Working Papers | Federal Reserve Bank of Minneapolishttps://www.minneapolisfed.org/research/working-papers/rssWorking Papersen{681444CE-72BC-4FF2-AAF3-E1A2C721C9AA}https://www.minneapolisfed.org/research/working-papers/the-puzzling-behavior-of-spreads-during-covidWorking paper 803 (January 2024): The Puzzling Behavior of Spreads during Covid by Fourakis, KarabarbounisAdvanced economies borrowed substantially during the Covid recession to fund their fiscal policy. The Covid recession differed from the Great Recession in that sovereign debt markets remained calm and spreads barely responded. We study the experience of Greece, the most extreme manifestation of the puzzling behavior of spreads during Covid. We develop a small open economy model with long-term debt and default, which we augment with official lenders, heterogeneous households and sectors, and Covid constraints on labor supply and consumption demand. The model is quantitatively consistent with the observed boom-bust cycle of Greece before Covid and salient observations on macro aggregates, government debt, and the sovereign spread during Covid. The spread is stable despite a rise in external borrowing during Covid, because lockdowns were perceived as transitory and the bailouts of the 2010s had tilted the composition of debt at the beginning of Covid away from defaultable private debt. The ECB's policy of purchasing debt in secondary markets during Covid did not stabilize spreads so much, but allowed the government to provide transfers that reduced inequality.<br/>Tue, 09 Jan 2024 00:00:00 -0600{2FEC814A-5CC4-4914-92A7-08CCB3404DA9}https://www.minneapolisfed.org/research/working-papers/financial-integration-and-monetary-policy-coordinationWorking paper 802 (January 2024): Financial Integration and Monetary Policy Coordination by Bianchi, CoulibalyFinancial integration generates macroeconomic spillovers that may require international monetary policy coordination. We show that individual central banks may set nominal interest rates too low or too high relative to the cooperative outcome. We identify three sufficient statistics that determine whether the Nash equilibrium exhibits under-tightening or over-tightening: the output gap, sectoral differences in labor intensity, and the trade balance response to changes in nominal rates. Independently of the shocks hitting the economy, we find that under-tightening is possible during economic expansions or contractions. For large shocks, the gains from coordination can be substantial.<br/>Thu, 04 Jan 2024 00:00:00 -0600{2D94BC15-666C-4FC9-ADF7-5F74F7701DC0}https://www.minneapolisfed.org/research/working-papers/benchmarking-global-optimizersWorking paper 801 (December 2023): Benchmarking Global Optimizers by Arnoud, Guvenen, KleinebergWe benchmark six global optimization algorithms by comparing their performance on challenging multidimensional test functions as well as on a method of simulated moments estimation of a panel data model of earnings dynamics. Five of the algorithms are from the popular NLopt open-source library: (i) Controlled Random Search with local mutation (CRS), (ii) Improved Stochastic Ranking Evolution Strategy (ISRES), (iii) Multi-Level Single-Linkage (MLSL), (iv) Stochastic Global Optimization (StoGo), and (v) Evolutionary Strategy with Cauchy distribution (ESCH). The sixth algorithm is TikTak, which is a multistart global optimization algorithm used in some recent economic applications. For completeness, we add three popular local algorithms to the comparison—the Nelder-Mead downhill simplex algorithm, the Derivative-Free Nonlinear Least Squares (DFNLS) algorithm, and a popular variant of the Davidon-Fletcher-Powell (DFPMIN) algorithm. To give a detailed comparison of algorithms, we use benchmarking tools recently developed in the optimization literature. We find that the success rate of many optimizers varies dramatically with the characteristics of each problem and the computational budget that is available. Overall, TikTak is the strongest performer both on the test functions and the economic application. The next-best performing optimizers are StoGo for the test functions and MLSL and ISRES for the economic application.<br/>Fri, 15 Dec 2023 00:00:00 -0600{1034A3F8-EC34-4C4F-B2C4-82EF6F314B4B}https://www.minneapolisfed.org/research/working-papers/perspectives-on-the-labor-shareWorking paper 800 (November 2023): Perspectives on the Labor Share by KarabarbounisAs of 2022, the share of U.S. income accruing to labor is at its lowest level since the Great Depression. Updating previous studies with more recent observations, I document the continuing decline of the labor share for the United States, other countries, and various industries. I discuss how changes in technology and product, labor, and capital markets affect the trend of the labor share. I also examine its relationship with other macroeconomic trends, such as rising markups, higher concentration of economic activity, and globalization. I conclude by offering some perspectives on the economic and policy implications of the labor share decline.<br/>Fri, 03 Nov 2023 00:00:00 -0500{C14E6E3C-80E1-4C2C-A5EA-765D9E267D68}https://www.minneapolisfed.org/research/working-papers/global-flight-to-safety-business-cycles-and-the-dollarWorking paper 799 (October 2023): Global Flight to Safety, Business Cycles, and the Dollar by Bodenstein, Cuba Borda, Gornemann, Presno, Prestipino, Queralto, RaffoWe develop a two-country macroeconomic model that we fit to a set of aggregate prices and quantities for the U.S. and the rest of the world. In addition to a standard array of shocks, the model includes time variation in agents’ preference for safe bonds. We allow for a component of this time variation to be common across countries and biased toward dollar-denominated safe assets, and refer to this component as global flight to safety (GFS). We find that GFS shocks are the most important shocks driving world business cycles, and are also important drivers of activity in the U.S. and especially abroad. An adverse GFS shock lowers global GDP and inflation, widens global corporate credit spreads, and appreciates the dollar. These effects are very close to those obtained from a structural VAR which uses the excess bond premium (Gilchrist and Zakraj¡sek, 2012) as proxy for global flight to safety.