Economic Research and Data

2007 Working Papers

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On-the-Job Search and Labor Market Reallocation

By Murat Tasci

This paper studies amplification of productivity shocks in labor markets through on-the-job-search. There is incomplete information about the quality of the employee-firm match which provides persistence in employment relationships and the rationale for on-the-job search. Amplification arises because productivity changes not only affect firms’ probability of contacting unemployed workers but also of contacting already employed workers. Since higher productivity raises the value of all matches, even low quality matches become productive enough to survive in expansions. Therefore the measure of workers in low quality matches is greater when productivity is high, implying a higher probability of switching to another match. In other words, firms are more likely to meet employed workers in expansions and those they meet are more likely to accept a firm’s job offer because they are more likely to be employed in a low quality match. This introduces strongly procyclical labor market reallocation through procyclical job-to-job transitions. Simulations with a productivity process that is consistent with average labor productivity in the U.S. show that standard deviations for unemployment, vacancies and market tightness (vacancy-unemployment ratio) match the U.S. data. The model also reconciles the presence of endogenous separation with the negative correlation of unemployment and vacancies over business cycle frequencies (i.e. it is consistent with the Beveridge curve).

PDF file, 286 KB

Foreclosures in Ohio: Does Lender Type Matter?

By O. Emre Ergungor

Whether mortgages are originated mostly by depository institutions regulated by the Federal agencies or by less-regulated lenders does not seem to affect the foreclosure fi ling rate in Ohio’s counties. What seems to matter is whether the lenders have a physical presence in the market, in which case, foreclosure rates are lower.

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The National Banking System: A Brief History

By Bruce Champ

During the period of the National Banking System (1863–1913), national banks could issue bank notes backed by holdings of eligible U.S. government securities. This paper presents an overview of the legal and financial history of this period. It begins with the reasons the National Banking System was created. It also examines the rules of operation for national banks as established by the National Banking Act and its subsequent revisions. Furthermore, the paper serves as a brief financial history of the period, examining the various forces that shaped the environment in which national banks operated.

This paper represents a preliminary chapter from a forthcoming monograph on the period of the National Banking System. Other chapters of the monograph will appear in the Federal Reserve Bank of Cleveland’s working paper series.

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The National Banking System: The National Bank Note Puzzle

By Bruce Champ

The era of the National Banking System (1863–1913) has been a puzzling one for monetary theorists and economic historians for well over a century. The puzzles associated with this period take various forms. Despite calculations of high profit rates on note issue for certain periods of the era, national banks never fully utilized their note-issuing powers. Relatedly, the behavior of interest rates during the period is also puzzling given the regime of bank note issuance put in place by the National Bank Acts. On the surface, it appears that an arbitrage condition is broken. The observed inelasticity in aggregate national bank note issue also is puzzling, particularly given the behavior of interest rates. This paper examines many of the puzzles of the national banking era and provides a summary of the current attempts to explain those puzzles.

This paper represents a preliminary chapter from a forthcoming monograph on the period of the National Banking System. Other chapters of the monograph will appear in the Federal Reserve Bank of Cleveland’s working paper series.

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Inflation Persistence, Inflation Targeting and the Great Moderation

By Charles T. Carlstrom, Timothy S. Fuerst and Matthius Paustian

There is growing evidence that the empirical Phillips curve within the US has changed significantly since the early 1980’s. In particular, inflation persistence has declined sharply. The paper demonstrates that this decline is consistent with a standard Dynamic New Keynesian (DNK) model in which: (i) the variability of technology shocks has declined, and (ii) the central bank more aggressively responds to inflation.

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Diagnosing Labor Market Search Models: A Multiple-Shock Approach

By Kenneth Beauchemin and Murat Tasci

This paper constructs a multiple-shock version of the Mortensen-Pissarides labor market search model to investigate the basic model’s well-known tendency to under predict the volatility of key labor market variables. Data on U.S. job finding and job separation probabilities are used to help estimate the parameters of a three-dimensional shock process comprising labor productivity, job separation, and matching or ‘allocative’ efficiency. The authors show that the Mortensen-Pissarides labor market search model requires significantly procyclical and volatile job separations to simultaneously account for high procyclical variations in jobfinding probabilities as well as relatively small net employment changes. Hence, the model is more fundamentally flawed than its inability to amplify shocks would suggest. This leads the authors to conclude that the model lacks mechanisms to generate procyclical matching efficiency and labor force reallocation. As for the latter, the authors conjecture that nontrivial labor force participation and job-to-job transitions are promising avenues of research.

