Skip to main content

2011 Working Papers

  • WP 11-34 | A Bayesian Evaluation of Alternative Models of Trend Inflation


    Todd E. Clark Taeyoung Doh

    Abstract

    With the concept of trend inflation now widely understood as to be important as a measure of the public’s perception of the inflation goal of the central bank and important to the accuracy of longer-term inflation forecasts, this paper uses Bayesian methods to assess alternative models of trend inflation. Reflecting models common in reduced-form inflation modeling and forecasting, we specify a range of models of inflation, including: AR with constant trend; AR with trend equal to last period’s inflation rate; local level model; AR with random walk trend; AR with trend equal to the long-run expectation from the Survey of Professional Forecasters; and AR with time-varying parameters. We consider versions of the models with constant shock variances and with stochastic volatility. We first use Bayesian metrics to compare the fits of the alternative models. We then use Bayesian methods of model averaging to account for uncertainty surrounding the model of trend inflation, to obtain an alternative estimate of trend inflation in the U.S. and to generate medium-term, model-average forecasts of inflation. Read More

  • WP 11-32 | Substitution between Net and Gross Settlement Systems: A Concern for Financial Stability?


    Ben R. Craig Falko Fecht

    Abstract

    While net settlement systems make more efficient use of liquidity than gross settlement systems, they are known to generate systemic risk. What does that tendency imply for the stability of the payments (or financial) system when the two settlement systems coexist? Do liquidity shortages induce banks to settle more transactions in the net settlement system, thereby increasing systemic risk? Or do banks require their counterparties to send payments through the gross settlement system when default risks are high, increasing the need for liquidity and the money market rate but reducing overall systemic risk? This paper studies the factors that drive the relative importance of net and gross settlement systems over the short run, using daily data on transaction volumes from the large- volume payment systems of all euro area countries that have had both a net and a gross settlement system at the same time. Applying a large portfolio of different econometric techniques, we find that it is actually the transaction volumes in gross settlement systems that affect the daily price of liquidity and the credit risk spread in money markets. Read More

  • WP 11-31 | Bank Mergers and Deposit Interest Rate Rigidity


    Valeriya Dinger

    Abstract

    In this paper I revisit the debate on the impact of bank and market characteristics on the rigidity of retail bank interest rates. Whereas existing research in this area has been exclusively concerned with static measures of bank and market structure, I adopt a dynamic approach which explores the rigidity effects of the changes of bank and market structure generated by bank mergers. I find that bank mergers significantly affect the frequency of changes to deposit rates. In particular, the probability of adjusting deposit rates in response to shocks in money market rates significantly drops after mergers that involve large target banks and after mergers that generate a substantial geographical expansion of bank operations. These effects, however, materialize only after a "transition" period characterized by very frequent changes of the deposit rates. Read More

  • WP 11-23R1 | The Impact of Vacant, Tax-Delinquent, and Foreclosed Property on Sales Prices of Neighboring Homes


    Stephan D. Whitaker Thomas J. Fitzpatrick IV

    Original Paper: WP 11-23 | Revisions: WP 11-23R2

    Abstract

    In this empirical analysis, we estimate the impact of vacancy, neglect associated with property-tax delinquency, and foreclosures on the value of neighboring homes using parcel-level observations. Numerous studies have estimated the impact of foreclosures on neighboring properties, and these papers theorize that the foreclosure impact works partially through creating vacant and neglected homes. To our knowledge, this is only the second attempt to estimate the impact of vacancy itself and the first to estimate the impact of tax-delinquent properties on neighboring home sales. We link vacancy observations from Postal Service data with property-tax delinquency and sales data from Cuyahoga County (the county encompassing Cleveland, Ohio). Read More

