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Staff Papers

In-depth analysis of current policy issues.

Number 23, December 2015

Assessing Monetary Accommodation: A Simple Empirical Model of Monetary Policy and Its Implications for Unemployment and Inflation
Evan F. Koenig and Alan Armen

Abstract: This note suggests that household wealth growth and a long-forward interest rate can be used to construct a simple and convenient reference standard for assessing the current stance of monetary policy. It shows that the difference between the federal funds rate and this reference interest rate is a powerful predictor of the unemployment rate and inflation, producing real-time forecasts that are competitive with consensus-based forecasts from surveys of forecasting professionals. Moreover, one can understand past FOMC policy actions as efforts to adjust the stance of policy, so measured, in response to unemployment and inflation gaps. There is little evidence of inertia in this version of the Taylor rule, in contrast to Taylor-rule specifications that assume a fixed reference real federal fund rate.

Number 22, December 2013 | Complete issue

Estimating the Output Gap in Real Time
Anton Cheremukhin

Abstract: I propose a novel method of estimating the potential level of U.S. GDP in real time. The proposed wage-based measure of economic potential remains virtually unchanged when new data are released. The distance between current and potential output — the output gap — satisfies Okun’s law and outperforms many other measures of slack in forecasting inflation. Thus, I provide a robust statistical tool useful for understanding current economic conditions and guiding policymaking.

Number 21, October 2013 | Complete issue

Cross-Country Variation in the Anchoring of Inflation Expectations
Scott Davis and Adrienne Mack

Abstract: This paper develops a method for measuring the anchoring of long-run inflation expectations that does not require estimates of long-run inflation expectations. Such estimates exist for only a few developed economies, and even then only a short time series is available. By not requiring estimates of long-term inflation expectations, this method is able to measure the anchoring of inflation expectations in sixty-four different developed and developing countries. In addition, with rolling-window estimations we can measure the anchoring of expectations across time within a country, and thus we can observe how inflation expectations became unanchored in many countries during the 1970s. Then we can observe how, through means like inflation targeting and monetary unification, these expectations were re-anchored during the 1980s, 1990s, and 2000s.

Number 20, July 2013 | Complete issue

How Bad Was It? The Costs and Consequences of the 2007–09 Financial Crisis
Tyler Atkinson, David Luttrell and Harvey Rosenblum

Abstract: The 2007–09 financial crisis was associated with a huge loss of economic output and financial wealth, psychological consequences and skill atrophy from extended unemployment, an increase in government intervention, and other significant costs. Assuming the financial crisis is to blame for these associated ills, an estimate of its cost is needed to weigh against the cost of policies intended to prevent similar episodes. We conservatively estimate that 40 to 90 percent of one year's output ($6 trillion to $14 trillion, the equivalent of $50,000 to $120,000 for every U.S. household) was foregone due to the 2007–09 recession. We also provide several alternative measures of lost consumption, national trauma, and other negative consequences of the worst recession since the 1930s. This more comprehensive evaluation of factors suggests that what the U.S. gave up as a result of the crisis is likely greater than the value of one year's output.

Number 19, December 2012 | Complete issue

How the Global Perspective Can Help Us Identify Structural Shocks
Alexander Chudik and Michael Fidora

Abstract: This paper argues that global perspective can help us with the identification of structural shocks by utilizing the information on the signs of the responses of individual countries (cross section units). We demonstrate the main idea by means of Monte Carlo experiments and present an empirical application where we look at the effects of oil supply shocks on output and on global exchange rate constellation. Using a large-scale GVAR model of oil prices and the global economy, we find supply shocks tend to have a stronger impact on emerging economies' real output as compared with mature economies, have a negative impact on real growth in oil-exporting economies as well, and tend to cause an appreciation (depreciation) of oil exporters' (oil importers') real exchange rates but also lead to an appreciation of the U.S. dollar. This paper also illustrates some pitfalls with the existing measures to summarize the available information on structural shocks identified using sign restrictions when the dimension of the model is large (as it is in the case of global models).

Number 18, November 2012 | Complete issue

Understanding the Risks Inherent in Shadow Banking: A Primer and Practical Lessons Learned
David Luttrell, Harvey Rosenblum and Jackson Thies

Abstract: Examinations of the 2007–09 financial crisis often use the term shadow banking. This paper explains the form and functioning of the shadow banking system, how it relates to systemic risk and the recent financial crisis, and what particular aspects should be highlighted to benefit policymakers as they implement new regulations designed to enhance financial market resiliency. The paper is divided into two parts: The first serves as a primer on shadow banking; the second provides a narrative of how the system froze during the financial crisis and pertinent lessons learned for the current reform effort.

