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This paper studies the challenge that increasing the inflation target poses to equilibrium determinacy in a medium-sized New Keynesian model without indexation fitted to the Great Moderation era. For moderate targets of the inflation rate, such as 2 or 4 percent, the probability of determinacy is near one conditional on the monetary policy rule of the estimated model. However, this probability drops significantly conditional on model-free estimates of the monetary policy rule based on real-time data. The difference is driven by the larger response of the federal funds rate to the output gap associated with the latter estimates.
(687.0 KB, 34 pages)
The Community Reinvestment Act (CRA), enacted in 1977, has served as an important tool to foster access to financial services for lower-income communities across the country. This study provides new evidence on the effectiveness of CRA on mortgage lending by focusing on a large number of neighborhoods that became eligible and ineligible for CRA credit in the Philadelphia
market because of an exogenous policy shock in 2014. The CRA effects are more evident when a lower-income neighborhood loses its CRA coverage, which leads to a 10 percent or more decrease in purchase originations by CRA-regulated lenders. Lending institutions not subject to CRA can substitute approximately half, but not all, of the decreased lending by CRA lenders. The increased market share of nondepository institutions in previously CRA eligible neighborhoods, however, was accompanied by a greater involvement in riskier Federal Housing Administration lending. This study demonstrates how different lenders respond to the incentive of CRA credit and how the use of metropolitan division median family incomes can generate unintended consequences on CRA lending activities.
(817.0 KB, 33 pages)
In this paper, the authors ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. Using Compustat data, the authors first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, they then estimate parameters of a firm dynamics model with endogenous entry and exit to include both bankruptcy options in a general equilibrium environment. Finally, the authors evaluate a bankruptcy policy change recommended by the American Bankruptcy Institute that amounts to a "fresh start" for bankrupt firms. The authors find that changes to the law can have sizable consequences for borrowing costs and capital structure, which via selection affects productivity (allocative efficiency rises by 2.58%) and welfare (rises by 0.54%).
(1.0 MB, 66 pages)
This paper provides a detailed examination of a new set of fiscal forecasts for the U.S. assembled by Croushore and van Norden (2017) from FOMC briefing books. The data are of particular interest because (1) they afford a look at fiscal forecasts over six complete business cycles and several fiscal policy regimes, covering both peacetime and several wars, (2) the forecasts were precisely those presented to monetary policymakers, (3) they include frequently updated estimates of both actual and cyclically adjusted deficits, (4) unlike most other U.S. fiscal forecasts, they were neither partisan nor constrained by unrealistic assumptions about future fiscal policy, and (5) forecasts for other variables (GDP growth, inflation) from the same forecasters are known to compare favorably with most other available forecasts.
The authors detail the performance of forecast federal expenditures, revenues, surpluses, and structural surpluses in terms of accuracy, bias, and efficiency. They find that (1) fiscal forecast errors can be economically large, even at relatively short forecast horizons, (2) while the accuracy of unemployment rate forecast errors improved after 1990, that of most fiscal variables deteriorated considerably, (3) there is limited evidence of forecast bias, and most of this evidence is confined to the period before 1993, (4) the forecasts appear to be efficient with respect to both the fed funds rate and CBO projections, and (5) cyclically adjusted deficit forecasts appear to be over-optimistic around both business cycle peaks and troughs.
(1.0 MB, 57 pages)
Recent federal investigations and new regulations have resulted in restrictions on for-profit institutions' access to federal student aid. The authors examine the enrollment effects of similar restrictions imposed on over 1,200 for-profit colleges in the 1990s. Using variation in regulations linked to student loan default rates, the authors estimate the impact of the loss of federal aid on the enrollment of Pell Grant recipients in sanctioned institutions and their local competitors. Enrollment in a sanctioned for-profit college declines by 53 percent in the five years following a sanction. For-profit sanctions result in negative spillovers on unsanctioned competitor for-profit colleges in the same county, which experience modest enrollment declines. These enrollment losses in the for-profit sector are offset by gains in enrollment in local community colleges, suggesting that the loss of federal student aid for poor-performing for-profit colleges does not reduce overall college-going but instead shifts students across higher education sectors. Finally, the authors provide suggestive evidence that students induced to enroll in community colleges following a for-profit competitor’s sanction are less likely to default on their federal loans.