  • WP 10-01R | The Duration of Bank Retail Interest Rates


    Ben R. Craig Valeriya Dinger

    Original Paper: WP 10-01

    Abstract

    We use bank retail interest rates as price examples in a study of the determinants of price durations. The extraordinary richness of the data allows us to address some major open issues from the price rigidity literature, such as the functional form of the hazard of changing a price, the effect of firm and market characteristics on the duration of prices, and asymmetry in the speed of adjustments to positive and negative cost shocks. We find that the probability of a bank changing its retail rate initially (that is, in roughly the first six months of a spell) increases with time. The most important determinants of the duration of retail interest rates are the cumulated change in the money market interest rates and the policy rate since the last retail rate change. Among bank and market characteristics, the size of the bank, its market share in a given local market, and its geographical scope significantly modify retail rate durations. Read More

  • WP 11-30R3 | The Financial Stress Index: Identification of Systemic Risk Conditions


    Mikhail V. Oet Ryan Eiben Timothy Bianco Dieter Gramlich Stephen Ong

    Abstract

    This paper develops a financial stress index for the United States, the Cleveland Financial Stress Index (CFSI), which provides a continuous signal of financial stress and broad coverage of the areas that could indicate it. The index is based on daily public-market data collected from four sectors of the financial markets—the credit, foreign exchange, equity, and interbank markets. A dynamic weighting method is employed to capture changes in the relative importance of these four sectors as they occur. In addition, the design of the index allows the origin of the stress to be identified. We compare the CFSI to alternative indexes, using a detailed benchmarking methodology, and show how the CFSI can be applied to systemic stress monitoring and early warning system design. To that end, we investigate alternative stress-signaling thresholds and frequency regimes and then establish optimal frequencies for filtering out market noise and idiosyncratic episodes. Finally, we quantify a powerful CFSI-based rating system that assigns a probability of systemic stress to ranges of CFSI outcomes. Read More

  • WP 11-29 | SAFE: An Early Warning System for Systemic Banking Risk


    Mikhail V. Oet Ryan Eiben Timothy Bianco Dieter Gramlich Stephen Ong Jing Wang

    Abstract

    This paper builds on existing microprudential and macroprudential early warning systems (EWSs) to develop a new, hybrid class of models for systemic risk, incorporating the structural characteristics of the financial system and a feedback amplification mechanism. The models explain financial stress using both public and proprietary supervisory data from systemically important institutions, regressing institutional imbalances using an optimal lag method. The Systemic Assessment of Financial Environment (SAFE) EWS monitors microprudential information from the largest bank holding companies to anticipate the buildup of macroeconomic stresses in the financial markets. To mitigate inherent uncertainty, SAFE develops a set of medium-term forecasting specifications that gives policymakers enough time to take ex-ante policy action and a set of short-term forecasting specifications for verification and adjustment of supervisory actions. This paper highlights the application of these models to stress testing, scenario analysis, and policy. Read More

  • WP 11-33 | The Term Structure of Inflation Compensation in the Nominal Yield Curve


    Mehmet Pasaogullari Simeon Tsonev

    Abstract

    We propose a DSGE model with regime switching in the central bank’s inflation target to explain inflation compensation in the UK. Taking advantage of the well-documented change in UK monetary policy to adopt inflation targeting, we estimate our model using nominal and inflation-linked Treasury bond data from the UK from 1985 to 2007. We find that this model can account for the term structure of inflation compensation in the nominal yield curve by generating regime-dependent conditional expectations of future inflation. Read More

  • WP 11-28 | A Medium Scale Forecasting Model for Monetary Policy


    Kenneth Beauchemin Saeed Zaman

    Abstract

    This paper presents a 16-variable Bayesian VAR forecasting model of the U.S. economy for use in a monetary policy setting. The variables that comprise the model are selected not only for their effectiveness in forecasting the primary variables of interest, but also for their relevance to the monetary policy process. In particular, the variables largely coincide with those of an augmented New-Keynesian DSGE model. We provide out-of sample forecast evaluations and illustrate the computation and use of predictive densities and fan charts. Although the reduced form model is the focus of the paper, we also provide an example of structural analysis to illustrate the macroeconomic response of a monetary policy shock Read More

  • WP 11-27 | U.S. Monetary-Policy Evolution and U.S. Intervention


    Michael Bordo Owen F. Humpage Anna Schwartz

    Abstract

    The United States all but abandoned its foreign-exchange-market intervention operations in late 1995, when they proved corrosive to the credibility of the Federal Reserve's commitment to price stability. We view this decision as the culmination of the evolution of U.S. monetary policy over the past century from a gold standard to a fiat money regime. The abandonment of intervention was necessary to secure monetary policy credibility. Read More

  • WP 11-26 | When Should Children Start School?