Number 17, March 2012 | Complete issue

All in the Family: The Close Connection Between Nominal-GDP Targeting and the Taylor Rule
Evan F. Koenig

Abstract: The classic Taylor rule for adjusting the stance of monetary policy is formally a special case of nominal- gross-domestic-product (GDP) targeting. Suitably implemented, moreover, nominal-GDP targeting satisfies the definition of a "flexible inflation targeting" policy rule. However, nominal-GDP targeting would require more discipline from policymakers than some analysts think is realistic.

Number 16, January 2012 | Complete issue

Inflation, Slack, and Fed Credibility
Evan F. Koenig and Tyler Atkinson

Abstract: It is generally agreed that slack has some impact on inflation. There is much less agreement on what form the relationship takes and whether it is stable enough to reliably help predict inflation. This analysis focuses on the Great Moderation period. We find that slack ( as measured by the unemployment rate) and changes in slack are negatively correlated with changes in inflation and also deviations of inflation from long-forward inflation expectations. These relationships could have been exploited to produce forecasts of trimmed mean PCE inflation more accurate than rule-of-thumb forecasts. Forecasts of trimmed mean PCE inflation also serve well as predictions of GDP inflation and headline PCE inflation. Our analysis suggests that currently high levels of slack should hold inflation below two percent over 2012.

Number 15, September 2011

Immigrants' Employment Outcomes over the Business Cycle
Pia Orrenius and Madeline Zavodny

Abstract: Immigrants have figured prominently in U.S. economic growth for decades, but the recent recession hit them hard. Immigrants' labor market outcomes began deteriorating even before the recession was officially under way, largely as a result of the housing bust. An analysis of employment and unemployment rates over the past fifteen years shows that immigrants' labor market outcomes are more cyclical than those of natives. The greater cyclicality of immigrants' employment and unemployment is concentrated among less-educated immigrants, but college-educated immigrants nonetheless have more-cyclically sensitive employment outcomes than college-educated natives.

Complete issue

Number 14, June 2011

An Exchange Rate Pass-Through into U.K. Import Prices: Evidence from Disaggregated Data
Haroon Mumtaz, Özlem Oomen, Jian Wang

Abstract: In this paper we estimate the rate of exchange rate pass-through (ERPT) into U.K. import prices using disaggregated data at the SITC-2 and SITC-3 digit levels. We show that the ERPT varies at the disaggregate level. Because of this heterogeneity at the disaggregate level, the estimate of the ERPT using aggregate data is found substantially upward-biased in our U.K. data. The upward bias exaggerates the impact of exchange rate movements on the competitiveness of imported goods relative to domestically produced goods. Further, we investigate the source of the heterogeneity of the ERPT at the disaggregate level. The industry-specific inflation rate is found significant in explaining this heterogeneity. Finally, we find a significant reduction in estimated ERPT since 1995. Unlike some previous studies, our results suggest that the decrease of the ERPT is correlated with the increased economic stability in the U.K. during the last decade.

Complete issue

Number 13, April 2011

An IS-LM Analysis of the Zero-Bound Problem
Evan F. Koenig

Abstract: Policy options for stimulating real activity are limited once short-term interest rates have been driven to zero. Monetary policy makers face the difficult challenge of preventing or reversing declines in near-term inflation expectations while preserving confidence in the central bank's commitment to long-term price stability. Fiscal policy makers must commit to a credible plan for maintaining or raising near-term government purchases while minimizing increases in future marginal tax rates.

Complete issue

Number 12, April 2011

Forecasting the End of the Global Recession: Did We Miss the Early Signs?
Adriana Z. Fernandez and Alex Nikolsko-Rzhevskyy

Abstract: This paper looks at the term-structure literature to identify early signs predicting recessionary patterns in the U.S. and other developed economies. Based on the National Bureau of Economic Research (NBER) and Economic Cycle Research Institute (ECRI) recession dates, we define the probability of recession as a function of the traditional yield spread, plus a forward-looking measure of growth expectations, namely the output gap growth spread. For other countries, we extend the model and make it additionally dependent on the probability of recession in the U.S. Our results indicate that most of the a-posteriori official recession dates could have been forecast as early as April 2009, when the first green shoots of recovery appeared in the U.S. data. Overall, the term-structure versions we apply allow us to signal recessions earlier and more accurately than traditional term-structure models and most professional forecasters.

