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2002 Working Papers

  • WP 02-15 | Do Energy-Price Shocks Affect Core-Price Measures?

    Owen F. Humpage Eduard Pelz


    This paper investigates the relationship between energy-price shocks and three core measures of inflation in a vector autoregression model that incorporates measures of monetary policy and inflation expectations. The sample set includes data at monthly frequencies from 1980 through 2000. We find that that positive energy-price shocks have significant, though small, effects on all core price measures after a lag of 12 to 18 months, but that negative shocks have no discernable impact. The results suggest that relative energy-price changes do not distort the inflation signals that standard core-price measures provide. Read More

  • WP 02-14 | Getting the Most Out of a Mandatory Subordinated Debt Requirement

    Rong Fan Joseph G. Haubrich Peter Ritchken James Thomson


    Recent advances in asset pricing—the reduced-form approach to pricing risky debt and derivatives—are used to quantitatively evaluate several proposals for mandatory bank issue of subordinated debt. We find that credit spreads on both fixed and floating rate subordinated debt provide relatively clean signals of bank risk and are not unduly influenced by non-risk factors. Fixed rate debt with a put is unacceptable, but making the putable debt floating resolves most problems. Our approach also helps to clarify several different notions of "bank risk". Read More

  • WP 02-13 | Scope and Scale Economies in Federal Reserve Payment Processing

    Robert Adams Paul Bauer Robin Sickles


    In the past decade, the U.S. economy has witnessed a tremendous surge in the usage of electronic payment processing services and an increased importance of the firms that provide these services. The payments industry has also undergone changes in cost structure with the introduction of new technology. Unfortunately, data on the private provision of payment processing services are not available. However, the Federal Reserve provides similar services and collects data on its own provision of payments processing, offering an opportunity to gain insights into the cost structure of payments processing. In this paper, we estimate the scope and scale economies and the technical change in the Federal Reserve's provision of payments processing from 1990-2000. We find considerable scale economies and evidence of some scope economies for the provision of automated clearinghouse, fedwire, and book-entry services no matter whether we specify a separable quadratic or a translog cost function. In addition, we find that disembodied technical change also attributed to the overall reduction in costs through the 1990s. Read More

  • WP 02-12 | Life Cycle Wage and Job Changes

    Ed Nosal Peter Rupert


    Evidence from the Panel Study of Income Dynamics shows that while the majority of job changers who state they were not fired or laid off choose jobs with wages that are higher than their previous jobs, a substantial proportion of these job changers choose jobs that have lower wages. A model is constructed that is consistent with workers choosing a career path that entails a job change to either a higher paying or lower paying job. In the model, a job consists of a tied wage and amenity package. Due to compensating wage differentials, higher wages are paid where other job amenities are unattractive. Given this, a worker chooses a career path that leads to a job change where the wage in the new job may be higher or lower than in the previous job, with the actual choice being determined by the rate of time preference. Read More

  • WP 02-11 | A Unified Framework for Monetary Theory And Policy Analysis

    Ricardo Lagos Randall Wright


    Search-theoretic models of monetary exchange are based on explicit description of the frictions that make money essential. However, tractable versions usually have strong assumptions that make them ill-suited for discussing some policy questions, especially those concerning changes in the money supply. Hence most policy analysis uses reduced-form models. We propose a framework that attempts to bridge this gap: it is based explicitly on microeconomic frictions, but allows for interesting macroeconomic policy analyses. At the same time, the model is analytically tractable and amenable to quantitative analysis. Read More

  • WP 02-10 | Dynamics, Cycles and Sunspot Equilibria in “Genuinely Dynamic, Fundamentally Disaggregative” Models of Money

    Ricardo Lagos Randall Wright


    This paper pursues a line of Cass and Shell, who advocate monetary models that are "genuinely dynamic and fundamentally disaggregative" and incorporate "diversity among households and variety among commodities." Recent search-theoretic models fit this description. We show that, like overlapping generations models, search models generate interesting dynamic equilibria, including cycles, chaos, and sunspot equilibria. This helps us understand how alternative models are related, and lends support to the notion that endogenous dynamics and uncertainty matter, perhaps especially in monetary economies. We also suggest such equilibria in search models may be more empirically relevant than in some other models. Read More

  • WP 02-09 | Price Setting, Price Dispersion, and the Value of Money — Or — The Law of Two Prices

    Elisabeth Curtis Randall Wright


    We study models that combine search, monetary exchange, price posting by sellers, and buyers with preferences that differ across random meetings - say, because sellers in different meetings produce different varieties of the same good. We show how these features interact to influence the price level (i.e., the value of money) and price dispersion. First, price-posting equilibria exist with valued fiat currency, which is not true in the standard model. Second, although both are possible, price dispersion is more common than a single price. Third, perhaps surprisingly, we prove generically there cannot be more than two prices in equilibrium. Read More

  • WP 02-08 | Search, Money and Capital: A Neoclassical Dichotomy

    S. Borağan Aruoba Randall Wright


    Recent work has reduced the gap between search-based monetary theory and mainstream macroeconomics by incorporating into the search model some centralized markets as well as some decentralized markets where money is essential. This paper takes a further step towards this integration by introducing labor, capital and neoclassical firms. The resulting framework nests the search-theoretic monetary model and a standard neoclassical growth model as special cases. Perhaps surprisingly, it also exhibits a dichotomy: one can determine the equilibrium path for the value of money independently of the paths of consumption, investment and employment in the centralized market. Read More

  • WP 02-07 | A Simple Search Model of Money with Heterogeneous Agents and Partial Acceptability

    Andrei Shevchenko Randall Wright


    Simple search models have equilibria where some agents accept money and others do not. We argue such equilibria should not be taken seriously - which is unfortunate if one wants a model with partial acceptability. We introduce heterogeneous agents and show partial acceptability arises naturally. There can be multiple equilibria with different degrees of acceptability. Given the type of heterogeneity we allow, the model is still simple: equilibria reduce to fixed points in [0,1]. We show that with other forms of heterogeneity, equilibria are generally fixed points in set space, and there exists no method to reduce this to a problem in R1. Read More

  • WP 02-06 | Does It Pay to Work?