    Dionissi Aliprantis

    Revisions: WP 11-26R

    Abstract

    Kindergarten-entrance-age effects are difficult to identify due to the nonrandom allocation of entrance-age and simultaneous relative-age effects. This paper presents evidence that instrumental variable frameworks do not identify age effects for the youngest children of a cohort using the results of statistical tests for essential heterogeneity in initial enrollment decisions. Restricting attention to the oldest children in a cohort yields a sample with quasirandom variation in entrance and relative ages. This variation is used to identify the parameters of education production functions in which both entrance and relative ages are inputs for achievement. Estimates of entrance-age parameters from the ECLS-K data set are positive, large, and persist until the spring of third grade. Relative-age parameters are smaller, tend to be negative, and fade-out for math achievement by third grade. For the average child in our sample these estimates imply that both an earlier entrance cutoff date and an earlier birthdate will increase achievement if the child remains eligible. Read More

  • WP 11-25 | Ability Matching and Occupational Choice


    Jonathan James

    Abstract

    This paper develops and estimates an individual model of occupational choice and learning that allows for correlated learning across occupation-specific abilities. As an individual learns about their occupation-specific ability in one occupation, this experience will be broadly informative about their abilities in all occupations. Workers continually process their entire history of information, which they use to determine when to change careers, as well as which new career to go to. Endogenizing information in this manner has been computationally prohibitive in the past. I estimate the model in an innovative way using the Expectation and Maximization (EM) algorithm. The model is estimated on the National Longitudinal Survey of Youth 1997. The estimates suggest that both direct and indirect learning play an important role in early career wage growth, with those with the lowest levels of education achieving the largest increases. Read More

  • WP 11-24 | Liquidity and the Threat of Fraudulent Assets


    Yiting Li Guillaume Rocheteau Pierre-Olivier Weill

    Abstract

    We study an over-the-counter (OTC) market with bilateral meetings and bargaining where the usefulness of assets, as means of payment or collateral, is limited by the threat of fraudulent practices. We assume that agents can produce fraudulent assets at a positive cost, which generates endogenous upper bounds on the quantity of each asset that can be sold, or posted as collateral in the OTC market. Each endogenous, asset-specific, resalability constraint depends on the vulnerability of the asset to fraud, on the frequency of trade, and on the current and future prices of the asset. In equilibrium, the set of assets can be partitioned into three liquidity tiers, which differ in their resalability, their prices, their sensitivity to shocks, and their responses to policy interventions. The dependence of an asset’s resalability on its price creates a pecuniary externality, which leads to the result that some policies commonly thought to improve liquidity can be welfare reducing. Read More

  • WP 11-23 | The Impact of Vacant, Tax-Delinquent, and Foreclosed Property on Sales Prices of Neighboring Homes


    Stephan D. Whitaker Thomas J. Fitzpatrick IV

    Revisions: WP 11-23R1 | WP 11-23R2

    Abstract

    In this empirical analysis, we estimate the impact of vacancy, neglect associated with property-tax delinquency, and foreclosures on the value of neighboring homes using parcel-level observations. Numerous studies have estimated the impact of foreclosures on neighboring properties, and these papers theorize that the foreclosure impact works partially through creating vacant and neglected homes. To our knowledge, this is only the second attempt to estimate the impact of vacancy itself and the first to estimate the impact of tax-delinquent properties on neighboring home sales. We link vacancy observations from Postal Service data with property-tax delinquency and sales data from Cuyahoga County (the county encompassing Cleveland, Ohio). Read More

