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  • Author: Davide Debortoli, Ricardo Nunes
  • Publication Date: 07-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We analyze how public debt evolves when successive policymakers have different policy goals and cannot make credible commitments about their future policies. We consider several cases to be able to disentangle and quantify the respective effects of imperfect commitment and political disagreement. Absent political turnover, imperfect commitment drives the long-run level of debt to zero. With political disagreement, debt is a sizeable fraction of GDP and increasing in the degree of polarization among parties, no matter the degree of commitment. The frequency of political turnover does not produce quantitatively relevant effects. These results are consistent with much of the existing empirical evidence. Finally, we find that in the presence of political disagreement the welfare gains of building commitment are lower.
  • Topic: Economics, Markets, Political Economy
  • Political Geography: United States
  • Author: David M. Arseneau, Sanjay K. Chugh
  • Publication Date: 01-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: A growing body of evidence suggests that ongoing relationships between consumers and firms may be important for understanding price dynamics. We investigate whether the existence of such customer relationships has important consequences for the conduct of both long-run and short-run policy. Our central result is that when consumers and firms are engaged in long-term relationships, the optimal rate of price inflation volatility is very low even though all prices are completely flexible. This finding is in contrast to those obtained in first-generation Ramsey models of optimal fiscal and monetary policy, which are based on Walrasian markets. Echoing the basic intuition of models based on sticky prices, unanticipated inflation in our environment causes a type of relative price distortion across markets. Such distortions stem from fundamental trading frictions that give rise to long-lived customer relationships and makes pursuing inflation stability optimal.
  • Topic: Economics, Markets
  • Political Geography: United States
  • Author: Houtan Bastani, Luca Guerrieri
  • Publication Date: 02-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: A key application of automatic differentiation (AD) is to facilitate numerical optimization problems. Such problems are at the core of many estimation techniques, including maximum likelihood. As one of the first applications of AD in the field of economics, we used Tapenade to construct derivatives for the likelihood function of any linear or linearized general equilibrium model solved under the assumption of rational expectations. We view our main contribution as providing an important check on finite-difference (FD) numerical derivatives. We also construct Monte Carlo experiments to compare maximum-likelihood estimates obtained with and without the aid of automatic derivatives. We find that the convergence rate of our optimization algorithm can increase substantially when we use AD derivatives.
  • Topic: Economics, Markets
  • Political Geography: United States
  • Author: Stephanie E. Curcuru, Tomas Dvorak, Francis E. Warnock
  • Publication Date: 02-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Were the U.S. to persistently earn substantially more on its foreign investments ("U.S. claims") than foreigners earn on their U.S. investments ("U.S. liabilities"), the likelihood that the current environment of sizeable global imbalances will evolve in a benign manner increases. However, using a monthly dataset on the foreign equity and bond portfolios of U.S. investors and the U.S. equity and bond portfolios of foreign investors, we find that the returns differential for portfolio securities is near zero, far smaller than previously reported. Examining all U.S. claims and liabilities (portfolio securities as well as direct investment and banking), we find that previous estimates of large differentials are biased upward. The bias owes to computing implied returns from an internally inconsistent dataset of revised data; original data produce a much smaller differential. We also attempt to reconcile our finding of a near zero returns differential with observed patterns of cumulated current account deficits, the net international investment position, and the net income balance. Overall, we find no evidence that the U.S. can count on earning substantially more on its claims than it pays on its liabilities.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Joseph W. Gruber, Steven B. Kamin
  • Publication Date: 03-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper addresses the popular view that differences in financial development explain the pattern of global current account imbalances. One strain of thinking explains the net flow of capital from developing to industrial economies on the basis of the industrial economies' more advanced financial systems and correspondingly more attractive assets. A related view addresses why the United States has attracted the lion's share of capital flows from developing to industrial economies; it stresses the exceptional depth, breadth, and safety of U.S. financial markets.
  • Topic: Economics, International Trade and Finance, Markets
  • Political Geography: United States
  • Author: Ricardo Correa
  • Publication Date: 03-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper uses data on publicly-traded firms in the U.S. to analyze the effect of interstate bank integration on the financial constraints borrowers face. A firm-level investment equation is estimated in order to test if bank integration reduces the sensitivity of capital expenditures to the level of internal funds. The staggered deregulation of cross-state bank acquisitions that took place in the U.S. between 1978 and 1994 helps estimate the model. Integration decreases financing constraints for bank-dependent firms. The change in firms' access to external finance is explained by an increase in the share of locally headquartered geographically diversified banks.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Francis E. Warnock, John Ammer, Sara B. Holland, David C. Smith
  • Publication Date: 05-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper investigates the underlying determinants of home bias using a comprehensive sample of U.S. investor holdings of foreign stocks. We document that U.S. cross-listings are economically important, as U.S. ownership in a foreign firm roughly doubles upon cross-listing in the United States. We explore the cross-sectional variation in this "cross-listing effect" and show that increases in U.S. investment are largest in firms from weak accounting backgrounds and in firms that are otherwise informationally opaque, indicating that U.S. investors value the improvements in disclosure associated with cross-listing. We confirm that relative equity valuations rise for cross-listed stocks, and provide evidence suggesting that valuation increases are due in part to increases in U.S. shareholder demand and in part to the fact that the equities become more attractive to non-U.S. shareholders.
  • Topic: Economics, International Trade and Finance, Markets
  • Political Geography: United States
  • Author: Steven B. Kamin, Carol C. Bertaut, Charles P. Thomas
  • Publication Date: 07-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper addresses three questions about the prospects for the U.S. current account deficit. Is it sustainable in the long term? If not, how long will it take for measures of external debt and debt service to reach levels that could prompt some pullback by global investors? And if and when such levels are breached, how readily would asset prices respond and the current account start to narrow?
  • Topic: Economics, Foreign Exchange, Government, International Political Economy, Political Economy
  • Political Geography: United States
  • Author: Luca Guerrieri, Christopher Gust, David López-Salido
  • Publication Date: 01-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We develop and estimate an open economy New Keynesian Phillips curve (NKPC) in which variable demand elasticities give rise to changes in desired markups in response to changes in competitive pressure from abroad. A parametric restriction on our specification yields the standard NKPC, in which the elasticity is constant, and there is no role for foreign competition to influence domestic inflation. By comparing the unrestricted and restricted specifications, we provide evidence that foreign competition plays an important role in accounting for the behavior of inflation in the traded goods sector. Our estimates suggest that foreign competition has lowered domestic goods inflation about 1 percentage point over the 2000-2006 period. Our results also provide evidence against demand curves with a constant elasticity in the context of models of monopolistic competition.
  • Topic: Economics, International Trade and Finance, Markets
  • Political Geography: United States
  • Author: Charles P. Thomas, Jaime Marquez, Sean Fahle
  • Publication Date: 01-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In this paper we construct a new measure of U.S. prices relative to those of its trading partners and use it to reexamine the behavior of U.S. net exports. Our measure differs from existing measures of the dollar's real effective exchange rate (REER) in that it explicitly incorporates both the difference in price levels between the United States and developing economies and the growing importance of these developing economies in world trade. Unlike existing REERs, our measure shows that relative U.S. prices have increased significantly over the past 15 years. In terms of simple correlations, the relationship between our measure of relative prices and U.S. net exports is much more coherent than that between existing REERs and net exports. To explore this relationship further, we use our measure to construct an index of foreign prices relevant for U.S. export volumes and reexamine several export equations. We find that export equations with the new index dominate those with previous measures in terms of in-sample fit, outof- sample fit, and parameter constancy. In addition, we find that with the new index of foreign prices the estimated elasticity of U.S. exports with respect to foreign income is a good bit higher than the unitary elasticity found in previous studies using other price measures. This has implications for U.S. current account adjustment.
  • Topic: Economics, Foreign Exchange, International Trade and Finance, Markets
  • Political Geography: United States
  • Author: Daniel O. Beltran, Laurie Pounder, Charles Thomas
  • Publication Date: 08-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The financial turmoil which began in August 2007 originated, in part, because investors reassessed the quality of the assets underlying many asset-backed securities (ABS), particularly U.S. mortgages. The prominence of European banks in the early stages of the turmoil created the perception that foreigners held an outsized share of risky U.S. securities and prompted questions of why Europeans were so exposed. This paper evaluates that perception by quantifying foreign exposure to ABS with U.S. underlying collateral. Using the latest survey data on foreign portfolio holdings of U.S. securities, we find that the ultimate losses that foreigners could incur arising from U.S. underlying assets are small relative to most scale variables, although initial total mark-to-market losses are estimated to be significantly larger. Among other reasons for this difference between ultimate and initial losses, we demonstrate that the securitization chain can amplify mark-to-market price declines in the presence of uncertainty or illiquidity. Finally, we show that, relative to the size of the market, foreigners’ holdings of U.S. mortgage-backed securities do not appear to be elevated compared with their holdings of other U.S. assets.
  • Topic: Economics, Financial Crisis, Financial Markets, Mortgages
  • Political Geography: United States, North America
  • Author: Lutz Kilian, Clara Vega
  • Publication Date: 11-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Models that treat innovations to the price of energy as predetermined with respect to U.S. macroeconomic aggregates are widely used in the literature. For example, it is common to order energy prices first in recursively identified VAR models of the transmission of energy price shocks. Since exactly identifying assumptions are inherently untestable, this approach in practice has required an act of faith in the empirical plausibility of the delay restriction used for identification. An alternative view that would invalidate such models is that energy prices respond instantaneously to macroeconomic news, implying that energy prices should be ordered last in recursively identified VAR models. In this paper, we propose a formal test of the identifying assumption that energy prices are predetermined with respect to U.S. macroeconomic aggregates. Our test is based on regressing cumulative changes in daily energy prices on daily news from U.S. macroeconomic data releases. Using a wide range of macroeconomic news, we find no compelling evidence of feedback at daily or monthly horizons, contradicting the view that energy prices respond instantaneously to macroeconomic news and supporting the use of delay restrictions for identification.
