Working Paper 9919
The Effects of Minimum Wages Throughout the
Wage Distribution
by David Neumark, Mark
Schweitzer, and William Wascher
This paper provides evidence on a wide set of margins along which labor markets can adjust in response to increases in the minimum wage, including wages, hours, employment, and ultimately labor income, representing the central margins of adjustment that impact the economic well-being of workers potentially affected by minimum wage increases. The evidence indicates that workers initially earning near the minimum wage are adversely affected by minimum wage increases, while, not surprisingly, higher-wage workers are little affected. Although wages of low-wage workers increase, their hours and employment decline, and the combined effect of these changes is a decline in earned income.
We also delve into the political economy of minimum wages, attempting to understand the vigorous support of labor unions for minimum wage increases. Using the same empirical framework, we find that relatively low-wage union members gain at the expense of the lowest-wage nonunion workers when minimum wages increase.
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Working Paper 9918 top
Intervention as Information: A Survey
by Richard T. Baillie, Owen
F. Humpage, and William P. Osterberg
Research has generally failed to find reliable connections between official exchange-market interventions and exchange rates that are consistent with either a monetary or a portfolio-balance theory of exchange-rate determination. Recently economists have suggested that intervention might sometimes influence exchange rates through its effects on agents’ expectations. This survey discusses newer research that analyzes informational aspects of intervention.
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Working Paper 9917 top
Results of a Study of the Stability of Cointegrating
Relations Comprised of Broad Monetary Aggregates
by John B. Carlson,
Dennis L. Hoffman, Benjamin D. Keen, and Robert H. Rasche
We find strong evidence of a stable "money demand" relationship for MZM and M2M through the 1990s. Though the M2 relation breaks down somewhere around 1990, evidence has been accumulating that the disturbance is well characterized as a permanent upward shift in M2 velocity, which began around 1990 and was largely over by 1994. Taken together, our results support the hypothesis that households permanently reallocated a portion of their wealth from time deposits to mutual funds. Although this reallocation may have been induced by depository restructuring, we argue that the substitution could be explained by appropriately measured opportunity cost.
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Working Paper 9916 top
Currency Portfolios and Nominal Exchange Rates
in a Dual Currency Search Economy
by Ben Craig and Christopher
J. Waller
We analyze a dual currency search model in which agents are allowed to hold multiple units of both currencies. Hence, agents hold portfolios of currency. We study equilibria in which the two currencies are identical and equilibria in which the two currencies differ according to the magnitude of the ’inflation tax’ risk associated with each currency. The inflation tax is modeled by having government agents randomly confiscate the two currencies at different rates. We are able to obtain analytical results in a very special case but in general we must rely on numerical methods to solve for the steady-state distributions of currency portfolios, prices and value functions. We find that when one of the currencies has the right amount of ’risk’, equilibria exist in which the safe currency trades for multiple units of the risky currency (pure currency exchange). As a result, the steady state has a distribution of nominal exchange rates. The mean and variance of the nominal exchange rate distribution is based on the fundamentals of the model such as the risk of confiscation, risk preferences, matching probabilities and relative money supplies. The mean and variance of this distribution typically change in predictable ways when the fundamentals change. While the ability to trade currencies improves average welfare, in general, the benefits of currency exchange are small.
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Working Paper 9915 top
Risk Sharing of Disaggregate Macroeconomic
and Idiosyncratic Shocks
by Gregory D. Hess and Kwanho Shin
We estimate the extent to which idiosyncratic and disaggregate macro shocks (such as regional and industry shocks) are not shared in the economy. Comparing the degree to which idiosyncratic and disaggregate macro shocks are not shared grants a deeper understanding as to why the economy lacks in specific areas of risk sharing arrangements. As well, it can point to areas where the economy's risk sharing capability can be enhanced. Using household data from the Panel Study of Income Dynamics, we find that a negligible amount of risk (around 10%) is shared in the aggregate, about 50% is shared within regions and industries, while the remaining 40% is not shared with other households. These findings suggest that given the low level of international risk sharing, increased international integration may not lead to a significant increase in international risk sharing.
