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FRB: Working Papers

Staff working papers in the Finance and Economics Discussion Series (FEDS) and International Finance Discussion Papers (IFDPS) are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are th


FEDS 2018-028: Optimal Public Debt with Life Cycle Motives

Fri, 20 Apr 2018 15:00:00 GMT

William B. Peterman and Erick Sager | Public debt can be optimal in standard incomplete market models with infinitely lived agents, since the associated capital crowd-out induces a higher interest rate. The higher interest rate encourages individuals to save and, hence, better self-insure against idiosyncratic labor earnings risk. Even though individual savings behavior is a crucial determinant of the optimality of public debt, this class of economies abstracts from empirically observed life cycle savings patterns. Thus, this paper studies how incorporating a life cycle affects optimal public debt. We find that while the infinitely lived agent model's optimal policy is public debt equal to 24% of output, the life cycle model's optimal policy is public savings equal to 61% of output. Although public debt also encourages life cycle agents to hold more savings during their lifetimes, the act of accumulating this savings mitigates the potential welfare benefit. Moreover, public savings improves life cycle agents' welfare by encouraging a flatter allocation of consumption and leisure over their lifetimes. Accordingly, abstracting from the life cycle yields an optimal policy that reduces average welfare by more than 0.6% of expected lifetime consumption. Furthermore, ignoring the life cycle overstates the influence of wealth inequality on optimal policy, since optimal policy is far less sensitive to wealth inequality in the life cycle model than in the infinitely lived agent model. These results demonstrate that studying optimal debt policy in an infinitely lived agent model, which abstracts from the realism of a life cycle in order to render models more computationally tractable, is not without loss of generality.

IFDP 2018-1226: Measuring Monetary Policy Spillovers between U.S. and German Bond Yields

Thu, 19 Apr 2018 12:10:00 GMT

Stephanie E. CurcuruMichiel De Pooter, and George Eckerd | In this paper we estimate the magnitude of spillovers between bond markets in the U.S. and Germany following monetary policy communications by the FOMC and the ECB. The identification of policy-related co-movements following FOMC announcements, in particular, can be difficult because many foreign bond markets, including those in Germany, are closed at the time of the announcement. To address this issue we use intraday futures market data to estimate spillovers during a narrow and overlapping event window. We find that about half of the reaction in German domestic yields spills over to U.S. yields following ECB announcements, which is nearly identical to the spillover from U.S. yields to German Bund yields following FOMC announcements. This result contrasts with the conventional wisdom that FOMC announcements spill over to other countries but that there is not much effect in the other direction. We also find that spillover estimates are slightly higher in the post-crisis period, but that there is little difference in the spillover impact
of conventional versus unconventional monetary policy. Our results based on futures prices differ noticeably from those using daily prices, which suggests that spillover estimates based on cash market data can be misleading.

FEDS 2018-027: The Regulatory and Monetary Policy Nexus in the Repo Market

Tue, 17 Apr 2018 16:40:00 GMT

Sriya Anbil and Zeynep Senyuz | We examine the interaction of regulatory reforms and changes in monetary policy in the U.S. repo market. Using a proprietary data set of repo transactions, we find that differences in regional implementation of Basel III capital reforms intensified European dealers' window-dressing by 80%. Money funds eligible to use the Fed's reverse repo (RRP) facility cut their private lending almost by half and instead lent to the Fed when European dealers withdraw, contributing to smooth implementation of Basel III. In a difference-in-differences setting, we show that ineligible funds lent 15% less to European dealers as they find their withdrawal for reporting purposes inconvenient. We find that intermediation through the RRP led to quantity and not pricing adjustments in the market, which is consistent with the RRP facility anchoring market rates.

FEDS 2018-026: The Fed's Asymmetric Forecast Errors

Mon, 16 Apr 2018 15:10:00 GMT

Andrew C. Chang | I show that the probability that the Board of Governors of the Federal Reserve System staff's forecasts (the "Greenbooks") overpredicted quarterly real gross domestic product (GDP) growth depends on both the forecast horizon and also whether the forecasted quarter was above or below trend real GDP growth. For forecasted quarters that grew below trend, Greenbooks were much more likely to overpredict real GDP growth, with one-quarter ahead forecasts overpredicting real GDP growth more than 75% of the time, and this rate of overprediction was higher for further ahead forecasts. For forecasted quarters that grew above trend, Greenbooks were slightly more likely to underpredict real GDP growth, with one-quarter ahead forecasts underpredicting growth about 60% of the time. Unconditionally, on average, Greenbooks overpredicted real GDP growth.