  • Topic: Economics, Energy Policy, Oil, Macroeconomics
  • Political Geography: United States, North America
  • Author: Seth Pruitt
  • Publication Date: 12-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: An economic agent who is uncertain of her economic model learns, and this learning is sensi- tive to the presence of data measurement error. I investigate this idea in an existing framework that describes the Federal Reserve’s role in U.S. inflation. This framework successfully fits the observed inflation to optimal policy, but fails to motivate the optimal policy by the perceived Philips curve trade-off between inflation and unemployment. I modify the framework to account for data uncertainty calibrated to the actual size of data revisions. The modified framework ameliorates the existing problems by adding sluggishness to the Federal Reserve’s learning: the key point is that data uncertainty is amplified by the nonlinearity induced by learning. Conse- quently there is an explanation for the rise and fall in inflation: the concurrent rise and fall in the perceived Philips curve trade-off.
  • Topic: Economics, Inflation, Models
  • Political Geography: United States, North America
  • Author: Beth Anne Wilson, Jane T. Haltmaier, Shaghil Ahmed, Brahima Coulibaly, Ross Knippenberg, Sylvain Leduc, Mario Marazzi
  • Publication Date: 09-2007
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper assesses China's role in Asia as an independent engine of growth, as a conduit of demand from the industrial countries, and as a competitor for export markets. We provide both macroeconomic and microeconomic evidence. The macroeconomic analysis focuses on the impact of U.S. and Chinese demand on the output of the Asian economies by estimating growth comovements and VARs. The results suggest an increasing role of China as an independent source of growth. The microeconomic analysis decomposes trade into basic products, parts and components, and finished goods. We find a large role for parts and components trade consistent with China playing an important and increasing role as a conduit. We also estimate some regressions that show that China's increasing presence in export markets has had a negative effect on exports of some products for some other Asian economies, but not for other products, including those of the important electronic high-technology industry.
  • Topic: Development, Economics, International Trade and Finance, Markets
  • Political Geography: United States, China, Asia
  • Author: Robert Vigfusson, Nathan Sheets, Joseph Gagnon
  • Publication Date: 09-2007
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: A growing body of empirical work has found evidence of a decline in exchange rate pass-through to import prices in a number of industrial countries. Our paper complements this work by examining pass-through from the other side of the transaction; that is, we assess the exchange rate sensitivity of export prices (denominated in the exporter's currency). We first sketch out a streamlined analytical model that highlights some key factors that determine pass-through. Using this model as reference, we find that the prices charged on exports to the United States are more responsive to the exchange rate than is the case for export prices to other destinations, which is consistent with results in the literature suggesting that import price pass-through in the U.S. market is relatively low. We also find that moves in the exchange rate sensitivity of export prices over time have been significantly affected by country and region-specific factors, including the Asian financial crisis (for emerging Asia), deepening integration with the United States (for Canada), and the effects of the 1992 ERM crisis (for the United Kingdom).
  • Topic: Economics, Foreign Exchange, International Trade and Finance, Markets
  • Political Geography: United States, United Kingdom, Canada, Asia
  • Author: Steven B. Kamin, Trevor A. Reeve
  • Publication Date: 04-2007
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In recent years, a number of studies have analyzed the experiences of a broad range of industrial economies during periods when their current account deficits have narrowed. Such studies identified systematic aspects of external adjustment, but it is unclear how good a guide the experience of other countries may be to the effects of a future narrowing of the U.S. external imbalance. In contrast, this paper focuses in depth on the historical experience of external adjustment in the United States. Using data from the past thirty-five years, we compare economic performance in episodes during which the U.S. trade balance deteriorated and episodes during which it adjusted. We find trade balance adjustment to have been generally benign: U.S. real GDP growth tended to fall, but not to a statistically significant extent; housing construction slumped; inflation generally rose modestly; and although nominal interest rates tended to rise, real interest rates fell. The paper then compares these outcomes to those in foreign industrial economies. We find that the economic performance of the United States during periods of external adjustment is remarkably similar to the foreign experience. Finally, we also examine the performance of the foreign industrial economies during the periods of U.S. deterioration and adjustment. Contrary to concerns that U.S. adjustment will prove injurious to foreign economies, our analysis suggests that the foreign economies fared reasonably well during past periods when the U.S. trade deficit narrowed: the growth of domestic demand and real GDP abroad generally strengthened during such episodes, although inflation and interest rates tended to rise as well.
  • Topic: Economics, Foreign Exchange, International Trade and Finance, Markets
  • Political Geography: United States
  • Author: Torben G. Andersen, Tim Bollerslev, Francis X. Diebold, Clara Vega
  • Publication Date: 09-2006
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Using a unique high-frequency futures dataset, we characterize the response of U.S., German and British stock, bond and foreign exchange markets to real-time U.S. macroeconomic news. We find that news produces conditional mean jumps; hence high-frequency stock, bond and exchange rate dynamics are linked to fundamentals. Equity markets, moreover, react differently to news depending on the stage of the business cycle, which explains the low correlation between stock and bond returns when averaged over the cycle. Hence our results qualify earlier work suggesting that bond markets react most strongly to macroeconomic news; in particular, when conditioning on the state of the economy, the equity and foreign exchange markets appear equally responsive. Finally, we also document important contemporaneous links across all markets and countries, even after controlling for the effects of macroeconomic news.
  • Topic: Economics, Foreign Exchange, International Trade and Finance, Markets
  • Political Geography: United States
  • Author: John H. Rogers, Charles Engel
  • Publication Date: 04-2006
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We investigate the possibility that the large current account deficits of the U.S. are the outcome of optimizing behavior. We develop a simple long-run world equilibrium model in which a country's current account is determined by the expected discounted present value of its future share of world GDP relative to its current share of world GDP. The model suggests that under some reasonable assumptions about future U.S. GDP growth relative to the rest of the advanced countries – more modest than the growth over the past 20 years – the current account deficit is near optimal levels. We then explore the implications for the real exchange rate. Under some plausible assumptions, the model implies little change in the real exchange rate over the adjustment path, though the conclusion is sensitive to assumptions about tastes and technology. Then we turn to empirical evidence. Two empirical analyses of current account sustainability using actual data suggest that the U.S. is not keeping on a long-run sustainable path. One is a direct test of our model, which finds that the dynamics of the U.S. current account – the increasing deficits over the past decade – are difficult to explain under a particular statistical model (Markov-switching) of expectations of future U.S. growth. But, if we use survey data on forecasted GDP growth in the G7, our very simple model appears to explain the evolution of the U.S. current account remarkably well. We conclude that expectations of robust performance of the U.S. economy relative to the rest of the advanced countries is a contender – though not the only legitimate contender – for explaining the U.S. current account deficit.
  • Topic: Economics, Foreign Exchange, International Trade and Finance, Markets
  • Political Geography: United States
  • Author: Jonathan H. Wright, David W. Berger, Alain P. Chaboud, Sergey V. Chernenko, Edward Howorka, Raj S. Iyer, David Liu
  • Publication Date: 04-2005
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We study the association between order flow and exchange rate returns in five years of high-frequency intraday data from the leading interdealer electronic broking system, EBS. While the association between order flow and exchange rate returns has been studied in several previous papers, these have mostly used relatively short spans of daily data from older bilateral dealing systems and, usually, transaction counts instead of actual trading volume. Using a substantially longer span of recent high-frequency data and measuring order flow as actual signed trading volume, we find a strong positive association between order flow and exchange rate returns at frequencies ranging from one minute to one day, and a more modest but still sizeable association at the monthly frequency. We find, however, no evidence that order flow has predictive power for future exchange rate movements beyond, possibly, the next minute. Focusing on the behavior of order flow and exchange rates at the time of scheduled U.S. economic data releases, we find that the surprise components of these announcements are associated with order flow at high frequency immediately after the data releases. This finding seems inconsistent with a simple efficient markets view of how a public news announcement is incorporated into prices.
  • Topic: Economics, International Trade and Finance, Science and Technology
  • Political Geography: United States
  • Author: John W. Schindler, Dustin H. Beckett
  • Publication Date: 04-2005
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Hong Kong plays a prominent role as a re-exporter of a large percentage of trade bound for or coming from China. Current reporting practices in China and its trading partners do not fully reflect this role and therefore provide a misleading picture of the origin or ultimate destination of Chinese exports and imports. We adjust bilateral trade data for both China and its trading partners to correct for this problem. We also correct for differences due to markups in Hong Kong and different standards for reporting trade (c.i.f. versus f.o.b.). For 2003, we estimate that China's overall trade surplus was between $53 billion and $126 billion, larger than that reported in official Chinese data, but smaller than that reported by China's trading partners. We also provide evidence that, in general, the actual origin of a good that is transshipped through Hong Kong is correctly reported by the importing country, but the final destination of such goods is not correctly reported by the exporting country.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States, China, Hong Kong
  • Author: Jaime Marquez, Mario Marazzi, Nathan Sheets, Joseph Gagnon, Robert J. Vigfusson, Jon Faust, Robert F. Martin, Trevor Reeve, John Rogers
  • Publication Date: 04-2005
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper documents a sustained decline in exchange rate pass-through to U.S. import prices, from above 0.5 during the 1980s to somewhere in the neighborhood of 0.2 during the last decade. This decline in the pass-through coefficient is robust to the measure of foreign prices that is included in the regression (i.e., CPI versus PPI), whether the estimation is done in levels or differences, and whether U.S. prices are included as an explanatory variable. Notably, the largest estimates of pass-through are obtained when commodity prices are excluded from the regression. In this case, the pass-through coefficient captures both the direct effect of the exchange rate on import prices and an indirect effect operating through changes in commodity prices. Our work indicates that an increasing share of exchange rate pass-through has occurred through this commodity-price channel in recent years. While the source of the decline in passthrough is difficult to pin down with certainty, our work points to several factors, including the reduced share of (commodity-intensive) industrial supplies in U.S. imports and the increased presence of Chinese exporters in U.S. markets. We detect a particular step down in the passthrough coefficient around the time of the Asian financial crisis and document a shift in the export pricing behavior of emerging Asian firms around that time.
