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

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. We compare these real-time data experiments with forecasting experiments using final-vintage data and find very different results. Because these final-vintage results are obtained with revised data that would not have been available at the time the forecasts would have been made, we conclude that the use of real-time data is essential for drawing proper conclusions about state-level forecasting models.

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 indicators are usually time-aggregated before computing forecasts of macroeconomic events, such as recessions. We propose a mixed-frequency alternative that delivers high-frequency probability forecasts (including their confidence bands) for low-frequency events. The new approach is compared with single-frequency alternatives using loss functions for rare-event forecasting. We find: (i) the weekly-sampled spread improves over the monthly-sampled to predict NBER recessions, (ii) the predictive content of financial variables is supplementary to economic activity for forecasts of vulnerability events, and (iii) a weekly activity index can date the 2020 business cycle peak in real-time 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

We review the macroeconomic performance over the period since the Global Financial Crisis and the challenges in the pursuit of the Federal Reserve’s dual mandate. We characterize the use of forward guidance and balance sheet policies after the federal funds rate reached the effective lower bound. We also review the evidence on the efficacy of these tools and consider whether policymakers might have used them more forcefully. Finally, we examine the post-crisis experience of other major central banks with these policy tools.

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

Job applications have risen over time yet job-finding rates remain unchanged. Meanwhile, separations have declined. We argue that increased applications raise the probability of a good match rather than the probability of job-finding. Using a search model with multiple applications and costly information, we show that when applications increase, firms invest in identifying good matches, reducing separations. Concurrently, increased congestion and selectivity over which offer to accept temper increases in job-finding rates. Our framework contains testable implications for changes in offers, acceptances, reservation wages, applicants per vacancy, and tenure, objects that enable it to generate the trends in unemployment flows.

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. 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 and the actual changes in the nominal interest rate and inflation during the Volcker disinflation, nearly 60 percent of all households would prefer to avoid the disinflation. This share depends negatively on the liquidity value of money, positively on the average duration of nominal borrowing, and positively on the short-run increase in the real interest rate.

The Geography of Business Dynamism and Skill Biased Technical Change

This paper seeks to explain several key components of the growing regional disparities in the U.S. since 1980: big cities saw a larger increase in the relative wages and 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. With the introduction of a new skill-biased, high fixed cost but low marginal cost technology, firms endogenously adopt more in big cities, cities that offer abundant amenities for high-skilled workers and cities that are more productive in using high-skilled labor. Differences in technology adoption account for the regional divergence in the relative wages and supply of skilled workers and in business dynamism. I document that firms in big cities invest more intensively in Information and Communication Technology, 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.

Domestic Policies and Sovereign Default

This paper incorporates fiscal and monetary policies into a model of sovereign default. In addition to the standard present-bias vs default-risk tradeoff faced by governments when choosing debt, distortionary policy instruments introduce an intertemporal tradeoff, which may mitigate or exacerbate the incentives to accumulate debt. Taxation, the money growth rate and currency depreciation all increase with the level of debt. The model reproduces standard business cycle statistics, the response of spreads, inflation and growth to terms-of-trade shocks, and the cyclical properties of fiscal and monetary policies in emerging markets. A counterfactual exercise for Argentina in 2005-2017 suggests that government expansion accounted for the rise in taxes, inflation and currency depreciation and kept output growth low, countering the benign effects of favorable terms of trade.

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 Solidity, 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.

The Mechanics of Individually- and Socially-Optimal Decisions during an Epidemic

I present a model where work implies social interactions and the spread of a disease is described by an SIR-type framework. Upon the outbreak of a disease reduced social contacts are decided at the cost of lower consumption. Private individuals do not internalize the effects of their decisions on the evolution of the epidemic while the planner does. Specifically, the planner internalizes that an early reduction in contacts implies fewer infectious in the future and, therefore, a lower risk of infection. This additional (relative to private individuals) bene t of reduced contacts implies that the planner's solution feature more social distancing early in the epidemics. The planner also internalizes that some infectious eventually recover and contribute further to a lower risk of infection. These mechanisms imply that the planner obtains a flatter infection curve than that generated by private individuals' responses.

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 Policy During a Pandemic

This paper studies international trade policy during a pandemic. We consider a multi-sector small open economy 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 along with higher import and export prices of these goods. The economy produces domestic varieties of both types of goods subject to sectoral adjustment costs, and varieties are traded internationally subject to trade barriers. We find that trade provides limited relief to the increased demand for essential goods: import prices increase, limiting access, while domestic producers reallocate domestic sales toward exports. We find that international trade policy changes can mitigate these effects. The optimal unilateral trade policy response to the pandemic is to subsidize imports of essential goods while taxing exports, leading to increased consumption of essential goods in the short-run. These findings are consistent with 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.

Fiscal Policy during a Pandemic

I study the effects of the 2020 coronavirus outbreak in the United States and subsequent fiscal policy response in a nonlinear DSGE model. The pandemic is a shock to the utility of contact-intensive services that propagates to other sectors via general equilibrium, triggering a deep recession. I use a calibrated version of the model that matches the path of the US unemployment rate in 2020 to analyze different types of fiscal policies. I find that the pandemic shock changes the ranking of policy multipliers. Unemployment benefits are the most effective tool to stabilize income for borrowers, who are the hardest hit during a pandemic, while liquidity assistance programs are the most effective if the policy objective is to stabilize employment in the affected sector. I also study the effects of the $2.2 trillion CARES Act of 2020.