  • WP 11-22R | Assessing the Evidence on Neighborhood Effects from Moving to Opportunity


    Dionissi Aliprantis

    Abstract

    This paper shows that treatment effects of the Moving to Opportunity (MTO) housing mobility program should not be interpreted as evidence on neighborhood effects. In a standard joint model of potential outcomes and selection into treatment, defining treatment as moving with an MTO voucher generates a model of program effects, while defining treatment as moving to a high-quality neighborhood generates a model of neighborhood effects. I state the assumptions necessary for using the random assignment of vouchers in a housing mobility program as an instrument to identify neighborhood effects. I then show that the literature using program effects to learn about neighborhood effects implicitly imposes dubious versions of these assumptions. Read More

  • WP 11-21 | Tests of Equal Forecast Accuracy for Overlapping Models


    Todd E. Clark Michael McCracken

    Abstract

    This paper examines the asymptotic and finite-sample properties of tests of equal forecast accuracy when the models being compared are overlapping in the sense of Vuong (1989). Two models are overlapping when the true model contains just a subset of variables common to the larger sets of variables included in the competing forecasting models. We consider an out-of-sample version of the two-step testing procedure recommended by Vuong but also show that an exact one-step procedure is sometimes applicable. When the models are overlapping, we provide a simple-to-use fixed regressor wild bootstrap that can be used to conduct valid inference. Monte Carlo simulations generally support the theoretical results: the two-step procedure is conservative while the one-step procedure can be accurately sized when appropriate. We conclude with an empirical application comparing the predictive content of credit spreads to growth in real stock prices for forecasting U.S. real GDP growth. Read More

  • WP 11-20 | Advances in Forecast Evaluation


    Todd E. Clark Michael McCracken

    Abstract

    This paper surveys recent developments in the evaluation of point forecasts. Taking West’s (2006) survey as a starting point, we briefly cover the state of the literature as of the time of West’s writing. We then focus on recent developments, including advancements in the evaluation of forecasts at the population level (based on true, unknown model coefficients), the evaluation of forecasts in the finite sample (based on estimated model coefficients), and the evaluation of conditional versus unconditional forecasts. We present original results in a few subject areas: the optimization of power in determining the split of a sample into in-sample and out-of-sample portions; whether the accuracy of inference in evaluation of multistep forecasts can be improved with the judicious choice of HAC estimator (it can); and the extension of West’s (1996) theory results for population-level, unconditional forecast evaluation to the case of conditional forecast evaluation. Read More

  • WP 11-19 | Inter-Regional Home Price Dynamics through the Foreclosure Crisis


    Francisca Richter Youngme Seo

    Abstract

    Overall regional conditions such as employment, geography, and amenities, favor the co-movement of housing prices in central cities and their suburbs. Simultaneously, over half a century of sprawl may induce a negative relation between suburban and central city home prices, with central city values falling relative to suburban home values. What happens to the relationship between subhousing markets when cities are shocked by the foreclosure crisis? This paper builds repeat-sales indices to explore home price dynamics before and after the foreclosure crisis in the Cleveland area, a market that in the aggregate had little home price appreciation prior to the crisis, but significant follow-up depreciation. The analysis finds evidence that connectedness, expressed as the relative importance of neighboring housing market conditions in explaining city home prices, increases among submarkets even as they experience varying levels of foreclosure rates, and that foreclosure effects give little sign of receding in the near future. Read More

  • WP 11-18 | The Federal Reserve as an Informed Foreign-Exchange Trader: 1973-1995


    Michael Bordo Owen F. Humpage Anna Schwartz

    Abstract

    If official interventions convey private information useful for price discovery in foreign-exchange markets, then they should have value as a forecast of near-term exchange-rate movements. Using a set of standard criteria, we show that approximately 60 percent of all U.S. foreign-exchange interventions between 1973 and 1995 were successful in this sense. This percentage, however, is no better than random. U.S. intervention sales and purchases of foreign exchange were incapable of forecasting dollar appreciations or depreciations. U.S. interventions, however, were associated with more moderate dollar movements in a manner consistent with leaning against the wind, but only about 22 percent of all U.S. interventions conformed to this pattern. We also found that the larger the size of an intervention, the greater was its probability of success, although some interventions were inefficiently large. Other potential characteristics of intervention, notably coordination and secrecy, did not seem to influence our success rates. Read More