  • Topic: Economics, Industrial Policy, International Trade and Finance
  • Political Geography: United States, China
  • Author: Luca Guerrieri, Dale W. Henderson, Jinill Kim
  • Publication Date: 02-2005
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In the last half of the 1990s, labor productivity growth rose in the U.S. and fell almost everywhere in Europe. We document changes in both capital deepening and multifactor productivity (MFP) growth in both the information and communication technology (ICT) and non-ICT sectors. We view MFP growth in the ICT sector as investment-specific productivity (ISP) growth. We perform simulations suggested by the data using a two-country DGE model with traded and nontraded goods. For ISP, we consider level increases and persistent growth rate increases that are symmetric across countries and allow for costs of adjusting capital-labor ratios that are higher in one country because of structural differences. ISP increases generate investment booms unless adjustment costs are too high. For MFP, we consider persistent growth rate shocks that are asymmetric. When such MFP shocks affect only traded goods (as often assumed), movements in 'international' variables are qualitatively similar to those in the data. However, when they also affect nontraded goods (as suggested by the data), movements in some of the variables are not. To obtain plausible results for the growth rate shocks, it is necessary to assume slow recognition.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States, Europe
  • Author: Steven B. Kamin, Sylvain Leduc, Hilary Croke
  • Publication Date: 02-2005
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Much has been written about prospects for U.S. current account adjustment, including the possibility of what is sometimes referred to as a “disorderly correction”: a sharp fall in the exchange rate that boosts interest rates, depresses stock prices, and weakens economic activity. This paper assesses some of the empirical evidence bearing on the likelihood of the disorderly correction scenario, drawing on the experience of previous current account adjustments in industrial economies. We examined the paths of key economic performance indicators before, during, and after the onset of adjustment, building on the analysis of Freund (2000).
  • Topic: Development, Economics, Industrial Policy, International Trade and Finance
  • Political Geography: United States
  • Author: Sylvain Leduc, Giancarlo Corsetti, Luca Dedola
  • Publication Date: 02-2005
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to efficient risk-sharing, negatively correlated with cross-country consumption ratios. This paper shows that a standard international business cycle model with incomplete asset markets augmented with distribution services can account quantitatively for these properties of real exchange rates. Distribution services, intensive in local inputs, drive a wedge between producer and consumer prices, thus lowering the impact of terms-of-trade changes on optimal agents' decisions. This reduces the price elasticity of tradables separately from assumptions on preferences.
  • Topic: Development, Economics, International Trade and Finance, Science and Technology
  • Political Geography: United States
  • Author: Luca Guerrieri, Christopher Gust, Christopher Erceg
  • Publication Date: 01-2005
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In this paper, we use an open economy DGE model (SIGMA) to assess the quantitative effects of fiscal shocks on the trade balance in the United States. We examine the effects of two alternative fiscal shocks: a rise in government consumption, and a reduction in the labor income tax rate. Our salient finding is that a fiscal deficit has a relatively small effect on the U.S. trade balance, irrespective of whether the source is a spending increase or tax cut. In our benchmark calibration, we find that a rise in the fiscal deficit of one percentage point of GDP induces the trade balance to deteriorate by less than 0.2 percentage point of GDP. Noticeably larger effects are only likely to be elicited under implausibly high values of the short-run trade price elasticity.
  • Topic: Conflict Resolution, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Fang Cai, Francis E. Warnock
  • Publication Date: 12-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We analyze foreigners' and domestic institutional investors' positions in U.S. equities. Controlling for many factors, we uncover a common preference for large firms and firms that are diversified internationally. The domestic preference for internationally diversified firms implies that investors might obtain substantial international diversification by investing at home. Using an international factor model, we show that exposure to foreign equity markets is indeed greater for domestic firms that are more diversified internationally, suggesting that at least some of the home-grown foreign exposure translates into international diversification benefits. After accounting for home-grown foreign exposure, the share of 'foreign' equities in investors' portfolios nearly doubles, reducing (but not eliminating) the observed home bias.
  • Topic: International Relations, Development, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Jonathan H. Wright, Alain P. Chaboud, Edward Howorka, David Liu, Sergey Chernenko, Raj S. Krishnasami Iyer
  • Publication Date: 11-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We introduce a new high-frequency foreign exchange dataset from EBS (Electronic Broking Service) that includes trading volume in the global interdealer spot market, data not previously available to researchers. The data also gives live transactable quotes, rather than the indicative quotes that have been used in most previous high frequency foreign exchange analysis. We describe intraday volume and volatility patterns in euro-dollar and dollar-yen trading. We study the effects of scheduled U.S. macroeconomic data releases, first confirming the finding of recent literature that the conditional mean of the exchange rate responds very quickly to the unexpected component of data releases. We next study the effects of data releases on trading volumes. News releases cause volume to rise, and to remain elevated for a longer period. However, in contrast to the result for the level of the exchange rate, even if the data release is entirely in line with expectations, we find that there is still typically a large pickup in trading volume.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Joseph E. Gagnon
  • Publication Date: 11-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Fast-growing countries tend to experience rapid export growth with little secular change in their terms of trade. This contradicts the standard Armington trade model, which predicts that fast-growing countries can experience rapid export growth only to the extent that they accept declining terms of trade. This paper generalizes the monopolistic competition trade model of Helpman and Krugman (1985), providing a basis for growth-led exports without declining terms of trade. The key mechanism behind this result is that fast-growing countries are able to develop new varieties of products that can be exported without pushing down the prices of existing products. There is strong support for the new model in long-run export growth of many countries in the post-war era.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Mark Carey
  • Publication Date: 10-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This introductory note summarizes and draws together the work reported in eight research papers written by staff economists of the Board's Division of International Finance as part of a project on global financial integration. The eight papers are also International Discussion Finance Discussion Papers (IFDPs), the numbers of which are specified on the table of contents that appears herein. When viewing this introduction online, the paper titles appearing on the table-of-contents page are web links that may be used to navigate directly to each paper's on-line file.
  • Topic: Economics, Globalization, International Trade and Finance
  • Political Geography: United States
  • Author: Gregory P. Nini
  • Publication Date: 09-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Empirical estimates of the benefit of financial intermediation are constructed by examining the role played by local banks in facilitating syndicated loans to borrowers in emerging market countries. Assuming that local banks possess a superior monitoring ability, the market is ideal for studying the value of intermediation since cross-border lending into emerging markets is plagued by particularly high information and agency costs and the supply of local bank capital is in limited short run supply. Using variation in the propensity of local banks to participate in foreign arranged syndicates, there are two economically important results. First, local banks are much more likely to participate in unconditionally riskier loans. Second, after controlling for borrower characteristics, loan characteristics, and the endogeneity of the local bank lending decision, loans with local bank participation have spreads that are 10 percent lower (29 basis points) than otherwise similar loans. Combined, the results support the conclusion that local banks, a particularly special type of financial intermediary, provide value by considerably reducing financing costs, especially for riskier borrowers.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Carol C. Bertaut, Linda S. Kole
  • Publication Date: 09-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Using data from the IMF Coordinated Portfolio Investment Surveys conducted in 2001, we analyze the determinants of 31 countries' international equity holdings. We show that investors in all countries underweight U.S. equities in their portfolios, many by more than they underweight foreign equities in general. Such behavior is surprising given the common perception of the United States as a desirable investment destination due to its well-developed legal and regulatory environment. Instead we find that investors in some countries are overweight in equities from other countries with which they have close regional or political ties. Such ties, along with distance, trade, issuance of U.S. ADRs or cross-listing on the London Stock exchange, market concentration, and estimated betas help explain patterns of diversification. However, even when all these variables are included, we find significant fixed effects for most countries, suggesting that a considerable amount of cross-country variation in investment positions and in home bias remains to be explained. Our work confirms previous findings and extends results most completely documented for the United States to other major investor countries. But it also suggests caution should be used when interpreting results derived from studies of one or a few countries.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States, London
  • Publication Date: 09-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This sixth and annual report required under the Senate Resolution of Advice and Consent of July 31, 1998, examines the progress that parties have made in implementing and enforcing the Organization for Economic Cooperation and Development (OECD) Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (Antribribery Convention).
  • Topic: Foreign Policy, Defense Policy, Economics
  • Political Geography: United States
  • Publication Date: 09-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The Convention was signed by the United States on December 17, 1997 and ratified on November 10, 1998. The U.S. deposited its instrument of ratification with the OECD on December 8, 1998. Congress responded to the signature of the Convention by amending the Foreign Corrupt Practices Act (the “FCPA”) on October 21, 1998. The new legislation, which entered into force on November 10, 1998, extends the FCPA to any person who engages in any act while in the territory of the U.S. and to any U.S. national and company engaged in an act outside the U.S. in furtherance of a proscribed purpose; adds “securing any improper advantage” to the list of improper purposes for payments to foreign officials; expands the term “a foreign official” to include any person acting for or on behalf of “public international organisation”; and allows the U.S. Attorney General to seek injunctive relief against foreign citizens or residents and entities other than “issuers” or “domestic concerns” that have engaged in or are about to engage in a violation of the FCPA.
  • Topic: Foreign Policy, Defense Policy, Economics
  • Political Geography: United States
  • Publication Date: 09-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Since the 1999 edition, the Department of Defense has used its consolidated real property inventory (the Facilities Analysis Database) as the basis for the annual publication of the Base Structure Report. This report contains a comprehensive listing of installations and sites owned and used by the Department. It summarizes the current facilities inventory and provides other basic information, such as information concerning the site locations, names of the nearest city, and, where available, includes personnel authorizations.
  • Topic: Security, Defense Policy, Economics
  • Political Geography: United States
  • Author: Francis E. Warnock, Charles P. Thomas, Jon Wongswan
  • Publication Date: 08-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper evaluates the performance of U.S. investors' portfolios in the equities of over 40 countries over a 25-year period. We find that these portfolios achieved a significantly higher Sharpe ratio than foreign benchmarks, especially since 1990. We uncover three potential reasons for this success. First, U.S. investors abstained from momentum trading and instead sold past winners. Second, conditional performance tests provide no evidence that the superior (unconditional) performance owed to private information, suggesting that the successful exploitation of publicly available information played a role. Third, the documented preference for cross-listed and well-governed foreign firms appears to have served U.S. investors well. We conclude with a short discussion of the implications of our findings for the home bias literature.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Francis E. Warnock, Karl V. Lins
  • Publication Date: 08-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper uses a sample of 4,410 firms from 29 countries to investigate the relation between corporate governance and the shareholder base. In contrast to previous work, our results strongly support the notion that poor corporate governance, at both the firm and country level, negatively impacts the willingness of foreign investors to hold a firm's equity. Specifically, we find that firms whose managers have sufficiently high control rights that they may reasonably be expected to expropriate minority equity investors attract significantly less U.S. investment, especially in countries with poor external governance. Our findings suggest that the prices U.S. investors are asked to pay for firms with poor governance are not low enough to fully compensate them for expected expropriation or increased estimation risk associated with expected poor disclosure by these firms. Because prior research shows that a smaller shareholder base is associated with a lower firm value, our results are consistent with the notion that the shareholder base represents an important channel through which poor expected corporate governance contributes to a reduction in firm value.
