The views expressed in these papers are solely those of the authors and should not be interpreted as reflecting the views of the Federal Reserve Bank of Philadelphia or Federal Reserve System.

03-1: Data Revisions and the Identification of Monetary Policy Shocks by Dean Croushore and Charles L. Evans

Monetary policy research using time series methods has been criticized for using more information than the Federal Reserve had available in setting policy. To quantify the role of this criticism, the authors propose a method to estimate a VAR with real-time data while accounting for the latent nature of many economic variables, such as output. The authors' estimated monetary policy shocks are closely correlated with a typically estimated measure. The impulse response functions are broadly similar across the methods. The authors' evidence suggests that the use of revised data in VAR analyses of monetary policy shocks may not be a serious limitation.

03-2: The Effects of a Baby Boom on Stock Prices and Capital Accumulation in the Presence of Social Security by Andrew B. Abel

Is the stock market boom a result of the baby boom? This paper develops an overlapping generations model in which a baby boom is modeled as a high realization of a random birth rate, and the price of capital is determined endogenously by a convex cost of adjustment. A baby boom increases national saving and investment and thus causes an increase in the price of capital. The price of capital is mean-reverting so the initial increase in the price of capital is followed by a decrease. Social Security can potentially affect national saving and investment, though in the long run, it does not affect the price of capital.

03-3: Non-Exclusive Contracts, Collateralized Trade, and a Theory of an Exchange by Yaron Leitner

Superseded by Working Paper 10-28.

03-4: Backward-Looking Interest-Rate Rules, Interest-Rate Smoothing, and Macroeconomic Instability by Jess Benhabib, Stephanie Schmitt-Grohé, and Martín Uribe

The existing literature on the stabilizing properties of interest-rate feedback rules has stressed the perils of linking interest rates to forecasts of future inflation. Such rules have been found to give rise to aggregate fluctuations due to self-fulfilling expectations. In response to this concern, a growing literature has focused on the stabilizing properties of interest-rate rules whereby the central bank responds to a measure of past inflation. The consensus view that has emerged is that backward-looking rules contribute to protecting the economy from embarking on expectations-driven fluctuations. A common characteristic of the existing studies that arrive at this conclusion is their focus on local analysis. The contribution of this paper is to conduct a more global analysis. The authors find that backward-looking interest-rate feedback rules do not guarantee uniqueness of equilibrium. They present examples in which for plausible parameterizations attracting equilibrium cycles exist. The paper also contributes to the quest for policy rules that guarantee macroeconomic stability globally. The authors' analysis indicates that policy rules whereby the interest rate is set as a function of the past interest rate and current inflation are likely to ensure global stability provided that the coefficient on lagged interest rates is greater than unity.

03-5: How Strong Is Co-Movement in Employment Over the Business Cycle? Evidence from State/Industry Data by Gerald A. Carlino and Robert H. DeFina

This study measures the extent of co-movement in employment across states and industries at business-cycle frequencies. The strength of co-movement is quantified using the bi-variate and multi-variate measures of cohesion developed in Crous, Forni, and Reichlin (2001). The data indicate that cohesion is generally positive for the state/industry pairs, although the distribution masses around a relatively low value. The results suggest that cohesion has risen over time and that cohesion increases with spatial aggregation. Evidence is presented revealing that the measured degree of co-movement is sensitive to the chosen periodicity of the data and that there is much greater cohesion across states for a given industry than across different industries within a state. An investigation into the sources of cross-state variation in cohesion reveals that important determinants include the strength of input-output linkages within each state, the different effects of monetary policy actions on each state's employment, and the degree of industrial diversity within a state. No state-level support is found for Shea's (1996) hypothesis that industries that locate together co-move to a greater extent than do those that are more spatially diffused.

