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Working Papers

Federal Reserve Bank of St. Louis working papers are preliminary materials circulated to stimulate discussion and critical comment.

Recent Working Papers

Firms as Learning Environments: Implications for Earnings Dynamics and Job Search

This paper demonstrates that heterogeneity in firms’ promotion of human capital accumulation is an important determinant of life-cycle earnings inequality. I use administrative micro data from Germany to show that different establishments offer systematically different earnings growth rates for their workers. This observation suggests that that the increase in inequality over the life cycle reflects not only inherent worker variation, but also differences in the firms that workers happen to match with over their lifetimes. To quantify this channel, I develop a life-cycle search model with heterogeneous workers and firms. In the model, a worker’s earnings can grow through both human capital accumulation and labor market competition channels. Human capital growth depends on both the worker’s ability and the firm’s learning environment. I find that heterogeneity in firm learning environments account for 40% of the increase in cross-sectional earnings variance over the life cycle, and that this mechanism is especially important for young workers. I then show that differences in labor market histories partially shape the worker-specific income profiles estimated by reduced-form statistical earnings processes. Finally, because young workers do not fully internalize the benefits of matching to high-growth firms, changes to the structure of unemployment insurance policies can incentivize these workers to search for better matches.

Anatomy of Corporate Credit Spreads: The Great Recession vs. COVID-19

We compare the evolution of corporate credit spreads during the Great Recession and the COVID-19 pandemic. The two crises featured increases of similar magnitudes in the median and cross-sectional dispersion of credit spreads, but the pandemic was short-lived and different sectors were affected. The micro-data reveal larger differences between the two episodes: the Great Recession featured an increase in the across-firm dispersion, and leverage was an important predictor of credit spreads. Differently, the COVID-19 crisis displayed a larger increase in within-firm dispersion, and funding liquidity was a more important predictor of movements in spreads. These findings suggest that, at the corporate level, the Great Recession was primarily a solvency crisis, while COVID-19 was a liquidity crisis.

Enduring Relationships in an Economy with Capital and Private Information

We study efficient risk sharing in a model where agents operate linear production technologies with private information about idiosyncratic productivity. Capital is the sole factor of production, and accumulable. We establish a time-invariant, one-to-one mapping between the capital allocated to an agent and his lifetime utility entitlement. The mapping implies properties that are distinct from those in models with private information about endowments. In contrast to the latter, the value of the risk-sharing arrangement in our model always remains above the autarky value. There is no need for long-term commitment. Further, in our model, there are no net expected transfers each period across individuals. This allows us to decentralize the efficient allocation into one-period insurance contracts that do not require long-term commitment on the part of the principal or agent. Furthermore, while the efficient allocation implies an increasing dispersion of lifetime utility entitlements and consumption, this need not lead to declines in individual consumption as in the endowment model. When technology is sufficiently productive, all individuals experience consumption growth.

Should Capital Be Taxed?

We design an infinite-horizon heterogeneous-agents and incomplete-markets model to demonstrate analytically that in the absence of any redistributional effects of government policies, optimal capital tax is zero despite capital overaccumulation under precautionary savings and borrowing constraints. Our result indicates that public debt is a better tool than capital taxation to restore aggregate productive efficiency.

Eggs in One Basket: Security and Convenience of Digital Currencies

Digital currencies store balances in anonymous electronic addresses. We analyze the trade-offs between safety and convenience of aggregating balances in addresses, electronic wallets and banks. In our model agents balance the risk of theft of a large account with the cost to safeguarding a large number of passwords of many small accounts. Account custodians (banks, wallets and other payment service providers) have different objectives and tradeoffs on these dimensions; we analyze the welfare effects of differing industry structures and interdependencies, and in particular the consequences of "password aggregation" programs which in effect consolidate risks across accounts.

FRED-SD: A Real-Time Database for State-Level Data with Forecasting Applications

We construct a real-time dataset (FRED-SD) with vintage data for the U.S. states that can be used to forecast both state-level and national-level variables. Our dataset includes approximately 28 variables per state, including labor market, production, and housing variables. We conduct two sets of real-time forecasting exercises. The first forecasts state-level labor-market variables using five different models and different levels of industrially-disaggregated data. The second forecasts a national-level variable exploiting the cross-section of state data. The state-forecasting experiments suggest that large models with industrially-disaggregated data tend to have higher predictive ability for industrially-diversified states. For national-level data, we find that forecasting and aggregating state-level data can outperform a random walk but not an autoregression.

