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

Corporate Income Tax, Legal Form of Organization, and Employment

A dynamic stochastic occupational choice model with heterogeneous agents is developed to evaluate the impact of a corporate income tax reduction on employment. In this framework, the key margin is the endogenous entrepreneurial choice of the legal form of organization (LFO). A reduction in the corporate income tax burden encourages adoption of the C corporation legal form, which reduces capital constraints on firms. Improved capital re-allocation increases overall productive efficiency in the economy and therefore expands the labor market. Relative to the benchmark economy, a corporate income tax cut can reduce the non-employment rate by up to 7 percent.

The response of multinationals’ foreign exchange rate

We use intraday data to estimate the daily foreign exchange exposure of U.S. multinationals and show that macroeconomic news affects these firms’ foreign exchange exposure. News creates a substantial shift in the joint distribution of stock and exchange rate returns that has both a transitory and a persistent component. For example, a positive domestic demand surprise, as reflected in higher-than-expected nonfarm payroll, increases the value of the low-exposure domestic activities and results in a persistent decrease in foreign exchange exposure.

Optimal Monetary Policy under Negative Interest Rate

In responding to the extremely weak global economy after the financial crisis in 2008, many industrial nations have been considering or have already implemented negative nominal interest rate policy. This situation raises two important questions for monetary theories: (i) Given the widely held doctrine of the zero lower bound on nominal interest rate, how is a negative interest rate (NIR) policy possible? (ii) Will NIR be effective in stimulating aggregate demand? (iii) Are there any new theoretical issues emerging under NIR policies? This article builds a model to show that (i) money injections can remain effective even when the nominal bank lending rate has reached zero or become negative; (ii) it is a good policy to keep the nominal interest rate as low as possible by purchasing government bonds with money; and (iii) the conventional wisdom on the notion of the liquidity trap and the Fisherian decomposition between the nominal and real interest rate can be invalid.

Truncated Firm Productivity Distributions and Trade Margins

A standard theoretical prediction is that average exports are independent of tariff rates when the underlying distribution of firm productivities is assumed to be the widely-used Pareto distribution. Assuming that the underlying distribution has no upper bound is undoubtedly inaccurate and produces theoretical results at odds with empirical results. In contrast, we show that upper-truncation of the Pareto distribution makes average exports rise with trade liberalization. This result is derived analytically, and is supported by simulations. We extend our analysis to the cases of lognormal and Fréchet distributions, which are also frequently used by trade economists. Our findings for lognormal and Fréchet distributions are qualitatively similar to the findings using the truncated Pareto.

Terms-of-Trade and Counterterrorism Externalities

This paper investigates the interplay of trade and terrorism externalities under free trade between a developed nation that exports a manufactured good to and imports a primary product from a developing nation. A terrorist organization targets both nations and reduces its attacks in response to a nation’s defensive counterterrorism efforts, while transferring some of its attacks abroad. Terms-of-trade considerations lead the developed nation to raise its counterterrorism level beyond the “small-country” level, thus compounding its overprovision of these measures. By contrast, the developing nation limits its defensive countermeasures below that of the small-country level. This asymmetry is a novel finding. The analysis is extended to include proactive countermeasures to weaken the terrorist group. Again, the developed country raises its efforts owing to the terms-of-trade externality, which now opposes the underprovision associated with proactive efforts. A sec ond extension allows for several developing-country exporters of the primary product.

Nominal GDP Targeting With Heterogeneous Labor Supply

We study nominal GDP targeting as optimal monetary policy in a model with a credit market friction following Azariadis, Bullard, Singh and Suda (2016), henceforth ABSS. As in ABSS, the macroeconomy we study has considerable income inequality which gives rise to a large private sector credit market. Households participating in this market use non-state contingent nominal contracts (NSCNC). We extend the ABSS framework to allow for endogenous and heterogeneous household labor supply among credit market participant households. We show that nominal GDP targeting continues to characterize optimal monetary policy in this setting. Optimal monetary policy repairs the distortion caused by the credit market friction and so leaves heterogeneous households supplying their desired amount of labor, a type of “divine coincidence” result. We also analyze the case when there is an aging population. We interpret these findings in light of the recent debate in monetary policy concerning labor force participation.

