Working Papers 2012: Abstracts

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12-11: Private Liquidity and Banking Regulation by Cyril Monnet and Daniel R. Sanches

The authors show that the regulation of bank lending practices is necessary for the optimal provision of private liquidity. In an environment in which bankers cannot commit to repay their creditors, the authors show that neither an unregulated banking system nor narrow banking can provide the socially efficient amount of liquidity. If the bankers provided such an amount, then they would prefer to default on their liabilities. The authors show that a regulation that increases the value of the banking sector’s assets (e.g., by limiting competition in bank lending) will mitigate the commitment problem. If the value of the bank charter is made sufficiently large, then it is possible to implement an efficient allocation. Thus, the creation of a valuable bank charter is necessary for efficiency. PDF Icon (396 KB, 45 pages)

12-10: Nonlinear Adventures at the Zero Lower Bound by Jesús Fernández-Villaverde, Grey Gordon, Pablo Guerrón-Quintana, and Juan F. Rubio-Ramírez

Motivated by the recent experience of the U.S. and the Eurozone, the authors describe the quantitative properties of a New Keynesian model with a zero lower bound (ZLB) on nominal interest rates, explicitly accounting for the nonlinearities that the bound brings. Besides showing how such a model can be efficiently computed, the authors found that the behavior of the economy is substantially affected by the presence of the ZLB. In particular, the authors document 1) the unconditional and conditional probabilities of hitting the ZLB; 2) the unconditional and conditional probabilty distributions of the duration of a spell at the ZLB; 3) the responses of output to government expenditure shocks at the ZLB, 4) the distribution of shocks that send the economy to the ZLB; and 5) the distribution of shocks that keep the economy at the ZLB. PDF Icon (470 KB, 47 pages)

12-9: Forecast Bias in Two Dimensions, by Dean Croushore

Economists have tried to uncover stylized facts about people's expectations, testing whether such expectations are rational. Tests in the early 1980s suggested that expectations were biased, and some economists took irrational expectations as a stylized fact. But, over time, the results of tests that led to such a conclusion were reversed. In this paper, the author examines how tests for bias in expectations, measured using the Survey of Professional Forecasters, have changed over time. In addition, key macroeconomic variables that are the subject of forecasts are revised over time, causing problems in determining how to measure the accuracy of forecasts. The results of bias tests are found to depend on the subsample in question, as well as what concept is used to measure the actual value of a macroeconomic variable. Thus, the author's analysis takes place in two dimensions: across subsamples and with alternative measures of realized values of variables. PDF Icon (1.11 MB, 32 pages)

12-8: Market Run-Ups, Market Freezes, Inventories, and Leverage, by Philip Bond and Yaron Leitner

The authors study trade between a buyer and a seller who have existing inventories of assets similar to those being traded. They analyze how these inventories affect trade, information dissemination, and prices. The authors show that when traders' initial leverages are moderate, inventories increase price and trade volume (a market "run-up"), but when leverages are high, trade is impossible (a market "freeze"). Their analysis predicts a pattern of trade in which prices and volumes first increase, and then markets break down. Moreover, the presence of competing buyers may amplify the increased-price effect. The authors discuss implications for regulatory intervention in illiquid markets. PDF Icon (406 KB, 47 pages)

12-7: The Private Premium in Public Bonds, by Anna Kovner and Chenyang Wei

This paper is the first to document the presence of a private premium in public bonds. The authors find that spreads are 31 basis points higher for public bonds of private companies than for bonds of public companies, even after controlling for observable differences, including rating, financial performance, industry, bond characteristics and issuance timing. The estimated private premium increases to 40 to 50 basis points when a propensity matching methodology is used or when they control for fixed issuer effects. Despite the premium pricing, bonds of private companies are no more likely to default or be downgraded than are public bonds. They do not have worse secondary market performance or higher CDS spreads nor are they necessarily less liquid. Bond investors appear to discount the value of privately held equity. The effect does not come only from the lack of a public market signal of asset quality, because very small public companies also pay high spreads. PDF Icon (379 KB, 40 pages)

12-6: Financial Globalization, Inequality, and the Raising of Public Debt, by Marina Azzimonti, Eva de Francisco, and Vincenzo Quadrini

During the last three decades, the stock of government debt has increased in most developed countries. During the same period, the authors also observe a significant liberalization of international financial markets and an increase in income inequality in several industrialized countries. In this paper they propose a multicountry political economy model with incomplete markets and endogenous government borrowing and show that governments choose higher levels of public debt when financial markets become internationally integrated and inequality increases. The authors also conduct an empirical analysis using OECD data and find that the predictions of the theoretical model are supported by the empirical results. PDF Icon (708 KB, 53 pages)

