Working Paper 9823
Central Bank
Intervention and Overnight Uncovered Interest
Rate Parity
by Richard T. Baillie and William P. Osterberg
This paper considers the impact of U.S. and German central bank intervention on the risk premium in forward foreign exchange markets. The model estimation is facilitated with the use of daily data on overnight Eurocurrency deposit rates, so that the interest rate maturity time of one day matches the sampling interval of the data. We also use the official net daily purchases and sales of dollars vis-à-vis the German Mark by the Federal Reserve System and the Bundesbank. The model involves FIGARCH innovations to model the degree of long term dependence in the volatility process. Some support is found for the intervention variables affecting the risk premium as predicted by theory. The impact of intervention in the two years immediately following the meltdown of the equity markets in October 1987 is particularly strong.
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Working Paper 9822top
Sources of Business
Cycles in Korea and the United States
by David Altig and
Alan C. Stockman
The authors estimate common and nation-specific components of technology shocks, real demand shocks, and combined (common and nation-specific) monetary shocks using quarterly data for Korea and the United States.
PDF file 175K
Working Paper 9821top
Private Money
Creation and the Suffolk Banking System
by Bruce D. Smith and Warren E. Weber
Recent legislation has removed U.S. legal impediments to issuing private bank notes. At the same time, improved transaction technologies have enabled banks and other entities to issue various forms of "e-cash." Consequently, developed economies may soon see the reemergence of privately issued substitutes for currency. The authors examine the potential economic consequences using the Bank of Suffolk as a model.
PDF file 87K
Working Paper 9820top
Will Electronic
Money be Adopted in the United States?
by Barbara A. Good
Although the cashless society has been predicted for at least twenty years, the new forms of card-based and software-based electronic money may prove to be a partial alternative to the current forms of payments. This paper examines their possible adoption, primarily in the United States.
PDF file 111K
Working Paper 9819top
Price-Level
and Interest-Rate Targeting in a Model with
Sticky Prices
by Charles T. Carlstrom
and Timothy S. Fuerst
This paper examines a standard sticky price monetary model. The equilibrium conditions of the model are perturbed relative to the canonical real business cycle model by two varying distortions: marginal cost and the nominal rate of interest. The paper explores the implications of two monetary policies that are frequently advocated: (1) an inflation target and (2) an interest rate target. Under an inflation rate target, marginal cost is stabilized while the nominal rate is variable. In contrast, under an interest rate target, the nominal rate is stabilized but marginal cost is (in general) variable. Both policies are subject to sunspot fluctuations arising from the endogenous movement of the money stock. These fluctuations can be avoided by eliminating the contemporaneous response of the money stock to innovations in the environment.
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Working Paper 9818top
Real Indeterminacy
in Monetary Models with Nominal Interest Rate
Distortions: The Problem with Inflation Targets
by Charles T. Carlstrom
and Timothy S. Fuerst
This paper demonstrates that in a standard monetary model there exists real indeterminacy whenever the nominal interest rate moves too closely with the real rate. A particular example of such a policy is if the central bank were to target the inflation rate. This is not a knife-edge result. The conclusion is robust to (1) a wide range of calibrations, (2) a more general monetary policy that targets a varying path for the inflation rate, and (3) a monetary environment that allows for endogenous velocity.
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Working Paper 9817top
Non-Par Banking:
Competition and Monopoly in Markets for Payments
Services
by Ed Stevens
Much of the literature treats the existence of non-par banking as a legal matter, emphasizing the Board of Governors' legal struggle to force non-par banks to pay Reserve banks at par. This treatment is not satisfactory. In competitive markets, par paying banks should have been able to undercut non par banks' prices, once the Reserve banks had eliminated exchange charges by integrating their balance sheets. More likely, the survival of non-par banking reflected the absence of competition in the markets in which non-par banks operated. Past empirical evidence is consistent with this conclusion: non-par banks typically were monopolists in isolated rural markets for banking services.