Airport Noise in Atlanta: The Inequality of Sound

We examine how changes in the geographic concentrations of Hispanic and African-American populations are correlated with changes in probabilities of airport noise, in Atlanta, during 2003 and 2012. We estimate ordered probit and locally weighted ordered probit regressions for three different noise categories to determine the correlations between these two demographic groups and the aircraft noise levels experienced by people in individual houses that sold. Then we determine the average coefficient for all houses sold in each Census block group, and we plot each year’s coefficients for each block group against the percentiles of the minority population. While the absolute level of noise has declined over the geographic area considered in 2012 compared with 2003, we find that the distribution of noise coefficients among Hispanics and blacks became more inequitable in 2012 compared with 2003. At least two potential mechanisms could generate these correlations. Due to residential mobility, income and preferences could combine to produce a concentration of minorities in certain neighborhoods. Or, perhaps noisier flight paths are imposed upon higher minority neighborhoods as a result of discrimination. Our findings contribute to the broader literature on environmental justice, even though we cannot definitively infer the mechanisms at work.

Optimal Taxes Under Private Information: The Role of Inflation

We consider an overlapping generation framework with search and private information to study optimal taxation. Agents sequentially trade in markets that are characterized by different frictions and trading protocols. In frictional decentralized markets, agents receive shocks that determine if they are going to be consumers or producers. Shocks are private information. Mechanism design is used to solve for the constrained optimal allocation. We then study whether a government can replicate the constrained optimal allocation with an array of policy instruments including fiat money. We show that if the government has a full set of non-linear taxes, then lump-sum taxes and inflation are irrelevant for the allocation. However, if the government is constrained to use linear taxes, then using the inflation tax is optimal even if lump-sum taxes are available.

Financial Frictions and Export Dynamics in Large Devaluations

We study the role of financial frictions and balance-sheet effects in accounting for the dynamics of aggregate exports in large devaluations. We investigate a small open economy with heterogeneous firms, where firms face financing constraints and debt can be denominated in foreign units. We find that these channels can explain only a small fraction of the dynamics of exports observed in the data. While these frictions distort production and investment decisions, they affect exports significantly less since firms reallocate sales across markets in response to real exchange rate changes. We document the importance of this mechanism using plant-level data.

Estimation of the discontinuous leverage effect: Evidence from the NASDAQ order book

An extensive empirical literature documents a generally negative correlation, named the “leverage effect,” between asset returns and changes of volatility. It is more challenging to establish such a return-volatility relationship for jumps in high-frequency data. We propose new nonparametric methods to assess and test for a discontinuous leverage effect — i.e. a relation between contemporaneous jumps in prices and volatility. The methods are robust to market microstructure noise and build on a newly developed price-jump localization and estimation procedure. Our empirical investigation of six years of transaction data from 320 NASDAQ firms displays no unconditional negative correlation between price and volatility cojumps. We show, however, that there is a strong relation between price-volatility cojumps if one conditions on the sign of price jumps and whether the price jumps are market-wide or idiosyncratic. Firms’ volatility levels strongly explain the cross-section of discontinuous leverage while debt-to-equity ratios have no significant explanatory power.

Systematic Cojumps, Market Component Portfolios and Scheduled Macroeconomic Announcements,

This study provides evidence of common bivariate jumps (i.e., systematic cojumps) between the market index and style-sorted portfolios. Systematic cojumps are prevalent in book-to-market portfolios and hence, their risk cannot easily be diversified away by investing in growth or value stocks. Nonetheless, large-cap firms have less exposure to systematic cojumps than small-cap firms. Probit regression reveals that systematic cojump occurrences are significantly associated with worse-than-expected scheduled macroeconomic announcements, especially those pertaining to the Federal Funds target rate. Tobit regression shows that Federal Funds news surprises are also significantly related to the magnitude of systematic cojumps.

Low Real Interest Rates and the Zero Lower Bound

How do low real interest rates constrain monetary policy? Is the zero lower bound optimal if the real interest rate is sufficiently low? What is the role of forward guidance? A model is constructed that can in- corporate sticky price frictions, collateral constraints, and conventional monetary distortions. The model has neo-Fisherian properties. Forward guidance in a liquidity trap works through the promise of higher future in‡flation, generated by a higher future nominal interest rate. With very tight collateral constraints, the real interest rate can be very low, but the zero lower bound need not be optimal.

