Working Papers
Stimulating discussion and critical comment on research in progress.
1998
- WP 98-23
- Central Bank Intervention and Overnight Uncovered Interest Rate Parity
- This paper considers the impact of U.S. and German central bank intervention on the risk premium in forward foreign exchange markets. The model estimation is facilitated with the use of daily data on overnight Eurocurrency deposit rates, so that the interest rate maturity time of one day matches the sampling interval of the data. We also use the official net daily purchases and sales of dollars vis-à-vis the German Mark by the Federal Reserve System and the Bundesbank. The model involves FIGARCH innovations to model the degree of long term dependence in the volatility process. Some support is found for the intervention variables affecting the risk premium as predicted by theory. The impact of intervention in the two years immediately following the meltdown of the equity markets in October 1987 is particularly strong. (PDF)
- WP 98-22
- Sources of business cycles in Korea and the United States
- The authors estimate common and nation-specific components of technology shocks, real demand shocks, and combined (common and nation-specific) monetary shocks using quarterly data for Korea and the United States (PDF)
- WP 98-21
- Private Money Creation and the Suffolk Banking System
- While much has been written on the history of the Suffolk Banking System, somewhat surprisingly (to our knowledge) no attempt has been made to formally model its monetary consequences. In this paper we attempt to fill this gap. (PDF)
- WP 98-20
- Will Electronic Money be Adopted in the United States?
- Although the cashless society has been predicted for at least twenty years, the new forms of card-based and software-based electronic money may prove to be a partial alternative to the current forms of payments. This paper examines their possible adoption, primarily in the United States. (PDF)
- WP 98-19
- Price-level and interest-rate targeting in a model with sticky prices
- An examination of a standard sticky-price monetary model whose conditions are perturbed relative to the canonical real-business-cycle model by two varying distortions: marginal cost and the nominal rate of interest. The paper explores the implications of two monetary policies that are frequently advocated: (1) an inflation target and (2) an interest rate target. (PDF)
- WP 98-18R
- Real indeterminacy in monetary models with nominal interest rate distortions: the problem with inflation targets
- This paper demonstrates that in a standard monetary model with a cash-in-advance constraint on consumption there exists real indeterminacy whenever the nominal interest rate moves too closely with the real rate. A particular example of such a policy is an inflation rate target. This is not a knife-edge result. The conclusion is robust to a wide range of calibrations and to a monetary environment that allows for endogenous velocity. (PDF)
- WP 98-17
- Non-par banking: competition and monopoly in markets for payments services
- Once the Federal Reserve Banks started providing par interbank funds transfers, their check collection service was unnecessary to bring nationwide par check collection in competitive banking markets. The survival of non-par banks probably reflected the absence of competition in the markets where they operated. The empirical evidence is consistent with this conclusion, since non-par banks typically were monopolists in isolated rural markets for banking services. (PDF)
- WP 98-16
- Evolutionary Programming as a Solution Technique for the Bellman Equation
- Evolutionary programming is a stochastic optimization procedure which has proved useful in optimizing difficult functions. It is shown that evolutionary programing can be used to solve the Bellman equation problem with a high degree of accuracy and substantially less CPU time than Bellman equation iteration. Future applications will focus on sometimes binding constraints - a class of problem for which standard solutions techniques are not applicable. (PDF)
- WP 98-15
- The Federal Reserve as an informed foreign-exchange trader
- U.S. exchange-market intervention has no apparent effect on market fundamentals but may influence expectations. If intervention can accurately forecast exchange-rate movements, knowledge that the Federal Reserve is trading can alter traders’ prior estimates of the distribution of exchange-rate changes. This paper finds that U.S. intervention has value only as a forecast that recent exchange-rate movements will moderate but not that they will reverse. (PDF)
- WP 98-14
- Earnings and Wealth Inequality and Income Taxation. Quantifying the Trade-Offs of Switching to a Proportional Income Tax in the U.S.
