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Working Papers

Working Papers

  • WP 18-15 | Understanding the Aspects of Federal Reserve Forward Guidance

    Kurt G. Lunsford


    This paper studies the effects of Federal Open Market Committee (FOMC) forward guidance language. I estimate two policy surprises at FOMC meetings: a change in the current federal funds rate and an orthogonal change in the expected path of the federal funds rate. From February 2000 to June 2003, the FOMC only gave forward guidance about risks to the economic outlook, and a surprise increase in the expected federal funds rate path had expansionary effects. This is consistent with models of central bank information effects, where a positive economic outlook causes private agents to revise up their expectations for the economy. From August 2003 to May 2006, the FOMC also gave forward guidance about policy inclinations, and a surprise increase in the federal funds rate path had contractionary effects. These results are consistent with standard macroeconomic models of forward guidance. Overall, the effects of forward guidance depend on the FOMC’s choice to use one or both of the economic-outlook and policy-inclination aspects of forward guidance.   Read More

  • WP 18-14 | All Fluctuations Are Not Created Equal: The Differential Roles of Transitory versus Persistent Changes in Driving Historical Monetary Policy

    Richard Ashley Kwok Ping Tsang Randal J. Verbrugge


    The historical analysis of FOMC behavior using estimated simple policy rules requires the specification of either an estimated natural rate of unemployment or an output gap. But in the 1970s, neither output gap nor natural rate estimates appear to guide FOMC deliberations. This paper uses the data to identify the particular implicit unemployment rate gap (if any) that is consistent with FOMC behavior. While its ability appears to have improved over time, our results indicate that, both before the Volcker period and through the Bernanke period, the FOMC distinguished persistent movements in the unemployment rate from other movements; implicitly such movements were treated as an intermediate target, one that departs substantially from conventional estimates of the natural rate. We further investigate historical FOMC responses to inflation fluctuations. In this regard, FOMC behavior changed in the Volcker-Greenspan-Bernanke period: its response to the inflation rate became much stronger, and it focused more intensely on very persistent movements in this variable. Our results shed light on the “Great Inflation” experience of the 1970s, and are consistent with the view that political pressures effectively limited the FOMC response to the buildup of inflation. They also suggest new directions for DSGE modeling.   Read More

  • WP 18-12 | Inflation, Debt, and Default

    Sewon Hur Illenin Kondo Fabrizio Perri


    We study how the co-movement of inflation and economic activity affects real interest rates and the likelihood of debt crises. First, we show that for advanced economies, periods with procyclical inflation are associated with lower real interest rates. Procyclical inflation implies that nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. However, such procyclicality also increases sovereign default risk when the economy deteriorates, since the government needs to make larger (real) payments. In order to evaluate both effects, we develop a model of sovereign default on domestic nominal debt with exogenous inflation risk and domestic risk-averse lenders. Countercyclical inflation is a substitute with default, while procyclical inflation is a complement with it, by increasing default incentives. In good times, when default is unlikely, procyclical inflation yields lower real rates. In bad times, as default becomes more material, procyclical inflation can magnify default risk and trigger an increase in real rates.   Read More

  • WP 18-13 | A Closer Look at the Behavior of Uncertainty and Disagreement: Micro Evidence from the Euro Area

    Robert Rich Joseph Tracy


    This paper examines point and density forecasts of real GDP growth, inflation and unemployment from the European Central Bank’s Survey of Professional Forecasters. We present individual uncertainty measures and introduce individual point- and density-based measures of disagreement. The data indicate substantial heterogeneity and persistence in respondents’ uncertainty and disagreement, with uncertainty associated with prominent respondent effects and disagreement associated with prominent time effects. We also examine the co-movement between uncertainty and disagreement and find an economically insignificant relationship that is robust to changes in the volatility of the forecasting environment. This provides further evidence that disagreement is not a reliable proxy for uncertainty.   Read More

  • WP 16-35R | Goods-Market Frictions and International Trade

    Pawel Krolikowski Andrew McCallum

    Original Paper: WP 16-35


    We add goods-market frictions to a general equilibrium dynamic model with heterogeneous exporting producers and identical importing retailers. Our tractable framework leads to endogenously unmatched producers, which attenuate welfare responses to foreign shocks but increase the trade elasticity relative to a model without search costs. Search frictions are quantitatively important in our calibration, attenuating welfare responses to tariffs by 40 percent and increasing the trade elasticity by 50 percent. Eliminating search costs raises welfare by 1 percent and increasing them by only a few dollars has the same effects on welfare and trade flows as a 10 percent tariff.   Read More

