Board of Governors of the Federal Reserve System

Abstract:

We provide novel empirical evidence that firms’ investment is more responsive to monetary policy when a higher fraction of their debt matures. In a heterogeneous firm New Keynesian model with financial frictions and endogenous debt maturity, two channels explain this finding: (1.) Firms with more maturing debt have larger roll-over needs and are therefore more exposed to fluctuations in the real interest rate (roll-over risk). (2.) These firms also have higher default risk and therefore react more strongly to changes in the real burden of outstanding nominal debt (debt overhang). Unconventional monetary policy, which operates through long-term interest rates, has larger effects on debt maturity but smaller effects on output and inflation than conventional monetary policy.

Keywords: Monetary policy, Investment, Corporate debt, Debt maturity

DOI: https://doi.org/10.17016/IFDP.2024.1402

Abstract:

We document that foreign economic policy uncertainty (EPU^F) has significant incremental predictive power for excess U.S. stock returns in the presence of domestic EPU, both in aggregate and for returns of portfolios constructed on firm characteristics, for 6 to 12-months-ahead horizons. We find that EPU^F shocks primarily transmit to equity prices through cash flow news rather than the discount rate news channel. We examine whether responses of select macro-financial variables to an adverse EPU^F shock are consistent with this transmission mechanism. Corporate investment outlays, payouts, and aggregate credit demand decline in response to such a shock.

Keywords: Economic policy uncertainty, Cash flows, Discount rates, ICAPM, Return predictability, Transmission channels

DOI: https://doi.org/10.17016/IFDP.2024.1401

Abstract:

We use a rarely accessed BIS database on bilateral cross-border bank claims by bank nationality to examine the interaction of monetary and fiscal policies. We find significant interactions: the transmission of the monetary policies of major currency issuers is significantly influenced by the fiscal stance of source (home) lending banking systems. Fiscal consolidation in a source country amplifies the effect of currency issuers' monetary policy on lending. For instance, a reduction in the German debt-to-GDP ratio amplifies the negative impact of US monetary policy tightening on USD-denominated cross-border bank lending outflows from German banks. The interaction effects are the strongest for US monetary policy.

Keywords: Monetary policy; Government debt; Cross-border claims; Difference-in-differences

DOI: https://doi.org/10.17016/IFDP.2024.1400

Abstract:

The allocative efficiency of capital flows is one of the oldest and most contentious questions. We answer it by matching cross-border securities holdings reported in the US external statistics from 1995 to 2022 with the corresponding firm-level measures of allocative efficiency. We find that US investors tilt their international equity investment toward firms with high MRPK and markups, thereby fostering their potential for growth. Foreign investors tilt their holdings toward US firms with high productivity and intangible capital. A horse race shows that productivity is the best predictor of foreign investment in US firms and MRPK for US investment in foreign firms. Both US and foreign firms that receive more international funding increase spending on intangible capital, and foreign firms also increase tangible capital. The results are stronger for more productive firms.

Keywords: productivity, capital allocation, capital flows

DOI: https://doi.org/10.17016/IFDP.2024.1399

Abstract:

We provide new estimates of the return on US external claims and liabilities using confidential, high-quality, security-level data. The excess return is positive on average, since claims are tilted toward higher-return equities. The excess return is large and positive in normal times but large and negative during global crises, reflecting the global insurance role of the US external balance sheet. Controlling for issuer's nationality, we find that US investors have a larger exposure to equity issued by Asia-headquartered corporations than reported in the aggregate statistics. Finally, equity portfolios are concentrated in 'superstar' firms, but for US liabilities foreign holdings are less concentrated than the overall market.

DOI: https://doi.org/10.17016/IFDP.2024.1398

Abstract:

Household savings rose above trend in many developed countries after the onset of COVID-19. Given its link to aggregate consumption, the presence of these "excess savings" has raised questions about their implications for the transmission of monetary policy. Using a panel of euro-area economies and high-frequency monetary policy shocks, we document that household excess savings dampen the effects of monetary policy on economic activity and inflation, especially during the pandemic period. To rationalize our empirical findings, we build a New Keynesian model in which households use savings to self-insure against counter-cyclical unemployment and consumption risk.

Keywords: Monetary Policy, Excess Savings, Precautionary Savings, Consumption Risk, Unemployment

DOI: https://doi.org/10.17016/IFDP.2024.1397

Abstract:

This paper examines labor markets across Latin American countries, revealing substantial differences in unemployment, informality, and worker transitions. Using surveys from eight countries, we construct comparable statistics on employment stocks and mobility patterns. Notable cross-country differences emerge, with economies mostly clustered into high unemployment-low informality or low unemployment-high informality groups. Transition probabilities and directional flows also vary significantly. We highlight the importance of using country-specific parameters when simulating labor market and aggregate outcomes. Finally, we compare our main results with those by sex and education groups.