  • Topic: Economics, Government, International Trade and Finance
  • Political Geography: United States
  • Author: Francis E. Warnock, John Ammer, Sara B. Holland, David C. Smith
  • Publication Date: 08-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We use a comprehensive 1997 survey to examine U.S. investors' preferences for foreign equities. We document a variety of firm characteristics that can influence U.S. investment, but the most important determinant is whether the stock is cross-listed on a U.S. exchange. Our selection bias-corrected estimates imply that firms that cross-list can increase their U.S. holdings by 8 to 11 percent of their market capitalization, roughly doubling the amount held without cross-listing. All else equal, we find that firms experience smaller increases in U.S. shareholdings upon cross-listing if they are Canadian, from English speaking countries, are members of the MSCI World index, or had higher quality accounting standards prior to crosslisting. We argue that these findings suggest that improvements in information production explain U.S. investors' attraction to foreign stocks that cross-list in the United States.
  • Topic: Economics, Government, International Trade and Finance
  • Political Geography: United States, Canada
  • Author: Luis-Felipe Zanna
  • Publication Date: 08-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Governments in emerging economies have pursued real exchange rate targeting through Purchasing Power Parity (PPP) rules that link the nominal depreciation rate to either the deviation of the real exchange rate from its long run level or to the difference between the domestic and the foreign CPI-inflation rates. In this paper we disentangle the conditions under which these rules may lead to endogenous fluctuations due to self-fulfilling expectations in a small open economy that faces nominal rigidities. We find that besides the specification of the rule, structural parameters such as the share of traded goods (that measures the degree of openness of the economy) and the degrees of imperfect competition and price stickiness in the non-traded sector play a crucial role in the determinacy of equilibrium. To evaluate the relevance of the real (in)determinacy results we pursue a learnability (E-stability) analysis for the aforementioned PPP rules. We show that for rules that guarantee a unique equilibrium, the fundamental solution that represents this equilibrium is learnable in the E-stability sense. Similarly we show that for PPP rules that open the possibility of sunspot equilibria, a common factor representation that describes these equilibria is also E-stable. In this sense sunspot equilibria and therefore aggregate instability are more likely to occur due to PPP rules than previously recognized.
  • Topic: Economics, Government, International Trade and Finance
  • Political Geography: United States
  • Author: Mark Carey, Gregory P. Nini
  • Publication Date: 08-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We offer evidence that interest rate spreads on syndicated loans to corporate borrowers are economically significantly smaller in Europe than in the U.S., other things equal. Differences in borrower, loan and lender characteristics associated with equilibrium mechanisms suggested in the literature do not appear to explain the phenomenon. Borrowers overwhelmingly issue in their natural home market, and bank portfolios display significant home “bias.” This may explain why pricing discrepancies are not competed away, but the fundamental causes of the discrepancies remain a puzzle. Thus, important determinants of loan origination market outcomes remain to be identified, home “bias” appears to be material for pricing, and corporate financing costs differ in Europe and the U.S.
  • Topic: Economics, Government, International Trade and Finance
  • Political Geography: United States, Europe
  • Author: Sanjay Chugh
  • Publication Date: 07-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Changes in monetary policy are typically implemented gradually, an empirical observation known as interest-rate smoothing. We propose the explanation that timenon- separable preferences may render interest-rate smoothing optimal. We find that when consumers have “catching-up-with-the-Joneses” preferences, optimal monetary policy reacts gradually to shocks to prevent inefficiently fast adjustments in consumption. We also extend our basic model to investigate the effects of capital formation and nominal rigidities on the dynamics of optimal monetary policy. Optimal policy responses continue to be gradual in the presence of capital and sticky prices, with a size and speed that are in line with empirical findings for the U.S. economy. Our results emphasize that gradualism in monetary policy may be needed simply to guide the economy on an optimally smooth path.
  • Topic: Economics, Government, International Trade and Finance
  • Political Geography: United States
  • Author: Neil R. Ericsson
  • Publication Date: 07-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This interview for Econometric Theory explores David Hendry's research. Issues discussed include estimation and inference for nonstationary time series; econometric methodology; strategies, concepts, and criteria for empirical modeling; the general-to-specific approach, as implemented in the computer packages PcGive and PcGets; computer-automated model selection procedures; David's textbook Dynamic Econometrics; Monte Carlo techniques (PcNaive); evaluation of these developments in simulation studies and in empirical investigations of consumer expenditure, money demand, inflation, and the housing and mortgage markets; economic forecasting and policy analysis; the history of econometric thought; and the use of computers for live empirical and Monte Carlo econometrics.
  • Topic: Economics, Government, International Trade and Finance
  • Political Geography: United States
  • Author: John Ammer, Nathanael Clinton
  • Publication Date: 07-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We assess the impact of credit ratings on the pricing of structured financial products, using a sample of more than 1300 changes in Moody's or Standard and Poor's (S) ratings of U.S. asset-backed securities (ABS). We find that rating downgrades tend to be accompanied by negative returns and widening spreads, with the average effects stronger than those that have been reported in prior research on corporate and sovereign bond ratings. A portion of the negative implications of ABS downgrades are anticipated by price movements ahead of the rating action, although to a lesser degree than has been found for bond ratings. Accordingly, ABS market participants appear to rely somewhat more on rating agencies as a source of negative news about credit risk. Nevertheless, because ABS rating downgrades are relatively rare events, their effects account for only a small fraction of the variance of returns. In contrast to our results on downgrades, market reactions to ABS rating upgrades are virtually zero, on average. Together, the results imply even greater asymmetry in the value-relevance of ABS rating changes than has been found in event studies of changes in bond ratings.
  • Topic: Security, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Jonathan H. Wright, Sergey V. Chernenko, Krista B. Schwarz
  • Publication Date: 06-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Forward and futures rates are frequently used as measures of market expectations. In this paper we apply standard forecast efficiency tests, and some newer exact sign and rank tests, to a wide range of forward and futures rates, and in this way test whether these are in fact rational expectations of future actual prices. The forward and futures rates that we study under a common methodology include foreign exchange forward rates, U.S. and foreign interest rate futures and forward rates, oil futures and natural gas futures. For most, but not all, of these instruments, we find that we can reject the hypothesis that the forward or futures rates are rational expectations of actual future prices. It is well known that foreign exchange forward rates give less accurate forecasts than a random walk, but we show that this is also true for some interest rate futures and forward rates. We conclude that forward and futures prices are not generally pure measures of market expectations: they are also heavily affected by the market price of risk.
  • Topic: Security, Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Athanasios Orphanides, John C. Williams
  • Publication Date: 04-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We develop an estimated model of the U.S. economy in which agents form expectations by continually updating their beliefs regarding the behavior of the economy and monetary policy. We explore the effects of policymakers' misperceptions of the natural rate of unemployment during the late 1960s and 1970s on the formation of expectations and macroeconomic outcomes. We find that the combination of monetary policy directed at tight stabilization of unemployment near its perceived natural rate and large real-time errors in estimates of the natural rate uprooted heretofore quiescent inflation expectations and destabilized the economy. Had monetary policy reacted less aggressively to perceived unemployment gaps, inflation expectations would have remained anchored and the stagflation of the 1970s would have been avoided. Indeed, we find that less activist policies would have been more effective at stabilizing both inflation and unemployment. We argue that policymakers, learning from the experience of the 1970s, eschewed activist policies in favor of policies that concentrated on the achievement of price stability, contributing to the subsequent improvements in macroeconomic performance of the U.S. economy.
  • Topic: Economics, Government, International Trade and Finance
  • Political Geography: United States
  • Author: Michael Ehrmann, Marcel Fratzscher
  • Publication Date: 04-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper investigates whether the degree and the nature of economic and monetary policy interdependence between the United States and the euro area have changed with the advent of EMU. Using real-time data, it addresses this issue from the perspective of financial markets by analysing the effects of monetary policy announcements and macroeconomic news on daily interest rates in the United States and the euro area. First, the paper finds that the interdependence of money markets has increased strongly around EMU. Although spillover effects from the United States to the euro area remain stronger than in the opposite direction, we present evidence that US markets have started reacting also to euro area developments since the onset of EMU. Second, beyond these general linkages, the paper finds that certain macroeconomic news about the US economy has a large and significant effect on euro area money markets, and that these effects have become stronger in recent years. Finally, we show that US macroeconomic news has become good leading indicators for economic developments in the euro area. This indicates that the higher money market interdependence between the United States and the euro area is at least partly explained by the increased real integration of the two economies in recent years.
  • Topic: Economics, Government, International Trade and Finance
  • Political Geography: United States
  • Author: Fabrice Collard, Harris Dellas
  • Publication Date: 04-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Was the high inflation of the 1970s mostly due to incomplete information about the structure of the economy (an unavoidable mistake as suggested by Orphanides, 2000)? Or, to weak reaction to expected inflation and/or excessive policy activism that led to indeterminacies (a policy mistake, a scenario suggested by Clarida, Gali and Gertler, 2000)? We study this question within the NNS model with policy commitment and imperfect information, requiring that the model have satisfactory overall empirical performance. We find that both explanations do a good job in accounting for the great inflation. Even with the commonly used specification of the interest policy rule, high and persistent inflation can occur following a significant productivity slowdown if policymakers significantly and persistently underestimate ”core” inflation.