(3.0 MB, 50 pages)
The authors analyze set identification in Bayesian vector autoregressions (VARs). Because set identification can be challenging, they propose to include micro data on heterogeneous entities to sharpen inference. First, the authors provide conditions when imposing a simple ranking of impulse-responses sharpens inference in bivariate and trivariate VARs. Importantly, they show that this set reduction also applies to variables not subject to ranking restrictions. Second, the authors develop two types of inference to address recent criticism: (1) an efficient fully Bayesian algorithm based on an agnostic prior that directly samples from the admissible set and (2) a prior-robust Bayesian algorithm to sample the posterior bounds of the identified set. Third, they apply our methodology to U.S. data to identify productivity news and defense spending shocks. The authors find that under both algorithms, the bounds of the identified sets shrink substantially under heterogeneity restrictions relative to standard sign restrictions.
(4.0 MB, 102 pages)
This paper discusses the new financial regulations in the post–financial crisis period, focusing on capital and liquidity regulations. Basel III and the capital stress tests introduced new requirements and new definitions while retaining the structure of the pre-2010 requirements. The total number of requirements increased, making it difficult to determine which constraints are binding. The authors find that the new common equity tier 1 (CET1) and Level 1 high-quality liquid assets (HQLAs) are the binding constraints at large U.S. banks, especially for banks that are active in capital markets activities. Banks have been holding more CET1 and a larger share of Level 1 HQLAs since the financial crisis of 2007 to 2009. The authors also find that the market pricing of bank debt appears to have responded to changes in liquidity measures, especially at large capital markets banks. The Basel III regulatory capital ratios appear to have little direct influence on spreads.
(627.0 KB, 30 pages)
This paper investigates the pro-cyclicality of capital in the advanced internal ratings-based (A-IRB) Basel approach for retail portfolios and identifies the fundamental assumptions required for stable A-IRB risk weights over the economic cycle. Specifically, it distinguishes between endogenous and exogenous segmentation risk drivers and, through application to a portfolio of first mortgages, shows that risk weights remain stable over the economic cycle when the segmentation scheme is derived using exogenous risk drivers, while segmentation schemes that include endogenous risk drivers are highly pro-cyclical. Also analyzed is the sensitivity of the A-IRB framework to model risk resulting from the selection, at the quantification stage, of a data sample period that does not include a period of significant economic downturn. The analysis illustrates important limitations and sensitivities of the A-IRB framework and sheds light on the implicit restrictions embedded in recent regulatory guidance that underscore the importance of rating systems that remain stable over time and throughout business cycles.
(1.0 MB, 36 pages)
The average loss rate for conventional mortgages rose from less than 10% pre-crisis to more than 30% during the crisis, reaching and sustaining greater than 40% post-crisis. Using a novel database that contains the components of mortgage losses, the authors identify a regime shift in loss severities caused by various government interventions and changes in business practices in the servicing industry. This regime shift helps explain the persistently high loss severities post-crisis, even after a strong recovery in the housing market. The authors' findings have implications for loss modeling, pricing, and, potentially, mortgage credit availability.
(531.0 KB, 46 pages)
The authors revisit self-fulfilling rollover crises by introducing an alternative equilibrium selection that involves bond auctions at depressed but strictly positive equilibrium prices, a scenario in line with observed sovereign debt crises. They refer to these auctions as "desperate deals," the defining feature of which is a price schedule that makes the government indifferent to default or repayment. The government randomizes at the time of repayment, which the authors show can be implemented in pure strategies by introducing stochastic political payoffs or external bailouts. Quantitatively, auctions at fire-sale prices are crucial for generating realistic spread volatility.
(927.0 KB, 61 pages)
The authors use the 2012 South Carolina Department of Revenue data breach as a natural experiment to study how data breaches and news coverage about them affect consumers' interactions with the credit market and their use of credit. They find that some consumers directly exposed to the breach protected themselves against potential losses from future fraudulent use of stolen information by monitoring their files and freezing access to their credit reports. However, these consumers continued their regular use of existing credit cards and did not switch lenders. The response of consumers exposed to the news about the breach only was negligible.
Supersedes Working Paper 15-42.
