bias in the index by calculating national average prices for the 59 item prices using population weights instead of the equal weight formula used by ACCRA. This correction results in a decline in the index values for all cities and changes in the rankings and bi-variate comparisons between city pairs. In some high-cost cities the index values decrease by over 25 percent, and in 74 percent of the cities the rank changes by greater than one spot.

No. 0901
Do Immigrants Work in Riskier Jobs?
Pia M. Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2009), "Do Immigrants Work in Riskier Jobs?," Demography 46 (3): 535-551.
Abstract: Recent media and government reports suggest that immigrants are more likely to hold jobs with worse working conditions than U.S.-born workers, perhaps because immigrants work in jobs that "natives don't want." Despite this widespread view, earlier studies have not found immigrants to be in riskier jobs than natives. This study combines individual-level data from the 2003–2005 American Community Survey with Bureau of Labor Statistics data on work-related injuries and fatalities to take a fresh look at whether foreign-born workers are employed in more dangerous jobs. The results indicate that immigrants are in fact more likely to work in risky jobs than U.S.-born workers, partly due to differences in average characteristics, such as immigrants' lower English language ability and educational attainment.

Globalization Institute Working Papers

Globalization Institute No. 40
Business Cycles and Remittances: Can the Beveridge-Nelson Decomposition Provide New Evidence? 
Roberto Coronado
Abstract: In this paper, I analyze the business cycle properties of remittances and output series for three pairs of countries: United States–Mexico, United States–El Salvador, and Germany–Turkey. Using an unobserved components state-space model (via the Beveridge-Nelson decomposition), I decompose the remittances and output series into stochastic permanent and cyclical components. I then use the resulting stationary cyclical components to estimate co-movements between remittances and output series. Empirical results indicate that remittances are countercyclical with all the home countries: Mexico, El Salvador, and Turkey. With respect to source countries, remittances to Mexico are countercyclical with the United States business cycle, while remittances from the United States to El Salvador and remittances from Germany to Turkey are strongly procyclical with output fluctuations in the source country. The contribution of this paper to the literature is twofold: (1) I use high-frequency data (quarterly) for a relatively long period of time; and (2) I employ more recent and sophisticated econometric techniques in the decomposition of the series into stochastic permanent and cyclical components. The existing literature lacks both of these important aspects of my analysis. I show that once both of these factors are incorporated into the analysis, empirical results are more aligned to those predicted by economic theory.

Globalization Institute No. 39
State-Dependent Pricing, Local-Currency Pricing, and Exchange Rate Pass-Through 
Anthony Landry
Published as: Landry, Anthony (2010), "State-Dependent Pricing, Local-Currency Pricing, and Exchange Rate Pass-Through," Journal of Economic Dynamics and Control 34 (10): 1859-1871.
Abstract: This paper presents a two-country DSGE model with state-dependent pricing as in Dotsey, King, and Wolman (1999) in which firms price-discriminate across countries by setting prices in local currency. In this model, a domestic monetary expansion has greater spillover effects to foreign prices and foreign economic activity than an otherwise identical model with time-dependent pricing. In addition, the predictions of the state-dependent pricing model match the business-cycle moments better than the predictions of the time-dependent pricing model when driven by monetary policy shocks.

Globalization Institute No. 36
Can Long-Horizon Forecasts Beat the Random Walk Under the Engel-West Explanation? 
Charles Engel, Jian Wang and Jason Wu
Abstract: Engel and West (EW, 2005) argue that as the discount factor gets closer to one, present-value asset pricing models place greater weight on future fundamentals. Consequently, current fundamentals have very weak forecasting power and exchange rates appear to follow approximately a random walk. We connect the Engel-West explanation to the studies of exchange rates with long-horizon regressions. We find that under EW's assumption that fundamentals are I(1) and observable to the econometrician, long-horizon regressions generally do not have significant forecasting power. However, when EW's assumptions are violated in a particular way, our analytical results show that there can be substantial power improvements for long-horizon regressions, even if the power of the corresponding shorthorizon regression is low. We simulate population Rsquared for long-horizon regressions in the latter setting, using Monetary and Taylor Rule models of exchange rates calibrated to the data. Simulations show that long-horizon regression can have substantial forecasting power for exchange rates.

Globalization Institute No. 28
Investment and Trade Patterns in a Sticky-Price, Open-Economy Model 
Enrique Martínez-García and Jens Søndergaard
Published as: Martínez-García, Enrique and Jens Søndergaard (2009), "Investment and Trade Patterns in a Sticky-Price, Open-Economy Model," in The Economics of Imperfect Markets, ed. Giorgio Calcagnini and Enrico Saltari (Berlin: Springer), 183-212.
Abstract: This paper develops a tractable two-country DSGE model with sticky prices à la Calvo (1983) and local-currency pricing. We analyze the capital investment decision in the presence of adjustment costs of two types, the capital adjustment cost (CAC) specification and the investment adjustment cost (IAC) specification. We compare the investment and trade patterns with adjustment costs against those of a model without adjustment costs and with (quasi-) flexible prices. We show that having adjustment costs results into more volatile consumption and net exports, and less volatile investment. We document three important facts on U.S. trade: a) the S-shaped cross-correlation function between real GDP and the real net exports share, b) the J-curve between terms of trade and net exports, and c) the weak and S-shaped cross-correlation between real GDP and terms of trade. We find that adding adjustment costs tends to reduce the model's ability to match these stylized facts. Nominal rigidities cannot account for these features either.

No. 0815
The Most-Favored Nation Rule in Club Enlargement Negotiation
Edwin L.C. Lai
Abstract: We study the effects of the Most-Favored Nation rule in an applicant's negotiation to join a club. When the applicant has to carry out a series of bilateral bargains with the existing members, we find that there are two effects of the MFN rule, viz. the hardened bargainer effect and the free-rider effect. The former effect tends to favor the applicant, while the latter effect tends to hurt the applicant. We find that the free-rider effect is stronger the more asymmetric are the members. The hardened bargainer effect is stronger the larger is the "size of the pie." As the number of members increase, it is more likely that the hardened bargainer effect would dominate.

No. 0814
What Do Majority-Voting Politics Say About Redistributive Taxation of Consumption and Factor Income? Not Much.
Jim Dolmas
Abstract: Tax rates on labor income, capital income and consumption— and the redistributive transfers those taxes finances differ widely across developed countries. Can majority-voting methods, applied to a calibrated growth model, explain that variation? The answer I fund is yes, and then some. In this paper, I examine a simple growth model, calibrated roughly to U.S. data, in which the political decision is over constant paths of taxes on factor income and consumption, used to finance a lump-sum transfer. I first look at outcomes under probabilistic voting, and find that equilibria are extremely sensitive to the specification of uncertainty. I then consider other ways to restrict the range of majority-rule outcomes, looking at the model's implications for the shape of the Pareto set and the uncovered set, and the existence or non-existence of a Condorcet winner. Solving the model on discrete grid of policy choices, I find that no Condorcet winner exists and that the Pareto and uncovered sets, while small relative to the entire issue space, are large relative to the range of tax policies we see in data for a collection of 20 OECD countries. Taking that data as the issue space, I find that none of the 20 can be ruled out on efficiency grounds, and that 10 of the 20 are in the uncovered set. Those 10 encompass policies as diverse as those of the US, Norway and Austria. One can construct a Condorcet cycle including all 10 countries' tax vectors.

The key features of the model here, as compared to other models on the endogenous determination of taxes and redistribution, is that the issue space is multidimensional and, at the same time, no one voter type is sufficiently numerous to be decisive. I conclude that the sharp predictions of papers in this literature may not survive an expansion of their issue spaces or the allowance for a slightly less homogeneous electorate.

No. 0813
Keynesian Economics without the LM and IS Curves: A Dynamic Generalization of the Taylor-Romer Model
Evan F. Koenig
Abstract: John Taylor and David Romer champion an approach to teaching undergraduate macroeconomics that dispenses with the LM half of the IS-LM model and replaces it with a rule for setting the interest rate as a function of inflation and the output gap—i.e., a Taylor rule. But the IS curve is problematic, too. It is consistent with the permanent-income hypothesis only when the interest rate that enters the IS equation is a long-term rate not the short-term rate controlled by the monetary authority. This article shows how the Taylor-Romer framework can be readily modified to eliminate this maturity mismatch. The modified model is a dynamic system in output and inflation, with a unique stable path that behaves very much like Taylor and Romer's aggregate demand (AD) schedule. Many—but not all—of the original Taylor-Romer model's predictions carry over to the new framework. It helps bridge the gap between the Taylor-Romer analysis and the more sophisticated models taught in graduate-level courses.

No. 0812
The Elasticity of Intertemporal Substitution: New Evidence from 401(k) Participation
Gary V. Engelhardt and Anil Kumar
Published as: Engelhardt, Gary V. and Anil Kumar (2009), "The Elasticity of Intertemporal Substitution: New Evidence from 401(k) Participation," Economics Letters 103 (1): 15-17.
Abstract: A key parameter in economics is the elasticity of intertemporal substitution (EIS), which measures the extent to which consumers shift total expenditures across time in response to changes in the effective rate of return. In contrast to the previous literature, which primarily has relied on Euler equation methods and generated a wide range of estimates, we show how a life-cycle-consistent econometric specification of employee 401(k) participation along with plausibly exogenous variation in rates of return due to employer matching contributions can be used to generate new estimates of the EIS. Because firms often cap the generosity of the match, employer matching generates nonlinearities in household budget sets. We draw on non-linear budget-set estimation methods rooted in the public economics literature, and using detailed administrative contribution, earnings, and pension-plan data for a sample of 401(k)-eligible households from the Health and Retirement Study, we estimate the EIS to be 0.74 in our richest specification, with a 95% confidence interval that ranges from 0.37 to 1.21.

No. 0811
Stationarity and the Term Structure of Interest Rates: A Characterisation of Stationary and Unit Root Yield Curves
Clive G. Bowsher and Roland Meeks
Abstract: The nature of yield curve dynamics and the determinants of the integration order of yields are investigated using a benchmark economy in which the logarithmic expectations theory holds and the regularity condition of a limiting yield and limiting term premium is satisfied. By considering a zero-coupon yield curve with a complete term structure of maturities, a linear vector autoregressive process is constructed that provides an arbitrarily accurate moving average representation of the complete yield curve as its cross-sectional dimension (n) goes to infinity. We use this to prove the following novel results. First, any I(2) component vanishes owing to the almost sure (a.s.) convergence of the innovations to yields, vt(n), as n. Second, the yield curve is stationary if and only if nvt(n) converges a.s., or equivalently the innovations to log discount bond prices converge a.s.; otherwise yields are I(1). A necessary condition for either stationarity or the absence of arbitrage is that the limiting yield is constant over time. Since the time-varying component of term premia is small in various fixed-income markets, these results provide insight into the critical determinants of the stationarity properties of the term structure.

No. 0810
Globalization of Production and the Technology Transfer Paradox
Ferre De Graeve
Abstract: This paper develops a growth model aimed at understanding the effects of globalization of production on rate of innovation, distribution of labor income between the North and South and welfare of workers in both regions. We adopt a dynamic general equilibrium product-cycle model, assuming that the North specializes in innovation and the South specializes in imitation. Globalization of production resulting from trade liberalization and imitation of the North's technology by the South increases the rate of innovation. When the South's participation in the product cycle is not too deep, further deepening of globalization of production lowers the wage of Southern labor relative to that of its counterpart in the North. This poses a technology transfer paradox similar to that discovered by Jones and Ruffin (forthcoming, JIE): an increase in the uncompensated technology transfer from the North to the South makes the North better off. However, a point will be reached where further deepening of globalization leads to increases in relative wage of the South. For this reason, the North would eventually lose from uncompensated technology transfer as globalization deepens.

No. 0809
The External Finance Premium and the Macroeconomy: US Post–WWII Evidence
Ferre De Graeve
Published as: De Graeve, Ferre (2008), "The External Finance Premium and the Macroeconomy: US Post–WWII Evidence," Journal of Economic Dynamics and Control 32 (1): 3415-3440.
Abstract: The central variable of theories of financial frictions—the external finance premium is unobservable. This paper distills the external finance premium from a DSGE model estimated on U.S. macroeconomic data. Within the DSGE framework, movements in the premium can be given an interpretation in terms of shocks driving business cycles. A key result is that the estimates based solely on nonfinancial macroeconomic data—picks up over 70 percent of the dynamics of lower grade corporate bond spreads. The paper also identifies a gain in fitting key macroeconomic aggregates by including financial frictions in the model and documents how shock transmission is affected.

No. 0808
On the Effectiveness of the Federal Reserve's New Liquidity Facilities
Tao Wu
Abstract: This paper examines the effectiveness of the new liquidity facilities that the Federal Reserve established in response to the recent financial crisis. I develop a no-arbitrage based affine term structure model with default risk and conduct a thorough factor analysis of the counterparty default risk among major financial institutions and the underlying mortgage default risk. The new facilities' effectiveness is examined, by first separately examining their effects in relieving financial institutions' liquidity concerns and reducing the counterparty risk premiums, and then quantifying their overall effects in reducing financial strains in the inter-bank money market.

Empirical results indicate that the Term Auction Facility (TAF) has a strong effect in reducing financial strains in the inter-bank money market, primarily through relieving financial institutions' liquidity concerns. Heightened uncertainty regarding the macroeconomy, financial markets, and mortgage default risk have significantly raised counterparty risk premiums among financial institutions, but have had little effect on their liquidity premiums. The Term Securities Lending Facility (TSLF) and the Primary Dealer Credit Facility (PDCF), however, are found to have had less discernible effects so far in relieving financial strains in the Libor market. This is consistent with market observations of a weaker interest from primary dealers in participating in the TSLF auctions than banks have shown in tapping the TAF.

No. 0807
Regulation and the Neo-Wicksellian Approach to Monetary Policy
John V. Duca and Tao Wu
Published as: Duca, John V. and Tao Wu (2009), "Regulation and the Neo-Wicksellian Approach to Monetary Policy," Journal of Money, Credit and Banking 41 (4): 799-807.
Abstract: Laubach and Williams (2003) employ a Kalman filter approach to jointly estimate the neutral real federal funds rate and trend output growth using an IS relationship and an output gap based inflation equation. They find a positive link between these two variables, but also much error surrounding neutral real rate estimates. We modify their approach by including variables for regulations on deposit interest rates and on wages and prices. These variables are statistically significant and notably affect estimates of two policy relevant coefficients: the sensitivity of output to the real interest rate and that of inflation to the output gap.

No. 0806
Variety, Globalization, and Social Efficiency
W. Michael Cox and Roy J. Ruffin
Published as: Cox, W. Michael and Roy J. Ruffin (2010), "Variety, Globalization, and Social Efficiency," Southern Economic Journal 76 (4): 1064-1075.
Abstract: This paper puts recent work on the benefits of variety into the context of a more complete quantitative analysis of the Dixit-Stiglitz-Krugman model of monopolistic competition. We show how the gains from globalization are reflected in the increase in variety and the exploitation of economies of scale, and that the social efficiency question is quantitatively insignificant. These results follow from examining a Bertrand-Nash equilibrium that allows for a finite number of varieties to affect the elasticity of demand facing each firm. We develop a precise expression for per capita real income with any number of sectors where globalization increases productivity through economies of scale.

No. 0805
The Effect of Minimum Wages on Immigrants' Employment and Earnings
Pia Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2008), "The Effect of Minimum Wages on Immigrants' Employment and Earnings," Industrial and Labor Relations Review 61 (4): 544-563.
Abstract: This study examines how minimum wage laws affect the employment and earnings of low-skilled immigrants and natives in the U.S. Minimum wage increases might have larger effects among low-skilled immigrants than among natives because, on average, immigrants earn less than natives due to lower levels of education, limited English skills, and less social capital. Results based on data from the Current Population Survey for the years 1994–2005 do not indicate that minimum wages have adverse employment effects among adult immigrants or natives who did not complete high school. However, low-skilled immigrants may have been discouraged from settling in states that set wage floors substantially above the federal minimum.

No. 0804
The Dynamics of Economic Functions: Modelling and Forecasting the Yield Curve
Clive G. Bowsher and Roland Meeks
Published as: Bowsher, Clive G. and Roland Meeks (2008), "The Dynamics of Economic Functions: Modelling and Forecasting the Yield Curve," Journal of the American Statistical Association 130 (484): 1419-1437.
Abstract: The class of Functional Signal plus Noise (FSN) models is introduced that provides a new, general method for modelling and forecasting time series of economic functions. The underlying, continuous economic function (or "signal") is a natural cubic spline whose dynamic evolution is driven by a cointegrated vector autoregression for the ordinates (or "y-values") at the knots of the spline. The natural cubic spline provides flexible cross-sectional fit and results in a linear, state space model. This FSN model achieves dimension reduction, provides a coherent description of the observed yield curve and its dynamics as the cross-sectional dimension N becomes large, and can feasibly be estimated and used for forecasting when N is large. The integration and cointegration properties of the model are derived. The FSN models are then applied to forecasting 36-dimensional yield curves for US Treasury bonds at the one month ahead horizon. The method consistently outperforms the Diebold and Li (2006) and random walk forecasts on the basis of both mean square forecast error criteria and economically relevant loss functions derived from the realised profits of pairs trading algorithms. The analysis also highlights in a concrete setting the dangers of attempts to infer the relative economic value of model forecasts on the basis of their associated mean square forecast errors.

No. 0803
Why Stop There? Mexican Migration to the U.S. Border Region
Pia M. Orrenius, Madeline Zavodny and Leslie Lukens
Published as: Orrenius, Pia M., Madeline Zavodny and Leslie Lukens (2009), "Differences between Mexican Migration to the U.S. Border and Interior: Evidence from Mexican Survey Data," in Labor Market Issues along the U.S.-Mexico Border, ed. Marie T. Mora and Alberto Dávila (Tuscon, AZ: University of Arizona Press), 139-159.
Abstract: The transformation of the U.S. border economy since the 1980s provides a fascinating backdrop to explore how migration to the U. S. side of the Mexican border has changed vis-a-vis migration to the U.S. interior. Some long-standing patterns of border migrants remained unchanged during this period while others underwent drastic changes. For example, border migrants are consistently more likely to be female, to have migrated within Mexico, and to lack migrant networks as compared with migrants to the U.S. interior. Meanwhile, the occupational profile of border migrants has changed drastically from being predominately agricultural work to being largely made up of service-sector and sales-related work. Border migration is more sensitive to Mexican and U.S. business cycles than migration to the U.S. interior throughout the period and, while the data suggest border migrant wages may have caught up to other migrants' wages by the early 2000s, multivariate analysis indicates that border migrants who are female and/or undocumented continue to earn far less than such migrants who work in the U.S. interior.

No. 0802
Deliverability and Regional Pricing in U.S. Natural Gas Markets
Stephen P. A. Brown and Mine K. Yücel
Published as: Brown, Stephen P.A. and Mine K. Yücel (2008), "Deliverability and Regional Pricing in U.S. Natural Gas Markets," Energy Economics 30 (5): 2441-2453.
Abstract: During the 1980s and early '90s, interstate natural gas markets in the United States made a transition away from the regulation that characterized the previous three decades. With abundant supplies and plentiful pipeline capacity, a new order emerged in which freer markets and arbitrage closely linked natural gas price movements throughout the country. After the mid-1990s, however, U.S. natural gas markets tightened and some pipelines were pushed to capacity. We look for the pricing effects of limited arbitrage through causality testing between prices at nodes on the U.S. natural gas transportation system and interchange prices at regional nodes on North American electricity grids. Our tests do reveal limited arbitrage, which is indicative of bottlenecks in the U.S. natural gas pipeline system.

No. 0801
The Poor, the Rich and the Enforcer: Institutional Choice and Growth
Erwan Quintin, Thorsten Koeppl and Cyril Monnet
Abstract: We study economies where improving the quality of institutions—modeled as improving contract enforcement—requires resources, but enables trade that raises output by reducing the dispersion of marginal products of capital. We find that in this type of environment it is optimal to combine institutional building with endowment redistribution, and that more ex-ante dispersion in marginal products increases the incentives to invest in enforcement. In addition, we show that institutional investments lead over time to a progressive reduction in inequality. Finally, the framework we describe enables us to formalize the hypothesis formulated by Engerman and Sokoloff (2002) that the initial concentration of human and physical capital can explain the divergence of different countries' institutional history.

Globalization Institute Working Papers

Globalization Institute No. 22
The Taylor Rule and Forecast Intervals for Exchange Rates 
Jian Wang and Jason J. Wu
Published as: Wang, Jian and Jason J. Wu (2012), "The Taylor Rule and Forecast Intervals for Exchange Rates," Journal of Money, Credit and Banking 44 (1): 103-144.
Abstract: This paper attacks the Meese-Rogoff (exchange rate disconnect) puzzle from a different perspective: out-of-sample interval forecasting. Most studies in the literature focus on point forecasts. In this paper, we apply Robust Semi-parametric (RS) interval forecasting to a group of Taylor rule models. Forecast intervals for twelve OECD exchange rates are generated and modified tests of Giacomini and White (2006) are conducted to compare the performance of Taylor rule models and the random walk. Our contribution is twofold. First, we find that in general, Taylor rule models generate tighter forecast intervals than the random walk, given that their intervals cover out-of-sample exchange rate realizations equally well. This result is more pronounced at longer horizons. Our results suggest a connection between exchange rates and economic fundamentals: economic variables contain information useful in forecasting the distributions of exchange rates. The benchmark Taylor rule model is also found to perform better than the monetary and PPP models. Second, the inference framework proposed in this paper for forecast-interval evaluation can be applied in a broader context, such as inflation forecasting, not just to the models and interval forecasting methods used in this paper.

Globalization Institute No. 21
Vertical Specialization and International Business Cycle Synchronization 
Costas Arkolakis and Ananth Ramanarayanan
Published as: Arkolakis, Costas and Ananth Ramanarayanan (2009), "Vertical Specialization and International Business Cycle Synchronization," The Scandinavian Journal of Economics 111 (4): 655-680.
Abstract: We explore the impact of vertical specialization—trade in goods across multiple stages of production—on the relationship between trade and international business cycle synchronization. We develop a model in which the degree of vertical specialization is endogenously determined by comparative advantage across heterogeneous goods and varies with trade barriers between countries. We show analytically that fluctuations in measured productivity in our model are not linked across countries through trade, despite the greater transmission of technology shocks implied by higher degrees of vertical specialization. In numerical simulations, we find this transmission is insufficient in generating substantial dependence of business cycle synchronization on trade intensity.

Globalization Institute No. 20
An International Perspective on Oil Price Shocks and U.S. Economic Activity
Nathan S. Balke, Stephen P. A. Brown and Mine K. Yücel
Abstract: The effect of oil price shocks on U.S. economic activity seems to have changed since the mid-1990s. A variety of explanations have been offered for the seeming change—including better luck, the reduced energy intensity of the U.S. economy, a more flexible economy, more experience with oil price shocks and better monetary policy. These explanations point to a weakening of the relationship between oil prices shocks and economic activity rather than the fundamentally different response that may be evident since the mid-1990s. Using a dynamic stochastic general equilibrium model of world economic activity, we employ Bayesian methods to assess how economic activity responds to oil price shocks arising from supply shocks and demand shocks originating in the United States or elsewhere in the world. We find that both oil supply and oil demand shocks have contributed significantly to oil price fluctuations and that U.S. output fluctuations are derived largely from domestic shocks.

Globalization Institute No. 19
Default and the Maturity Structure in Sovereign Bonds 
Cristina Arellano and Ananth Ramanarayanan
Abstract: This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. We document that in Argentina, Brazil, Mexico, and Russia, when interest rate spreads rise, debt maturity shortens and the spread on short-term bonds is higher than on long-term bonds. To account for this pattern, we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Short-term debt can deliver higher immediate consumption than long-term debt; large longterm loans are not available because the borrower cannot commit to save in the near future towards repayment in the far future. However, issuing long-term debt can insure against the need to roll-over short-term debt at high interest rate spreads. The trade-off between these two benefits is quantitatively important for understanding the maturity composition in emerging markets. When calibrated to data from Brazil, the model matches the dynamics in the maturity of debt issuances and its comovement with the level of spreads across maturities.

Globalization Institute No. 17
The Real Exchange Rate in Sticky Price Models: Does Investment Matter? 
Enrique Martinez-Garcia and Jens Søndergaard
Published as: Martínez-García, Enrique and Jens Søndergaard (2013), "Investment and Real Exchange in Sticky Price Models," Macroeconomic Dynamics17 (2): 195-234.
Abstract: This paper re-examines the ability of sticky-price models to generate volatile and persistent real exchange rates. We use a DSGE framework with pricing-to-market akin to those in Chari, et al. (2002) and Steinsson (2008) to illustrate the link between real exchange rate dynamics and what the model assumes about physical capital. We show that adding capital accumulation to the model facilitates consumption smoothing and significantly impedes the model's ability to generate volatile real exchange rates. Our analysis, therefore, caveats the results in Steinsson (2008) who shows how real shocks in a sticky-price model without capital can replicate the observed real exchange rate dynamics. Finally, we find that the CKM (2002) persistence anomaly remains robust to several alternative capital specifications including set-ups with variable capital utilization and investment adjustment costs (see, e.g., Christiano, et al., 2005). In summary, the PPP puzzle is still very much alive and well.

Globalization Institute No. 16
Technical Note on 'The Real Exchange Rate in Sticky Price Models: Does Investment Matter?' 
Enrique Martinez-Garcia and Jens Søndergaard

Abstract: This technical note is developed as a mathematical companion to the paper "The Real Exchange Rate in Sticky Price Models: Does Investment Matter?" (Institute working paper no. 17). It contains three basic calculations. First, we derive the equilibrium conditions of the model. Second, we compute the zero-inflation, zero-trade balance (deterministic) steady state. Third, we describe the log-linearization of the equilibrium conditions around the deterministic steady state. Simultaneously, we explain the system of equations that constitutes the basis for the paper to broaden its scope. Commentary is provided whenever necessary to complement the model description and to place into context the assumptions embedded in our DSGE framework.

Globalization Institute No. 15
Variety, Globalization, and Social Efficiency 
W. Michael Cox and Roy J. Ruffin
Published as: Cox, W. Michael and Roy J. Ruffin (2010), "Variety, Globalization, and Social Efficiency," Southern Economic Journal 76 (4): 1064-1075.
Abstract: This paper puts recent work on the benefits of variety into the context of a more complete quantitative analysis of the Dixit-Stiglitz-Krugman model of monopolistic competition. We show how the gains from globalization are reflected in the increase in variety and the exploitation of economies of scale, and that the social efficiency question is quantitatively insignificant. These results follow from examining a Bertrand-Nash equilibrium that allows for a finite number of varieties to affect the elasticity of demand facing each firm. We develop a precise expression for per capita real income with any number of sectors where globalization increases productivity through economies of scale.

Globalization Institute No. 11
Globalization and Monetary Policy: An Introduction 
Enrique Martinez-Garcia
Abstract: Greater openness has become an almost universal feature of modern, developed economies. This paper develops a workhorse international model, and explores the role of standard monetary policy rules applied to an open economy. For this purpose, I build a two-country DSGE model with monopolistic competition, sticky prices, and pricing-to-market. I also derive the steady state and a log-linear approximation of the equilibrium conditions. The paper provides a lengthy explanation of the steps required to derive this benchmark model, and a discussion of: (a) how to account for certain well-known anomalies in the international literature, and (b) how to start "thinking" about monetary policy in this environment.

Globalization Institute No. 8
How Should Central Banks Define Price Stability? 
Mark A. Wynne
Published as: Wynne, Mark A. (2009), "How Should Central Banks Define Price Stability?," in Designing Central Banks, eds. David Mayes and Geoffrey Wood (London: Routledge), 107-129.
Abstract: It is now generally accepted that the primary objective of central banks should be the maintenance of price stability. This paper considers the question of how central banks should define price stability. I address three specific questions. First, should central banks target broad or narrow measures of inflation? Second, should central banks target headline or core measure of inflation? And third, should central banks define price stability as prevailing at some positive measured rate of inflation?

Globalization Institute No. 6
Driving Forces of the Canadian Economy: An Accounting Exercise 
Simona E. Cociuba and Alexander Ueberfeldt
Abstract: This paper analyzes the Canadian economy for the post-1960 period. It uses an accounting procedure developed in Chari, Kehoe, and McGrattan (2006). The procedure identifies accounting factors that help align the predictions of the neoclassical growth model with macroeconomic variables observed in the data. The paper finds that total factor productivity and the consumption-leisure trade-off—the productivity and labor factors—are key to understanding the changes in output, labor supply and labor productivity observed in the Canadian economy. The paper performs a decomposition of the labor factor for Canada and the United States. It finds that the decline in the gender wage gap is a major driving force of the decrease in the labor market distortions. Moreover, the milder reduction in the labor market distortions observed in Canada, compared to the U.S., is due to a relative increase in effective labor taxes in Canada.