  • Topic: Economics, International Trade and Finance, Political Economy
  • Political Geography: United States
  • Author: Ester Faia, Tommaso Monacelli
  • Publication Date: 04-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We analyze welfare maximizing monetary policy in a dynamic two-country model with price stickiness and imperfect competition. In this context, a typical terms of trade externality affects policy interaction between independent monetary authorities. Unlike the existing literature, we remain consistent to a public finance approach by an explicit consideration of all the distortions that are relevant to the Ramsey planner. This strategy entails two main advantages. First, it allows an accurate characterization of optimal policy in an economy that evolves around a steady-state which is not necessarily efficient. Second, it allows to describe a full range of alternative dynamic equilibria when price setters in both countries are completely forward looking and households' preferences are not restricted. In this context, we study optimal policy both in the long-run and along a dynamic path, and we compare optimal commitment policy under Nash competition and under cooperation. By deriving a second order accurate solution to the policy functions, we also characterize the welfare gains from international policy cooperation.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Nicoletta Batini, Paul Levine, Joseph Pearlman
  • Publication Date: 04-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We examine the performance of forward-looking inflation-forecast-based rules in open economies. In a New Keynesian two-bloc model, a methodology first employed by Batini and Pearlman (2002) is used to obtain analytically the feedback parameters/horizon pairs associated with unique and stable equi-libria. Three key findings emerge: first, indeterminacy occurs for any value of the feedback parameter on inflation if the forecast horizon lies too far into the future. Second, the problem of indeterminacy is intrinsically more serious in the open economy. Third, the problem is compounded further in the open economy when central banks respond to expected consumer, rather than pro-ducer price inflation.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Dale W. Henderson, Ragna Alstadheim
  • Publication Date: 04-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We consider monetary-policy rules with inflation-rate targets and interest-rate or money-growth instruments using a flexible-price, perfect-foresight model. There is always a locally-unique target equilibrium. There may also be below-target equilibria (BTE) with inflation always below target and constant, asymptotically approaching or eventually reaching a below-target value, or oscillating. Liquidity traps are neither necessary nor sufficient for BTE which can arise if monetary policy keeps the interest rate above a lower bound. We construct monetary rules that preclude BTE when fiscal policy does not. Plausible fiscal policies preclude BTE for any monetary policy; those policies exclude surpluses and, possibly, balanced budgets.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Francis E. Warnock, John D. Burger
  • Publication Date: 02-2004
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We analyze the development of, and foreign participation in, 49 local bond markets. Countries with stable inflation rates and strong creditor rights have more developed local bond markets and rely less on foreign-currency-denominated bonds. Less developed bond markets have returns characterized by high variance and negative skewness, factors eschewed by U.S. investors. Results based on a three-moment CAPM indicate, however, that it is diversifiable idiosyncratic risk that U.S. investors appear to shun. Taken as a whole our results hint at a virtuous cycle of bond market development: Creditor friendly policies and laws can spark local bond market development that enables the development of derivatives markets and, in turn, attracts foreign participation.
  • Topic: Development, Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Robert J. Vigfusson, Lawrence J. Christiano, Martin Eichenbaum
  • Publication Date: 12-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We investigate what happens to hours worked after a positive shock to technology, using the aggregate technology series computed in Basu, Fernald and Kimball (1999). We conclude that hours worked rise after such a shock.
  • Topic: Economics, Industrial Policy, Science and Technology
  • Political Geography: United States
  • Author: Robert J. Vigfusson
  • Publication Date: 12-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper studies how much of productivity fluctuations are industry specific versus how much are country specific. Using data on manufacturing industries in Canada and the United States, the paper shows that the correlation between cross-border pairings of the same industry are more often highly correlated than previously thought. In addition, the paper confirms earlier findings that the similarity of input use can help describe the co-movement of productivity fluctuations across industries.
  • Topic: Economics, Industrial Policy, Science and Technology
  • Political Geography: United States, Canada, North America
  • Author: Jon Faust, Brian M. Doyle
  • Publication Date: 12-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper investigates breaks in the variability and co-movement of output, consumption, and investment in the G-7 economies. In contrast with most other papers on co-movement, we test for changes in co-movement allowing for breaks in mean and variance. Despite claims that rising integration among these economies has increased output correlations among them, we find no clear evidence of an increase in correlation of growth rates of output, consumption, or investment. This finding is true even for the United States and Canada, which have seen a tremendous increase in bilateral trade shares, and for the members of the euro area in the G-7.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States, Canada, North America
  • Author: John H. Rogers, Jonathan H. Wright, Jon Faust, Shing-Yi B. Wang
  • Publication Date: 10-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Many recent papers have studied movements in stock, bond, and currency prices over short windows of time around macro announcements. This paper adds to the announcement effects literature in two ways. First, we study the joint announcement effects across a broad range of assets--exchange rates and U.S. and foreign term structures. In order to evaluate whether the joint effects can be reconciled with conventional theory, we interpret the joint movements in light of uncovered interest rate parity or changes in risk premia. For several real macro announcements, we find that a stronger than expected release appreciates the dollar today, but that it must either (i) lower the relative risk premium for holding foreign currency rather than dollars, or (ii) imply considerable future expected dollar depreciation. The latter implies an overshooting behavior akin to that described by Dornbusch (1976). Second, we use a longer span of high frequency data than has been common in announcement work. A longer span of high frequency data contributes to the precision of our estimates and allows us to explore the possibility that the effects of macro surprises on asset prices have varied over time. We find evidence, for example, that PPI releases had a larger effect on U.S. interest rates before about 1992 than subsequently.
  • Topic: International Relations, Economics, Government, International Trade and Finance
  • Political Geography: United States
  • Author: Joseph E. Gagnon
  • Publication Date: 10-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Most macroeconomic models imply that faster output growth tends to lower a country's trade balance by raising its imports with little change to its exports. Krugman (1989) proposed a model in which countries grow by producing new varieties of goods. In his model, faster-growing countries are able to export these new goods and maintain balanced trade without suffering any deterioration in their terms of trade. This paper analyzes the growth of U.S. imports from different source countries and finds strong support for Krugman's model.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Jonathan H. Wright
  • Publication Date: 09-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Recent empirical work has considered the prediction of inflation by combining the information in a large number of time series. One such method that has been found to give consistently good results consists of simple equal weighted averaging of the forecasts over a large number of different models, each of which is a linear regression model that relates inflation to a single predictor and a lagged dependent variable. In this paper, I consider using Bayesian Model Averaging for pseudo out-of-sample prediction of US inflation, and find that it gives more accurate forecasts than simple equal weighted averaging. This superior performance is consistent across subsamples and inflation measures. Meanwhile, both methods substantially outperform a naive time series benchmark of predicting inflation by an autoregression.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Jonathan H. Wright
  • Publication Date: 09-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Exchange rate forecasting is hard and the seminal result of Meese and Rogoff (1983) that the exchange rate is well approximated by a driftless random walk, at least for prediction purposes, has never really been overturned despite much effort at constructing other forecasting models. However, in several other macro and financial forecasting applications, researchers in recent years have considered methods for forecasting that combine the information in a large number of time series. One method that has been found to be remarkably useful for out-of-sample prediction is simple averaging of the forecasts of different models. This often seems to work better than the forecasts from any one model. Bayesian Model Averaging is a closely related method that has also been found to be useful for out-of-sample prediction. This starts out with many possible models and prior beliefs about the probability that each model is the true one. It then involves computing the posterior probability that each model is the true one, and averages the forecasts from the different models, weighting them by these posterior probabilities. This is effectively a shrinkage methodology, but with shrinkage over models not just over parameters. I apply this Bayesian Model Averaging approach to pseudo-out-of-sample exchange rate forecasting over the last ten years. I find that it compares quite favorably to a driftless random walk forecast. Depending on the currency-horizon pair, the Bayesian Model Averaging forecasts sometimes do quite a bit better than the random walk benchmark (in terms of mean square prediction error), while they never do much worse. The forecasts generated by this model averaging methodology are however very close to (but not identical to) those from the random walk forecast.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Jon Wongswan
  • Publication Date: 09-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Using the conditional Capital Asset Pricing Model (CAPM), this paper tests for the existence and pattern of contagion and capital market integration in global equity markets. Contagion is defined as significant excess conditional correlation among different countries' asset returns above what could be explained by economic fundamentals (systematic risks). Capital market integration is defined as the situation in which only systematic risks are priced. The paper uses a panel of sixteen countries, divided into three blocs: Asia, Latin America, and Germany-U.K.-U.S., for the period from 1990 through 1999. The results show evidence of contagion and capital market integration. In addition, contagion is found to be a regional phenomenon.
  • Topic: International Relations, Economics, Globalization, International Trade and Finance
  • Political Geography: United States, United Kingdom, Asia, Germany, Latin America
  • Author: Jane Ihrig, David Prior
  • Publication Date: 08-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: <p>This paper examines if the type of exchange rate used or size of the movement in the exchange rate matters in estimating exchange-rate exposure of U.S. nonfinancial multinationals. We find that switching from a broad trade-weighted exchange rate to a 2-digit SIC industry exchange rate increases the number of significantly exposed firms in a simple Jorion (1990) regression by 60 percent. Then separating crisis from non-crisis months we find additional evidence of exposure. Although the value of exposure does not change with the size of the exchange rate movement, we find some firms have significant exposure only in crisis periods while others have significant exposure only during normal fluctuations in exchange rates. All told, we find about 1 in 4 firms' returns is significantly affected by movement in the exchange rate between 1995 and 1999. </p><blockquote><p> </p> </blockquote><p> </p><p> </p>
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Publication Date: 07-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (Antibribery Convention) of the Organization of Economic Cooperation and Development (OECD) is one of the most important instruments through which the U.S. government fights transnational corruption. The Convention obligates the Parties to criminalize bribery of foreign public officials in the conduct of international business. It is aimed at proscribing offers, promises or payments of bribes by companies based in the OECD signatory countries that engage in transactions in other countries.
