| Macroeconomics and Growth |
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| No. 396, October 2009 |
| Prices and Quantities in the Monetary Policy Transmission Mechanism |
| Tobias Adrian and Hyun Song Shin |
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| Central banks have various tools for implementing monetary policy, but the tool receiving the most attention in the literature has been the overnight interest rate. The financial crisis that erupted in the summer of 2007 has refocused attention on other channels of monetary policy, notably the transmission of policy through the supply of credit and overall conditions in the capital markets. In 2008, the Federal Reserve put into place various lender-of-last-resort programs under section 13(3) of the Federal Reserve Act to cushion the strains on financial intermediaries’ balance sheets and thereby target the unusually wide spreads in various credit markets. While classic monetary policy targets a price—for example, the federal funds rate—the liquidity facilities affect balance sheet quantities. The financial crisis forcefully demonstrated that the collapse of the financial sector’s balance sheet capacity can have powerful adverse effects on the real economy. This study reexamines the distinctions between prices and quantities in monetary policy transmission. |
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| No. 397, October 2009 |
| Monetary Tightening Cycles and the Predictability of Economic Activity |
| Arturo Estrella and Tobias Adrian |
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| Eleven of fourteen monetary tightening cycles since 1955 were followed by increases in unemployment; three were not. The term spread at the end of these cycles discriminates almost perfectly between subsequent outcomes, but levels of nominal or real interest rates, as well as other interest rate spreads, generally do not. |
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| No. 398, October 2009 |
| Financial Intermediaries and Monetary Economics |
| Tobias Adrian and Hyun Song Shin |
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| This study reconsiders the role of financial intermediaries in monetary economics. Adrian and Shin explore the hypothesis that financial intermediaries drive the business cycle by way of their role in determining the price of risk. In this framework, balance sheet quantities emerge as a key indicator of risk appetite and hence of the “risk-taking channel” of monetary policy. The authors document evidence that the balance sheets of financial intermediaries reflect the transmission of monetary policy through capital market conditions. They find short-term interest rates to be important in influencing the size of financial intermediary balance sheets. The findings suggest that the traditional focus on the money stock for the conduct of monetary policy may have more modern counterparts, and point to the importance of tracking balance sheet quantities for the conduct of monetary policy. |
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| No. 399, October 2009 |
| Labor Supply Heterogeneity and Macroeconomic Comovement
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| Stefano Eusepi and Bruce Preston |
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| Standard real business cycle models must rely on total factor productivity (TFP) shocks to explain the observed comovement of consumption, investment, and hours worked. This paper shows that a neoclassical model consistent with observed heterogeneity in labor supply and consumption can generate comovement in the absence of TFP shocks. Intertemporal substitution of goods and leisure induces comovement over the business cycle through heterogeneity in the consumption behavior of employed and unemployed workers. This result stems from two model features introduced to capture important characteristics of U.S. labor market data. First, individual consumption is affected by the number of hours worked: Employed agents consume more on average than the unemployed do. Second, changes in the employment rate, a central factor explaining variation in total hours, affect aggregate consumption. Demand shocks—such as shifts in the marginal efficiency of investment as well as government spending shocks and news shocks—are shown to generate economic fluctuations consistent with observed business cycles. |
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| No. 404, November 2009 |
| Conventional and Unconventional Monetary Policy |
| Vasco Cúrdia and Michael Woodford |
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| Cúrdia and Woodford extend a standard New Keynesian model both to incorporate heterogeneity in spending opportunities along with two sources of (potentially time-varying) credit spreads and to allow a role for the central bank’s balance sheet in determining equilibrium. They use the model to investigate the implications of imperfect financial intermediation for familiar monetary policy prescriptions and to consider additional dimensions of central bank policy—variations in the size and composition of the central bank’s balance sheet as well as payment of interest on reserves—alongside the traditional question of the proper operating target for an overnight policy rate. The authors also study the special problems that arise when the zero lower bound for the policy rate is reached. They show that it is possible to provide criteria for the choice of policy along each of these possible dimensions within a single unified framework, and to achieve policy prescriptions that apply equally well regardless of whether financial markets work efficiently and whether the zero bound on nominal interest rates is reached. |
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| No. 407, November 2009 |
| How Rigid Are Producer Prices? |
| Pinelopi Koujianou Goldberg and Rebecca Hellerstein |