No. 0709
Gasoline Content Regulation as a Trade Barrier: Do Boutique Fuels Discourage Fuel Imports?
Adriana Z. Fernández, Robert W. Gilmer and Jonathan L. Story
Abstract: This paper examines the impact of Clean Air Act Amendments of 1990 (CAAA) environmental regulations on U.S. motor gasoline import patterns. Following the damage to U.S. petroleum refining infrastructure from hurricanes Katrina and Rita, the federal government provided temporary relief for several weeks from so-called boutique fuel specifications designed to improve air quality in certain regions of the country. These temporary waivers increased marketers' ability to sell gasoline originally destined for specific regional markets into a greater number of markets. We hypothesize that these same waivers also encouraged gasoline imports more than increased prices would have alone. We test our hypothesis using two analyses. The first consists of a simple transfer function analysis designed to separate price effects (and thus effects of refinery closures) from the effects of regulatory relief. The second analysis consists of a natural experiment comparing the primary recipient of regulatory relief—the Gulf Coast gasoline market— to the rest of the United States. Both analyses suggest that the CAAA-related specifications prevent a substantial amount of gasoline imports from entering the United States under normal circumstances.

No. 0708
The Minimum Wage and Latino Workers
Pia M. Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2011), "The Minimum Wage and Latino Workers," in Latinos and the Economy: Integration and Impact in Schools, Labor Markets and Beyond, ed. David L. Leal and Stephen Trejo (New York: Springer), 169-191.
Abstract: Because Latinos comprise a large and growing share of the low-skilled labor force in the U.S., Latinos may be disproportionately affected by minimum wage laws. We compare the effects of minimum wage laws on employment and earnings among Hispanic immigrants and natives compared with non-Hispanic whites and blacks. We focus on adults who have not finished high school and on teenagers, groups likely to earn low wages. Conventional economic theory predicts that higher minimum wages lead to higher hourly earnings among people who are employed but lower employment rates. Data from the Current Population Survey during the period 1994–2005 indicate that there is a significant disemployment effect of higher minimum wages on Latino teenagers, although it is smaller for foreign- than native-born Latinos. Adult Latino immigrants are less affected by minimum wage laws than other low-education natives. We investigate whether skill levels and undocumented status help explain these findings.

No. 0707
National, Regional and Metro-Specific Factors of the U.S. Housing Market
Dong Fu
Abstract: We build a dynamic latent factor model to decompose housing prices in major U.S. metropolitan areas into national, regional, and metro-specific idiosyncratic factors, in order to distinguish the different dynamics behind housing price movements. We find that there is a distinctive national factor that has contributed about one-fourth of the individual metropolitan's housing price volatility. The regional factor accounts for another one-fourth and the idiosyncratic factor explains about half of housing price fluctuations. However, at the regional level, the factors' contributions vary across a fairly wide range. Although it only has modest explanatory power of housing price volatility, the national factor seems to account for much of the price increase in the current housing boom. Interestingly, the regional factor exerts negative influence on housing prices in a fairly large number of metros lately, only to be outweighed by the national factor's positive contribution. We also explore the possible forces influencing the national factor of housing price movements, including monetary policy, population growth, real economic activity, general inflation and other asset prices.

No. 0706
Pricing-to-Market with State-Dependent Pricing
Anthony Landry
Abstract: This paper extracts information on inflation expectations, the real interest rate, and various risk premiums by exploring the underlying common factors among the actual inflation, University of Michigan consumer survey inflation forecast, yields on U.S. nominal Treasury bonds, and particularly, yields on Treasury Inflation Protected Securities (TIPS). Our findings suggest that a significant liquidity risk premium on TIPS exists, which leads to inflation expectations that are generally higher than the inflation compensation measure at the 10-year horizon. On the other hand, the estimated expected inflation is mostly lower than the consumer survey inflation forecast at the 12-month horizon. Survey participants slowly adjust their inflation forecasts in response to inflation changes. The nominal interest rate adjustment lags inflation movements, too. Our model also edges out a parsimonious seasonal AR(2) time series model in the one-step-ahead forecast of inflation.

No. 0705
Inflation Expectations, Real Interest Rate and Risk Premiums—Evidence from Bond Market and Consumer Survey Data
Dong Fu
Abstract: This paper extracts information on inflation expectations, the real interest rate, and various risk premiums by exploring the underlying common factors among the actual inflation, University of Michigan consumer survey inflation forecast, yields on U.S. nominal Treasury bonds, and particularly, yields on Treasury Inflation Protected Securities (TIPS). Our findings suggest that a significant liquidity risk premium on TIPS exists, which leads to inflation expectations that are generally higher than the inflation compensation measure at the 10-year horizon. On the other hand, the estimated expected inflation is mostly lower than the consumer survey inflation forecast at the 12-month horizon. Survey participants slowly adjust their inflation forecasts in response to inflation changes. The nominal interest rate adjustment lags inflation movements, too. Our model also edges out a parsimonious seasonal AR(2) time series model in the one-step-ahead forecast of inflation.

No. 0704
Real Business Cycle Dynamics Under First-Order Risk Aversion
Jim Dolmas
Abstract: This paper incorporates preferences that display first-order risk aversion (FORA) into a standard real business cycle mode. Although FORA preferences represent a sharp departure from the expected utitility/constant relative risk aversion (EU/CRRA) preferences common in the business cycle literature, the change has only a negligible effect on thr model's second moment implications. In fact, for what I argue is an empirically reasonable "ballpark" calibration of the FORA preferences, the moment implications are essentially identical to those under EU/CRRA, while the welfare cost of aggregate fluctuations in the model is substantially larger.

No. 0703
What Drives Natural Gas Prices?
Stephen P. A. Brown and Mine K. Yücel
Published as: Brown, Stephen P.A. and Mine K. Yücel (2008), "What Drives Natural Gas Prices?," The Energy Journal 29 (2): 45-60.
Abstract: For many years, fuel switching between natural gas and residual fuel oil kept natural gas prices closely aligned with those for crude oil. More recently, however, the number of U.S. facilities able to switch between natural gas and residual fuel oil has declined, and over the past five years, U.S. natural gas prices have been on an upward trend with crude oil prices but with considerable independent movement. Natural gas market analysts generally emphasize weather and inventories as drivers of natural gas prices. Using an error-correction model, we show that when these and other additional factors are taken into account, movements in crude oil prices have a prominent role in shaping natural gas prices. Our findings imply a continuum of prices at which natural gas and petroleum products are substitutes.

No. 0702
The Impact of Evolving Labor Practices and Demographics on U.S. Inflation and Unemployment
John V. Duca and Carl M. Campbell III
Abstract: Since the early 1990s, NAIRU estimates have declined and unemployment duration has risen relative to the unemployment rate. These developments may have arisen from the aging of the workforce or practices reducing job turnover. We assess the internal consistency of these hypotheses using simulation methods and test their external consistency using modified NAIRU models. We find that demographics cannot fully account for changes in the NAIRU, consistent with Staiger, Stock, and Watson (2001) and in contrast to Shimer (1998, 2001). Instead, our results attribute shifts in the NAIRU and duration to a combination of shifts in demographics and job turnover.

No. 0701

Home Bias, Exchange Rate Disconnect, and Optimal Exchange Rate Policy
Jian Wang
Published as: Wang, Jian (2010), "Home Bias, Exchange Rate Disconnect, and Optimal Exchange Rate Policy," Journal of International Money and Finance 29 (1): 55-78.
Abstract: This paper examines how much the central bank should adjust the interest rate in response to real exchange rate fluctuations. The paper first demonstrates in a two-country Dynamic Stochastic General Equilibrium (DSGE) model, that the home bias in consumption is important to duplicate the exchange rate volatility and exchange rate disconnect documented in the data. When home bias is high, the shock to Uncovered Interest-rate Parity (UIP) can substantially drive up exchange rate volatility while leaving the volatility of real macroeconomic variables, such as GDP, almost untouched. The model predicts the volatility of the real exchange rate relative to that of GDP increases with the extent of home bias. This relation is strongly supported by the data. Then a second-order accurate solution method is employed to solve the model and compare the conditional welfare under different policy regimes. The results suggest that the monetary authority should not seek to vigorously stabilize exchange rate fluctuations. In particular, when the central bank does not take a strong stance against the inflation rate, exchange rate stabilization may induce substantial welfare loss. The model also suggests no welfare gain from the international monetary cooperation, which extends Obstfeld and Rogoff's (2002) findings to a DSGE model.

Globalization Institute Working Papers

Globalization Institute No. 5
Production Sharing and Real Business Cycles in a Small Open Economy 
José Joaquín López
Abstract: Production sharing and vertical specialization account for a significant share of trade between developed and developing countries. The Mexican maquiladora industry provides an ideal example of production sharing in a small open economy. The typical "maquila" imports most of its inputs from and exports all its output to the United States. This article tries to determine to what extent production sharing, as in the Mexican maquiladora, can serve as a transmission mechanism of business cycles in small open economies. We utilize a simple two-sector small open economy model of real business cycles that incorporates production sharing in the traded sector. The transmission channel of business cycles is introduced in the model via demand shocks to the traded sector, originated in the United States' manufacturing sector. The model is successful in replicating real business cycles statistics for the maquiladora sector, as well as some of the characteristics of the nontraded sector.

Globalization Institute No. 3
International Trade in Durable Goods: Understanding Volatility, Cyclicality, and Elasticities
Charles Engel and Jian Wang
Published as: Engel, Charles and Jian Wang (2010), "International Trade in Durable Goods: Understanding Volatility, Cyclicality, and Elasticities," Journal of International Economics 83 (1): 37-52.
Abstract: Data for OECD countries document: 1. imports and exports are about three times as volatile as GDP; 2. imports and exports are pro-cyclical, and positively correlated with each other; 3. net exports are counter-cyclical. Standard models fail to replicate the behavior of imports and exports, though they can match net exports relatively well. Inspired by the fact that a large fraction of international trade is in durable goods, we propose a two-country two-sector model, in which durable goods are traded across countries. Our model can match the business cycle statistics on the volatility and comovement of the imports and exports relatively well. In addition, the model with trade in durables helps to understand the empirical regularity noted in the trade literature: home and foreign goods are highly substitutable in the long run, but the short-run elasticity of substitution is low. We note that durable consumption also has implications for the appropriate measures of consumption and prices to assess risk-sharing opportunities, as in the empirical work on the Backus-Smith puzzle. The fact that our model can match data better in multiple dimensions suggests that trade in durable goods may be an important element in open-economy macro models.

Globalization Institute No. 2
A Monetary Model of the Exchange Rate with Informational Frictions
Technical Appendix  (For code and dataset files, contact the author )
Enrique Martínez-García
Published as: Martínez-García, Enrique (2010), "A Model of the Exchange Rate with Informational Fractions," The B.E. Journal of Macroeconomics 10 (1), Contributions: Article 2.
Abstract: Data for the U.S. and the Euro area during the post-Bretton Woods period shows that nominal and real exchange rates are more volatile than consumption, very persistent, and highly correlated with each other. Standard models with nominal rigidities match reasonably well the volatility and persistence of the nominal exchange rate, but require an average contract duration above 4 quarters to approximate the real exchange rate counterparts. I propose a two-country model with financial intermediaries and argue that: First, sticky and asymmetric information introduces a lag in the consumption response to currently unobservable shocks, mostly foreign. Accordingly, the real exchange rate becomes more volatile to induce enough expenditure-switching across countries for all markets to clear. Second, differences in the degree of price stickiness across markets and firms weaken the correlation between the nominal exchange rate and the relative CPI price. This correlation is important to match the moments of the real exchange rate. The model suggests that asymmetric information and differences in price stickiness account better for the stylized facts without relying on an average contract duration for the U.S. larger than the current empirical estimates.

No. 0606
Argentina's Unimpressive Recovery: Insights from a Real Business Cycle Approach
Carlos E. J. M. Zarazaga
Abstract: Argentina's GDP increased 30% between 2002 and 2005, prompting optimistic assessments that the country had finally left behind its secular stagnation. However, this strong performance followed a sharp decline in economic activity and therefore could be the manifestation of a bounce-back effect with no lasting impact on Argentina's mediocre long-run growth rates. The paper examines this conjecture with the quantitative discipline imposed by a Real Business-Cycle methodology and concludes that the 2002-05 expansion was not only a rebound, but also considerably weaker than the model predicts, a finding not consistent with upbeat views about the country's long-run prospects.

No. 0605
The Role of Total Factor Productivity in "Phoenix Miracles": Insights from an Emerging Market Crisis
Carlos E. J. M. Zarazaga
Abstract: Key macroeconomic variables such as GDP and investment typically display a V-shaped pattern during major emerging market crises. A notable exception to that pattern is intermediated credit, which follows an L-shaped trajectory instead: it declines at first in lockstep with economic activity, but later on it fails to recover while output does. From the vantage point of "credit crunch" theories of crises, it is as if output almost literally "rises from its ashes," prompting the metaphoric characterization of emerging markets post-collapse recoveries as Phoenix Miracles.
This paper reorganizes the evidence for a particular emerging market crisis, the one that Argentina experienced in 2000-01, under the guide of the neoclassical growth model. Under that lens, there is nothing special about the V-shaped trajectory that GDP, investment, and labor input followed during the crisis and its aftermath. That is exactly the pattern, and in the same orders of magnitude, that a neoclassical growth model with TFP taken as exogenous would predict. Furthermore, from the vantage point of that model, there is no Phoenix Miracle: the post-collapse recovery of TFP and GDP was about as strong as the model would have predicted.

No. 0604
Expectations and Exchange Rate Dynamics: A State-Dependent Pricing Approach
Anthony E. Landry
Published as: Landry, Anthony (2009), "Expectations and Exchange Rate Dynamics: A State-Dependent Pricing Approach," Journal of International Economics 78 (1): 60-71.
Abstract: We introduce elements of state-dependent pricing and strategic complementarity into an otherwise standard New Open Economy Macroeconomics (NOEM) model. Relative to previous NOEM works, there are new implications for the dynamics of real and nominal economic activity: complementarity in the timing of price adjustment alters an open economy's response to monetary disturbances. Using a two-country Producer-Currency-Pricing environment, our framework replicates key international features following a domestic monetary expansion: (i) a delayed surge in inflation across countries, (ii) a delayed overshooting of exchange rates, (iii) a J-curve dynamic in the domestic trade balance, and (iv) a high international output correlation relative to consumption correlation. Overall, the model is consistent with many empirical aspects of international economic fluctuations, while stressing pricing behavior and exchange rate effects highlighted in traditional Keynesian works.

No. 0603
An Economic Interpretation of Suicide Cycles in Japan
Jahyeong Koo and W. Michael Cox
Published as: Koo, Jahyeong and W. Michael Cox (2008), "An Economic Interpretation of Suicide Cycles in Japan," Contemporary Economic Policy 26 (1): 162-174.
Abstract: Suicide rates in Japan have increased dramatically in recent years, making. Japan's male rate the highest among developed economies. This study revises the standard economic model of suicide to accommodate Japan's experience, focusing on the change in human capital for the unemployed. We then use the new model and de-trended data to empirically investigate the relationship between the suicide cycle and the unemployment cycle. Unlike previous aggregate time series studies, we find that the relationship between the suicide rate and the unemployment rate is significantly and robustly positive for both males and females even after controlling for several social variables.

No. 0602
The Welfare Effects of Pay-as-You-Go Retirement Programs: The Role of Tax and Benefit Timing
Alan D.Viard
Published as: Viard, Alan D. (2007), "The Welfare Effects of Pay-as-You-Go Retirement Programs: The Role of Tax and Benefit Timing," Contemporary Economic Policy 25 (2): 282-292.
Abstract: It is well known that pay-as-you-go retirement programs reduce steady-state welfare and the capital stock in dynamically efficient OLG economies. The common two-period OLG model obscures, however, the dependence of these effects on the ages at which taxes are paid and benefits are received. Program changes that shift taxes to older workers or benefits to younger retirees have effects similar to reductions in program size, yielding steady-state welfare gains and increases in capital accumulation while imposing transition costs on current generations. This analysis has policy implications for both tax and benefit timing.

No. 0601
Employer Matching and 401(k) Participation: Evidence from the Health and Retirement Study
Gary V. Engelhardt and Anil Kumar
Published as: Engelhardt, Gary V. and Anil Kumar (2007), "Employer Matching and 401(k) Participation: Evidence from the Health and Retirement Study," Journal of Public Economics 91 (10): 1920-1943.
Abstract: Employer matching of employee 401(k) contributions can provide a powerful incentive to save for retirement and is a key component in pension-plan design in the United States. Using detailed administrative contribution, earnings, and pension-plan data from the Health and Retirement Study, this analysis formulates a life-cycle-consistent discrete choice regression model of 401(k) participation and estimates the determinants of participation accounting for non-linearities in the household budget set induced by matching. The estimates indicate that an increase in the match rate by 25 cents per dollar of employee contribution raises 401(k) participation by 3.75 to 6 percentage points, and the estimated elasticity of participation with respect to matching ranges from 0.02-0.07. The estimated elasticity of intertemporal substitution is 0.74-0.83. Overall, the analysis reveals that matching is a rather poor instrument with which to raise retirement saving.

No. 0511
Mutual Funds and the Evolving Long-Run Effects of Stock Wealth on U.S. Consumption
John V. Duca
Published as: Duca, John V. (2006), "Mutual Funds and the Evolving Long-Run Effects of Stock Wealth on U.S. Consumption," Journal of Economics and Business 58 (3): 202-221.
Abstract: Lower mutual fund loads have plausibly boosted the stock wealth elasticity of U.S. consumption by enhancing stock liquidity and arguably by inducing stock ownership among middle-income families, consistent with theory and cross-section data (Guiso, Haliassios, and Jappelli (2003), Haliassios (2002), Heaton and Lucas (1996, 2000), and Vissing-Jorgensen (2002)). In load-modified models, the stock wealth elasticity is declining in loads and more stable long-run wealth and income coefficients arise, especially controlling for mortgage refinancing and equity withdrawal activity. Modified models imply that the stock wealth elasticity has risen, while conventional models overestimate the wealth and underestimate the income elasticities of consumption.

No. 0510
Ireland's Great Depression
Alan Ahearne, Finn Kydland and Mark A. Wynne
Published as: Ahearne, Alan, Finn Kydland and Mark A. Wynne (2006), "Ireland's Great Depression," The Economic and Social Review 37 (2): 215-243.
Abstract: We argue that Ireland experienced a great depression in the 1980s comparable in severity to the better known and more studied depression episodes of the interwar period. Using the business cycle accounting framework of Chari, Kehoe and McGrattan (2005), we examine the factors that lead to the depression and the subsequent recovery in the 1990s. We calculate efficiency, labor, investment and government wedges, and evaluate the contribution of each to the downturn and subsequent recovery. We find that the efficiency wedge on its own can account for a significant portion of the downturn, but predicts a stronger recovery in output. The labor wedge also helps account for what happened during the depression episode. We also find that the investment wedge played no role in the depression.

No. 0509
An Estimate of the Measurement Bias in the HICP
Mark A. Wynne
Abstract: This paper provides an estimate of the measurement bias in the Harmonised Index of Consumer Prices (HICP) that the European Central Bank uses to define price stability in the euro area. The estimate is based on a comparison of the rate of increase in consumer prices as measured by the HICP and the responses to a question about recent changes in the cost of living on the European Commission's monthly Harmonised Consumer Survey (HCS). I find that the HICP may overstate the true rate of inflation by about 1.0 to 1.5 percentage points a year.

No. 0508
Did 9/11 Worsen the Job Prospects of Hispanic Immigrants?
Pia M. Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2009), "The Effects of Tougher Enforcement on the Job Prospects of Recent Latin American Immigrants," Journal of Policy Analysis and Management 28 (2): 239-257.
Abstract: This paper examines whether the economic aftermath of 9/11 had an adverse impact on the labor market outcomes of male immigrants from Latin America, who compose the bulk of undocumented foreign-born workers in the U.S. The crackdown on use of fraudulent Social Security numbers, increased requirements for government-issued identification, and other changes associated with greater focus on national security likely lowered the demand for foreign-born workers—particularly the undocumented—relative to natives after 9/11. The relative decline in demand for such workers could have negatively affected employment, hours worked, and earnings. Using Current Population Survey data and a difference-in-difference estimation technique, we find a negative impact after 9/11 on earnings and hours worked among recent male Hispanic immigrants vis-a-vis natives and a negative effect on employment, hours worked, and earnings vis-a-vis Hispanic immigrants who had been in the U.S. longer.

No. 0507
Is It Is or Is It Ain't My Obligation? Regional Debt in a Fiscal Federation
Russell Cooper, Hubert Kempf, and Dan Peled
Published as: Cooper, Russell, Hubert Kempf and Dan Peled (2008), "Is It Is or Is It Ain't My Obligation? Regional Debt in a Fiscal Federation," International Economic Review 49 (4): 1469-1504.
Abstract: This paper studies the repayment of regional debt in a multiregion economy with a central authority: Who pays the obligation issued by a region? With commitment, a central government will use its taxation power to smooth distortionary taxes across regions. Absent commitment, the central government may be induced to bail out the regional government in order to smooth consumption and distortionary taxes across the regions. We characterize the conditions under which bailouts occur and their welfare implications. The gains to creating a federation are higher when the (government spending) shocks across regions are negatively correlated and volatile. We use these insights to comment on actual fiscal relations in three quite different federations: the U.S., the European Union and Argentina.

No. 0506
Trimmed Mean PCE Inflation
Jim Dolmas
Abstract: Research over the past decade has led to improved measures of core inflation in the Consumer Price Index, or CPI. This paper discusses the application of some of the insights and techniques of that line of research to the Federal Reserve Bard of Governors' preferred inflation gauge, the price index for Personal Consumption Expenditures (PCE). The result is a new measure of core PCE inflation—the trimmed mean PCE—and a somewhat different characterization of the economy's recent inflation experience.
Compared to the story told by the usual "excluding food and energy" measure, the trimmed mean PCE tells us that the lows reached in 2003 weren't quite so low and that the highs reached in mid-2004 were really a bit higher. On a 12-month basis, the new measure suggests that core PCE inflation is currently about half a percentage point higher than what is being indicated by the "excluding food and energy" inflation rate.

No. 0505
Nonparametric Estimation of the Impact of Taxes on Female Labor Supply
Anil Kumar
Published as: Kumar, Anil (2012), "Nonparametric Estimation of the Impact of Taxes on Female Labor Supply," Journal of Applied Econometrics 27 (3): 415-439.
Abstract: Econometric models with nonlinear budgets sets frequently arise in the study of impact of taxation on labor supply. Blomquist and Newey (2002) have suggested a nonparametric method to estimate the uncompensated wage and income effects when the budget set is nonlinear. This paper extends their nonparametric estimation method to censored dependent variables. The modified method is applied to estimate female wage and income elasticities using the 1985 and 1989 waves of PSID exploiting the drastic change in the complete budget set caused by TRA 1986 as a source of identification. I find evidence of downward bias in estimated elasticities if the nonlinearity in the budget set is ignored. The estimated wage elasticities range from 0.6 to 0.74 for total hours and from 0.26 to 0.29 on the intensive margin. The income elasticity estimates range from -0.4 to -0.67 overall and from -0.12 to -0.15 on the intensive margin.

No. 0504
Lifecycle-Consistent Female Labor Supply with Nonlinear Taxes: Evidence from Unobserved Effects Panel Data Models with Censoring, Selection and Endogeneity
Anil Kumar
Published as: Kumar, Anil (2016), "Lifecycle-Consistent Female Labor Supply with Nonlinear Taxes: Evidence from Unobserved Effects Panel Data Models with Censoring, Selection and Endogeneity," Review of Economics of the Household 14 (1): 207-229.
Abstract:This paper uses the PSID from 1979–2007 to estimate lifecycle-consistent labor supply elasticities of U.S. females with nonlinear taxes, in a two-stage budgeting framework. The paper is the first to estimate U.S. female labor supply models using semiparametric unobserved effects panel data methods with censoring, selection and endogeneity. The paper finds that female labor supply elasticities, particularly on the intensive margin, are sensitive to both the method used to account for unobserved effects and to economic assumptions regarding lifecycle behavior. The estimated lifecycle-consistent uncompensated wage elasticity for U.S. females from the correlated random effects model with instrumental variables is 0.56 on the extensive margin and 0.31 on the intensive margin, implying an overall wage elasticity of 0.87. In comparison, fixed effects models yield an overall wage elasticity of 0.77, substantially smaller than pooled panel models.

No. 0503
Industrial Structure and Economic Complementarities in City Pairs on the Texas-Mexico Border
Robert W. Gilmer and Jesus Cañas
Abstract: The U.S.–Mexico border provides a number of examples of pairs of neighboring cities, one in the U.S. and the other in Mexico. The advent of the North American Industrial Classification System provides a new opportunity to look at these cities using a common industrial classification system. Using U.S. data from the Bureau of Labor Statistics and Bureau of Economic Analysis, and comparable information from the 1999 Mexican economic census, we were able to compare employment by industry sector in city pairs that are located along the Texas–Mexico border: El Paso–Juarez, Laredo–Nuevo Laredo, Brownsville–Matamoros, and McAllen-Reynosa.
This paper focuses on the distribution of employment in border city pairs. It is primarily descriptive in nature, but looks at industrial structure from several perspectives. First, we look at each city as part of its own national economy, then as part of the combined U.S.–Mexico economy. Second, we demonstrate that each city-pair has a distribution of employment by industry that complements the sister city. Different wage levels, distinct legal and regulatory systems and unlike stages of development provide each city with unique opportunities to specialize in the local marketplace. Finally, we interpret the role of these cities as part of a combined US-Mexico economy. The chief economic role played by all city-pairs is that of a manufacturing center, driven largely by maquiladora activity and its support industries.

No. 0502
Business Cycle Coordination Along the Texas-Mexico Border
Keith R. Phillips and Jesus Cañas
Abstract: In this paper we use a dynamic single-factor model originally due to Stock and Watson [18, 19] to measure the business cycle in four Texas border Metropolitan Statistical Areas (MSAs) and Mexico. We then measure the degree of economic integration between border cities, the US, Texas, and Mexican economies using correlation, spectral and cluster analysis. Results suggest border MSAs are significantly integrated with the broader economies and that major changes have occurred in these relationships since 1994, the year in which NATFA was enacted and the time maquiladora industry began to accelerate.

No. 0501
VAR Estimation and Forecasting When Data Are Subject to Revision
N. Kundan Kishor and Evan F. Koenig
Published as: Kishor, N. Kundan and Evan F. Koenig (2012), "VAR Estimation and Forecasting When Data Are Subject to Revision," Journal of Business and Economic Statistics 30 (2): 181-190.
Abstract: Conventional VAR estimation and forecasting ignores the fact that economic data are often subject to revision many months or years after their initial release. This paper shows how VAR analysis can be modified to account for such revisions. The proposed approach assumes that government statistical releases are efficient with a finite lag. It takes no stand on whether earlier revisions are "noise" or "news." The technique is illustrated using data on employment and the unemployment rate, real GDP and the unemployment rate, and real GDP and the GDP/consumption ratio. In each case, the proposed procedure outperforms conventional VAR analysis and the more-restrictive methods for handling the data-revision problem that are found in the existing literature.

No. 0406
The Impact of Paying Interest on Reserves in the Presence of Government Deficit Financing
Mark G. Guzman
Published as: Guzman, Mark G. (2008), "The Impact of Paying Interest on Reserves in the Presence of Government Deficit Financing," Economic Inquiry 46 (4): 624-642.
Abstract: This paper re-examines the impact that paying interest on reserves has on price level indeterminacy, price level volatility, and overall economic well-being. Unlike previous papers which examined these issues, the model developed in this paper allows the return on reserves to equal the return on government securities, which is less than the prevailing return on storage. Equally important, this model also considers how deficit financing changes the impact that paying interest on reserves has on the economy. I show that the number of steady state equilibria are equal to, or greater than, the number that arise when no interest is paid on reserves. In other words, the level of economic indeterminacy is equal to or greater than in an economy without interest payments. When the level of indeterminacy is the same, then economic volatility is reduced with the introduction of interest payments. However, when there exists greater indeterminacy in the interest-on-reserves economy, then there also exists greater volatility. In addition, under certain conditions, paying interest on reserves can be welfare enhancing. When it is not, an appropriate expansionary open market operation can offset the welfare losses associated with interest payments. Finally, under a narrow set of conditions, unpleasant monetarist arithmetic may obtain.

No. 0405
Optimal Monetary Policy in Economies with "Sticky-Information" Wages
Evan F. Koenig
Abstract: In economies with sticky-information wage setting, policymakers legitimately give attention to output stabilization as well as price-level or inflation stabilization. Consistent with Kydland and Prescott (1990), trend deviations in prices are predicted to be negatively correlated with trend deviations in output. A variant of the Taylor rule is optimal if household consumption decisions are forward-looking. Interestingly, it is essential that policy not be made contingent on the most up-to-date estimates of potential output, potential-output growth, or the natural real interest rate. New results on the "persistence problem" and a new rationalization for McCallum's P-bar inflation equation are also presented.