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The National Banking System: Empirical Observations

By Bruce Champ

This paper provides a summary of the main features of U.S. financial and banking data during the period of the National Banking System (1863–1914). The purpose of the paper is to provide an overview of the stylized facts associated with the era, with an emphasis on those impinging on national bank behavior. The paper takes a detailed look at key elements of national bank balance sheets over time, over the seasons, and during panic periods. The interesting and puzzling patterns of interest rate movements during the era also are examined. The paper introduces a new set of disaggregated data on the national bank era that has not been examined by prior research. As data are presented in the paper, some of the key puzzles associated with the era are introduced.

This paper represents a preliminary chapter from a forthcoming monograph on the period of the National Banking System. Other chapters of the monograph will appear in the Federal Reserve Bank of Cleveland’s working paper series.

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Entry, Exit and Plant-Level Dynamics over the Business Cycle

By Yoonsoo Lee and Toshihiko Mukoyama

This paper analyzes the implications of plant-level dynamics over the business cycle. We first document basic patterns of entry and exit of U.S. manufacturing plants, in terms of employment and productivity, between 1972 and 1997. We show how entry and exit patterns vary during the business cycle, and that the cyclical pattern of entry is very different from the cyclical pattern of exit. Second, we build a general equilibrium model of plant entry, exit, and employment and compare its predictions to the data. In our model, plants enter and exit endogenously, and the size and productivity of entering and exiting plants are also determined endogenously. Finally, we explore the policy implications of the model. Imposing a firing tax that is constant over time can destabilize the economy by causing fluctuations in the entry rate. Entry subsidies are found to be effective in
stabilizing the entry rate and output.

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Oil and the Great Moderation
By Anton Nakov and Andrea Pescatori

We assess the extent to which the period of great U.S. macroeconomic stability since the mid-1980s can be accounted for by changes in oil shocks and the oil share in GDP. To do this we estimate a DSGE model with an oil-producing sector before and after 1984 and perform counterfactual simulations. We nest two popular explanations for the Great Moderation: (1) smaller (non-oil) real shocks;and (2) better monetary policy. We find that the reduced oil share accounted for as much as one-third of the infl ation moderation and 13% of the growth moderation, while smaller oil shocks accounted for 11% of the inflation moderation and 7% of the growth moderation. This notwithstanding, better monetary policy explains the bulk of the inflation moderation, while most of the growth moderation is explained by smaller TFP shocks.

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Counterfeiting as Private Money in Mechanism Design
By Ricardo Cavalcanti and Ed Nosal

We describe counterfeiting activity as the issuance of private money, one which is diffi cult to monitor. Our approach, which amends the basic random-matching model of money in mechanism design, allows a tractable welfare analysis of currency competition. We show that it is not effi cient to eliminate counterfeiting activity completely. We do not appeal to lottery devices, and we argue that this is consistent with imperfect monitoring.

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Crime and the Labor Market: A Search Model With Optimal Contracts
By Bryan Engelhardt, Guillaume Rocheteau and Peter Rupert

This paper extends the Pissarides (2000) model of the labor market to include crime and punishment `a la Becker (1968). All workers, irrespective of their labor force status can commit crimes and the employment contract is determined optimally. The model is used to study, analytically and quantitatively, the effects of various labor market and crime policies. For instance, a more generous unemployment insurance system reduces the crime rate of the unemployed but its effect on the crime rate of the employed depends on job duration and jail sentences. When the model is calibrated to U.S. data, the overall effect on crime is positive but quantitatively small. Wage subsidies reduce unemployment and crime rates of employed and unemployed workers, and improve society’s welfare. Hiring subsidies reduce unemployment but they can raise the crime rate of employed workers. Crime policies (police technology and jail sentences) affect crime rates signifi cantly but have only negligible effects on the labor market.

PDF file, 390 KB

Money and Capital
By S. Borağan Aruoba, Christopher J. Waller, and Randall Wright

We revisit classic questions concerning the effects of money on investment in a new framework: a two-sector model where some trade occurs in centralized and some in decentralized markets, as in recent monetary theory, but extended to include capital. This allows us to incorporate novel elements from the microfoundations literature on trading with frictions, including stochastic exchange opportunities, alternative pricing mechanisms, etc. We calibrate models with bargaining and with price taking in the decentralized market. With bargaining, inflation has little impact on investment, but a sizable impact on welfare: going from 10 percent inflation to the Friedman rule e.g. barely affects capital, but is worth 3 percent of consumption. With price taking, this policy increases capital between 3 percent and 5 percent, and is worth 1.5 percent of consumption across steady states or 1 percent with transition. Fiscal distortions are also big. So is the impact of holdup problems from bargaining, even if the decentralized market accounts for only 5 percent of output. Many of these numbers are quite different from previous studies. Our two-sector specification is a key to the results.