Keywords: Latin America, Labor markets, Informality, Unemployment, Transitions

DOI: https://doi.org/10.17016/IFDP.2024.1396

Abstract:

In a simple New Keynesian open economy setting, we analyze how local input shortages influence policy transmission and equilibrium determinacy. Shortages increase the elasticity of the local price of the scarce factor to domestic economic activity, affecting the cyclicality of marginal costs and incomes. As a result, the slope of both the Phillips and the IS curve is altered, crucially influencing monetary and fiscal policy transmission. These changes are affected by factor ownership and propensities to consume. Theoretically, shortages can also raise the risk of self-fulfilling fluctuations if a rising price of the constrained factor boosts incomes for agents with high propensities to consume. We illustrate these channels for the 2022 German energy crisis.

Keywords: Supply constraints, heterogeneous households, monetary transmission, transfer multiplier, sunspots

DOI: https://doi.org/10.17016/IFDP.2024.1395

Abstract:

We examine the impact of an export market expansion created by the US-Vietnam Bilateral Trade Agreement (BTA) on labor market competition among Vietnamese manufacturing firms. We measure distortionary wedges between equilibrium marginal revenue products of labor (MRPL) and wages nonparametrically and find that the median firm pays workers 59% of their MRPL. The BTA permanently decreases labor market distortion in manufacturing by 3.4%, mainly for domestic private firms. The median distortion is 26% higher for women than men, and the decline in distortion for women drives the overall distortion reduction. We shed some light on the mechanisms for these results.

Keywords: International Trade, Export Market Access, Labor Market Distortion, Misallocation, Income Distribution, Labor Share, Gender Inequality, Monopsony, Oligopsony

DOI: https://doi.org/10.17016/IFDP.2024.1394

Abstract:

There is substantial asymmetry in effective corporate income tax rates across firms. While tax asymmetries would reduce productivity in frictionless economies, they can improve efficiency in a distorted economy if taxes alleviate other economic frictions. We develop a framework to estimate to what extent tax asymmetries affect productivity in distorted economies. Using US firm-level balance sheet data alongside measures of effective marginal tax rates, we find a positive correlation between tax rates and factor productivity, suggesting that tax asymmetry exacerbates the distortions from other economic frictions. Eliminating tax rate asymmetries would raise aggregate productivity by 3 to 4 percent if taxes distort capital costs alone. Models where taxes also distort the marginal cost of labor predict potential gains as high as 9 percent.

Keywords: Business taxation, Aggregate productivity, TFP, Misallocation

DOI: https://doi.org/10.17016/.IFDP.2024.1393

Abstract:

Existing high-frequency monetary policy shocks explain surprisingly little variation in stock prices and exchange rates around FOMC announcements. Further, both of these asset classes display heightened volatility relative to non-announcement times. We use a heteroskedasticity-based procedure to estimate a “Fed non-yield shock”, which is orthogonal to yield changes and is identified from excess volatility in the S&P 500 and various dollar exchange rates. A positive non-yield shock raises stock prices in the U.S. and around the globe, and depreciates the dollar against all major currencies. The non-yield shock is essentially uncorrelated with previous monetary policy shocks and its effects are large in comparison. Its strong effects on the VIX and other risk-related measures point towards a dominant risk premium channel. We show that the non-yield shock can be related to Fed communications and that its existence has implications for the identification of structural monetary policy shocks.

Keywords: Federal Reserve, Monetary Policy, Stock Market, Exchange Rates, Asset Prices, Risk Premia, Information Effects, High-frequency Identification

DOI: https://doi.org/10.17016/IFDP.2024.1392

Abstract:

We propose a model with costly international financial intermediation that links exchange rate movements to shifts in the demand for domestically produced goods relative to the demand for imported goods (trade rebalancing). Our model is consistent with stylized facts of exchange rate dynamics, including those related to the trade balance, which is typically overlooked in the literature on exchange rate determination. In a quantitative assessment, trade rebalancing explains nearly 50 percent of exchange rate fluctuations over the business cycle, whereas exogenous deviations from the uncovered interest rate parity—the primary source of exchange rate fluctuations in the literature—account for just above 20 percent. Using data on trade flows or the trade balance is key to properly identifying the determinants of the exchange rate. Thus, our model overcomes the sharp dichotomy between the real exchange rate and the macroeconomy embedded in other models of exchange rate determination.