FEDS 2018-025: A Day Late and a Dollar Short: Liquidity and Household Formation among Student Borrowers

Fri, 13 Apr 2018 19:15:00 GMT

Sarena Goodman, Adam Isen, and Constantine Yannelis | The federal government encourages human capital investment through lending and grant programs, but resources from these programs may also finance non-education activities for students whose liquidity is otherwise restricted. This paper explores this possibility, using administrative data for the universe of federal student loan borrowers linked to tax records. We examine the effects of a sharp discontinuity in program limits—generated by the timing of a student borrower's 24th birthday—on household formation early in the lifecycle. After demonstrating that this discontinuity induces a jump in federal support, we estimate an immediate and persistent increase in homeownership, with larger effects among those most financially constrained. In the first year, borrowers with higher limits also earn less but are more likely to save; however, there are no differences in subsequent years. Finally, effects on marriage and fertility lag homeownership. Altogether, the results appea r to be driven by liquidity rather than human capital or wealth effects.

FEDS 2018-024: How much has wealth concentration grown in the United States? A re-examination of data from 2001-2013

Fri, 13 Apr 2018 18:46:00 GMT

Jesse Bricker, Alice Henriques, and Peter Hansen | Well known research based on capitalized income tax data shows robust growth in wealth concentration in the late 2000s. We show that these robust growth estimates rely on an assumption---homogeneous rates of return across the wealth distribution---that is not supported by data. When the capitalization model incorporates heterogeneous rates of return (on just interest-bearing assets), wealth concentration estimates in 2011 fall from 40.5% to 33.9%. These estimates are consistent in levels and trend with other micro wealth data and show that wealth concentration increases until the Great Recession, then declines before increasing again.

FEDS 2018-023: New Perspectives on the Decline of U.S. Manufacturing Employment

Fri, 13 Apr 2018 18:45:00 GMT

Teresa C. Fort, Justin R. Pierce, and Peter K. Schott | We use relatively unexplored dimensions of US microdata to examine how US manufacturing employment has evolved across industries, firms, establishments, and regions from 1977 to 2012. We show that these data provide support for both trade- and technology-based explanations of the overall decline of employment over this period, while also highlighting the difficulties of estimating an overall contribution for each mechanism. Toward that end, we discuss how further analysis of these trends might yield sharper insights.

IFDP 2018-1225: Structural Change and Global Trade

Tue, 10 Apr 2018 18:05:00 GMT

Logan T. Lewis, Ryan Monarch, Michael Sposi, and Jing Zhang | Services, which are less traded than goods, rose from 50 percent of world expenditure in 1970 to 80 percent in 2015. Such structural change restrained "openness"--the ratio of world trade to world GDP--over this period. We quantify this with a general equilibrium trade model featuring non-homothetic preferences and input-output linkages. Openness would have been 70 percent in 2015, 23 percentage points higher than the data, if expenditure patterns were unchanged from 1970. Structural change is critical for estimating the dynamics of trade barriers and welfare gains from trade. Ongoing structural change implies declining openness, even absent rising protectionism.

FEDS 2018-022: Collateral Runs

Wed, 4 Apr 2018 15:00:00 GMT

Sebastian Infante and Alexandros P. Vardoulakis | This paper models an unexplored source of liquidity risk faced by large broker-dealers: collateral runs. By setting different contracting terms on repurchase agreements with cash borrowers and lenders, dealers can source funds for their own activities. Cash borrowers internalize the risk of losing their collateral in case their dealer defaults, prompting them to withdraw it. This incentive creates strategic complementarities for counterparties to withdraw their collateral, reducing a dealer's liquidity position and compromising her solvency. Collateral runs are markedly different than traditional wholesale funding runs because they are triggered by a contraction in dealers' assets, rather than their liabilities.