    Jagadeesh Gokhale Laurence Kotlikoff Alexi Sluchynsky


    Does it pay to work? This is a tough question to answer because of the complexity of the tax code and a plethora of dynamic linkages involved. First, earning more today typically alters current saving and, therefore, future capital income taxes. Second, earning more today generally alters future consumption and, therefore, future consumption taxes. Third, changing future levels of income and assets changes the eligibility for and levels received of income- and asset-tested transfer benefits. Fourth, the most important transfer program, Social Security, explicitly links future transfer payments to current earnings. Fifth, income taxes in retirement depend on past earnings because Social Security benefits depend on past earnings and these benefits are subject to federal income taxation. This paper attempts to capture the net effective tax on work by using an intertemporal model capable of carefully determining tax and transfer payments at each stage of the life cycle. Read More

  • WP 02-05 | Imperfect Capital Markets and Nominal Wage Rigidities

    Charles T. Carlstrom Timothy Fuerst


    Should monetary policy respond to asset prices? This paper analyzes a general equilibrium model with imperfect capital markets and rigid nominal wages. Within the context of this model, there is a natural role for the benevolent central bank to dampen the real effects of asset price movements. Read More

  • WP 02-04 | Monetary Policy in a Financial Crisis

    Lawrence Christiano Christopher Gust Jorge Roldos


    What are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis? Under what conditions will a cut stimulate output and employment, and raise welfare? Under what conditions will a cut have the opposite effects? We answer these questions in a general class of open economy models, where a financial crisis is modeled as a time when collateral constraints are suddenly binding. We find that when there are frictions in adjusting the level of output in the traded good sector and in adjusting the rate at which that output can be used in other parts of the economy, then a cut in the interest rate is most likely to result in a welfare-reducing fall in output and employment. When these frictions are absent, a cut in the interest rate improves asset positions and promotes a welfare-increasing economic expansion. Read More

  • WP 02-03 | Community Banks as Small Business Lenders: The Tough Road Ahead

    O. Emre Ergungor


    This paper investigates the performance of community banks as small business (relationship) lenders. Theory suggests that competition reduces the benefits of bank-borrower relationships, making small business loans more risky and less profitable. In support of this theory, the evidence indicates that community banks' performance deteriorates with increasing small business lending. Policies that encourage community banks to engage in more aggressive small business lending may lessen the soundness of these institutions. Read More

  • WP 02-02 | Does It Matter (for Equilibrium Determinacy) What Price Index the Central Bank Targets?

    Charles T. Carlstrom


    What inflation rate should the central bank target? We address determinacy issues related to this question in a two-sector model in which prices can differ in equilibrium. We assume that the degree of nominal price stickiness can vary across the sectors and that labor is immobile. The contribution of this paper is to demonstrate that a modified Taylor Principle holds in this environment. If the central bank elects to target sector one, and if it responds with a coefficient greater than unity to price movements in this sector, then this policy rule will ensure determinacy across all sectors. The results of this paper have at least two implications. First, the equilibrium-determinacy criterion does not imply a preference to any particular measure of inflation. Second, since the Taylor Principle applies at the sectoral level, there is no need for a Taylor Principle at the aggregate level. Read More

  • WP 01-01R | Market- vs. Bank-Based Financial Systems: Do Investor Rights Really Matter?

    O. Emre Ergungor

    Original Paper: WP 01-01


    Why are common-law countries market-dominated and civil-law countries bank-dominated? This paper provides an explanation tied to legal traditions. Civil-law courts have been less effective in resolving conflicts than common-law courts because civil-law judges traditionally refrain from interpreting the codes and creating new rules. In a civil-law environment, where potential conflicts between borrowers and individual lenders inhibit the development of markets because the courts are unable to penalize defrauding borrowers, I show that banks can induce borrowers to honor their obligations by threatening to withhold services that only banks can provide. In other words, banks emerge as the primary contract enforcers in economies where courts are imperfect. Read More

  • WP 02-01 | The Mismatch Between Life Insurance Holdings and Financial Vulnerabilities: Evidence from the Survey of Consumer Finances

    Douglas Bernheim Katherine Carman Jagadeesh Gokhale Laurence Kotlikoff


    Using the 1995 Survey of Consumer Finances and an elaborate lifecycle model, we quantify the potential financial impact of each individual's death on his or her survivors, and we measure the degree to which life insurance moderates these consequences. Life insurance is essentially uncorrelated with financial vulnerability at every stage of the life cycle. As a result, the impact of insurance among at-risk households is modest, and substantial uninsured vulnerabilities are widespread, particularly among younger couples. Roughly two-thirds of poverty among surviving women and more than one-third of poverty among surviving men results from a failure to insure survivors against a diminished living standard. We also identify a systematic gender bias: for any given level of financial vulnerability, couples provide significantly more protection for wives than for husbands. Read More