Complete issue


Number 11, October 2010

Analyzing the Export Flow from Texas to Mexico
Andrew J. Cassey

Abstract: From 1997 to 2008, Texas shipped 40 percent of its manufacturing exports to Mexico. This puts Texas–Mexico among the largest state–country trading relationships. But this share has been declining recently. A gravity equation cannot account for either of these facts, even though Texas and Mexico share a border. This positive contiguity effect is not unique in state export data. I study the features of the Texas–Mexico relationship to try to account for the size of the export flow and the recent decline in share. Data limitations prevent a full accounting, but the most likely feature is the changing source of maquiladora inputs from the United States to Asia.

Complete issue

Number 10, September 2010

The Global Slack Hypothesis
Enrique Martínez García and Mark A. Wynne

Abstract: We illustrate the analytical content of the global slack hypothesis in the context of a variant of the widely used New Open-Economy Macro model of Clarida, Galí, and Gertler (2002) under the assumptions of both producer currency pricing and local currency pricing. The model predicts that the Phillips curve for domestic CPI inflation will be flatter under most plausible parameterizations, the more important international trade is to the domestic economy. The model also predicts that foreign output gaps will matter for inflation dynamics, along with the domestic output gap. We also show that the terms of trade gap can capture foreign influences on domestic CPI inflation in an open economy as well. When the Phillips curve includes the terms of trade gap rather than the foreign output gap, the response of domestic inflation to the domestic output gap is the same as in the closed-economy case ceteris paribus. We also note the conceptual and statistical difficulties of measuring the output gaps and suggest that measurement error bias can be a serious concern in the estimation of the open-economy Phillips curve relationship with reduced-form regressions when global slack is not actually observable.

Complete issue | Matlab and Dynare Codes

Number 9, March 2010

The Difficult Art of Eliciting Long-Run Inflation Expectations from Government Bond Prices
Carlos E. J. M. Zarazaga

Abstract: Central banks are always concerned with keeping long-run inflation expectations well anchored at some implicit or explicit low target inflation rate. To that end, they are constantly on the lookout for indicators that can gauge those expectations accurately. One such indicator frequently reported in the specialized financial press and by central banks around the world is constructed with the forward rates technique, which exploits price differentials between government bonds of various maturities. This article examines the theory behind those indicators and assesses the extent to which they can be trusted in practice.

Complete issue


Number 8, November 2009

Exchange Rate Policies
Charles Engel

Abstract: Modern macroeconomic theory teaches us new lessons about exchange rates: Currency depreciations or appreciations that change the relative competitiveness of producers in different countries are undesirable from a global perspective if they lead to relative prices that do not reflect the true relative costs of production. From this standpoint, "external balance" does not mean that trade balances should be zero, but rather that global resources are allocated efficiently. The implications of this insight for the role of the exchange rate in monetary policy are explored here. Some of the traditional arguments for purely floating exchange rates are challenged by this approach. The paper also briefly considers sterilized intervention and comments on the role of international reserves.

Complete issue

Number 7, June 2009

Excluding Items from Personal Consumption Expenditures Inflation
Jim Dolmas

Abstract: Core inflation measures constructed by excluding particularly volatile items from the price index have a long history. The most common such measures are indexes excluding the prices of food and energy items. This paper attempts to shed some statistical light on the impact of excluding certain items from the personal consumption expenditures (PCE) price index. In particular, I am interested in the trade-off between reducing shortrun volatility (relative to the volatility of the headline index) and possibly distorting the measurement of inflation over longer horizons. Some of the questions this paper addresses are: Which items have the highest time series volatility? Among the items with high volatility, are there meaningful patterns in the distribution of volatility across high and low frequencies? Which items, by their exclusion, have the largest impact on longer-horizon measures of inflation? And which, by their exclusion, contribute the most to reducing high-frequency volatility in measured inflation? Excluding items that answer the last question yields a PCE index which compares favorably to PCE ex food and energy along several dimensions, while excluding only half as many items by expenditure weight.

Complete issue


Number 6, June 2008

The Relative Performance of Alternative Taylor Rule Specifications
Adriana Z. Fernandez, Evan F. Koenig, Alex Nikolsko-Rzhevskyy

Abstract: We look at how well several alternative Taylor rule specifications describe Federal Reserve policy decisions in real time, using the newly developed Giacomini and Rossi (2007) test for non-nested model selection in the presence of (possible) parameter instability. Further, we isolate those Taylor rule features that are most important for achieving relatively strong real-time performance. A second-order partial adjustment version of the Koenig (2004a) model performs consistently better than alternative specifications. Key features of this rule are the partial adjustment of the federal funds rate toward an equilibrium rate that depends on the unemployment rate and forward-looking inflation measures.