(1.0 MB, 46 pages)
The authors investigate the association between the yields on debt issued by U.S. systemically important banks (SIBs) and their idiosyncratic risk factors, macroeconomic factors, and bond features in the secondary market. Although greater SIB risk levels are expected to increase debt yields (Evanoff and Wall, 2000), prevalence of government safety nets complicates the market discipline mechanism, rendering the issue an empirical exercise. Their main objectives are twofold. First, they study how bond buyers reacted to elevation of SIB-specific and macroeconomic risk factors over the recent business cycle. Second, they investigate the degree to which the proportion of variance in yields explained by SIB and macroeconomic risk factors changed across the phases of the cycle. Their data include over 8 million bond trades across 26 SIBs. The authors divide their sample period into the pre-crisis (2003:Q1 to 2007:Q3), crisis (2007:Q4 to 2009:Q2), and post-crisis (2009:Q3 to 2014:Q3) sub-periods to contrast the findings. They obtain several results. First, bond buyers do react to changes in the SIB-specific risk factors (leverage, credit risk, inefficiency, lack of profitability, illiquidity, and interest rate risk) by demanding higher yields. Second, bond buyers’ responses to risk factors are sensitive to the phase of the business cycle. Third, the proportion of variance in yields driven by SIB-specific and bond-specific risk factors increased from 23 percent in the pre-crisis period to 47 percent and 73 percent, respectively, during the crisis and post-crisis periods. These findings indicate that the force of market discipline improved greatly during the crisis and post-crisis periods, at the expense of macroeconomic factors. The strengthening of market discipline in the crisis and post-crisis periods, despite the unprecedented regulatory intervention in the form of quantitative easing programs, the Troubled Asset Relief Program, large bailouts, and generally accommodative fiscal and monetary policies adopted during these periods, demonstrates that regulatory intervention and market discipline can work in tandem.
(535.0 KB, 54 pages)
Infrequent but turbulent episodes of outright sovereign default on domestic creditors are considered a “forgotten history” in macroeconomics. The authors propose a heterogeneous-agents model in which optimal debt and default on domestic and foreign creditors are driven by distributional incentives and endogenous default costs due to value of debt for self-insurance, liquidity, and risk-sharing. The government’s aim to redistribute resources across agents and through time in response to uninsurable shocks produces a rich dynamic feedback mechanism linking debt issuance, the distribution of government bond holdings, the default decision, and risk premia. Calibrated to Spanish data, the model is consistent with key cyclical comovements and features of debt-crisis dynamics. Debt exhibits protracted fluctuations. Defaults have a low frequency of 0.93 percent, are preceded by surging debt and spreads, and occur with relatively low external debt. Default risk limits the sustainable debt, and yet spreads are zero most of the time.
(918.0 KB, 76 pages)
The authors present theory and evidence highlighting the role of natural amenities in neighborhood dynamics, suburbanization, and variation across cities in the persistence of the spatial distribution of income. Their model generates three predictions that they confirm using a novel database of consistent-boundary neighborhoods in U.S. metropolitan areas, 1880-2010, and spatial data for natural features such as coastlines and hills. First, persistent natural amenities anchor neighborhoods to high incomes over time. Second, naturally heterogeneous cities exhibit persistent spatial distributions of income. Third, downtown neighborhoods in coastal cities were less susceptible to the widespread decentralization of income in the mid-20th century and experienced an increase in income more quickly after 1980.
Supersedes Working Paper 15-46.
(3.0 MB, 63 pages)
The authors investigate the role of information technology (IT) in the collection of delinquent consumer debt. They argue that the widespread adoption of IT by the debt collection industry in the 1990s contributed to the observed expansion of unsecured risky lending such as credit cards. The authors' model stresses the importance of delinquency and private information about borrower solvency. The prevalence of delinquency implies that the costs of debt collection must be borne by lenders to sustain incentives to repay debt. IT mitigates informational asymmetries, allowing lenders to concentrate collection efforts on delinquent borrowers who are more likely to repay.
Supersedes Working Paper 13-12.
(719.0 KB, 55 pages)
A sovereign default model in which the sovereign derives private benefits from public office and contests elections to stay in power is developed. The economy’s growth process is modeled as a Markov switching regime, which is shown to be a better description of the data for the authors' set of emerging economies. In the model, consistent with evidence, the sovereign is less likely to be reelected if economic growth is weak. In the low-growth regime, there is higher probability of loss of private benefits due to turnover, which makes the sovereign behave more myopically. This growth-linked variation in effective discount factor is shown to be important in generating volatility in sovereign spreads.
(823.0 KB, 41 pages)