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Working Paper 9816top
Evolutionary
Programming as a Solution Technique for the
Bellman Equation
by Paul Gomme
Evolutionary programming is a stochastic optimization procedure which has proved useful in optimizing difficult functions. It is shown that evolutionary programing can be used to solve the Bellman equation problem with a high degree of accuracy and substantially less CPU time than Bellman equation iteration. Future applications will focus on sometimes binding constraints - a class of problem for which standard solutions techniques are not applicable.
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Working Paper 9815top
The Federal
Reserve as an Informed Foreign-Exchange Trader
by Owen F. Humpage
U.S. exchange-market interventions have no apparent effect on market fundamentals, but may influence expectations. If intervention can accurately forecast exchange-rate movements, knowledge that the Federal Reserve was trading will cause traders to alter their prior estimates of the distribution of exchange-rate changes. This paper finds that U.S. intervention has value only as a forecast that recent exchange-rate movements will moderate, but not that they will reverse. Less than half of the interventions, however, seem successful, and the favorable results are generally confined to two relatively short periods that are characterized by uncertainty about future Federal Reserve policies.
PDF file 130K
Working Paper 9814top
Earnings and
Wealth Inequality and Income Taxation: Quantifying
the Trade-Offs of Switching to a Proportional
Income Tax in the U.S.
by Ana Castañeda, Javier Díaz-Giménez and
José-Victor Ríos-Rull
This paper quantifies the steady-state aggregate, distributional and mobility effects of switching the U.S. to a proportional income tax system. As a prerequisite to the analysis, we propose a theory of earnings and wealth inequality capable of accounting quantitatively for the key aggregate and inequality facts of the U.S. economy. This theory is based on savings to smooth uninsured household-specific risk, for dynastic households that also have some life-cycle characteristics. A suitable calibration of our model economy replicates the U.S. growth facts, earnings and wealth distributions, the progressivity of the tax system and the size of the U.S. government. We also solve a similar model economy in which the government levies a proportional income tax to finance the same flow of government expenditures and public transfers. Our findings show that in this class of model worlds a switch from the U.S. tax system to a proportional tax system implies the following trade-offs, i) it increases efficiency as measured by aggregate output by 4.4%, ii.) it does not increase inequality as measured by the Gini index of the earnings, and iii.) it increases inequality as measured by the Gini index of the wealth distribution by 10.4%, and iv.) it changes by little the mobility between the different earnings and wealth groups.
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Working Paper 9813top
Monetary Aggregates
and Output
by Scott Freeman and Finn Kydland
This paper offers a general equilibrium model that explains how the observed correlations of money and output fluctuations may come about through endogenously determined fluctuations in the money multiplier. The model is calibrated to meet long run features of the U.S. economy (including monetary features) and then subjected to shocks to the Solow residual following a random process like that observed in U.S. data. The model's predicted business-cycle frequency correlations, of both real and nominal variables, share the following features with U.S. data: i) M1 is positively correlated with real output; ii) the money multiplier and deposit-to-currency ratio are positively correlated with real output; iii) the price level is negatively correlated with output [in spite of (i) and (ii)]; iv) the correlation of M1 with contemporaneous prices is substantially weaker than the correlation of M1 with real output; v) correlations among real variables are essentially unchanged under different monetary policy regimes; and vi) real money balances are smoother than money demand equations would predict. Although features (i) and (iv) may have been considered support for a causal influence of money on output, the paper demonstrates that they are consistent with an economy in which money has no such causal influence.
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Working Paper 9812top
Expectations,
Credibility, and Time-Consistent Monetary
Policy
by Peter N. Ireland
This paper addressses the problem of multiple equilibria in a model of time-consistent monetary policy. It suggests that this problem originates in the assumption that agents have rational expectations and proposes several alternative restrictions on expectations that allow the monetary authority to build credibility for a disinflationary policy by demonstrating that it will stick to that policy even if it imposes short-run costs on the economy. Starting with these restrictions, the paper derives conditions that guarantee the uniqueness of the model's steady state; monetary policy in this unique steady state involves the constant deflation advocated by Milton Friedman.