Collaboration in Bipartite Networks, with an Application to Coauthorship Networks

This paper studies the impact of collaboration on research output. First, we build a micro founded model for scientific knowledge production, where collaboration between researchers is represented by a bipartite network. The equilibrium of the game incorporates both the complementarity effect between collaborating researchers and the substitutability effect between concurrent projects of the same researcher. Next, we develop a Bayesian MCMC procedure to estimate the structural parameters, taking into account the endogenous matching of researchers and projects. Finally, we illustrate the empirical relevance of the model by analyzing the coauthorship network of economists registered in the RePEc Author Service.

The Role of Establishment Size in the City-Size Earnings Premium in Spain

Both large establishments and large cities are known to offer workers an earnings premium. In this paper, we show that these two premia are closely linked by documenting a new fact: when workers move to a large city, they also move to larger establishments. We then ask how much of the city- size earnings premium can be attributed to transitions to larger and better-paying establishments. Using administrative data from Spain, we find that 38 percent of the city-size earnings premium can be explained by establishment-size composition. Most of the gains from the transition to larger establishments realize in the short-term upon moving to the large city. Establishment size explains 29 percent of the short-term gains, but only 5 percent of the medium-term gains that accrue as workers gain experience in the large city. The small contribution to the medium-term gains is due to two facts: first, within large cities workers transition to large establishments only slightly faster than in smaller cities; second, the relationship between earnings and establishment size is weaker in large cities.

Forecasting Low Frequency Macroeconomic Events with High Frequency Data

High-frequency financial and economic activity indicators are usually time aggregated before forecasts of low-frequency macroeconomic events, such as recessions, are computed. We propose a mixed-frequency modelling alternative that delivers high-frequency probability forecasts (including their confidence bands) for these low-frequency events. The new approach is compared with single-frequency alternatives using loss functions adequate to rare event forecasting. We provide evidence that: (i) weekly-sampled spread improves over monthly-sampled to predict NBER recessions, (ii) the predictive content of the spread and the Chicago Fed Financial Condition Index (NFCI) is supplementary to economic activity for one-year-ahead forecasts of contractions, and (iii) a weekly activity index can date the 2020 business cycle peak two months in advance using a mixed-frequency filtering.

Convergence to Rational Expectations in Learning Models: A Note of Caution

This paper illustrates a challenge in analyzing the learning algorithms resulting in second-order difference equations. We show in a simple monetary model that the learning dynamics do not converge to the rational expectations monetary steady state. We then show that to guarantee convergence, the gain parameter used in the learning rule has to be restricted based on economic fundamentals in the monetary model.

Monetary Policy and Economic Performance since the Financial Crisis

The analysis in this paper was presented to the Federal Open Market Committee as background for its discussion of the Federal Reserve’s review of monetary policy strategy, tools, and communication practices. The Committee discussed issues related to the review at five consecutive meetings from July 2019 to January 2020. References to the FOMC’s current framework for monetary policy refer to the framework articulated in the Statement on Longer-Run Goals and Monetary Policy Strategy first issued in January 2012 and reaffirmed each January, most recently in January 2019.

Home Production and Leisure During the COVID-19 Recession

Between the months of February and April of 2020, average weekly market hours dropped by 6.25, meanwhile 35% of commuting workers reported switching to remote work arrangements. In this paper, we examine implications of these changes for the time allocation of different households, and on aggregate. We estimate that home production activity increased by 2.1 hours a week, or 34% of lost market hours, whereas leisure activity increased by 3.8 hours a week. The monthly value of home production increased by $30.83 billion – that is 10.5% of the concurrent $292.61 billion drop in monthly GDP. Although market hours declined the most for single, less educated individuals, the lost market hours were absorbed into home production the most by married individuals with children.

Labor Market Policies During an Epidemic

We study the positive and normative implications of labor market policies that counteract the economic fallout from containment measures during an epidemic. We incorporate a standard epidemiological model into an equilibrium search model of the labor market to compare unemployment insurance (UI) expansions and payroll subsidies. In isolation, payroll subsidies that preserve match capital and enable a swift economic recovery are preferred over a cost-equivalent UI expansion. When considered jointly, however, a cost-equivalent optimal mix allocates 20 percent of the budget to payroll subsidies and 80 percent to UI. The two policies are complementary, catering to different rungs of the productivity ladder. The small share of payroll subsidies is sufficient to preserve high-productivity jobs, but it leaves room for social assistance to workers who face inevitable job loss.