No. 0404
The Impact of E-Business Technologies on Supply Chain Operations: A Macroeconomic Perspective
Amit Basu and Thomas F. Siems
Abstract: New information technologies and e-business solutions have transformed supply chain operations from mass production to mass customization. This paper assesses the impact of these innovations on economic productivity, focusing on the macroeconomic benefits as supply chain operations have evolved from simple production and planning systems to today's real-time performance-management information systems using advanced e-business technologies. While many factors can influence macroeconomic variables, the impact of IT-enabled supply chains should not be overlooked. We find evidence that the impact of e-business technologies on supply chain operations have resulted in a reduced "bullwhip effect," lower inventory, reduced logistics costs, and streamlined procurement processes. These improvements, in turn, have likely helped to lower inflation, reduce economic volatility, strengthen productivity growth, and improve standards of living.

No. 0403
Why Have U.S. Households Increasingly Relied on Mutual Funds to Own Equity?
John V. Duca
Published as: Duca, John V. (2005), "Why Have U.S. Households Increasingly Relied on Mutual Funds to Own Equity?" Review of Income and Wealth 51 (3): 375-396.
Abstract: Since the early 1990s, U.S. households have increasingly used mutual funds to own equity assets. Results indicate that this owes to two developments over the period 1970–2002 that are broadly consistent with the implications of Heaton and Lucas' (2000) model of equity participation. In that model, lower asset transfer costs and lower income risk can induce equity investing by less wealthy households, who—in practice and owing to diversification considerations—are more apt to indirectly hold stocks through mutual funds. The first factor is a pronounced decline in equity mutual fund loads, which are highly negatively correlated with the overall stock ownership rate, which has doubled owing to a rising percentage of households that own stocks only through mutual funds. The second is a general improvement since the 1970s in household expectations about future family financial conditions that may have induced households at the margin to become shareholders.

No. 0402
Accounting for Fluctuations in Social Network Usage and Migration Dynamics
Mark G. Guzman, Joseph H. Haslag and Pia M. Orrenius
Abstract: In this paper, we examine network capital usage and migration patterns in a theoretical model. Networks are modeled as impacting the migration decision in many ways. When young, larger networks reduce the time lost moving from one region to another. In addition networks decrease the time spent searching for a job. Finally, when old, migrants receive transfer payments through the network. We show that the number and properties of steady state equilibria as well as the global dynamics depend crucially on whether the returns to network capital accumulation exhibit constant, increasing, or decreasing returns to scales relative to the level of network capital. With constant returns to scale, migration flows and network capital levels are characterized by either a unique steady state equilibria or by a two-period cycle. The fluctuations in network capital usage exhibited by our model are consistent with recent empirical data regarding the usage of networks by Mexican immigrants. In the case of increasing returns to scale, either there exists a unique, stable steady state equilibria or multiple equilibria which are characterized as either sinks or saddles. When the returns to scale are decreasing, there exists a unique, stable steady state equilibrium. Finally, we show that increasing barriers to migration will result in an increase in the flow of immigrants, contrary to the desired effect, in the constant and increasing returns to scale cases.

No. 0401
A New Monthly Index of the Texas Business Cycle
Keith R. Phillips
Published as: Phillips, Keith R. (2005), "A New Monthly Index of the Texas Business Cycle," Journal of Economic and Social Measurement 30 (4): 317-333.
Abstract: The timing, length and severity of economic recessions and expansions in a state are important to businesses seeking to set up operations or expand in those areas. Given a limited amount of data at the state level and their sometimes inconsistent movements, it is not straight forward to define a state business cycle. In this article I attempt to measure the Texas business cycle using a technique developed by Stock and Watson (1989,1991) that statistically estimates the underlying comovement in broad indicators of the state's economy.
The new Texas Coincident Index (TCI) is constructed with the Texas unemployment rate, a quarterly Real Gross State Product measure due to Berger and Phillips (1995), and a nonfarm employment series that is benchmarked quarterly and is seasonally adjusted using the two-step approach described in Berger and Phillips (1993). Use of these components and the Kalman filter, which smoothes across variables as well as over time, results in an index which is much smoother and gives clearer signals of turning points than the old TCI produced by Phillips (1988). The new TCI exhibits cyclical patterns that are highly correlated with those of employment and RGSP, and matches well with recessions and expansions that were independently identified.

No. 0306
The Relative Price Effects of Monetary Shocks
Nathan S. Balke and Mark A. Wynne
Published as: Balke, Nathan S. and Mark A. Wynne (2007), "The Relative Price Effects of Monetary Shocks," Journal of Macroeconomics 29 (1): 19-36.
Abstract: We document the response of the individual components of the Producer Price Index (PPI) to commonly used measures of monetary shocks, and show that these responses are at variance with many widely-used "macro" models of monetary non-neutrality. Monetary shocks are shown to have large relative price effects, resulting in an increase in the dispersion of the cross-section distribution of prices. Furthermore, in response to a contractionary (expansionary) monetary shock, a substantial number of prices tend to rise (fall). Most of the existing models of monetary nonneutrality are not capable of replicating these types of relative price responses.

No. 0305
A Role for Government Policy and Sunspots in Explaining Endogenous Fluctuations in Illegal Immigration
Mark G. Guzman, Pia M. Orrenius and Joseph Haslag
Published as: Guzman, Mark, Joseph Haslag and Pia M. Orrenius (2015), "Government Policy under Price Uncertainty: A Source of Volatility in Illegal Immigration," Canadian Journal of Economics 48 (3): 940-962.
Abstract: In this paper we provide an alternative explanation for why illegal immigration can exhibit substantial fluctuations despite a constant wage gap. We develop a model economy in which migrants make decisions in the face of uncertain border enforcement and lump-sum transfers from the host country. The uncertainty is extrinsic in nature, a sunspot, and arises as a result of ambiguity regarding the commodity price of money. Migrants are restricted from participating in state-contingent insurance markets in the host country, whereas host country natives are not. We establish the existence of sunspot equilibria that are not mere randomizations over certainty equilibria. Volatility in migration flows stems from two distinct sources: the tension between transfers inducing migration and enforcement discouraging it and secondly the existence of a sunspot. Finally, we examine the impact of a change in tax/transfer policies by the government on migration.

No. 0304
Business Cycles: The Role of Energy Prices
Stephen P. A. Brown, Mine K. Yücel, and John Thompson
Abstract: Oil price shocks have figured prominently U.S. business cycles since the end of World War II-although the relationship seems to have weakened during the 1990s. In addition the economy appears to respond asymmetrically to oil price shocks, rising oil prices hurt economic activity more than falling oil prices help it. This section of the Encyclopedia of Energy sorts through an extensive economics literature that relates oil price shocks to aggregate economic activity. It examines how oil price shocks create business cycles, why they seem to have a disproportionate effect on economic activity, why the economy responds asymmetrically to oil prices, and why the relationship between oil prices and economic activity may have weakened. It also addresses the issue of developing energy policy to mitigate the economic effects of oil price shocks.

No. 0303
The Effect of Undocumented Immigration and Border Enforcement on Crime Rates along the U.S.-Mexico Border
Roberto Coronado and Pia M. Orrenius
Published as: Coronado, Roberto and Pia M. Orrenius (2007), "The Effect of Undocumented Immigration and Border Enforcement on Crime Rates along the U.S.-Mexico Border," Migraciones Internacionales 4 (1): 39-64.
Abstract: In the 1990s, the U.S. border led the nation in the decline of property-related crimes, while violent crime rates fell twice as fast in the U.S. as in the median border county. This paper asks how changes in undocumented immigration and border enforcement have played a role in generating these divergent trends. We find that while migrant apprehensions are correlated with a greater incidence of violent crime, they are not systematically associated with higher rates of property crime. Border patrol enforcement is associated with lower property crime rates but higher violent crime. Interestingly, it is local enforcement (same or neighboring sector) that is correlated with higher violent crime. Higher border enforcement overall is correlated with less violent crime. Several trends likely underlie these results. First, more enforcement in urban versus rural areas has pushed property crime rates down by keeping migrants and smugglers away from densely populated areas. Second, it is likely that more enforcement (and other factors) have led to an increased use of professional smugglers which in turn has led to more violence on the border.

No. 0302
Does Immigration Affect Wages? A Look at Occupation-Level Evidence
Pia M. Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2007), "Does Immigration Affect Wages? A Look at Occupation-Level Evidence," Labour Economics 14 (5): 757-773.
Abstract: Previous research has reached mixed conclusions about the effect of higher levels of immigration on the wages of natives. This paper reexamines this question using data from the Current Population Survey and the Immigration and Naturalization Service and focuses on differential effects by skill level. Using occupation as a proxy for skill, we find that an increase in the fraction of foreign-born workers tends to lower the wages of natives in blue collar occupations—particularly after controlling for endogeneity—but does not have a statistically significant negative effect among natives in skilled occupations. The results also indicate that immigrants adjusting their immigration status within the U.S., but not newly arriving immigrants, have a significant negative impact on the wages of low-skilled natives. This suggests that immigrants become closer substitutes for natives as they spend more time in the U.S.

No. 0301
Fiscal Policy and Growth
Dong Fu, Lori L. Taylor and Mine K. Yücel
Abstract: In the literature neither taxes, government spending nor deficits are robustly correlated with economic growth when evaluated individually. The lack of correlation may arise from the inability of any single budgetary component to fully capture the stance of fiscal policy. We use pair-wise combinations of fiscal indicators to assess the relationship between fiscal policy and U.S. growth.

We develop a VAR methodology for evaluating simultaneous shocks to more than one variable and use it to examine the impulse responses for simultaneous, unexpected and equivalent structural shocks to pair-wise combinations of fiscal indicators. We also exploit the identity relationship between taxes, spending and deficits and follow Sims and Zha (1998) to evaluate an unexpected structural shock to one included fiscal indicator, holding constant the other included indicator. We find that an increase in the size of federal government leads to slower economic growth, that the deficit is an unreliable indicator of the stance of fiscal policy, and that tax revenues are the most consistent indicator of fiscal policy.

No. 0206
Measurement Bias in The HICP: What Do We Know and What Do We Need to Know?
Mark A. Wynne and Diego Rodriguez-Palenzuela
Published as: Wynne, Mark A. and Diego Rodriquez-Palenzuela (2004), "Measurement Bias in The HICP: What Do We Know and What Do We Need to Know?" Journal of Economic Surveys 18 (1): 79-112.
Abstract: The Harmonized Index of Consumer Prices (HICP) is the primary measure of inflation in the euro area, and plays a central role in the policy deliberations of the European Central Bank (ECB). The ECB defines its Treaty mandate of price stability as ".a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2 percent [.] to be maintained over the medium term." Among the rationales given for defining price stability as prevailing at some positive measured inflation rate is the possibility that the HICP as published incorporates measurement errors of one sort or another that may cause it to systematically overstate the true rate of inflation in the euro area. This paper reviews what currently is known about the scope of measurement error in the HICP. We conclude that given the vague conceptual framework of the HICP, the scant research on price measurement issues in the EU and the ongoing improvements in the HICP, there is very little scientific basis at this time for a point (or even an interval) estimate of a positive bias in the HICP.

No. 0205
A First Assessment of Some Measures of Core Inflation for the Euro Area
Juan-Luis Vega and Mark A. Wynne
Published as: Vega, Juan-Luis and Mark A. Wynne (2003), "A First Assessment of Some Measures of Core Inflation for the Euro Area," German Economic Review 4 (3): 269-306.
Abstract: Core inflation plays an important role in the deliberations of monetary policymakers. In this paper we evaluate a number of measures of core inflation constructed using euro area data. In addition to the traditional exclusion-type core measures, we examine two newer ones, documenting their properties and evaluating their performance in terms of their ability to track underlying or trend inflation in real time. We focus on core measures derived from the Harmonized Index of Consumer Prices (HICP) as the European Central Bank has chosen to define its mandate for price stability in terms of this index, and because this is the only index of consumer prices that is compiled in an comparable manner across all members of the European Union. We document significant excess kurtosis in the cross-section distribution of price changes in the euro area, and show that several categories of prices are more volatile than those typically excluded from traditional measures of core inflation. Contrary to what one might expect, traditional measures of core inflation are not significantly less volatile than headline measures. We document the superior performance of alternative measures of core inflation in tracking trend inflation on average, but show that none of the various measures of core gave significant advance warning of the pickup in trend inflation at the beginning of 1999.

No. 0204
Argentina's Recovery and "Excess" Capital Shallowing of the 1990s
Finn E. Kydland and Carlos E. J. M. Zarazaga
Published as: Kydland, Finn E. and Carlos E.J.M. Zarazaga (2002), "Argentina's Recovery and "Excess" Capital Shallowing of the 1990s," Estudios de Economia 29 (1): 35-45.
Abstract: The paper examines Argentina's economic expansion in the 1990s through the lens of a parsimonious neoclassical growth model. The main finding is that investment remained considerably weaker than what the model would have predicted. The resulting excessive "capital shallowing" could be identified as a weakness of the rapid economic growth of the 1990s that may have played a role in Argentina's ultimate inability to escape the crisis that started to unfold towards the end of that decade.

No. 0203
How Much Does International Trade Affect Business Cycle Synchronization?
William C. Gruben, Jahyeong Koo and Eric Millis
Abstract: In a recent article, Jeffrey Frankel and Andrew Rose (1998) examine the hypothesis that greater trade flows between two countries cause greater synchronicity between their business cycles. The increase in business cycle synchronicity may be seen as rationalizing a common monetary policy and, so, a shared currency. Arguing that product specialization would lower the synchronicity of business cycles, Frankel and Rose posit that a regression of output correlation on overall trade will indicate whether (positive) common demand shocks and productivity spillovers dominate or (negative) specialization effects do. The authors apply instrumental variables to confirm a causal relationship. In this paper, we refine the estimation in two ways. First, we test for instrument validity and find that the confirming null hypothesis is rejected in most cases. We find evidence to suggest that the instrumental variables method applied is inappropriate and results in inflated coefficients. We develop and apply an alternative OLS-based estimation procedure. Second, we add structure-of-trade variables to the model to separate the effects of intra- and inter-industry trade flows. Although our results suggest that the Frankel and Rose model overestimates the effect of trade on business cycle correlation, the overall results of our model are consistent with theirs. With our own model estimation, we find that specialization generally does not significantly asynchronize business cycles between two countries.

No. 0202
State and Local Policy, Factor Markets and Regional Growth
Stephen P.A. Brown, Kathy J. Hayes and Lori L. Taylor
Published as: Brown, Stephen P.A. , Kathy J. Hayes and Lori L. Taylor (2003), "State and Local Policy, Factor Markets and Regional Growth," The Review of Regional Studies 33 (1): 40-60.
Abstract: A large and growing literature to explain how state and local policies affect factor markets, firm location and economic growth has developed in three distinct threads. These threads have variously emphasized how policy and natural amenities affect regional economic growth or firm location; how variations in policy and natural amenities can lead to persistent wage differentials across regions; and how regional variation in factor inputs, including public capital, affects output. In this article, we expand the modeling framework of Roback and Gyourko and Tracy to integrate these threads into a single inquiry about how state and local policies—including the provision public capital—affects factor markets and economic growth. Using the model as the basis for estimation, we find that state and local policies have a more profound influence on the private capital-to-labor ratio in a region than on private output. Furthermore, the evidence suggests that the growth of government—either in the form of services or public capital—discourages private sector growth.

No. 0201
Coyote Crossings: The Role of Smugglers in Illegal Immigration and Border Enforcement
Mark G. Guzman, Joseph H. Haslag and Pia M. Orrenius
Published as: Guzman, Mark G., Joseph H. Haslag and Pia M. Orrenius (2008), "On the Determinants of Optimal Border Enforcement," Economic Theory 34 (2): 261-296.
Abstract: Illegal immigration and border enforcement in the United States have increased concomitantly for over thirty years. One interpretation is that U.S. border policies have been ineffective. We offer an alternative view, extending the current immigration-enforcement literature by incorporating both the practice of people smuggling and a role for nonwage income into a two-country, dynamic general equilibrium model. We state conditions under which two steady state equilibria exist: one with a low level of capital and high amount of illegal immigration and the other with a high level of capital, but relatively little migration. We then analyze two shocks: a positive technology shock to smuggling services and an increase in border enforcement. In the low-capital steady state, the capital-labor ratio declines with technological progress in smuggling, while illegal immigration increases. In the high-capital steady state, a technology shock causes the capital-labor ratio to rise while the effect on migration is indeterminate. We show that an increase in border enforcement is qualitatively equivalent to a negative technology shock to smuggling. Finally, we show that a developed country would never chose small levels of border enforcement over an open border. Moreover, a high level of border enforcement is optimal only if it significantly decreases capital accumulation. In addition we provide conditions under which an increase in smuggler technology will lead to a decline in the optimal level of enforcement.

No. 0110
Are Labor Markets Segmented in Argentina? A Semiparametric Approach
Sangeeta Pratap and Erwan Quintin
Published as: Pratap, Sangeeta and Erwan Quintin (2006), "Are Labor Markets Segmented in developing countries? A Semiparametric Approach," European Economic Review 50 (7): 1817-1841.
Abstract: We use data from Argentina's household survey to evaluate the hypothesis that informal workers would expect higher wages in the formal sector. Using various definitions of informal employment we find that, on average, formal wages are higher than informal wages. Parametric tests suggest that a formal premium remains after controlling for individual and establishment characteristics. However, this approach suffers from several econometric problems, which we address with semiparametric methods. The resulting formal premium estimates prove either small and insignificant, or negative. In other words, we find no evidence that Argentina's labor markets are segmented along formal/informal lines.

No. 0109
Limited Enforcement and the Organization of Production
Erwan Quintin
Published as: Quintin, Erwan (2008), "Limited Enforcement and the Organization of Production," Journal of Macroeconomics 30 (3): 1222-1245.
Abstract: This paper describes a dynamic, general equilibrium model designed to assess whether contractual imperfections in the form of limited enforcement can account for international differences in the organization of production. In the model, limited enforcement constrains some agents to operate establishments below their optimal scale. As a result, economies where contracts are enforced more efficiently tend to be richer and emphasize large scale production. Calibrated simulations of the model reveal that these effects can be large and account for a sizeable part of the observed differences in the size distribution of manufacturing establishments between Mexico and the United States.

No. 0108
Banking and Finance in Argentina in the Period 1900–35
Leonard Nakamura and Carlos E. J. M. Zarazaga
Abstract: From 1900 to 1935, Argentina evolved from an economy highly dependent on external, primarily British, finance to one more nearly self-sufficient. We examine the failure of domestic finance to adequately fill the void left by the decline of London and the breakdown of the world financial system in the interwar period, when neither the Buenos Aires Bolsa nor the private domestic banks developed rapidly enough to fully replace British investors as efficient channels for financing private investment. One consequence is that Argentine investable funds were increasingly concentrated in a single institution, the Banco de la Nacion Argentina (BNA), creating a lopsided financial structure that was vulnerable to rent seeking and to authoritarian capture. Nevertheless, several measures, including gold reserves, interest rates, money supply, bank credit, and the market capitalization of domestic corporations, attest to the very high level of financial development achieved by Argentina.

No. 0107
Argentina's Lost Decade
Finn E. Kydland and Carlos E. J. M. Zarazaga
Published as: Kydland, Finn E. and Carlos E.J.M. Zarazaga (2002), "Argentina's Lost Decade," Review of Economic Dynamics 5 (1): 152-165.
Abstract: Argentina suffered a great depression in the 1980s that was as severe as the Great Depression experienced in the United States and Germany in the interwar period. Our paper examines this great depression from the perspective of growth theory, taking total factor productivity as exogenous. Overall, the predictions of the model are encouraging for the view that neoclassical growth theory can account for the main growth features of Argentina's lost decade and the subsequent recovery in the 1990s.

No. 0106
Did NAFTA Really Cause Mexico's High Maquiladora Growth?
William C. Gruben
Abstract: Although Mexico's maquiladora or in-bond plant system is an important and well-recognized component of Mexico-U.S. trade, the connection between the acceleration in maquiladora growth and NAFTA is less clearly understood. A broad cross-section of maquiladora observers-including journalists, political activists, industry analysts, and professors-argue that Mexico's maquiladoras have been strongly influenced by NAFTA and have grown rapidly as a result. There are reasons to wonder if these conjectures are correct. I test for the contribution of NAFTA to fluctuations in maquiladora employment and find evidence that no such connection exists. Instead, maquiladoras' post-NAFTA growth is connected to changes in Mexican wages relative to those in Asia and in the United States, and to fluctuations in U.S. industrial production. Indeed, for every 1 percent change in U.S. industrial production I find a change in maquiladora employment of between 1.2 percent and 1.3 percent. This connection is consistent with declining maquiladora employment in 2001, as U.S. industrial production has fallen, but is not consistent with the NAFTA-caused-maquiladora growth story typically found in newspapers and magazines.

No. 0105
Dollarization and Monetary Unions: Implementation Guidelines
William C. Gruben, Mark A. Wynne, and Carlos E. J. M. Zarazaga

No. 0104
Capital Account Liberalization and Disinflation in the 1990s
William C. Gruben and Darryl McLeod
Abstract: As a way of addressing arguments in the literature (Rodrik, 1998) that the act of capital account liberalization leads to inflation, we present a simple theoretical model in which capital account liberalization raises the absolute value of the elasticity of money demand because agents have broader money holding options than under a closed capital account. The central bank maximizes seigniorage, balancing the benefits of higher inflation against potential losses of foreign currency reserves. The optimum seigniorage-maximizing rate of inflation falls when capital controls are loosened, as a result of the impact of liberalization on the elasticity of money demand. In a series of OLS and instrumental variables models that are heavily influenced by the work of Romer (1993) on current account openness and Grilli and Milesi-Ferretti (1995) on capital account openness, we test the impact of the act capital account liberalization (and many other factors) on inflation and find results that are consistent with our simple theoretical model and that are inconsistent with the recent work of Rodrik (1998).

No. 0103
Do Amnesty Programs Encourage Illegal Immigration? Evidence from IRCA
Pia M. Orrenius and Madeline Zavodny
Published as: Orrenius, Pia M. and Madeline Zavodny (2003), "Do Amnesty Programs Encourage Illegal Immigration? Evidence from IRCA," Demography 40 (3): 437-450.
Abstract: This paper examines whether allowing certain undocumented immigrants to legalize their status leads to additional illegal immigration. We focus on the effects of the 1986 Immigration Reform and Control Act, which granted amnesty to over 3 million undocumented immigrants. We find that apprehensions of persons attempting to illegally cross the U.S.-Mexico border declined immediately following passage of the law but returned to normal levels during the period when illegal immigrants could file for amnesty and the years thereafter. Our findings suggest that the amnesty program did not change long-run patterns of illegal immigration from Mexico.

No. 0102
Energy Prices and Aggregate Economic Activity: An Interpretative Survey
Stephen P. A. Brown and Mine K. Yücel
Published as: Brown, Stephen P.A. and Mine K. Yücel (2002), "Energy Prices and Aggregate Economic Activity: An Interpretative Survey," The Quarterly Review of Economics and Finance 42 (2): 198-208.
Abstract: In this paper, we survey the theory and evidence linking fluctuations in energy prices to aggregate economic activity. We then briefly examine the implications of this research for both monetary policy and energy policy in response to oil price shocks. Research seems to provide relatively reliable guidance for monetary policy. Because the precise channels through which oil price shocks affect economic activity are only partially known, however, research offers less guidance about how energy policy should cope with oil price shocks.

No. 0101
What Goes Down Must Come Up: Understanding Time-Variation in the NAIRU
Evan F. Koenig
Abstract: The behavior of inflation during the 1990s is consistent with the predictions of a model that assumes a constant long-run NAIRU and a constant long-run markup of output prices over unit labor costs. Within this framework, inflation fell during the late 1990s-despite low unemployment-chiefly because an unusually high markup allowed firms to increase wages without raising prices. As the markup returns to normal, the recent unusually favorable unemployment-inflation trade-off can be expected to deteriorate. More generally, movements in the markup induce persistent but ultimately temporary variation in the NAIRU.

No. 0006
The Dynamics of Immigration Policy with Wealth-heterogeneous Immigrants
James F. Dolmas and Gregory W. Huffman
Abstract: In this paper we consider a simple intertemporal economy in which immigrants, if admitted, bring heterogeneous amounts of capital. We show that under certain conditions there is a level of immigration which maximizes the economy's capital-labor ratio, and that this level of immigration is the preferred choice of a majority of the economy's citizens. We then characterize, in an overlapping generations setting, the dynamics of capital accumulation and immigration policy, which can include multiple steady state equilibria and a sensitivity of immigration levels to changes in the economy's technology growth rate.

No. 0005
Self-Selection Among Undocumented Immigrants from Mexico
Pia Orrenius and Madeline Zavodny
Published as: Orreninus, Pia M. and Madeline Zavodny (2005), "Self-Selection Among Undocumented Immigrants from Mexico," Journal of Development Economics 78 (1): 215-240.
Abstract: This paper examines the effect of changes in migration determinants on the skill level of undocumented immigrants from Mexico. We focus on the effect of changes in economic conditions, migrant networks, and border enforcement on the educational attainment of Mexican-born men who cross the border illegally. Although previous research indicates that illegal aliens from Mexico tend to be unskilled relative to U.S. natives and that economic conditions, networks and border enforcement affect the size of illegal immigrant flows across the border, the interaction of these variables has not been investigated. Results from hazard models using data from the Mexican Migration Project indicate that improvements in U.S. and Mexican economic conditions are associated with relatively less-skilled undocumented immigrants. Stricter border enforcement is associated with higher skill levels. Access to a network of previous immigrants appears to lower the cost of migrating but has no differential effect by skill level.

No. 0004
The Use and Abuse of "Real-Time" Data in Economic Forecasting
Evan F. Koenig, Sheila Dolmas and Jeremy Piger
Published as: Koenig, Evan F., Shelia Dolmas and Jeremy Piger (2003), "The Use and Abuse of "Real-Time" Data in Economic Forecasting," The Review of Economics and Statistics 85 (3): 618-628.
Abstract: We distinguish between three different ways of using real-time data to estimate forecasting equations and argue that the most popular approach should generally be avoided. The point is illustrated with a model that uses monthly industrial production, employment, and retail sales data to predict real GDP growth. When the model is estimated using our preferred method, its out-of-sample forecasting performance is superior to that obtained using conventional estimation and compares favorably with that of the Blue-Chip consensus.

No. 0003
Unilateral OECD Policies to Mitigate Global Climate Change
Stephen P. A. Brown and Hillard G. Huntington
Abstract: This article offers an alternative perspective for thinking about climate change policy when the developing countries are not participating. If industrialized countries cooperate with each other to reduce their emissions, but comply at levels below those required under the Kyoto protocol, they will have incentives to adopt policies that are more costly to the world than a carbon tax. These incentives result from terms-of-trade gains that result if conservation lowers world prices lower for fuels the industrialized countries import. We consider cases where the industrialized countries act cooperatively and non-cooperatively to achieve these gains. Because the regional terms-of-trade effects of a particular policy cancel each other at the world level, participating nations have incentives to adopt policies that are more costly to non-participants than a carbon tax that minimizes world costs.

No. 0002
On Fed Watching and Central Bank Transparency in an Overlapping Generations Model
Joseph H. Haslag
Abstract: I develop a simple general equilibrium model that integrates fed watching with central bank opaqueness. With the intergenerational conflict, opaqueness can solve a Ramsey problem. With monetary uncertainty as the only source of randomness, transparency is the welfare maximizing policy. With other sources of variation, transparency is costly in the sense that it limits the central bank's response to intrinsic shocks. In short, opaqueness is the veil that permits the central bank freedom to choose money growth in a way to raise welfare.

No. 0001
Low Frequency Movements in Stock Prices: A State Space Decomposition
Nathan S. Balke and Mark E. Wohar
Published as: Balke, Nathan S. and Mark E. Wohar (2002), "Low Frequency Movements in Stock Prices: A State Space Decomposition," The Review of Economics and Statistics 84 (4): 649-667.
Abstract: Previous analyses have concluded that expectations of future excess stock returns rather than future real dividend growth or real interest rates are responsible for most of the volatility in stock prices. In this paper, we employ a state-space model to model the dynamics of the log price-dividend ratio along with long-term and short term interest rates, real dividend growth, and inflation. The advantage of the state space approach is that we can parsimoniously model the low frequency movements present in the data. We find that if one allows permanent changes, even though very small, in real dividend growth, real interest rates, inflation but not excess stock returns then expectations of real dividend growth and real interest rates become significant contributors to fluctuations in stock prices. However, we also show that stock price decompositions are very sensitive to assumptions about which unobserved market fundamentals have a permanent component. When we allow excess stock returns to have a permanent component but not real dividend growth, then excess stock returns becomes an important contributor to stock price movements while real dividend growth is not. Unfortunately, the data is not particularly informative about which of these alternative models is more likely.

No. 9914
Does the Choice of Nominal Anchor Matter?
David M. Gould
Abstract: The conventional wisdom on nominal anchors is that exchange rate-based inflation stabilizations lead to economic booms while monetary-based stabilizations lead to recessions. This study finds strong evidence against this view. Rather than determining the path of economic growth, the choice of nominal anchor appears to be endogenously determined by the state of the economy. To peg or manage the exchange rate, a high level of international reserves is important, especially when a government's credibility is low after a period of high inflation. After controlling for the level of international reserves and the rate of inflation, growth after monetary-based stabilizations does not significantly differ from that following exchange rate-based stabilizations.