Keywords: Exchange Rates, Risk Sharing, Financial Intermediation, Trade Balance

DOI: https://doi.org/10.17016/IFDP.2024.1391

Abstract:

We use a merged global data set of security-level corporate bond issuance and firm-level financial statement data to show that, in contrast to earlier periods of financial stress, during the COVID pandemic nonfinancial firms around the world were more likely to issue bonds, driven by a boom in local-currency-denominated issuance. We observe a distinct cross-regional difference in the characteristics of issuing firms, finding that in advanced economies issuance during COVID was driven by less risky firms, as predicted by existing theories; in emerging markets, only issuance of U.S. dollar denominated bonds came from larger or less risky firms.

Keywords: COVID, corporate bonds, crises, issuance

DOI: https://doi.org/10.17016/IFDP.2024.1390

Abstract:

We show that reducing the probability of a trade war promotes long-term importer-exporter relationships that ensure provision of high-quality inputs via incentive premia. Empirically, we introduce a method for distinguishing between these long-term relationships--which the literature has termed "Japanese" due to their introduction by Japanese firms--from spot-market relationships in customs data. We show that the use of "Japanese" relationships varies intuitively across trading partners and products and find that the use of such relationships increases after a reduction in the possibility of a trade war. Extending the standard general equilibrium trade model to encompass potential trade wars and relational contracts, we estimate that eliminating "Japanese" procurement reduces welfare about a third as much as moving to autarky.

Keywords: Supply chain, Uncertainty, Trade war, Procurement

DOI: https://doi.org/10.17016/IFDP.2024.1389

Abstract:

This paper studies the cross-sectional dimension of Fisher’s debt-deflation mechanism that triggers Sudden Stop crises. Analyzing microdata from Mexico, we show that this dimension has macroeconomic implications that operate via opposing effects. We propose a small open economy, asset-pricing model with heterogeneous-agents and aggregate risk to measure the effects of inequality during crises. In contrast to a representative-agent model, heterogeneity generates persistent current account reversals with smaller drops in asset prices and larger drops in consumption driven by the leveraged households. Moreover, in a lower inequality calibration, we find that crises are less severe, as observed in the data.

Keywords: Inequality, Sudden Stops, Debt-deflation, Asset-pricing, Household leverage

DOI: https://doi.org/10.17016/IFDP.2024.1388

Abstract:

In principle, physical currency should be disappearing: payments are increasingly electronic, with new technologies emerging rapidly, and governments increasingly restrict large-denomination notes as a way to reduce crime and tax evasion. Nonetheless, demand for U.S. banknotes continues to grow, and consistently increases at times of crisis both within and outside the United States because dollar banknotes remain a desirable store of value and medium of exchange when local currency or bank deposits are inferior. Most recently, the COVID crisis resulted in historic increases in currency demand. After allowing for the effect of crises, U.S. banknote demand appears to be driven by the usual factors determining money demand, with no discernible downward trend.

In this work, I review developments in demand for U.S. currency over the past few decades with a focus on developments since early 2020. In addition, I revisit the question of international demand: I present the raw data available for measuring international banknote flows and updates on indirect methods of estimating the stock of currency held abroad. These methods continue to indicate that a large share of U.S. currency is held abroad, especially in the $100 denomination.

As shown earlier (Judson 2012, 2017), once a country or region begins using dollars, subsequent crises result in additional inflows: the dominant sources of international demand over recent decades are the countries and regions that were already heavy dollar users in the early to mid-1990s. While international demand for U.S. currency eased during the early 2000s as financial conditions improved, the abrupt return to strong international demand that began with the collapse of Lehman Brothers in 2008 has not slowed and reached new heights over 2020 and 2021. In contrast, however, the growth rate of demand for smaller denominations is slowing, perhaps indicating the first signs of declining domestic cash demand.

Keywords: Currency, Banknotes, Dollarization, Crisis

DOI: https://doi.org/10.17016/.IFDP.2024.1387

Abstract:

We assess the impacts from physical hazards (or severe weather events) on economic activity in a panel of 98 countries using local projection methods. Proxying the strength of an event by the monetary damages it caused, we find severe weather events to reduce the level of GDP. For most events in the EM-DAT data set the effects are small. The largest events in our sample (above the 90th percentile of damages) bring down the level of GDP by 0.5 percent for several years without recovery to trend. Smaller events (below the 90th percentile) see a less immediate decrease in initial years (0.1 percent) that progressively widens to become similar to the effect of larger disasters after 10 years. Climatological hazards (droughts and forest fires) appear to have the largest effects. These findings are robust across country groupings by development and alternative measures of the strength of the physical hazard.

Keywords: Climate-related risk, GDP growth, Natural hazards and disasters, Rare disasters, Vulnerability to climate impacts

DOI: https://doi.org/10.17016/IFDP.2024.1386