Job Applications and Labor Market Flows

Unemployment inflows have declined sharply since the 1980s while unemployment outflows have remained mostly steady despite a rise in workers' applications over time. Using a random search model of multiple applications with costly information, we show how rising applications incentivize more firms to acquire information, improving the realized distribution of match qualities. Higher concentrations of high productivity matches reduce the incidence of endogenous separations, causing unemployment inflow rates to fall. Quantitatively, our model replicates the relative change in inflow and outflow rates as well as the decline in acceptance rates, job offers and the rise in reservation wages.

Managing a New Policy Framework: Paul Volcker, the St. Louis Fed, and the 1979-82 War on Inflation

In October 1979, Federal Reserve Chairman Paul Volcker persuaded his FOMC colleagues to adopt a new policy framework that i) accepted responsibility for controlling inflation and ii) implemented new operating procedures to control the growth of monetary aggregates in an effort to restore price stability. These moves were strongly supported by monetarist-oriented economists, including the leadership and staff of the Federal Reserve Bank of St. Louis. The next three years saw inflation peak and then fall sharply, but also two recessions and considerable volatility in interest rates and money supply growth rates. This article reviews the episode through the lens of speeches and FOMC meeting statements of Volcker and St. Louis Fed president Lawrence Roos, and articles by Roos’ staff. The FOMC adopted monetarist principles to establish the Fed’s anti-inflation credibility but Volcker was willing to accept deviations of money growth from the FOMC’s targets, unlike Roos, who viewed the targets as sacrosanct. The FOMC abandoned monetary aggregates in October 1982, but preserved the Fed’s commitment to price stability. The episode illustrates how Volcker used a change in operating procedures to alter policy fundamentally, and later adapt the procedures to changed circumstances without abandoning the foundational features of the policy.

Inequality in the Welfare Costs of Disinflation

We use an incomplete markets economy to quantify the distribution of welfare gains and losses of the US "Volcker" disinflation. In the long run households prefer low inflation, but disinflation requires a transition period and a redistribution from net nominal borrowers to net nominal savers. Even with perfectly flexible prices, welfare costs may be significant for households with nominal liabilities. When calibrated to match the micro and macro moments of the early 1980s high inflation environment, almost half of all borrowers (14 percent of all households) would prefer to avoid the redistribution and equilibrium effects of the disinflation. This share depends negatively on the liquidity value of money and positively on the average duration of nominal borrowing.

The Geography of Business Dynamism and Skill Biased Technical Change

This paper seeks to explain three key components of the growing regional disparities in the U.S. since 1980, referred to as the Great Divergence by Moretti (2012). Namely, big cities saw a larger increase in the relative wages of skilled workers, a larger increase in the relative supply of skilled workers, and a smaller decline in business dynamism. These trends can be explained by differences across cities in the extent to which firms adopt new skill-biased technologies. In response to the introduction of a new skill-biased, high fixed cost but low marginal cost technology, firms endogenously adopt more in big cities, in cities that offer abundant amenities for high-skilled workers and in cities that are more productive in using high-skilled labor. The differences in adoption can account for the increasing relationship between skill intensity and city size, the divergence of the city size wage premium by skill group and the changing cross sectional patterns of business dynamism. I document a new fact that firms in big cities invest more in Information and Communication Technology per employee than firms in small cities,consistent with patterns of technology adoption in the model.

Hot Money for a Cold Economy

What is the theoretical justification for taxing unspent money transfers in a recession? To examine this question, I study a model economy where fiat money is necessary as a medium of exchange and, incidentally, serves as a store of value. This latter property is shown to open the door to business cycles and depressions driven entirely by speculation. Unconditional money transfers do not guarantee escape from a psychologically-induced depression. I demonstrate how money transfers subject to a short expiration date do eliminate speculative equilibria. This hot money policy compares favorably to negative interest rate policy because the latter taxes all money savings whereas the former only threatens to tax gifted money.