Bank panics and scale economies

A bank panic is an expectation-driven redemption event that results in a self-fulfilling prophecy of losses on demand deposits. From the standpoint of theory in the tradition of Diamond and Dybvig (1983) and Green and Lin (2003), it is surprisingly difficult to generate bank panic equilibria if one allows for a plausible degree of contractual flexibility. A common assumption employed in the standard banking model is that returns are linear in the scale of investment. Instead, we assume the existence of a fixed investment cost, so that a higher risk-adjusted rate of return is available only if investment exceeds a minimum scale requirement. With this simple and empirically-plausible modification to the standard model, we find that bank panic equilibria emerge easily and naturally, even under highly flexible contractual arrangements. While bank panics can be eliminated through an appropriate policy, it is not always desirable to do so. We use our model to examine a number of issues, including the likely effectiveness of recent financial market regulations. Our model also lends some support for the claim that low-interest rate policy induces a “reach-for-yield” phenomenon resulting in a more panic-prone financial system.

Liquidity Premiums on Government Debt and the Fiscal Theory of the Price Level

We construct a dynamic general equilibrium model where agents use nominal government bonds as collateral in secured lending arrangements. If the collateral constraint binds, agents price in a liquidity premium on bonds that lowers the real rate on bonds. In equilibrium, the price level is determined according to the …fiscal theory of the price level. However, the market value of government debt exceeds its fundamental value. We then examine the dynamic properties of the model and show that the market value of the government debt can ‡fluctuate even though there are no changes to current or future taxes or spending. The price dynamics are driven solely by the liquidity premium on the debt.

Sticky Wages, Monetary Policy and Fiscal Policy Multipliers

This paper demonstrates how adding nominal wage rigidity to a standard sticky price model can create a mechanism by which increases in government spending cause increases in consumption. The increase in output arising from government purchases puts upward pressure on the price level. At a fixed short-run nominal wage, this bids down the real wage, which leads producers to increase labor demand. Increased labor demand allows households to both finance the tax bill associated with the government spending as well as increase their own consumption. Our approach does not rely upon existing ingredients for generating large fiscal multipliers, such as the zero lower bound, borrowing constrained households or an interaction between consumption and government purchases in the utility function.

Capital Goods Trade, Relative Prices, and Economic Development

International trade in capital goods has quantitatively important effects on economic development through capital formation and TFP. Capital goods trade enables poor countries to access more efficient technologies, leading to lower relative prices of capital goods and higher capital-output ratios. Moreover, poor countries can use their comparative advantage and allocate their resources more efficiently, and increase their TFP. We quantify these channels using a multisector, multicountry, Ricardian model of trade with capital accumulation. The model matches several trade and development facts within a unified framework. Frictionless trade in capital goods reduces the income gap between rich and poor countries by 40 percent. More than half of the reduction in the income gap is due to the TFP channel.

Capital Accumulation and Dynamic Gains from Trade

We compute welfare gains from trade in a dynamic, multicountry model with capital accumulation and trade imbalances. We develop a gradient-free method to compute the exact transition paths for 44 countries following a trade liberalization. We fi nd that (i) the gains are negatively correlated with size, measured by total real GDP, (ii) larger countries accumulate a current account surplus and financial resources flow from larger countries to smaller countries boosting consumption in the latter, (iii) countries with larger short-run trade defi cits accumulate capital faster, (iv) the gains are nonlinear in the reduction in trade costs, and (v) capital accumulation accounts for substantial gains. The net foreign asset (NFA) position before the liberalization and the intensities of tradables in investment goods production and consumption goods production are quantitatively important for the gains.

International Trade and Intertemporal Substitution

This paper studies the role of international trade delivery lags and variation in the intertemporal marginal rate of substitution in accounting for puzzling features of cyclical fluctuations of international trade volumes. Our insight is that, because international trade is time-intensive, variation in the rate at which agents are willing to substitute across time affects how trade volumes respond to changes in output and prices. We calibrate our model to match key features of U.S. data and discipline the variation in the intertemporal marginal rate of substitution using asset price data. We find that our model is quantitatively consistent with U.S. cyclical import fluctuations.