03-6: What Is the Value of Recourse to Asset Backed Securities? A Clinical Study of Credit Card Banks by Eric J. Higgins and Joseph R. Mason

The present paper uses data from revolving credit card securitizations to show that, conditional on being in a position where implicit recourse has become necessary and actually providing that recourse, recourse to securitized debt may benefit short- and long-term stock returns, and long-term operating performance of sponsors. The paper suggests that this result may come about because those sponsors providing the recourse do not seem to be extreme default or insolvency risks. However, sponsors providing recourse do experience an abnormal delay in their normal issuance cycle around the event. Hence, it appears that the asset-backed securities market is like the commercial paper market, where a firm's ability to issue is directly correlated with credit quality. Therefore, although in violation of regulatory guidelines and FASB140, recourse may have beneficial effects for sponsors by revealing that the shocks that made recourse necessary are transitory.

03-7: Credit Card Securitization and Regulatory Arbitrage by Charles W. Calomiris and Joseph R. Mason

This paper explores the motivations and desirability of off-balance-sheet financing of credit card receivables by banks. The authors explore three related issues: the degree to which securitizations result in the transfer of risk out of the originating bank, the extent to which securitization permits banks to economize on capital by avoiding regulatory minimum capital requirements, and whether banks' avoidance of minimum capital regulation through securitization with implicit recourse has been undesirable from a regulatory standpoint. The authors show that this intermediation structure could be motivated either by desirable efficient contracting in the presence of asymmetric information or by undesirable safety net abuse. They find that securitization results in some transfer of risk out of the originating bank but that risk remains in the securitizing bank as a result of implicit recourse. Clearly, then, securitization with implicit recourse provides an important means of avoiding minimum capital requirements. The authors also find, however, that securitizing banks set their capital relative to managed assets according to market perceptions of their risk and seem not to be motivated by maximizing implicit subsidies relating to the government safety net when managing their risk. Thus, the evidence is more consistent with the efficient contracting view of securitization with implicit recourse than with the safety net abuse view. Concerns expressed by policymakers about this form of capital requirement avoidance appear to be overstated.

03-8: A Short-Term Model of the Fed's Portfolio Choice by Dean Croushore

What would happen if the Federal Reserve were to change the assets in its portfolio? Suppose that instead of using open-market operations in Treasury securities to increase the monetary base, the Fed were to engage in open-market operations in private securities or to use discount loans via a mechanism that allowed banks to borrow as much as they would like at a fixed discount rate. The analysis in this paper shows the impact on the economy in a static general-equilibrium model. This model follows Santomero (1983), adapted to evaluate a change in the Fed’s portfolio and how that affects the economy’s general equilibrium at a point in time. The nature of the exercise done here is completely static in nature and does not evaluate the economy’s response to a disappearance of government debt, analysis of which would require a more complete model that’s dynamic in nature and incorporates real effects. The present model focuses on the more narrow issue of the direction of portfolio changes with no real-side economic effects. But the model is general equilibrium in nature and thus performs a reasonable comparative-static exercise. In what follows, the author first describes the model in Section I. Next, the author models a situation in which the Fed changes its portfolio in such a way as to keep the interest rate on deposits from changing (Section II). Section III generates results under a special set of assumptions that lock most interest rates together. Section IV attempts to generalize the results to a situation in which the monetary base is unchanged. Section V summarizes the results.

03-9: Urban Decline and Housing Reinvestment: The Role of Construction Costs and the Supply Side by Joseph Gyourko and Albert Saiz

Negative demand shocks have afflicted many American cities in the 20th century and are the main explanation for their decaying housing markets. But what is the role of housing supply? Rational entrepreneurs should not invest in new buildings and renovation when home values are below replacement cost. Households with an investment motive should behave similarly. Empirically, the authors find that construction costs are not very sensitive to building activity but do vary with local income, unionization rates in the construction sector, the level of local regulation, and region. They also document that the variance in building costs generates substantial variance in renovation expenditures across cities. Owner-occupied homes with market values below replacement costs spend about 50 percent less on renovation than similar homes with market values above construction costs. The authors also report on the distribution of the ratio of house value-to-construction cost across markets. The distribution is relatively flat in a number of declining cities, especially older manufacturing areas. In these places, a relatively modest 10 percent decline in replacement costs would find between 7-15 percent of the local housing stock moving from being valued below cost to above cost. Even though modest declines in construction costs are unlikely to change basic urban trends, the authors' results suggest they can be an important factor in determining whether various neighborhoods in declining cities will experience any significant reinvestment. In this respect, declining cities truly cannot afford to be expensive cities in terms of replacement costs: Urban scholars and policy makers should begin to pay more attention to the cost side of cities.