On the Essentiality of Credit and Banking at the Friedman Rule

We investigate the essentiality of credit and banking in a microfounded monetary model in which agents face heterogeneous idiosyncratic time preference shocks. Three main results arise from our analysis. First, the constrained-efficient allocation is unattainable without banks. Second, financial intermediation can improve the equilibrium allocation even at the Friedman rule because it relaxes the liquidity constraints of impatient borrowers. Third, changes in credit conditions are not necessarily neutral in a monetary equilibrium at the Friedman rule. If the debt limit is sufficiently low, money and credit are perfect substitutes and tightening the debt limit is neutral. As the debt limit increases, however, patient agents always hold money but impatient agents prefer not to since it is costly for them to do so given they are facing a positive shadow rate. Borrowing instead is costless when interest rates are zero and increasing the debt limit improves the allocation.

Seigniorage and Sovereign Default: The Response of Emerging Markets to COVID-19

Monetary policy affects the tradeoffs faced by governments in sovereign default models. In the absence of lump-sum taxation, governments rely on both distortionary taxes and seigniorage to finance expenditure. Furthermore, monetary policy adds a time-consistency problem in debt choice, which may mitigate or exacerbate the incentives to accumulate debt. A deterioration of the terms-of-trade leads to an increase in sovereign-default risk and inflation, and a reduction in growth, which are consistent with the empirical evidence for emerging economies. An unanticipated shock resembling the COVID-19 pandemic generates a significant currency depreciation, increased inflation, and distress in government finances.

A New Daily Federal Funds Rate Series and History of the Federal Funds Market, 1928-1954

This article describes the origins and development of the federal funds market from its inception in the 1920s to the early 1950s. We present a newly digitized daily data series on the federal funds rate from April 1928 through June 1954. We compare the behavior of the funds rate with other money market interest rates and the Federal Reserve discount rate. Our federal funds rate series will enhance the ability of researchers to study an eventful period in U.S. financial history and to better understand how monetary policy was transmitted to banking and financial markets. For the 1920s and 1930s, our series is the best available measure of the overnight risk-free interest rate, better than the call money rate which many studies have used for that purpose. For the 1940s-1950s, our series provides new information about the transition away from wartime interest-rate pegs culminating in the 1951 Treasury-Federal Reserve Accord.

Counterterrorism Policy: Spillovers, Regime Stability, and Corner Solutions

This paper takes a unique approach to the scenario where a resident terrorist group in a (fragile) developing nation poses a terrorism threat at home and abroad. The host developing nation’s proactive countermeasures against the resident terrorist group not only limits terrorism at home and abroad, but also bolsters regime stability at home. A two-stage game is presented in which the developed country takes a leadership role to institute a tax-subsidy combination to discourage (encourage) proactive measures at home (abroad) in stage 1. Stage 2 involves both nations’ counterterrorism choices under alternative stage-1 public-policy packages. Unlike the extant literature, we explore corner and interior solutions in both stages based on the terrorists’ targeting preferences and the host nation’s regime-stability preferences. Surprisingly, the developed nation may profit from policy packages that reduce global counterterrorism while raising global terrorism. This outcome and others involve engineered counterterrorism burden shifting.

A Local-Spillover Decomposition of the Causal Effect of U.S. Defense Spending Shocks

This paper decomposes the causal effect of government defense spending into: (i) a local (or direct) effect, and (ii) a spillover (or indirect) effect. Using state-level defense spending data, we show that a negative cross-state spillover effect explains the existing simultaneous findings of a low aggregate multiplier and a high local multiplier. We show that enlisting disaggregate data improves the precision of aggregate effect estimates, relative to using aggregate time series alone. Moreover, we compare two-step efficient GMM with two alternative moment weighting approaches used in existing research.

Endogenous Social Distancing in an Epidemic

I present a model where work implies social interactions and the spread of a disease is described by an SIR-type framework where both susceptible and infectious are asymptomatic. Upon the outbreak of a disease a lower contact rate can be achieved at the cost of lower consumption. Individuals do not internalize the effects of their decisions on the evolution of the epidemic while the planner does. Specifically, the planner internalizes that a low contact rate early in the epidemic implies a low stock of infectious in the future; and a low stock of infectious in the future permits an increase in the contact rate without risking additional infections. Since a low contact rate is associated with low consumption, the planner effectively substitutes consumption early in the epidemic for consumption later. The individual's response does not, hence the planner obtains a flatter infection curve than that generated by the individual's' response, even though the planner's objective is not to ``flatten the curve.''