  • WP 11-17 | Indexed Debt Contracts and the Financial Accelerator


    Charles T. Carlstrom Timothy Fuerst Matthius Paustian

    Abstract

    This paper addresses the positive and normative implications of indexing risky debt to observable aggregate conditions. These issues are pursued within the context of the celebrated financial accelerator model of Bernanke, Gertler, and Gilchrist (1999). The principal conclusions are that the optimal degree of indexation is significant, and that the business cycle properties of the model are altered under this level of indexation. Read More

  • WP 11-16 | Public Policy in Support of Small Business: The American Experience


    Ben R. Craig William Jackson III James Thomson

    Abstract

    Information problems in small enterprise credit markets can result in a market equilibrium characterized by credit rationing. These information problems are potentially more severe during sharp economic downturns such as the recent Great Recession. Government interventions to alleviate credit constraints on small firms need to be designed to correct the specific market failure resulting in socially suboptimal credit flows. We argue that Small Business Administration loan guarantees are a potentially appropriate intervention and provide a review of empirical research that supports our contention. Read More

  • WP 11-15 | Beyond the Transaction: Depository Institutions and Reduced Mortgage Default for Low-Income Homebuyers


    O. Emre Ergungor Stephanie Moulton

    Abstract

    We evaluate the effects of the lending institution and soft information on mortgage loan performance for low-income homebuyers. We find that even after controlling for bank selection, those who receive a loan from a local bank are signifi cantly less likely to become delinquent or default than other bank or nonbank borrowers, suggesting an information effect. These effects are most pronounced for higher-risk borrowers, who likely benefit more from informational advantages of local banks. These findings support previous research on small business lending and provide additional explanation for observed differences in mortgage loan performance between bank and nonbank lenders. Read More

  • WP 11-14 | Banking Relationships and Sell-Side Research


    O. Emre Ergungor Leonardo Madureira Ajai Singh

    Abstract

    This paper examines disclosures by sell-side analysts when their institution has a lending relationship with the firms being covered. Lending-affiliated analysts’ earnings forecasts are found to be more accurate relative to forecasts by other analysts but this differential accuracy manifests itself only after the advent of the loan. Despite this increased earnings forecast accuracy, lending-affiliated analysts exhibit undue optimism in their brokerage recommendations and forecasts of long term growth. The optimism exists both before and after the lending commences. The evidence suggests that any insights into the covered firm via the lending relationship are employed by bank analysts in a selective manner. They appear unwilling to compromise on disclosures where ex post accuracy is clearly revealed, possibly to preserve their own personal reputation. However, they are overly optimistic on other disclosures where resolution is less readily verifiable, possibly to promote their lending client’s financial standing. Read More

  • WP 11-13 | On the Evolution of U.S. Foreign-Exchange-Market Intervention: Thesis, Theory, and Institutions


    Michael Bordo Owen F. Humpage Anna Schwartz

    Abstract

    Attitudes about foreign-exchange-market intervention in the United States evolved in tandem with views about monetary policy as policy makers grappled with the perennial problem of having more economic objectives than independent instruments with which to achieve them. This paper—the introductory chapter to our history of U.S. foreign exchange market intervention—explains this thesis and summarizes our conclusion: The Federal Reserve abandoned frequent foreign-exchange-market intervention because, rather than providing a solution to the instruments-versus-objectives problem, it interfered with the Federal Reserve’s ability to credibly commit to low and stable inflation. This chapter also provides a theoretical discussion of intervention, background on U.S. institutions for conducting intervention, and a roadmap to the remainder of our book. Read More