<br/>Wed, 11 Oct 2023 00:00:00 -0500{213D6843-A2C3-4A04-B38D-7B07C2566B6C}https://www.minneapolisfed.org/research/working-papers/minimum-wages-and-labor-markets-in-the-twin-citiesWorking paper 793 (Revised August 2023): Minimum Wages and Labor Markets in the Twin Cities by Karabarbounis, Lise, NathWe present new evidence on the labor market effects of large minimum wage increases by examining the policy changes implemented by Minneapolis and Saint Paul. Beginning with synthetic difference-in-differences methods, we find that the increase in the minimum wage decreased substantially restaurant and retail employment, even after accounting for potential confounding effects from the pandemic and civil unrest. Next, using variation in exposure to the minimum wage across establishments and workers within zip codes and industries of the Twin Cities, we find employment effects that are about half as large as those from the time series. The cross-sectional estimates difference out contemporaneous city-industry effects across establishments and workers, but they do not include equilibrium effects induced by the minimum wage such as changes in entry. We quantify a model of establishment dynamics to reconcile the different estimates and argue that they plausibly reflect lower and upper bounds of employment losses. We use the model to show that our estimates are consistent with an establishment elasticity of labor demand of -1 and illustrate how they can inform deeper parameters characterizing product and labor market competition, factor substitution, and establishment dynamics.<br/>Wed, 02 Aug 2023 00:00:00 -0500{7A9DAF7A-CD83-4F9A-9D6D-8632503AF8EE}https://www.minneapolisfed.org/research/working-papers/overborrowing-underborrowing-and-macroprudential-policyWorking paper 798 (May 2023): Overborrowing, Underborrowing, and Macroprudential Policy by Arce, Bengui, BianchiIn this paper, we revisit the scope for macroprudential policy in production economies with pecuniary externalities and collateral constraints. We study competitive equilibria and constrained-efficient equilibria and examine the extent to which the gap between the two depends on the production structure and the policy instruments available to the planner. We argue that macroprudential policy is desirable regardless of whether the competitive equilibrium features more or less borrowing than the constrained-efficient equilibrium. In our quantitative analysis, macroprudential taxes on borrowing turn out to be larger when the government has access to ex-post stabilization policies.<br/>Wed, 31 May 2023 00:00:00 -0500{C3614511-1319-4143-B6DD-03C00FB735F5}https://www.minneapolisfed.org/research/working-papers/helicopter-drops-and-liquidity-trapsWorking paper 797 (Revised April 2023): Helicopter Drops and Liquidity Traps by Amador, BianchiWe show that if the central bank operates without commitment and faces constraints on its balance sheet, helicopter drops can be a useful stabilization tool during a liquidity trap. In our model, even with balance sheet constraints, helicopter drops are at best irrelevant under commitment.<br/>Fri, 14 Apr 2023 00:00:00 -0500{B9E08A32-F59E-41CF-B0D8-217862D2929D}https://www.minneapolisfed.org/research/working-papers/a-theory-of-fear-of-floatingWorking paper 796 (February 2023): A Theory of Fear of Floating by Bianchi, CoulibalyMany central banks whose exchange rate regimes are classified as flexible are reluctant to let the exchange rate fluctuate. This phenomenon is known as “fear of floating”. We present a simple theory in which fear of floating emerges as an optimal policy outcome. The key feature of the model is an occasionally binding borrowing constraint linked to the exchange rate that introduces a feedback loop between aggregate demand and credit conditions. Contrary to the Mundellian paradigm, we show that a depreciation can be contractionary, and letting the exchange rate float can expose the economy to self-fulfilling crises.<br/>Fri, 03 Feb 2023 00:00:00 -0600{E3E51EBB-45B2-4265-9D29-04811C94ABD5}https://www.minneapolisfed.org/research/working-papers/stagflation-and-topsyturvy-capital-flowsWorking paper 795 (January 2023): Stagflation and Topsy-Turvy Capital Flows by Bengui, CoulibalyAre unregulated capital flows excessive during a stagflation episode? We argue that they likely are, owing to a macroeconomic externality operating through the economy’s supply side. Inflows raise domestic wages through a wealth effect on labor supply and cause unwelcome upward pressure on marginal costs in countries where monetary policy is trying to drive down costs to stabilize inflation. Yet, market forces are likely to generate such inflows. Optimal capital flow management instead requires net outflows, suggesting topsy-turvy capital flows following markup shocks.<br/>Thu, 26 Jan 2023 00:00:00 -0600{0E5441D9-3D3B-43C2-9E3F-AE58C4833A56}https://www.minneapolisfed.org/research/working-papers/the-macroeconomics-of-the-greek-depressionWorking paper 758 (Revised January 2023): The Macroeconomics of the Greek Depression by Chodorow-Reich, Karabarbounis, KekreGreece experienced a boom until 2007, followed by a collapse of unprecedented magnitude and persistence. We assess the sources of the boom and the bust, using a rich estimated dynamic general equilibrium model. External demand and government consumption fueled the boom in production, whereas transfers fueled the boom in consumption. Different from the standard narrative, wages and prices declined substantially during the bust. Tax policy accounts for the largest fraction of the bust in production, whereas uninsurable risk accounts for the bust in consumption and wages. We assess how the composition of fiscal adjustment and bailouts affected the crisis.<br/>Tue, 10 Jan 2023 00:00:00 -0600{809431D4-4ACC-4B1C-9B96-76672DC3A0F2}https://www.minneapolisfed.org/research/working-papers/permanent-primary-deficits-idiosyncratic-longrun-risk-and-growthWorking paper 794 (November 2022): Permanent Primary Deficits, Idiosyncratic Long-Run Risk, and Growth by Amol, LuttmerWe consider an economy with perpetual youth and inelastic labor supply that grows endogenously. Consumers are subject to idiosyncratic capital accumulation risk and markets are incomplete. The government purchases consumption goods, makes transfers in the form of baby bonds, and it can use consumption and wealth taxes. The wealth distribution is given in closed form. When the intertemporal elasticity of substitution ɛ is equal to 1, the government can run a permanent primary deficit, up to a finite upper bound, if the coefficient of relative risk aversion is high enough and the factor share of labor is not too close to 1. This causes the risk-free rate _r_ to be below the growth rate _g_ of the economy. But the government can implement Pareto improvements when _r - g_ does not exceed zero by enough. If ɛ ≠ 1, then there may not be an upper bound on the permanent primary deficits of the government. If ɛ Є (0,1), this happens when the economy is relatively unproductive, and then taking deficits to be very large makes all consumers worse off. If ɛ Є (1,∞), very large deficits are possible if the economy is sufficiently productive, and then they imply unbounded Pareto improvements.