IFDP 2018-1224: Searching for Yield Abroad: Risk-Taking Through Foreign Investment in U.S. Bonds

Wed, 28 Mar 2018 20:00:00 GMT

John Ammer, Stijn Claessens, Alexandra Tabova, and Caleb Wroblewski | The risk-taking effects of low interest rates, now prevailing in many advanced countries, "search-for-yield," can be hard to analyze due to both a paucity of data and challenges in identification. Unique, security-level data on portfolio investment into the United States allow us to overcome both problems. Analyzing holdings of investors from 36 countries in close to 15,000 unique U.S. corporate bonds between 2003 and 2016, we show that declining home-country interest rates lead investors to shift their portfolios toward riskier U.S. corporate bonds, consistent with "search-for-yield". We estimate even stronger effects when home interest rates reach a low level, suggesting that risk-taking further accelerates.

FEDS 2018-021: Spectral backtests of forecast distributions with application to risk management

Fri, 23 Mar 2018 15:00:00 GMT

Michael B. Gordy and Alexander J. McNeil | We study a class of backtests for forecast distributions in which the test statistic is a spectral transformation that weights exceedance events by a function of the modeled probability level. The choice of the kernel function makes explicit the user's priorities for model performance. The class of spectral backtests includes tests of unconditional coverage and tests of conditional coverage. We show how the class embeds a wide variety of backtests in the existing literature, and propose novel variants as well. In an empirical application, we backtest forecast distributions for the overnight P&L of ten bank trading portfolios. For some portfolios, test results depend materially on the choice of kernel.

FEDS 2018-020: The Impact of the Current Expected Credit Loss Standard (CECL) on the Timing and Comparability of Reserves

Fri, 9 Mar 2018 14:00:00 GMT

Sarah Chae, Robert F. Sarama, Cindy M. Vojtech, and James Wang | The new forward-looking credit loss provisioning standard, CECL, is intended to promote proactive provisioning as loan loss reserves can be conditioned on expectations of the economic cycle. We study the degree to which one modeling decision--expectations about the path of future house prices--affects the size and timing of provisions for first-lien residential mortgage portfolios. While we find that provisions are generally less pro-cyclical compared to the current incurred loss standard, CECL may complicate the comparability of provisions across banks and time. Market participants will need to disentangle the degree to which variation in provisions across firms is driven by underlying risk versus differences in modeling assumptions.

FEDS 2018-019: "Unconventional" Monetary Policy as Conventional Monetary Policy: A Perspective from the U.S. in the 1920s

Fri, 9 Mar 2018 13:56:00 GMT

Mark Carlson and Burcu Duygan-Bump | To implement monetary policy in the 1920s, the Federal Reserve utilized administered interest rates and conducted open market operations in both government securities and private money market securities, sometimes in fairly considerable amounts. We show how the Fed was able to effectively use these tools to influence conditions in money markets, even those in which it was not an active participant. Moreover, our results suggest that the transmission of monetary policy to money markets occurred not just through changing the supply of reserves but importantly through financial market arbitrage and the rebalancing of investor portfolios. The tools used in the 1920s by the Federal Reserve resemble the extraordinary monetary policy tools used by central banks recently and provide further evidence on their effectiveness even in ordinary times.

FEDS 2017-018: Liquidity Requirements, Free-Riding, and the Implications for Financial Stability Evidence from the early 1900s

Fri, 9 Mar 2018 13:55:00 GMT

Mark Carlson and Matthew Jaremski | Maintaining sufficient liquidity in the financial system is vital for financial stability. However, since returns on liquid assets are typically low, individual financial institutions may seek to hold fewer such assets, especially if they believe they can rely on other institutions for liquidity support. We examine whether state banks in the early 1900s took advantage of relatively high cash balances maintained by national banks, due to reserve requirements, to hold less cash themselves. We find that state banks did hold less cash in places where both state legal requirements were lower and national banks were more prevalent

FEDS 2018-017: Transparency and collateral: central versus bilateral clearing

Thu, 8 Mar 2018 20:35:00 GMT

Gaetano Antinolfi, Francesca Carapella, and Francesco Carli | Bilateral financial contracts typically require an assessment of counterparty risk. Central clearing of these financial contracts allows market participants to mutualize their counterparty risk, but this insurance may weaken incentives to acquire and to reveal information about such risk. When considering this trade-off, participants would choose central clearing if information acquisition is incentive compatible. If it is not, they may prefer bilateral clearing, when this choice prevents strategic default while economizing on costly collateral. In either case, participants independently choose the efficient clearing arrangement. Consequently, central clearing can be socially inefficient under certain circumstances. These results stand in contrast to those in Achary and Bisin (2014), who find that central clearing is always the optimal clearing arrangement.