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.

04-1: Local Open Economies Within the U.S.: How Do Industries Respond to Immigration? by Ethan Lewis

A series of studies has found that relative wages and employment rates in different local labor markets of the US are surprisingly unaffected by local factor supplies. This paper evaluates two explanations for this puzzling empirical fact: (1) Interregional trade mitigates the local impact of supply shocks. (2) Production technology rapidly adapts to the local mix of workers. The author tests these alternative explanations by estimating the effect of increases in relative supplies of particular skill groups on the relative growth rates of different industries and on the relative utilization of these skill groups within industries. Labor supply shocks are identified with a component of foreign immigration driven by the historical regional settlement patterns of immigrants from different countries. Using establishment-level output and capital stock data from the Longitudinal Research Database, augmented with employment and labor force data from the 1980 and 1990 Censuses of Population, changes in local labor supply during the 1980s are shown to have had little influence on local industry mix. Instead, citywide increases in the relative supply of a particular skill group lead to increases in relative factor intensity, with little or no effect on relative wages. These patterns suggest that industries adapt their use of labor inputs to local supplies, as predicted by theoretical models of endogenous technological change. Consistent with this interpretation, on-the-job computer use expanded most rapidly over the 1980s in cities where the relative supply of educated labor grew fastest.

04-2: The Rise of the Skilled City by Edward L. Glaeser and Albert Saiz

For more than a century, educated cities have grown more quickly than comparable cities with less human capital. This fact survives a battery of other control variables, metropolitan area fixed effects, and tests for reverse causality. The authors also find that skilled cities are growing because they are becoming more economically productive (relative to less skilled cities), not because these cities are becoming more attractive places to live. Most surprisingly, they find evidence suggesting that the skills-city growth connection occurs mainly in declining areas and occurs in large part because skilled cities are better at adapting to economic shocks. As in Schultz (1964), skills appear to permit adaptation.

04-3: How Did the Miami Labor Market Absorb the Mariel Immigrants? by Ethan Lewis

Card's (1990) well-known analysis of the Mariel boatlift concluded that this mass influx of mostly less-skilled Cubans to Miami had little impact on the labor market outcomes of the city's less-skilled workers. This paper evaluates two explanations for this. First, consistent with an open-economy framework, this paper asks whether after the boatlift, Miami increased its production of unskilled-intensive manufactured goods, allowing it to "export" the impact of the boatlift. Second, this paper asks whether Miami adapted to the boatlift by implementing new skill-complementary technologies more slowly than would have otherwise been the case. Using a confidential micro data version of the Annual Surveys of Manufactures, the author shows that following the boatlift, Miami's relative output of different manufacturing industries trended similary to other cities with similar pre-boatlift trends in manufacturing mix. The response of industry mix to the boatlift therefore appears to be small. Supporting the second type of adjustment, utilization of Cuban labor by Miami's industries rose proportionately to the supply increase generated by the boatlift. In addition, post-boatlift computer use at work was lower in Miami than in other cities with similar levels of computer-based employment before the event, even among non-Hispanic workers in the same detailed cells defined by industry, occupation, and education. This suggests the boatlift induced Miami's industries to employ more unskilled-intensive production technologies. The results suggest an explanation for why native wages are consistently found to be insensitive to local immigration shocks: markets adapt production technology to local factor supplies.

04-4: Why Is Manufacturing Trade Rising Even as Manufacturing Output is Falling? by Raphael Bergoeing, Timothy J. Kehoe, Vanessa Strauss-Kahn, and Kei-Mu Yi

04-5: Fresh Start or Head Start? The Effect of Filing for Personal Bankruptcy on the Labor Supply by Song Han and Wenli Li

The key feature of the modern U.S. personal bankruptcy law is to provide debtors a financial fresh start through debt discharge. The primary justification for the discharge policy is to preserve human capital by maintaining incentives for work. In this paper, the authors test this fresh start argument by providing the first estimate of the effect of personal bankruptcy filing on the labor supply using data from the Panel Study of Income Dynamics (PSID). Their econometric approach controls for the endogenous self-selection of bankruptcy filing and allows for dependence over time for the same household. They find that filing for bankruptcy does not have a positive impact on annual hours worked by bankrupt households, a result mainly due to the wealth effects of debt discharge. The finding is robust to a number of alternative model specifications and sample selections. Therefore, the authors' analysis does not find supporting evidence for the human capital argument for bankruptcy discharge.