- This paper quantifies the steady-state aggregate, distributional and mobility effects of switching the U.S. to a proportional income tax system. (PDF)
- WP 98-13
- Monetary Aggregates and Output
- This paper offers a general equilibrium model that explains how the observed correlations of money and output fluctuations may come about through endogenously determined fluctuations in the money multiplier. The model is calibrated to meet long run features of the U.S. economy (including monetary features) and then subjected to shocks to the Solow residual following a random process like that observed in U.S. data. The model?s predicted business-cycle frequency correlations, of both real and nominal variables, share the following features with U.S. data: i) M1 is positively correlated with real output; ii) the money multiplier and deposit-to-currency ratio are positively correlated with real output; iii) the price level is negatively correlated with output [in spite of (i) and (ii)]; iv) the correlation of M1 with contemporaneous prices is substantially weaker than the correlation of M1 with real output; v) correlations among real variables are essentially unchanged under different monetary policy regimes; and vi) real money balances are smoother than money demand equations would predict. Although features (i) and (iv) may have been considered support for a causal influence of money on output, the paper demonstrates that they are consistent with an economy in which money has no such causal influence. (PDF)
- WP 98-12
- Expectations, Credibility, and Time-Consistent Monetary Policy
- This paper addressses the problem of multiple equilibria in a model of time-consistent monetary policy. It suggests that this problem originates in the assumption that agents have rational expectations and proposes several alternative restrictions on expectations that allow the monetary authority to build credibility for a disinflationary policy by demonstrating that it will stick to that policy even if it imposes short-run costs on the economy. Starting with these restrictions, the paper derives conditions that guarantee the uniqueness of the model?s steady state; monetary policy in this unique steady state involves the constant deflation advocated by Milton Friedman. (PDF)
- WP 98-11
- Simulating the transmission of wealth inequality via bequests
- Answering the question of how much wealth inequality arises from inheritance inequality requires data that are unavailable and potentially uncollectable. The alternative approach taken here (from Blinder [1974, 1976] and Davies [1982]) is to simulate the transmission of inequality via bequests. (PDF)
- WP 98-10
- Optimal employment of scale economies in the Federal Reserve’s currency infrastructure
- Given estimates of shipping costs and scale economies for high-speed currency sorting, the authors investigate whether the Federal Reserve might lower its costs by reallocating the volume of sorting among its processing sites. (PDF)
- WP 98-09
- Self-selection and Discrimination in Credit Markets
- In this paper we make two contributions toward a better understanding of the causes and consequences of discrimination in credit markets. First, we develop an explicit theoretical model of the underwriting process in which lenders use a simple Bayesian updating process to evaluate applicant creditworthiness. Using a signal correlated with an applicant?s true creditworthiness and their prior beliefs about the distribution of credit risk in the applicant pool, lenders are able to evaluate an applicant?s expected or ?inferred? creditworthiness to determine which loans to approve and which ones to deny. Second, we explicitly model the self-selection behavior of individuals to show how market frictions like bigotry can affect application decisions. Because these decisions shape banks? prior beliefs about the distribution of credit risk, they also affect the Bayesian posterior from which banks compute an applicant?s inferred creditworthiness, implying that statistical discrimination can arise endogenously. In a market in which only some lenders have ?tastes for discrimination,? we show that there are conditions under which lenders without racial animus will also discriminate. (PDF)
- WP 98-08
- The Importance of Bank Seniority for Relationship Lending
- The idea that banks exist to reduce the costs of monitoring is central to modern theories of financial intermediation. The fact that banks are generally granted senior positions on their small-business loans, however, is hard to reconcile with the typical view that junior lenders have the best incentives to engage in this costly monitoring. Our paper addresses this puzzling contradiction by showing that bank seniority plays an important role in encouraging the formation of valuable bank-firm relationships. (PDF)
- WP 98-07
- Money and Dynamic Arrangements with Private Information