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Working Paper 9811top
Simulating the
Transmission of Wealth Inequality Via Bequests
by Jagadeesh Gokhale, Laurence J. Kotlikoff,
James Sefton, and Martin Weale
Answering the question of how much wealth inequality arises from inheritance inequality requires data that are unavailable and potentially uncollectable. The alternative approach taken here (from Blinder [1974, 1976] and Davis [1982]) is to simulate the transmission of inequality via bequests.
PDF file 171K
Working Paper 9810top
Optimal Employment
of Scale Economies in the Federal Reserve's
Currency Infrastructure
by Paul W. Bauer, Apostolos
Burnetas, Viswanath CVSA, and Gregory Reynolds
This paper investigates whether the Federal Reserve might lower its currency processing costs by reallocating high-speed currency sorting volume among its processing sites. Although scale economy estimates from Bauer, Bohn, and Hancock (1998) suggests that consolidation might permit some processing cost savings, it can be very expensive to ship currency due to security and insurance requirements and these costs increase rapidly as currency is transported further and further from a given processing site. Given estimates of currency shipping costs and scale economies for high-speed sorting, our model determines the distribution of sorting volumes across possible processing sites that minimizes the Federal Reserve's overall costs. These cost savings are achieved while leaving service levels to depository institutions roughly constant. The sensitivity of our results is explored by employing a range of estimates for shipping costs and scale economies.
PDF file 145K
Working Paper 9809top
Self-Selection
and Discrimination in Credit Markets
by Stanley D. Longhofer and Stephen R. Peters
Revised: February 1999
In this paper we make two contributions toward a better understanding of the causes and consequences of discrimination in credit markets. First, we develop an explicit theoretical model of the underwriting process in which lenders use a simple Bayesian updating process to evaluate applicant creditworthiness. Using a signal correlated with an applicant's true creditworthiness and their prior beliefs about the distribution of credit risk in the applicant pool, lenders are able to evaluate an applicant's expected or "inferred" creditworthiness to determine which loans to approve and which to deny. Second, we explicitly model the self-selection behavior of individuals to show how market frictions like bigotry can affect application decisions. Because these decisions shape banks' prior beliefs about the distribution of credit risk, they also affect the Bayesian posterior from which banks compute an applicant's inferred creditworthiness, implying that statistical discrimination can arise endogenously. In a market in which only some lenders have a "taste for discrimination," we show that there are conditions under which lenders without racial animus will also discriminate. Using this model, we address a number of empirical and policy issues.
PDF file 191K | Supplemental Proofs 21K
Working Paper 9808top
The Importance
of Bank Seniority for Relationship Lending
by Stanley D. Longhofer and João A.C. Santos
Revised: September 1999
This paper brings together two seemingly-unrelated branches of the literature that focus on different aspects of a bank's interaction with its borrowers - the relative priority of bank debt, and the role of banks as "relationship lenders." Specifically, we show that bank seniority plays an important role in encouraging the formation of ongoing bank-firm relationships. Because the bank is senior, it is more able to reap the benefits from its relationship with the firm; because the firm has a relationship with a bank, it is more willing to exert effort, thus reducing the impact of a recession on its prospects. As a result, the firm's ex ante value is enhanced when the bank's debt is senior to that of the firm's other creditors.
The intuition behind our model lies in the fact that in bad states of the world it is the most senior claimants that first benefit from improving the quality of the firm, and it is in such states that the true value of relationship lending comes to light. If banks are made junior to other creditors, they may benefit little in bad states from additional investment in the firm and hence will have little incentive to build relationships that might allow them to determine the value of such an investment. As a result, making the bank senior improves its incentives to build a relationship with the firm, thereby fulfilling an important function of intermediated debt.
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Working Paper 9807top
Money and Dynamic
Arrangements with Private Information
by S. Rao Aiyagari and Stephen D. Williamson
We construct a model with private information in which consumers write dynamic contracts with financial intermediaries. A role for money arises due to random limited participation of consumers in the financial market. Without defection constraints, a Friedman rule is optimal, the mean and variability of wealth tend to fall in the steady state, and the welfare effects of inflation are very small. With defection constraints, the effects of inflation on the distribution of welfare and consumption are large, but the effect on average welfare is still small. Also, the relaxation of defection constraints resulting from higher inflation causes a substantial increase in the real interest rate.