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Private Takings
By Ed Nosal

This paper considers the implications associated with a recent Supreme Court ruling that can be interpreted as supporting the use of eminent domain in transferring the property rights of one private agent—a landowner—to another private agent—a developer. Compared to voluntary exchange, when property rights are transferred via eminent domain, landowners’ investments in their properties become more inefficient and, as a result, any any benefit associated with mitigating the holdout problem between landowners and the developer is reduced. Social welfare can only increase if the holdout problem is significant; otherwise, social welfare will fall when property rights are transferred via eminent domain.

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The Dynamics of Market Structure and Market Size in Two Health Services Industries
By Timothy Dunne, Shawn D. Klimek, Mark J. Roberts and Yi Xu

The relationship between the size of a market and the competitiveness of the market has been of long-standing interest to IO economists. Empirical studies have used the relationship between the size of the geographic market and both the number of firms in the market and the average sales of the firms to draw inferences about the degree of competition in the market. This paper extends this framework to incorporate the analysis of entry and exit flows. A key implication of recent entry and exit models is that current market structure will likely depend upon the history of past participation. The paper explores these issues empirically by examining producer dynamics for two health service industries, dentistry and chiropractic services. We find that the number of potential entrants and past number of incumbent firms are correlated with current market structure. The empirical results also show that as market size increases the number of firms rises less than proportionately, firm size increases, and average productivity increases. However, the magnitude of the correlations are sensitive to the inclusion of the market history variables.

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A Model of Money and Credit, with Application to the Credit Card Debt Puzzle
By Irina A. Telyukova and Randall Wright

Many individuals simultaneously have significant credit card debt and money in the bank. The credit card debt puzzle is: given high interest rates on credit cards and low rates on bank accounts, why not pay down debt? While some economists go to elaborate lengths to explain this, we argue it is a special case of the rate-of-return-dominance puzzle from monetary economics. We extend standard monetary theory to incorporate consumer debt, which is interesting in its own right since developing models where money and credit coexist is a long-standing challenge. Our model is quite tractable—e.g., it readily yields nice existence and characterization results—and helps puts into context recent discussions of consumer debt.

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Inflation-Output Gap Trade-off with a Dominant Oil Supplier
By Anton Nakov and Andrea Pescatori

An exogenous oil price shock raises inflation and contracts output, similar to a negative productivity shock. In the standard New Keynesian model, however, this does not generate any trade-off between inflation and output gap volatility: under a strict inflation-targeting policy, the output decline is exactly equal to the efficient output contraction in response to the shock. Modeling the oil sector from optimizing first principles rather than assuming an exogenous oil price, we show that the presence of a dominant oil supplier (OPEC) leads to inefficient fluctuations in the oil price markup. The latter reflects a dynamic distortion of the production process, and as a result, stabilizing inflation does not automatically stabilize the distance of output from first-best. Our model is a step away from discussing the effects of exogenous oil price changes and toward analyzing the implications of the underlying shocks that cause the oil price to change in the first place.

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Incomplete Markets and Households’ Exposure to Interest Rate and Inflation Risk: Implications for the Monetary Policy Maker
By Andrea Pescatori

The present paper studies optimal monetary policy when the representative agent assumption is abandoned and financial wealth heterogeneity across households is introduced. Incomplete markets make households incapable of perfectly insuring against interest rate and inflation risk, creating a trade-off between price level and debt-servicing stabilization. We derive a welfare-based loss function for the policymaker, which includes an additional target related to the cross-sectional distribution of household debt. The extent of the deviation from price stability depends on the initial level of debt dispersion. Using U.S. microdata to calibrate the model, we find an optimal inflation volatility equal to almost 20 percent of the actual volatility of the last 15 years. Finally, the paper studies the design of optimal simple implementable rules. Superinertial rules, which imply a hump-shaped interest rate response to shocks, significantly outperform standard rules.

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Crashes and Recoveries in Illiquid Markets
By Ricardo Lagos, Guillaume Rocheteau, and Pierre-Olivier Weill

We study the dynamics of liquidity provision by dealers during an asset market crash, described as a temporary negative shock to investors’ aggregate asset demand. We consider a class of dynamic market settings where dealers can trade continuously with each other, while trading between dealers and investors is subject to delays and involves bargaining. We derive conditions on fundamentals, such as preferences, market structure and the characteristics of the market crash (e.g., severity, persistence) under which dealers provide liquidity to investors following the crash. We also characterize the conditions under which dealers’ incentives to provide liquidity are consistent with market efficiency.

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On the Cyclicality of R&D: Disaggregated Evidence
By Min Ouyang

This paper explores the link between short-run cycles and long-run growth by examining the cyclicality of R&D. Existing theories propose that R&D is concentrated when output is low, but aggregate data repeatedly show that R&D appears procyclical. We estimate the relationship between R&D and output at the disaggregated industry level, using an annual panel of 20 U.S. manufacturing industries from 1958 to 1998. The results indicate that R&D is in fact procyclical, but interestingly, estimates using demand-shift instruments suggest that R&D responds asymmetrically to demand shocks. We discuss the possibilities that liquidity constraints and technology improvement cause the observed procyclicality of R&D.

