Working Paper 9716
Electronic Money
by Barbara A. Good
A new technology brings with it not only the potential for success, but also a never-ending series of questions regarding its design, its value to the user, its ultimate use and acceptability. Electronic money in its various forms, has the potential of changing the retail payments arena in a way that has not happened since the advent of the credit card. But, at this time it is only potential.
Stored-value cards may help to make the transition from paper-based payments to electronically-based payments more likely as these systems, especially stored value cards, incorporate familiar aspects of using money in a way that could prove to be both convenient and acceptable to the public.
This paper will attempt to identify the issues that need to be addressed in order for stored-value cards and other electronic money systems to become a major payment mechanism in the global financial market. These new payments devices require a thorough evaluation of the appropriate regulatory, legal, and policy responses, as well as an estimate of the market acceptance (diffusion of this technology) throughout the financial and social system. These types of cards have the potential to have far reaching effects, if they are accepted by both consumers and merchants.
PDF file 236K
Working Paper 9715top
Depositor Preference Legislation
and Failed Banks' Resolution Costs
by William P. Osterberg and James
B. Thomson
Included in the Omnibus Budget Reconciliation Act of 1993 was a provision that improved the priority of depositors and thus of the FDIC in the event of a depository institution's failure. While intended to reduce the FDIC's cost of resolving commercial bank failures, this provision might have induced general creditors to react so as to offset the intended benefit. Depositor preference legislation (DPL) might also have affected the FDIC's choice of resolution type.
Here we examine the empirical impact of DPL on resolution type and on resolution costs for commercial banks. Given the short time period since the passage of national DPL in 1993, we focus on the impact of state DPL statutes, utilizing call-report data and FDIC data on resolution costs and resolution types for all operating FDIC-BIF insured commercial banks that were closed or required FDIC financial assistance from January 1986 through December 1992. We improve on previous studies by controlling for the endogeneity of book capital and by adjusting for the sample selection bias induced by regulatory closure rules.
We find that DPL has 1) tended to increase, rather than reduce, FDIC resolution costs and 2) induced the FDIC to choose assisted mergers over liquidations. However, the source of the higher resolution costs is unclear and there is no evidence that general creditors reacted by increasing collateralization.
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Working Paper 9714 top
Interest Rate Option Pricing
with Volatility Humps
by Peter Ritchken and Iyuan Chuang
This paper develops a simple model for pricing interest rate options. Analytical solutions are developed for European claims and extremely efficient algorithms exist for the pricing of American options. The interest rate claims are priced in the Heath-Jarrow-Morton paradigm, and hence incorporate full information on the term structure. The volatility structure for forward rates is humped, and includes as a special case the exponentially dampened volatility structure used in the Generalized Vasicek model. The structure of volatilities is captured without using time varying parameters. As a result, the volatility structure is stationary. It is not possible to have all the above properties hold in a Heath Jarrow Morton model with a single state variable. It is shown that the full dynamics of the term structure can, however, be captured by a three state Markovian system. As a result, simple path reconnecting lattices cannot be constructed to price American claims. Nonetheless, we provide extremely efficient lattice based algorithms for pricing claims, which rely on carrying small matrices of information at each node. Empirical support for the models developed are provided.
PDF file 730K
Working Paper 9713 top
Expectations, Credibility, and Disinflation
in a Small Macroeconomic Model
by Chan G. Huh and Kevin J. Lansing
We use a version of the Fuhrer-Moore model to study the effects of expectations and central bank credibility on the economy's dynamic transition path during a disinflation. Simulations are compared under four different specifications of the model that vary according to the way that expectations are formed (rational versus adaptive) and the degree of central bank credibility (full versus partial). In general, the various specifications exhibit qualitatively similar behavior and can reasonably approximate the trend movements in U.S. macrovariables during the Volcker disinflation of the early 1980s. However, the specification with adaptive expectations and partial credibility is the only one to capture the temporary rise in the long-term nominal interest rate observed in U.S. data at the start of the disinflation. Our simulations also show that incremental reductions in the sacrifice ratio are largest at the low end of the credibility range, suggesting that a central bank may face diminishing returns in its efforts to enhance credibility.