Shadow Bank Runs

Short-term debt is commonly used to fund illiquid assets. A conventional view asserts that such arrangements are run-prone in part because redemptions must be processed on a first-come, first-served basis. This sequential service protocol, however, appears absent in the wholesale banking sector---and yet, shadow banks appear vulnerable to runs. We explain how banking arrangements that fund fixed-cost operations using short-term debt can be run-prone even in the absence of sequential service. Interventions designed to eliminate run risk may or may not improve depositor welfare. We describe how optimal policies vary under different conditions and compare these to recent policy interventions by the Security and Exchange Commission and the Federal Reserve. We conclude that the conventional view concerning the societal benefits of liquidity transformation and its recommendations for prudential policy extend far beyond their application to depository institutions.

Measuring Labor Supply and Demand Shocks during COVID-19

We measure labor demand and supply shocks at the sector level around the COVID-19 outbreak by estimating a Bayesian structural vector autoregression on monthly statistics of hours worked and real wages. Most sectors were subject to historically large negative labor supply and demand shocks in March and April, with substantial heterogeneity in the size of shocks across sectors. Our estimates suggest that two-thirds of the drop in the aggregate growth rate of hours in March and April 2020 are attributable to labor supply. We validate our estimates of supply shocks by showing that they are correlated with sectoral measures of telework.

International Trade of Essential Goods During a Pandemic

This paper studies the role of international trade of essential goods during a pandemic. We consider a multi-country, multi-sector model with essential and non-essential goods. Essential goods provide utility relative to a reference consumption level, and a pandemic consists of an increase in this reference level. Each country produces domestic varieties of both types of goods using capital and labor subject to sectoral adjustment costs, and all varieties are traded internationally subject to trade barriers. We study the role of international trade of essential goods in mitigating or amplifying the impact of a pandemic. We find that the effects depend crucially on the countries' trade imbalances in essential goods. Net importers of these goods are relatively worse off during a pandemic than net exporters. The welfare losses of net importers are lower in a world with high trade barriers, while the reverse is the case for net exporters. Yet, once a pandemic arrives, net exporters of essential goods benefit from an increase in trade barriers, while net importers benefit from a decrease in them. These findings are consistent with preliminary evidence on changes in trade barriers across countries during the COVID-19 pandemic.

Scarring Body and Mind: The Long-Term Belief-Scarring Effects of COVID-19

The largest economic cost of the COVID-19 pandemic could arise if it changed behavior long after the immediate health crisis is resolved. A common explanation for such a long-lived effect is the scarring of beliefs. We show how to quantify the extent of such belief changes and determine their impact on future economic outcomes. We find that the long-run effect of the COVID crisis depends crucially on whether bankruptcies and changes in habit make existing capital obsolete. A policy that avoided most permanent separation of workers from capital could generate a much larger benefit than originally thought, that could easily be 180% of annual GDP, in present value.

Maturity Structure and Liquidity Risk

This paper studies the optimal maturity structure for government debt when markets for liquidity insurance are incomplete or non-competitive. There is no fiscal risk. Government debt in the model solves a dynamic inefficiency. Issuing debt in short and long maturities solves a liquidity insurance problem, but optimal yield curve policy is only possible if long-duration debt is rendered illiquid. Optimal policy is implementable through treasury operations only--adjustments in the primary deficit are not necessary.

Are Government Bonds Net Wealth or a Liability? ---Optimal Debt and Taxes in an OLG Model with Uninsurable Income Risk

A positive national debt is often rationalized either by the assumption of dynamic inefficiency in an overlapping-generations (OLG) model, or by the hypothesis of heterogeneous-agents and incomplete-markets (HAIM) in an infinite horizon model. Both assumptions imply insufficient private liquidity to support private saving and investment, thus calling for a positive level of public debt to improve social welfare. However, since public debt is financed often by distortionary future taxes, optimal debt and tax policies ought to be studied jointly in a single framework. In this paper we use a primal Ramsey approach to analytically characterize optimal debt and tax policy in an OLG-HAIM model. We show that (i) public debt can be a liability instead of net wealth, despite insufficient private liquidity to support private saving and investment, and (ii) such a debt policy can dramatically change the government's optimal tax scheme since the sign and magnitude of the optimal quantity of debt dictate the sign and magnitude of optimal taxes as well as the priority order of tax tools (such as a labor tax vs. a capital tax) in financing the public debt.


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