04-6: Inflation Targeting: What Inflation Rate to Target? by Kevin X. D. Huang and Zheng Liu
Revision forthcoming in the Journal of Monetary Economics

In an economy with nominal rigidities in both an intermediate good sector and a finished good sector, and thus with a natural distinction between CPI and PPI inflation rates, a benevolent central bank faces a tradeoff between stabilizing the two measures of inflation: a final output gap, and unique to the authors' model, a real marginal cost gap in the intermediate sector, so that optimal monetary policy is second-best. The authors discuss how to implement the optimal policy with minimal information requirement and evaluate the robustness of these simple rules when the central bank may not know the exact sources of shocks or nominal rigidities. A main finding is that a simple hybrid rule under which the short-term interest rate responds to CPI inflation and PPI inflation results in a welfare level close to the optimum, whereas policy rules that ignore PPI inflation or PPI sector shocks can result in significant welfare losses.

04-7: Specific Factors Meet Intermediate Inputs: Implications for Strategic Complementarities and Persistence by Kevin X. D. Huang

A central challenge to monetary business-cycle theory is to find a solution to the problem of persistence and delay in the real effects of monetary shocks. Previous research has identified separately specific factors and intermediate inputs as two promising mechanisms for generating the persistence and delay in a staggered price-setting framework. Models based on either of these two mechanisms have also been used in the design of optimal monetary policy.

By examining a staggered price model that features both specific factors and intermediate inputs, the author finds an offsetting interaction between the two individually promising mechanisms, which leads to a cancellation of much of the impact of each in propagating monetary shocks. This finding posits a challenge to the search for a robust monetary transmission mechanism and design of optimal monetary policy.

04-8: Multiple Stages of Processing and the Quantity Anomaly in International Business Cycle Models by Kevin X. D. Huang and Zheng Liu

The authors construct a two-country DSGE model with multiple stages of processing and local-currency staggered price-setting to study cross-country quantity correlations driven by monetary shocks. The model embodies a mechanism that propagates a monetary surprise in the home country to lower the foreign price level while restraining the home price level from rising too quickly. It does so through reducing material costs in terms of the foreign currency unit while dampening the upward movements in the costs in terms of the home currency unit, both in absolute terms and relative to the costs of primary factors. The authors show that, through this mechanism and a resulting factor substitution effect, the model is able to generate significant cross-country quantity correlations, with correlations in consumption considerably lower than correlations in output, as in the data.

04-9: Consistent Economic Indexes for the 50 States by Theodore M. Crone and Alan Clayton-Matthews

Supersedes Working Paper No. 02-7/R

In the late 1980s James Stock and Mark Watson developed for the U.S. economy an alternative coincident index to the one now published by the Conference Board. They used the Kalman filter to estimate a latent dynamic factor for the national economy and designated the common factor as the coincident index. This paper uses the Stock/Watson methodology to estimate a consistent set of coincident indexes for the 50 states. These indexes provide researchers with a comprehensive monthly measure of economic activity that can be used to examine a number of state and regional issues.

04-10: Life Insurance and Household Consumption by Jay Hong and José-Victor Ríos-Rull

In this paper, the authors use data of life insurance holdings by age, sex, and marital status to infer how individuals value consumption in different demographic stages. Essentially, they use revealed preference to estimate equivalence scales and altruism simultaneously in the context of a fully specified model with agents facing U.S. demographic features and with access to savings markets and life insurance markets. The authors' findings indicate that individuals are very caring for their dependents, that there are large economies of scale in consumption, that children are costly but wives with children produce a lot of goods in the home, and that while females seem to have some form of habits created by marriage, men do not. These findings contrast sharply with the standard notions of equivalence scales.

04-11: Inventories and the Business Cycle: An Equilibrium Analysis of (S, s) Policies by Aubhik Khan and Julia K. Thomas

The authors develop an equilibrium business cycle model in which the producers of final goods pursue generalized (S,s) inventory policies with respect to intermediate goods, a consequence of nonconvex factor adjustment costs. Calibrating their model to reproduce the average inventory-to-sales ratio in postwar U.S. data, they find that it explains over half of the cyclical variability of inventory investment. Moreover, inventory accumulation is strongly procyclical, and production is more volatile than sales, as in the data.