<br/>Wed, 16 Nov 2022 00:00:00 -0600{0F4C1978-A3E2-4BF4-B0A0-26061E65A4E1}https://www.minneapolisfed.org/research/working-papers/use-it-or-lose-it-efficiency-and-redistributional-effects-of-wealth-taxationWorking paper 764 (Revised October 2022): Use It or Lose It: Efficiency and Redistributional Effects of Wealth Taxation by Chen, Guvenen, Kambourov, Kuruscu, OcampoHow does wealth taxation differ from capital income taxation? When the return on investment is equal across individuals, a well-known result is that the two tax systems are equivalent. Motivated by recent empirical evidence documenting persistent return heterogeneity, we revisit this question. With heterogeneity, the two tax systems typically have opposite implications for both efficiency and inequality. Under capital income taxation, entrepreneurs who are more productive and therefore generate more income pay higher taxes. Under wealth taxation, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the tax base, shifts the tax burden toward unproductive entrepreneurs, and raises the savings rate of productive ones. This reallocation increases aggregate productivity and output. In the simulated model parameterized to match the US data, replacing the capital income tax with a wealth tax in a revenue-neutral fashion delivers a significantly higher average welfare. Turning to optimal taxation, the optimal wealth tax (OWT) is positive and yields large welfare gains by raising efficiency and lowering inequality. In contrast, the optimal capital income tax (OKIT) is negative—a subsidy—and delivers lower welfare gains than OWT, owing to the welfare losses from higher inequality. Furthermore, when the transition path is considered, the gains from OKIT turn into significant welfare losses for existing cohorts, whereas OWT continues to deliver robust welfare gains. These results suggest that moderate wealth taxation may be a more appealing alternative than capital income taxation, which can be significantly more distorting under return heterogeneity than under the equal-returns assumption.<br/>Tue, 04 Oct 2022 00:00:00 -0500{E422F1BB-891D-4AA9-B7E3-59BF4CD9178A}https://www.minneapolisfed.org/research/working-papers/reparations-and-persistent-racial-wealth-gapsWorking paper 776 (Revised May 2022): Reparations and Persistent Racial Wealth Gaps by Boerma, KarabarbounisWe analyze the magnitude and persistence of the racial wealth gap using a long-run model of heterogeneous dynasties with an occupational choice and bequests. Our innovation is to introduce endogenous beliefs about risky returns, reflecting differences in dynasties' investment experiences over time. Feeding the exclusion of Black dynasties from labor and capital markets into the model as the only driving force, we find that the model quantitatively reproduces current and historical racial gaps in wealth, income, entrepreneurship, mobility, and beliefs about risky returns. We explore how the future trajectory of the racial wealth gap might change in response to various policies. Wealth transfers to all Black dynasties that eliminate the average wealth gap today do not lead to long-run wealth convergence. The logic is that centuries-long exclusions lead Black dynasties to hold pessimistic beliefs about risky returns and to forgo investment opportunities after the wealth transfer. Investment subsidies toward Black entrepreneurs are more effective than wealth transfers in permanently eliminating the racial wealth gap.<br/>Fri, 13 May 2022 00:00:00 -0500{170C11B5-BCCE-4DC6-8D7D-E8426DCDF459}https://www.minneapolisfed.org/research/working-papers/on-wars-sanctions-and-sovereign-defaultWorking paper 792 (April 2022): On Wars, Sanctions and Sovereign Default by Bianchi, Sosa-PadillaThis paper explores the role of restrictions on the use of international reserves as economic sanctions. We develop a simple model of the strategic game between a sanctioning (creditor) country and a sanctioned (debtor) country. We show how the sanctioning country should impose restrictions optimally, internalizing the geopolitical benefits and the financial costs of a potential default from the sanctioned country.<br/>Tue, 26 Apr 2022 00:00:00 -0500{9F1FD961-185E-4F6D-A36C-1DEC1FE399E6}https://www.minneapolisfed.org/research/working-papers/mussa-meets-backussmith-the-role-of-primary-commoditiesWorking paper 781 (Revised April 2022): Mussa Meets Backus-Smith: The Role of Primary Commodities by Ayres, Hevia, NicoliniWe show that explicitly modeling primary commodities in an otherwise totally standard incomplete markets open economy model can go a long way in explaining the Mussa puzzle and the Backus-Smith puzzle, two of the main puzzles in the international economics literature.<br/>Wed, 20 Apr 2022 00:00:00 -0500{3BE7EC25-561F-4CEB-AEA9-497F12B70F31}https://www.minneapolisfed.org/research/working-papers/online-appendix-for-mussa-meets-backussmith-the-role-of-primary-commoditiesWorking paper 782 (Revised April 2022): Online Appendix for: Mussa Meets Backus-Smith: The Role of Primary Commodities by Ayres, Hevia, NicoliniThis appendix supports Working Paper 781, <a href="https://doi.org/10.21034/wp.781"> Mussa Meets Backus-Smith: The Role of Primary Commodities</a>.Wed, 20 Apr 2022 00:00:00 -0500{FF52727E-F94B-4688-81D4-AC1883050158}https://www.minneapolisfed.org/research/working-papers/the-global-distribution-of-college-graduate-qualityWorking paper 791 (March 2022): The Global Distribution of College Graduate Quality by Martellini, Schoellman, SockinWe measure college graduate quality — the average human capital of a college’s graduates—using the average earnings of the college’s graduates adjusted to a common labor market. Our implementation uses the database of the website Glassdoor, which has the necessary information on earnings and education for non-migrants and migrants who graduate from roughly 3,300 colleges in 66 countries. Graduates of colleges in the richest countries have 50 percent more human capital than graduates of colleges in the poorest countries. Migration reinforces these differences. Poorer countries do not just lose a higher share of their skilled workers; their emigrants are highly positively selected on human capital. Finally, we show that these stocks and flows matter for growth and development by showing that college graduate quality predicts the share of a college’s students who become inventors, engage in entrepreneurship, and become top executives, both within and across countries.<br/>Mon, 07 Mar 2022 00:00:00 -0600{B80C9844-64AC-421E-8063-0E4AE2CA1A14}https://www.minneapolisfed.org/research/working-papers/the-incredible-taylor-principleWorking paper 790 (January 2022): The Incredible Taylor Principle by Neumeyer, NicoliniThis note addresses the role of the Taylor principle to solve the indeterminacy of equilibria in economies in which the monetary authority follows an interest rate rule. We first study the role of imposing two additional ad-hoc restrictions on the definition of equilibrium. Imposing the equilibrium to be locally unique never delivers a unique outcome. Imposing the equilibrium to be bounded, renders the outcome unique only if the inflation target is the Friedman rule. Second, we show that the Taylor principle is strongly time inconsistent - in a sense we make very precise - and that policies that implement the Friedman rule are the only sustainable policies.