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1995 Working Papers

  • WP 95-20 | Sectoral Wage Convergence: A Nonparametric Distributional Analysis


    Mark E. Schweitzer Max Dupuy

    Abstract

    The large shift of U.S. employment from goods producers to service producers has generated concern over future income distribution because of perceived large relative pay differences. This paper applies a density overlap statistic to compare the sectors' distribution of weekly wages at all wage levels. A simple refinement yields locational information by decile. To counter problematic features of Current Population Survey data--namely, sampling variation at infrequent wage rates and extensive rounding at common wage rates--we employ nonparametric density-estimation procedures to isolate the underlying shapes of the densities. The validity and accuracy of the estimation procedures are evaluated with simulations designed to fit the dataset. Bootstrapped standard errors and confidence intervals are calculated to indicate the statistical significance of the results. Read More

  • WP 95-19 | Does Means-Testing Welfare Discourage Saving? Evidence from the National Longitudinal Survey of Women


    Elizabeth Powers

    Abstract

    This paper empirically tests whether the asset limit associated with the Aid to Families with Dependent Children (AFDC) program discourages wealth accumulation by actual and prospective participants. Prior to 1981, the AFDC asset test varied substantially across states, and this variation can be used to identify the effect of the limit on wealth. Wealth holdings for female-headed households (the primary recipient group for AFDC) for 1978 are estimated using data from the National Longitudinal Survey of Women. A $1 difference in state limits results in an estimated $.50 difference in total net wealth holdings of female-headed households in different states. This qualitative finding of a significantly positive effect is reasonably robust with respect to a variety of specifications of the wealth equation and instrumenting of the limit to correct for the potential endogeneity of policy. After instrumenting, a $1 difference in limits implies a difference in potential AFDC recipients' wealth holdings of $.30. Read More

  • WP 95-18 | Understanding the Postwar Decline in United States Saving: A Cohort Analysis


    Jagadeesh Gokhale Laurence Kotlikoff John Sabelhaus

    Abstract

    The rate of saving in the, United States has declined dramatically in recent decades. Since 1980, the U.S. net national saving rate has averaged just 4 percent. Since 1990, it has averaged just 2.4 percent-one-quarter the mean rate observed in the 1950s and 60s. This paper develops a unique cohort data set to study the decline in U.S. national saving. It decomposes postwar changes in U.S. saving into those due to changes in cohort-specific consumption propensities, those due to changes in the intergenerational distribution of resources, those due to changes in the rate of government consumption, and those due to demographic changes. Read More

  • WP 95-17 | Some Monte Carlo Results on Nonparametric Changepoint Tests


    Edward Bryden John Carlson Ben R. Craig

    Abstract

    For long periods since 1982, core inflation has behaved as if it were generated by a process with a fixed mean and serially independent error term. Nonparametric changepoint tests proposed by Pettitt (1979) and Lombard (1987) suggest that since 1982, changes in core inflation have been infrequent and rather abrupt. However, little is known about the small-sample properties, the power of the tests, or the robustness of changepoint tests when a series is not i.i.d. This paper uses Monte Carlo analysis to investigate the probabilities of false positive tests under alternative assumptions about the time-series properties of the underlying process. Read More

  • WP 95-16 | Fertility and Welfare Participation


    Elizabeth Powers

    Abstract

    Despite the attention that the fertility of welfare recipients has received recently, surprisingly little is known about it. This paper answers some basic questions about the phenomenon of welfare births. Among the findings from the March 1987 Current Population Survey are that 13.4 percent of all births are into the 7.3 percent of families receiving Aid to Families with Dependent Children (AFDC) and that (unadjusted) fertility rates of welfare recipients exceed those of other groups. Using data from the National Longitudinal Survey of Youth, I find that nearly 60 percent of women who use AFDC in one or more years of the sample period have at least one "AFDC birth." I do not find prima facie evidence supporting the notions that women use AFDC to begin families earlier and that mothers use AFDC to realize their desires for large families. Read More

  • WP 95-15 | Bank Capital and Equity Investment Regulations


    João dos Santos

    Abstract

    This paper uses an intermediation model to study the efficiency and welfare implications of both banks' required capital-asset ratio and the regulation that limits, and in some countries forbids, banks' investments in equity to a certain proportion of each firm's capital. There are two sources of moral hazard in the model: one between the bank and the provider of deposit insurance, and the other between the bank and the entrepreneur who demands funds to finance an investment project. Among other things, the paper shows that capital regulation irnproves the bank's stability and can also be Pareto-improving. Equity regulation is never Pareto-improving and does not increase the bank's stability. Read More