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Working Paper 9712 top
Simulating U.S. Tax Reform
by David Altig, Alan
J. Auerbach, Laurence J. Kotlikoff, Kent A. Smetters, and Jan Walliser
This paper uses a new, large-scale, dynamic simulation model to compare the equity, efficiency, and macroeconomic effects of five alternatives to the current U.S. federal income tax. These reforms are a proportional income tax, a proportional consumption tax, a flat tax a flat tax with transition relief, and a progressive variant of the flat tax called the "X tax." The model incorporates intragenerational heterogeneity and kinked budget constraints. It predicts major macroeconomic gains (including an 11 percent increase in long-run output) from replacing the federal tax system with a proportional consumption tax. Future middle- and upper-income classes gain from this policy, but initial older generations are hurt by the policy's implicit capital levy. Poor members of current and future generations also lose. The flat tax, which adds a standard deduction to the consumption tax, makes all members of future generations better off, but at a cost of halving the economy's long-run output gain and harming initial older generations. Insulating these older generations through transition relief further reduces the long-run gains from tax reform. Switching to a proportional income tax without deductions and exemptions hurts current and future low lifetime earners, but helps everyone else. It also raises long-run output by over 5 percent. The X tax makes everyone better off in the long run and also raises long-run output by 7.5 percent. But it harms initial older generations who bear its implicit wealth tax.
PDF file 451K
Working Paper 9711 top
Algorithms for Solving Dynamic
Models with Occasionally Binding Constraints
by Lawrence J. Christiano and Jonas D.M. Fisher
We describe and compare several algorithms for approximating the solution to a model in which inequality constraints occasionally bind. Their performance is evaluated and compared using various parameterizations of the one sector growth model with irreversible investment. We develop parameterized expectation algorithms which, on the basis of speed, accuracy and convenience of implementation, appear to dominate the other algorithms.
PDF file 2,160K
Working Paper 9710 top
Absolute Priority Rule Violations,
Credit Rationing, and Efficiency
by Stanley D. Longhofer
Violations of the absolute priority rule (APR) are commonplace in private workouts, formal business reorganizations, and personal bankruptcies. While some theorists suggest they may arise endogenously, they are clearly magnified by the institutional structure of the bankruptcy code. This paper shows that APR violations exacerbate credit rationing problems by reducing the payment lenders receive in default states. Furthermore, APR violations make default more likely to occur, thereby making debt financing more costly. Together, these results support the view that APR violations create an impediment to efficient financial contracting.
PDF file 163K
Working Paper 9709 top
A Note on Purifying Mixed Strategy
Equilibria in the Search Model of Money
by Randall Wright
The simple search-theoretic model of
fiat money has three symmetric Nash equilibria: all
agents accept money with probability 1; all agents accept
money with probability 0; and all agents accept money
with probability 0; and all agents accept money with
probability 
. Here
we construct a nonsymmetric pure strategy equilibrium,
payoff-equivalent to the symmetric mixed strategy equilibrium,
pay-off equivalent to the symmetric mixed strategy equilibrium,
where a fraction 
of agents always accept money and 1 – N never accept
money. Counter to what has been conjectured previously,
we find N > y. We also study evolutionary dynamics,
and show that the economy converges to monetary exchange
if the initial proportion of agents accepting money
exceeds N.
PDF file 197K
Working Paper 9708 top
Indeterminacy and Stabilization
Policy
by Jang-Ting Guo and Kevin J. Lansing
It has been shown that a one-sector real business cycle model with sufficient increasing returns in production may possess an indeterminate steady state that can be exploited to generate business cycles driven by "animal spirits" of agents. This note shows how an income tax schedule that exhibits a progressivity feature can ensure saddle path stability in such a framework and thereby stabilize the economy against sunspot fluctuations. Conversely, an economy that exhibits a flat or regressive tax schedule is more susceptible to indeterminacy
PDF file 251K
Working Paper 9707
Efficient Inflation Estimation
by Michael F. Bryan,
Stephen G. Cecchetti, and Rodney L. Wiggins II
This paper investigates the use of trimmed means as high-frequency estimators of inflation. The known characteristics of price change distributions, specifically the observation that they generally exhibit high levels of kurtosis, imply that simple averages of price data are unlikely to produce efficient estimates of inflation. Trimmed means produce superior estimates of "core inflation," which we define as a long-run centered moving average of CPI and PPI inflation. We find that trimming 9% from each tail of the CPI price-change distribution, or 45% from the tails of the PPI price-change distribution, yields an efficient estimator of core inflation for these two series, although lesser trims also produce substantial efficiency gains. Historically, the optimal trimmed estimators are found to be nearly 23% more efficient (in terms of root-mean-square error) than the standard mean CPI, and 45% more efficient than the mean PPI. Moreover, the efficient estimators are robust to sample period and to the definition of the presumed underlying long-run trend in inflation.