The Effects of Terror on International Air Passenger Transport: An Empirical Invstigation

This paper presents a theoretical model (adapted from the structural gravity model by Anderson and van Wincoop, 2003) to capture the effects of terrorism on air passenger traffic between nations affected by terrorism. We then use equations derived from this model, in conjunction with alternative functional forms for trade costs, to estimate the effects of terrorism on bilateral air passenger flows from 57 source countries to 25 destination countries for the period of 2000 to 2014. We find that an additional terrorist incident results in approximately a 1.2% decrease in the bilateral air passenger transport per unit distance while doubling of the accumulated terrorist incidents during the past 5 years reduces it by 18%. Terrorism adversely impacts the bilateral air passenger transport per unit distance both by reducing national output and especially by increasing psychological distress, which could be an important contributing factor in perceived travel costs. Last but not the least, we show that the responsiveness of international air travel to terrorism critically depends on the nature of the terrorist attacks. Specifically, international air passenger transport is found to be extremely sensitive to fatal terrorist attacks and terrorist attacks of targets such as airports, transportation or tourists.

Chinese Foreign Exchange Reserves, Policy Choices and the U.S. Economy

China is both a major trading partner of the United States and the largest official holder of U.S. assets in the world. The value of Chinese foreign exchange reserves peaked at just over $4 trillion in June 2014, but has since declined to $3.19 trillion as of August 2016. This very large decline is in foreign exchange reserves is unprecedented and some analysts have speculated that continued sales of these (mostly U.S.) assets might significantly impact the U.S. and global economies. This article explains the reasons for this large decline in official assets, what China’s policy choices are, and how these choices could affect the U.S. economy.

The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate

The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates today forecast future booms in GDP, consumption, investment, and employment. We show that a Kiyotaki-Moore model accounts for both properties when interest-rate movements are driven, in a significant way, by self-fulfilling belief shocks that redistribute income away from lenders and to borrowers during booms. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate and future aggregate economic activity depends critically on the property that the interest rate is state-contingent. Bayesian estimation of our benchmark DSGE model on US data shows that the model driven by redistribution shocks results in a better fit to the data than both standard RBC models and Kiyotaki-Moore type models with unique equilibrium.

Family Economics Writ Large

Powerful currents have reshaped the structure of families over the last century. There has been (i) a dramatic drop in fertility and greater parental investment in children; (ii) a rise in married female labor-force participation; (iii) a significant decline in marriage and a rise in divorce; (iv) a higher degree of positive assortative mating; (v) more children living with a single mother; (vi) shifts in social norms governing premarital sex and married women''s roles in the workplace. Macroeconomic models explaining these aggregate trends are surveyed. The relentless flow of technological progress and its role in shaping family life are stressed.

Training and Search On the Job

The paper studies human capital accumulation over workers’ careers in an on the job search setting with heterogenous firms. In renegotiation proof employment con- tracts, more productive firms provide more training. Both general and specific training induce higher wages within jobs, and with future employers, even conditional on the future employer type. Because matches do not internalize the specific capital loss from employer changes, specific human capital can be over-accumulated, more so in low type firms. While validating the Acemoglu and Pischke (1999) mechanisms, the analysis nevertheless arrives at the opposite conclusion: That increased labor market friction reduces training in equilibrium.

The Aggregate Implications of Size Dependent Distortions

This paper examines the aggregate implications of size-dependent distortions. These regulations misallocate labor across firms and hence reduce aggregate productivity. It then considers a case-study of labor laws in France where firms that have 50 employees or more face substantially more regulation than firms that have less than 50. The size distribution of firms is visibly distorted by these regulations: there are many firms with exactly 49 employees. A quantitative model is developed with a payroll tax of 0.15% that only applies to firm above 50 employees. Removing the regulation improves labor allocation across firms, leading in steady state to an increase in output per worker slightly less than 0.3%.

Markets, Externalities, and the Dynamic Gains of Openness

Inflows of foreign knowledge are the key for developing countries to catch up with the world technology frontier. In this paper, I construct a simple tractable model to analyze (a) the incentives of foreign firms to bring their know-how to a developing country and (b) the incentives of domestic firms to invest in their own know-how, given the exposure to foreign ideas and competition. The model embeds two diffusion mechanisms typically considered separately in the literature: externalities and markets. The dynamic gains of openness can be substantial under either mechanism, but their relative preponderance significantly changes the dynamic implications of openness. Notably, openness allows developing countries to fully catch up only when market transactions fully dominate the diffusion of ideas. While externalities can also push domestic firms to upgrade their productivity, the equilibrium exposure to ideas in the country remains below the frontier and domestic firms never catch up.