<br/>Fri, 28 Jan 2022 00:00:00 -0600{F132EDC8-1697-44FA-B1CA-46847025CCC5}https://www.minneapolisfed.org/research/working-papers/dynamic-urn-ball-discoveryWorking paper 789 (December 2021): Dynamic Urn-Ball Discovery by LuttmerUnder certain assumptions, monopolistic competition with CES preferences is efficient, as first discovered by Dixit and Stiglitz. One assumption, invariably left implicit, is that there are, at any given point in time, no bounds on the number of products that can be discovered. But square wheels do not work, and round wheels keep getting rediscovered. Giving away patents to entrepreneurs who happen to be the first to discover a product generates an inefficiently large amount of variety. The stock of undiscovered products is a commons that can attract too many discovery attempts. Perpetual patents can be efficient, but only when combined with just the right tax on patent-protected monopoly profits. Such a tax is, however, too crude an instrument in an economy with even the least amount of heterogeneity.<br/>Mon, 20 Dec 2021 00:00:00 -0600{0223FF3F-B037-42B3-9169-73662C8414A9}https://www.minneapolisfed.org/research/working-papers/monetaryfiscal-interactions-with-forty-budget-constraintsWorking paper 788 (December 2021): Monetary/Fiscal Interactions with Forty Budget Constraints by Bassetto, CaraccioloIt is well known that monetary and fiscal policy are connected by a common budget constraint. In this paper, we study how this manifests itself in the context of the Eurozone, where that connection links the European Central Bank, the 19 national central banks, the Treasuries of 19 countries, and the European Union. Our goal is twofold. First, we wish to clarify how seigniorage flows from the monetary authority to the budget of each country. Second, we seek to answer the question of how the taxpayers of each country are affected by a default of one of the participants to the union. In answering this question, we analyze the mechanisms that ensure (or do not ensure) that net liabilities across countries stay bounded, and we establish how the answer depends on the liquidity premium that each category of assets commands (cash, excess reserves within the Eurosystem, and government bonds). We find that the official risk-sharing provisions of the policy of quantitative easing (QE), whereby national central banks retain 90% of the risk intrinsic in bonds of their own country, only holds under restrictive assumptions; under plausible scenarios, a significantly larger fraction of the risk is mutualized.Thu, 02 Dec 2021 00:00:00 -0600{B163B063-C779-4AFB-BA6C-CC058ACE8195}https://www.minneapolisfed.org/research/working-papers/the-prudential-use-of-capital-controls-and-foreign-currency-reservesWorking paper 787 (November 2021): The Prudential Use of Capital Controls and Foreign Currency Reserves by Bianchi, LorenzoniWe provide a simple framework to study the prudential use of capital controls and currency reserves that have been explored in the recent literature. We cover the role of both pecuniary externalities and aggregate demand externalities. The model features a central policy dilemma for emerging economies facing large capital outflows: the choice between increasing the policy rate to stabilize the exchange rate and decreasing the policy rate to stabilize employment. Ex ante capital controls and reserve accumulation can help mitigate this dilemma. We use our framework to survey the recent literature and provide an overview of recent empirical findings on the use of these policies.<br/>Fri, 12 Nov 2021 00:00:00 -0600{07D5165B-7A33-4EA7-B5C0-CE9AF136D893}https://www.minneapolisfed.org/research/working-papers/scrambling-for-dollars-international-liquidity-banks-and-exchange-ratesWorking paper 786 (November 2021): Scrambling for Dollars: International Liquidity, Banks and Exchange Rates by Bianchi, Bigio, EngelWe develop a theory of exchange rate fluctuations arising from financial institutions’ demand for dollar liquid assets. Financial flows are unpredictable and may leave banks “scrambling for dollars.” Because of settlement frictions in interbank markets, a precautionary demand for dollar reserves emerges and gives rise to an endogenous convenience yield on the dollar. We show that an increase in the dollar funding risk leads to a rise in the convenience yield and an appreciation of the dollar, as banks scramble for dollars. We present empirical evidence on the relationship between exchange rate fluctuations for the G10 currencies and the quantity of dollar liquidity, which is consistent with the theory.<br/>Fri, 05 Nov 2021 00:00:00 -0500{63B40BC8-5F5D-4794-9D5C-7A6B475F70F7}https://www.minneapolisfed.org/research/working-papers/bank-runs-fragility-and-credit-easingWorking paper 785 (October 2021): Bank Runs, Fragility, and Credit Easing by Amador, BianchiWe present a tractable dynamic macroeconomic model of self-fulfilling bank runs. A bank is vulnerable to a run when a loss of investors’ confidence triggers deposit withdrawals and leads the bank to default on its obligations. We analytically characterize how the vulnerability of an individual bank depends on macroeconomic aggregates and how the number of banks facing a run affects macroeconomic aggregates in turn. In general equilibrium, runs can be partial or complete, depending on aggregate leverage and the dynamics of asset prices. Our normative analysis shows that the effectiveness of credit easing and its welfare implications depend on whether a financial crisis is driven by fundamentals or by self-fulfilling runs.<br/>Fri, 15 Oct 2021 00:00:00 -0500{FC0E70DD-EEE8-4D31-8D6A-E7EEEFB03CC6}https://www.minneapolisfed.org/research/working-papers/the-welfare-costs-of-inflationWorking paper 783 (September 2021): The Welfare Costs of Inflation by Benati, NicoliniWe revisit the estimation of the welfare costs of inflation originating from lack of liquidity satiation. We use data for the United States and several other developed countries. Our computations are heavily influenced by the recent experience of very low, even negative, short-term rates observed in the countries we study. We obtain estimates that range between 0.20% and 1.5% of lifetime consumption for the United States and find even higher values for some European countries.<br/>Fri, 24 Sep 2021 00:00:00 -0500{1B988F69-9311-4532-A3B7-050D0DF8104A}https://www.minneapolisfed.org/research/working-papers/online-appendix-for-the-welfare-costs-of-inflationWorking paper 784 (September 2021): Online Appendix for: The Welfare Costs of Inflation by Benati, NicoliniThis online appendix supports Working Paper 783, <a href="https://doi.org/10.21034/wp.783"<em>The Welfare Costs of Inflation</em></a>.Fri, 24 Sep 2021 00:00:00 -0500{3B02ADED-A658-4D47-8094-1EC83191046D}https://www.minneapolisfed.org/research/working-papers/liquidity-traps-prudential-policies-and-international-spilloversWorking paper 780 (July 2021): Liquidity Traps, Prudential Policies, and International Spillovers by Bianchi, CoulibalyWe present a simple open economy framework to study the transmission channels of monetary and macroprudential policies and evaluate the implications for international spillovers and global welfare. Using an analytical decomposition, we first identify three transmission channels: intertemporal substitution, expenditure switching, and aggregate income. Quantitatively, expenditure switching plays a prominent role for monetary policy, while macroprudential policy operates almost entirely through intertemporal substitution. Turning to the normative analysis, we show that the risk of a liquidity trap generates a monetary policy tradeoff between stabilizing output today and reducing capital flows to lower the likelihood of a future recession. However, leaning against the wind is not necessarily optimal, even in the absence of capital controls. Finally, we argue that contrary to emerging policy concerns, capital controls are not beggar-thy-neighbor and can enhance global macroeconomic stability.