03-10: An Introduction to the Economics of Payment Card Networks by Robert M. Hunt

Open payment card networks typically coordinate the activities of thousands of financial institutions that issue cards, millions of retail locations that accept them, and several hundred million consumers that use them. This coordination can include the collective setting of certain prices and other controversial network rules. Such practices have recently come under the scrutiny of antitrust authorities in the U.S. and abroad. This paper provides a brief overview of the economics of the payment card industry, explaining some of the differences from the textbook model of competitive markets. Such differences are important factors for the antitrust analysis of payment card networks.

03-11: A Note on Global Welfare in Pharmaceutical Patenting by F.M. Scherer

This paper revisits the question of whether global welfare is higher under a uniform world-wide system of pharmaceutical product patents or with international rules allowing low-income nations to free-ride on the discoveries of firms in rich nations. Key variables include the extent to which free-riding reduces the discovery of new drugs, the rent potential of rich as compared to poor nations, the ratio of the marginal utility of income in poor as compared to rich nations, and the competitive environment within which R&D decisions are made. Global welfare is found to be higher with free-riding over plausible discovery impairment and income utility combinations, especially when rent-seeking behavior leads to an expansion of R&D outlays exhausting appropriable rents.

03-12: Immigration and Housing Rents in American Cities by Albert Saiz

Is there a local economic impact of immigration? Immigration pushes up rents and housing values in destination cities. The positive association of rent growth and immigrant inflows is pervasive in time series for all metropolitan areas. The author uses instrumental variables based on a “shift-share” of national levels of immigration into metropolitan areas. Conditioning on other variables, an immigration inflow equal to 1 percent of the city population is associated with increases in rents and housing values of about 1 percent. The results suggest an economic impact that is an order of magnitude bigger than that found on labor markets.

03-13: Applying Efficiency Measurement Techniques to Central Banks by Loretta J. Mester

This paper reviews the standard techniques of efficiency measurement, discusses some of the issues that arise in applying these standard techniques to central banks, and reviews some of the literature that has attempted to apply these techniques to central banking. The uniqueness of some of the activities of central banking, the difficulty in measuring some of the central banking outputs, and the complicated and multiple objectives pursued by central banks makes application of the standard techniques problematic. However, certain central bank activities do lend themselves to efficiency measurement, e.g., payment services provision.

03-14: The Macroeconomics of U.S. Consumer Bankruptcy Choice: Chapter 7 or Chapter 13? by Wenli Li and Pierre-Daniel Sarte

Because of the recent surge in U.S. personal defaults, Congress is currently debating bankruptcy reform legislation requiring a means test for Chapter 7 filers. This paper explores the effects of such a reform in a model where, in contrast to previous work, bankruptcy options and production are explicitly taken into account. The authors' findings indicate that means testing would not improve upon current bankruptcy provisions and, at best, leaves aggregate filings, output, and welfare unchanged. Put simply, given already existing provisions, the introduction of an efficient means test would not bind. However, we do find that a tightening of existing bankruptcy laws, in the form of lower Chapter 7 asset exemptions, can be welfare improving. Contrary to previous studies, the analysis also suggests that eliminating bankruptcy entirely would cause significant declines in both output and welfare.