- We construct a model with private information in which consumers write dynamic contracts with financial intermediaries. A role for money arises due to random limited participation of consumers in the financial market. Without defection constraints, a Friedman rule is optimal, the mean and variability of wealth tend to fall in the steady state, and the welfare effects of inflation are very small. With defection constraints, the effects of inflation on the distribution of welfare and consumption are large, but the effect on average welfare is still small. Also, the relaxation of defection constraints resulting from higher inflation causes a substantial increase in the real interest rate. (PDF)
- WP 98-06
- Measuring the rate of technological progress in structures
- An effort to measure technological progress in structures by using panel data on the age and rents of buildings in a vintage capital model, where buildings are replaced at some chosen periodicity. It finds that there has been significant technological advance in structures, which accounts for a major part of economic growth. (PDF)
- WP 98-05
- The FDICIA and Bank CEOs’ Pay-Performance Relationship: An Empirical Investigation
- Banking problems in the 1980s led to passage of the FDICIA (1991). The purpose of this legislation was to improve market and regulatory discipline of banks’ performance through changes in incentive structures. This paper looks at how the FDICIA changes bank CEOs’ pay-performance relationship. It finds that the FDICIA improves healthy banks’ growth opportunities, making their CEOs’ total compensation less sensitive to performance. Meanwhile, the FDICIA restricts unhealthy banks’ growth opportunities, making their CEOs’ total compensation more sensitive to performance. These results support the agency-cost-of-debt theory developed in John and John (1993). This paper shows that since enactment of the FDICIA, CEOs’ compensation structure has become more incentive-based for both healthy and unhealthy banks. At the same time, the main components of CEOs’ compensation, salary and bonus, have become more sensitive to accounting earnings, while stock-based compensation has become more responsive to stock returns. (PDF)
- WP 98-04
- Solving Dynamic Equilibrium Models by a Method of Undetermined Coefficients
- This paper presents an undetermined-coefficients method for obtaining a linear approximation to the solution of a dynamic rational-expectations model. It also shows how that solution can be used to compute the model?s implications for impulse response functions and for second moments. (PDF)
- WP 98-03
- Large shareholders and market discipline in a regulated industry: a clinical study of Mellon Bank
- An analysis of the 1987 change in control at Mellon, which was one of only a few banks with a large shareholder. It finds that the large shareholder did not monitor the firm extensively before it experienced performance difficulties, but was able to enforce a management change when problems arose-without having to acquire a majority stake. (PDF)
- WP 98-02
- Appointing the Median Voter of a Policy Board
- Partisan politics and elector uncertainty generate policy uncertainty and partisan business cycles. To reduce policy uncertainty, society must design the policy-making environment to overcome electoral uncertainty and partisanship without ignoring the electorate’s wishes. I show that delegating policy to an independent policy board with discretionary powers substantially reduces policy uncertainty while maintaining political accountability. Board members are chosen in a partisan, noncooperative environment yet, in the benchmark model, policy uncertainty is eliminated and the policy rule is replicated. Thus, a political "invisible hand" is at work--by setting up the policy institution properly and having the participants pursue their own self-interest, the social "optimum" prevails. (PDF)
- WP 98-02
- Appointing the Median Voter of a Policy Board
- Partisan politics and elector uncertainty generate policy uncertainty and partisan business cycles. To reduce policy uncertainty, society must design the policy-making environment to overcome electoral uncertainty and partisanship without ignoring the electorate?s wishes. I show that delegating policy to an independent policy board with discretionary powers substantially reduces policy uncertainty while maintaining political accountability. Board members are chosen in a partisan, noncooperative environment yet, in the benchmark model, policy uncertainty is eliminated and the policy rule is replicated. Thus, a political ?invisible hand? is at work?by setting up the policy institution properly and having the participants pursue their own self-interest, the social ?optimum? prevails. (PDF)
- WP 98-01
- Reducing Working Hours: A General Equilibrium Analysis
- This paper examines the effects of restricting the weekly hours of workers in a heterogeneous-agent, general equilibrium framework. The framework presented here contains two types of workers, which allows the author to explore the consequences of a mismatch between the skills of the nonemployed and the skills of the employed. Previous studies of these issues have been based on partial equilibrium models. (PDF)