Complete issue

Number 5, May 2008

The International Product Cycle and Globalization of Production
Edwin Lai

Abstract: This paper develops a growth model aimed at understanding the potential effects of globalization of production on rate of innovation, distribution of skilled labor income between the North and South, and welfare of skilled 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. In the initial stage of globalization of production, deeper globalization unambiguously improves the welfare of skilled labor in the North, though welfare of Southern skilled labor may still increase. In the later stage, deeper globalization of production unambiguously improves the welfare of skilled labor in the South, though welfare of Northern skilled labor may still improve.

Complete issue

Number 4, May 2008

Measuring Core Inflation: Notes from a 2007 Dallas Fed Conference
Jim Dolmas and Mark A. Wynne

Abstract: In May 2007, the Federal Reserve Bank of Dallas hosted a conference, organized with the Federal Reserve Bank of Cleveland, titled "Price Measurement for Monetary Policy." The conference broadly focused on two issues—the measurement of core inflation and the measurement of inflation expectations. This paper summarizes the conference papers on core inflation.

Complete issue

Number 3, February 2008

The Globalization of U.S. Business Investment
Mark A. Wynne and Erasmus K. Kersting

Abstract: This paper documents some key facts about foreign direct investment flows by U.S. businesses overseas and foreign businesses in the United States. We show how the pattern of flows has evolved, examine the sources and destination of these flows, document associated employment and productivity gains, and show how investment-related sales compare with traditional exports. While the United States is a net debtor to the rest of the world, direct investment overseas by U.S. businesses exceeds direct investment in the U.S. by foreign businesses. Furthermore, U.S. businesses seem to earn more on their foreign investments than foreign firms earn on their U.S. investments. The globalization of business investment is a long-standing phenomenon, but it has accelerated in recent years and become a source of concern for some, as it is intimately related to the debate on offshore outsourcing. Yet contrary to what some think, the bulk of U.S. investment overseas is in other high-income countries. And foreign investment in the U.S. has been an important source of employment growth in recent years.

Complete issue


Number 2, April 2007

Openness and Inflation
Mark A. Wynne and Erasmus K. Kersting

Abstract: This paper reviews the evidence on the relationship between openness and inflation. There is a robust negative relationship across countries, first documented by Romer (1993), between a country's openness to trade and its long-run inflation rate. However, a key part of the standard explanation for this relationship—that central banks have a smaller incentive to engineer surprise inflations in more-open economies because the Phillips curve is steeper—seems at odds with the facts. While the United States is still not a very open economy by conventional measures, there are channels through which global developments may influence the nation's inflation. We document evidence that global resource utilization may play a role in U.S. inflation and suggest avenues for future research.

Complete issue

Number 1, March 2007

Globalization, Aggregate Productivity, and Inflation
W. Michael Cox

Abstract: This paper investigates the effects of globalization on aggregate productivity, output growth, and inflation. I present a simple two-country, two-good, flexible exchange rate model using Fisher Ideal aggregators to examine changes in the mapping from microeconomic to macroeconomic productivity growth as nations globalize. Advances in industry-specific labor productivity are shown to have potentially a much greater passthrough to aggregate productivity, output, and prices the more open nations are to trade. Globalization raises both the level and growth rate of aggregate productivity by allowing more economywide reorganization in response to ongoing technological advances than would be optimal otherwise.

I develop a globalized version of the quantity equation of money, where inflation in the home country depends on domestic money growth and a weighted average of home and foreign GDP growth. Relative country size, consumer preferences, production technologies, and the openness of trade are the chief determinants of these weights. Calibrating the model to match certain stylized facts about the U.S. and global economies, U.S. consumer price inflation falls from roughly 3.8 percent when economies are closed to under 2 percent in the transition period, eventually settling at around 2.3 percent in free trade. Producer and consumer prices trek a common path under autarky but diverge as the world globalizes. Both home and foreign aggregate productivity growth rates increase—by 0.4 and 0.7 percentage points, respectively. Roughly 30 percent of the output weight in the determination of home inflation shifts from the home to the foreign economy—greater than might be expected from strong home bias.

Complete issue