<br/>Tue, 27 Jul 2021 00:00:00 -0500{C8C1B26C-35F0-4971-8588-34AE2F578CF8}https://www.minneapolisfed.org/research/working-papers/monetary-independence-and-rollover-crisesWorking paper 755 (May 2021): Monetary Independence and Rollover Crises by Bianchi, MondragonThis paper shows that the inability to use monetary policy for macroeconomic stabilization leaves a government more vulnerable to a rollover crisis. We study a sovereign default model with self-fulfilling rollover crises, foreign currency debt, and nominal rigidities. When the government lacks monetary independence, lenders anticipate that the government would face a severe recession in the event of a liquidity crisis, and are therefore more prone to run on government bonds. In a quantitative application to the Eurozone debt crisis, we find that the lack of monetary autonomy played a central role in making Spain vulnerable to a rollover crisis. Finally, we argue that a lender of last resort can go a long way towards reducing the costs of giving up monetary independence.<br/>Wed, 26 May 2021 00:00:00 -0500{803A47BE-E57A-48EF-9702-04ABB96092B5}https://www.minneapolisfed.org/research/working-papers/fiscal-stimulus-under-sovereign-riskWorking paper 762 (Revised May 2021): Fiscal Stimulus under Sovereign Risk by Bianchi, Ottonello, PresnoWhat is the optimal fiscal policy response to a recession when the government is subject to sovereign risk? We study this question in a model of endogenous sovereign default with nominal rigidities. Increasing spending in a recession reduces unemployment, but exposes the government to a debt crisis. We quantitatively analyze this trade-off between stimulus and austerity and find that expanding government spending may be undesirable even in the presence of sizeable Keynesian stabilization gains and inequality concerns. Consistent with these findings, we show that sovereign risk is a key driver of the observed fiscal procyclicality in the data.<br/>Wed, 26 May 2021 00:00:00 -0500{6AA7BE4C-9A23-49FB-A457-7C92796AE2EF}https://www.minneapolisfed.org/research/working-papers/capital-buffers-in-a-quantitative-model-of-banking-industry-dynamicsWorking paper 779 (May 2021): Capital Buffers in a Quantitative Model of Banking Industry Dynamics by Corbae, D'ErasmoWe develop a model of banking industry dynamics to study the quantitative impact of regulatory policies on bank risk taking and market structure. Since our model is matched to U.S. data, we propose a market structure where big banks with market power interact with small, competitive fringe banks as well as non-bank lenders. Banks face idiosyncratic funding shocks in addition to aggregate shocks which affect the fraction of performing loans in their portfolio. A nontrivial bank size distribution arises out of endogenous entry and exit, as well as banks' buffer stock of capital. We show the model predictions are consistent with untargeted business cycle properties, the bank lending channel, and empirical studies of the role of concentration on financial stability. We find that regulatory policies can have an important impact on banking market structure, which, along with selection effects, can generate changes in allocative efficiency and stability.<br/>Wed, 26 May 2021 00:00:00 -0500{1DD9E52C-5021-4DD5-BBA5-194C67A5C205}https://www.minneapolisfed.org/research/working-papers/inferring-inequality-with-home-productionWorking paper 746 (Revised March 2021): Inferring Inequality with Home Production by Boerma, KarabarbounisWe revisit the causes, welfare consequences, and policy implications of the dispersion in households' labor market outcomes using a model with uninsurable risk, incomplete asset markets, and home production. Allowing households to be heterogeneous in both their disutility of home work and their home production efficiency, we find that home production amplifies welfare-based differences meaning that inequality in standards of living is larger than we thought. We infer significant home production efficiency differences across households because hours working at home do not covary with consumption and wages in the cross section of households. Heterogeneity in home production efficiency is essential for inequality, as home production would not amplify inequality if differences at home only reflected heterogeneity in disutility of work.<br/>Wed, 31 Mar 2021 00:00:00 -0500{B18779D5-9450-4421-9A07-AAC8C2A5BB61}https://www.minneapolisfed.org/research/working-papers/priors-and-the-slope-of-the-phillips-curveWorking paper 778 (March 2021): Priors and the Slope of the Phillips Curve by Jones, Kulish, NicoliniThe slope of the Phillips curve in New Keynesian models is difficult to estimate using aggregate data. We show that in a Bayesian estimation, the priors placed on the parameters governing nominal rigidities significantly influence posterior estimates and thus inferences about the importance of nominal rigidities. Conversely, we show that priors play a negligible role in a New Keynesian model estimated using state-level data. An estimation with state-level data exploits a relatively large panel dataset and removes the influence of endogenous monetary policy.<br/>Wed, 17 Mar 2021 00:00:00 -0500{40E0FB99-C753-49FD-AC68-A147C8D8130F}https://www.minneapolisfed.org/research/working-papers/because-of-monopolies-income-inequality-significantly-understates-economic-inequalityWorking paper 777 (March 2021): Because of Monopolies, Income Inequality Significantly Understates Economic Inequality by SchmitzIn social science research, household income is widely used as a stand-in for, or approximation to, the economic well-being of households. In a parallel way, income-inequality has been employed as a stand-in for inequality of economic well-being, or for brevity, "economic-inequality." But there is a force in market economies, ones with extensive amounts of monopoly, like the United States, which leads income-inequality to understate economic-inequality. This force has not been recognized before and derives from how monopolies behave. Monopolies, of course, raise prices. This reduces the purchasing power of households, or the value of their income. But monopolies, in fact, reduce the purchasing power of low-income households much more than high-income households. What has not been recognized is that, in many markets, as monopolies raise the prices for their goods, they simultaneously destroy substitutes for their products, low-cost substitutes that are purchased by low-income households. In these markets, then, while high-income households face higher prices, low-income households are shut out of markets, markets for goods and services that are extremely important for their economic well-being. It often leaves them with extremely poor alternatives, and sometimes none, for these products. Some of the markets we discuss include those for housing, financial services, and K-12 public education services. We also discuss markets for legal services, health care services, used durable equipment and repair services. Monopolies that infiltrate public institutions to enrich members, including those in foster care services, voting institutions and antitrust institutions, are also discussed.