  • WP 95-14 | Defining the Monetary Base in a Deregulated Financial System


    Edward Stevens

    Abstract

    The monetary base typically is defined as a measure of the money-supply "impulse" originating from the stock of high-powered, central-bank money. In addition to nonbanks' demand for hand-to-hand currency, banks have demanded base money in the United States since 1913 to satisfy two needs. One is a reserve need, to fulfill a Federal Reserve regulatory requirement. The other is an operational need, to protect against teller shortages of coin and currency and against daylight and overnight overdrafts of banks' accounts at Reserve Banks. As the level of reserve requirements declines, the aggregate demand for base money originating from banks reflects reserve requirements less and less, and reflects operating needs more and more. Moreover, the adjusted measure of the monetary base, combining the quantity of base money with an adjustment for changes in reserve requirements, becomes unreliable. It includes adjustments for banks that are, in fact, unaffected by changes in reserve requirements. Read More

  • WP 95-13 | A Note on Absolute Priority Rule Violations, Credit Rationing, and Efficiency


    Stanley Longhofer

    Abstract

    Violations of the absolute priority rule (APR) are commonplace in private workouts, formal business reorganizations, and personal bankruptcies. While some theorists suggest that these might arise endogenously, they are clearly magnified by the institutional structure of the bankruptcy code. This paper shows that APR violations exacerbate credit rationing problems by reducing the payment lenders receive in default states. Furthermore, APR violations make default more likely, raising the interest rate that firms must pay when borrowing. Both of these problems arise even when APR violations have no impact on the borrower's incentive to undertake risk-shifting behavior. Read More

  • WP 95-12 | The Role of Warrants in Corporate Reorganizations


    Stanley Longhofer

    Abstract

    That a firm's initial equityholders often emerge from Chapter 11 bankruptcy proceedings with more value than the absolute priority rule would suggest is now a generally accepted fact. The form in which this value is distributed, however, is less well understood. In particular, why do the original shareholders of some firms emerge from Chapter 11 bankruptcy with stock in the reorganized firm, while others receive warrants? This essay proposes that informational asymmetries provide the answer to this question. By proposing a reorganization plan in which they receive warrants, the original stockholders of a firm with good future prospects can signal their superior information to the creditors in a way that firms with poor prospects will not wish to mimic. Read More

  • WP 95-11 | Voting on Social Security: Evidence from OECD Countries


    Friedrich Breyer Ben R. Craig

    Abstract

    This article tests the subset of public choice models for social security that have empirical implications. The data, collected from OECD countries for the years 1960, 1970, 1980, and 1990, provide some support for each of the theories. Higher median voter age, more income heterogeneity, greater similarity in family size, and variables that make a public pension program more profitable are all associated with a larger program. However, none of the theories explains why the shape of the age distribution and the time trend are so important. The results are robust under both fixed-effects and random-effects estimation. Read More

  • WP 95-10 | Optimal Taxation of Capital Income in a Growth Model with Monopoly Profits


    Jang-Ting Guo Kevin Lansing

    Abstract

    This paper shows that the optimal steady-state tax on capital income in a neoclassical growth model can be positive, negative, or zero, depending crucially on the level of monopoly profits and the degree to which profits can be taxed. With an empirically plausible level of profits, the model implies that the optimal steady-state tax on capital can range between -6 percent and 24 percent, depending on the structure of dividend taxation. Similarly, we find that the available welfare gain of switching from the existing U.S. tax policy to a revenue-neutral optimal tax policy can range between 0.8 percent and 3.9 percent of steady-state output. Read More

  • WP 95-09 | Optimal Fiscal Policy, Public Capital, and the Productivity Slowdown


    Steven Cassou Kevin Lansing

    Abstract

    This paper develops a quantitative theoretical model for the optimal provision of public capital. We show that the ratio of public to private capital in the U.S. economy from 1925 to 1992 evolves in a manner that is generally consistent with an optimal transition path derived from the model. The model is also used to quantify the conditions under which an increase in the stock of public capital is desirable and to investigate the effects of hypothetical nonoptimal fiscal policies on productivity growth. Read More

  • WP 95-08 | Marginal Tax Rates and Income Inequality: A Quantitative-Theoretic Analysis


    David Altig Charles T. Carlstrom

    Abstract

    In this paper, we employ a quantified general equilibrium model to study the effects of changes in marginal income-tax rate structures on the distribution of income. Our approach builds on recent efforts by Fullerton and Rogers (1 993) in extending the well-known work of Auerbach and Kotlikoff (1987) to allow for many different cohort types, and hence a nontrivial endogenous distribution of income. In addition, we utilize (and describe) a solution algorithm that allows us to study the distributional consequences of distortions on labor and consumption arising from actual discrete rate structures taken from the U.S. tax code. Read More