03-15: Growth Effects of Progressive Taxes by Wenli Li and Pierre-Daniel Sarte

The authors study the effects of progressive taxes in conventional endogenous growth models augmented to include heterogeneous households. In contrast to representative agent models with flat-rate taxes, this framework allows the author to distinguish between marginal tax rates and the empirical proxies that are typically used for these rates such as the share of tax revenue, or government expenditures, in GDP. The analysis then illustrates how the endogenous nature of these proxy variables causes them to be weakly correlated, or even increase, with economic growth. This study, therefore, helps explain why cross-country regressions have mostly failed to uncover the distortional growth effects of taxes. In fact, while past U.S. tax reforms appear to have contributed only small increases in per capita GDP growth, the authors' analysis nevertheless suggests that differences in tax codes across countries explain a two and a half percent variation in cross-sectional growth rates. Finally, the authors show that progressivity also introduces significant lags in the effects of tax changes on output growth.

03-16: Cost Savings From Electronic Payments and ATMs in Europe by David Humphrey, Magnus Willesson, Göran Bergendahl, and Ted Lindblom

Electronic payments are considerably cheaper than their paper-based alternatives. Similarly, ATMs are a more cost-efficient way to deliver certain depositor services than are branch offices. As the share of electronic payments in 12 European countries rose from 0.43 in 1987 to 0.79 in 1999 and ATMs expanded while the number of branch offices was constant, bank operating costs are estimated to be $32 billion lower than they otherwise might have been, saving 0.38% of the 12 nations’ GDP. The authors' results are robust to the form of cost function estimated — composite, Fourier, or translog.

03-17/R: An Empirical Look At Software Patents by James Bessen and Robert M. Hunt

U.S. legal changes have made it easier to obtain patents on inventions that use software. Software patents have grown rapidly and now comprise 15 percent of all patents. They are acquired primarily by large manufacturing firms in industries known for strategic patenting; only 5 percent belong to software publishers. The very large increase in software patent propensity over time is not adequately explained by changes in R&D investments, employment of computer programmers, or productivity growth. The residual increase in patent propensity is consistent with a sizable rise in the cost effectiveness of software patents during the 1990s. We find evidence that software patents substitute for R&D at the firm level; they are associated with lower R&D intensity. This result occurs primarily in industries known for strategic patenting and is difficult to reconcile with the traditional incentive theory of patents.

03-18: Postwar Period Changes in Employment Volatility: New Evidence from State/Industry Panel Data by Gerald Carlino, Robert DeFina, and Keith Sill

Many recent studies have identified a decline in the volatility of U.S. real output over the last half century. This study examines a less discussed and analyzed trend, but one as significant as the drop in output volatility, namely a substantial decline in employment volatility during the postwar period. Using a new panel data set covering industry employment by state since 1952, the authors find that a large decline in employment growth volatility began in the early 1950s and largely ended by the mid-to-late 1960s. This study also illuminates the geographical dimension of the declines, an aspect that has heretofore been unexamined. The data indicate that all states have shared in the volatility decline, although the magnitudes have differed.

A pooled cross-section/time-series model indicates that fluctuations in statespecific (state level differences in demographic and industrial composition) and macro variables (e.g., changes in monetary policy regimes) have each played a potentially substantial role in explaining volatility trends. The authors find that state-specific forces account for between 1 percent and 24 percent of the variations in employment volatility across time and space. Macro variables account for between 30 percent and 76 percent of the movements in employment volatility, a range broadly consistent with the findings of Stock and Watson (2002). An important finding of this study is that “unknown forms of good luck,” in the form of smaller shocks to employment, account for between 1 percent and 10 percent of the observed fluctuations. This latter finding suggests a reduced role for unknown forms of good luck in describing the postwar decline in volatility compared to the findings in Stock and Watson’s (2002) analysis of the variance of real output growth.

03-19: International Risk-Sharing and the Transmission of Productivity Shocks by Giancarlo Corsetti, Luca Dedola, and Sylvain Leduc

A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to efficient risk-sharing, negatively correlated with relative consumptions across countries. This paper shows that a model with incomplete markets and a low price elasticity of imports can account for these properties of real exchange rates. The low price elasticity stems from introducing distribution services, which drive a wedge between producer and consumer prices and lowers the impact of terms-of-trade changes on optimal agents’ decisions. In the authors' model, two very different patterns of the international transmission of productivity shocks generate the observed degree of risk-sharing: one associated with an improvement, the other with a worsening of the country’s terms of trade and real exchange rate. The authors provide VAR evidence on the effect of technology shocks to U.S. manufacturing, identified through long-run restrictions, in support of the first transmission pattern. These findings are at odds with the presumption that terms-of-trade movements foster international risk-pooling.