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Working Paper 9914 top
The Adequacy of Life Insurance: Evidence from
the Health and Retirement Survey
by B. Douglas Bernheim, Lorenzo Forni, Jagadeesh Gokhale, and Laurence
J. Kotlikoff
This study examines life insurance adequacy among married American couples approaching retirement based on the 1992 Health and Retirement Survey with matched Social Security earnings histories. It evaluates each household’s life insurance needs based on new financial planning software that embodies a life-cycle-planning model and covers a broad array of demographic, economic, and financial characteristics. A sizable minority of households are significantly underinsured. Almost one third of wives and over 10 percent of husbands would have suffered living-standard reductions greater than 20 percent had their spouses died in 1992. Under-insurance seems more common among low-income households, couples with asymmetric earnings, younger households, couples with dependent children, and non-whites. In general, households with greater vulnerabilities do not compensate adequately through greater life insurance holdings. Among some groups, the frequency of under-insurance exceeds two-thirds, and the frequency of severe under-insurance (a reduction in living standard of 40 percent or greater) exceeds one-quarter.
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Working Paper 9913 top
The Impact of Social Security and Other Factors
on the Distribution of Wealth
by Jagadeesh Gokhale and Laurence J. Kotlikoff
Auerbach et al. (1995), document the dramatic postwar increase in the annuitization of the resources of America’s elderly. Gokhale et al. (1996) suggest that greater annuitization may explain the significant postwar rise in the consumption propensity of the elderly out of remaining lifetime resources. Gokhale et al. (2000) consider the related point that increased annuitization will reduce bequests, especially for lower and middle-income households, whose entire earnings are taxed under Social Security. By differentially disenfranchising the children of the poor from receipt of inheritances, Social Security may materially alter the distribution of wealth. This paper uses data from the PSID to further analyze how Social Security and other factors affect wealth inequality. The Gini coefficient of the simulated equilibrium wealth distribution is 21 percent larger and the share of wealth held by the wealthiest 1 percent of households is 79 percent higher in the presence of Social Security.
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Working Paper 9912 top
Social Security's Treatment of Postwar Americans:
How Bad Can It Get?
by Jagadeesh Gokhale and Laurence J. Kotlikoff
As currently legislated, the U.S. Social Security System represents a bad deal for postwar Americans. Of every dollar postwar Americans have earned or will earn over their lifetimes, over 5 cents will be lost to the Old Age Survivor Insurance System (OASI) in the form of payroll taxes paid in excess of benefits received. This lifetime net tax rate can also be understood by comparing the rate of return postwar contributors receive from OASI and the return they can earn on the market. The OASI return -- 1.86 percent -- is less than half the return currently being paid on inflation-indexed long-term government bonds, and the OASI return is much riskier. Of course, Social Security is an insurance as well as a net tax system. But, viewed as an insurance company, the insurance OASI sells (or, rather, forces households to buy) is no bargain. The load charged averages 66 cents per dollar of premium.
These findings, developed in an extensive micro simulation study by Caldwell, et al. (1999), assume that current law can be maintained through time. But Social Security faces a staggering long-term funding problem. Meeting the system's promised benefit payments on an ongoing basis requires raising the OASDI 10.8 tax rate immediately and permanently by two fifths!
How bad can Social Security's treatment of postwar Americans get once adjustments are made to "save" the system? This paper examines that question using the machinery developed in Caldwell, et al. Specifically, it considers Social Security's treatment of postwar Americans under alternative tax increases and benefit cuts that would help bring the system's finances into present value balance. The alternatives include immediate tax increases, eliminating the ceiling on taxable payroll, immediate and sustained benefit cuts, increasing the system's normal retirement ages beyond those currently legislated, switching from wage to price indexing in calculating benefits, and limiting the price indexation of benefits. The choice among these and other alternatives have important consequences for which postwar generations and which members of those generations will be forced to pay for the system's long-term financing problems.