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| Conventional wisdom suggests that producer prices are more rigid than consumer prices and thus they play less of an allocative role than do consumer prices. Analyzing 1987-2008 Bureau of Labor Statistics microdata for the producer price index, the authors find that producer prices for finished goods and services in fact exhibit roughly the same rigidity as consumer prices that include sales and substantially less rigidity than consumer prices that exclude them. Moreover, large firms change prices two to three times more frequently than small firms do, and by smaller amounts, particularly when prices decrease. Longer price durations are associated with larger price changes, although considerable heterogeneity exists. Long-term contracts are associated with somewhat greater price rigidity for goods and services. The size of price decreases plays a key role in inflation dynamics, while the size of price increases does not. The frequencies of price increases and decreases tend to move together and so cancel one another out. |
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| No. 408, November 2009 |
| Implications of the Financial Crisis for Potential Growth: Past, Present, and Future |
| Charles Steindel |
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| The scale of the recent collapse in asset values and the magnitude of the recession suggest that activities connected to the increase in values over the 2002-07 period—notably, expansion of the financial markets, homebuilding, and real estate—were overstated. If this is true, aggregate U.S. economic growth would have been overstated, implying that previous rates of potential GDP growth may also have been overstated and that the trajectory of potential GDP may be slower going forward. Slowing growth in the finance, homebuilding, and real estate sectors could hold back aggregate growth. A detailed examination of these sectors’ direct contributions to GDP, however, suggests that overstatements of past growth would likely not have made a large difference in recorded GDP growth. Slower growth in these sectors would have, at most, a moderate direct effect on aggregate activity. The recent experience’s longer term effects on GDP would seem to stem largely from factors other than retrenchment in these sectors. |
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| No. 411, December 2009 |
| Investment Shocks and the Relative Price of Investment |
| Alejandro Justiniano, Giorgio E. Primiceri, and Andrea Tambalotti |
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| The authors estimate a New Neoclassical Synthesis model of the business cycle with two investment shocks. The first, an investment-specific technology shock, affects the transformation of consumption into investment goods and is identified with the relative price of investment. The second shock affects the production of installed capital from investment goods or, more broadly, the transformation of savings into future capital input. The study finds that this shock is the most important driver of U.S. business cycle fluctuations in the postwar period and that it is likely to proxy for more fundamental disturbances to the functioning of the financial sector. To corroborate this interpretation, the authors show that the shock correlates strongly with interest rate spreads and that it played a particularly important role in the recession of 2008. |
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| No. 418, December 2009 |
| The Homeownership Gap |
| Andrew Haughwout, Richard Peach, and Joseph Tracy |
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| After rising for a decade, the U.S. homeownership rate peaked at 69 percent in the third quarter of 2006. Over the next two and a half years, as home prices fell in many parts of the country and the unemployment rate rose sharply, the homeownership rate declined by 1.7 percentage points. An important question is, How much more will this rate decline over the current economic downturn? To address this question, Haughwout, Peach, and Tracy propose the concept of the “homeownership gap” as a gauge of downward pressure on the homeownership rate. They define the homeownership gap as the difference between the “official” homeownership rate and a recomputed rate that excludes owners who are in a negative equity position, meaning that the value of their houses is less than the outstanding mortgage balance. Their estimate of this gap suggests that the official homeownership rate will likely experience significant downward pressure in the coming years. |
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| No. 419, December 2009 |
| Estimating the Cross-Sectional Distribution of Price Stickiness from Aggregate Data |
| Carlos Carvalho and Niels Arne Dam |
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| This study estimates a multisector sticky-price model for the U.S. economy in which the degree of price stickiness is allowed to vary across sectors. For this purpose, the authors use a specification that allows them to extract information about the underlying cross-sectional distribution from aggregate data. Estimating the model using only aggregate data on nominal and real output, they find that the inferred distribution of price stickiness is strikingly similar to the empirical distribution constructed from the recent microeconomic evidence on price setting in the U.S. economy. The authors also explore their Bayesian approach to combine the aggregate time-series data with the microeconomic information on the distribution of price rigidity. Their results show that allowing for this type of heterogeneity is critically important to understanding the joint dynamics of output and prices, and it constitutes a step toward reconciling the extent of nominal price rigidity implied by aggregate data with the evidence from microeconomic data on price stickiness. |
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| No. 420, December 2009 |
| Real-Time Underlying Inflation Gauges for Monetary Policymakers |
| Marlene Amstad and Simon Potter |
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| Central banks analyze a wide range of data to obtain better measures of underlying inflationary pressures. Factor models have been widely used to formalize this procedure. Using a dynamic factor model, this paper develops a measure of underlying inflation (UIG) at time horizons of relevance for monetary policymakers for both consumer price index inflation and personal consumption expenditures inflation. The UIG uses a broad data set allowing for high-frequency updates on underlying inflation. The paper complements the existing literature on U.S. “core” measures by illustrating how UIG has been used and interpreted in real time since late 2005. |
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