  • WP 11-12 | Bayesian VARs Specification Choices and Forecast Accuracy


    Andrea Carriero Todd E. Clark Massimiliano Marcellino

    Abstract

    In this paper we examine how the forecasting performance of Bayesian VARs is affected by a number of specification choices. In the baseline case, we use a Normal-Inverted Wishart prior that, when combined with a (pseudo-) iterated approach, makes the analytical computation of multi-step forecasts feasible and simple, in particular when using standard and fixed values for the tightness and the lag length. We then assess the role of the optimal choice of the tightness, of the lag length and of both; compare alternative approaches to multi-step forecasting (direct, iterated, and pseudo-iterated); discuss the treatment of the error variance and of cross-variable shrinkage; and address a set of additional issues, including the size of the VAR, modeling in levels or growth rates, and the extent of forecast bias induced by shrinkage. We obtain a large set of empirical results, but we can summarize them by saying that we find very small losses (and sometimes even gains) from the adoption of specification choices that make BVAR modeling quick and easy. This finding could therefore further enhance the diffusion of the BVAR as an econometric tool for a vast range of applications. Read More

  • WP 07-23R2 | The National Banking System: A Brief History


    Bruce Champ

    Original Paper: WP 07-23 | Revisions: WP 07-23R

    Abstract

    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 appear in the Federal Reserve Bank of Cleveland’s working paper series as working paper 07-19R and working paper 07-22R. Read More

  • WP 07-22R2 | The National Banking System: The National Bank Note Puzzle


    Bruce Champ

    Original Paper: WP 07-22 | Revisions: WP 07-22R

    Abstract

    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 appear in the Federal Reserve Bank of Cleveland’s working paper series as working paper 07-19R and working paper 07-23R. Read More

  • WP 07-19R2 | The National Banking System: Empirical Observations


    Bruce Champ

    Original Paper: WP 07-19 | Revisions: WP 07-19R

    Abstract

    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 appear in the Federal Reserve Bank of Cleveland’s working paper series as working paper 07-22R2 and working paper 07-23R2. Read More

  • WP 11-11 | Search Frictions and the Labor Wedge


    Andrea Pescatori Murat Tasci

    Revisions: WP 11-11R

    Abstract

    We show that search frictions embedded in an RBC model primarily manifest themselves at the extensive margin. The ability to distinguish between the intensive and extensive margins, however, affects the measurement of the marginal rate of substitution (MRS). In fact, the correct measurement of the MRS, interms of hours per worker, implies a less variable and procyclical labor wedge than the one found in Chari et al. (2007), especially at low Frisch elasticity. Themain result is very robust to alternative wage determination mechanisms, even though implications for employment fluctuations may differ. Read More

  • WP 11-10 | Prioritization in Private-Activity-Bond Volume Cap Allocation


    Stephan D. Whitaker

    Abstract

    This paper proposes and tests a structural model reflecting the process of authorizing private-activity municipal bond issuance. Private-activity municipal bonds offer tax-exempt financing for programs including industrial development, utilities, low-income housing, and student loans. The Federal tax code sets annual caps on the total tax-exempt issuance within each state, so authorization becomes a scarce resource distributed via a political process. Interviews with program administrators in several states suggested the authorization process involves prioritizing categories of use, authorizing bonds for high-priority uses first, and then authorizing bonds for lower-priority uses until the cap is exhausted. A model representing this process suggests variables to include in reduced-form estimations and an alternative interpretation of the coefficients. The fit of the model can be improved by adding measures of political influence and imposing a structure that reflects the political prioritization process. Read More

  • WP 11-09 | False Security How Securitization Failed to Protect Arrangers and Investors from Borrower Claims


