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  • Author: Daniel O. Beltran, Maxwell Kretchmer, Jaime Marquez, Charles Thomas
  • Publication Date: 01-2012
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Foreign official holdings of U.S. Treasuries increased from $400 billion in January 1994 to about $3 trillion in June 2010. Most of this growth is accounted for by a handful of emerging market economies that have been running large current account surpluses. These countries are channeling their savings through the official sector, which is then acquiring foreign exchange reserves. Any shift in policy to reduce their current account surpluses or dampen the rate of reserves accumulation would likely slow the pace of foreign official purchases of U.S. Treasuries. Would such a slowing of foreign official purchases of Treasury notes and bonds affect long-term Treasury yields? Most likely yes, and the effects appear to be large. By our estimates, if foreign official inflows into U.S. Treasuries were to decrease in a given month by $100 billion, 5-year Treasury rates would rise by about 40-60 basis points in the short run. But once we allow foreign private investors to react to the yield change induced by the shock to foreign official inflows, the long-run effect is about 20 basis points.
  • Topic: Economics, International Cooperation, Foreign Direct Investment, Fiscal Policy
  • Political Geography: North America, United States of America
  • Author: Brahima Coulibaly
  • Publication Date: 02-2012
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: During the 2008-2009 global financial crisis, emerging market economies (EMEs) loosened monetary policy considerably to cushion the shock. In previous crises episodes, by contrast, EMEs generally had to tighten monetary policy to defend the value of their currencies, to contain capital flight, and to bolster policy credibility. Our study aims to understand the factors that enabled this remarkable shift in monetary policy, and also to assess whether this marks a new era in which EMEs can now conduct countercyclical policy, more in line with advanced economies. The results indicate statistically significant linkages between some characteristics of the economies and their ability to conduct countercyclical monetary policy. We find that macroeconomic fundamentals and lower vulnerabilities, openness to trade, and international capital flows, financial reforms, and the adoption of inflation targeting all facilitated the conduct of countercyclical policy. Of these factors, the most important have been the financial reforms achieved over the past decades and the adoption of inflation targeting. As long as EMEs maintain these strong economic fundamentals, continue to reform their financial sector, and adopt credible and transparent monetary policy frameworks such as inflation targeting, the conduct of countercyclical monetary policy will likely be sustainable.
  • Topic: Economics, Emerging Markets, Monetary Policy, Global Financial Crisis
  • Political Geography: Global Focus
  • Author: Christopher J. Erceg, Jesper Linde
  • Publication Date: 04-2012
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper uses a New Keynesian DSGE model of a small open economy to compare how the e¤ects of fiscal consolidation di¤er depending on whether monetary policy is constrained by currency union membership or by the zero lower bound on policy rates. We show that there are important di¤erences in the impact of fiscal shocks across these monetary regimes that depend both on the duration of the zero lower bound and on features that determine the responsiveness of inflation.
  • Topic: Economics, Economic Theory, Fiscal Policy, Consolidation
  • Political Geography: Global Focus
  • Author: Mathias Trabandt, Harald Uhlig
  • Publication Date: 05-2012
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We seek to understand how Laffer curves differ across countries in the US and the EU-14, thereby providing insights into fiscal limits for government spending and the service of sovereign debt. As an application, we analyze the consequences for the permanent sustainability of current debt levels, when interest rates are permanently increased e.g. due to default fears. We build on the analysis in Trabandt and Uhlig (2011) and extend it in several ways. To obtain a better fit to the data, we allow for monopolistic competition as well as partial taxation of pure profit income. We update the sample to 2010, thereby including recent increases in government spending and their fiscal consequences. We provide new tax rate data. We conduct an analysis for the pessimistic case that the recent fiscal shifts are permanent. We include a cross-country analysis on consumption taxes as well as a more detailed investigation of the inclusion of human capital considerations for labor taxation.
  • Topic: Economics, Economic Theory, Human Capital, Fiscal Policy
  • Political Geography: Global Focus
  • Author: Nathan Foley-Fisher, Bernardo Guimaraes
  • Publication Date: 08-2012
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper empirically investigates the impact of changes in U.S. real interest rates on sovereign default risk in emerging economies using the method of identification through heteroskedasticity. Policy-induced increases in U.S. interest rates starkly raise default risk in emerging market economies. However, the overall correlation between U.S. real interest rates and the risk of default is negative, demonstrating that the effects of other variables dominate the anterior relationship.