The comovement between inventory investment and final sales is often interpreted as evidence that inventories amplify aggregate fluctuations. In contrast, the authors' model economy exhibits a business cycle similar to that of a comparable benchmark without inventories, though they do observe somewhat higher variability in employment, and lower variability in consumption and investment. Thus, equilibrium analysis, which necessarily endogenizes final sales, alters our understanding of the role of inventory accumulation for cyclical movements in GDP. The presence of inventories does not substantially raise the variability of production, because it dampens movements in final sales. Similarly, when reductions in adjustment costs lower, but do not eliminate, average inventory holdings, the variability of GDP is essentially unchanged, because the reduced costs cause an offsetting rise in the variability of final sales.

04-12: A Redefinition of Economic Regions in the U.S. 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 applied 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 determined 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.

04-13: Modeling Inventories over the Business Cycle by Aubhik Khan and Julia K. Thomas

The authors search for useful models of aggregate fluctuations with inventories. They focus exclusively on dynamic stochastic general equilibrium models that endogenously give rise to inventory investment and evaluate two leading candidates: the (S,s) model and the stockout avoidance model. Each model is examined under both technology shocks and preference shocks, and its performance gauged by its ability to explain the observed magnitude of inventories in the U.S. economy, alongside other empirical regularities, such as the procyclicality of inventory investment and its positive correlation with sales. The authors find that the (S,s) model is far more consistent with the behavior of aggregate inventories in the postwar U.S. when aggregate fluctuations arise from technology, rather than preference, shocks. The converse is true for the stockout avoidance model. Overall, while the (S,s) model performs well with respect to the inventory facts and other business cycle regularities, the stockout avoidance model does not. There, the essential motive for stocks is insufficient to generate inventory holdings near the data without destroying the model’s performance along other important margins. Finally, the stockout avoidance model appears incapable of sustaining inventories alongside capital. This suggests a fundamental problem in using reduced-form inventory models with stocks rationalized by this motive.

04-14/R: Bankruptcy Exemptions, Credit History, and the Mortgage Market by Souphala Chomsisengphet and Ronel Elul

The authors develop and test a model of mortgage underwriting, with particular reference to the role of generic credit bureau scores. In their model, scores are used in a standardized fashion, which reflects the prevalence of automated underwriting in industry practice. They show that their model has implications for the debate on the effect of personal bankruptcy exemptions on secured lending.

Recent literature (Berkowitz and Hynes (1999), Lin and White (2001)) has developed conflicting theories — and found conflicting results — seeking to explain how exemptions affect the mortgage market. By contrast, the authors' model implies that when lenders use credit scores in a standardized manner, exemptions should actually be irrelevant to the mortgage underwriting decision. Merging data from a major credit bureau with the Home Mortgage Disclosure Act (HMDA) data set, they confirm this prediction of their model.

The authors' model also implies that while an econometrician ignoring borrower credit quality may find exemptions to be significant, once one controls for credit scores, exemptions should have no effect on the likelihood that a mortgage application is denied. They confirm this empirically and argue that it may help explain some of the results of the previous literature. Finally, they also discuss the extent to which this use of generic credit scores for mortgage underwriting is optimal.

04-15: Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics by Aubhik Khan and Julia K. Thomas

The authors solve equilibrium models of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity. Nonconvex adjustment costs lead plants to pursue generalized (S,s) decision rules with respect to capital; as a result, their individual investments are lumpy. In partial equilibrium, this yields substantial skewness and kurtosis in aggregate investment, though with differences in plant-level productivity, these nonlinearities are far less pronounced. Moreover, nonconvex costs, like quadratic adjustment costs, greatly increase the persistence of aggregate investment rates, yielding a better match with the data.

In general equilibrium, aggregate nonlinearities disappear, and investment rates are very persistent, regardless of capital adjustment costs. While the aggregate implications of lumpy investment change substantially in equilibrium, the inclusion of fixed costs or idiosyncratic shocks yields an average distribution of plant investment rates that, in contrast, is largely unaffected by market-clearing movements in real wages and interest rates. Nonetheless, the authors find that to understand the dynamics of plant-level investment requires general equilibrium analysis.