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Working Paper 9911 top
Optimal Monetary Policy in a Small Open Economy:
A General Equilibrium Analysis
by Charles T. Carlstrom
and Timothy S. Fuerst
This paper uses a small open economy model to address two outstanding issues in monetary policy: (1) what restrictions on the policy rule ensure that the central bank does not introduce real indeterminacy into the economy, and (2) what is the optimal long run rate of inflation. The small open economy model provides unique insights on both fronts. In the case of determinacy issues, the model’s simplicity makes the analysis remarkably transparent. As for long run inflation rates, a small open economy takes as given the foreign nominal interest rate. To the extent that this rate distorts domestic behavior, there is a role for positive domestic nominal rates (in contrast to Friedman’s celebrated optimum quantity of money). This motivation arises naturally in the setting of a small open economy.
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Working Paper 9910 top
Timing and Real Indeterminacy in Monetary
Models
by Charles T. Carlstrom
and Timothy S. Fuerst
An increasingly common approach to the theoretical analysis of monetary policy is to ensure that a proposed policy does not introduce real indeterminacy and thus sunspot fluctuations into the model economy. Policy is typically conducted in terms of directives for the nominal interest rate. This paper uses a discrete-time money-in-the-utility function model to demonstrate how seemingly minor modifications in the trading environment result in dramatic differences in the policy restrictions needed to ensure real determinacy. These differences arise because of the differing pricing equations for the nominal interest rate.
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Working Paper 9909R* top
Protection for Whom? Creditor Conflicts in
Bankruptcy
by Stanley D. Longhofer and Stephen R. Peters
Revised. In this article we provide a rationale for bankruptcy law that is based on the conflicts among creditors that occur when a debtor’s liabilities exceed its assets. In the absence of a bankruptcy law, the private debt-collection remedies that creditors pursue when a debtor is insolvent result in an ad hoc disposal of the debtor’s assets, thereby reducing the aggregate value of creditors’ claims. We show that coordination clauses can be used by creditors in their loan agreements that will result in coordination, ex post. Although all creditors would benefit from including these clauses in their contracts, they nevertheless choose not to in precisely those circumstances in which it is desirable to coordinate. This is an important insight because previous theories supporting a role for bankruptcy law are based on the notion that creditors want to contract about bankruptcy, but cannot. In contract, we demonstrate that creditors will choose not to coordinate ex ante, even though it is in their best interest ex post.
We also examine a variety of other contractual mechanisms, including covenants and seniority, and show that although including these terms in loan contracts can improve creditors’ incentives to write coordination clauses, they do so only in special circumstances. Our analysis of creditor conflicts and the potential for private contracting remedies provides an economic rationale for the existence of a bankruptcy law that mandates ex post coordination among the creditors of an insolvent debtor.
*Originally published September 1999; Revised June 2000
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Working Paper 9908 top
Wage Adjustments: A Break from the Past
by Erica L. Groshen and Mark
E. Schweitzer
The authors examine 39 years of wage data for workers in mobile occupations within a set of employers in three midwestern cities. They study wage changes during years of rising, falling, and steady inflation to identify regularities that could broaden understanding of the inflationary process at the micro level.
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Working Paper 9907 top
Banking and Commerce: A Liquidity Approach
by Joseph G. Haubrich
and João A. C. Santos
This paper looks at the advantages and disadvantages of mixing banking and commerce, using the "liquidity" approach to financial intermediation. Adding a commercial firm makes it easier for a bank to dispose of assets seized in a loan default. This 'internal market' increases the liquidity of such assets and improves the bank's ability to perform financial intermediation. More generally, owning a commercial firm may act either as a substitute or a complement to commercial lending. In some cases, a bank will voluntarily refrain from making loans, choosing to become a non-bank bank in an unregulated environment.