No. 9913
Is Foreign-Currency Indexed Debt a Commitment Technology? Some Evidence from Brazil and Mexico
William C. Gruben and Darryl McLeod

Abstract: We examine the effects of foreign currency-indexed debt upon inflationary expectations in Brazil and Mexico. Conjecturing that markets will view increasing overhangs of foreign currency-indexed debt as a commitment technology that fiscally punishes devaluation, we test whether increasing such overhangs will attenuate the effect of monetary growth upon inflationary expectations. We find some econometric confirmation of these conjectures in both the Brazilian and Mexican cases. Finding that the results are consistent with the notion that increasing the share of dollar indexed debt may also permit some temporary monetary independence even under pegged exchange rate regimes, we present some evidence of independent policy behavior during periods when are model results would suggest it.

No. 9912
Legal Fee Restrictions, Moral Hazard, and Attorney Profits
Rudy Santore and Alan D. Viard
Published as: Santore, Rudy and Alan D. Viard (2001), "Legal Fee Restrictions, Moral Hazard, and Attorney Profits," Journal of Law and Economics 44 (2): 549-572.
Abstract: When attorney effort is unobservable and certain other simplifying assumptions (such as risk neutrality) hold, it is efficient for an attorney to purchase the rights to a client's legal claim. However, the American Bar Association Model Rules of Professional Conduct prohibit this arrangement. We show that this ethical restriction, which is formally equivalent to requiring a minimum fixed fee of zero, can create economic rents for attorneys, even though they continue to compete along the contingent-fee dimension. The contingent fee is not bid down to the zero-profit level, because such a fee does not induce sufficient attorney effort. We thereby provide a political economy explanation for these restrictions.

No. 9911
Oil Price Shocks and the U.S. Economy: Where Does the Asymmetry Originate?
Nathan S. Balke, Stephen P. A. Brown and Mine Yucel
Published as: Balke, Nathan S., Stephen P.A. Brown and Mine K. Yucel (2002), "Oil Price Shocks and the U.S. Economy: Where Does the Asymmetry Originate?," The Energy Journal 23 (3): 27-52.
Abstract: Rising oil prices appear to retard aggregate U.S. economic activity by more than falling oil prices stimulate it. Past research suggests adjustment costs and/or monetary policy may be possible explanations ofthe asymmetric response. This paper uses a quasi-vector autoregressive model of U. S. economy to examine from where the asymmetry might originate. The analysis uses counterfactual impulse response experiments to detennine that monetary policy alone cannot account for the asymmetry. The robustness ofshort-lived asymmetry across the base case and counterfactuals is consistent with the adjustment-cost explanation.

No. 9910
The Role of Family Networks, Coyote Prices and the Rural Economy in Migration from Western Mexico: 1965-1994
Pia M. Orrenius

Abstract: The Mexico-U.S. wage gap alone cannot explain the large increases in migration from Mexico to the United States in the last three decades. This paper explores three alternative migration determinants: family migrant networks, the Mexican migrant-smuggling (coyote) industry and the rural economy. The premise of this paper is that successive cohorts of migrants and an expanding coyote industry have led to declines in the costs of migration partly through the formation of networks, while the long-term decline of the rural economy has led to increases in the gains to U.S. migration. Using unique, source-country data collected by the Mexican Migration Project from both migrant and non-migrant households in western Mexico, this paper estimates how the probability of migrating is influenced by the above determinants in two ways. First, the effect of coyote prices and economic output are estimated using an instrumental variables strategy in which coyote prices are instrumented for using border enforcement hours. Second, family network effects are estimated controlling for individual fixed effects. My findings suggest that sibling networks are by far the most significant determinant of initial migration, although falling coyote prices and worsened economic conditions have also been significant push/pull factors in out migration from western Mexico over this time period.

No. 9909
Central Bank Responsibility, Seigniorage, and Welfare
Joseph H. Haslag and Joydeep Bhattacharya

Abstract: Historically, countries have relied on seigniorage. In this paper, we explore a set of features in which a benevolent government will rely on seigniorage. We use a simple overlapping generations model with return-dominated money. Money is valued because of a reserve requirement. The government has to raise a fixed amount of revenue solely for the purposes of making transfers to the old. It has two revenue-generating options: lump-sum taxes (money creation) under the control of the treasury (central bank). We restrict the amount of seigniorage collected to be nonnegative and require that the government's budget constraint be satisfied on a per-period basis. Our question is, Can we find stationary monetary competitive equilibria that are welfare maxima, given that the money stock cannot contract? Computational experiments reveal, somewhat surprisingly, that the answer is yes. Indeed, in our setup, benevolent governments may require that at least part, if not all, of the revenue be raised via money creation.

No. 9908
Autocracy, Democracy, Bureaucracy, or Monopoly: Can You Judge a Government by Its Size?
Stephen P.A. Brown and Jason L. Saving
Abstract: We develop a simple theoretical framework to examine on an integrated basis how the form of government affects its power and size. The analytical framework abstracts from distortions that arise from the means ofgovernment finance and separates government power into two dimensions-pure coercive power and pure monopoly power. A government can exert its coercive power to shift the demand for its services outward and/or its monopoly power to restrict the output along a given demand curve to earn rents. Among the implications drawn from the analysis are that government officials have an incentive to provide a non-optimal combination of taxes and services, and that neither size nor rents alone are reliable indicators ofthe extent to which government fails to achieve optimality in its provision of services.

No. 9907
Bank Structure, Capital Accumulation and Growth: A Simple Macroeconomic Model
Mark G. Guzman
Published as: Guzman, Mark G. (2000), "Bank Structure, Capital Accumulation and Growth: A Simple Macroeconomic Model," Economic Theory 16 (2): 421-455.
Abstract: This paper analyzes the equilibrium growth paths of two economies that are identical in all respects, except for the organization of their financial systems: in particular, one has a competitive banking system and the other has a monopolistic banking system. In addition, the sources of inefficiencies, as a result of monopoly banking, and their relationship to the existence of credit rationing are explored. Monopoly in banking tends to depress the equilibrium law of motion for the capital stock for either of two reasons. When credit rationing exists, monopoly banks ration credit more heavily than competitive banks. When credit is not rationed, the existence of monopoly banking leads to excessive monitoring of credit financed investment. Both of these have adverse consequences for capital accumulation. In addition, monopoly banking is more likely to lead to credit rationing than is competitive banking. Finally, the scope for development trap phenomena to arise is considered under both a competitive and a monopolistic banking system.

No. 9906
Has Monetary Policy Become Less Effective?
Joseph H. Haslag
Abstract: High-powered money has been declining relative to nominal GDP in the United States. Does the ability of monetary policy to affect aggregate activity decline as the money-income ratio falls? In this paper, I specify simple model economy, examining the effects that monetary policy actions and financial innovation would have on the equilibrium money-income ratio. The downward trend in the money-income ratio can be accounted for by increasing inflation, falling reserve requirements, or steady financial development. Whereas higher inflation and falling reserve requirements would reduce the potency of monetary policy, monetary policy's effects are invariant to financial innovation.

No. 9905
When Does Financial Liberalization Make Banks Risky? An Empirical Examination of Argentina, Canada and Mexico
William C. Gruben, Jahyeong Koo and Robert R. Moore
Abstract: In the literature on systemic banking crises, two common themes are: (1) lack of market discipline encourages risky lending and (2) financial liberalization or privatization lead to risky lending. However, there is evidence to suggest that neither financial liberalization nor weak market discipline always precedes risky lending. We test for depositor discipline and, separately for post-liberalization or post-privatization risky lending in Argentina, Canada, and Mexico. In the countries without market discipline, lending risk increases significantly in the wake of liberalization. Where depositors discipline banks, banks neither behave riskily nor does their risk increase in the wake of privatization.

No. 9904
Privatization, Competition, and Supercompetition in the Mexican Commercial Banking System
William C. Gruben and Robert P. McComb
Published as: Gruben, William C. and Robert P. McComb (2003), "Privatization, Competition, and Supercompetition in the Mexican Commercial Banking System," Journal of Banking & Finance 27 (2): 229-249.
Abstract: Much literature before and after the privatization of Mexico's commercial banking system in 1991-1992 argued that the system was collusive and noncompetitive and would likely continue to be for years. Banks would collude to underloan so that – at least in comparison with what would happen in a competitive system - they could overcharge. Because a parallel literature on lending after bank privatization suggests that the problem is often not too little, but too much, we resolved to test for competitive behavior in the Mexican banking system. Using an empirical approach developed by Shaffer (Econom. Lett. 29 (1989) 321, J. Money Credit Bank. 25 (1993) 49, Federal Reserve Bank of Philadelphia, Working paper no. 93-28R), we find a structural break in the middle of the privatization period that signals the start of an episode of what Shaffer calls “supercompetitive” behavior. In such a supercompetition, banks run at levels of output where marginal cost exceeds marginal revenue. This behavior is consistent with a struggle in which banks take losses now because they think the market share they get in the bargain offers a positive present value of expected future return. The behavior can also be consistent with just the sort of banking crises that ensued in Mexico.

No. 9903
Core Inflation: A Review of Some Conceptual Issues
Mark A. Wynne
Published as: Wynne, Mark A. (2008), "Core Inflation: A Review of Some Conceptual Issues," Federal Reserve Bank of St. Louis Review 90 (3, Part 2): 205-228.
Abstract: This paper reviews various approaches to the measurement of core inflation that have been proposed in recent years. The objective is to determine whether the European Central Bank (ECB) should pay special attention to one or other of these measures in assessing inflation developments in the euro area. I put particular emphasis on the conceptual and practical problems that arise in the measurement of core inflation, and propose some criteria that could be used by the ECB to choose a core inflation measure.

No. 9902
Financial Repression, Financial Development and Economic Growth
Joseph H. Haslag and Jahyeong Koo
Abstract: In this paper, we examine the empirical relationship between financial repression, financial development, and growth. Theory has developed in which financial repression and growth are linked. The main contribution of this paper is to look at two parts. First, what, if any, is the empirical link between financial repression and growth, controlling for the level of financial development. Second, is there an empirical link between financial repression and financial development?

No. 9901
Seigniorage in a Neoclassical Economy: Some Computational Results
Joydeep Bhattacharya and Joseph H. Haslag
Abstract: In this paper, we consider a government that executes a permanent open market sale. The government is forced to eventually use money creation to pay for the debt's expenses, choosing between changing either the money growth rate (the inflation-tax rate) or the reserve requirement ratio (the inflation-tax base). We first derive conditions under which each of the two second-best alternative policies are feasible in an economy with neoclassical production. Armed with these conditions, we ask the following question: Which monetary policy action is better in a welfare sense? With neoclassical production, monetary policy potentially has long-run effects on the capital stock and the marginal product of capital. The curvature of the production function is crucial. The computational experiments show, somewhat surprisingly, that a permanent increase in government bonds is financed by either lower reserve requirements or faster money growth. Accordingly, steady-state welfare for all generations is higher under the reserve-requirement policy.

No. 9805
The Rise of Goods-Market Competition and the Fall of Nominal Wage Contracting: Endogenous Wage Contracting in a Multisector Economy
John V. Duca and David D. VanHoose
Published as: Duca, John V. and David D. VanHoose (2001), "The Rise of Goods-Market Competition and the Fall of Nominal Wage Contracting: Endogenous Wage Contracting in a Multisector Economy," Journal of Macroeconomics 23 (1): 1-29.
Abstract: This paper shows how heterogeneity wage-setting and a link between nominal wage flexibility andg goods-market competition rise in a multisector economy that is affected by aggregate and sector-specific shocks. Aggregate volatility increases the variance of real contract wages, whereas sectoral volatility increase the relative variance of real Walrasian wages. Given this tradeoff, the prevalence of nominal wage contracting reflects both the relative volatility of aggregate versus sectoral disturbances and the overall degree of goods-market market competition. We find that these variables help explain the decline in unionization (a proxy for contracting in) the United States.

No. 9804
On the Political Economy of Immigration and Income Redistribution
Jim Dolmas and Gregory W. Huffman
Published as: Dolmas, Jim and Gregory W. Huffman (2004), "On the Political Economy of Immigration and Income Redistribution," International Economic Review 45 (4): 1129-1168.
Abstract: In this paper, we study several general equilibrium models in which the agents in an economy must decide on the appropriate level of immigration into the country. Immigration does not enter directly into the native agents' utility functions, and natives have identical preferences over consumption goods. However, natives may be endowed with different amounts of capital, which alone gives rise to alternative levels of desired immigration, We show that the natives' preferences over desired levels of immigration are influenced by the prospect that new immigrants will be voting in the future, which may lead to higher taxation to finance government spending from which they will benefit. We also show that changes in the degree of international capital mobility, the distribution of initial capital among natives, the wealth or poverty of the immigrant pool, and the future voting rights and entitlements of immigrants can all have dramatic effect on the equilibrium immigration and taxation policies.

No. 9803
What Should Economists Measure? The Implications of Mass Production vs. Mass Customization
W. Michael Cox and Roy J. Ruffin

No. 9802
How Well Does the Beige Book Reflect Economic Activity? Evaluating Qualitative Information Quantitatively
Nathan S. Balke and D'Ann Petersen
Published as: Nathan S. Balke and D'Ann Petersen (2002), "How Well Does the Beige Book Reflect Economic Activity? Evaluating Qualitative Information Quantitatively," Journal of Money, Credit and Banking 34 (1): 114-136.
Abstract: Eight times a year, approximately two weeks before every FOMC meeting, the Federal Reserve releases a description of economic conditions in the twelve Federal Reserve districts. Called t he Beige Book, this description relies primarily on surveys and anecdotal evidence gathered by the twelve district banks. In this paper, we read and numerically scored past Beige Books in order to determine the extent to which the descriptions in these books accurately reflect current economic activity as measured by quarterly real GDP growth. We find that both in sample and out-of-sample the quantitative Beige Book indices do have significant predictive content for current and next quarter real GDP growth. Furthermore, the Beige Book has information about current quarter real GDP growth not present in other indicators such as the Blue Chip Consensus forecast or time series models that use real-time data.

No. 9801
Revenue-Maximizing Monetary Policy
Joseph H. Haslag and Eric R. Young
Abstract: In this paper, we examine the impact that changes in the rate of money creation and reserve requirements have on real seigniorage revenue. We consider two additional features that differ from previous analyses. First, the model economies grow endogenously, and that growth depends on the accumulation of intermediated capital. Second, agents have two means of financing; one is bank deposits against which reserves must be held and the other is a nonbank intermediary. Thus, growth-rate effects and financing substitution defects are both present, and one can assess the quantitative importance of each factor.

No. 9713
Measuring Regional Cost of Living
Jahyeong Koo, Keith Phillips and Fiona Sigalla
Published as: Koo, Jahyeong, Keith R. Phillips and Fiona Sigalla (2000), "Measuring Regional Cost of Living," Journal of Business & Economic Statistics 18 (1): 127-136.
Abstract: The American Chamber of Commerce Research Association (ACCRA) produces the only source of publicly available regional cost of living data which, this paper suggests, may provide misleading information. An evaluation of the quality of the ACCRA indexes concludes that they contain substantial errors and biases, predominantly from the estimated prices, although error also is introduced by the choice of index formula. To evaluate the ACCRA index, this paper uses category indexes produced by BLS researchers, Kokoski, Cardiff and Moulton (KCM 1994) to produce new regional cost-of-living indexes which substantially reduce the errors and biases found in the ACCRA indexes.

No. 9712
Decomposition of Feedback Between Time Series in a Bivariate Error-Correction Model
Jahyeong Koo and Paul A. Johnson
Abstract: This paper adapts Geweke's [1982] method of decomposing the feedback between time series by frequency to the case of 1(1) time series generated by a bivariate error-correction model. The method is applied to long-run data on US and UK price levels with the finding that most of the feedback between the two time series occurs at very low frequencies.

No. 9711
Quasi-Specific Factors: Worker Comparative Advantage in the Two-Sector Production Model
Roy J. Ruffin
Published as: Ruffin, Roy J. (2001),"Quasi-Specific Factors: Worker Comparative Advantage in the Two-Sector Production Model," Journal of International Economics 53 (2): 445-461.
Abstract: This paper integrates the Heckscher–Ohlin, specific factors, and the Ricardian models of production with applications to international trade and labor economics. The model economy exhibits both Heckscher–Ohlin and specific factors properties, but never at the same time. In international trade, the wage skill premium across countries can move in different directions and has natural limits within countries. In labor economics, we show that the earning of economic rents is not inconsistent with competitive markets in general equilibrium and that process and skill-based innovations have contrasting effects on wage inequality.

No. 9710
Real-Time GDP Growth Forecasts
Evan F. Koenig and Sheila Dolmas
Abstract: We forecast current-quarter real GDP growth using monthly data that would have been available to an analyst in real time. We demonstrate that using real-time data is of major importance both when estimating GDP forecasting models and when evaluating their performance. Moreover, we show that the out-of-sample forecasting performance ofour model is comparable orsuperior to that ofthe Blue-Chip consensusforecast provided that more than one month of current-quarter data are available.

No. 9709
Goods-Market Competition and Profit Sharing: A Multisector Macro Approach
John V. Duca and David D. VanHoose
Published as: Duca, John V. and David D. VanHoose (1998), "Goods-Market Competition and Profit Sharing: A Multisector Macro Approach," Journal of Economics and Business 50 (6): 525-534.
Abstract: This paper develops a theoretical model that relates the degree of goods-market competition with the extent of profit sharing. Our multisector framework indicates that increased competition in goods markets leads to an increased weighting on firm profits in an optimally indexed contract. Consequently, our model predicts that a rising extent of profit-sharing arrangements in the United States should accompany an increase in the degree of goods-market competition. Available, but limited, data on profit sharing in the United States are generally consistent with this fundamental implication of the model.

No. 9708
Allocative Inefficiency and School Competition
Shawna Grosskopf, Kathy Hayes, Lori L. Taylor and William L. Weber
Published as: Grosskopf, Shawna, Kathy Hayes, Lori L. Taylor and William L. Webster (1998), "Allocative Inefficiency and School Competition," Proceedings, Annual Conference on Taxation and Minutes of the Annual Meeting of the National Tax Association 91: 282-290.
Abstract: A substantial literature indicates that the public school system in the United States is inefficient. Some have posited that this inefficiency arises from a lack of competition in the education market. On the other hand, the Tiebout hypothesis suggests that public schools may already face significant competition. In this paper, the authors examine the extent to which competition for students influences public school inefficiency in Texas. They use a Shephard input distance function to model educational production and use bootstrapping techniques to examine allocative inefficiencies. Switching regressions estimation suggests that school districts in noncompetitive metropolitan areas are more than twice as allocatively inefficient as school districts in competitive metropolitan areas.

No. 9707
Business Cycles Under Monetary Union: EU and US Business Cycles Compared
Mark A. Wynne and Jahyeong Koo
Published as: Wynne, Mark A. and Jahyeong Koo (2000),"Business Cycles under Monetary Union: A Comparison of the EU and US," Economica 67 (267): 347-374.
Abstract: This paper documents business cycle similarities and differences among the 12 Federal Reserve districts in the USA and the 15 countries that make up the EU. The comparison is suggestive of what might be expected to emerge in the way of business cycle synchronization from a monetary union between the member states of the EU.

No. 9706
On the Political Economy of Immigration
Jim Dolmas and Gregory W. Huffman
Abstract: This paper explores the interactions between immigration, inequality and redistributive fiscal policy in a dynamic general equilibrium model in which government policies are endogenously determined through voting. A model is constructed in which agents vote on the level of immigration into the economy. It is shown that agents' preferences over the level of immigration are influenced by the effects of immigration on factor prices. Agents' preferences over immigration are shown to depend non-trivially on the characteristics of immigrants and whether they will receive the franchise to vote in the future. It is shown that subtle changes in the distribution of wealth among existing citizens can have a dramatic impact on the equilibrium behavior of the economy.

No. 9705
Inequality, Inflation, and Central Bank Independence
Jim Dolmas, Gregory W. Huffman, and Mark A. Wynne
Published as: Dolmas, Jim, Gregory W. Huffman and Mark A. Wynne (2000), "Inequality, Inflation, and Central Bank Independence," Canadian Journal of Economics 33 (1): 271-287.
Abstract: What can account for the different contemporaneous inflation experiences of various countries, and of the same country over time? We present an analysis of the determination of inflation from a political economy perspective. We document a positive correlation between income inequality and inflation and then present a theory of the determination of inflation outcomes in democratic societies that illustrates how greater inequality leads to greater inflation, owing to a desire by voters for wealth redistribution. We conclude by showing that democracies with more independent central banks tend to have better inflation outcomes for a given degree of inequality.

No. 9704
The Political Economy of Endogenous Taxation and Redistribution
Jim Dolmas and Gregory W. Huffman
Published as: Dolmas, Jim and Gregory W. Huffman (1997), "The Political Economy of Endogenous Taxation and Redistribution," Economics Letters 56 (2): 223-227.
Abstract: This paper examines a simple dynamic model in which agents vote over capital income taxation and redistributive transfers. We show that in equilibrium the typical agent's preferences over the tax rate are single-peaked and derive a closed-form solution for the majority-rule tax rate. We also show that high levels of initial wealth inequality can place the economy on the 'wrong side of the Laffer curve'.

No. 9703
Specialization and the Effects of Transactions Costs on Equilibrium Exchange
James Dolmas and Joseph H. Haslag
Abstract: In this paper, we examine economies in which there are fixed costs associated with executing trades of differentiated goods. When traders exchange units of the home goods for another household's consumption good, the results uphold the conventional wisdom — it does not matter who pays the transactions cost. However, when we introduce fiat money into the environment, the results demonstrate that it does matter who pays. Our results demonstrate that when members of the household specialize, bearing the transaction cost can yield different equilibrium outcomes.

No. 9702
More on Optimal Denominations for Coins and Currency
Mark A. Wynne
Published as: Wynne, Mark A. (1997), "More on Optimal Denominations for Coins and Currency," Economic Letters 55 (2): 221-225.
Abstract: Telser [Telser, L.B., 1995. Optimal denominations for coins and currency. Economics Letters 49, 425–427.] has shown that the problem of Bâchet helps answer the question of the optimal denominational structure of currency in the U.S. and U.K. This note provides further evidence to support this claim using cross-country data.

No. 9701
Nonlinear Dynamics and Covered Interest Rate Parity
Nathan S. Balke and Mark E. Wohar
Published as: Balke, Nathan S. and Mark E. Wohar (1998), "Nonlinear Dynamics and Covered Interest Rate Parity," Empirical Economica 23 (4): 535-559.
Abstract: This paper examines the dynamics of deviations from covered interest parity using daily data on the UK/US spot, forward exchange rates and interest rates over the period January 1974 to September 1993. Like other studies we find a substantial number of instances during the sample in which the covered interest parity condition exceeds the transaction costs band, implying arbitrage profit opportunities. While most of these implied profit opportunities are relatively small, there is also evidence of some very large deviations from covered interest parity in the sample. In order to examine the persistence of these deviations, we estimated a threshold autoregression in which the dynamics behavior of deviations from covered interest parity is different outside the transaction costs band than inside them. We find that while the impulse response functions when inside the transaction costs band are nearly symmetric, those for the outside the bands are asymmetric-suggesting less persistence outside of the transaction costs band than inside the band.

No. 9615
Aggregate Price Adjustment: The Fischerian Alternative
Evan F. Koenig
Abstract: I consider an economy in which a fraction of contracts is renegotiated each period. In the spirit of Fischer (1977) and in contrast to Taylor (1979, 1980), Calvo (1983), and Fuhrer and Moore (1992, 1995a,b), contracts specify a price path rather than a fixed price level. The aggregate price adjustment rule derived from these assumptions is an expectations-augmented Phillips curve with a built in "speed" or "Lipsey Loop" effect. The rule is consistent with the natural rate hypothesis and implies that disinflations are unambiguously contractionary. When supplemented with a specification of aggregate demand, the model can be used to find the money-supply path required to achieve a given desired path of the aggregate price level. Alternatively, the model can be used to find the aggregate-price-Ievel path implied by a given monetary policy. Policy-induced recessions can be quite persistent even when contracts are renegotiated frequently. For realistic parameter values, the model generates a liquidity effect: disinflations are initially accompanied by a rising short-term interest rate and a declining money supply.

No. 9614
The Effect of the Minimum Wage on Hours of Work
Madeline Zavodny
Abstract: Recent studies of the effects ofthe minimum wage have focused on employment, but employers may adjust hours as well. This study examines the effect of increases in the minimum wage on teen hours of work and employment using both state- and individual-level panel data from the Current Population Survey. The results indicate that teens who are likely to be affected by minimum wage increases are less likely to remain employed than unaffected teen workers, but experience greater increases in hours conditional on remaining employed. The effect of the minimum wage on hours among workers likely to be affected remains non-negative even when accounting for teens who do not remain employed. The results suggest that aggregate data mask employment shifts among teen workers with different skill levels.

No. 9613
Oil Prices and Aggregate Economic Activity: A Study of Eight OECD Countries
Stephen P.A. Brown, David B. Oppedahl and Mine K. Yücel
Abstract: This article uses impulse response functions based on vector autoregressive models for eight OECD countries to analyze how oil price shocks move through major channels of the economy to affect aggregate economic activity and inflation. For each country, the model represents the interactions between real oil prices, aggregate economic activity and monetary and financial variables. The results suggest that for energy-importing countries, an oil price shock presents a trade-off between an increased price level and a GDP loss. Although it does not appear that an energy-importing country can use its intemal macroeconomic policies to eliminate the effect of oil price shocks on GDP, countries seem to be able to defer and reduce the effect by accepting higher rates of inflation.

No. 9612
The Policy Sensitivity of Industries and Regions
Lori L. Taylor and Mine K. Yücel

No. 9611
Does the Choice of Nominal Anchor Matter?
David M. Gould
Abstract: The conventional wisdom on nominal anchors is that exchange rate-based inflation stabilizations lead to economic booms while monetary-based stabilizations lead to recessions. The study finds strong evidence against this view. Rather than determining the path of economic growth, the choice of nominal anchor appears to be endogenously determined by the state of the economy. To peg or manage the exchange rate, a high level of international reserves is important, especially when a government's credibility is low after a period of high inflations. After controlling for the level of international reserves and the rate of inflation, growth after monetary-based stabilizations does not significantly differ from that following exchange rate-based stabilizations.

No. 9610
What's Good for GM...? Using Auto Industry Stock Returns to Forecast Business Cycles and Test the Q-Theory of Investment
Gregory R. Duffee and Stephen Prowse
Abstract: We examine the ability of auto industry stock returns to forecast quarterly changes in the growth rates of real GDP, consumption and investment. We find that auto stock returns are superior to aggregate stock market returns in predicting growth rates of GDP and various forms of consumption. The superior predictive power of auto returns holds for both in-sample and out-of-sample forecasts and has not declined over time. We then apply this finding in this paper — that market returns have no explanatory power for future output or consumption growth when auto returns are included in the regression — to analyze the causal relation between the stock market and investment. We use auto returns to proxy for forecasts of future fundamentals, allowing market returns to capture the effect of the stock market on investment. We find that aggregate returns forecast equipment investment in the presence of auto returns, providing empirical support for q-theory. Results for structures investment are less convincing.

No. 9609
An Equilibrium Analysis of Relative Price Changes and Aggregate Inflation
Nathan S. Balke and Mark A. Wynne
Published as: Balke, Nathan S. and Mark A. Wynne (2000), "An Equilibrium Analysis of Relative Price Changes and Aggregate Inflation," Journal of Monetary Economics 45 (2): 269-292.
Abstract: Inflation is positively correlated with the variability of relative prices as measured by the standard deviation of the cross-section distribution of prices, and also with the third moment (skewness) of the cross-section distribution of prices. The conventional interpretation of these relationships is that they reflect sluggishness in the adjustment of individual prices in response to shocks. In this paper we question this interpretation. First, we show that similar correlations among the moments exist in alternative measures of underlying technology shocks. Second, when these shocks are fed into a general equilibrium model with multiple sectors and flexible prices, the resulting prices also display a positive correlation between aggregate inflation and skewness of the cross-section distribution.

No. 9608
Some Implications of Increased Cooperation in World Oil Conservation
Stephen P.A. Brown and Hillard G. Huntington
Abstract: This paper combines recent studies of world oil markets and the recent literature on damage estimates from CO2 emissions to derive cost and benefit curves for the reduction of CO2 emissions through cooperative programs of oil conservation. The analysis shows that the desirability of extending cooperation in global energy conservation policies is essentially an empirical issue, rather than a conceptual one. The current evidence suggests that over the next two decades, the OECD will have more than sufficient incentive to reduce oil consumption and the associated CO, emissions through unilateral actions. During this period, extending cooperation to the oil-importing developing countries may be unneccesary and undesirable.

