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2. Risk Choices and Compensation Design
- Author:
- Mark Carey and Bo Sun
- Publication Date:
- 01-2015
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- We analyze the impact of bad-tail risks on managerial pay functions, especially the decision to pay managers in stock or in options. In contrast to conventional wisdom, we find that options are often a superior vehicle for limiting managerial incentives to take bad-tail risks while providing incentives to exert effort. Arrangements similar to collar options are able to incent the desired project choice in wider range of circumstances than call options or stock. However, information requirements appear high. We briefly explore alternatives with features similar to maluses and clawbacks, which are a bit like weakening the limited liability of managers.
- Topic:
- Labor Issues, Risk, Business Management, Stock Markets, and Wage Growth
- Political Geography:
- Global Focus
3. Large Capital Inflows, Sectoral Allocation, and Economic Performance
- Author:
- Gianluca Benigno, Nathan Converse, and Luca Fornaro
- Publication Date:
- 03-2015
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- This paper describes the stylized facts characterizing periods of exceptionally large capital inflows in a sample of 70 middle- and high-income countries over the last 35 years. We identify 155 episodes of large capital inflows and find that these events are typically accompanied by an economic boom and followed by a slump. Moreover, during episodes of large capital inflows capital and labor shift out of the manufacturing sector, especially if the inflows begin during a period of low international interest rates. However, accumulating reserves during the period in which capital inflows are unusually large appears to limit the extent of labor reallocation. Larger credit booms and capital inflows during the episodes we identify increase the probability of a sudden stop occurring during or immediately after the episode. In addition, the severity of the post-inflows recession is significantly related to the extent of labor reallocation during the boom, with a stronger shift of labor out of manufacturing during the inflows episode associated with a sharper contraction in the aftermath of the episode.
- Topic:
- Industrial Policy, Labor Issues, Capital Flows, Manufacturing, and Capital
- Political Geography:
- Global Focus
4. Risk, Financial Development and Firm Dynamics
- Author:
- Bernardo Morias
- Publication Date:
- 05-2015
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- I document that the average productivity of firms tends to increase, and its variance to decrease, as they age. These two facts combined suggest that managers learn to reduce their mistakes as they operate. I develop a quantitative framework mimicking these dynamics and find that young firms have substantially higher financing costs due to lower and riskier returns. In this scenario, a reduction in the financial development of an economy raises disproportionately the cost of credit of young-productive firms increasing the input misallocation within this subgroup. To test the validity of the theory, I find that the data confirms some novel predictions on a series of firm-level moments. Finally, I show that introducing these two facts allows the model to better explain the relation between financial and economic development.
- Topic:
- Development, Economic Theory, Risk, Fiscal Policy, Models, and Productivity
- Political Geography:
- Global Focus
5. International Financial Spillovers to Emerging Market Economies: How Important Are Economic Fundamentals?
- Author:
- Shaghil Ahmed, Brahima Coulibaly, and Andrei Zlate
- Publication Date:
- 05-2015
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- We assess the importance of economic fundamentals in the transmission of international shocks to financial markets in various emerging market economies (EMEs). Our analysis covers the so-called taper-tantrum episode of 2013 and six earlier episodes of severe EME-wide financial stress since the mid-1990s. Cross-country regressions lead us to the following results: (1) EMEs with relatively better economic fundamentals suffered less deterioration in financial markets during the 2013 taper-tantrum episode. (2) Differentiation among EMEs set in quite early and persisted throughout this episode. (3) Controlling for economic fundamentals, we also find that, during the taper tantrum, financial conditions deteriorated more in those EMEs that had earlier experienced larger private capital inflows and greater exchange rate appreciation. (4) For earlier episodes, we find little evidence of investor differentiation across EMEs being explained by differences in their relative vulnerabilities during EME crises of the 1990s and early 2000s. (5) That said, differentiation across EMEs based on fundamentals does not appear to be unique to the 2013 episode. Differences in economic fundamentals played a role in explaining the heterogeneous EME financial market responses during the global financial crisis of 2008, and the role of fundamentals appeared to progressively increase through the European crisis in 2011 and subsequently the 2013 taper tantrum.