<br/>Tue, 09 Mar 2021 00:00:00 -0600{4FEED366-FF56-40D2-A9F2-3AFCC37CE0E5}https://www.minneapolisfed.org/research/working-papers/a-ramsey-theory-of-financial-distortionsWorking paper 775 (December 2020): A Ramsey Theory of Financial Distortions by Bassetto, CuiThe interest rate on government debt is significantly lower than the rates of return on other assets. From the perspective of standard models of optimal taxation, this empirical fact is puzzling: typically, the government should finance expenditures either through contingent taxes, or by previously-issued state-contingent debt, or by labor taxes, with only minor effects arising from intertemporal distortions on interest rates. We study how this answer changes in an economy with financial frictions, where the government cannot directly redistribute towards the agents in need of liquidity, but has otherwise access to a complete set of linear tax instruments. We establish a stark result. Provided this is feasible, optimal policy calls for the government to increase its debt, up to the point at which it provides sufficient liquidity to avoid financial constraints. In this case, capital-income taxes are zero in the long run, and the returns on government debt and capital are equalized. However, if the fiscal space is insufficient, a wedge opens between the rate of return on government debt and capital. In this case, optimal long-run tax policy is driven by a trade-off between the desire to mitigate financial frictions by subsidizing capital and the incentive to exploit the quasi-rents accruing to producers of capital by taxing capital instead. This latter incentive magnifies the wedge between rates of return on publicly and privately-issued assets.<br/>Wed, 23 Dec 2020 00:00:00 -0600{FA835F53-58DE-44BB-B050-30203EC0D17D}https://www.minneapolisfed.org/research/working-papers/two-illustrations-of-the-quantity-theory-of-money-reloadedWorking paper 774 (December 2020): Two Illustrations of the Quantity Theory of Money Reloaded by Gao, Kulish, NicoliniIn this paper, we review the relationship between inflation rates, nominal interest rates, and rates of growth of monetary aggregates for a large group of OECD countries. We conclude that the low-frequency behavior of these series maintains a close relationship, as predicted by standard quantity theory models. In an estimated model, we show those relationships to be relatively invariant to alternative frictions that can deliver very different high-frequency dynamics. We argue that these relationships are useful for policy design aimed at controlling inflation.<br/>Tue, 15 Dec 2020 00:00:00 -0600{B3C8D450-A755-495B-9847-DC72F8B7A95C}https://www.minneapolisfed.org/research/working-papers/solving-the-housing-crisis-will-require-fighting-monopolies-in-constructionWorking paper 773 (December 2020): Solving the Housing Crisis will Require Fighting Monopolies in Construction by SchmitzU.S. government concerns about great disparities in housing conditions are at least 100 years old. For the first 50 years of this period, U.S. housing crises were widely considered to stem from the failure of the construction industry to adopt new technology -- in particular, factory production methods. The introduction of these methods in many industries had already greatly narrowed the quality of goods consumed by low- and high-income Americans. It was widely known why the industry failed to adopt these methods: Monopolies in traditional construction blocked and sabotaged them. Very little has changed in the last 50 years. The industry still fails to adopt factory methods, with monopolies, like HUD and NAHB, blocking attempts to adopt them. As a result, the productivity record of the construction industry has been horrendous. One thing has changed. Today there is very little discussion of factory-built housing; of the very few that recognize the industry's failure to adopt factory methods, there is no realization that monopolies are blocking the methods. That these monopolies, in particular, HUD and NAHB, can cause so much hardship in our country, and through misinformation and deceit cover it up, seems almost beyond belief. But, unfortunately, it's a history that is not uncommon. There are many other industries where monopolies have inflicted great harm on Americans, like the tobacco industry, yet through misinformation and deceit cover up the great harm.<br/>Fri, 11 Dec 2020 00:00:00 -0600{69DB4323-0F4F-4F39-82B6-D9B072972911}https://www.minneapolisfed.org/research/working-papers/monopolies-silent-spreaders-of-poverty-and-economic-inequalityWorking Paper 772: Monopolies: Silent Spreaders of Poverty and Economic Inequality (September 2020)The Covid-19 crisis has exposed the vast inequalities that exist within the US economy. As the virus has spread silently, it has laid bare other crises that face our nation---especially the economic vulnerabilities of the country's poor and marginalized. Many of these vulnerabilities can, in fact, be traced back to a single cause that itself has spread silently, but over the last several decades, not months: Monopolies. That monopolies are "silent spreaders of poverty and economic inequality" was well known to economic and legal scholars of the 1930s and 1940s. Wendell Berge, who was Assistant Attorney General for Antitrust in the 1940s, wrote: "Monopoly conditions have often grown up almost unnoticed by the public until one day it is suddenly realized that an industry is no longer competitive but is governed by an economic oligarchy." The harm caused by these monopolies that have mostly avoided detection often exist in markets with small firms, low concentration levels, and small price-cost margins, as in residential construction, or wreak their harm in public institutions, where prices and concentration have no meaning. While there has been a very welcome resurgence in the concern about monopolies in the last decade or so, this has primarily involved vast corporations, and often about their threat to democratic institutions. Though greatly welcomed, we should not let apprehension with these larger companies distract us from the many hidden monopolies that have silently spread harm to the poor for the last 100 years -- not just the last 10 or so. We should stand on the shoulders of giants that taught us this about monopolies, not only Berge, but Thurman Arnold, Henry Simons, and others.