FRED-QD: A Quarterly Database for Macroeconomic Research

In this paper we present and describe a large quarterly frequency, macroeconomic database. The data provided are closely modeled to that used in Stock and Watson (2012a). As in our previous work on FRED-MD, our goal is simply to provide a publicly available source of macroeconomic “big data” that is updated in real time using the FRED database. We show that factors extracted from this data set exhibit similar behavior to those extracted from the original Stock and Watson data set. The dominant factors are shown to be insensitive to outliers, but outliers do affect the relative influence of the series as indicated by leverage scores. We then investigate the role unit root tests play in the choice of transformation codes with an emphasis on identifying instances in which the unit root-based codes differ from those already used in the literature. Finally, we show that factors extracted from our data set are useful for forecasting a range of macroeconomic series and that the choice of transformation codes can contribute substantially to the accuracy of these forecasts.

The 2008 U.S. Auto Market Collapse

New vehicle sales in the U.S. fell nearly 40 percent during the past recession, causing significant job losses and unprecedented government interventions in the auto industry. This paper explores three potential explanations for this decline: increasing oil prices, falling home values, and falling household income expectations. First, we use the historical macroeconomic relationship between oil prices and vehicle sales to show that the oil price spike explains roughly 15 percent of the auto sales decline between 2007 and 2009. Second, we establish that declining home values explain only a small portion of the observed reduction in household new vehicle sales. Using a county-level panel from the episode, we find (1) a one-dollar fall in home values reduced household new vehicle spending by 0.5 to 0.7 cents and overall new vehicle spending by 0.9 to 1.2 cents and (2) falling home values explain between 16 and 19 percent of the overall new vehicle spending decline. Next, examining state-level data for 1997-2016, we find (3) the short-run responses of new vehicle consumption to home value changes are larger in the 2005-2011 period relative to other years, but at longer horizons (e.g. 5 years), the responses are similar across the two sub-periods and (4) the service flow from vehicles, as measured by miles traveled, responds very little to house price shocks. We also detail the sources of the differences between our findings (1) and (2) from existing research. Third, we establish that declining current and expected future income expectations potentially played an important role in the auto market's collapse. We build a permanent income model augmented to include infrequent repeated car buying. Our calibrated model matches the pre-recession distribution of auto vintages and the liquid-wealth-to-income ratio, and exhibits a large vehicle sales decline in response to a mild decline in expected permanent income due to a transitory slowdown in income growth. In response to the shock, households delay replacing existing vehicles, allowing them to smooth the effects of the income shock without significantly adjusting the service flow from their vehicles. Augmenting our model with a richer set of household expectations allows us to match 65 percent of the overall new vehicle spending decline (i.e. roughly the portion of the decline not explained by oil prices and falling home values). Combining our negative results regarding housing wealth and oil prices with our positive model-based findings, we interpret the auto market collapse as consistent with existing permanent income based approaches to durable goods purchases (e.g., Leahy and Zeira (2005)).

A Comparison of Fed "Tightening" Episodes since the 1980s

Deciding to undertake a series of tightening actions present unique challenges for Federal Reserve policymakers. These challenges are both political and economic. Using a variety of economic and financial market metrics, this article examines how the economy and financial markets evolved in response to the five tightening episodes enacted by the FOMC since 1983. The primary aim is to compare the most-recent episode, from December 2015 to December 2018, with the previous four episodes. The findings in this article indicate that the current episode bears some resemblance to previous Fed tightening episodes, but also differs in several key dimensions. For example, in the first four episodes, the data show the FOMC was generally tightening into a strengthening economy with building price pressures. In contrast, in the fifth episode the FOMC began its tightening regime during a deceleration in economic activity and with headline and core inflation remaining well below the FOMC’s 2 percent inflation target. Moreover, both short- and long-term inflation expectations were drifting lower. These developments helped explain why there was a one-year gap between the first and second increases in the federal funds target rate in the most-recent episode. Another key difference is that in three of the first four episodes, the FOMC continued to tighten after the yield curve inverted; a recession then followed shortly thereafter. However, in the final episode, the FOMC ended its tightening policy about eight months before the yield curve inverted. It remains to be seen if a recession follows this inversion.

Optimal Fiscal Policies under Market Failures

In a canonical model of heterogeneous agents with precautionary saving motives, Aiyagari (1995) breaks the classical result of zero capital tax obtained in representative-agent models. Aiyagari argues that with capital overaccumulation the optimal long-run capital tax should be strictly positive in order to achieve aggregate allocative efficiency suggested by the modified golden rule (MGR). In this paper, we find that, depending on the sources of capital overaccumulation, capital taxation may not be the most efficient means to restore the MGR when government debt is feasible. To demonstrate our point, we study optimal policy mix in achieving the socially optimal (MGR) level of aggregate capital stock in an infinite horizon heterogeneous-agents incomplete-markets economy where capital may be overaccumulated for two distinct reasons: (i) precautionary savings and (ii) production externalities. By solving the Ramsey problem analytically along the entire transitional path, we reveal that public debt and capital taxation play very distinct roles in dealing with the overaccumulation problem. The Ramsey planner opts neither to use a capital tax to correct the overaccumulation problem if it is caused solely by precautionary saving—regardless of the feasibility of public debt—nor to use debt (financed by consumption tax) to correct the overaccumulation problem if it is caused solely by production externality (such as pollution)—regardless of the feasibility of a capital tax. The key is that the MGR has two margins: an intratemporal margin pertaining to the marginal product of capital (MPK) and an intertemporal margin pertaining to the time discount rate. To achieve the MGR, the Ramsey planner needs to equate not only the private MPK with the social MPK but also the interest rate with the time discount rate—neither of which is equalized in a competitive equilibrium. Yet public debt and a capital tax are each effective only in calibrating one of the two margins, respectively, but not both.


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