    Kathleen Engel Thomas J. Fitzpatrick IV

    Abstract

    The future of housing finance is in a state of flux. In February 2011, the Obama Administration released a proposal outlining three plans for the future of housing finance. In all three plans, Freddie Mac and Fannie Mae will be phased out over a period of years and replaced with a private securitization market, which may be backed, in whole or in part, by a government guarantee. Whether the fi al plan relies upon government-guaranteed securities or private-label securities, Congress will have to resolve a range of complex legal aspects of securitization, from the bankruptcy remoteness of pools of securities to setting national standards for loans and financing. One issue that does not appear to be getting much attention is the potential liability of the parties to a securitization for the unlawful actions of loan originators. In this paper, the authors take the position that any new housing finance system must clarify the liability of participants in the securitization pipeline so that the market can more accurately price securities up front and create incentives for more effective compliance programs to stop problem loans from entering the pipeline. Read More

  • WP 11-08 | US Intervention during the Bretton Woods Era: 1962-1973


    Michael Bordo Owen F. Humpage Anna Schwartz

    Abstract

    By the early 1960s, outstanding U.S. dollar liabilities began to exceed the U.S. gold stock, suggesting that the United States could not completely maintain its pledge to convert dollars into gold at the official price. This raised uncertainty about the Bretton Woods parity grid, and speculation seemed to grow. In response, the Federal Reserve instituted a series of swap lines to provide central banks with cover for unwanted, but temporary accumulations of dollars and to provide foreign central banks with dollar funds to finance their own interventions. The Treasury also began intervening in the market. The operations often forestalled gold losses, but in so doing, delayed the need to solve Bretton Woods’ fundamental underlying problems. In addition, the institutional arrangements forged between the Federal Reserve and the U.S. Treasury raised important questions bearing on Federal Reserve independence. Read More

  • WP 11-07 | Inflation Expectations, Real Rates, and Risk Premia: Evidence from Inflation Swaps


    Joseph G. Haubrich George Pennacchi Peter Ritchken

    Abstract

    This paper develops a model of the term structures of nominal and real interest rates driven by state variables representing the short-term real interest rate, expected inflation, inflation’s central tendency, and four volatility factors that follow GARCH processes. We derive analytical solutions for nominal bond yields, yields on inflation-indexed bonds that have an indexation lag, and the term structure of expected inflation. Unlike prior studies, the model’s parameters are estimated using data on inflation swap rates, as well as nominal yields and survey forecasts of inflation. The volatility state variables fully determine bonds’ time varying risk premia and allow for stochastic volatility and correlation between bond yields, yet they have small effects on the cross section of nominal yields. Allowing for time-varying volatility is particularly important for real interest rate and expected inflation processes, but long-horizon real and inflation risk premia are relatively stable. Read More

  • WP 11-06 | The Demand for Income Tax Progressivity in the Growth Model


    Daniel R. Carroll

    Abstract

    This paper examines the degree of income tax progressivity chosen through a simple majority vote in a model with savings. Households have permanent differences with respect to their labor productivity and their discount factors. The government has limited commitment to future policy so voting is repeated every period. Because the model features mobility within the wealth distribution, the median voter is determined endogenously. In a numerical experiment, the model is initialized to the 1992 U.S. joint distribution of income and wealth as well as several statistics of the federal income tax distribution. Support for a high degree of progressivity is widespread. In the long run, households that vote for lower progressivity have high labor productivity and/or very high wealth. A movement towards greater progressivity decreases aggregate capital and income as well as long-run income and wealth inequality. Read More

  • WP 10-21R | Homeownership for the Long Run: An Analysis of Homeowner Subsidies


    O. Emre Ergungor

    Original Paper: WP 10-21

    Abstract

    This paper examines the impact of interest-rate and down-payment subsidies on default rates and losses given default, and finds that down-payment subsidies create successful homeowners at a lower cost than interest-rate subsidies. Read More

  • WP 11-05 | Liquidity in Frictional Asset Markets


    Guillaume Rocheteau Pierre-Olivier Weill

    Abstract

    On November 14–15, 2008, the Federal Reserve Bank of Cleveland hosted a conference on “Liquidity in Frictional Asset Markets.” In this paper we review the literature on asset markets with trading frictions in both finance and monetary theory using a simple search-theoretic model, and we discuss the papers presented at the conference in the context of this literature. We will show the diversity of topics covered in this literature, e.g., the dynamics of housing and credit markets, the functioning of payment systems, optimal monetary policy and the cost of inflation, the role of banks, and the effect of informational frictions on asset trading. Read More