  • WP 95-07 | Optimal Fiscal Policy when Public Capital is Productive: A Business Cycle Perspective


    Kevin Lansing

    Abstract

    This paper develops a dynamic general-equilibrium model with productive public capital to help account for differences in the business cycle characteristics of public- versus private-sector expenditures in postwar U.S. data. A specification that allows for multiple stochastic shocks (to technology and depreciation rates) can reproduce a number of features describing the cyclical behavior of U.S. public investment and public consumption as well as other fiscal variables, such as average marginal tax rates and the government debt-to-output ratio. The model also delivers reasonable predictions for the behavior of private-sector aggregates. It is less successful, however, in capturing the large variability of public consumption expenditures in U.S. data, and it overpredicts the variability of the capital tax relative to the labor tax. Read More

  • WP 95-05 | Debt and Equity as Optimal Contracts


    João dos Santos

    Abstract

    The model presented in this paper is a particular case of the principal-agent problem. An entrepreneur has an investment project whose returns depend on his effort, which is not observable by the financier. After determining the optimal contract that is used to finance such a project, I show that this contract can be replicated by a unique combination of debt and equity, which proves the op optimality of these financial instruments. Read More

  • WP 95-04 | Interest Rate Rules vs. Money Growth Rules: A Welfare Comparison in a Cash-In-Advance Economy


    Charles T. Carlstrom Timothy Fuerst

    Abstract

    This paper considers the welfare consequences of two particularly simple rules for monetary policy: an interest rate peg and a money growth peg. The model economy consists of a real side that is the standard real business cycle model, and a monetary side that amounts to imposing cash-in-advance constraints on certain market transactions.The paper also considers the effect of assuming a rigidity in the typical household's cash savings choice. The competitive equilibrium of the economy is not Pareto efficient, partly because of two intertemporal distortions: a distortion on the capital accumulation decision, and a distortion on portfolio choice that arises from the assumed rigidity. The principal result of the paper is that the interest rate rule (but not the money growth rule) entirely eliminates these two intertemporal distortions and is thus the benevolent central banker's policy choice. Read More

  • WP 95-03 | Computable General-Equilibrium Models and Monetary Policy Advice


    David Altig Charles T. Carlstrom Kevin Lansing

    Abstract

    This paper argues that variations of extant general-equilibrium monetary models are capable of generating real-time economic forecasts comparable in accuracy to those generated under the, standard Federal Reserve Board staff methodology. Specifically, we argue that over the 1984-1990 period, forecasts generated by versions of the "limited participation" models developed by Fuerst (1992) and Christian0 and Eichenbaum (1992a, 1992b) compare favorably with those contained in the Board staff's "Greenbook" briefing documents. We conclude that further development of these models holds promise for fully integrating the forecasting and policy analysis elements of the Federal Reserve's monetary policy advice process. Read More

  • WP 95-01 | More on the Differences between Reported and Actual U.S. Central Bank Foreign Exchange Intervention


    William Osterberg Rebecca Wetmore-Humes

    Abstract

    It is unclear whether the distinction between U.S. foreign exchange intervention and newspaper reports of such activity is important. Dominguez and Frankel (1993) argue that unreported intervention has a weaker impact on the market. In this paper, we ask the empirical question: If intervention is reported (was actual), does it matter whether it occurred (was reported)? For a subsample for both the yen-to-dollar and Deutschemark-todollar exchange rates, we reject the hypothesis that the impact of intervention on the variance does not depend on whether it was reported. We also find that the sign of the impact depends on whether the intervention was reported. In addition, we uncover some evidence for impacts of false reports of intervention. We suggest that remaining concerns about these distinctions should be focused on the market microstructure surrounding the actual intervention operations. Read More

  • WP 95-06 | Imperfect State Verification and Financial Contracting


    Joseph G. Haubrich

    Abstract

    Standard work on costly state verification, monitoring, and auditing generally assumes perfect signals about the underlying state, especially in questions about financial contracting. Relaxing that assumption has several intriguing consequences. Most imperfect audits turn out to be useless, and those that are useful cannot be ranked by conventional criteria such as Blackwell's information measure. Thus, the notion of "more" or "less" information becomes problematic. Read More

  • WP 95-02 | The Changing Role of Banks and the Changing Value of Deposit Guarantees


    Abstract

    This article develops a model for pricing deposit guarantees. The model treats the bank's investments as a portfolio of default-free bonds and risky loans. The risk of the loans is determined by individual firms' financing and investment decisions. Pushing back risk to the level of the borrowing firms allows us to link deposit guarantees to specific characteristics of these loans, such as their durations, and to correlations between business risk and interest rates. Since the nature of bank loans has been changing over time, our model should predict the accompanying change in value of the government guarantees. Read More