  • Topic: Foreign Policy, Defense Policy, Economics
  • Political Geography: United States
  • Author: Francis E. Warnock, Hali J. Edison
  • Publication Date: 07-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We analyze a unique data set and uncover a remarkable result that casts a new light on the home bias phenomenon. The data are comprehensive, security-level holdings of emerging market equities by U.S. investors. We document, as expected, that at a point in time U.S. portfolios are tilted towards firms that are large, have fewer restrictions on foreign ownership, or are cross-listed on a U.S. exchange. The size of the cross-listing effect is striking. In contrast to the well-documented underweighting of foreign stocks, emerging market equities that are cross-listed on a U.S. exchange are incorporated into U.S. portfolios at full international CAPM weights. Our results suggest that information asymmetries play an important role in equity home bias and that the benefits of international risk sharing are limited to select firms.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Francis E. Warnock, Hali J. Edison
  • Publication Date: 07-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We analyze capital flows to emerging markets in a framework that incorporates two quantitative measures of financial integration, the intensity of capital controls and the extent of cross-border listings, while controlling for traditional global (push) and country-specific (pull) factors. Two important results emerge. First, the cross-listing of an emerging market firm on a U.S. exchange is an important but short-lived capital flows event, suggesting that the cross-listed stock is in effect a new security that U.S. investors quickly bring into their portfolios. Second, the effect of financial liberalization on capital flows is more nuanced than is suggested by event studies: A reduction in capital controls results in increased inflows only when the controls were binding. Among the standard push and pull factors, global factors are important—slack U.S. economic activity is associated with increased flows to emerging markets—and U.S. investors appear to chase expected, but not past, returns.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Publication Date: 06-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Since 1999, the Department of Defense has used its real property inventory as the basis for the annual publication of the Base Structure Report. This report contains a comprehensive listing of installations and sites used by the Department, summarizes the current facilities inventory, and provides other basic information concerning the locations.
  • Topic: Security, Defense Policy, Economics
  • Political Geography: United States
  • Author: Jaime Marquez, Shing-Yi B. Wang
  • Publication Date: 06-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We study whether aggregation residuals in U.S. private investment in information technology (IT) exhibit a predictable pattern that is consistent with Hicks' composite-good theorem and that may be used for forecasting. To determine whether one can extract such a pattern, we apply the general-to-specific strategy developed by Krolzig and Hendry (2001). This strategy combines ordinary least squares with a computer-automated algorithm that selects a specification based on coefficients' statistical significance, residual properties, and parameter constancy. Then, we derive the testable implications from Hicks' theorem and evaluate them with econometric formulations; we find qualified support for these implications. Having obtained these formulations, we evaluate their ex-post predictive accuracy and compare it to that of an autoregressive model. The key finding is that ignoring movement in relative prices results in a loss of information for predicting aggregation residuals.
  • Topic: Economics, International Trade and Finance, Science and Technology
  • Political Geography: United States
  • Author: Carolyn Evans, James Harrigan
  • Publication Date: 05-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Time is money, and distance matters. We model the interaction of these truisms, and show the implications for global specialization and trade: products where timely delivery is important will be produced near the source of final demand, where wages will be higher as a result. In the model, timely delivery is important because it allows retailers to respond to fluctuating final demand without holding costly inventories, and timely delivery is only possible from nearby locations. Using a unique dataset that allows us to measure the retail demand for timely delivery, we show that the sources of US apparel imports have shifted in the way predicted by the model, with products where timeliness matters increasingly imported from nearby countries.
  • Topic: Economics, International Trade and Finance, Science and Technology
  • Political Geography: United States
  • Author: Jorge D. Selaive, Vicente Tuesta
  • Publication Date: 05-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: An unresolved issue in international macroeconomics is the apparent lack of risk-sharing across countries, which contradicts the prediction of models based on the assumption of complete markets. We assess the importance of financial frictions in this issue by constructing an incomplete market model with stationary net foreign assets (NFA) and imperfect pass-through (IPT). In this paper, there is a cost of bond holdings that allows us to incorporate the dynamics of NFA into the risk-sharing condition. On theoretical grounds, our results suggest that the dynamics of NFA may account for the lack of risk-sharing across countries. In addition, the IPT mechanism, by closing the current account channel, does not help to explain this feature of the data. On empirical grounds, we test the risk-sharing condition derived in the paper, and we find that growth factors of consumption and real exchange rates behave in a manner that may be consistent with a significant role for the net foreign asset position.
  • Topic: Development, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Jaime Marquez, Jane Ihrig
  • Publication Date: 05-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: One of the most remarkable macroeconomic developments of the past decade has been the widespread decline in inflation despite declines in unemployment rates. For the United States, these seemingly contradictory developments have been reconciled in terms of three factors: (1) an acceleration in productivity, (2) structural changes in labor markets that lowered the natural unemployment rate (NAIRU), and (3) improved credibility of monetary policy. Here we ask whether comparable factors were at work in foreign industrial countries. To address this question, we empirically characterize the relationship between inflation, the unemployment rate, and structural factors using an extended Phillips curve model with quarterly data through 1994. By undertaking counterfactual simulations from 1995 to 2001, we quantify the separate contributions of unemployment-rate movements, labor-market reforms (that affected the NAIRU), and productivity developments on inflation. In line with previous work on the United States, we find that productivity advancements were the main structural factor reducing inflation in the United States. For foreign countries, persistent labor-market slack was the main factor exerting downward pressure on inflation. This persistence stemmed, in part, from structural reforms that lowered the NAIRU while the unemployment rate was declining.
  • Topic: International Relations, Development, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: J. Benson Durham
  • Publication Date: 02-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In contrast to the empirical literature's focus on foreign direct investment (FDI), this study examines the effects of foreign portfolio investment (FPI) and “other” foreign investment (OFI) on economic growth using data on 88 countries from 1977 through 2000. Most measures suggest that FPI has no effect, and some results indicate that OFI has a negative impact on growth that is somewhat mitigated by initial financial and/or legal development. However, these results are questionable due to possible simultaneity bias. The empirical analyses also examine whether non-FDI foreign investment affects growth indirectly. FPI does not correlate positively with macroeconomic volatility, but the results indicate that the negative indirect effect of OFI through macroeconomic volatility comprises a substantial portion of the gross negative effect of OFI on growth.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Fang Cai
  • Publication Date: 02-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper uses a unique dataset of audit trail transactions to examine the trading behavior of market makers in the Treasury bond futures market when Long-Term Capital Management (LTCM) faced binding margin constraints in 1998. Although identities are concealed in the dataset, I find strong evidence that during the crisis market makers in the aggregate engaged in front running against customer orders from a particular clearing firm (coded “PI7”) that closely match various features of LTCM's trades through Bear Stearns. That is, market makers traded on their own accounts in the same direction as PI7 customers did, but one or two minutes beforehand. Furthermore, a significant percentage of market makers made abnormal profits on most of the trading days during the crisis. Their aggregate abnormal profits, however, were more than offset by abnormal losses realized after the private sector recapitalization of LTCM. Moreover, I show that before the rescue, a market maker's cumulative abnormal profit was positively correlated both to her tie as contra party with PI7 and to the intensity of her front running, but these relationships turned negative after the rescue. The overall evidence suggests that the recapitalization plan effectively relaxed LTCM's binding constraints and therefore reversed the profitability of front running.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Jon Wongswan
  • Publication Date: 02-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper provides evidence of transmission of information from the U.S. and Japan to Korean and Thai equity markets during the period from 1995 through 2000. Information is defined as important macroeconomic announcements in the U.S., Japan, Korea, and Thailand. Using high-frequency intraday data, I focus the study on return volatility and trading volume because the implications of new information are much clearer than for returns. I find a large and significant association between emerging-economy equity volatility and trading volume and developed-economy macroeconomic announcements at short-time horizons. This is the first strong evidence of this sort of international information transmission. Previous studies' findings of at most weak evidence may be due to their use of lower frequency data and their focus on developed-economy financial market innovations as the measure of information.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States, Japan, Asia, Korea, Thailand
  • Publication Date: 02-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Section 2504 of title 10, United States Code, requires that the Secretary of Defense submit an annual report to the Committee on Armed Services of the Senate and the Committee on Armed Services of the House of Representatives, by March 1st of each year.
  • Topic: Defense Policy, Economics, Industrial Policy, Science and Technology
  • Political Geography: United States
  • Author: Robert F. Martin
  • Publication Date: 01-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We study consumption of durable and nondurable goods when the durable good is subject to transaction costs. In the model, agents derive utility from a service flow of a durable good and a consumption flow of a nondurable good. The key feature of the model is the existence of a fixed transaction cost in the durable good market. The fixed cost induces an inaction region in the purchase of the durable good. More importantly, the inability to adjust the durable stock induces variation in consumption of the nondurable good over the inaction region. The variation is a function of the degree of complementarity between durable and nondurable goods in the period utility function, the rate of intertemporal substitution, and a precautionary motive induced by incomplete markets. We test the model using the PSID. Housing serves as the durable good. The data indicate an increase in consumption before moving to a smaller house and a decrease in consumption before moving to a larger house. This result is consistent with the model when there exists complementarity between the durable and nondurable good or when there is a strong precautionary effect.
  • Topic: Economics, Industrial Policy, International Trade and Finance
  • Political Geography: United States
  • Author: Francis E. Warnock, John D. Burger
  • Publication Date: 01-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: While there is a severe home bias in U.S. investors' foreign bond portfolios, we find that portfolio weights are greater for countries with more open capital accounts and whose bond returns are less correlated with U.S. returns. Positions in local-currency-denominated bonds are particularly sensitive to past and prospective returns volatility. An analysis of changes in portfolio weights over time indicates that U.S. investors have recently moved out of smaller markets and those with low and declining credit ratings. Our data also allow for an analysis of the size and currency composition of international bond markets. We find that countries with stronger institutions and better inflation performance have larger local currency bond markets. An implication for developing countries is that creditor friendly policies, such as vigilance on the inflation front and the development of strong institutions, can enable local bond market development and may in turn attract global investors.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Joseph E. Gagnon
  • Publication Date: 01-2003
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Krugman (1989) argued that differences across countries in estimated income elasticities of import demand are due to omission of an exporter supply effect. He showed that such an effect can be derived in a theoretical model with economies of scale in production and a taste for variety in consumption. In his model, countries grow by producing new varieties of goods, and they are able to export these goods without suffering any deterioration in their terms of trade. This paper analyzes U.S. import demand from different source countries and finds strong evidence of a supply effect of roughly half the magnitude (0.75) of the income elasticity (1.5). Price elasticities for the most part are estimated close to -1, which is typical for the literature. Exclusion of the supply effect leads to overestimation of the income elasticity. Results based on U.S. exports to different destinations are less robust, but largely corroborate these findings.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: David Bowman
  • Publication Date: 12-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: A model that contains no costs to changing prices but in which prices do not respond to nominal shocks is presented. In models that do not feature superneutrality of money flexible price equilibria will allow certain types of monetary shocks to affect the real economy. Sticky price behavior may in fact be better at protecting the real economy from the effects of monetary shocks in such environments. This point is demonstrated in a standard monetary model with liquidity effects. An equilibrium in which sticky prices are supported without menu costs is then constructed. In equilibrium firms choose to keep prices fixed in response to nominal shocks because doing so provides a service to their customers, increasing profits by expanding the customer base.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Alan Sutherland
  • Publication Date: 12-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The welfare gains from international coordination of monetary policy are analysed in a two-country model with sticky prices. The gains from coordination are compared under two alternative structures for financial markets: financial autarky and risk sharing. The welfare gains from coordination are found to be largest when there is risk sharing and the elasticity of substitution between home and foreign goods is greater than unity. When there is no risk sharing the gains to coordination are almost zero. It is also shown that the welfare gain from risk sharing can be negative when monetary policy is uncoordinated.