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Liquidity in Asset Markets with Search Frictions
By Ricardo Lagos and Guillaume Rocheteau

We study how trading frictions in asset markets affect the distribution of asset holdings, asset prices, efficiency, and standard measures of liquidity. To this end, we analyze the equilibrium and optimal allocations of a search-theoretic model of financial intermediation similar to Duffie, Gârleanu and Pedersen (2005). In contrast with the existing literature, the model we develop imposes no restrictions on asset holdings, so traders can accommodate frictions by varying their trading needs through changes in their asset positions. We find that this is a critical aspect of investor behavior in illiquid markets. A reduction in trading frictions leads to an increase in the dispersion of asset holdings and trade volume. Transaction costs and intermediaries’ incentives to make markets are nonmonotonic in trade frictions. With the entry of dealers, these nonmonotonicities give rise to an externality in liquidity provision that can lead to multiple equilibria. Tight spreads are correlated with large volume and short trading delays across equilibria. From a normative standpoint we show that the asset allocation across investors and the number of dealers are socially inefficient.

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On Forecasting the Term Structure of Credit Spreads
By C.N.V. Krishnan, Peter H. Ritchken, and James B. Thomson

Predictions of firm-by-firm term structures of credit spreads based on current spot and forward values can be improved upon by exploiting information contained in the shape of the credit-spread curve. However, the current credit-spread curve is not a sufficient statistic for predicting future credit spreads; the explanatory power can be increased further by exploiting information contained in the shape of the riskless-yield curve. In the presence of credit-spread and riskless factors, other macroeconomic, marketwide, and firm-specific risk variables do not significantly improve predictions of credit spreads. Current credit-spread and riskless-yield curves impound essentially all marketwide and firm-specific information necessary for predicting future credit spreads.

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Harming Depositors and Helping Borrowers: The Disparate Impact of Bank Consolidation
By Kwangwoo Park and George Pennacchi

A model of multimarket spatial competition is developed where small, single-market banks compete with large, multimarket banks (LMBs) for retail loans and deposits. Consistent with empirical evidence, LMBs are assumed to have different operating costs, set retail interest rates that are uniform across markets, and have access to wholesale funding. If LMBs have significant funding advantages that offset any loan operating cost disadvantages, then market-extension mergers by LMBs promote loan competition, especially in concentrated markets. However, such mergers reduce retail deposit competition, especially in less concentrated markets. Prior empirical research and our own analysis of retail deposit rates support the model’s predictions.

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Limited Liability and the Development of Capital Markets
By Ed Nosal and Michael Smart

We study the consequences of the introduction of widespread limited liability for corporations. In the traditional view, limited liability reduces transactions costs and enhances investment incentives for individuals and firms. But this view does not explain several important stylized facts of the British experience, including the slow rate of adoption of limited liability by firms in the years following legal reforms. We construct an alternative model that accounts for this and other features of the nineteenth century British experience. In the model, project risk is private information, and a firm’s decision to adopt limited liability may be interpreted in equilibrium as a signal the firm is more likely to default. Hence less risky firms may choose unlimited liability or forego investments entirely. We show the choice of liability rule can lead to "development traps," in which profitable investments are not undertaken, through its effect on equilibrium beliefs of uninformed investors in the economy.

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On Government Intervention in the Small-Firm Credit Market and Its Effect on Economic Performance
By Ben R. Craig, William E. Jackson, III, and James B. Thomson

In this paper we empirically test whether the Small Business Administration’s main guaranteed lending program—the 7(a) program—has a greater impact on economic performance in low-income markets than in others. This hypothesis is predicated on our previous research (Craig, Jackson, and Thomson 2007b), where we investigate aggregate SBA guaranteed lending. In that research we found that the overall impact of SBA guaranteed lending on economic performance is significant and positive in low-income markets.

Using local labor market employment rates as our measure of economic performance, we find a quantitatively similar positive impact of SBA 7(a) guaranteed lending. This impact on economic performance is also significantly larger in low-income areas than in other areas. This result suggests that the 7(a) program, which is the largest SBA guaranteed lending program, is also the main contributor to the positive impact of SBA guaranteed lending on local market economic performance.

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Search in Asset Markets: Market Structure, Liquidity, and Welfare
By Ricardo Lagos and Guillaume Rocheteau

This paper investigates how market structure affects efficiency and several dimensions of liquidity in an asset market. To this end, we generalize the search-theoretic model of financial intermediation of Darrell Duffie et al. (2005) to allow for entry of dealers and unrestricted asset holdings.

PDF file, 149 KB

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