No. 9607
Is Airline Price Dispersion the Result of Careful Planning or Competitive Forces?
Kathy J. Hayes and Leola B. Ross
Published as: Hayes, Kathy J. and Leola B. Ross (1998), "Is Airline Price Dispersion the Result of Careful Planning or Competitive Forces?" Review of Industrial Organization 13 (5): 523-541.
Abstract: We develop a model of price dispersion to distinguish the impact of price discrimination from that of peak load pricing schemes or atypical competition resulting from the financial difficulties of the early 1990s. By utilizing three alternative measures of dispersion and appealing to economic theory for our specification, we find robust results suggesting an estrangement between price dispersion and price discrimination. While some discrimination continues to persist at monopolized endpoints, most dispersion is associated with fare wars and peak load pricing schemes.

No. 9606
An Exploration into the Effects of Dynamic Economic Stabilization
Jim Dolmas and Gregory W. Huffman
Published as: Dolmas, Jim and Gregory W. Huffman (1997), "An Exploration into the Effects of Dynamic Economic Stabilization ," in Business Cycles and Macroeconomic Stability: Should We Rebuild Built-in Stabilizers?, ed. Jean-Olivier Hairault, Pierre-Yves Henin and Franck Portier (Springer), 3-30.
Abstract: This paper analyzes the stochastic properties of a dynamic general equilibrium model under two government policies which might be interpreted as ‘countercyclical’ fiscal policies. In one case, we examine the effects on fluctuations of government spending on infrastructure investment in an economy in which public capital is an input to the aggregate production function. In the other, we examine the effects on aggregate business cycle fluctuations of a proportional tax on lay-offs. Our results find only weak evidence for the stabilizing effects of either policy.

No. 9605
Endogenous Tax Determination and the Distribution of Wealth
Gregory W. Huffman
Published as: Huffman, Gregory W. (1996), "Endogenous Tax Determination and the Distribution of Wealth," Carnegie-Rochester Conference Series on Public Policy 45: 207-242.
Abstract: In this paper a dynamic model is constructed in which labor and capital taxes are determined endogenously through majority voting. The wealth distribution of the economy is shown to influence the voting behavior and hence the equilibrium levels of the tax rates, which in turn affect the future distribution of wealth. It is shown that the economy exhibits a unique dynamic behavior. Because the tax rates are endogenously determined, asset prices, wealth distribution, and the tax rates can display persistent fluctuations or cycles in reaction to exogenous disturbances, or even due to initial conditions. “Tax smoothing” does not necessarily appear to arise naturally in such an environment. The features in the model that can produce these fluctuations are studied in detail.

No. 9604
The Response of Local Governments to Reagan-Bush Fiscal Federalism
D. Boisso, Shawna Grosskopf and Kathy Hayes

No. 9603
Inflation, Unemployment, and Duration
John V. Duca
Published as: Duca, John V. (1996), "Inflation, Unemployment, and Duration," Economics Letters 52 (3): 293-298.
Abstract: In the earky 1990s, core CPI inflation and employment cost inflation have been overpredicted by Phillips curve models, while the duration of unemployment has been unusually high. Duration adds significant information about core inflation in the post-Volcker disinflation period.

No. 9602
Regional Productivity and Efficiency in the U.S.: Effects of Business Cycles and Public Capital
Dale Boisso, Shawna Grosskopf and Kathy Hayes
Published as: Boisso, Dale, Shawna Grosskopf and Kathy Hayes (2000), "Productivity and Efficiency in the U.S.: Effects of Business Cycles and Public Capital," Regional Science and Urban Economics 30 (6): 663-681.
Abstract: We add to the literature on the US productivity slowdown and effects of public capital on productivity by employing Malmquist productivity indexes to measure productivity. These indexes allow us to decompose productivity growth into efficiency change and technological innovation. We derive these components for each observation, which we exploit to explore factors which may lead to differences in productivity across regions, including business cycles, both own-state and cross-border public infrastructure investment, and relative sizes of the manufacturing, service and public sector. Our results suggest that the components of total factor productivity change lend important insights into the fairly complex effects of public capital on productivity growth.

No. 9601
The Monetary Policy Effects on Seignorage Revenue in a Simple Growth Model
Joseph H. Haslag
Abstract: Monetary policy has two levers with which to manipulate seignorage revenue collection. Generally speaking, the inflation rate affects the tax rate while reserve requirements affect the size of the tax base. In this paper, I ask how seignorage revenue responds to changes in these two levels, both separately and together. Because both monetary policy variables affect the growth rate, the tradeoff is whether the growth-rate effects dominate the policy impact. I begin with an examination of statistical regularities between seignorage revenue and these two monetary policy measures, using cross-country data.

No. 9519
Credit and Economic Activity: Shocks or Propagation Mechanism?
Nathan S. Balke and Chih-Ping Chang
Published as: Balke, Nathan S.  (2000), "Credit and Economic Activity: Credit Regimes and Nonlinear Propagation of Shocks?" The Review of Economics and Statistics 82 (2): 344-349.

No. 9518
Targeting Nominal Income: A Closer Look
Evan F. Koenig
Published as: Koenig, Evan F. (1996), "Targeting Nominal Income: A Closer Look," Economics Letters 51 (1): 89-93.
Abstract: I derive conditions under which the monetary authority should target nominal spending. The relevant spending target is a weighted average of income and consumption. Despite ‘sticky’ nominal wages, under optimal policy the economy behaves as if all markets clear.

No. 9517
Hyperinflations and Moral Hazard in the Appropriation of Seigniorage: An Empirical Implementation with a Calibration Approach
Carlos E. Zarazaga

No. 9516
The Stock Market and Monetary Policy: The Role of Macroeconomic States
Chih-Ping Chang and Huan Zhang

No. 9515
Monetary Policy, Banking, and Growth
Joseph H. Haslag
Published as: Haslag, Joseph H. (1998), "Monetary Policy, Banking, and Growth," Economic Inquiry 36 (3): 489-500.
Abstract: There is ample empirical evidence suggesting that countries with high inflation tend to grow slower than countries with low inflation. Based on the regression evidence, the inflation-rate effect is fairly large; on average, per-capita real GDP grows between 1/4- and 3/4-percentage-points slower in a country in which the average inflation rate is 10% as compared with a country in which inflation is 0%. The purpose of this paper is to determine whether a model economy that is reasonably calibrated can account for such large inflation-rate effects. The answer is yes.

No. 9514
Credit Availability, Bank Consumer Lending, and Consumer Durables
John V. Duca and Bonnie Garrett
Abstract: This study tests the empirical implications of a modified screening model of lending [Stiglitz and Weiss (1-981, Part IV) ] using a proxy for nonrate credit conditions based on Federal Reserve survey data. Consistent with screening models, this proxy (1) significantly affects bank consumer lending, (2) is significantly affected by the real federal funds rate and ex ante default risk measures, and (3) substantially affects consumer durables. Other results indicate that deposit rate deregulation has reduced the impact of monetary policy on consuner credit availability and consumer durable spending.

No. 9513
The Interest Sensitivity of GDP and Accurate Reg Q Measures
John V. Duca
Abstract: This study constructs Reg Q measures that account for the introduction of small saver certificates in 1979 and money market certificates in 1978. In nonVAR models, not properly accounting for Reg Q upwardly biases the estimated real rate elasticity of U.S. GDP and yields rate elasticities that are not stable enough for practical use. Although the impact of real funds rate innovations remains sensitive to sample period, accurately measured Reg Q innovations are significant in VARs and, in contrast to innovations in a naive Reg Q measure, have impulse response functions that do not change much as samples are extended beyond the early 1980s.

No. 9512
Regulatory Changes and Housing Coefficients
John V. Duca
Abstract: This study assesses whether regulatory actions account for major changes in estimates of important housing coefficients since the late-1970s. Results imply that the bulk of these changes owe to the end of Reg Q and that Reg Q measures need to account for the introduction of deposit instruments in the late-1970s. Findings imply that models of the aggregate housing stock are unlikely to yield coefficients that are stable enough for practical use unless they accurately control for regulatory changes. In this regard, accounting for small saver or money market certificates yields significant improvements over a naive Reg Q measure.

No. 9511
A Comparison of Alternative Monetary Environments
Joseph H. Haslag
Abstract: : In many macroeconomic models, agents hold fiat money balances, despite being rate-of-return dominated, to satisfy either a cash-in-advance constraint or reserve requirements. In this paper, I compare the allocations from the two different economies. Despite the inherent differences in these two modelling approaches, the alternative monetary environments are equivalent in the sense that one can obtain identical equilibrium allocations. This equivalence result hold for a particular combination of monetary policy variables; that is, namely, there is a combination policy characterized by the inflation rate and reserve requirement ratio such that the reserve-requirement model is equivalent to other monetary environments.

No. 9510
Oil Prices and Inflation
Stephen P.A. Brown, David B. Oppedahl and Mine K. Yücel
Abstract: This article uses impulse response functions based on a vector autoregressive model of the U.S. economy to analyze how oil price shocks move through major channels of the economy to affect inflation. The model represents the interactions between oil prices, real GDP, a monetary aggregate, short-term interest rates, the spread between long- and short-term interest rates, and the GDP deflator for the period 1970 through 1994. The responses of the model to monetary and interest rate shocks generally conform to economic theory. The analysis shows that oil price shocks have permanent effects on the price level and nominal GDP. These findings suggest that during the estimation period, monetary policy generally accommodated the inflationary pressure of oil price shocks.

No. 9509
Are Deep Recessions Followed by Strong Recoveries? Results for the G-7 Countries
Nathan S. Balke and Mark A. Wynne
Published as: Balke, Nathan S. and Mark A. Wynne (1996), "Are Deep Recessions Followed by Strong Recoveries? Results for the G-7 Countries," Applied Economics 28 (7): 889-897.
Abstract: The hypothesis is examined that the severity of a recession favourably affects the rate of growth of output during the period immediately after the recession. Our empirical analysis is based on the behaviour of industrial output in the G-7 countries during the period 1960 to 1985. The depth of a recession, defined as the cumulative output loss between the peak and trough dates, is shown to be negatively correlated with growth in the first 12 months of the subsequent expansion.

No. 9508
The Role of Intratemporal Adjustment Costs in a Multi-Sector Economy
Gregory W. Huffman and Mark A. Wynne
Published as: Huffman, Gregory W. and Mark A. Wynne (1999), "The Role of Intraemporal Adjustment Costs in a Multisector Economy," Journal of Monetary Economics 43 (2): 317-350.
Abstract: A multi-sector business cycle model is constructed which is capable of reproducing the procyclical behavior of cross-industry measures of capital, employment, and output. It is shown that some variants of conventional business cycle models may not be capable of reproducing these facts. It is then shown how the introduction of intratemporal adjustment costs can be crucial to such a model. These costs imply that it is difficult or costly to alter the composition of the capital goods that are produced. The presence of these costs eliminates many counterfactual observations ofthe model that would otherwise be present. The dynamic response of variables in the model is different from what one would observe in the standard one-sector model. The effect of including intratemporal adjustment costs for labor as well is also analyzed.

No. 9507
Alternative Methods of Corporate Control in Commercial Banks
Stephen Prowse
Abstract: In this article, Stephen Prowse investigates how owners of commercial banks encourage management to follow value-maximizing policies. While the "corporate control mechanism" in nonfinancial firms is well documented, for the banking industry much less evidence is available. Moreover, unique factors in the operating environment of commercial banks may mean that their corporate control mechanism operates differently from that of nonfinancial firms. ; Prowse analyzes a sample of bank holding companies (BHCs) from 1987 to 1992 to determine how many underwent a change in corporate control by hostile takeover, friendly merger, action by the board of directors, or intervention by regulators. Prowse finds that the primary market-based corporate control mechanism among BHCs is action by the board, although bank boards appear to be much less assertive than boards of nonfinancial firms. Overall, the market-based corporate control mechanisms in banks do not appear as efficient at disciplining managers as they are in other firms. By default, this has given a primary role to regulators to provide a "last resort" control mechanism. Prowse analyzes reasons for this and evaluates how proposed banking legislation might affect corporate governance.

No. 9506
On Competition and School Efficiency
Shawna Grosskopf, Kathy Hayes, Lori L. Taylor and William L. Weber
Abstract: A substantial literature indicates that the public school system in the United States is inefficient. Some have posited that this inefficiency arises from a lack of competition in the education market. On the other hand, the Tiebout hypothesis suggests that public schools already face significant competition. In this paper, the authors examine the extent to which competition for students influences the distribution of public school inefficiency in Texas. They use a Shephard input distance function to model educational production and use bootstrapping techniques to test for technical, allocative and scale inefficiencies. The authors find evidence of substantial inefficiency in the Texas school systen but only weak and inconsistent evidence that competition for enrollment enhances school district efficiency

No. 9505
Building Trade Barriers and Knocking Them Down: The Political Economy of Unilateral Trade Liberalizations
David M. Gould and Graeme L. Woodbridge
Published as: Gould, David M. and Graeme L. Woodbridge (1997), "Building Trade Barriers and Knocking Them Down: The Political Economy of Unilateral Trade Liberalizations," Review of International Economics 5 (2): 256-271.
Abstract: This paper examines the dynamic behavior of trade protection and liberalization. Consistent with evidence on the development of trade policies, policy decisions are modeled as the outcome of a political contest between import-competing interests and exporters. Uncertainty about the success of political contests yields a dynamic equilibrium in which tariffs gradually increase over time. Eventually, increasing tariffs reduce profits in the exporting sector to such a degree that exporters enter the political arena and lobby actively against protection. Depending on the market characteristics, a political contest may generate a liberalization or a move toward autarky.

No. 9504
Building a Regional Forecasting Model Utilizing Long-Term Relationships and Short-Term Indicators
Keith R. Phillips and Chih-Ping Chang
Abstract: Chang and Phillips develop a simple labor-demand error correction model of regional employment growth. The model is constructed to forecast well at both long-term and short-term horizons. In developing the model, we utilize past research which has found that relative nominal wages play an important role in explaining why some regions consistently grow faster than others. The variables in the model include regional employment, u.s. employment, an industry-adjusted relative wage measure, and a regional leading index. While the wage variable is used to capture long-term shifts in relative labor demand, the leading index is included to control for shorter-term cyclical shocks. Out-of-sample forecast errors from the model are shown to be smaller than errors from a model suggested by LeSage (1990a) which divides regional employment into base and nonbase and estimates a bivariate error-correction model.

No. 9503
Country-Bashing Tariffs: Do Bilateral Trade Deficits Matter?
W. Michael Cox and Roy J. Ruffin
Published as: Cox, W. Michael and Roy J. Ruffin (1998), "Country-Bashing Tariffs: Do Bilateral Trade Deficits Matter," Journal of International Economics 46 (1): 61-72.
Abstract: This paper investigates the impact of restricting bilateral trade imbalances in a three country, three good model. Bilateral trade balances matter because, in the Nash equilibrium, each country will impose tariffs on countries with whom they have bilateral deficits or promote trade with countries with whom they have bilateral surpluses. All countries lose from a Nash country-bashing war. Each country loses from the unilateral elimination of its bilateral imbalances. But a country can gain from a bilateral agreement with its deficit partner provided that country has a surplus with a country devoted to free trade.

No. 9502
Inflation and Intermediation in a Model with Endogenous Growth
Joseph H. Haslag
Abstract: In this paper, I examine the effects that changes in money growth/inflation have on inside money and capital accumulation in a general equilibrium model. Money is held to meet a cash-in-advance constraint and a reserve requirement. A change in the inflation rate will,in general, affect the ratio of inside money to outside money (the money multiplier). The data indicate a small, negative relationship between changes in the inflation rate and the money multiplier. The model can replicate this stylized observation provided the computational experiments impose enough complementarity between the cash good and credit good. In addition, the model predicts that an anticipated increase in the inflation rate causes agents to substitute unintermediated capital fiat money for unintermediated capital (disintermediation). Disintermediation occurs over time in the sense that intermediated capital grows at a slower rate in the higher inflation environment. In this setup, the model is also capable of replicating Goldsmith's observation; the ratio of intermediaries' assets to output rises over time.

No. 9501
An Equilibrium Analysis of Central Bank Independence and Inflation
Gregory W. Huffman
Published as: Huffman, Gregory W. (1997), "An Equilibrium Analysis of Central Bank Independence and Inflation," Canadian Journal of Economics 30 (4): 943-958.
Abstract: A dynamic equilibrium model is constructed to analyse the implications of different degrees of central bank independence. In the main model, agents are permitted to vote on the desired inflation and labour taxes to finance government spending. Multiple perfect-foresight equilibria arise, and one of them exhibits fluctuations in output, investment, and the inflation rates as a result of permitting agents to vote. If, instead of having agents vote each period on these parameters, inflation and labour taxes in the model are set at fixed levels, these fluctuations do not arise, and a lower inflation rate can appear.

No. 9415
The Effects of Monetary Policy in a Model with Reserve Requirements
Joseph H. Haslag
Abstract: In this paper, the effects of monetary policy are examined in a simple convex model with endogenous growth. In an economy with a reserve requirement, monetary policy has growth-rate effects. I compare quantitatively the effect that changes in money growth cum inflation have on growth, on the welfare costs of inflation, and on seignorage revenue, contrasting the results with a reserve requirement with other types of distortions considered in the literature. I show that the inflation rate affects the growth rate in a model with reserve requirements. More specifically, the growth-rate effects are larger in a model with reserve requirements than previous estimates in which other distortions are present. Not surprisingly, larger growth-rate effects translate into larger estimates of the welfare costs of inflation. Indeed, the welfare costs of moderate inflations are moderately higher than previous estimates. Finally, I show that if seignorage revenue is a small contributor to total tax revenues then the growth-rate effects more than offset a decline in the inflation rate or reserve requirements.

No. 9414
The P* Model of Inflation, Revisited
Evan F. Koenig
Abstract: Error-correction M2-demand and inflation equations are estimated simultaneously in a combined model that includes the p* model and the Federal Reserve Board's M2 model as special cases. The ability of the combined model to explain movements in inflation is significantly better than that of the standard p* model. However, the forecasting performance of the combined model breaks down in the 1990s. A reformulation of the M2-demand equation markedly improves the model's in-sample and out-of-sample performance. Even in the post-1990 period, M2 growth is explainable and serves as a reliable indicator of future inflation.

No. 9413
The Role of Tax Policy in the Boom/Bust Cycle of the Texas Construction Sector
D'Ann Petersen, Keith Phillips and Mine Yücel
Abstract: The boom and bust of the Texas construction sector is well known, yet its causes and effects are less well understood. At first glance the rise and fall of the Texas construction sector seems to have followed the movements in oil prices. However, a closer look at the data suggests that there may have been other factors which exacerbated the effects that oil price swings had on the construction industry. Of particular interest are the effects of the tax law changes in 1981 and 1986 which made real estate investing more lucrative in the first half of the decade. In this article we attempt to determine how much of an impact such factors had on the excessive buildup and subsequent crash of tle Texas construction industry. We use a vector-autoregressive (VAR) model to analyze the roles tax laws, interest rates and oil prices played in the movements of both residential and nonresidential construction in Texas.

No. 9412
The Information Content of the Paper-Bill Spread
Kenneth M. Emery
Published as: Emery, Kenneth M. (1996), "The Information Content of the Paper-Bill Spread," Journal of Economics and Business 48 (1): 1-10.
Abstract: In a series of articles, Benjamin M. Friedman and Kenneth N. Kuttner maintain that the difference between the commercial paper rate and the Treasury bill rate has highly significant predictive value for real output even in the presence of money and regardless of sample. The results presented in this paper do not support Friedman and Kuttner's claims.

No. 9411
Monetary Base Rules: The Currency Caveat
R. W. Hafer, Joseph H. Haslag, and Scott E. Hein
Abstract: Monetary policy rules that rely on the monetary base have been forwarded by Meltzer (1984) and McCallum (1988). They claim that following monetary base rules would minimize fluctuations around the target growth rate for nominal GNP. Critics ofsuch rules contend that currency has not been properly accounted for in their simulations. This paper examines the properties ofseveral monetary base rules, explicitly taking the demand for currency into account. Assuming that currency is supplied elastically, our investigation quantities changes in the composition of the monetary base under these rules and provide an estimate of how these compositional changes might affect the variability around the target nominal GNP growth rate.

No. 9410
U.S. Banks, Competition, and the Mexican Banking System: How Much Will NAFTA Matter?
William C. Gruben, John H. Welch and Jeffery W. Gunther

No. 9409
The Role of Intellectual Property Rights in Economic Growth
David M. Gould and William C. Gruben
Published as: Gould, David M. and William C. Gruben (1996), "The Role of Intellectual Property Rights in Economic Growth," Journal of Development Economics 48 (2): 323-350.
Abstract: This paper examines the role of intellectual property rights in economic growth, utilizing cross-country data on patent protection, trade regime, and country-specific characteristics. The evidence suggests that intellectual property protection is a significant determinant of economic growth. These effects appear to be slightly stronger in relatively open economies and are robust to both the measure of openness used and to other alternative model specifications.

No. 9408
On the Political Economy of School Deregulation
Shawna Grosskopf, Kathy Hayes, Lori Taylor, and William Weber
Abstract: In this paper, we simulate the likely impacts of deregulation. The simulation indicates that parents and students in poor school districts with a relatively high proportion of minority students are resource constrained rather than bounded by regulation in pursing better education for their students. The potential gains from deregulation increase as property wealth and expenditures per student increase. The simulation also indicates that in regulation-constrained school districts, many education professionals are extracting rents (in terms of excess employment) from the current system, and that deregulation and incentives for increased efficiency would lead many school districts to substitute teacher aides for teachers, administrators, and professional staff.

No. 9407
Fiscal Policy in More General Equilibrium
Jim Dolmas and Mark Wynne
Abstract: In this paper, we examine the sensitivity of existing results in the equilibrium analysis of fiscal policy to assumptions about the slope of the long-run supply curve of capital. In the 'standard' model, based on teh neoclassical growth model, the long-run supply of capital is perfectly elastic at the representative agent's fixed rate of time preference. This assumption is shown to have strong implications for the effects of government consumption purchases on output, employment, interest rates and other macroeconomic variables. We explore the implications of relaxing this assumption in a more general model that allows for flexible time preference. We show that the multiplier effect of permanent changes in government purchases on output is enhanced, primarily as a result of increased capital accumulation. In an interesting Keynesian twist, private consumption may in fact rise in response to increased goverment purchases.

No. 9406
The Dynamics of Recoveries
Nathan S. Balke and Mark A. Wynne
Abstact: In this paper, we examine whether the early stages of an expansion are different from its later stages. We find that growth in aggregate output is higher in the early stages of an expansion than in the later stages. We term this a recovery effect. In addition to finding a recovery effect for output, we find that the shape of the business cycle is characterized by concave expansions—output grows at a slower rate later in the expansion than in the beginning of the expansion—and linear recessions—the rate of contraction is not significantly different over the course of the recession. The high growth during the recovery seems to be associated with high inventory investment, purchases of consumer durables, and investment in residential structures. We also find that the strength of the recovery depends, in part, on the depth of the preceding recession. This bounce-back result is quite robust across alternative business cycle dates. In Monte Carlo analyses, we show that linear time series models are unable to generate significant bounce-back effects or replicate the actual shape of the business cycle.

No. 9405
Protecting Social Interest in Free Invention
Stephen P.A. Brown and William C. Gruben
Abstact: Although industrialized countries have increasingly pressured developing countries to tighten the protection of intellectual property, recent economic literature has questioned whether the developing countries should give into such pressure. The literature has found that for an invention-importing country, where domestic invention is scarce or nonexistent, protection of intellectual property developed elsewhere can reduce the country's welfare and, in some cases, world welfare. The analysis presented here concludes that this finding may not be applicable to products, such as antibiotics, fungicides, herbjcides and pesticides, whose effectiveness diminishes with cumulative use. Protecting the intellectual property rights for these products can increase welfare—even when invention is provided for free.

No. 9404
Energy Policy: Does it Achieve its Intended Goals?
Mine Yücel and Shengyi Guo
Abstract: A good understanding of markets targeted by energy policy is necessary for energy tax policy to be successful. This paper analyzes coal, natural gas and oil markets to determine the extent to which these fuel prices move together. We find that there was a stable long-run relationship between coal and oil prices until 19/4 and that this relationship changed after 1974. The long-run relationship found between coal, natural gas and oil prices implies that a single-fuel tax in these markets would not be effective as a single tax policy. Similarly, an equal percentage tax on these energy sources, which does not change relative prices initially, would not keep relative prices unchanged in the long run. Our results show that energy policy must take account of the long-run relationship between different energy prices. Otherwise, the long-run results of energy policy could be quite different than intended.

No. 9403
The Disappearing January Blip and Other State Employment Mysteries
Frank Berger and Keith R. Phillips

No. 9402
Capacity Utilization and the Evolution of Manufacturing Output: A Closer Look at the "Bounce-Back Effect"
Evan F. Koenig
Abstract: A simple error-correction model of output and utilization growth captures both the tendency for output growth to be especially rapid early in expansions and the tendency for deep recessions to be followed by strong recoveries. Estimates suggest that manufacturing capacity utilization typically peaks at around 83.5 percent. Once an expansion is underway, two thirds of the gap between actual utilization and normal peak utilization is closed each year. Output and utilization switch to a low-growth state during cyclical contractions. Capacity growth slows slightly during cyclical contractions and in response to weak output growth, but is independent of capacity utilization.

No. 9401
Adding Bond Funds to M2 in the P-Star Model of Inflation
Zsolt Becsi and John Duca
Published as: Becsi, Zsolt and John Duca (1994), "Adding Bond Funds to M2 in the P-Star Model of Inflation," Economics Letters 46 (2): 143-147.
Abstract: During the early 1990s, M2 growth has been unusually weak and the P-Star model has underpredicted inflation; at the same time, bond funds have grown rapidly. We find that the P-Star model performs well recently when M2 is adjusted for bond funds.

No. 9342
On the Fluctuations Induced by Majority Voting
Gregory W. Huffman
Abstract: In this paper a dynamic model is constructed in which labor and capital taxes are determined- endogenously through majority voting. The wealth distribution of the economy is shown to influence the voting behavior, and hence the equilibrium levels of the tax rates, which in turn affect the future distribution of wealth. It is shown that the economy exhibits a unique dynamic behavior. Because of the endogenously determined taxes, the asset prices, wealth distribution, and the tax rates can display persistent fluctuations, and even limit cycles, in reaction to exogenous disturbances, or even due to initial conditions. It is also shown that "tax smoothing" does not necessarily appear to naturally arise in such a model, as the economy can display extreme fluctuations in the endogenously determined tax rates.

No. 9341
Are Net Discount Rates Stationary? Some Further Evidence
Joseph H. Haslag, Michael Nieswiadomy, and D. J. Slottje
Published as: Haslag, Joseph H., Michael Nieswiadomy and D.J. Slottje (1994), "Are Net Discount Rates Stationary? Some Further Evidence," The Journal of Risk and Insurance 61 (3): 513-518.
Abstract: Gamber and Sorensen provide evidence suggesting that the net discount ratio experienced a level shift in the mean between 1977 and 1981. If such a shift occurred, the nonlinearity in the data shows up as a failure to reject the null hypothesis that a unit root is present; that is, the series is I(1). In this reply, evidence is presented-the Phillips-Perron test and a univariate version of the Stock-Watson q-test-suggesting that the net discount ratio is stationary. Hence, the mean is constant. In addition, if one extends the analysis to include the 1989 through 1993 period, the net discount ratio appears to be reverting.

No. 9340
A Survey of Measurement Biases in Price Indexes
Mark A. Wynne and Fiona Sigalla
Published as: Wynne, Mark A. and Fiona Sigalla (1996), "A Survey of Measurement Biases in Price Indexes," Journal of Economic Surveys 10 (1): 55-89.
Abstract: This paper reviews the literature on measurement error in the major US price indexes—the Consumer Price Index (CPI), the Producer Price Index (RPI), and the Gross Domestic Product (GDP) deflators. We take as our point of departure Triplett's, 1975, survey and focus on the studies of measurement error that have appeared since then. We review the problems of substitution bias, quality bias, new goods bias, and outlet substitution bias that are generally considered to be the main sources of error in price indexes. The bulk of the paper is devoted to problems in the CPI and PPI, as the GDP deflators tend to be based mainly on the components of these series. We find that there has been surprisingly little work on the problem of overall measurement error in any of these price indexes, and we conclude that there is very little scientific basis for the commonly accepted notion that measured inflation at 2 to 3 percent a year is consistent with price stability.

No. 9339
Searching for a Stable M2-Demand Equation
Evan F. Koenig
Abstract: The Federal Reserve Board's error-correction model of M2 demand fails to explain much of the recent weakness in money growth. By slightly generalizing the Board model, however, its performance both prior to and during the recent episode of "missing money" can be substantially improved. The results suggest that weakness in M2 growth has been primarily due to a long-run trend toward more efficient use of M2 balances together with a normal response to a growing gap between long-term interest rates and M2 deposit rates.