  • WP 18-11 | A Class of Time-Varying Parameter Structural VARs for Inference under Exact or Set Identification

    Mark Bognanni


    This paper develops a new class of structural vector autoregressions (SVARs) with time-varying parameters, which I call a drifting SVAR (DSVAR). The DSVAR is the first structural time-varying parameter model to allow for internally consistent probabilistic inference under exact—or set—identification, nesting the widely used SVAR framework as a special case. I prove that the DSVAR implies a reduced-form representation, from which structural inference can proceed similarly to the widely used two-step approach for SVARs: beginning with estimation of a reduced form and then choosing among observationally equivalent candidate structural parameters via the imposition of identifying restrictions. In a special case, the implied reduced form is a tractable known model for which I provide the first algorithm for Bayesian estimation of all free parameters. I demonstrate the framework in the context of Baumeister and Peersman’s (2013b) work on time variation in the elasticity of oil demand.   Read More

  • 16-10R | Rival Growth Prospects and Equity Prices: Evidence from Mass Layoff Announcements

    Adam Bordeman Bharadwaj Kannan Roberto Pinheiro

    Original Paper: WP 16-10


    We investigate the impact of mass layoff announcements on the equity value of industry rivals. When a layoff announcement conveys good (bad) news for the announcer, rivals on average witness a 0.44 percent increase (0.60 percent decrease) in cumulative abnormal stock returns. This effect is concentrated on rivals with high growth opportunities. Consistent with this finding, we also show that our results are strongest in technology industries, where growth opportunities matter the most. Our results suggest that investors perceive layoff announcements as news about industry prospects rather than just the announcer.   Read More

  • WP 18-10 | Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation

    Douglas Davis Oleg Korenok John Lightle Edward S. Prescott


    We develop a stylized interbank market environment and use it to evaluate with experimental methods the effects of liquidity requirements. Baseline and liquidity-regulated regimes are analyzed in a simple shock environment, which features a single idiosyncratic shock, and in a compound shock environment, in which the idiosyncratic shock is followed by a randomly occurring second-stage shock. Interbank trading of the illiquid asset follows each shock. In the simple shock environment, we find that liquidity regulations reduce the incidence of bankruptcies, but at a large loss of investment efficiency. In the compound shock environment, liquidity regulations not only impose a loss of investment efficiency but also fail to reduce bankruptcies.   Read More

  • 16-13r | Information Production, Misconduct Effort, and the Duration of Financial Misrepresentation

    Jonathan Black Mattias Nilsson Roberto Pinheiro Maximiliano da Silva

    Original Paper: WP 16-13


    We examine the link between information produced by auditors and analysts and fraud duration. Using a hazard model, we analyze misstatement periods related to SEC accounting and auditing enforcement releases (AAERs) between 1982 and 2012. Results suggest that misconduct is more likely to end just after firms announce an auditor switch or issue audited financial statements, particularly when the audit report contains explanatory language. Analyst following increases the fraud termination hazard. However, increases (decreases) in analyst coverage have a negative (positive) marginal impact on the termination hazard, suggesting that analysts signal whistleblowers with their choice to add or drop coverage. Finally, our results suggest that misconduct lasts longer when it is well planned, more complex, or involves more accrual manipulation. Taken together, our findings are consistent with auditors and analysts playing a key informational role in fraud detection, while managerial effort to conceal misconduct significantly extends its duration.   Read More

  • WP 18-09 | Combining Survey Long-Run Forecasts and Nowcasts with BVAR Forecasts Using Relative Entropy

    Ellis W. Tallman Saeed Zaman


    This paper constructs hybrid forecasts that combine both short- and long-term conditioning information from external surveys with forecasts from a standard fixed-coefficient vector autoregression (VAR) model. Specifically, we use relative entropy to tilt one-step ahead and long-horizon VAR forecasts to match the nowcast and long-horizon forecast from the Survey of Professional Forecasters. The results indicate meaningful gains in multi-horizon forecast accuracy relative to model forecasts that do not incorporate long-term survey conditions. The accuracy gains are achieved for a range of variables, including those that are not directly tilted but are affected through spillover effects from tilted variables. The forecast accuracy gains for inflation are substantial, statistically significant, and are competitive with the forecast accuracy from both time-varying VARs and univariate benchmarks. We view our proposal as an indirect approach to accommodating structural change and moving end points.   Read More