<br/>Tue, 22 Sep 2020 00:00:00 -0500{F45B1C9A-A2F1-4EE5-893B-0F328D31CA82}https://www.minneapolisfed.org/research/working-papers/bounded-learning-from-incumbent-firmsWorking Paper 771 (August 2020): Bounded Learning from Incumbent Firms by Erzo G.J. LuttmerSocial learning plays an important role in models of productivity dispersion and long-run growth. In economies with a continuum of producers and unbounded productivity distributions, social learning can sometimes leave long-run growth rates completely indeterminate. This paper modifies a model in which potential entrants attempt to imitate randomly selected incumbent firms by introducing an upper bound on how much entrants can learn from incumbents. When this upper bound is taken to infinity, a unique long-run growth rate emerges, even though the economy without upper bound has an unbounded continuum of balanced growth rates.<br/>Fri, 07 Aug 2020 00:00:00 -0500{B98B0472-E916-453F-8E5C-BD9106E71AEB}https://www.minneapolisfed.org/research/working-papers/a-quantitative-theory-of-the-credit-scoreWorking paper 770 (August 2020): A Quantitative Theory of the Credit Score by Chatterjee, Corbae, Dempsey, Ríos-RullWhat is the role of credit scores in credit markets? We argue that it is a stand in for a market assessment of a person's unobservable type (which here we take to be patience). We pose a model of persistent hidden types where observable actions shape the public assessment of a person's type via Bayesian updating. We show how dynamic reputation can incentivize repayment without monetary costs of default beyond the administrative cost of filing for bankruptcy. Importantly we show how an economy with credit scores implements the same equilibrium allocation. We estimate the model using both credit market data and the evolution of individual’s credit scores. We find a 3% difference in patience in almost equally sized groups in the population with significant turnover and a shift towards becoming more patient with age. If tracking of individual credit actions is outlawed, the benefits of bankruptcy forgiveness are outweighed by the higher interest rates associated with lower incentives to repay.<br/>Tue, 04 Aug 2020 00:00:00 -0500{8B4FA8FE-926F-43A4-9385-18B813832579}https://www.minneapolisfed.org/research/working-papers/reorganization-or-liquidation-bankruptcy-choice-and-firm-dynamicsWorking Paper 769 (July 2020): Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics by Dean Corbae and Pablo D'ErasmoIn this paper, we 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, we first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, we then estimate parameters of a general equilibrium firm dynamics model with endogenous entry and exit to include both bankruptcy options. Finally, we evaluate a bankruptcy policy change similar to one recommended by the American Bankruptcy Institute that amounts to a "fresh start" for bankrupt firms. We find that changes to the law can have sizable consequences for borrowing costs and capital structure which via selection affects productivity, as well as long run welfare.<br/>Tue, 28 Jul 2020 00:00:00 -0500{05847FE5-356C-484C-86BC-DB27A5A38FE7}https://www.minneapolisfed.org/research/working-papers/measuring-the-transmission-rate-of-covid-19-what-can-we-learn-from-cross-country-comparisonsWorking Paper 768 (May 2020): Measuring the Transmission Rate of COVID-19: What Can We Learn From Cross Country Comparisons? by Han Gao and Juan Pablo NicoliniWe modify a standard SIR epidemiological model to allow for testing and asymptomatic agents. We explore cross country variation's ability to allow for identification of key parameters of the model: the fatality rate and the evolution over time of the normalized transmission rate. We first show that as long as tests are applied only to agents who exhibit symptoms, those parameters cannot be identified. We briefly discuss which additional information may allow for identification. Finally, we also describe conditions under which the normalized transmission rate can be computed with very high accuracy, and how cross country evidence can be used to evaluate the effect of lockdowns on evolution of the effective transmission rate over time.<br/>Fri, 29 May 2020 11:45:00 -0500{997FB0A4-90E7-4169-B21B-81B37D11B607}https://www.minneapolisfed.org/research/working-papers/reserve-accumulation-macroeconomic-stabilization-and-sovereign-riskWorking paper 767 (May 2020): Reserve Accumulation, Macroeconomic Stabilization, and Sovereign Risk by Bianchi, Sosa-PadillaIn the past three decades, governments in emerging markets have accumulated large amounts of international reserves, especially those with fixed exchange rates. We propose a theory of reserve accumulation that can account for these facts. Using a model of endogenous sovereign default with nominal rigidities, we show that the interaction between sovereign risk and aggregate demand amplification generates a macroeconomic-stabilization hedging role for international reserves. Reserves increase debt sustainability to such an extent that financing reserves with debt accumulation may not lead to increases in spreads. We also study simple and implementable rules for reserve accumulation. Our findings suggest that a simple linear rule linked to spreads can achieve significant welfare gains, while those rules currently used in policy studies of reserve adequacy can be counterproductive.<br/>Fri, 29 May 2020 00:00:00 -0500{16FD2BEA-E3FD-462A-837C-A3CDAADC41B8}https://www.minneapolisfed.org/research/working-papers/pandemic-recession-l-or-v-shapedWorking Paper 766: Pandemic Recession: L- or V-Shaped? (May 2020)We develop and calibrate a search-theoretic model of the labor market in order to forecast the evolution of the aggregate US labor market during and after the coronavirus pandemic. The model is designed to capture the heterogeneity of the transitions of individual workers across states of unemployment and employment and across different employers. The model is designed also to capture the trade-offs in the choice between temporary and permanent layoffs. Under reasonable parametrizations of the model, the lockdown instituted to prevent the spread of the novel coronavirus is shown to have long-lasting negative effects on unemployment. This is because the lockdown disproportionately disrupts the employment of workers who need years to find stable jobs.