- Topic:
- Economics, Emerging Markets, Markets, Exchange Rate Policy, Fiscal Policy, and Economic Crisis
- Political Geography:
- Global Focus
6. Inference Based on SVARs Identified with Sign and Zero Restrictions: Theory and Applications
- Author:
- Jonas E. Arias, Juan F. Rubio-Ramirez, and Daniel F. Waggoner
- Publication Date:
- 03-2014
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- Are optimism shocks an important source of business cycle fluctuations? Are deficit-financed tax cuts better than deficit-financed spending to increase output? These questions have been previously studied using SVARs identified with sign and zero restrictions and the answers have been positive and definite in both cases. While the identification of SVARs with sign and zero restrictions is theoretically attractive because it allows the researcher to remain agnostic with respect to the responses of the key variables of interest, we show that current implementation of these techniques does not respect the agnosticism of the theory. These algorithms impose additional sign restrictions on variables that are seemingly unrestricted that bias the results and produce misleading confidence intervals. We provide an alternative and efficient algorithm that does not introduce any additional sign restriction, hence preserving the agnosticism of the theory. Without the additional restrictions, it is hard to support the claim that either optimism shocks are an important source of business cycle fluctuations or deficit-financed tax cuts work best at improving output. Our algorithm is not only correct but also faster than current ones.
- Topic:
- Economics, Business, Tax Systems, Economic Theory, and Deficit
- Political Geography:
- Global Focus
7. Sovereign Debt Crises
- Author:
- Ricardo Correa and Horacio Sapriza
- Publication Date:
- 05-2014
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- Sovereign debt crises have been recurrent events over the past two centuries. In recent years, the timing of sovereign crises has coincided or has directly followed banking crises. The link between sovereigns and banks tightened as the contingent liability that the banking sector represents for the sovereign grew, as financial "safety nets" became more common. This chapter analyzes the transmission channels between sovereigns and banks, with a focus on the effect of sovereign distress on bank solvency and financing. It then highlights the notable cost to the real economy of the close connection between sovereigns and banks. Breaking the "feedback loop" between these two sectors should be an important policy priority.
- Topic:
- Debt, Sovereignty, Banking, and Economic Crisis
- Political Geography:
- Global Focus
8. The Decline of Drudgery and the Paradox of Hard Work
- Author:
- Brendan Epstein and Miles S. Kimball
- Publication Date:
- 06-2014
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- We develop a theory that focuses on the general equilibrium and long-run macroeconomic consequences of trends in job utility. Given secular increases in job utility, work hours per capita can remain approximately constant over time even if the income effect of higher wages on labor supply exceeds the substitution effect. In addition, secular improvements in job utility can be substantial relative to welfare gains from ordinary technological progress. These two implications are connected by an equation flowing from optimal hours choices: improvements in job utility that have a significant effect on labor supply tend to have large welfare effects.
- Topic:
- Labor Issues, Economic Theory, Welfare, Social Services, and Wage Growth
- Political Geography:
- Global Focus
9. Understanding the Great Recession
- Author:
- Lawrence J. Christiano, Martin Eichenbaum, and Mathias Trabandt
- Publication Date:
- 06-2014
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- We argue that the vast bulk of movements in aggregate real economic activity during the Great Recession were due to financial frictions. We reach this conclusion by looking through the lens of an estimated New Keynesian model in which firms face moderate degrees of price rigidities, no nominal rigidities in the wages and a binding zero lower bound constraint on the nominal interest rate. Our model does a good job of accounting for the joint behavior of labor and goods markets, as well as inflation, during the Great Recession. According to the model the observed fall in total factor productivity and the rise in the cost of working capital played critical roles in accounting for the small size of the drop in inflation that occurred during the Great Recession.
- Topic:
- Global Recession, Financial Crisis, Economic Theory, Interest Rates, Models, and Economic Crisis
- Political Geography:
- Global Focus
10. Taxes and International Risk Sharing
- Author:
- Brendan Epstein, Rahul Mukherjee, and Shanthi Ramnath
- Publication Date:
- 06-2014
- Content Type:
- Commentary and Analysis
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- We examine the extent to which differences in international tax rates may account for the small correlations of per capita consumption fluctuations across countries. Theory implies a close relationship between relative consumption growth, and consumption and capital income tax rate differentials. We find strong empirical evidence for this relationship. Idiosyncratic output fluctuations account for the majority of cross country consumption growth variability, but trends in tax differentials are informative about the dynamic evolution of international risk sharing. In particular, adjusting for capital taxes reveals an intuitive positive relationship between financial connectedness and risk sharing that is absent in baseline measures.
- Topic:
- Tax Systems, Risk, Capital, and Consumerism
- Political Geography:
- Global Focus