  • Topic: Economics, Human Welfare, International Trade and Finance
  • Political Geography: United States
  • Author: Simon Gilchrist, Jean-Olivier Hairault, Hubert Kempf
  • Publication Date: 12-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In this paper, we consider the effect of a monetary union in a model with a significant role for financial market imperfections. We do so by introducing a financial accelerator into a stochastic general equilibrium macro model of a two country economy. We show that financial market imperfections introduce important cross-country transmission mechanisms to asymmetric shocks to supply and demand. Within this framework, we study the likely costs and benefits of monetary union. We also consider the effects of cross-country heterogeneity in financial markets. Both the presence of financial frictions and the use of a single currency have significant impacts on the international propagation of exogenous shocks. The introduction of asymmetries in the financial contract widens the difference in cyclical behavior of national economies in a monetary union, but financial integration compensates the loss of policy instruments.
  • Topic: Development, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Jaime Marquez
  • Publication Date: 11-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The most widely accepted explanation for the inverse association between private investments and current accounts [Glick and Rogoff, 1995] rests on data for manufactures through 1990. Is this consensus robust to revisions to the national accounts and the expansion of information technologies since 1990? To address this question I replicate their results and I find that post 1990 developments eliminate the support for such a conclusion. I also implement alternative formulations and find, again, a lack of empirical support for their findings. Thus I examine the role of measurement errors and focus on the treatment of the manufacturing sector as representative of the whole economy and the exclusion of the contribution of capital when measuring productivity. Correcting these two measurement errors restores to Glick and Rogoff's conclusion its original strength.
  • Topic: Economics, International Trade and Finance, Science and Technology
  • Political Geography: United States
  • Author: John H. Rogers
  • Publication Date: 10-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In light of 50 years of economic policies designed to integrate Europe -- culminating in the elimination of euro zone national currencies in early 2002 -- and a vast academic literature on international economic integration, it is of interest to assess how far European integration has come in practice. Using a unique data set, I document the pattern of price dispersion across European and U.S. cities from 1990 to 2001. I find a striking decline in dispersion for traded goods prices in Europe, most of which took place between 1991 and 1994. The level of traded goods price dispersion in the euro area is now quite close to that of the United States. A decline in dispersion of non-tradeables prices in Europe has also taken place, but to a smaller extent. For U.S. cities, there is no evidence of a decline in price dispersion, even for tradeables. I examine several possible explanations for the decline in European price dispersion, including harmonization of tax rates, convergence of incomes and labor costs, liberalization of trade and factor markets, and increased coherence of monetary policy. I also investigate how much of the variation in national inflation rates in Europe can be explained by price level convergence. Finally, after showing that prices in likely next-round entrants into the euro zone are well below prices in Western Europe, I discuss the potential inflationary consequences of accession into monetary union for Eastern Europe.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States, Europe
  • Author: John H. Rogers, Jonathan H. Wright, Jon Faust, Eric Swanson
  • Publication Date: 10-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper proposes a new approach to identifying the effects of monetary policy shocks in an international vector autoregression. Using high-frequency data on the prices of Fed Funds futures contracts, we measure the impact of the surprise component of the FOMC-day Federal Reserve policy decision on financial variables, such as the exchange rate and the foreign interest rate. We show how this information can be used to achieve identification without having to make the usual strong assumption of a recursive ordering.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Carlos Ó. Arteta
  • Publication Date: 09-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The dollarization of bank deposits and credit is widespread in developing countries, resulting in varying degrees of currency mismatches in domestic financial intermediation, which in turn might accentuate bank balance sheet fragility. It is widely argued that flexible exchange rate regimes encourage banks to match dollar-denominated liabilities with a corresponding amount of dollar-denominated assets, ameliorating currency mismatches. Does the behavior of dollar deposits and credit in financially dollarized economies support that presumption? A new database on deposit and credit dollarization in developing and transition countries is assembled and used to address this question. Empirical results suggest that, if anything, floating regimes seem to exacerbate, rather than ameliorate, currency mismatches in domestic financial intermediation, as those regimes seem to encourage deposit dollarization more strongly than they encourage matching via credit dollarization.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Publication Date: 09-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The United States possesses unprecedented— and unequaled—strength and influence in the world. Sustained by faith in the principles of liberty, and the value of a free society, this position comes with unparalleled responsibilities, obligations, and opportunity. The great strength of this nation must be used to promote a balance of power that favors freedom.
  • Topic: Security, Defense Policy, Economics
  • Political Geography: United States
  • Author: Luca Guerrieri
  • Publication Date: 08-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: One of the criticisms routinely advanced against models of the business cycle with staggered contracts is their inability to generate inflation persistence. This paper finds that staggered contracts µa la Taylor are, in fact, capable of reproducing the inflation persistence implied by U.S. data. Following Fuhrer and Moore, I capture the moments that the contract specification needs to replicate by using the correlograms from a small vector autoregression (VAR) that includes inflation among the endogenous variables. A simple structural model substitutes the inflation equation from the VAR with the contract specification. I estimate the contract parameters in the structural model by maximum likelihood. The correlogram for the endogenous variables from the estimated structural model, including that for inflation, are very close to the correlograms from the VAR (and are contained within their 90% confidence intervals). By the same metric, where Taylor contracts do not fare well is in reproducing the cross-correlations between inflation and output.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Joseph W. Gruber
  • Publication Date: 08-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Empirical work regarding Intertemporal Current Account (ICA) models has centered around two distinct testing methodologies, present value tests and a productivity shock approach as formulated by Glick and Rogoff (1995). In previous work, Gruber (2001), I have tested and ICA model that allows for habits in aggregate consumption via the present value method. This paper applies the alternative Glick and Rogoff style approach to testing the model. The benefits of doing such are an ability to separate country-specific from worldwide output changes, a distinction of considerable importance, as well as to impose restrictions on the relationship between investment and output, neither of which are possible in the present value framework. The results of the test are supportive of the existence of habits and coincide with the results of Gruber (2001). The degree of habit persistence implied by the model is estimated for the G-7 countries. The paper also proposes habit formation as a possible solution to an empirical puzzle identified in the original Glick and Rogoff paper.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Jonathan H. Wright
  • Publication Date: 07-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper proposes a new test of the null hypothesis that a generalized method of moments model is identified. The test can detect local or global underidentification, and underidentification in some or all directions. The idea of the test is to compare the volume of two confidence sets -- one that is robust to lack of identification and one that is not. Under the null hypothesis the relative volume of these two sets is Op(1), but under the alternative, the robust confidence set has high probability of being unbounded.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Trevor A. Reeve
  • Publication Date: 07-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: What determines industrial structure? Do sector-specific characteristics such as unionization, regulation, and trade policy dominate production patterns? One is inclined to believe so based on countless industry-level studies and the many political battles that are continually fought over trade and industrial policy. In contrast, standard neoclassical trade theory suggests that industrial structure is primarily driven by relative factor supplies. This paper demonstrates that aggregate factor endowments explain much of the structure of production—independent of industry idiosyncrasies—and quantifies the extent to which shifts in industrial structure in a cross section of countries are driven by the broad forces of factor accumulation. This result has important implications for policy. In particular, investment in physical capital and education may have as great an impact on the pattern of production as sector-specific trade and industrial policies. Thus, general equilibrium effects should not be ignored in efforts either to understand industrial structure or to form policies that attempt to alter it. These conclusions are reached through an empirical application of the factor proportions model of production.
  • Topic: Economics, Industrial Policy, International Trade and Finance
  • Political Geography: United States
  • Author: Beth Anne Wilson, Shaghil Ahmed, Andrew Levin
  • Publication Date: 07-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The volatility of U.S. real GDP growth since 1984 has been markedly lower than that over the previous quarter-century. In this paper, we utilize frequency-domain and VAR methods to distinguish among several competing explanations for this phenomenon: improvements in monetary policy, better business practices, and a fortuitous reduction in exogenous disturbances. We find that reduced innovation variances account for much of the decline in aggregate output volatility. Our results support the “good-luck” hypothesis as the leading explanation for the decline in aggregate output volatility, although “good-practices” and “good-policy” are also contributing factors. Applying the same methods to consumer price inflation, we find that the post-1984 decline in inflation volatility can be attributed largely to improvements in monetary policy.
  • Topic: Economics, Industrial Policy, International Trade and Finance
  • Political Geography: United States
  • Author: Christopher J. Erceg, Andrew T. Levin
  • Publication Date: 07-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: The durable goods sector is much more interest sensitive than the non-durables sector, and these sectoral differences have important implications for monetary policy. In this paper, we perform VAR analysis of quarterly US data and find that a monetary policy innovation has a peak impact on durable expenditures that is roughly five times as large as its impact on non-durable expenditures. We then proceed to formulate and calibrate a two-sector dynamic general equilibrium model that roughly matches the impluse response functions of the data. While the social welfare function involves sector-specific output gaps and inflation rates, we find that performance of the optimal policy rule can be closely approximated by a very simple rule that targets a weighted average of aggregate wage and price inflation rates. In contrast, some commonly-prescribed policy rules (such as strict price inflation targeting and Taylor's rule) perform very poorly in terms of social welfare.