12-5: Home Production and Social Security Reform, by Michael Dotsey, Wenli Li, and Fang Yang

This paper incorporates home production into a dynamic general equilibrium model of overlapping generations with endogenous retirement to study Social Security reforms. As such, the model differentiates both consumption goods and labor effort according to their respective roles in home production and market activities. Using a calibrated model, the authors find that eliminating the current pay-as-you-go Social Security system has important implications for both labor supply and consumption decisions and that these decisions are influenced by the presence of a home production technology. Comparing their benchmark economy to one with differentiated goods but no home production, the authors find that eliminating Social Security benefits generates larger welfare gains in the presence of home production. This result is due to the self insurance aspects generated by the presence of home production. Comparing their economy to a one-good economy without home production, the authors show that the welfare gains of eliminating Social Security are magnified even further. These policy analyses suggest the importance of modeling home production and distinguishing between both time use and consumption goods depending on whether they are involved in market or home production. PDF Icon (481 KB, 38 pages)

12-4: Bayesian Estimation of DSGE Models, by Pablo A. Guerrón-Quintana and James M. Nason

The authors survey Bayesian methods for estimating dynamic stochastic general equilibrium (DSGE) models in this article. They focus on New Keynesian (NK)DSGE models because of the interest shown in this class of models by economists in academic and policy-making institutions. This interest stems from the ability of this class of DSGE model to transmit real, nominal, and fiscal and monetary policy shocks into endogenous fluctuations at business cycle frequencies. Intuition about these propagation mechanisms is developed by reviewing the structure of a canonical NKDSGE model. Estimation and evaluation of the NKDSGE model rests on being able to detrend its optimality and equilibrium conditions, to construct a linear approximation of the model, to solve for its linear approximate decision rules, and to map from this solution into a state space model to generate Kalman filter projections. The likelihood of the linear approximate NKDSGE model is based on these projections. The projections and likelihood are useful inputs into the Metropolis-Hastings Markov chain Monte Carlo simulator that the authors employ to produce Bayesian estimates of the NKDSGE model. They discuss an algorithm that implements this simulator. This algorithm involves choosing priors of the NKDSGE model parameters and fixing initial conditions to start the simulator. The output of the simulator is posterior estimates of two NKDSGE models, which are summarized and compared to results in the existing literature. Given the posterior distributions, the NKDSGE models are evaluated with tools that determine which is most favored by the data. The authors also give a short history of DSGE model estimation as well as pointing to issues that are at the frontier of this research. PDF Icon (269 KB, 30 pages)

12-3: Common and Idiosyncratic Disturbances in Developed Small Open Economies, by Pablo A. Guerrón-Quintana

Using an estimated dynamic stochastic general equilibrium model, the author shows that shocks to a common international stochastic trend explain on average about 10 percent of the variability of output in several small developed economies. These shocks explain roughly twice as much of the volatility of consumption growth as the volatility of output growth. Country-specific disturbances account for the bulk of the volatility in the data. Substantial heterogeneity in the estimated parameters and stochastic processes translates into a rich array of impulse responses across countries. PDF Icon (494 KB, 46 pages)

12-2/R: Exogenous vs. Endogenous Separation, by Shigeru Fujita and Garey Ramey

This paper assesses how various approaches to modeling the separation margin affect the quantitative ability of the Mortensen-Pissarides labor matching model. The model with a constant separation rate fails to produce realistic volatility and productivity responsiveness of the separation rate and worker flows. The specification with endogenous separation succeeds along these dimensions. Allowing for on-the-job search enables the model to replicate the Beveridge curve. All specifications, however, fail to generate sufficient volatility of the job finding rate. While adopting the Hagedorn-Manovskii calibration remedies this problem, the volume of job-to-job transitions in the on-the-job search specification becomes essentially zero. PDF Icon (349 KB, 29 pages)

12-1: The Macroeconomics of Firms' Savings, by Roc Armenter and Viktoria Hnatkovska

The authors document that the U.S. non-financial corporate sector became a net lender in the 2000s, using aggregate and firm-level data. They develop a structural model with investment, debt, and equity. Debt is fiscally advantageous but subject to a no-default borrowing constraint. Equity allows the firm to suspend dividends when the cash flow is negative. Firms accumulate financial assets for precautionary reasons, yet value equity as partial insurance against shocks. The calibrated model replicates the prevalence of net savings in the period 2000-2007 and attributes the rise in corporate savings over the past 40 years to lower dividend taxes. PDF Icon (534 KB, 48 pages)