No. 9338
Exchange Rate Uncertainty and Economic Growth in Latin America
Darryl McLeod and John H. Welch

No. 9337
Assessing the Economic Cost of Unilateral Oil Conservation
Stephen P.A. Brown and Hillard G. Huntington
Abstract: This article examines the costs of U.S. oil conservation policy by using parameters from five world oil models used in a recent Energy Modeling Forun study. Variation in the estimated cost of U.S. conservation across the models suggests that taxing oil consumption would better serve economic efficiency than government controls on oil consumption levels. Furthermore, the analysis shows that unilateral U.S. conservation lowers the world oil price and stimulates non-U.S. oil consumption. When this effect is taken into account, the estimated cost of achieving a given level of world oil conservation through unilateral U.S. action can be substantially greater than the cost of achieving the same level of U.S. oil conservation.

No. 9336
Income Taxes as Reciprocal Tariffs
W. Michael Cox, David M. Gould, and Roy J. Ruffin
Abstract: In this paper we show that there is a formal equivalence between the theory of tariffs in international trade theory and the basic theory of income taxation in a simple neoclassical model that allows for household production. Many insights from international trade theory can thus illuminate important aspects of public finance. Income taxes, which are like international tariff wars, dramatically reduce specialization within an economy. Income taxes (tariffs) hurt low income people (small countries) more than high income people (large countries). As in tariff theory the costs of income taxes are small only if they succeed in rising revenue; thus it really hurts an economy to be on the downward portion of the tax revenue (Laffer) curve. Income taxes (tariffs) have more of a negative welfare impact the larger is the value of market income (trade) compared to total production (GDP) or, that is, the more heterogeneous the society.

No. 9335
Problems of Testing Fiscal Solvency in High Inflation Economies: Evidence from Argentina, Brazil, and Mexico
John H. Welch
Abstract: Most cointegration tests of dynamic government solvency use a measure of seignorage that is significantly biased for high inflation. Using a more appropriate measure, cointegration tests indicate govemment solvency in Argentina, Brazil, and Mexico during the 1980s.

No. 9334
The Inefficiency of Seigniorage from Required Reserves
Scott Freeman
Abstract: Most cointegration tests of dynamic government solvency use a measure of seignorage that is significantly biased for high inflation. Using a more appropriate measure, cointegration tests indicate govemment solvency in Argentina, Brazil, and Mexico during the 1980s.

No. 9333
Wealth Effects, Heterogeneity and Dynamic Fiscal Policy
Zsolt Becsi
Abstract: This paper studies the dynamic effects official policies in a simple perfect foresight model with heterogeneous agents. To obtain an analytical solution, Long and Plosser's (1983) functional form assumptions are combined with heterogeneous wealth levels and consumption/leisure tastes. As a result, the aggregate consumption-leisure ratio depends on the covariance of wealth shares and taste parameters. Policy effects decompose into a "representative agent effect" as in Hall (1971) and Judd (1987) and a "distributional effect" through changes of this covariance. Depending on how the covariance changes, the two effects may have opposite signs. The distributional effect can dominate the representative agent effect even if wealth inequality changes little.

No. 9332
Endogenous Growth and International Trade
Roy J. Ruffin
Published as: Ruffin, Roy J. (1994), "Endogenous Growth and International Trade," Review of International Economics 2 (1): 27-39.
Abstract: This paper clarifies and slightly generalizes the basic endogenous-growth model. I prove the basic theorems without the usual assumption that the distribution of knowledge around the world is irrelevant. Results are stated in terms of lemmas, theorems, and corollaries in order to bring out as clearly as possible the role of each assumption.

No. 9331
The Credibility and Performance of Unilateral Target Zones: A Comparison of the Mexican and Chilean Cases
Raul A. Feliz and John H. Welch

No. 9330
On the Existence of Nonoptimal Equilibria in Dynamic Stochastic Economies
Jeremy Greenwood and Gregory W. Huffman
Published as: Greenwood, Jeremy and Gregory W. Huffman (1995), "On the Existence of Nonoptimal Equilibria in Dynamic Stochastic Economies," Journal of Economic Theory 65 (2): 611-623.
Abstract: The question of the existence of the stationary equilibrium for distorted versions of the standard neo-classical growth model is addressed in this paper. The conditions presented guaranteeing the existence of nontrivial equilibrium for the class of economies under study are simple and intuitively appealing, while the existence proof developed is elementary. Examples are given illustrating that economies with distortional taxation, endogenous growth with externalities, and monopolistic competition can all fit into the framework provided.

No. 9329
Retaliation, Liberalization, and Trade Wars: The Political Economy of Nonstrategic Trade Policy
David M. Gould and Graeme L. Woodbridge
Published as: Gould, David M. and Graeme L. Woodbridge (1998), "The Political Economy of Retaliation, Liberalization and Trade Wars," European Journal of Political Economy 14 (1): 115-137.
Abstract: In this paper, we examine the dynamic process behind protection, retaliation, and trade wars. Consistent with empirical evidence on the development of trade policies, we model policy decisions as an outcome of political contests within two trading nations, rather than as an outcome of a strategic game between two governments. Uncertainty about the incidence and success of retaliation yields a dynamic political equilibrium in which one country imposes a tariff that increases gradually over time. Eventually, the cost of the tariff to the other country's exporting interests induces retaliation. We show that depending on the characteristics of the markets in the two countries, retaliation may encourage liberalization or may cause a trade war.

No. 9328
On the Optimality of Interest-Bearing Reserves in Economies of Overlapping Generations
Scott Freeman and Joseph Haslag
Published as: Freeman, Scott and Joseph Haslag (1996), "On the Optimality of Interest-Bearing Reserves in Economies of Overlapping Generations," European Journal of Political Economy 7 (3): 557-565.
Abstract: Paying interest on required reserves is considered in an overlapping generations model in which the return to capital dominates the return to fiat money. As Smith (1991) showed, financing interest on reserves benefits the initial old at the expense of future generations. We show that the transfer of wealth associated with interest on reserves can be offset by an accommodating open market purchase, so that the payment of interest on reserves is a Pareto improvement. We also show that paying interest on reserves improves welfare even when financed by distorting taxes on capital.

No. 9327
Coal, Natural Gas and Oil Markets after World War II: What's Old, What's New?
Mine K. Yücel and Shengyi Guo

No. 9326
Clearinghouse Banks and Banknote Over-issue
Scott Freeman
Published as: Freeman, Scott (1996), "Clearinghouse Banks and Banknote Over-issue," Journal of Monetary Economics 38 (1): 101-115.
Abstract: The paper presents a model of banks as clearinghouses of private debt where money is used as the means of payment. Implications of the model include: i) the private provision of banknotes or a discount window may be needed to avoid the insufficient debt clearing that results from an inflexible currency stock; and ii) an uncontrolled total money stock may result in a multiplicity of equilibria including an inflationary banknote over-issue.

No. 9325
Growth and Equity with Endogenous Human Capital: Taiwan's Economic Miracle Revisited
Maw-Lin Lee, Ben-Chieh Liu, and Ping Wang
Published as: Lee, Maw-Lin, Ben-Chieh Liu and Ping Wang (1994), "Growth and Equity with Endogenous Human Capital: Taiwan's Economic Miracle Revisited," Southern Economic Journal 61 (2): 435-444.
Abstract: We adopt an endogenous growth model to reexamine the major determinants of economic growth, income distribution, and their dynamic interactions in a newly-industrialized country, Taiwan, 1964-1986. 3SLS estimations from a four-equation system indicate that human capital evolution was crucial in achieving Taiwan's economic miracle: the rapid human capital accumulation enlarged the labor income share, which, coupled with an increased use of progressive labor income taxes, led also to a more equitable distribution of income. This finding therefore supplements, in part, the Kuznets hypothesis in explaining the development processes in several newly industrialized economies in general and Taiwan in particular.

No. 9324
A General Two-Sector Model of Endogenous Growth with Human and Physical Capital: Balanced Growth and Transitional Dynamics
Eric W. Bond, Ping Wang,and Chong K. Yip
Published as: Bond, Eric W., Ping Wang and Chong K. Yip (1996), "A General Two-Sector Model of Endogenous Growth with Human and Physical Capital: Balanced Growth and Transitional Dynamics," Journal of Economic Theory 68 (1): 149-173.
Abstract: We examine a two-sector endogenous growth model with general constant-return-to-scale production technologies governing the evolution of human and physical capital. We prove the existence, uniqueness, and saddle-path stability of the balanced growth equilibrium. A dual approach drawing on techniques from international trade theory is used to provide complete characterization of the transitional dynamics of consumption, goods and education outputs, human and physical capital inputs, and the relative price of human capital investment. We investigate the long-run effects of changes in time preference and factor taxation, and show the emergence of instability or indeterminacy when factor taxes are too distortionary.

No. 9323
Retaliation, Liberalization, and Trade Wars: The Political Economy of Nonstrategic Trade Policy
David M. Gould and Graeme L. Woodbridge
Published as: Gould, David M. and Graeme L. Woodbridge (1998), "The Political Economy of Retaliation, Liberalization and Trade Wars," European Journal of Political Economy 14 (1): 115-137.
Abstract: In this paper, we examine the dynamic process behind protection, retaliation, and trade wars. Consistent with empirical evidence on the development of trade policies, we model policy decisions as an outcome of political contests within two trading nations, rather than as an outcome of a strategic game between two governments. Uncertainty about the incidence and success of retaliation yields a dynamic political equilibrium in which one country imposes a tariff that increases gradually over time. Eventually, the cost of the tariff to the other country's exporting interests induces retaliation. We show that depending on the characteristics of the markets in the two countries, retaliation may encourage liberalization or may cause a trade war.

No. 9322
Recessions and Recoveries in Real Business Cycle Models: Do Real Business Cycle Models Generate Cyclical Behavior?
Nathan Balke and Mark A. Wynne
Published as: Balke, Nathan and Mark A. Wynne (1995), "Recessions and Recoveries in Real Business Cycle Models," Economic Inquiry 33 (4): 640-663.
Abstract: We evaluate the ability of a simple real business cycle model to generate business cycles in the classical NBER sense of the term, where recessions are periods of absolute declines in economic activity. We use the "phase" classification of Burns and Mitchell [1946] to determine the "shape" of the business cycle and to look for asymmetries between expansions and contractions. We show that such a model can generate business cycles of plausible duration and depth, but cannot match the actual "shape" of the business cycle. Nonlinear models, such as Friedman's [1993] “plucking” model may more closely match the observed shape.

No. 9321
Should Bond Funds be Included in M2?
John V. Duca
Abstract: In the early 1990s, U.S. M2 growth has been weaker than estimated while bond mutual funds have experienced large inflows. This study assesses whether adding bond funds to M2 would yield a monetary aggregate that is more explainable using a standard error correction model of money. Results indicate that it is important to net out institutional and IRA/Keogh assets from bond funds (as is done for M2) and that adding such a bond fund series to M2 results in an aggregate that is somewhat more explainable than M2.

No. 9320
The Output Effects of Government Consumption: A Note
Mark A. Wynne
Abstract: This paper presents a simplified analysis of the effects of government consumption in the context of the neoclassical growth model. The analysis complements the recent paper of Aiyagari, Christiano and Eichenbaum (1992), and provides a simpler demonstration of one of their main results that there is an analog to the Keynesian multiplier in such a model.

No. 9319
Allocative Inefficiency and Local Government: Evidence Rejecting the Tiebout Hypothesis
Lori L. Taylor
Published as: Taylor, Lori L. (1995), "Allocative Inefficiency and Local Government," Journal of Urban Economics 37 (2): 201-211.
Abstract: . K. Brueckner (Journal of Public Economics, 19, 311-331, 1992; 11, 223-245, 1979) demonstrated that hedonic estimates of property values can be used to test for allocative efficiency in local Government. However, previous applications of his technique have incorporated data from multiple labor markets, introducing the possibility that governmental amenities might have been capitalized into wages differentials rather than property values. This analysis applies his approach to data from a single metropolitan area. The estimation suggests that local governments do not systematically overprovide any public services and may underprovide highway services.

No. 9318
Why the Composite Index of Leading Indicators Doesn't Lead
Evan F. Koenig and Kenneth M. Emery
Published as: Koenig, Evan F. and Kenneth M. Emery (1994), "Why the Composite Index of Leading Indicators Does Not Lead," Contemporary Economic Policy (12) 1: 52-66.
Abstract: This paper assesses the real-time performance of the Commerce Department's composite index of leading indicators. The authors find that the composite leading index has failed to provide reliable advance warning of cyclical turning points. One reason for this failure is that the leading index's transition from expansion to contraction generally is not very sharp. Consequently, discerning real-time cyclical peaks in the index is difficult. Transitions from contraction to expansion on average are sharp. However, cyclical troughs in the leading index often precede cyclical troughs in the economy by only a few months. Thus, even timely recognition of troughs in the leading index fails to provide advance warning of turnarounds in the general level of economic activity.

No. 9317
An Alternative Neo-Classical Growth Model with Closed-Form Decision Rules
Gregory W. Huffman
Published as: Huffman, Gregory W. (1993), "An Alternative Neo-Classical Growth Model with Closed-Form Decision Rules," Economics Letters 42 (1): 59-63.
Abstract: A version of a representative agent model is constructed in which closed-form decision rules are produced for rather general production technologies. Agents trade in capital, and the decision rules can be used to characterize the volume of this trade.

No. 9316
Price Stabilization, Output Stabilization and Coordinated Monetary Policy Actions
Joseph H. Haslag
Abstract: This paper examines the effects that monetary policy actions have on prices and output when the monetary authority uses open market operations in conjunction with changes in reserve requirements. Both anecdotal and empirical evidence suggest that the Fed uses open market opertions to accommodate changes in the reserve requirements. In this paper, I derive separate accommodation schemes in which the monetary authority stabilizes prices and stabilizes output. The paper, thus, describes what the monetary authority can accomplish by coordinating their policy actions. Furthermore, the description may be helpful in terms of judging past monetary policy behavior.

No. 9315
Output, Inflation, and Stabilization in a Small Open Economy: Evidence from Mexico
John H. Rogers and Ping Wang
Published as: Rogers, John H. and Ping Wang (1995), "Output, Inflation, and Stabilization in a Small Open Economy: Evidence from Mexico," Journal of Development Economics 46 (2): 271-293.
Abstract: We study the sources of fluctuation in output and inflation for Mexico, considering fiscal, real, money growth, exchange rate, and asset market disturbances, which are identified using an estimable equilibrium model incorporating important features of high-inflation economies. Changes in inflation are influenced by all shocks, while output growth is explained by real, fiscal, and asset shocks. The results lend strong support to the fiscal view of inflation, and to a lesser degree support the balance of payments view. We also find that higher inflation and higher budget deficits cause each other to spiral upward.

No. 9314
Technological Unemployment
W. Michael Cox

No. 9313
Default Risk, Dollarization, and Currency Substitution in Mexico
William Gruben and John Welch
Published as: Gruben, William and John Welch (1996), "Default Risk and Dollarization in Mexico," Journal of Money, Credit and Banking 28 (3, Part 1): 393-401.
Abstract: Most empirical evidence of dollarization in Latin America accords with the theoretical claim that increases in expected devaluation increase dollarization. But John H. Rogers (1992) finds that, between 1978 and 1982, relative holdings of Mexdollars were negatively related to expected devaluation. Expected returns on Mexdollar deposits, however, depended on the solvency of the banking system. The authors investigate these links. They find that banking system insolvency decreases Mexdollar deposit demand and increases peso deposit demand. Once these effects are controlled for, Mexdollar demand increases with expected devaluation, even between 1978 and 1982.

No. 9312
Borrowing Constraints, Household Debt, and Racial Discrimination in Loan Markets
John V. Duca and Stuart Rosenthal
Published as: Duca, John V. and Stuart Rosenthal (1993), "Borrowing Constraints, Household Debt, and Racial Discrimination in Loan Markets," Journal of Financial Intermediation 3 (1): 77-103.
Abstract: Two-step selection methods are applied to the 1983 Survey of Consumer Finances to examine the extent to which borrowing constraints restrict household access to debt and the manner in which lenders vary debt limits across borrowers. Results indicate that 30% of young families are credit constrained, and that roughly half of these families would hold at least $12,000 (1982 dollars) more debt if borrowing constraints were relaxed. Debt limits increase with income and wealth, and are relaxed for families with a good credit history. In addition, minorities face tighter debt limits and are more likely to be credit constrained than white families.

No. 9311
Real Effects of Money and Welfare Costs of Inflation in an Endogenously Growing Economy with Transactions Costs
Ping Wang and Chong K. Yip
Abstract: This paper studies the real effects of anticipated inflation in a monetary endogenous growth nodel where money is introduced via a transactions cost technology. Through a reduction in real balances per unit of consumption, an increase in the money growth rate raises transaction time and lowers the endogenous labor-augmenting technical progress, thus suppressing the growth rate of the econony. The main driving force of this non-superneutral result is that money affects the engine of growth directly. Quantitatively, the adverse non-superneutral effect on econonlc growth is unsubstantial, but the welfare loss of anticipated inflation is not negligible.

No. 9310
Does It Matter How Monetary Policy Is Implemented?
Joseph H. Haslag and Scott Hein
Published as: Haslag, Joseph H. and Scott Hein (1995), "Does It Matter How Monetary Policy Is Implemented," Journal of Monetary Economics 35 (2): 359-386.
Abstract: In the U.S., existing monetary base measures add an adjustment factor for changes in reserve requirement ratios to high powered money. Implicitly, the monetary base assumes that the economic effects of changes in reserve requirements are identical to those due to changes in high-powered money. Theory, however, does not generally support the prediction that the two policy tools will have the same economic effects. Structural VARs are estimated to compare the short-run paths of inflation and output growth under two different types of policy shocks. In doing so, this analysis gives one a measure of the costs associated with this implicit equivalence assumption. The evidence is consistent with the hypothesis that the Federal Reserve at least partially offsets reserve requirement changes with open market operations and the hypothesis that dynamic explanations of macroeconomic variables are improved by separating reserve requirement changes from other monetary policy moves.

No. 9309
The Algebra of Price Stability
Nathan S. Balke and Kenneth M. Emery
Published as: Balke, Nathan S. and Kenneth M. Emery (1994), "The Algebra of Price Stability," Journal of Macroeconomics 16 (1): 77-97.
Abstract: In this paper, we propose two definitions of price stability that encompass the interpretations of price stability found in the economic literature. To determine the conditions under which monetary policy can achieve price stability, we examine several well-known classes of monetary rules including the targeting of monetary aggregates, nominal GNP, prices, and interest rates. In addition, we use a linear rational expectations model to explore the degree to which price stability constrains short-term stabilization policy. We find that price stability does not necessarily prevent the monetary authority from pursuing short-term stabilization goals.

No. 9308
On Quantity Theory Restrictions and the Signalling Value of the Money Multiplier
Joseph Haslag
Abstract: This paper examines the issue of which money measure is most closely related to prices. The contribution of this paper lies in examining the appropriate interpretation of results indicating that the money multiplier is siqnificantly related to inflation. The analysis forwarded in this paper provides some indirect evidence as to what interpretation — either broader categories of indebtedness are related to prices or the money multiplier signals shocks to the demand for base money — is appropriate. The evidence bears on the predictions posited in Sargent and Wallace's (1982) paper in which base money is the money measure most highly correlated with prices when quantity theory restrictions are present.

No. 9307
Money Demand and Relative Prices During Episodes of Hyperinflation
Ellis W. Tallman and Ping Wang
Published as: Tallman, Ellis W. and Ping Wang (1995), "Money Demand and the Relative Price of Capital Goods in Hyperinflation," Journal of Monetary Economics 36 (2): 375-404.
Abstract: We investigate dynamic interactions between relative price movements and money demand behaviors during hyperinflations, viewing relative price changes as resulting primarily from real disturbances. We develop a general equilibrium model with heterogeneous consumption and capital goods to illustrate how monetary shocks may produce real effects through the relative price channel. This motivates the design of long-run restrictions to identify a structural vector autoregression, employing data from the post-WWI Germany and the post-WWII Chinese hyperinflationary episodes. The empirical results support the contention that both real and nominal shocks have important effects on the relative price and money demand during hyperinflations.

No. 9306
Constructing an Alternative Measure of Changes in Reserve Requirement Ratios
Joseph H. Haslag and Scott E. Hein

No. 9305
Money, Output, and Income Velocity
Theodore Palivos and Ping Wang
Published as: Palivos, Theodore and Ping Wang (1995), "Money, Output, and Income Velocity," Applied Economics 27 (11): 1113-1125.
Abstract: This paper attempts to assess empirically the contribution of three structural shocks — monetary, institutional (financial and fiscal), and technological — to output and velocity fluctuations in the national bank era and the post-1973 period. To identify these shocks we impose only long–run restrictions, derived from a monetary growth model. We find that higher money growth increases (decreases) velocity in the first (second) period, depending crucially on the resulting changes in the transactions frequency. Credit–enhancing financial or expansionary fiscal shocks have a permanent positive effect on velocity and a himp–shaped effect on output, whereas technological shocks cause velocity to decrease in the short run and output to move to a permanently higher level.

No. 9304
The Political Economy of School Reform
S. Grosskopf, K. Hayes, L. Taylor, and W. Weber
Abstract: Despite ali the rhetoric about school reform, there are few signs of substantive change. One source of the delay in changing the system may be opposition by interest groups that do not expect to gain from reform. The authors use distance function methodology to simulate deregulation of urban school districts in Texas and thereby identify the probable winners and losers of educational reform. The simulation indicates that parents and students in school districts that are poor and have a relatively high proportion of minority students have little to gain from deregulation because they are already using their inputs more efficiently than wealthier school districts with fewer minority students. Furthermore, the potential gains from deregulation increase as property wealth and expenditures per student increase. The simulation also indicates that many education professionals are extracting rents (in terms of excess employment) from the current system, and that deregulation and incentives for increased efficiency would lead nany school districts to substitute teacher aides for teachers, administrators, and professional staff.

No. 9303
A General Two Sector Model of Endogenous Growth with Human and Physical Capital
Eric Bond, Ping Wang, and Chong K. Yip
Published as: Bond, Eric W., Ping Wang and Chong K. Yip (1996), "A General Two-Sector Model of Endogenous Growth with Human and Physical Capital: Balanced Growth and Transitional Dynamics," Journal of Economic Theory 68 (1): 149-173.
Abstract: We examine a two-sector endogenous growth model with general constant-return-to-scale production technologies governing the evolution of human and physical capital. We prove the existence, uniqueness, and saddle-path stability of the balanced growth equilibrium. A dual approach drawing on techniques from international trade theory is used to provide complete characterization of the transitional dynamics of consumption, goods and education outputs, human and physical capital inputs, and the relative price of human capital investment. We investigate the long-run effects of changes in time preference and factor taxation, and show the emergence of instability or indeterminacy when factor taxes are too distortionary.

No. 9302
The New Face of Latin America: Financial Flows, Markets, and Institutions in the 1990s
John Welch
Published as: Welch, John (1993), "The New Face of Latin America: Financial Flows, Markets, and Institutions in the 1990s," Journal of Latin American Studies 25 (1): 1-24.
Abstract: The gains and difficulties Latin American countries face from financial market development and liberalisation have received much attention in current economic literature. Nevertheless, significant issues have received little or no attention, even though the success of these efforts depends upon them. The purpose of this article is to explore the benefits from open and developed — two words that are not necessarily synonymous — financial and capital markets in Latin America and possible important obstacles which will be faced in the remainder of the 1990s.

No. 9301
Human Capital Externalities, Trade, and Economic Growth
David Gould and Roy J. Ruffin
Abstract: Human capital, because of its special role in innovative activity and technological progress, has formed the bedrock of the new theories of endogenous growth. Human capital, however, not only serves as an engine of growth, but also as a productive input along with labor and physical capital. In this study, we distinguish between these two roles of human capital and find evidence of the importance of both. We also find that the relationship between growth and the external effects of human capital vary according to trade regime. When literacy rates are relatively high, open economies grow about 0.65 to 1.75 percentage points more than closed economies.

No. 9216
An Analysis of the Impact of Two Fiscal Policies on the Behavior of a Dynamic Asset Market
Gregory W. Huffman
Abstract: A stochastic general equilibrium model is constructed in which an analysis can be conducted into the effects of-various distortional govemment policies on the behavior financial market variables. In particular, a tax on transactions in assets and a capital gains tax are studied separately. The effects of these policies on the equilibrium behavior of capital prices, rates of return, and the level of transaction volume are quantified. Additionally some estimates of the welfare costs of such policies are presented. Although the model is a version of the representative agent framework with time-separable preferences, it is also shown that it can generate an endogenous distribution of wealth.

No. 9215
Energy Security: A Comparison of Protectionist Policies
Mine K. Yücel and Carol Dahl
Published as: Yücel, Mine K. and Carol Dahl (1995), "Protectionist Oil Policies: A Dynamic Comparison for the USA," Energy Policy 23 (7): 599-605.
Abstract: Rising US oil imports have spawned a variety of policies for increasing energy security. We provide a qualitative comparison of policies using a dynamic optimal control model. Thirty-year price and output paths for OPEC and the USA are simulated assuming that US producers are competitive and OPEC is a dominant firm. We find that the policies have quite different effects on imports and welfare. The tariff reduces imports the most, followed by the gasoline tax. A per unit tariff and gasoline tax are costly in terms of US welfare, whereas an ad valorem tariff can both lower imports and enhance US welfare.

No. 9214
Forecasting Turning Points: Is a Two-State Characterization of the Business Cycle Appropriate?
Kenneth M. Emery and Evan F. Koenig
Published as: Emery, Kenneth M. and Evan F. Koenig (1992), "Forecasting Turning Points: Is a Two-State Characterization of the Business Cycle Appropriate?," Economics Letters 39 (4): 431-435.
Abstract: Two-state models of the Commerce Department's leading and coincident indexes appear to be misspecified. Cyclical peaks in these indexes are more rounded than are cyclical troughs. Further, the variability of changes in the indexes is unusually high near cyclical troughs.

No. 9213
Measuring the Value of School Quality
Lori Taylor

No. 9212
The Analysis of Fiscal Policy in Neoclassical Models
Mark Wynne
Abstract: This paper presents an analysis of the effects of changes in government purchases in the context of a simple static neoclassical model. I show why there can never be a multiplier in such a model under standard assumptions about tastes and technology when the capital stock is held fixed. The standard analysis is extended to include an examination of the effects of changes in public sector employment. The introduction of public sector employment means that we must be careful in choosing between alternative empirical measures of the theoretical concept of aggregate output. Under current national income accounting conventions, GNP may in fact fall in response to increased government purchases.

No. 9211
Nominal Feedback Rules for Monetary Policy: Some Comments
Evan F. Koenig

No. 9210
Cointegration and Tests of a Classical Model of Inflation in Argentina, Bolivia, Brazil, Mexico, and Peru
Raul Anibal Feliz and John H. Welch
Published as: Anibal Feliz, Raul and John H. Welch (1997), "Cointegration and Tests of a Classical Model of Inflation in Argentina, Bolivia, Brazil, Mexico, and Peru," Journal of Development Economics 52 (1): 189-219.
Abstract: We develop a classical model of inflation with rational expectations that carries a number of testable implications. First, money growth and inflation are cointegrated. Second, the changes in real money demand — the equilibrium error — anticipate future monetary policy. Third, cointegration between money growth and inflation implies, as Campbell and Shiller (Journal of Political Economy, 1987, 95, 1062–1088, and Journal of Economic Dynamics and Control, 1988, 12, 505–522) show, cross-equation restrictions readily generated from an error-correction representation of the variables. Our results show that the allegedly different inflationary experiences of Argentina, Bolivia, Brazil, Mexico, and Peru are consistent with this classical model of inflation. In all countries, the data fail to reject these three conditions in all but one of the periods studied.

No. 9209
Threshold Cointegration
Nathan S. Balke and Thomas B. Fomby
Published as: Balke, Nathan S. and Thomas B. Fomby (1997), "Threshold Cointegration," International Economic Review 38 (3): 627-645.
Abstract: In this paper, we consider a model in which there is discontinuous adjustment to a long-run equilibrium. Here, the equilibrium error follows a threshold autoregression that is mean-reverting outside a given range and has a unit root inside the range. We suggest a two-step approach for examining threshold cointegration. We find that standard time series methods developed for testing for cointegration in the linear case work reasonably well when threshold cointegration is present. We then consider a 'sup-Wald' test of linearity that takes the double-threshold model as the alternative hypothesis.

No. 9208
On the Future Erosion of the North American Free Trade Agreement
William C. Gruben

No. 9207
The Effects of Credit Availability, Nonbank Competition, and Tax Reform on Bank Consumer Lending
John V. Duca and Bonnie Garrett
Abstract: This study investigates the slowdown in U.S. bank consumer lending since the mid-1980s. Owing to important data considerations, the focus is on consumer loans rather than on C&I, real estate, or total bank loans. The study finds that nonrate credit conditions, tax reform, and nonbank competition variables, as well as more traditional variables, are significant determinants of consumer lending. Other results indicate that, after adjusting for securitization activity, the slowdown in consumer loan growth at banks since 1989 is largely explained by changes in nonrate credit conditions, the rise in unemployment, and the fall-off in consumer spending.