<br/>Tue, 12 May 2020 00:00:00 -0500{BE3FB70C-E2EA-4B82-9BBA-F7836D03D852}https://www.minneapolisfed.org/research/working-papers/a-fisherian-approach-to-financial-crises-lessons-from-the-sudden-stops-literatureWorking Paper 765: A Fisherian Approach to Financial Crises: Lessons from the Sudden Stops Literature (April 2020)Sudden Stops are financial crises defined by a large, sudden current-account reversal. They occur in both advanced and emerging economies and result in deep recessions, collapsing asset prices, and real exchange-rate depreciations. They are preceded by economic expansions, current-account deficits, credit booms, and appreciated asset prices and real exchange rates. Fisherian models (i.e. models with credit constraints linked to market prices) explain these stylized facts as an outcome of Irving Fisher's debt-deflation mechanism. On the normative side, these models feature a pecuniary externality that provides a foundation for macroprudential policy (MPP). We review the stylized facts of Sudden Stops, the evidence on MPP use and effectiveness, and the findings of the literature on Fisherian models. Quantitatively, Fisherian amplification is strong and optimal MPP reduces sharply the size and frequency of crises, but it is also complex and potentially time-inconsistent, and simple MPP rules are less effective. We also provide a new MPP analysis incorporating investment. Using a constant debt-tax policy, we construct a crisis probability-output frontier showing that there is a tradeoff between financial stability and long-run output (i.e., reducing the probability of crises reduces long-run output).<br/>Wed, 01 Apr 2020 00:00:00 -0500{3593D866-0A20-4456-B548-7856F5AA7846}https://www.minneapolisfed.org/research/working-papers/labor-market-trends-and-the-changing-value-of-timeWorking Paper 763: Labor Market Trends and the Changing Value of Time (September 2019)During the past two decades, households experienced increases in their average wages and expenditures alongside with divergent trends in their wages, expenditures, and time allocation. We develop a model with incomplete asset markets and household heterogeneity in market and home technologies and preferences to account for these labor market trends and assess their welfare consequences. Using micro data on expenditures and time use, we identify the sources of heterogeneity across households, document how these sources have changed over time, and perform counterfactual analyses. Given the observed increase in leisure expenditures relative to leisure time and the complementarity of these inputs in leisure technology, we infer a significant increase in the average productivity of time spent on leisure. The increasing productivity of leisure time generates significant welfare gains for the average household and moderates negative welfare effects from the rising dispersion of expenditures and time allocation across households.<br/>Fri, 20 Sep 2019 00:00:00 -0500{EA77313E-67B9-4114-9C2B-C8CCEF2ACE59}https://www.minneapolisfed.org/research/working-papers/a-macroprudential-theory-of-foreign-reserve-accumulationWorking Paper 761: A Macroprudential Theory of Foreign Reserve Accumulation (August 2019)This paper proposes a theory of foreign reserves as macroprudential policy. We study an open economy model of financial crises, in which pecuniary externalities lead to over-borrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross section, and can quantitatively account for the recent upward trend in international reserves.<br/>Mon, 26 Aug 2019 00:00:00 -0500{DA22721D-2178-4A6B-856C-170A61E29E17}https://www.minneapolisfed.org/research/working-papers/on-the-risk-of-leaving-the-euroWorking Paper 760: On the Risk of Leaving the Euro (August 2019)Following the sovereign debt crisis of 2012, some southern European countries have debated proposals to leave the Euro. We evaluate this policy change in a standard monetary model with seigniorage financing of the deficit. The main novel feature is that we depart from rational expectations while maintaining full rationality of agents in a sense made very precise. Our first contribution is to show that small departures from rational expectations imply that inflation upon exit can be orders of magnitude higher than under rational expectations. Our second contribution is to provide a framework for policy analysis in models without rational expectations.<br/>Thu, 08 Aug 2019 00:00:00 -0500{A8B6C14E-840C-4689-B88A-C80D3E05C96F}https://www.minneapolisfed.org/research/working-papers/the-seniority-structure-of-sovereign-debtWorking Paper 759: The Seniority Structure of Sovereign Debt (May 2019)Sovereign governments owe debt to many foreign creditors and can choose which creditors to favor when making payments. This paper documents the de facto seniority structure of sovereign debt using new data on defaults (missed payments or arrears) and creditor losses in debt restructuring (haircuts). We overturn conventional wisdom by showing that official bilateral (government-to-government) debt is junior, or at least not senior, to private sovereign debt such as bank loans and bonds. Private creditors are typically paid first and lose less than bilateral official creditors. We confirm that multilateral institutions like the IMF and World Bank are senior creditors.<br/>Thu, 30 May 2019 00:00:00 -0500{47848256-9FA3-402C-A606-3637513D9857}https://www.minneapolisfed.org/research/working-papers/self-fulfilling-debt-crises-with-long-stagnationsWorking Paper 757: Self-Fulfilling Debt Crises with Long Stagnations (April 2019)We explore quantitatively the possibility of multiple equilibria in a model of sovereign debt crises. The source of multiplicity is the one identified by Calvo (1988). This type of multiplicity has been at the heart of the policy debate through the recent European sovereign debt crisis. Key for multiplicity in the model is a stochastic process for output featuring long periods of either high or low growth. We calibrate the output process in the model using data for the southern European countries that were exposed to the debt crisis. We find that expectations-driven sovereign debt crises are empirically plausible, but only in periods of stagnation. Multiplicity is state dependent: in periods of stagnation and for intermediate levels of debt, interest rates may be high for reasons unrelated to fundamentals.<br/>Thu, 18 Apr 2019 00:00:00 -0500{3B04B8B2-D85D-4DE4-97A4-9326E8E9A7CB}https://www.minneapolisfed.org/research/working-papers/firm-and-worker-dynamics-in-an-aging-labor-marketWorking Paper 756: Firm and Worker Dynamics in an Aging Labor Market (April 2019)I develop an idea flows theory of firm and worker dynamics in order to assess the consequences of population aging. Older people are less likely to attempt entrepreneurship and switch employers because they have found better jobs. Consequently, aging reduces entry and worker mobility through a composition effect. In equilibrium, the lower entry rate implies fewer new, better job opportunities for workers, while the better matched labor market dissuades job creation and entry. Aging accounts for a large share of substantial declines in firm and worker dynamics since the 1980s, primarily due to equilibrium forces. Cross-state evidence supports these predictions.<br/>Wed, 10 Apr 2019 00:00:00 -0500