Of Cities and Slums

The emergence of slums is a common feature in a country''s path towards urbanization, structural transformation and development. Based on salient micro and macro evidence of Brazilian labor, housing and education markets, we construct a simple model to examine the conditions for slums to emerge. We then use the model to examine whether slums are barriers or stepping stones for lower skilled households and for the development of the country as a whole. We calibrate our model to explore the dynamic interaction between skill formation, income inequality and structural transformation with the rise (and potential fall) of slums in Brazil. We then conduct policy counterfactuals. For instance, we find that cracking down on slums could slow down the acquisition of human capital, the growth of cities (outside slums) and non-agricultural employment. The impact of reducing housing barriers to entry into cities and of different forms of school integration between the city and the slums is also explored.

A Survey of the Empirical Literature on U.S. Unconventional Monetary Policy

This paper reviews and critically evaluates the empirical literature on the effects of U.S. unconventional monetary policy on both financial markets and the real economy. In order to understand how such policies could work, we also briefly review the literature on the theory of such policies. We show that event studies provide very strong evidence that U.S. unconventional policy announcements have strongly influenced international bond yields, exchange rates, and equity prices in the desired manner. In addition, such studies indicate that such policies curtailed market perceptions of extreme events. Calibrated modeling and vector autoregressive (VAR) exercises strongly suggest that these policies significantly improved macroeconomic outcomes, raising U.S. GDP and CPI, through these changes in asset prices. Both event studies and VARs imply positive international spillovers of such policies.

Openness and the Optimal Taxation of Foreign Know-How

Developing countries frequently offer tax incentives and even subsidize the entry and operation of foreign firms. I examine the optimality of such policies in an economy where growth is driven by entrepreneurial know-how, a skill that is continuously updated on the basis of the productive ideas implemented in the country. Openness allows foreign ideas to disseminate inside a country and can foster the country’'s domestic accumulation of know- how. With externalities, however, laissez-faire openness is suboptimal and can be growth-and even welfare-reducing. I examine the gains from openness under an optimal taxation program –the self-funding taxes on domestic and foreign …firms that maximize the welfare of the recipient country, subject to the equilibrium behavior of national and foreign firms. Under optimal taxation, openness is always welfare enhancing and leads lagging countries to catch up with the world frontier. Yet, a country may want to subsidize the entry of foreign …firms only if it can also subsidize the domestic accumulation of know-how. I also consider the optimal tax program under a number of restrictions that developing countries typically face. For instance, a country must not subsidize entry of foreign firms if doing so requires taxing the concurrent cohort of domestic firms. Similarly, an international agreement that requires equal taxation of domestic and foreign firms can be welfare reducing for a country close to the knowledge frontier.

The Value of Constraints on Discretionary Government Policy

This paper investigates how institutional constraints discipline the behavior of discretionary governments subject to an expenditure bias. The focus is on constraints implemented in actual economies: monetary policy targets, limits on the deficit and debt ceilings. For a variety of aggregate shocks considered, the best policy is to impose a minimum primary surplus of about half a percent of output. Most welfare gains from constraining government behavior during normal times, which to a large extent is sufficient to discipline policy in adverse times. Monetary policy targets are not generally desirable as they hinder the ability of governments to smooth distortions. Allowing for the effective use of inflation during transitions is a key component of good institutional design. Debt ceilings are benign, but always dominated by deficit constraints. More pre-commitment to government actions is ineffective in curbing inefficiently high public expenditure.

Vocational Considerations and Trends in Social Security Disability

Along with health, Social Security Disability Insurance (SSDI) evaluates work-limiting disability by considering vocational factors including age, education, and past work experience. As the number of SSDI applicants and awards has increased, these vocational criteria are increasingly important to acceptances and denials. A unique state-level dataset allows us to estimate how these factors relate to the SSDI award process. These estimates are used to asses how changes to the demographic and occupational composition have contributed to awards trends. In our results, the prevalence of workers in their 50s are especially important. Further, increasing educational attainment lowers applications and vocational awards.


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