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Working Paper 9806top
Measuring the
Rate of Technological Progress in Structures
by Michael Gort, Jeremy Greenwood, and Peter
Rupert
How much technological progress has been made in structures? This paper attempts to measure that progress using panel data on the age and rents for buildings. These data are interpreted according to a vintage capital model in which buildings are replaced with some chosen periodicity. There appears to have been significant technological advance in structures, which accounts for a major part of economic growth.
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Working Paper 9805top
The FDICIA and
Bank CEOs' Pay-Performance Relationship:
An Empirical Investigation
by Ying Yan
Banking problems in the 1980s led to passage of the FDICIA (1991). The purpose of this legislation was to improve market and regulatory discipline of banks' performance through changes in incentive structures. This paper looks at how the FDICIA changes bank CEOs' pay-performance relationship. It finds that the FDICIA improves healthy banks' growth opportunities, making their CEOs' total compensation less sensitive to performance. Meanwhile, the FDICIA restricts unhealthy banks' growth opportunities, making their CEOs' total compensation more sensitive to performance. These results support the agency-cost-of-debt theory developed in John and John (1993). This paper shows that since enactment of the FDICIA, CEOs' compensation structure has become more incentive-based for both healthy and unhealthy banks. At the same time, the main components of CEOs' compensation, salary and bonus, have become more sensitive to accounting earnings, while stock-based compensation has become more responsive to stock returns.
PDF file 123K
Working Paper 9804top
Solving Dynamic
Equilibrium Models by a Method of Undetermined
Coefficients
by Lawrence J. Christiano
This paper presents an undetermined-coefficients method for obtaining a linear approximation to the solution of a dynamic rational-expectations model. It also shows how that solution can be used to compute the model's implications for impulse response functions and for second moments.
PDF file 371K
Working Paper
9803top
Large Shareholders
and Market Discipline in a Regulated Industry:
A Clinical Study of Mellon Bank
by Joseph G. Haubrich
and James B. Thomson
The change in control at Mellon Bank in 1987 sheds a unique light on several aspects of corporate control, because Mellon was one of only a few banks with a large shareholder. We find that the large shareholder did not monitor the firm extensively before it experienced performance difficulties, but was able to enforce a management change when problems arose. Contrary to some theoretical models, the shareholder did not have to acquire a majority stake to effect the change. Mellon's rapid recovery relative to peer banks' reveals the inability of regulatory intervention to substitute fully for market-based forms of corporate control.
PDF file 281K
Working Paper 9802top
Appointing the
Median Voter of a Policy Board
by Christopher J. Waller
Partisan politics and elector uncertainty generate policy uncertainty and partisan business cycles. To reduce policy uncertainty, society must design the policy-making environment to overcome electoral uncertainty and partisanship without ignoring the electorate's wishes. I show that delegating policy to an independent policy board with discretionary powers substantially reduces policy uncertainty while maintaining political accountability. Board members are chosen in a partisan, noncooperative environment yet, in the benchmark model, policy uncertainty is eliminated and the policy rule is replicated. Thus, a political "invisible hand" is at work-by setting up the policy institution properly and having the participants pursue their own self-interest, the social "optimum" prevails.
PDF file 275K
Working Paper 9801top
Reducing Working
Hours: A General Equilibrium Analysis
by Terry J. Fitzgerald
This paper examines the effects of restricting the weekly hours of workers in a heterogeneous-agent, general equilibrium framework. The framework presented here contains two types of workers, which allows the author to explore the consequences of a mismatch between the skills of the nonemployed and the skills of the employed. Previous studies of these issues have been based on partial equilibrium models.
The main findings are that restricting weekly hours increases employment substantially, but may also lead to large declines in wages, productivity, output, and consumption, and can result in an increased wage disparity between skilled and unskilled workers. In one case, the policy raises the wages and consumption of skilled workers, while lowering them for the unskilled. A skills mismatch is shown to have dramatic effects on the aggregate and distributional consequences of the policy.
PDF file 268K
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