  • Topic: Economics, Human Welfare, International Trade and Finance
  • Political Geography: United States
  • Author: Philippe Bacchetta, Eric van Wincoop
  • Publication Date: 07-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Nominal rigidities due to menu costs have become a standard element in closed economy macroeconomic modeling. The "New Open Economy Macroeconomics" literature has investigated the implications of nominal rigidities in an open economy context and found that the currency in which prices are set has significant macroeconomic and policy implications. In this paper we solve for the optimal invoicing choice by integrating this microeconomic decision at the firm level into a general equilibrium open economy model. Strategic interactions between firms play a critical role in the analysis. We find that the less competition firms face in foreign markets, as reflected in market share and product differentiation, the more likely they will price in their own currency. We also show that when a set of countries forms a monetary union, the new currency is likely to be used more extensively in trade than the sum of the currencies it replaces.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Margarida Duarte, Alexandar L. Wolman
  • Publication Date: 07-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We develop a general equilibrium model of a two-region currency union. There are two types of goods: non-trade goods, and traded goods for which markets are segmented. Monetary policy is set by a central monetary authority and is non-neutral due to nominal price rigidities. Fiscal policy is determined at the regional level by each region's government. We find that productivity shocks alone generate significant variation in inflation across the two countries. Government spending shocks, in contrast, do not account for a significant portion of inflation variation. Varying relative country size, we find that smaller countries experience higher variability of their inflation differential in response to shocks to productivity growth. Moreover, we show that regional governments can suppress incipient inflation differentials associated with shocks to productivity growth by letting the income tax rate respond negatively to inflation differentials.
  • Topic: Development, Economics, International Trade and Finance
  • Political Geography: United States
  • Author: Gunter Coenen, Volker Wieland
  • Publication Date: 07-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In this paper we estimate a small macroeconometric model of the United States, the euro area and Japan with rational expectations and nominal rigidities due to staggered contracts. Comparing three popular contracting specifications we find that euro area and Japanese inflation dynamics are best explained by Taylor-style contracts, while Buiter-Jewitt/Fuhrer- Moore contracts perform somewhat better in fitting U.S. inflation dynamics. We are unable to fit Calvo-style contracts to inflation dynamics in any of the three economies without allowing either for ad-hoc persistence in unobservables or a significant backward-looking element. The completed model matches inflation and output dynamics in the United States, the euro area and Japan quite well. We then use it to evaluate the role of the exchange rate for monetary policy. Preliminary results, which are similar across the three economies, indicate little gain from a direct policy response to the exchange rate.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States, Japan, Israel
  • Author: Giancarlo Corsetti, Luca Dedola
  • Publication Date: 07-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper builds a baseline two-country model of real and monetary transmission under optimal international price discrimination. Distributing traded goods to consumers requires nontradables; because of distributive trade, the price elasticity of export demand depends on the exchange rate. Profit-maximizing monopolistic firms drive a wedge between wholesale and retail prices across countries. This entails possibly large deviations from the law of one price and incomplete pass-through on import prices. Yet, consistent with expenditure-switching effects, a nominal depreciation generally worsens the terms of trade. Moreover, the exchange rate and the terms of trade can be more volatile than fundamentals. For plausible ranges of the distribution margin, there can be multiple steady states, whereas large differences in nominal and real exchange rates across equilibria translate into small differences in consumption, employment and the price level. Finally, we show that with competitive goods markets international policy cooperation is redundant even under financial autarky.
  • Topic: Economics, Emerging Markets, International Trade and Finance
  • Political Geography: United States
  • Author: Brett Berger
  • Publication Date: 06-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper describes the numerical optimization methods used in Berger (2001) to find the complete time paths of key economic variables in neoclassical vintage capital models. An interior and a non-interior point method are discussed. Both of the methods are part of the general class of “path-following” algorithms. These algorithms can be efficiently applied to convex programming problems; and due to the standard shape of production and utility functions, many economic problems can be written as convex programming problems. Vintage capital models add scale and complexity to standard growth models because one must now handle the dynamics of multiple capital stocks. This increase in complexity will often prevent the discovery (or existence) of closed form solutions, making numerical solutions of the type found in Berger (2001) necessary.
  • Topic: Economics, Industrial Policy, International Trade and Finance
  • Political Geography: United States
  • Author: Christopher Gust, Jaime Marquez
  • Publication Date: 05-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: While information technologies (IT) are credited with the recent acceleration in productivity in the United States, many other industrial countries have not experienced a pickup in productivity growth. To explain this productivity divergence, we use panel data from 1992 to 1999 for 13 industrial countries and find that this divergence is driven in part by differences in both the production and adoption of information technologies. Based on this finding, we proceed to investigate what factors might play a role in explaining differences in IT adoption. Our results support the view that burdensome regulatory environments and in particular regulations affecting labor market practices have impeded the adoption of information technologies and slowed productivity growth in a number of industrial countries. We then develop a theoretical model with vintage capital and labor to evaluate the effect of more stringent labor market regulations on a firm's decision to adopt new technologies. We establish conditions under which a tax on firing workers delays the adoption of IT technology. These conditions occur when technological change is skill-biased and a firm must upgrade the quality of its workforce through labor turnover. The resulting delay in adopting IT technology then has negative implications for economy-wide productivity and is largely consistent with our empirical results.
  • Topic: Economics, International Trade and Finance, Science and Technology
  • Political Geography: United States
  • Author: Mark Carey
  • Publication Date: 05-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Resampling implementation of a stress-scenario approach to estimating portfolio default loss distributions is proposed as the basis for estimates of the appropriate absolute level of economic capital allocations for portfolio credit risk. Estimates are presented for stress scenarios of varying severity. Implications of use of different analysis time horizons are analyzed. Results for a numeraire portfolio are quite sensitive to such variations. Although the analysis is framed in terms of recent proposals to revise regulatory capital requirements for banks, the arguments and results are also relevant for bankers making capital structure decisions.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States
  • Author: David C. Smith, Allen N. Berger, Qinglei Dai, Steven Ongena
  • Publication Date: 05-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We model two dimensions of bank globalization – bank nationality (a bank from the firm's host nation, its home nation, or a third nation) and bank reach (a global, regional, or local bank) using a two-stage nested multinomial logit model. Our data set includes over 2,000 foreign affiliates of multinational corporations operating in 20 European nations. We find that these firms frequently use host nation banks for cash management services, and that bank reach may be strongly influenced by this choice of bank nationality. Our results suggest limits to the degree of future bank globalization.
  • Topic: Economics, Globalization, International Trade and Finance
  • Political Geography: United States
  • Author: Carol C. Bertaut
  • Publication Date: 04-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Although most recent empirical research regarding the size and significance of the impact of changes in wealth on consumption has looked for such effects in the United States, equity prices in the 1990s rose considerably in most other industrial countries as well. This paper investigates the strength of the wealth effect across countries. Using a variety of methods, I find evidence of significant wealth effects in the United Kingdom and Canada of a size comparable to that in the United States, reflecting the importance of equities in aggregate household wealth in these countries. A significant wealth effect is also evident in Japan, but because household wealth has changed little on balance in Japan in recent years, this channel has been less important in explaining Japanese consumption growth in the second half of the 1990s. Despite a rapid appreciation in equity prices and an increase in equity ownership in the major continental European countries since 1995, equities remain a less important form of household wealth in most of these countries, and the consumption response to changes in wealth remains limited. However, in some smaller European countries where equity issuance is more common, the emerging evidence suggests that wealth effects may be more important.
  • Topic: International Relations, Economics, Globalization, International Trade and Finance
  • Political Geography: United States, United Kingdom, Europe, Canada
  • Author: Francis E. Warnock, Chad Cleaver
  • Publication Date: 04-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We examine an assumption common in empirical work on bilateral portfolio capital flows that the countries the flows are attributed to are also the countries of the security's issuer, seller, or ultimate buyer. We do this by estimating U.S. investors' holdings of debt and equities in over 40 countries and, for the same countries, foreign investors' holdings of U.S. debt and equities. A comparison of our estimates with data from benchmark surveys provides insight into U.S. data on international debt and equity transactions. We find that, contrary to the common assumption, the data do not track the location of U.S. investment or the location of investors in U.S. assets very well. Because the U.S. portfolio flow data collection system was designed to measure cross-border transactions with foreign counterparties who are often intermediaries, the majority of the flows are attributed to financial centers. By aggregating our country-level estimates, we find that U.S. data accurately portray net inflows into U.S. equities and net outflows into foreign bonds. However, the data substantially overcount net inflows into U.S. bonds and may undercount net outflows into foreign equities. We conclude with a discussion of the implications of our findings for research on capital flows.
  • Topic: International Relations, Economics, International Trade and Finance
  • Political Geography: United States
  • Publication Date: 03-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Section 2504 of title 10, United States Code, requires that the Secretary of Defense submit an annual report to the Committee on Armed Services of the Senate and the Committee on Armed Services of the House of Representatives, by March 1st of each year. The report is to include:”(1) A description of the departmental guidance prepared pursuant to section 2506 of this title.(2) A description of the methods and analyses being undertaken by the Department of Defense alone or in cooperation with other Federal agencies, to identify and address concerns regarding technological and industrial capabilities of the national technology and industrial base.(3) A description of the assessments prepared pursuant to section 2505 of this title and other analyses used in developing the budget submission of the Department of Defense for the next fiscal year.(4) Identification of each program designed to sustain specific essential technological and industrial capabilities and processes of the national technology and industrial base.” This report contains the required information.
  • Topic: Defense Policy, Economics, Industrial Policy, Science and Technology
  • Political Geography: United States
  • Author: Ellen E. Meade, D. Nathan Sheets
  • Publication Date: 02-2002
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper looks at the monetary policy decisions of the U.S. Federal Reserve and asks whether those decisions have been influenced solely by national concerns, or whether regional factors have played a role. All of the Federal Reserve's policymakers have some regional identity, i.e., either their positions explicitly carry some regional affiliation or their region of origin is a factor that must be considered in the selection process. This research is relevant for the Fed, and it may also be relevant for Europe's fledgling central bank in Frankfurt. Critics have asserted that ECB policymakers have an incentive to base policy on national developments and respond to national political pressures. We find that Fed policymakers do take into account developments in regional unemployment when deciding monetary policy, and that these regional developments are more important for central bankers at the hub than in the spokes. These findings are robust to a variety of different specifications of the voting equation.
  • Topic: Economics, International Trade and Finance
  • Political Geography: United States, Europe