  • Topic: Economics, Interest Rates, Risk, Fiscal Policy
  • Political Geography: North America, United States of America
  • Author: Etienne Gagnon, David López-Salido, Nicholas Vincent
  • Publication Date: 08-2012
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Firms employ a rich variety of pricing strategies whose implications for aggregate price dynamics often diverge. This situation poses a challenge for macroeconomists interested in bridging micro and macro price stickiness. In responding to this challenge, we note that differences in macro price stickiness across pricing mechanisms can often be traced back to price changes that are either triggered or cancelled by shocks. We exploit observed micro price behavior to quantify the importance of this margin of adjustment for the response of inflation to shocks. Across a range of empirical exercises, we find strong evidence that changes in the timing of price adjustments contribute significantly to the flexibility of the aggregate price level.
  • Topic: Economics, Monetary Policy, Inflation, Price
  • Political Geography: Global Focus
  • Author: Lutz Kilian, Robert J. Vigfusson
  • Publication Date: 01-2011
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: It is customary to suggest that the asymmetry in the transmission of oil price shocks to real output is well established. Much of the empirical work cited as being in support of asymmetries, however, has not directly tested the hypothesis of an asymmetric transmission of oil price innovations. Moreover, many of the papers quantifying these asymmetric responses are based on censored oil price VAR models which recently have been shown to be invalid. Other studies are based on dynamic correlations in the data that do not shed light on the central question of whether the structural responses of real output triggered by positive and negative oil price innovations are asymmetric. Recently, a number of new methodologies have been introduced and applied to the problem of testing and quantifying asymmetric responses of U.S. real economic activity to positive and negative oil price innovations. Our objective is to put this literature in perspective, to contrast it with more traditional approaches, to highlight directions for further research, and to reconcile some seemingly conflicting results reported in the literature.
  • Topic: Economics, Energy Policy, International Trade and Finance, Oil, Natural Resources
  • Political Geography: North America, United States of America
  • Author: Stephanie E. Curcuru, Charles Thomas, Francis E. Warnock, Jon Wongswan
  • Publication Date: 02-2011
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Counter to extant stylized facts, using newly available data on country allocations in U.S. investors' foreign equity portfolios we find that (i) U.S. investors do not exhibit returns-chasing behavior, but, consistent with partial portfolio rebalancing, tend to sell past winners; and (ii) U.S. investors increase portfolio weights on a country's equity market just prior to its strong performance, behavior inconsistent with an informational disadvantage. Over the past two decades, U.S. investors' foreign equity portfolios outperformed a value-weighted foreign benchmark by 160 basis points per year.
  • Topic: Economics, Finance, Investment, Stock Markets, Equity
  • Political Geography: North America, United States of America
  • Author: Joseph W. Gruber, Flippo di Mauro, Bernd Schnatz, Nico Zorell
  • Publication Date: 03-2011
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Global and U.S. trade declined dramatically in the wake of the global financial crisis in late 2008 and early 2009. The subsequent recovery in trade, while vigorous at first, gradually lost momentum in 2010. Against this backdrop, this paper explores the prospects for global and U.S. trade in the medium term. We develop a unified empirical framework – an error correction model – that exploits the cointegrating relationship between trade and economic activity. The model allows us to juxtapose several scenarios with different assumptions about the strength of GDP growth going forward and the relationship between trade and economic activity. Our analysis suggests that during the crisis both world trade and U.S. exports declined significantly more than would have been expected on the basis of historical relationships with economic activity. Moreover, this gap between actual and equilibrium trade is closing only slowly and could persist for some time to come.
  • Topic: Economics, International Cooperation, International Trade and Finance, Financial Crisis
  • Political Geography: North America, United States of America
  • Author: David Bowman, Fang Cai, Sally Davies, Steve Kamin
  • Publication Date: 06-2011
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Prior to the recent financial crisis, one of the most prominent examples of unconventional monetary stimulus was Japan's "quantitative easing policy" (QEP). Most analysts agree that QEP did not succeed in stimulating aggregate demand sufficiently to overcome persistent deflation. However, it remains unclear whether QEP simply provided little stimulus, or whether its positive effects were overwhelmed by the contractionary forces in Japan's post-bubble economy. In the spirit of Kashyap and Stein (2000) and Hosono (2006), this paper uses bank-level data from 2000 to 2009 to examine the effectiveness in promoting bank lending of a key element of QEP, the Bank of Japan's injections of liquidity into the interbank market. We identify a robust, positive, and statistically significant effect of bank liquidity positions on lending, suggesting that the expansion of reserves associated with QEP likely boosted the flow of credit. However, the overall size of that boost was probably quite small. First, the estimated response of lending to liquidity positions in our regressions is small. Second, much of the effect of the BOJ's reserve injections on bank liquidity was offset as banks reduced their lending to each other. Finally, the effect of liquidity on lending appears to have held only during the initial years of QEP, when the banking system was at its weakest; by 2005, even before QEP was abandoned, the relationship between liquidity and lending had evaporated.
  • Topic: Economics, Financial Crisis, Lending, Banking
  • Political Geography: Japan, Asia