04-16/R: Matching and Learning in Cities: Urban Density and the Rate of Invention by Gerald Carlino, Satyajit Chatterjee, and Robert Hunt 

Superseded by Working Paper 06-14

04-17: The CPI for Rents: A Case of Understated Inflation by Theodore M. Crone, Leonard I. Nakamura, and Richard Voith

Superseded by Working Paper 08-28

04-18: Trade and the (Dis) Incentive to Reform Labor Markets: The Case of Reform in the European Union by George Alessandria and Alain Delacroix

In a closed economy general equilibrium model, Hopenhayn and Rogerson (1993) find large welfare gains to removing firing restrictions. Alessandria and Delacroix explore the extent to which international trade alters this result. When economies trade, labor market policies in one country spill over to other countries through a change in the terms of trade. This reduces the incentive to reform labor markets. In a policy game over firing taxes between countries, they find that countries optimally choose positive levels of firing taxes. A coordinated elimination of firing taxes yields considerable benefits. This insight provides some explanation for recent efforts toward labor market reform in the European Union.

04-19: Violating Purchasing Power Parity by George Alessandria and Joseph Kaboski

Superseded by Working Paper 07-29

04-20: Transactions Accounts and Loan Monitoring by Loretta J. Mester, Leonard I. Nakamura, and Micheline Renault

Superseded by Working Paper 05-14

04-21/R: On the Stability of Employment Growth: A Postwar View from the U.S. States by Gerald Carlino, Robert DeFina, and Keith Sill (Supersedes Working Paper 02-14)

In 1952, the average quarterly volatility of U.S. state employment growth was 1.5 percent. By 1995, it was just under 0.5 percent. While all states shared in the decline, some declined more dramatically than others. The authors analyze aspects of this decline using data covering postwar industry employment by state. Estimates from a pooled cross-section/time-series model indicate that fluctuations in macroeconomic and state-specific variables have both played an important role in explaining volatility trends. However, macroeconomic shocks account for more of the postwar fluctuations in state employment growth volatility than do state-specific forces.

04-22: Hedonic Estimates of the Cost of Housing Services: Rental and Owner-Occupied Units by Theodore M. Crone, Leonard I. Nakamura, and Richard P. Voith

Recent papers have questioned the accuracy of the Bureau of Labor Statistics' methodology for measuring rent increases and changes in implicit rents for owner-occupied housing. The authors compare the BLS estimates of increases in rents and owner-occupied housing costs to regression-based estimates using data from the American Housing Survey. A hedonic approach that explicitly calculates capitalization rates produces a methodologically consistent measure of the rental cost of owner-occupied housing. They estimate that between 1985 and 1999 the Consumer Price Index (CPI-U) may have understated the cumulative increase in rents. But any understatement was slight. On the other hand, the authors estimate that the CPI overstated the increase in the cost of housing services for homeowners by 0.4 percent on an annualized basis from 1985 to 1999.

04-23: Vacancy Persistence by Shigeru Fujita

This paper reevaluates the quantitative performance of the standard labor-market matching model developed by Mortensen and Pissarides with special attention to the behavior of vacancies, one of the key variables in the model. The author first estimates trivariate vector autoregressions with gross worker flows and vacancies and identifies an aggregate shock by imposing only minimal sign restrictions on the responses of worker flows and employment growth and no restrictions on the response of vacancies. The data strongly suggest a hump-shaped and persistent response of vacancies. The calibrated model, on the other hand, predicts that vacancies respond to aggregate shocks with no delay and are not persistent even though an aggregate productivity shock is assumed to be highly persistent. These problems in vacancy behavior also cause gross flow series to exhibit counterfactual cyclical properties.

04-24: Financial Intermediaries, Markets, and Growth by Falko Fecht, Kevin X. D. Huang, and Antoine Martin

The authors build a model in which financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. The authors' model predicts that bank-oriented economies should grow slower than more market-oriented economies, which is consistent with some recent empirical evidence. They show that the mix of intermediaries and market that maximizes welfare under a given level of financial development depends on economic fundamentals. They also show the optimal mix of two structurally very similar economies can be very different.