PDF file 940K
Working Paper 9706top
Trust and Investment Corporations
in China
by Zhaohui Hong and Ying Yan
Trust and investment corporations (TICs) have played a very important role in China's economic reform. However, this sector is now in a chaotic situation because it lacks proper regulation and clear distinction from other financial sectors. Substantial reform is imperative in order to sustain TICs' financial stability and avoid an adverse effect on the economy. This paper gives a detailed description of Chinese TICs' formation and expansion. After pointing out the problems and their sources, we suggest that TICs in China should resume the international standard trust services instead of conducting businesses that overlap with the banking and securities industries. Chinese settlors should be treated as shareholders instead of debtholders. To smooth out the process of transition, we propose an intermediate scheme that takes into account both the realities in China and the international trust operation standard.
PDF file 77K
Working Paper 9705top
Identifying Inflation's Grease
and Sand Effects in the Labor Market
by Erica L. Groshen and Mark
E. Schweitzer
Inflation has been accused of causing distortionary price and wage fluctuations (sand) as well as lauded for facilitating adjustments to shocks when wages are rigid downwards (grease). This paper investigates whether these two effects can be distinguished from each other in a labor market by the following identification strategy: inflation-induced deviations among employers' mean wage-changes represent unintended intramarket distortions (sand), while inflation-induced, interoccupational wage-changes reflect intended alignments with intermarket forces (grease).
Using a unique 40-year panel of wage changes made by large midwestern employers, we find a wide variety of evidence to support the identification strategy. We also find some indications that occupational wages in large firms gained flexibility in the past four years. These results strongly support other findings that grease and sand effects exist, but also suggest that they offset each other in a welfare sense and in unemployment effects. Thus, at levels up to five percent, the net impact of inflation is beneficial but statistically indistinguishable from zero. It turns detrimental after that. When positive, net benefits never exceed a tenth of gross benefits.
PDF file 226K
Working Paper 9704top
Securities Activities In Banking
Conglomerates: Should Their Location Be Regulated?
by João Cabral dos Santos
This paper reviews the arguments as to whether the location of the securities unit in a banking conglomerate should be subject to regulation. This review is complemented with evidence on the regulations and on securities units' predominant location in the G-10 countries and in the United States before the Glass-Steagall Act. The paper argues that correcting the safety net's distortions and allowing banks to choose where to locate their securities units is a better alternative than retaining such distortions and relying on corporate separateness to limit the problems they may create. Separateness imposes costs and provides banks with insulation that is more apparent than real. However, if authorities opt for requiring separateness, a regulation allowing banks to choose between the bank-parent model and the holding-company model seems more appropriate than a regulation requiring them to adopt either one of these models.
PDF file 225K
Working Paper 9703top
Social Security Privatization:
A Simple Proposal
by David Altig and
Jagadeesh Gokhale
This paper proposes a Social Security reform for the United States that gradually, but ultimately fully, privatizes the system. This proposal follows the "no-harm, no-foul" principle in that it preserves the benefits of older generations and yet promises the same or higher retirement benefits for the young. As such it is both economically and politically feasible.The paper demonstrates that the transition to a privatized system can be financed without any additional taxation, including additional payroll taxation. Our approach is likely to improve U.S. national saving and work incentives compared to the current system. It also has advantages over other privatization proposals that recommend or may require additional taxation to finance the transition. The paper points out, however, that there is only a limited window of opportunity for implementing such a reform of the U.S. Social Security system.
PDF file 462K
Working Paper 9702top
Credit Rationing, Bankruptcy
Cost, and The Optimal Debt Contract For Small Business
by Ying Yan
This paper examines whether the costly random verification scheme affects the optimal debt contract for small business. It finds, contrary to Townsend (1979) and Williamson (1986, 1987), that the standard debt contract is the optimal debt contract with the costly random verification scheme. Credit rationing, characterized as a loan granted in an amount less than requested, becomes more severe as the bankruptcy cost rises. This result supports the 1994 amendments to the Bankruptcy Code, since it shows that simplifying the bankruptcy procedure for small business reduces credit rationing and therefore enhances lending.
PDF file 422K
Working Paper 9701top
Estimating the Cost of U.S. Indexed Bonds
by Silverio Foresi, Alessandro Penati, and George Pennacchi
This paper presents an equilibrium bond pricing model driven by two stochastic factors: the real interest rate and the expected rate of inflation. The model's parameters are estimated using a maximum likelihood technique based on a Kalman filter. Data on nominal U.S. Treasury securities and Survey of Professional Forecasters predictions of the GDP deflator are employed to identify the separate effects of real and nominal variables. The market prices of real interest rate risk and inflation risk are estimated, which allows us to construct yield curves for nominal and indexed U.S. Treasury securities. The relative costs of nominal and indexed bonds can then be assessed.
PDF file 974K
1996 1997 1998
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