  • WP 11-04 | On the Coexistence of Money and Higher-Return Assets and its Social Role


    Guillaume Rocheteau

    Abstract

    This paper adopts mechanism design to tackle the central issue in monetary theory, namely, the coexistence of money and higher-return assets. I describe an economy with pairwise meetings, where fiat money and risk-free capital compete as means of payment. Whenever fiat money has an essential role, any constrained-efficient allocation is such that capital commands a higher rate of return than fiat money. Read More

  • WP 11-03 | The Cost of Inflation: A Mechanism Design Approach


    Guillaume Rocheteau

    Abstract

    I apply mechanism design to quantify the cost of inflation that can be attributed to monetary frictions alone. In an environment with pairwise meetings, the money demand that is consistent with a constrained-efficient allocation takes the form of a continuous correspondence that can fit the data over the period 1900-2006. For such parameterizations, the cost of moderate inflation is zero. This result is robust to different assumptions regarding the observability of money holdings, the introduction of match-specific heterogeneity, and endogeneous participation decisions. Read More

  • WP 11-02 | Disadvantaged Business Enterprise Goals in Government Procurement Contracting: An Analysis of Bidding Behavior and Costs


    William Dewald Timothy Dunne Georgia Kosmopoulou Carlos Lamarche

    Abstract

    Programs that encourage the participation of disadvantaged business enterprises (DBE) as subcontractors have been a part of government procurement auctions for over three decades. In this paper, we examine the impact of a program that requires prime contractors to subcontract out a portion of a highway procurement project to DBE firms. We study how DBE subcontracting requirements affect bidding behavior in federally funded projects. Within a symmetric independent private value framework, we use the equilibrium bidding function to obtain the cost distribution of firms undertaking projects either with or without subcontracting goals. We then use nonparametric estimation methods to uncover and compare the cost of firms bidding on a class of asphalt projects related to surface treatment in Texas. The analysis shows little differences in the cost structure between auctions that have subcontracting goals and those that do not. Read More

  • WP 11-01 | Assessing the Evidence on Neighborhood Effects from Moving to Opportunity


    Dionissi Aliprantis

    Revisions: WP 12-33R

    Abstract

    The interpretation of estimates from Moving to Opportunity (MTO) as neighborhood effects has created significant controversy among social scientists. This paper presents a framework that clarifies the interpretation of results from the MTO housing mobility experiment. The paper defi nes several neighborhood treatments and estimates their Local Average Treatment Effects (LATEs) using assigned treatment in MTO as an instrumental variable. This framework clarifies that while parameters estimated in the literature do not suffer from selection bias, selection into treatment is an inescapable issue if one seeks to learn about neighborhood effects from MTO. The LATE parameters estimated in this paper are neighborhood effects for the subgroup of MTO families who are compliers with respect to the defined treatment. In contrast, the Treatment-on-the-Treated (TOT) parameters reported in the literature are program effects. Read More

  • WP 10-17R | The Ins and Outs of Unemployment in the Long Run: A New Estimate for the Natural Rate?


    Murat Tasci

    Original Paper: WP 10-17

    Abstract

    In this paper, we present a simple, reduced-form model of comovements in real activity and worker fl ows and use it to uncover the trend changes in these flows, which determine the trend in the unemployment rate. We argue that this trend rate has several key features that are reminiscent of a “natural rate.” We show that the natural rate, measured this way, has been relatively stable in the last decade, even after the most recent recession. This was due to two opposing trend changes: On the one hand, the trend in the job-finding rate, after being relatively stable for decades, declined by a significant margin after 2000, pushing trend unemployment up. But the trend in the separation rate has somewhat offset that effect, with a continued secular decline since the early 1980s. We also show that, contrary to the business-cycle movements of the unemployment rate, most of the low-frequency variation in the rate can be accounted for by changes in the trend of the separation rate, not the job-finding rate. Read More