No. 9206
Budget Constrained Frontier Measures of Fiscal Equality and Efficiency in Schooling
Shawna Grosskopf, Kathy Hayes, Lori L. Taylor, William Weber
Published as: Grosskopf, Shawna, Kathy Hayes, Lori L. Taylor and William L. Webster (1997), "Budget Constrained Frontier Measures of Fiscal Equality and Efficiency in Schooling," Review of Economics and Statistics 79 (1): 116-124.
Abstract: Equality and efficiency are key issues in educational reform. Here the authors analyze the efficiency and equality consequences of various school finance reforms using a cost-indirect output distance function. This function readily models multiple-output production under conditions of budgetary constraint, and provides a natural measure of performance that is closely related to Farrell-type measures of efficiency. The analysis suggests that despite school district inefficiency, finance reforms can affect student achievement. However, any potential gains in output from redistribution are dwarfed by the potential gains from increased efficiency. More strikingly, the analysis demonstrates that budgetary reforms designed to equalize expenditures could actually increase the inequality of student achievement.

No. 9205
Inflation and Its Variability: A Note
Kenneth M. Emery
Published as: Emery, Kenneth M. (1993), "Inflation and Its Variability: An Alternative Specification," Applied Economics 25 (1): 43-46.

No. 9204
Does Aggregate Output Have a Unit Root?
Mark A. Wynne
Published as: Wynne, Mark A. (1992), "Does Aggregate Output Have a Unit Root?" Economics Letters 39 (2): 179-182.
Abstract: Gross National Private Product is a more appropriate empirical counterpart for the theoretical concept of aggregate output than GNP. The two series have different stochastic properties over the past 100 years.

No. 9203
Immigrant Links to the Home Country: Implications for Trade, Welfare and Factor Rewards
David M. Gould
Abstract: In this paper, I examine how ties to immigrants' home countries can influence trade, welfare and factor rewards. Immigrant ties, or links, include knowledge of home-country markets, language, preferences, and personal contacts that have the potential to decrease trading transactions costs. An important implication from the model is that while immigration tends to decrease trade and labor wages, immigration that includes immigrant links can have the opposite effects — increasing trade and wages. Furthermore, the total potential gains from trade may increase through the trade enhancing effects of immigrant links.

No. 9202
The Case of the "Missing M2"
John V. Duca
Abstract: Since the third quarter of 1990, the growth of M2 in the United States has been weaker than econometric models predicted. John V. Duca assesses whether this shortfall in M2 growth is associated with inflows into bond and equity mutual funds or the thrift resolution process. ; Duca finds that while, to some degree, bond funds are good substitutes for M2, bond and equity funds do not account for the shortfall. Most of the missing M2, he concludes, appears to be related to activity of the Resolution Trust Corporation. Duca reasons that resolution procedures can depress M2 in ways not reflected in standard models, such as by forcing an early call of small time deposits and by imparting the risk of prepayment to small time deposits.

No. 9201
Are Deep Recessions Followed by Strong Recoveries?
Mark A. Wynne and Nathan S. Balke
Published as: Wynne, Mark A. and Nathan S. Balke (1992), "Are Deep Recessions Followed by Strong Recoveries?" Economics Letters 39 (2): 183-189.
Abstract: We examine the hypothesis that deep recessions are followed by strong recoveries using a monthly data set for industrial production covering the period 1884–1990. There is a statistically significant relationship between growth in the first twelve months of a recovery and the peak-to-trough decline in industrial activity. This effect is still found when we exclude the Great Depression from our sample. We find no evidence that the length of the recession affects the strength of the subsequent recovery.

No. 9119
Student Emigration and the Willingness to Pay for Public Schools: A Test of the Publicness of Public High Schools in the U.S.
Lori L. Taylor
Published as: Taylor, Lori L. (1992), "Student Emigration and the Willingness to Pay for Public Schools: A Test of the Publicness of Public High Schools in the U.S.," Public Finance = Finances publiques 47 (1): 131-152.
Abstract: This paper presents a test of Weisbrod's hypothesis that a public-goods aspect to education, coupled with anticipated emigration by students, leads communities to underinvest in education. It analyzes, in a simultaneous equations framework, the effects of both immigration and emigration on high school finance decisions in the United States. The analysis does not support the hypothesis of a public investment motive in educational finance. However, the revealed negative correlation between immigration and educational expenditures suggests that communities may be free-riding on human capital produced elsewhere by substituting "imported" human capital for local production.

No. 9118
Allocative Inefficiency in Education
Shawna Grosskopf, Kathy Hayes, Lori Taylor and William Weber

No. 9117
The Algebra of Price Stability
Nathan S. Balke and Kenneth M. Emery
Published as: Balke, Nathan S. and Kenneth M. Emery (1994), "The Algebra of Price Stability," Journal of Macroeconomics 16 (1): 77-97.
Abstract: In this paper, we propose two definitions of price stability that encompass the interpretations of price stability found in the economic literature. To determine the conditions under which monetary policy can achieve price stability, we examine several well-known classes of monetary rules including the targeting of monetary aggregates, nominal GNP, prices, and interest rates. In addition, we use a linear rational expectations model to explore the degree to which price stability constrains short-term stabilization policy. We find that price stability does not necessarily prevent the monetary authority from pursuing short-term stabilization goals.

No. 9116
Public Deficits in Mexico: A Comment
John H. Welch
Published as: Welch, John (1992), "Public Deficits in Mexico: A Comment," Estudios Economicos 7 (1): 139-144.
Abstract: This comment shows that the Mexican intertemporal budget balance was maintained for the period 1981 to 1988. The result contrasts with the one obtained by Feliz and Torres (1991).

No. 9115
North American Free Trade and the Peso: The Case for a North American Currency Area
Darryl McLeod and John H. Welch
Abstract: This paper discusses the nature and policy implications of recent fluctuations in the peso-dollar rate. We conclude that this is a propitious time for a shift in exchange rate regime but that a target zone for the peso has important advantages over a fixed rate or crawling peg system. Implementing this new regime as part of a "North American Dollar Area" agreement would benefit Mexico in particular and generally complement the NAFTA’s goal of increasing regional trade and investment.

No. 9114
The Optimality of Nominal Contracts
Scott Freeman and Guido Tabellini
Published as: Freeman, Scott and Guido Tabellini (1998), "The Optimality of Nominal Contracts," Economic Theory 11 (3): 545-562.
Abstract: This paper presents a model in which agents choose to use money as a medium of exchange, a means of payment, and a unit of account. The paper defines conditions under which nominal contracts, promising future payment of a fixed number of units of fiat money, prove to be the optimal contract form in the presence of either relative or aggregate price risk. When relative prices are random, nominal contracts are optimal if individuals have ex ante similar preferences over future consumption. When the aggregate price level is random, whether from shocks to the money supply or aggregate output, nominal contracts (perhaps coupled with equity contracts) lead to optimal risk-sharing if individuals have the same degree of relative risk aversion. Finally, nominal contracts may be optimal if the repayment of contracts is subject to a binding cash-in-advance constraint. In this case, a contingent contract increases the risk of holding excessive cash balances.

No. 9113
Rational Inflation and Real Internal Debt Bubbles in Argentina and Brazil?
John H. Welch

No. 9112
Credit Cards and Money Demand: A Cross-Sectional Study
John V. Duca and William C. Whitesell
Published as: Duca, John V. and William C. Whitesell (1995), "Credit Cards and Money Demand: A Cross-Sectional Study," Journal of Money, Credit and Banking 27 (2): 604-623.
Abstract: This study investigates credit card holding and the household demands for several monetary assets in a simulataneous equations framework. It exploits the detailed data on household assets, as well as demographic and preference characteristics in the 1983 Survey of Consumer Finance. A key finding is that, consistent with theory, a higher probability of credit card ownership implies a lower demand for liquid money balances with no effect on small time deposit balances.

No. 9111
An Econometric Analysis of Borrowing Constraints and Household Debt
John V. Duca and Stuart S. Rosenthal

No. 9110
Underdevelopment and the Enforcement of Laws and Contracts
Scott Freeman
Abstract: This paper presents a model of endogenously determined contract enforcement with two equilibria. In one, contracts are enforced and market activity is unhampered. In the other, contracts are not enforced, discouraging market activity, which leaves the nation without the resources and incentives to enforce contlacts. Even identically endowed nations may therefore find thernselves in very different equilibria. The model is offered to explain the wide and persistent gap between developed and undeveloped economies.

No. 9109
Detecting Level Shifts in Time Series: Misspecification and a Proposed Solution
Nathan S. Balke
Published as: Balke, Nathan S. (1993), "Detecting Level Shifts in Time Series," Journal of Business and Economic Statistics 11 (1): 81-92.
Abstract: This article demonstrates the difficulty that traditional outlier detection methods, such as that of Tsay, have in identifying level shifts in time series. Initializing the outlier/level-shift search with an estimated autoregressive moving average model lowers the power of the level-shift detection statistics. Furthermore, the rule employed by these methods for distinguishing between level shifts and innovation outliers does not work well in the presence of level shifts. A simple modification to Tsay's procedure is proposed that improves the ability to correctly identify level shifts. This modification is relatively easy to implement and appears to be quite effective in practice.

No. 9108
Learning from One Another: The U.S. and European Banking Experience
Robert T. Clair and Gerald P. O'Driscoll, Jr.
Published as: Clair, Robert T. and Gerald P. O'Driscoll, Jr. (1993), "Learning from One Another: The U.S. and European Banking Experience," Journal of Multinational Finance Management 2 (3-4): 33-52.
Abstract: In this paper, the authors compare and contrast the banking structures in the United States and the countries of the European Comtnunity (EC). While the U.S. has a large number of small, undiversified banks. By contrast, Europe contains a smaller number of larger banksprovidinga widerarray of financial services than their American counterparts. The differences will only be heightened by the Single Market initiative in Europe. The paper identifies a crucial regulatory difference between the U.S. and the EC regulatory approaches. While the EC is moving to home country regulation of banks, the U.S. relies on host state regulation. While the former system facilitates competitive entry, the latter inhibits it. The paper concludes by warning European policy makers against adopting co~nprehensive safety nets for banks, in order to avoid US.-style banking problems.

No. 9107
Hyperinflation and Internal Debt Repudiation in Argentina and Brazil: From Expectations Management to the "Bonex" and "Collor" Plans
John H. Welch

No. 9106
What Motivates Oil Producers?: Testing Alternative Hypotheses
Carol Dahl and Mine Yücel
Abstract: Conventional wisdon holds that OPEC is a weakly funccioning cartel with non-OPEC producers forming a "competitive fringe". However, several studies have challenged the cartel hypochesis for OPEC, and a few have even challenged the competitiveness of the fringe. In this paper we test competing hypotheses using recently developed cost data that allows the most general model to date. Because economic theory suggests that natural resource producers should dynamically optimize, we explicitly incorpoarte and test whether various oil producing countries do. Under our specification there was no evidence for dynanic optinization. Although formal target-revenue models were rejected, there was some evidence that targeting may influence production for OPEC countries. There was no evidence that any of the oil-producing countrles in OPEC behaved in a competitive manner. On the other hand, we were unable to detect any formal evidence of coordination among countries. More surprisingly, we do not find evidence that the fringe is competitive either.

No. 9105
Variations in Texas School Quality
Lori L. Taylor and Beverly J. Fox
Abstract: The main contribution of the study is the list of the value-added rankings of more than 700 Texas school districts, one that more closely approximates true school quality than rankings using single test scores or expenditure measures. We show that the distribution of school quatity in Texas is essentially random. No systematic relationship exists between grade school and high school quality. We also demonstrate that quality is unaffected by school district size and that there are few systematic differences in quality between school districts in urban counties and school districts in nonurban counties.

No. 9104
Evaluating Monetary Base Targeting Rules
R.W. Hafer, Joseph H. Haslag, Scott E. Hein

No. 9103
Government Purchases and Real Wages<
Mark A. Wynne

No. 9102
Immigrant Links to the Home Country: Empirical Implications for U.S. and Canadian Bilateral Trade Flows
David M. Gould
Published as: Gould, David M. (1994), "Immigrant Links to the Home Country: Empirical Implications for U.S. Bilateral Trade Flows," The Review of Economics and Statistics 76 (2): 302-316.
Abstract: Immigrants' ties to their home countries can play a key role in fostering bilateral trade linkages. Immigrant ties include knowledge of home-country markets, language, preferences, and business contacts that have the potential to decrease trading transaction costs. Empirical results for the United States suggest that immigrant links have historically been important in increasing bilateral trade flows with immigrants' home countries.

No. 9101
Large Shocks, Small Shocks, and Economic Fluctuations: Outliers in Macroeconomic Times Series
Nathan S. Balke and Thomas B. Fomby
Published as: Balke, Nathan S. and Thomas B. Fomby (1994), "Large Shocks, Small Shocks, and Economic Fluctuations: Outliers in Macroeconomic Times Series," Journal of Applied Econometrics 9 (2): 181-200.
Abstract: We analyse fifteen post-World War II US macroeconomic time series using a modified outlier identification procedure based on Tsay (1988a). 'Large shocks' appear to be present in all the series we examined. Furthermore, there are three basic outlier patterns: (I) outliers seem to be associated with business cycles, (2) outliers are clustered together-both over time and across series, (3) there appears to be a dichotomy between outlier behaviour of real versus nominal series. Also, after controlling for outliers, much of the evidence of non-linearity in many of the time series is eliminated.

No. 9013
Methanol As an Alternative Fuel
Mine Yücel
Abstract: Methanol, because of its low pollution characteristics, is a possible alternative to gasoline as a motor fuel. In this article, Mine Yücel calculates the economic, pollution, and health effects of switching from gasoline to methanol fuels. ; Yucel finds that use of methanol would lower oil demand and oil prices, while increased demand for methanol's natural gas feedstock would increase natural gas prices. Fuel prices would increase because methanol is more costly than gasoline. However, methanol use would reduce ozone pollution and some of the health risks associated with gasoline.

No. 9012
Fisher Effects and Central Bank Independence
Kenneth M. Emery

No. 9011
Is Increased Price Flexibility Stabilizing? The Role of the Permanent Income Hypothesis
Evan F. Koenig

No. 9010
The Impact of Differential Human Capital Stocks on Club Allocations
Lori L. Taylor

No. 9009
Does It Matter How Monetary Policy Is Implemented?
Joseph H. Haslag and Scott E. Hein
Published as: Haslag, Joseph H. and Scott E. Hein (1995), "Does It Matter How Monetary Policy Is Implemented?" Journal of Monetary Economics 35 (2): 359-386.
Abstract: In the U.S., existing monetary base measures add an adjustment factor for changes in reserve requirement ratios to high powered money. Implicitly, the monetary base assumes that the economic effects of changes in reserve requirements are identical to those due to changes in high-powered money. Theory, however, does not generally support the prediction that the two policy tools will have the same economic effects. Structural VARs are estimated to compare the short-run paths of inflation and output growth under two different types of policy shocks. In doing so, this analysis gives one a measure of the costs associated with this implicit equivalence assumption. The evidence is consistent with the hypothesis that the Federal Reserve at least partially offsets reserve requirement changes with open market operations and the hypothesis that dynamic explanations of macroeconomic variables are improved by separating reserve requirement changes from other monetary policy moves.

No. 9008
Lender of Last Resort: A Contemporary Perspective
George G. Kaufman
Published as: Kaufman, George G. (1991), "Lender of Last Resort: A Contemporary Perspective," Journal of Financial Services Research 5 (2): 95-110.
Abstract: This article re-examines the role of the central bank's lender of last resort (LLR) function in the current economic environment. It argues that the traditional role of protecting the money supply from collapse is no longer valid. LLR intervention is appropriate to offset temporary liquidity strains that are likely to depress asset prices and aggregate real income below their equilibrium levels. However, such support should be provided only rarely and through open market operations rather than the discount window.

No. 9007
The Aggregate Effects of Temporary Government Purchases
Mark A. Wynne
Abstract: How do changes in the level of government purchases affect the macroeconomy? This paper looks at the effects of temporary government purchases in the context of a simple dynamic general equilibrium model. The model is parameterised in a parsimonious manner and perturbed by a spending shock that captures the temporary component of government spending in the US during World War II. There is a remarkable correspondence between the movements in output, consumption and effort predicted by the model and those observed in reality.

No. 9006
Are Net Discount Ratios Stationary? The Implications for Present Value Calculations
Joseph H. Haslag, Michael Nieswiadomy and D.J. Slottje
Published as: Haslag, Jospeh H., Michael Nieswiadomy and D.J. Slottje (1991), "Are Net Discount Ratios Stationary? The Implications for Present Value Calculations," Journal of Risk and Insurance 58 (3): 505-512.
Abstract: This article analyzes the relationship between real interest rates and real growth rates in wages. The stationarity of these time series has been discussed in the literature. However, since the net discount ratio, (1 + g1)/(l + r1), is a nonlinear transformation, it is not necessarily stationary even if the interest rate and growth rate in wages series are each stationary. On the other hand, the net discount ratio may be stationary even if the interest rate and growth rate series are both non- stationary. The significant finding of this article is that this ratio is stationary. This conclusion appears robust since it holds for at least four different Treasury securities analyzed: three month, six month, one year, and three year. Therefore, a real net discount ratio, (1 + g1)/(1 + r1), can be used with confidence in constructing present value forecasts of expected earnings.

No. 9005
U.S. Oil Demand and Conservation
S.P.A. Brown and Keith R. Phillips
Published as: Brown, S.P.A. and Keith R. Phillips (1991), "U.S. Oil Demand and Conservation," Contemporary Economic Policy 9 (1): 67-72.
Abstract: Recent history has lent casual support to three popular theories about U.S. oil demand: U.S. oil consumption is very insensitive to changing oil prices; non-price conservation has reduced U.S. oil demand; and U.S. oil consumption falls more when oil prices rise than it rises when prices fall. Together these theories suggest that oil consumption could be held constant without much economic sacrifice. Our econonetric evidence does not support these theories. We find that U.S. oil consumption is fairly responsive to changes in price over the long run, but with a considerable lag. The lag accounts for the data that seems to support the popular theories. Sharp oil price increases (or their equivalent) will be required to hold oil consumption constant during the I990s.

No. 9004
Banking Reform
Gerald P. O'Driscoll, Jr.

No. 9003
Inflation, Real Interest Rates and the Fisher Equation Since 1983
Kenneth H. Emery
Abstract: This paper demonstrates that the time series properties of inflation have changed dramatically since 1983. Specifically, the inflation rate can now best be described as a stationary white-noise process with strong mean-reverting tendencies. These findings contrast sharply with the nonstationary and highly persistant characteristics of inflation for the rest of the post-Accord period. The most recent behavior of inflation has important implications for the perceived anti-inflation credibility of the Federal Reserve, for empirical models of inflation, and for the formation of inflation expectations.

No. 9002
Demographics and the Foreign Indebtedness of the United States
John K. Hill

No. 9001
Another Look at the Credit-Output Link
Cara S. Lown and Donald W. Hayes

No. 8917
Dynamic Modeling and Testing of OPEC Behavior
Mine Yücel and Carol Dahl
Published as: Yücel, Mine K. and Carol Dahl (1991), "Testing Alternative Hypotheses of Oil Producer Behavior," Energy Journal 12 (4): 117-138.
Abstract: Although conventional wisdom suggests that OPEC is a cartel, many studies since 1973 have considered other underlying forces in order to understand and forecast OPEC behavior. Using the most general model to date on quarterly data from 1971:1 to 1986:4, we econometrically test a variety of hypotheses. We find that the various OPEC countries have quite dissimilar ways suggesting that a cartel hypothesis is not appropriate. Under our specification, there was no evidence for dynamic optimization or a strong target revenue model. There was some evidence that a form of target revenue may be included in the goals for Iran, Libya, Saudi Arabia and the UAE. Iraqi behavior was most consistent with a static competitive market structure, while a static noncompetitive market structure was not rejected for Algeria, Nigeria, Saudi Arabia Kuwait and Venezuela. However, given their divergence in behavior, we do not conclude in favor of a weak cartel but that there is a noncompetitive core of swing producers that each swing to their own rhythm.

No. 8916
The Location Quotient and Central Place Theory
R. W. Gilmer, S. R. Keil and R. S. Hack

No. 8915
Are the Permanent Income Model of Consumption and the Accelerator Model of Investment Compatible?
Evan F. Koenig
Abstract: The permanent–income model implies that consumption will be rising when the real interest rate is high. The accelerator model implies that investment will be greater, the greater is the rate of increase of sales. In combination, the permanent–income and accelerator models imply that a money–induced rise in interest rates is expansionary—a prediction at variance with the relationship between monetary policy and economic activity that we observe in the real world.

No. 8914
Nominal GNP Growth and Adjusted Reserve Growth: Nonnested Tests of the St. Louis and Board Measures
Joseph H. Haslag and Scott E. Hein
Published as: Haslag, Jospeh H. and Scott E. Hein (1995), "Quasi Balance–Sheet Measures of U.S. Monetary Policy: A Closer Look," Journal of Money, Credit and Banking 27 (1): 124-139.

No. 8913
Do Maquiladoras Take American Jobs? Some Tentative Econometric Results
William C. Gruben
Published as: Gruben, William C. (1990), "Do Maquiladoras Take American Jobs? Some Tentative Econometric Results," Journal of Borderlands Studies 5 (1): 31-45.

No. 8912
A Dynamic Comparison of An Oil Tariff, a Producer Subsidy, and a Gasoline Tax
Mine Yücel and Carol Dahl
Abstract: Recent increases in oil imports have spawned a variety of suggestions aimed at protecting the domestic oil industry. if implemented, these policies including an oil tariff, a domestic producer subsidy, and a gasoline tax, would result in income transfers involving billions of dollars, Since they would have immediate as well as tong term implications which might differ winthin and across policies, we provide policy makers with a qualitative comparison of these policies using a dynamic optimal control model. Fifty year price and output paths for OPEC and the U.S. are simulated assuming that U.S. producers are competitive and OPEC is a dominant firm, maximizing its profits, taking U.S. output as given. We then compare the effects of these policies on U.S. vulnerability and security, macroeconomic activity, the federal government budget deficit, and welfare issues.

No. 8911
Are Reserve Requirement Changes Really Exogenous? An Example of Regulatory Accommodation of Industry Goals
Cara S. Lawn and John H. Wood

No. 8910
The Clearing House Interbank Payments System: A Description of Its Operation and Risk Management
Robert T. Clair

No. 8909
Macroeconomic Policy and Income Inequality: An Error-Correction Representation
Joseph H. Haslag and Daniel J. Slottje
Abstract: This paper investigates whether fiscal and monetary policy actions are co–integrated with inequality in the size distribution of income. The effects of monetary policy on the size distribution of income have generally been ignored in the literature. We find that aggregate monetary and fiscal policy measures are co–integrated with various measures of income inequality. Indeed, teh evidence from the error–correction specification implied by co–integrating regression suggests that impacts of monetary policy actions on the size distribution of income are statistically significant.

No. 8908
Daylight Overdrafts: Who Really Bears the Risk?
Robert T. Clair
Published as: Clair, Robert T. (1991), "Daylight Overdrafts: Who Really Bears the Risk?,"in Governing Banking's Future: Markets vs. Regulation, ed. Catherine England (New York: Springer), 117-140.
Abstract: Numerous governmental and private-sector studies have addressed the problem of payment system risk in recent years. The consensus emerging from those studies is that daylight overdrafts are the primary source of risk in the U.S. electronic payment systems. The institutions that create overdrafts do not bear the full costs, and although recent regulation of the large-dollar transfer systems has reduced somewhat the risk associated with overdrafts, problems remain.

No. 8907
The Effects of Financial Deregulation on Inflation, Velocity Growth, and Monetary Targeting
W. Michael Cox and Joseph H. Haslag

No. 8906
Real Money Balances and the Timing of Consumption: An Empirical Investigation
Evan F. Koenig
Published as: Koenig, Evan F. (1990), "Real Money Balances and the Timing of Consumption: An Empirical Investigation," Quarterly Journal of Economics 105 (2): 399-425.
Abstract: This paper examines the correlation between changes in consumer spending on nondurables and services, and levels or changes in a variety of other variables that might be expected to enter directly as arguments of the household utility function or to serve as measures of household liquidity. Empirical results strongly suggest that an increase in real money balances raises the marginal utility of consumption. Once the influence of real balances is accounted for, there is little evidence that other variables have a direct impact on the timing of consumption.

No. 8905
Stock Returns and Inflation: Further Tests of the Proxy and Debt-Monetization Hypotheses
David Ely and Kenneth J. Robinson
Published as: Ely, David and Kenneth J. Robinson (1992), "Stock Returns and Inflation: Further Tests of the Role of the Central Bank," Journal of Macroeconomics 14 (3): 525-543.
Abstract: This study investigates the anomalous relationship between real stock returns and inflation. Specifically, we investigate hypotheses that claim the proxy relationship between inflation and expected real output is driven by the practice of debt monetization and/or countercyclical monetary policy carried out by the central bank. Using a rational expectations approach to the determination of stock returns, the equilibrium process in the monetary sector is not found to be a consistent explanation for the anomalous relationship. Also, the results do not favor the hypothesis that debt monetization lies behind the performance of the stock market during inflationary time periods.

No. 8904
Federal Reserve System Reserve Requirements: 1959–88—A Note
Joseph H. Haslag and Scott E. Hein
Published as: Haslag, Joseph H. and Scott E. Hein (1989), "Federal Reserve System Reserve Requirements: 1959–88—A Note," Journal of Money, Credit and Banking 21 (4): 515-523.

No. 8903
Asymmetric Information and the Role of Fed Watching
Nathan Balke and Joseph H. Haslag

No. 8902
Further Evidence on the Liquidity Effect Using an Efficient-Markets Approach
Kenneth J. Robinson and Eugenie D. Short
Abstract: The degree to which policy actions of the central bank affect market interest rates has been a much-debated issue in monetary theory. This paper updates and improves upon recent empirical estimates of the effect of monetary policy on interest rates. Interest rates are assumed to be determined in an efficient market in which expectations are formed rationally. Tests of the proposition that unanticipated increases in the money stock are correlated with declines in interest rates are then undertaken. The empirical results provide mixed evidence of the presence of a liquidity effect. One possible explanation for a negative influence of monetary poricy on interest rates is that financial deregulation has made money growth a less reliable indicator of inflationary pressures.

No. 8901
An Econometric Analysis of U.S. Oil Demand
S. P. A. Brown and Keith R. Phillips
Abstract: Recent history has lent casual support to theories that U.S. oil consumption is very insensitive to changing oil prices, that non-price conservation has reduced U.S. oil demand, and that U.S. oil consumption falls more when price rises than it rises when price falls. We find that econometric evidence does not support any of these theories. U.S. oil consumption is fairly responsive to changes in price over the long run, but it requires nearly a decade to adjust fully. That slow response accounts for the evidence that seems to support other theories. These findings suggest that lower oil prices will stimulate U.S. oil consumption considerably.

No. 8811
The Incidence of Sanctions Against U.S. Employers of Illegal Aliens
John K. Hill and James E. Pearce
Published as: Hill, John K. and James E. Pearce (1990), "The Incidence of Sanctions Against U.S. Employers of Illegal Aliens," Journal of Political Economy 98 (1): 28-44.
Abstract: This article assesses the significance of sanctions against employers of illegal aliens for resource allocation and income distribution in the United States. Data from the 1980 Census of Population are used to identify the industries likely to be monitored most closely by the immigration authorities. A general equilibrium incidence analysis then is carried out using alternative assumptions about the overall level of enforcement. Estimates are made of the effects sanctions will have on the real wages of legal U.S. workers.

No. 8810
Evidence on the Two Monetary Base Measures and Economic Activity
Joseph H. Haslag and Scott E. Hein
Published as: Haslag, Joseph H. and Scott E. Hein (1990), "Economic Activity and Two Monetary Base Measures," Review of Economics and Statistics 72 (4): 664-671.
Abstract: Both the Federal Reserve Bank of St. Louis and the Board of Governors maintain separate monetary base series. Because of differing adjustment procedures to account for changes in reserve requirements, these series may not be used interchangeably. Using non-nested testing procedures, the two measures are compared in terms of their ability to explain quarterly growth rates of nominal GNP. The evidence presented in this paper indeed rejects the notion that one can interchange these two measures. Rather, our findings suggest that the St. Louis base measure is superior in explaining nominal GNP growth.

No. 8809
The Contribution of Nonhomothetic Preferences to Trade
Linda Hunter
Published as: Hunter, Linda (1991), "The Contribution of Nonhomothetic Preferences to Trade," Journal of International Economics 30 (3-4): 345-358.
Abstract: This paper estimates the economic significance of preference nonhomotheticity in international trade. Tastes are assumed to be identical, but budget shares depend on per capita income. A linear expenditure system is estimated for 34 countries over 11 commodity aggregates. A counterfactual exercise is conducted to estimate the volume of trade caused by deviations from homotheticity. The results indicate that nonhomothetic preferences may account for as much as one-quarter of interindustry trade flows.