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Working Paper 9906 top
The Band Pass Filter
by Lawrence J. Christiano and Terry J. Fitzgerald
The 'ideal' band pass filter can be used to isolate the component of a time series that lies within a particular band of frequencies. However, applying this filter requires a dataset of infinite length. In practice, some sort of approximation is needed. Using projections, we derive approximations that are optimal when the time series representations underlying the raw data have a unit root, or are stationary about a trend. We identify one approximation which, though it is only optimal for one particular time series representation, nevertheless works well for standard macroeconomic time series.
To illustrate the use of this approximation, we use it to characterize the change in the nature of The Phillips curve and the money-inflation relation before and after the 1960s. We find that there is surprisingly little change in the Phillips curve and substantial change in money growth-inflation relations.
PDF file 1,489K | Matlab Code 14K
Working Paper 9905R* top
Monetary Policy Regimes and Beliefs
by David Andolfatto and Paul
Gomme
Revised. This paper investigates the role of beliefs over monetary policy in propagating the effects of monetary policy shocks within the context of a dynamic, stochastic general equilibrium model. In our model, monetary policy periodically switches between low and high money growth regimes. When individuals are unable to observe the regime directly, they will have to form inferences over regime-type based on historical money growth rates. We show that for an empirically plausible money growth process, beliefs evolve slowly in the wake of a regime change. As a result, our model is able to capture some of the observed persistence of real and nominal variables following such a regime change.
*Originally published July 1999; Revised July 2001
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Working Paper 9904 top
More on Marriage, Fertility, and the Distribution
of Income
by Jeremy Greenwood, Nezih Guner and John Knowles
According to Pareto, the distribution of income depends on “the nature of the people comprising a society, on the organization of the latter, and, also, in part, on chance.” An overlapping generations model of marriage, fertility and income distribution is developed here. The “nature of the people” is captured by attitudes toward marriage, divorce, fertility, and children. Singles search for mates in a marriage market. They are free to accept or reject marriage proposals. Married agents make their decisions through bargaining about work, and the quantity and quality of children. They can divorce. Social policies, such as child tax credits or child support requirements, re‡ect the “organization of the (society).” Finally, “chance” is modeled by randomness in income, opportunities for marriage, and marital bliss.
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Working Paper 9903 top
A Method for Taking Models to the Data
by Peter N. Ireland
This paper develops a method for combining the power of a dynamic, stochastic, general equilibrium model with the flexibility of a vector autoregressive time-series model to obtain a hybrid that can be taken directly to the data. It estimates this hybrid model via maximum likelihood and uses the results to address a number of issues concerning the ability of a prototypical real business cycle model to explain movements in aggregate output and employment in the postwar US economy, the stability of the real business cycle model's structural parameters, and the performance of the hybrid model's out-of-sample forecasts.
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Working Paper 9902 top
Taylor Rules in a Limited Participation Model
by Lawrence J. Christiano and Christopher J. Gust
We use the limited participation model of money as a laboratory for studying the operating characteristics of Taylor rules for setting the rate of interest. Rules are evaluated according to their ability to protect the economy from bad outcomes such as the burst of inflation observed in the 1970's. Based on our analysis, we argue for a rule which: (i) raises the nominal interest rate more than one-for-one with a rise in inflation; and (ii) does not change the interest rate in response to a change in output relative to trend.
PDF file 487
Working Paper 9901 top
Maximum Likelihood in the Frequency Domain:
A Time to Build Example
by Lawrence J. Christiano and Robert J. Vigfusson
A well known result is that the Gaussian log-likelihood can be expressed as the sum over different frequency components. This implies that the likelihood ratio statistic has a similar linear decomposition. We exploit these observations to devise diagnostic methods that are useful for interpreting maximum likelihood parameter estimates and likelihood ratio tests. We apply the methods to the estimation and testing of two real business cycle models. The standard real business cycle model is rejected in favor of an alternative in which capital investment requires a planning period.
PDF file 412K
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