03-20: On the Welfare Gains of Eliminating a Small Likelihood of Economic Crises: A Case for Stabilization Policies? by Satyajit Chatterjee and Dean Corbae

This paper is superseded by Working Paper 06-18.

03-21: The Evolution of the Philadelphia Stock Exchange: 1964-2002 by John P. Caskey

This paper analyzes the evolution of the Philadelphia Stock Exchange (PHLX), America’s oldest stock exchange, from 1964 through 2002. The paper seeks to explain how the PHLX managed to attract a sufficient volume of trading orders to support its members and cover its operating costs during this period, and how it adapted to survive in an era with profound changes in the structure of securities markets.

03-22/R: Monetary Policy, Oil Shocks, and TFP: Accounting for the Decline in U.S. Volatility by Sylvain Leduc and Keith Sill

The volatility of the U.S. economy since the mid-1980s is much lower than it was during the prior 20-year period. The proximate causes of the increased stability and their relative importance remain unsettled, but the sharpness of the volatility decline and its timing has led authors such as Taylor (2000) to argue that a sudden shift in monetary policy is a prime candidate. The authors assess this claim using a calibrated stochastic dynamic general equilibrium model to quantify the contribution of monetary policy and exogenous shocks to the postwar volatility pattern for U.S. output. Their principal finding is that the change in monetary policy played a relatively small role in the postwar volatility decline, accounting for 10 to 15 percent of the drop in real output volatility. The model attributes most of the output volatility decline to smaller TFP shocks: oil shocks end up increasing volatility in the post-84 period relative to the pre-79 period. Negative oil shocks do lead to significant downturns in real output in the model, but the pattern of exogenous shocks post-84 is not different enough from the pre-79 pattern to play a meaningful role in lowering output volatility.

03-23: An Alternative Definition of Economic Regions in the U.S. Based on Similarities in State Business Cycles by Theodore M. Crone

Since the 1950s, the Bureau of Economic analysis (BEA) has grouped the states into eight regions based primarily on cross-sectional similarities in their socioeconomic characteristics. This is the most frequently used grouping of states in the U.S. for economic analysis. Since several recent studies concentrate on similarities and differences in regional business cycles, this paper groups states into regions based not on a broad set of socioeconomic characteristics but on the similarities in their business cycles. The analysis makes use of a consistent set of coincident indexes estimated from a Stock and Watson-type model. The author applies k-means cluster analysis to the cyclical components of these indexes to group the 48 contiguous states into eight regions with similar cycles. Having grouped the states into regions, the author determines the relative strength of cohesion among the states in the various regions. Finally, the author compares the regions defined in this paper with the BEA regions.

03-24: On the Contribution of Agglomeration Economies to the Spatial Concentration of U.S. Employment by Satyajit Chatterjee

Why does the level of economic activity vary so much across space? One reason given is “agglomeration economies,” meaning that a firm’s or household’s production costs (of market and home goods, respectively) are lower when production is carried out in close proximity to other firms and households. In this paper the author explores, via a quantitative spatial macroeconomic model, the contribution of agglomeration economies to the observed spatial concentration of U.S. employment. The approach is analogous to “business-cycle accounting” or “growth accounting.” The results of the “spatial accounting” performed in this study depend on the details of the model used. The critical detail pertains to how the model rationalizes the stability of low density localities. If it is rationalized via an appeal to restrictions on labor mobility, the accounting implies that the bulk of spatial concentration results from an unequal distribution of natural advantages. In contrast, if it is rationalized via an agglomeration threshold (an employment level below which local increasing returns do not operate), the accounting implies that the bulk of the spatial concentration results from increasing returns.