No. 8808
The Development and Uses of Regional Indexes of Leading Economic Indicators
Keith R. Phillips
Published as: Phillips, Keith R. (1994), "Regional Indexes of Leading Economic Indicators," in Forecasting and Financial Economic Cycles, eds. Michael P. Niemira and Philip A. Klein (New York: Wiley), 347-361.

No. 8807
Unionization and Unemployment Rates: A Re-examination of Olson's Labor Cartelization Hypothesis
William C. Gruben and Keith R. Phillips

No. 8806
Tax Policy and Texas Economic Development
Stephen P. A. Brown

No. 8805
Investment and the Nominal Interest Rate: the Variable Velocity Case
Evan F. Koenig
Published as: Koenig, Evan F. (1989), "Investment and the Nominal Interest Rate: the Variable Velocity Case," Economic Inquiry 27 (2): 325-344.
Abstract: Models treating money either as a consumer good or as a producer good are encompassed by a model in which both households and firms use money as a buffer between receipts and expenditures. A rise in nominal interest rates increases resources devoted to intermediation, while discouraging purchases financed from accumulated cash. If investment is financed from contemporaneous earnings, there is a tendency to substitute out of consumption and into investment when interest rates are high. Greater resources devoted to intermediation generate a negative wealth effect. The net impact on investment is ambiguous.

No. 8804
Augmented Information in a theory of Ambiguity. Credibility and Inflation
Nathan Balke and Joseph H. Haslag
Abstract: The paper exanines the phenomenon of "Fed Watching" within the context of a macroecononic policy game. Unlike previous policy game models, individuals are allowed to acquire information about monetary growth in addition to the historical data. Agent's decisions are based on the opportunity costs of resources expended to augment their information set. Incorporated into the Cuikerman and Meltzer model of asymmetric information, the public's optimizing behavior makes the agent's information set a strategic variable. In this setting, it is shown that individuals strategic behavior can influence the monetary authority's strategy with respect to monetary growth control. Further, the policymaker strategically chooses the control variance of money growth to influence agent's information-seeking behavior.

No. 8803
Theoretical Macroeconomic Modelling and Qualitative Specifications of the Bond Market
William R. Russell and Joseph H. Haslag

No. 8802
Exchange and Interest Rate Management and the International Transmission of Disturbances
W. Michael Cox and Douglas McTaggart

No. 8801
Estimating the Impact of Monetary Policy on Short-Term Interest Rates in a Rational Expectations—Efficient Markets Model: Further Evidence
Kenneth J. Robinson and Eugenie D. Short

No. 8708
Labor Choices of Farm Families: Substitutes, Complements and Simultaneous Decision Making
Hilary H. Smith

No. 8707
Depository Institution Failures: The Deposit Insurance Connection
Gerald P. O'Driscoll, Jr.
Published as: O'Driscoll Jr., Gerald P. (1988), "Bank Failures: The Deposit Insurance Connection," Contemporary Economic Policy 6 (2): 1-12.
Abstract: It is generally accepted that banks must be regulated so as to avoid the moral hazard situation that deposit insurance generates. Accepting this argument implies that expanded bank powers must await deposit insurance reform. This article rejects the accepted view and argues instead that the existing regulatory system enhances rather than diminishes the riskiness of banks' portfolios. The article argues that the benefits from permitting banks to diversify probably would outweigh the costs. It concludes, however, that deposit insurance is a major culprit in the current wave of bank failures.

No. 8706
Lower Oil Prices and State Employment
S. P. A. Brown and John K. Hill
Published as: Brown, S.P.A. and John K. Hill (1988), "Lower Oil Prices and State Employment," Contemporary Economic Policy 6 (3): 60-68.
Abstract: Even after two years of adjustment, it was apparent that the sharp drop in oil prices occurring during late 1985 and early 1986 would have a profound effect on the regional distribution of employment in the United States. In this paper, we develop and implement a procedure for quantifying the long-term consequences of lower oil prices on employment in each of the 50 states. We use the estimates developed to determine how much of the variation in state employment growth during 1986 can be attributed to the oil price decline. We also use the estimates to gauge the feasibility of political action, such as an oil import tariff, to reverse the oil price decline.

No. 8705
The Capital Gains and Losses on U.S. Government Debt: 1942-1986
W. Michael Cox and Cara S. Lown
Published as: Cox, W. Michael and Cara S. Lown (1989), "The Capital Gains and Losses on U.S. Government Debt: 1942–1986," Review of Economics and Statistics 71 (1): 1-14.
Abstract: The capital gains and losses on U.S. Treasury securities are calculated and reported on a quarterly basis over the 1942-87 period. These data are then used to calculate an adjusted measure of the federal budget deficit for the years 1975-87. Whereas the rising trend in interest rates over the 1975-81 period substantially reduced the federal deficit, this study shows that the reversal of that trend over the 1981-86 period contributed even more greatly to an increase in the deficit. Also calculated and reported are holding-period rates of return on overall marketable Treasury debt, providing a contrast to existing interest rate series.

No. 8704
Random Coefficients Models of the Inflationary Consequences of Discretionary Central Bank Behavior
Kenneth J. Robinson
Abstract: There exists fairly widespread agreement that, especially over a long-run time period, inflation is always and everywhere a monetary phenomenon. This proposition, however, leaves unanswered the question why a central bank would allow, or possibly persue, an inflationary monetary policy. To answer this questjon, a centrai bank objective function is derived which recognizes the existence of both benefits and costs associated with inflation. The empirical results indicate that while Federal Reserve behavior is random in nature, benefits, in the form of seigniorage, and costs, composed of deviations of unemployment from the policymaker's preferred rate, are significant factors in explaining Federal Reserve behavior.

No. 8703
Increasing the Efficiency of Pooled Estimation with a Block Covariance Structure
Jeffery W. Gunther and Ronald H. Schmidt
Published as: Gunther, Jeffery W. and Ronald H. Schmidt (1993), "Increasing the Efficiency of Pooled Estimation with a Block–Diagonal Covariance Structure," The Annals of Regional Science 27 (2): 133-142.
Abstract: A small number of time-series observations relative to regions precludes estimation of the entire structure of regional dependence in a pooled regression model. The resulting need for parsimonious models of regional dependence can be satisfied through the use of spatial autocorrelation structures. This article explores an alternative methodology that allows the researcher to estimate disturbance covariances for regions that are closely linked, even when the number of time-series observations is relatively low. The approach presented here shares the advantage of spatial autocorrelation structures in being parsimonious, but offers the additional advantage of relying more completely on sample information to provide estimates of dependence between regions within specified regional groups. Monte Carlo experiments suggest that block-covariance models offer substantial efficiency gains over simple heteroskedastic models. The experiments also suggest that when the number of time-series observations is limited and the correlations of disturbances between regions are small, block structures yield efficiency gains over a full-information model.

No. 8702
The Incidence of Sanctions Against U.S. Employers of Illegal Aliens
John K. Hill and James E. Pearce
Published as: Hill, John K. and James E. Pearce (1990), "The Incidence of Sanctions Against U.S. Employers of Illegal Aliens," Journal of Political Economy 98 (1): 28-44.
Abstract: This article assesses the significance of sanctions against employers of illegal aliens for resource allocation and income distribution in the United States. Data from the 1980 Census of Population are used to identify the industries likely to be monitored most closely by the immigration authorities. A general equilibrium incidence analysis then is carried out using alternative assumptions about the overall level of enforcement. Estimates are made of the effects sanctions will have on the real wages of legal U.S. workers.

No. 8701
Financial Innovation and Monetary Policy Effectiveness
Cara S. Lown
Abstract: How financial innovation and financial intermediaries affect the Federal Reserve's ability to target the monetary aggregates and/or interest rates has been a long standing debate in macroeconomics. With the recent development of new money market instruments and the growth of money market funds this issue is again being discussed. This article develops a model of the financial sector to examine how the growth in money market funds has altered the effectiveness of monetary policy. The work presented in this paper differs from previous work in that the important actors in the model are specified from first principles. The major conclusion reached is that, when an explicit role for the intermediary is specified, the asset choice of the money market fund is the key variable in determining the effectiveness of monetary policy.

No. 8606
Fiscal Policymaking and the Central Bank Institutional Constraint
Richard C. K. Burdekin and Leroy O. Laney
Published as: Burdekin, Richard C.K. and Leroy O. Laney (1988), "Fiscal Policymaking and the Central Bank Institutional Constraint," Kyklos 41 (4): 642-662.
Abstract: The interaction between monetary and fiscal policy is at the heart of macroeconomics, but traditional analysis often ignores the institutional aspects. In recent years a developing literature has concentrated on issues such as the influence of central bank independence on the conduct of monetary policy, and as a part of this, the extent to which the central bank accommodates government fiscal policy. Much less has been done, however, to investigate the reverse interactjon: the extent to which central bank independence influences the formation of fiscal policy. This paper concentrates pnimarily on that channel of influence, and finds some support for the case that fiscal policies are indeed affected by the independence of the central bank. Fiscal deficits, for example, may therefore be lower in countries with more independent central banks because of the greater prospect that monetary policy will not be as accommodative of those deficits.

No. 8605
Swiss Monetary Policy: Central Bank Independence and Stabilization Goals
Richard C.K. Burdekin
Abstract: The paper estimates a reaction function relating the rate of growth of the Swiss monetary base to a set of economic stabiilizalion objectives. Econometric results over quarterly data from 1966:2 - 1983:4 indicate the state of the federal budget, government purchases, the inflation rate and the exchange rate between the Swiss franc and the Deutsche mark to be significant explanatory variabies. The results suggest that the monetary base contracts in response to federal budget deficits and to inflation. For government purchases and the exchange rate the response is accommodative.

No. 8604
Structural Changes in Residential Energy Demand
Roger H. Dunstan and Ronald H. Schmidt
Published as: Dunstan, Roger H. and Ronald H. Schmidt (1988), "Structural Changes in Residential Energy Demand," Energy Economics 10 (3): 206-212.
Abstract: Residential energy consumers in the USA faced several demand shocks in the 1970s and 1980s. These included price rises engineered by the Organization of Petroleum Exporting Countries, natural gas curtailments, shortages of petroleum products and deregulation of energy markets. One result of these events has been structural change in the demand for electricity and petroleum by residential consumers. Demand functions are now more responsive to price changes and consumers react more quickly in adjusting their capital stocks to new levels.

No. 8603
Cross-Country Evidence on the Relationship Between Central Banks and Governments
Richard C.K. Burdekin
Published as: Burdekin, Richard C.K. (1987), "Cross-Country Evidence on the Relationship Between Central Banks and Governments," Journal of Macroeconomics 9 (3): 391-405.
Abstract: The influence of government pressure on central bank behavior is examined for Canada, France, the U.K., and West Germany. With the budget deficit proxying for this pressure, there is evidence of an overall expansionary effect of the deficit on monetary policy response to stabilization objectives. Despite there otherwise being little consistency in the reaction functions estimated across the four countries, the marked tendency is for policy to become more accommodative at higher levels of the deficit. Hence, the results point to a potentially important regularity in the relationship between central banks and governments.

No. 8602
Interaction Between Central Bank Behavior and Fiscal Policymaking: The Case of the U.S.
Richard C.K. Burdekin
Publised as: Burdekin, Richard C.K. (1988), "Interaction Between Central Bank Behaviour and Fiscal Policy: the U.S. Case," Applied Economics 20 (1): 97-111.
Abstract: Federal Reserve behaviour is analysed using a model which incorporates an effect an effect of iscal pressure on monetary policy formulation. Incentive structures are hypothesized to be such that the central bank plans over a longer horizan than that relevant to the administration. With the cyclically adjusted deficit proxying for fiscal pressure from the administration, the response to the deficit then plays an interactive role in affecting the trade-off weights applied to the competing goals of monetary policy. The model performs well for the USA, and provides a pattern of policy that is stable over the full 1961–83 period.

No. 8601
Money, Deregulation and the Business Cycle
Gerald P. O'Driscoll, Jr.
Published as: O'Driscoll Jr., Gerald P. (1986), "Money, Deregulation and the Business Cycle," Cato Journal 6 (2): 587-616.

No. 8508
Money: Mengers's Evolutionary Theory
Gerald P. O'Driscoll, Jr.

No. 8507
The Market Value of Government of Canada Debt; Monthly, 1937–84
W. Michael Cox and Joseph Haslag
Published as: Cox, W. Michael and Joseph Haslag (1986), "The Market Value of Government of Canada Debt; Monthly, 1937–84," The Canadian Journal of Economics 19 (3): 469-497.
Abstract: Monthly market value statistics Canada debt are reported for the 1937-1984. In addition, two series on privately-he1d government of Canada debt are report, as well as security-price indices for two Federal debt aggregates. Finally, a historical comparison is made of public debt in Canada and the United States over the 1942-1984 period.

No. 8506
Fluctuations in U.S. Voting Behavior: Evidence from Presidential Elections
Richard C. K. Burdekin
Published as: Burdekin, Richard C.K. (1988), "Economic Performance and the Determination of Presidential Elections in the U.S.," The American Economist 32 (2): 71-75.
Abstract: The relationship between economic conditions and voting behavior is evaluated in the context of U.S. presidential elections, 1916-1984. The approach represents a reapplication of the model employed by Gerald Kramer (1971) in an earlier study of congressional elections. A critique of the Kramer model by George Stigler (1973) is reconsidered in this different context, with application of a Chow test and analysis of the predictive errors in fact providing strong support for Kramer's basic model. The systematic explanatory power that is evidenced opposes Stigler's claim that the framework lacks robustness.

No. 8505
The Fairness of Discounting: A Majority Rule Approach
S. P. A. Brown
Published as: Brown, S.P.A. (1987), "The Fairness of Discounting: A Majority Rule Approach," Public Choice 55 (3): 215-226.
Abstract: A model of majority rule is developed in which each of a finite number of generations votes on a redistribution of income between itself and the other generations. In voting, each generation expresses tastes for its own income and for the distribution of income across generations. The model is then used to derive the conditions under which discounting is justified — namely those conditions for which the majority rule exhibits a positive marginal rate of time preference. It is demonstrated that when each generation is wealthier than those preceding it, the parameters representing the taste for income equality must be relatively high for the majority rule to exhibit a positive marginal rate of time preference.

No. 8504
Specific Training. Unions, and the Relationship Between Employer Size and Wages
James E. Pearce
Abstract: In this paper I demonstrate that the explanatory power of employer size variables in nonunion wage regressions is diminished by allowing the coefficient of tenure (years on current job) to vary with employer size. Among nonunion workers, average tenure and the coefficient of tenure increase with both firm size and plant size. This pattern is consistent with the hypothesis that investment in specific human capital accounts for much of the previously unexplained relationship between employer size and nonunion wages . The relationships between compensation tenure, and employer size are different for union workers. Employer size is less important generally, and the importance of plant size is especially low. Also, the data are more consistent with the specific human capital model when union compensation is measured by annual income rather than the hourly wage.

No. 8503
Prices vs. Quantities in Cartel Theory with Special Reference to OPEC
John K. Hill and Ronald H. Schmidt

No. 8502
Immigrant Decisions Concerning Length of Stay and Frequency of Visit
John K. Hill
Published as: Hill, John K. (1987), "Immigrant Decisions Concerning Length of Stay and Frequency of Visit," Journal of Development Economics 25 (1): 221-234.
Abstract: The temporary and repetitive character of contemporary labor migration is explained by assuming that immigrants have a preference for location. A life-cycle model of immigrant behavior is developed to determine net lifetime income, total time allocated to home-country and foreign-country residence, and the number of migratory trips. Because of income effects, home wages and foreign wages are not symmetric in their effect on the location of work effort. It is also shown that changes in travelling costs have predictable consequences for the number of border crossings, but not for the total time spent in the foreign labor market.

No. 8501
The Behavior of Treasury Securities Monthly, 1942–1984
W. Michael Cox
Published as: Cox, W. Michael (1985), "The Behavior of Treasury Securities Monthly, 1942–1984," Journal of Monetary Economics 16 (2): 227-250.
Abstract: The monthly market value statistics on outstanding United States Treasury debt are reported for the 1981–1984 period. In addition, a monthly series on privately held gross Federal debt is reported for the extended 1942–1984 period, together with monthly security-price indices for various Federal debt aggregates. Examination of the stochastic structure of T-bill prices indicates that the riskiness of T-bills has increased dramatically in recent years.

No. 8411
Natural Gas Pipelines: Rent Revealed
S. P. A. Brown

No. 8410
Financial Stability and FDIC Insurance
Roger W. Garrison, Eugenie D. Short and Gerald P. O'Driscoll, Jr.
Published as: Garrison, Roger W., Eugenie D. Short and Gerald P. O'Driscoll, Jr. (1988), "Financial Stability and FDIC Insurance," in The Financial Services Revolution: Policy Directions for the Future,Vol. 1, eds. Catherine England and Thomas F. Huertas (Netherlands: Springer), 187-207.
Abstract: The Federal Deposit Insurance Corporation (FDIC) was created over five decades ago to increase the stability of the banking system. Questions of how and whether the FDIC enhances stability or welfare are now being raised in the economic literature. Buser et al. (1981) argue that deposit insurance has been deliberately under-priced so that the FDIC’s package deal, which includes both insurance and regulation, will be attractive to banks. These authors identify a deadweight loss associated with this particular incentive structure. Campbell and Glenn (1984) discuss the determinants of the optimal policies regarding deposit-insurance pricing and bank closings. They show that appropriate policy depends in an important way on the nature of the mechanism for determining insolvency. Chan and Mak (1984) show that, given some exogenously determined constraint on the bank-failure rate, a risk-sensitive premium for deposit insurance may be ill-advised. These authors focus their analysis on the trade-off between depositors’ welfare and the soundness of the insurance system.

No. 8409
Tax Indexation and Inflationary Finance
W. Michael Cox and Michael Williams

No. 8408
Insulating Policies for Large and Small Countries
W. Michael Cox and Douglas McTaggart
Abstract: In this paper we investigate policies for the large and small country that provide complete insulation from foreign real and monetary disturbances. We find that when there exists two channels of transmission, the integrated commodity and capital markets, using only exchange rate policies does not provide complete insulation. However, floating the exchange rate and pursuing a specific interest rate target does. In terms of output variability however, insulating policies may be undesirable.

No. 8407
Small Sample Efficiency Gains From a First Observation Correction for Hatanaka's Estimator of the Lagged Dependent Variable-Serial Correlation Regression Model
Thomas B. Fomby
Published as: Fomby, Thomas B. (1987), "Small Sample Efficiency Gains From a First Observation Correction for Hatanaka's Estimator of the Lagged Dependent Variable-Serial Correlation Regression Model," Communications in Statistics – Simulation and Computation 16 (2): 551-571.
Abstract: Evidence presented by Fomby and Guilkey (1983) suggests that Hatanaka's estimator of the coefficients in the lagged dependent variable-serial correlation regression model performs poorly, not because of poor selection of the estimate of the autocorrelation coefficient, but because of the lack of a first observation correction. This study conducts a Monte Carlo investigationof the small sample efficiency gains obtainable from a first observation correction suggested by Harvey (1981). Results presented here indicate that substantial gains result from the first observation correction. However, in comparing Hatanaka's procedure with first observation correction to maximum likelihood search, it appears that ignoring the determinantal term of the full likelihood function causes some loss of small sample efficiency. Thus, when computer costsand programming constraints are not binding, maximum likelihood search is to be recommended. In contrast, users who have access to only rudimentary least squares programs would be well served when using Hatanaka's two-step procedure with first observation correction because of the ease of calculating consistent standard errors of the estimates.

No. 8406
Transportation Technologies and the Optimal Depletion of West Coast Oil Reserves
Roger H. Dunstan and Ronald H. Schmidt

No. 8405
Price Expectations, Uncertainty, and Changes in Drilling Activity
Ronald H. Schmidt
Abstract: Estimated models of drilling activity often use stationary lag structures of past prices to capture the effects of price expectations. Results from a model of optimal depletion by members of a competitive fringe, however, suggest replacing the price expectations variable with the difference between expected growth rates in prices and the firm's discount rate to explain changes in drilling activity. Using oil price growth rates for each month estimated with information available at that time, empirical results were found to support the theoretical claim by yielding better goodness-of-fit results than were found with models using lagged price structures.

No. 8404
Safety-Net Mechanisms: The Case of International Lending
Gerald P. O'Driscoll, Jr.
Published as: O'Driscoll Jr., Gerald P. and Eugenie S. Short (1984), "Safety-Net Mechanisms: The Case of International Lending," Cato Journal 4 (1): 185-204.

No. 8403
Do Workers Earn Less Along the U.S.–Mexico Border?
Alberto E. Davila and J. Peter Mattil

No. 8402
Some Time Series Methods of Forecasting the Texas Economy
James G. Hoehn and William C. Gruben, with Thomas B. Fomby

No. 8401
Potential Effects of State Regulatory Agencies on the Post-Decontrol Natural Gas Market
Ronald H. Schmidt

No. 8306
Intratemporal Welfare and the Optimal Depletion of Exhaustible Resources
Ronald H. Schmidt

No. 8305
Deposit Insurance in a Deregulated Financial Environment: The Case for Reform
Eugenie Dudding Short and Gerald P. O'Driscoll, Jr.

No. 8304
A Comparison of Forecasting Accuracies of Alternative Regional Production Index Methodologies
Thomas B. Fomby
Published as: Fomby, Thomas B. (1986), "A Comparison of Forecasting Accuracies of Alternative Regional Production Index Methodologies," Journal of Business and Economic Statistics 4 (2): 177-186.
Abstract: This article examines the forecasting accuracies of various methods used by Federal Reserve Banks to estimate real value added by regional manufacturing industries. Using Texas manufacturing data and weighted forecasting accuracy measures consistent with index number construction for Texas, obtained results support the use of very simple methods based on the assumption of product exhaustion, allowing for technical change. More complex methods using Cobb–Douglas production functions estimated by Bayesian techniques did not perform as well, not because of lack of conceptual sophistication or appropriate prior information but probably because of the small number of observations and collinearity of the data that are available when constructing regional production indices. These results must be qualified. The weighted forecasting accuracy measures tend to obscure the fact that no one method is uniformly superior to the other methods for all industries. Given industry weights different from those for Texas, the results presented here could be reversed. Confirmation of the conclusions drawn await the results of other regional manufacturing studies.

No. 8303
On Regional Integration in Bank Commercial Lending
Dale K. Osborne
Abstract: This paper tests the hypothesis that average interest rates for ten categories of commercial loans (short-term and long-term loans in five size classes) in the regions of the United States behave as if they were generated in an integrated national market. The tests, derived fron two model s of commercial lending 'in an integrated market, indicate that all regions are highly integrated in short-term lending in all size classes. In long-term lending, five of the six negions appear to be highly integrated in four of the five size classes. The exceptional region is the Southeast, which seems not only to be poorly integrated with the other regions but also to be far less homogeneous. The exceptional loan-size class is 0 to $10,000.

No. 8302
Monetary Regimes and the Term Structure of Interest Rates, 1862-1982
Scott Ulman and John H. Wood
Abstract: American yield curves have been characterized by positive slopes when interest rates have been low and by negative slopes when interest rates have been high, with, however, some apparent revisions in the late 1870s and early 1970s of what should be considered "high" and "low". Annual observations on short- and long-term yields between 1862 and 1982 are consistent with both traditional and modern expectations theories under regressive expectations, where "the normal rate" toward which short rates are expected to regress is a function of the monetary standard; specifically, paper or gold. But the model presented here does not allow us to distinguish empirically between the impacts of alternative monetary regimes on the normal rate and term premia.

No. 8301
Recent Interest Rate Behavior in Perspective: Some Descriptive Statistics
James G. Hoehn

No. 8204
Fisher to Fama to Fisher: Inflation and Interest Rates, 1890–1981
Scott Ulman

No. 8203
On the Selective Hedging of Bank Assets with Treasury Bill Futures Contracts
G. O. Koppenhaver

No. 8202
A Note on Environmental Risk and the Rate of Discount
S. P. A. Brown
Published as: Brown, S.P.A. (1983), "A Note on Environmental Risk and the Rate of Discount," Journal of Environmental Economics and Management 10 (3): 282-286.
Abstract: This paper examines the use of risk-adjusted discount rates to evaluate future environmental risks. It is determined that the risk-adjusted discount rate should be lower—not higher—than the risk-free rate if evaluation of future environmental risks is to point toward optimality.

No. 8201
Money Stock Control with Reserve and Interest Rate Instruments Under Rational Expectations
Bennett T. McCallum and James G. Hoehn
Published as: McCallum, Benett T. and James G. Hoehn (1983), "Instrument Choice for Money Stock Control with Contemporaneous and Lagged Reserve Requirements," Journal of Money Credit and Banking 15 (1): 96-101.
Abstract: This paper conducts a theoretical comparison of the potential effectiveness, in terms of money stock controllability, of interest rate and reserve instruments. Whereas previous studies have been basically static, the present analysis is carried out in the context of a dynamic macroeconomic model with rational expectations. Particular attention is paid to the distinction between contemporaneous and lagged reserve accounting (CRA and LRA). The criterion employed is the expectation of squared deviations of the (log of the) money stock from target values that are reset each period. Analysis in the basic model suggests the following substantive conclusions. (1) With a reserve instrument, monetary control will be more effective under CRA than LRA. (2) With a reserve instrument and LRA, control will be poorer than with an interest rate instrument. (3) For a wide range of parameter values, control will be better with a reserve instrument and CRA than with an interest rate instrument.

No. 8102
The Global Dollar: Trends and Issues in Official and Private International Finance
Deborah L. Allen and Leroy O. Laney
Published as: Allen, Deborah L. and Leroy O. Laney (1982), "The Global Dollar: Trends and Issues in Official and Private International Finance," Annals of the American Academy of Political and Social Science 460: 29-37.
Abstract: At the close of nearly a decade of managed floating exchange rates, the U.S. dollar remains the world's primary inter national reserve asset and vehicle currency. Some underlying macroeconomic characteristics of the United States as the major reserve currency country have undergone a marginal diminution relative to other emerging reserve centers, and noticeable currency diversification of private and official international liquidity has taken place. The underlying microfoundations of dollar financial markets remain dominant, however, and continue to underpin the U.S. currency in its reserve role. In spite of efforts to introduce officially sponsored multiple currency units, such as the Interna tional Monetary Fund's Special Drawing Right, into a larger role, these currency composites have met with only limited success to date. One must look primarily to private markets for the future evolution of the international financial system, and on this basis it is likely that the dollar will remain most important. The decade of the 1970s also witnessed a trend toward privatization of international financial markets in general, at the expense of the role formerly played by official lending agencies. This environment also will likely reinforce the role of market forces in determining the future course of the world monetary system.

No. 8101
Coefficient Bias from the Observation Interval of a Time Series
James M. Holmes, Gary D. Praetzel and Donald H. Dutkowsky

No. 8005
Unionism and the Cyclical Behavior of the Labor Market in U.S. Manufacturing
James E. Pearce
Published as: Pearce, James E. (1983), "Unionism and the Cyclical Behavior of the Labor Market in U.S. Manufacturing," The Review of Economics and Statistics 65 (3): 450-458.

No. 8004
Cyclical Variation in Labor Force Participation and Employment
James E. Pearce

No. 8003
Trade Unionism, Implicit Contracting, and the Response to Demand Variation in U.S. Manufacturing
James E. Pearce

No. 8002
Official Reserve Asset Choice and Substitution Account Proposals
Leroy O. Laney

No. 8001
The Hedging Performance of the New Futures Markets: Additional Evidence
Sydney Smith Hicks

No. 7905
National Monetary Independence and Managed Floating Exchange Rates
Leroy O. Laney

No. 7904
A Note on the Inadequacy of Aggregate Bank Portfolio Statistics
Sydney Smith Hicks

No. 7903
Congestion Taxes Reconsidered
Dale K. Osborne

No. 7902
Commercial Banks and Business Loans: This Recovery and the Future
Sydney Smith Hicks

No. 7901
Monetary Effects on Interest Rates: A Note on the Positive Responsiveness of Interest Rates
Sydney Smith Hicks

No. 7809
On the Stability of OPEC
Dale K. Osborne

No. 7808
Commercial Banks and Their Business Loan Portfolios: This Recovery and the Future
Sydney Smith Hicks

No. 7807
Interpersonal Comparisons
Dale K. Osborne

No. 7806
On Banking Structure and Checking-Account Prices
Dale Osborne and Jeanne Wendel

No. 7805
The Main Fault with Traditional Research on Banking Competition
Dale Osborne and Jeanne Wendel

No. 7804
The Effects of Recognition and Impact Lags on Monetary Rule Performance
Wallace H. Duncan

No. 7803
A New Inflation in the 1970s?
Charles J. Smaistrla and Adrian W. Throop
Published as: Smaistrla, Charles J. and Adrian W. Throop (1980), "A New Inflation in the 1970s?" Financial Analysts Journal
36 (2): 47-52 + 54-57.

No. 7802
The Case for an Inflation-Adjusted Deficit
Patrick J. Lawler

No. 7801
A Criticism of the Traditional Analysis of Banking Competition
Dale Osborne and Jeanne Wendel